REVISION: Best Prices
Date Posted: Apr 04, 2013
We explore the role of strategic price-discrimination by retailers for price determination and inflation dynamics. We model two types of customers, “loyals" who buy only one brand and do not strategically time purchases, and “shoppers" who seek out low-priced products both across brands and across time. Shoppers always pay the lowest price available, the “best price”. Retailers in this setting optimally choose long periods of constant regular prices punctuated by frequent temporary sales
REVISION: The Macroprudential Toolkit
Date Posted: Apr 04, 2013
Most treatments of financial regulation worry about threats to the banking system and the economy from defaults or credit crunches. This paper argues that the recent crisis points to fire sales through capital markets as another source of financial and economic instability. Accounting for fire sales implies several changes to the standard approach. First, if there are three channels of instability, then three regulatory tools are needed to deliver stability. Second, if only a single capital tool
REVISION: The Optimal Conduct of Monetary Policy with Interest on Reserves
Date Posted: Apr 04, 2013
In a world with interest on reserves, the central bank has two distinct tools that it can use to raise the short-term policy rate: it can either increase the interest it pays on reserve balances, or it can reduce the quantity of reserves in the system. We argue that by using both of these tools together, and by broadening the scope of reserve requirements, the central bank can simultaneously pursue two objectives: i) it can manage the inflation-output tradeoff using a Taylor-type rule; and ii) i
REVISION: Stressed Out: Macroprudential Principles for Stress Testing
Date Posted: Apr 04, 2013
Since the conference version of this report in February 2011, bank stress tests have been almost continuously in the news. In the United States, the Dodd-Frank Act mandates annual stress tests for key institutions. In early 2011, the Federal Reserve conducted the first test under the Act on major banks, and is currently conducting the second test, the results of which will be announced in early 2012. Europe completed a stress test in July 2011 that ignored many principles of this report. Like th
REVISION: Financial Regulation in General Equilibrium
Date Posted: Apr 04, 2013
This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a “shadow banking system” that each help households finance their expenditures. Households sometimes choose to default on their loans, and when they do this triggers forced selling by the shadow banks. Because the forced selling comes when n
New: Aligning Incentives at Systemically Important Financial Institutions
Date Posted: Mar 28, 2013
UBS recently announced it would pay part of the bonuses of 6,500 highly compensated employees with bonds that would be forfeited if the bank does not meet its capital requirements. This memo underscores the benefits of contingent deferred compensation and makes recommendations for how such compensation should be structured at systemically important institutions. We also revise our proposal for contingent convertible bonds, explaining how these hybrid bonds can be combined with better designs for
New: Who Should Pay for Credit Ratings and How?
Date Posted: Mar 27, 2013
This paper analyzes a model where investors use a credit rating to decide whether to finance a firm. The rating quality depends on the unobservable effort exerted by a credit rating agency (CRA). We analyze optimal compensation schemes for the CRA that differ depending on whether a social planner, the firm, or investors order the rating. We find that rating errors are larger when the firm orders it than when investors do. However, investors ask for ratings inefficiently often. Which arrangement
New: Financial Regulation in General Equilibrium
Date Posted: Apr 05, 2012
This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a “shadow banking system” that each help households finance their expenditures. Households sometimes choose to default on their loans, and when they do this triggers forced selling by the shadow banks. Because the forced selling comes when net w
Update: Reforming Money Market Funds
Date Posted: Feb 20, 2012
The current stable-NAV model for prime money market funds exposes fund investors and systemically important borrowers to runs like those that occurred after the failure of Lehman in September 2008. This working paper, by the Squam Lake Group, argues that, to reduce this risk, funds should have either floating NAVs or buffers provided by their sponsors that can absorb losses up to a level to be set by regulators. We suggest alternative designs for such a buffer, as well as considerations that s
New PDF Uploaded
New: Modeling and Measuring Systemic Risk
Date Posted: Aug 12, 2011
An important challenge worthy of NSF support is to quantify systemic financial risk. There are at least three major components to this challenge: modeling, measurement, and data accessibility. Progress on this challenge will require extending existing research in many directions and will require collaboration between economists, statisticians, decision theorists, sociologists, psychologists, and neuroscientists.
New: A Macroprudential Approach to Financial Regulation
Date Posted: Nov 14, 2010
Many observers have argued the regulatory framework in place prior to the global financial crisis was deficient because it was largely “microprudential” in nature (Crockett, 2000; Borio, Furfine, and Lowe, 2001; Borio, 2003; Kashyap and Stein, 2004; Kashyap, Rajan, and Stein, 2008; Brunnermeier et al., 2009; Bank of England, 2009; French et al., 2010). A microprudential approach is one in which regulation is partial-equilibrium in its conception, and aimed at preventing the costly failure of ind
New: Will the U.S. Bank Recapitalization Succeed? Eight Lessons from Japan
Date Posted: Sep 24, 2009
During the financial crisis that started in 2007, the U.S. government has used a variety of tools to try to rehabilitate the U.S. banking industry. Many of those strategies were used also in Japan to combat its banking problems in the 1990s. There are also a surprising number of other similarities between the current U.S. crisis and the recent Japanese crisis. The Japanese policies were only partially successful in recapitalizing the banks until the economy finally started to recover in 2003. Fr
REVISION: Will the U.S. Bank Recapitalization Succeed? Eight Lessons from Japan
Date Posted: Aug 26, 2009
During the financial crisis that started in 2007, the U.S. government has used a variety of tools to try to rehabilitate the U.S. banking industry. Many of those strategies were used also in Japan to combat its banking problems in the 1990s. There are also a surprising number of other similarities between the current U.S. crisis and the recent Japanese crisis. The Japanese policies were only partially successful in recapitalizing the banks until the economy finally started to recover in 2003. Fr
New: A New Metric for Banking Integration in Europe
Date Posted: Feb 21, 2009
Most observers have concluded that while money markets and government bond markets are rapidly integrating following the introduction of the common currency in the euro area, there is little evidence that a similar integration process is taking place for retail banking. Data on cross-border retail bank flows, cross-border bank mergers and the law of one price reveal no evidence of integration in retail banking. This paper shows that the previous tests of bank integration are weak in that they
New: Investment Spikes: New Facts and a General Equilibrium Exploration
Date Posted: Aug 08, 2008
Using plant-level data from Chile and the U.S. we show that investment spikes are highly pro-cyclical, so much so that changes in the number of establishments undergoing investment spikes (the "extensive margin") account for the bulk of variation in aggregate investment. The number of establishments undergoing investment spikes also has independent predictive power for aggregate investment, even controlling for past investment and sales. We re-calibrate the Thomas (2002) model (that includes fix
New: The Contradiction in China's Gradualist Banking Reforms
Date Posted: Aug 05, 2008
China's state-owned banks historically have funded money losing enterprises to maintain employment and social stability. We survey the banking industry in China, focusing on the largest banks which are being reformed to increase their competitiveness following China's 2001 WTO commitment to open the domestic banking market by 2007. We assemble macroeconomic, microeconomic and anecdotal evidence suggesting that government influence, while less explicit than in the past, is continuing despite the
The Japanese Banking Crisis: Where Did It Come From and How Will It End?
Date Posted: Apr 17, 2008
We argue that the deregulation leading up to the Big Bang has played a major role in the current banking problems. This deregulation allowed large corporations to quickly switch from depending on banks to relying on capital market financing. We present evidence showing that large Japanese borrowers, particularly manufacturing firms, have already become almost as independent of banks as comparable U.S. firms. The deregulation was much less favorable for savers and consequently they mostly continu
The Choice Between Public and Private Debt: An Analysis of Post-Deregulation Corporate Financing in ...
Date Posted: Apr 16, 2008
As a result of deregulation, there was a dramatic shift during the 1980s in Japan away from bank debt financing towards public debt financing: in 1975, more than 90% of the corporate debt of public companies was bank debt; in 1992 it was less than 50%. This paper presents a theory of the choice between bank debt and public debt and then examines the theory using firm-level data on borrowing sources in Japan. We find that high net worth companies are more prone to use public debt. We also fin
Internal Finance and Firm Investment
Date Posted: Apr 14, 2008
We examine the neoclassical investment model using a panel of U.S. manufacturing firms. The standard model with no financing constraints cannot be rejected for firms with high (pre-sample) dividend payouts. However, it is decisively rejected for firms with low (pre-sample) payouts (firms we expect to face financing constraints). Here, investment is sensitive to both firm cash flow and macroeconomic credit conditions, holding constant investment opportunities. Sample splits based on firm size
New: The Role of Banks in Reducing the Costs of Financial Distress in Japan
Date Posted: Jan 07, 2008
No abstract is available for this paper.
New: Investment Spikes: New Facts and a General Equilibrium Exploration
Date Posted: Jul 09, 2007
Using plant-level data from Chile and the U.S. we show that investment spikes are highly pro-cyclical, so much so that changes in the number of establishments undergoing investment spikes (the "extensive margin") account for the bulk of variation in aggregate investment. The number of establishments undergoing investment spikes also has independent predictive power for aggregate investment, even controlling for past investment and sales. We re-calibrate the Thomas (2002) model (that includes fix
New: Monetary Policy and Credit Conditions: Evidence From the Composition of External Finance
Date Posted: Jul 03, 2007
No abstract is available for this paper.
New: Internal Net Worth and the Investment Process: An Application to U.S. Agriculture
Date Posted: Jul 02, 2007
No abstract is available for this paper.
New: Monetary Policy and Credit Conditions: Evidence from the Composition of External Finance
Date Posted: Apr 17, 2007
In this paper we use the relative movements in bank loans and commercial paper to provide evidence on the existence of a loan supply channel of monetary policy transmission. A first necessary condition for monetary policy to work through a lending channel is that banks must view loans and securities as imperfect substitutes, so that monetary tightening does affect the availability of bank loans. We find that tighter monetary policy leads to a shift in firms' mix of external financing -- commerci
New: Credit Conditions and the Cyclical Behavior of Inventories: A Case Studyof the 1981-82 Recession
Date Posted: Jan 24, 2007
No abstract is available for this paper.
New: Stability First: Reflections Inspired by Otmar Issing's Success as the ECB's Chief Economist
Date Posted: Jun 08, 2006
In this paper, we review Otmar Issing's career as the ECB's inaugural chief economist and we document many notable successes. We try to infer some general principles that contributed to these successes and draw some lessons. In doing so, we review the evidence using Woodford's (2003) recent revival of the Wicksellian approach to monetary policy making. Suitably interpreted the baseline model can rationalize Issing's three guiding principles for successful policymaking. This baseline model, howev
New: Zombie Lending and Depressed Restructuring in Japan
Date Posted: May 16, 2006
In this paper, we propose a bank-based explanation for the decade-long Japanese slowdown following the asset price collapse in the early 1990s. We start with the well known observation that most large Japanese banks were only able to comply with capital standards because regulators were lax in their inspections. To facilitate this forbearance the banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (that we call zombies). Thus, the normal comp
New: Zombie Lending and Depressed Restructuring in Japan
Date Posted: Mar 10, 2006
In this paper, we propose a bank-based explanation for the decade-long Japanese slowdown following the asset price collapse in the early 1990s. We start with the well known observation that most large Japanese banks were only able to comply with capital standards because regulators were lax in their inspections. To facilitate this forbearance the banks often engaged in sham loan restructurings that kept credit flowing to otherwise insolvent borrowers (that we call zombies). Thus, the normal comp
Monetary Transmission in the Euro Area: Where Do We Stand?
Date Posted: Aug 03, 2005
Drawing on recent Eurosystem research that uses a range of econometric techniques and a number of new data sets, we propose a comprehensive description of how monetary policy affects the euro area economy. We focus mainly on three questions: (1) what are the stylised facts concerning the transmission of monetary policy for the area as a whole and for individual countries? (2) can the "classic" interest rate channel (IRC) alone, without capital market imperfections, explain these facts? (3) if no
Solutions to Japan's Banking Problems: What Might Work and What Definitely Will Fail
Date Posted: Jan 28, 2005
We study the longstanding banking problems in Japan. By examining both the past policies in Japan that have failed, and the successful policies in other high income OECD countries that have overcome banking crises, we develop a roadmap for resolving the problems.
We distill the problems into four basic troubles. The first is that most of the banks are severely under-capitalized when their condition is properly evaluated. The second is that the banks are not currently allocating credit
Monetary Policy and Bank Lending
Date Posted: Jun 19, 2004
This paper surveys recent work that relates to the "lending" view of monetary policy transmission. It has three main goals: 1) to explain why it is important to distinguish between the lending and "money" views of policy transmission; 2) to outline the microeconomic conditions that are needed to generate a lending channel; and 3) to review the empirical evidence that bears on the lending view.
The Output Composition Puzzle: A Difference in the Monetary Transmission Mechanism in the Euro Area ...
Date Posted: Mar 16, 2004
We revisit recent evidence on how monetary policy affects output and prices in the U.S. and in the euro area. The response patterns to a shift in monetary policy are similar in most respects, but differ noticeably as to the composition of output changes. In the euro area investment is the predominant driver of output changes, while in the U.S. consumption shifts are significantly more important. We dub this difference the output composition puzzle and explore its implications and several potenti
Banks as Liquidity Providers: An Explanation for the Coexistence of Lending and Deposit-Taking
Date Posted: Nov 15, 2003
What ties together the traditional commercial banking activities of deposit-taking and lending? We argue that since banks often lend via commitments, their lending and deposit-taking may be two manifestations of one primitive function: the provision of liquidity on demand. There will be synergies between the two activities to the extent that both require banks to hold large balances of liquid assets: If deposit withdrawals and commitment takedowns are imperfectly correlated, the two activities c
Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking
Date Posted: Nov 15, 2003
This paper addresses the following question: what ties together the traditional commercial banking activities of deposit-taking and lending? We begin by observing that since banks often lend via commitments, or credit lines, their lending and deposit-taking may be two manifestations of the same primitive function: the provision of liquidity on demand. After all, once the decision to extend a line of credit has been made, it is really nothing more than a checking account with overdraft privileges
The Output Composition Puzzle: A Difference in the Monetary Transmission Mechanism in the Euro Area ...
Date Posted: Sep 21, 2003
We revisit recent evidence on how monetary policy affects output and prices in the U.S. and in the euro area. The response patterns to a shift in monetary policy are similar in most respects, but differ noticeably as to the composition of output changes. In the euro area investment is the predominant driver of output changes, while in the U.S. consumption shifts are significantly more important. We dub this difference the output composition puzzle and explore its implications and several potenti
Monetary Transmission in the Euro Area: Does the Interest Rate Channel Explain it All?
Date Posted: Sep 21, 2003
Drawing on recent Eurosystem research that uses a range of econometric techniques and a number of new data sets, we propose a comprehensive description of how monetary policy affects the euro area economy. We focus mainly on three questions: (1) what are the stylized facts concerning the transmission of monetary policy for the area as a whole and for individual countries? (2) can the 'classic' interest rate channel (IRC) alone, without capital market imperfections, explain these facts? (3) if no
Sorting Out Japan's Financial Crisis
Date Posted: Dec 14, 2002
This paper makes three contributions. First, I report information on the size of the Japanese financial crisis. Drawing principally on work by Fukao (2003) and Doi and Hoshi (2003) I estimate that the current taxpayer liability for losses incurred but yet to be recognized is likely to be at least 24% of GDP. Second, I explain why it has been so difficult to end the crisis. Third, I sketch the likely ingredients of what will be required to successfully resolve the crisis. The overarching principl
Why Don't Prices Rise During Periods of Peak Demand? Evidence from Scanner Data
Date Posted: Oct 02, 2002
We examine retail and wholesale prices for a large supermarket chain over seven and one-half years. We find that prices fall on average during seasonal demand peaks for a product, largely due to changes in retail margins. Retail margins for specific goods fall during peak demand periods for that good, even if these periods do not coincide with aggregate demand peaks for the retailer. This is consistent with "loss leader" models of retailer competition. Models stressing cyclical demand elasti
Bank Monitoring and Investment: Evidence from the Changing Structure of Japanese Corporate Banking R...
Date Posted: Jan 05, 2002
During this decade the structure of corporate finance in Japan has changed dramatically. Japanese firms that once used bank debt as their prime source of financing now rely more heavily on the public capital markets. This trend was facilitated by the substantial deregulation of the Japanese capital markets. In an earlier paper (Moshi, Kashyap, and Scharfstein 1988). we demonstrated that investment by firms with close bank relationships appears to be less liquidity constrained than investment by
The Japanese Banking Crisis: Where Did It Come From and How Will it End?
Date Posted: Nov 11, 2001
We argue that the deregulation leading up to the Big Bang has played a major role in the current banking problems. This deregulation allowed large corporations to quickly switch from depending on banks to relying on capital market financing. We present evidence showing that large Japanese borrowers, particularly manufacturing firms, have already become almost as independent of banks as comparable U.S. firms. The deregulation was much less favorable for savers and consequently they mostly continu
Why Don't Prices Rise During Periods of Peak Demand? Evidence from Scanner Data
Date Posted: Oct 05, 2001
We examine the retail prices and wholesale prices of a large supermarket chain in Chicago over seven and one-half years. We show that prices tend to fall during the seasonal demand peak for a product and that changes in retail margins account for most of those price changes; thus we add to the growing body of evidence that markups are counter-cyclical. The pattern of margin changes that we observe is consistent with "loss leader" models such as the Lal and Matutes (1994) model of retailer pricin
The Impact of Monetary Policy on Bank Balance Sheets
Date Posted: Jun 28, 2001
This paper uses disaggregated data on bank balance sheets to provide a test of the lending view of monetary policy transmission. We argue that if the lending view is correct, one should expect the loan and security portfolios of large and small banks to respond differentially to a contraction in monetary policy. We first develop this point with a theoretical model; we then test to see if the model's predictions are borne out in the data.
Interest Rate Spreads, Credit Constraints, and Investment Fluctuations: An Empirical Investigation
Date Posted: Jan 14, 2001
We present a simple framework that incorporates a role for "interest rate spreads" in models of investment fluctuations. Formally, we develop a simple model of investment and financial contracting under asymmetric information that can be used to generate an Euler equation describing firms' intertemporal decisions about investment. The Euler equation is then estimated using data on U.S. producers' durable equipment investment. We find that during certain periods -- owing to agency-cost problems
International Cycles
Date Posted: Sep 15, 2000
We study twenty years of monthly production data for 11 manufacturing industries in 19 countries. Using the fact that in some countries production virtually shuts down for one summer month, together with the differences in the timing of aggregate cyclical fluctuations, we are able to learn about the cost structure of different industries. Our primary finding is that during a boom year summer shut-downs are shorter. Rather than increasing production further during the rest of the year, produce
Banks as Liquidity Providers: An Explanation for the Co-Existence of Lending and Deposit-Taking
Date Posted: Sep 15, 2000
This paper addresses the following question: what ties together the traditional commercial banking activities of deposit-taking and lending? We begin by observing that since banks often lend via commitments, or credit lines, their lending and deposit-taking may be two manifestations of the same primitive function: the provision of liquidity on demand. After all, once the decision to extend a line of credit has been made, it is really nothing more than a checking account with overdraft privileg
Do Firms Smooth the Seasonal in Production in a Boom? Theory and Evidence
Date Posted: Aug 11, 2000
Using disaggregated production data we show that the size of seasonal cycles changes significantly over the course of the business cycle. In particular, during periods of high economy-wide activity, some industries smooth seasonal fluctuations while others exaggerate them. We interpret this finding using a simple analytical model that describes the conditions under which seasonal and cyclical fluctuations can be separated. Our model implies that seasonal fluctuations can safely be disentangle
What Do a Million Banks Have to Say About the Transmission of Monetary Policy?
Date Posted: Jun 10, 2000
In an effort to shed new light on the monetary transmission mechanism, we create a panel data set that includes quarterly observations of every insured commercial bank in the United States over the period 1976-1993. Our key cross-sectional finding is that the impact of monetary policy on lending behavior is significantly more pronounced for banks with less liquid balance sheets -- i.e., banks with lower ratios of cash and securities to assets. Moreover, this result is entirely attributable to
The Japanese Banking Crisis: Where Did it Come From and How Will it End?
Date Posted: Aug 25, 1999
We argue that the deregulation leading up to the Big Bang has played a major role in the current banking problems. This deregulation allowed large corporations to quickly switch from depending on banks to relying on capital market financing. We present evidence showing that large Japanese borrowers, particularly manufacturing firms, have already become almost as independent of banks as comparable U.S. firms. The deregulation was much less favorable for savers and consequently they mostly con
Interactions Between the Seasonal and Business Cycles in Production and Inventories
Date Posted: Jul 27, 1998
This paper shows that in several U.S. manufacturing industries, the seasonal variability of production and inventories varies with the state of the business cycle. We present a simple model which implies that if firms reduce the seasonal variability of their production as the economy strengthens, and they either hold constant or increase the stock of inventories they bring into the high-production seasons of the year, then they must be facing upward-sloping and convex marginal cost curves. We co