Globalization Institute No. 351

Identifying Global and National Output and Fiscal Policy Shocks Using a GVAR
Alexander Chudik, M. Hashem Pesaran and Kamiar Mohaddes
Abstract: The paper contributes to the growing Global VAR (GVAR) literature by showing how global and national shocks can be identified within a GVAR framework. The usefulness of the proposed approach is illustrated in an application to the analysis of the interactions between public debt and real output growth in a multi-country setting, and the results are compared to those obtained from standard single-country VAR analysis. We find that on average (across countries) global shocks explain about one-third of the long-horizon forecast error variance of output growth, and about one-fifth of the long-run variance of the rate of change of debt-to-GDP. Evidence on the degree of cross-sectional dependence in these variables and their innovations is exploited to identify the global shocks, and priors are used to identify the national shocks within a Bayesian framework. It is found that posterior median debt elasticity with respect to output is much larger when the rise in output is due to a fiscal policy shock, as compared to when the rise in output is due to a positive technology shock. The cross-country average of the median debt elasticity is 1.58 when the rise in output is due to a fiscal expansion as compared to 0.75 when the rise in output follows from a favorable output shock.

DOI: https://doi.org/10.24149/gwp351
Supplement DOI: https://doi.org/10.24149/gwp351supp


Argentina’s “Missing Capital” Puzzle and Limited Commitment Constraints
Marek Kapička, Finn E. Kydland and Carlos E. Zarazaga
Abstract: Capital accumulation in Argentina was slow in the 1990s, despite high total factor productivity (TFP) growth and low international interest rates. A possible explanation for the “missing capital” is that foreign investors were reluctant to take advantage of the high returns to investment seemingly offered by that small open economy under such favorable conditions, on the grounds that previous historical developments had led them to perceive Argentina as a country prone to external debt “opportunistic defaults.” The paper examines this conjecture from the perspective of an optimal contract between foreign lenders and a small open economy subject to limited commitment constraints. Numerical experiments for a deterministic version of that analytical framework show that limited commitment constraints introduce an asymmetry to the capital accumulation process of small open economies: the responses of investment to positive TFP shocks are muted and shortlived, while those to negative TFP shocks are large and persistent. Furthermore, under some circumstances, a lower international interest rate environment can magnify the asymmetry. A quantitative implementation of the model economy to data from Argentina accounts, in line with asymmetry just described, for the rapid decline that that country’s capital stock experienced, along with a falling TFP during the 1980s, as well as for the lack of any visible recovery of that stock during the significant surges of TFP observed between 1992-1998 and 2002-2008. In the absence of the limited commitment constraint, Argentina’s capital stock in 2008 would have been 50% higher than it actually was.

DOI: https://doi.org/10.24149/wp1815


Inflation and the Gig Economy: Have the Rise of Online Retailing and Self-Employment Disrupted the Phillips Curve?
John V. Duca
Abstract: During the recovery from the Great Recession, inflation did not reach the central bank’s 2 percent objective as quickly as many models had predicted. This coincided with increases in online shopping, which arguably made retail markets more contestable and damped retail inflation. This hypothesis is tested using data on the online share of retail sales, which are incorporated into an econometric model. Results imply that the rise of online retail has flattened the Phillips Curve, reducing the sensitivity of inflation to unemployment rate changes. Improvement in fit from just including the online share is tiny—so far. Other results indicate that market-based price indexes are more sensitive to unemployment than measures such as core PCE, which puts a sizable weight on items with imputed prices that may slowly adjust to market conditions. Further, measures of online sales that internalize substitution between online and traditional mail order sales better help track the impact of online sales on inflation dynamics.

A complementary factor is the “gig” economy and the rise of self-employment, which by reducing the bargaining power of labor, could lower the natural rate of unemployment. Model performance and fits are improved using a hybrid approach in which the rise of online sales can flatten the slope of the Phillips Curve by reducing retail pricing power and the prevalence of gig or self-employment can lower the natural rate of unemployment.

By omitting important structural changes in both goods and labor markets, conventional Phillips Curve models have failed to track how the rise of online retailing has flattened the Phillips Curve and how the rise of the gig economy (self-employment) has lowered the natural rate of unemployment. One notable difference between the price-price and wage-price results is that the combined effects of online shopping and self-employment are more notable on wage inflation than on price inflation. This could plausibly reflect that improvements in information technology may have undermined the pricing power of workers in labor markets to a greater degree than they have affected the pricing power of producers in goods markets.

DOI: https://doi.org/10.24149/wp1814

Globalization Institute No. 349

Mean Group Estimation in Presence of Weakly Cross-Correlated Estimators
Alexander Chudik and M. Hashem Pesaran
Abstract: This paper extends the mean group (MG) estimator for random coefficient panel data models by allowing the underlying individual estimators to be weakly cross-correlated. Weak cross-sectional dependence of the individual estimators can arise, for example, in panels with spatially correlated errors. We establish that the MG estimator is asymptotically correctly centered, and its asymptotic covariance matrix can be consistently estimated. The random coefficient specification allows for correct inference even when nothing is known about the weak cross-sectional dependence of the errors. This is in contrast to the well-known homogeneous case, where cross-sectional dependence of errors results in incorrect inference unless the nature of the cross-sectional error dependence is known and can be taken into account. Evidence on small sample performance of the MG estimators is provided using Monte Carlo experiments with both strictly and weakly exogenous regressors and cross-sectionally correlated innovations.

DOI: https://doi.org/10.24149/gwp349


Rationally Inattentive Consumer: An Experiment
Andrea Civelli, Cary Deck, Justin D. LeBlanc and Antonella Tutino
Abstract: This paper presents a laboratory experiment that directly tests the theoretical predictions of consumption choices under rational inattention. Subjects are asked to select consumption when income is random. They can optimally decide to reduce uncertainty about income by acquiring signals about it. The informativeness of the signals directly relates to the cognitive effort required to process the information. We find that subjects’ behavior is largely in line with the predictions of the theory: 1) Subjects optimally make stochastic consumption choices; 2) They respond to incentives and changes in the economic environment by varying their attention and consumption; 3) They respond asymmetrically to positive and negative shocks to income, with negative shocks triggering stronger and faster reactions than positive shocks.

DOI: https://doi.org/10.24149/wp1813

Globalization Institute No. 348

Modeling Time-Variation Over the Business Cycle (1960-2017): An International Perspective
Enrique Martínez-García
Abstract: In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (U.S., U.K., Germany, France, Italy, Spain, Japan, and Canada) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models (Granger et al. (1991), Granger (2008)). With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycles. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model—yet globalization’s contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.

DOI: https://doi.org/10.24149/gwp348


Global Trends in Interest Rates
Marco Del Negro, Domenico Giannone, Marc P. Giannoni and Andrea Tambalotti
Abstract: The trend in the world real interest rate for safe and liquid assets fluctuated close to 2 percent for more than a century, but has dropped significantly over the past three decades. This decline has been common among advanced economies, as trends in real interest rates across countries have converged over this period. It was driven by an increase in the convenience yield for safety and liquidity and by lower global economic growth.

DOI: https://doi.org/10.24149/wp1812

Globalization Institute No. 343

The Heterogeneous Effects of Global and National Business Cycles on Employment in U.S. States and Metropolitan Areas
Alexander Chudik, Janet Koech and Mark A. Wynne
Abstract: The growth of globalization in recent decades has increased the importance of external factors as drivers of the business cycle in many countries. Globalization affects countries not just at the macro level but at the level of states and metro areas as well. This paper isolates the relative importance of global, national and region-specific shocks as drivers of the business cycle in individual U.S. states and metro areas. We document significant heterogeneity in the sensitivity of states and metro areas to global shocks, and show that direct trade linkages are not the only channel through which the global business cycle impacts regional economies.

DOI: https://doi.org/10.24149/gwp343


A Closer Look at the Behavior of Uncertainty and Disagreement: Micro Evidence from the Euro Area
Robert Rich and Joseph Tracy
Abstract: This paper examines point and density forecasts of real GDP growth, inflation and unemployment from the European Central Bank’s Survey of Professional Forecasters. We present individual uncertainty measures and introduce individual point- and density-based measures of disagreement. The data indicate substantial heterogeneity and persistence in respondents’ uncertainty and disagreement, with uncertainty associated with prominent respondent effects and disagreement associated with prominent time effects. We also examine the co-movement between uncertainty and disagreement and find an economically insignificant relationship that is robust to changes in the volatility of the forecasting environment. This provides further evidence that disagreement is not a reliable proxy for uncertainty.

DOI: https://doi.org/10.24149/wp1811

Globalization Institute No. 342

Explosive Dynamics in House Prices? An Exploration of Financial Market Spillovers in Housing Markets Around the World (Revised September 2018)
Enrique Martínez-García and Valerie Grossman
Abstract: Asset prices in general, and real house prices in particular, are often characterized by a nonlinear data-generating process which displays mildly explosive behavior in some periods. Here, we investigate the emergence of explosiveness in the dynamics of real house prices and the role played by asset market spillovers. We establish a timeline of periodically-collapsing episodes of explosiveness for a panel of 23 countries from the Federal Reserve Bank of Dallas’ International House Price Database (Mack and Martínez-García (2011)) between first quarter 1975 and fourth quarter 2015 using the recursive unit root test methodology proposed by Phillips et al. (2015a,b). Motivated by the theory of financial arbitrage, we examine within a dynamic panel logit/probit framework whether macro fundamentals—and, more specifically, financial variables—help predict episodes of explosiveness in real house prices. We find that interest rate spreads and real stock market growth together with standard macro variables (growth in personal disposable income per capita and inflation) are amongst the best predictors. We, therefore, argue that financial developments in other asset markets play a significant role in the emergence of explosiveness in housing markets.
Original paper
DOI: https://doi.org/10.24149/gwp342r1


Labor Market Effects of Credit Constraints: Evidence from a Natural Experiment (Revised May 2019)
Anil Kumar and Che-Yuan Liang
Abstract: We exploit the 1998 and 2003 constitutional amendment in Texas—allowing home equity loans and lines of credit for non-housing purposes—as natural experiments to estimate the effect of easier credit access on the labor market. Using state-level as well as micro data and the synthetic control approach, we find that easier access to housing credit led to a notably lower labor force participation rate between 1998 and 2007. We show that our findings are remarkably robust to improved synthetic control methods based on insights from machine-learning. We explore treatment effect heterogeneity using grouped data from the basic monthly CPS and find that declines in the labor force participation rate were larger among females, prime age individuals and the college-educated. Our research shows that negative labor market effects of easier credit access should be an important factor when assessing its stimulative impact on overall growth.
Revision 1
Original paper
DOI: https://doi.org/10.24149/wp1810r2


Hispanics in the U.S. Labor Market: A Tale of Three Generations
Pia M. Orrenius and Madeline Zavodny
Abstract: Immigrants’ descendants typically assimilate toward mainstream social and economic outcomes across generations. Hispanics in the United States are a possible exception to this pattern. Although there is a growing literature on intergenerational progress, or lack thereof, in education and earnings among Hispanics, there is little research on employment differences across immigrant generations. Using data from 1996 to 2017, this study reveals considerable differences in Hispanics’ employment rates across immigrant generations. Hispanic immigrant men tend to have higher employment rates than non-Hispanic whites and second- and third-plus generation Hispanics. Hispanic immigrant women have much lower employment rates, but employment rates rise considerably in the second generation. Nonetheless, U.S.-born Hispanic women are less likely than non-Hispanic white women to work. The evidence thus suggests segmented assimilation, in which the descendants of Hispanic immigrants have worse outcomes across generations. While relatively low education levels do not appear to hamper Hispanic immigrants’ employment, they play a key role in explaining low levels of employment among Hispanic immigrants’ descendants. Race and selective ethnic attrition may also contribute to some of the patterns uncovered here.

DOI: https://doi.org/10.24149/wp1809


Valuation Risk Revalued (Revised May 2019)
Oliver de Groot, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: This paper shows the recent success of valuation risk (time-preference shocks in Epstein-Zin utility) in resolving asset pricing puzzles rests sensitively on an undesirable asymptote that occurs because the preference specification fails to satisfy a key restriction on the weights in the Epstein-Zin time-aggregator. When we revise the preferences to satisfy the restriction in a simple asset pricing model, the puzzles resurface. However, when estimating a sequence of Bansal-Yaron long-run risk models, we find valuation risk under the revised specification consistently improves the ability of the models to match asset price and cash-flow dynamics.
Original paper
DOI: https://doi.org/10.24149/wp1808r1


Texas Service Sector Outlook Survey: Survey Methodology and Performance
Jesus Cañas and Amy Jordan
Abstract: The Texas Service Sector Outlook Survey (TSSOS) and Texas Retail Outlook Survey (TROS) are monthly surveys of service sector and retail firms in Texas conducted by the Federal Reserve Bank of Dallas. TSSOS and TROS track the Texas private services sector, including general service businesses, retailers and wholesalers. The surveys provide invaluable information on regional economic conditions—information that Dallas Fed economists and the Bank president use in the formulation of monetary policy. This paper describes the survey’s methodology and analyzes the explanatory and predictive power of TSSOS and TROS indexes with regard to Texas employment growth. Regression analysis shows that several TSSOS and TROS indexes help explain monthly variation in Texas employment. In addition, most TSSOS and TROS indexes are also useful in forecasting Texas employment growth.

DOI: https://doi.org/10.24149/wp1807


The Impact of the Dodd-Frank Act on Small Business
Michael D. Bordo and John V. Duca
Abstract: There are concerns that the Dodd-Frank Act (DFA) has impeded small-business lending. By increasing the fixed regulatory compliance requirements needed to make business loans and operate a bank, the DFA disproportionately reduced the incentives for all banks to make very modest loans and reduced the viability of small banks, whose small-business share of commercial and industrial (C&I) loans is generally much higher than that of larger banks. Despite an economic recovery, the small-loan share of C&I loans at large banks and banks with $300 or more million in assets has fallen 9 percentage points since the DFA was passed in 2010, with the magnitude of the decline twice as large at small banks. Controlling for cyclical effects and bank size, we find that these declines in the small-loan share of C&I loans are almost all statistically attributed to the change in regulatory regime. Examining Federal Reserve survey data, we find evidence that the DFA prompted a relative tightening of bank credit standards on C&I loans to small versus large firms, consistent with the DFA inducing a decline in small-business lending through loan supply effects. We also empirically model the pace of business formation, finding that it had downshifted around the time when the DFA and the Sarbanes-Oxley Act were announced. Timing patterns suggest that business formation has more recently ticked higher, coinciding with efforts to provide regulatory relief to smaller banks via modifying rules implementing the DFA. The upturn contrasts with the impact of the Sarbanes-Oxley Act, which appears to persistently restrain business formation.

DOI: https://doi.org/10.24149/wp1806


The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States: Reply to Jentsch and Lunsford (Revised February 2019)
Karel Mertens and Morten O. Ravn
Abstract: In this reply to a comment by Jentsch and Lunsford, we show that, when focusing on the relevant impulse responses, the evidence for economic and statistically significant macroeconomic effects of tax changes in Mertens and Ravn (2013) remains present for a range of asymptotically valid inference methods.
Original paper
DOI: https://doi.org/10.24149/wp1805r1


The Zero Lower Bound and Estimation Accuracy (Revised February 2019)
Tyler Atkinson, Alexander W. Richter and Nathaniel A. Throckmorton
Abstract: During the Great Recession, many central banks lowered their policy rate to its zero lower bound (ZLB), creating a kink in the policy rule and calling into question linear estimation methods. There are two promising alternatives: estimate a fully nonlinear model that accounts for precautionary savings effects of the ZLB or a piecewise linear model that is much faster but ignores the precautionary savings effects. Repeated estimation with artificial datasets reveals some advantages of the nonlinear model, but they are not large enough to justify the longer estimation time, regardless of the ZLB duration in the data. Misspecification of the estimated models has a much larger impact on accuracy. It biases the parameter estimates and creates significant differences between the predictions of the models and the data generating process.
Original paper
DOI: https://doi.org/10.24149/wp1804r1


The Near Term Growth Impact of the Tax Cuts and Jobs Act
Karel Mertens
Abstract: This note uses existing empirical estimates of the macroeconomic effects of tax changes to project the near term impact of the Tax Cuts and Jobs Act on US GDP growth. Applying recent reduced form estimates of tax multipliers with the projected revenue impact of the Act yields a level of GDP that is predicted to be 1.3% higher by 2020, with most of the growth front-loaded in 2018. Accounting for the composition of the Act in terms of its individual and corporate provisions leads to a similar GDP increase by 2020, but with stronger growth in 2018 and a partial reversal in the following years. Accounting for the impact of TCJA on marginal individual tax rates raises the projected growth impact considerably, while accounting for the distribution of the tax changes across income groups suggests a more delayed positive impact on GDP. These projections are conditional on mean-reverting dynamics of future taxes that are estimated from postwar US data.

DOI: https://doi.org/10.24149/wp1803

Globalization Institute No. 338

New Perspectives on Forecasting Inflation in Emerging Market Economies: An Empirical Assessment
Roberto Duncan and Enrique Martínez-García
Abstract: We use a broad-range set of inflation models and pseudo out-of-sample forecasts to assess their predictive ability among 14 emerging market economies (EMEs) at different horizons (1 to 12 quarters ahead) with quarterly data over the period 1980Q1-2016Q4. We find, in general, that a simple arithmetic average of the current and three previous observations (the RW-AO model) consistently outperforms its standard competitors - based on the root mean squared prediction error (RMSPE) and on the accuracy in predicting the direction of change. These include conventional models based on domestic factors, existing open-economy Phillips curve-based specifications, factor-augmented models, and time-varying parameter models. Often, the RMSPE and directional accuracy gains of the RW-AO model are shown to be statistically significant. Our results are robust to forecast combinations, intercept corrections, alternative transformations of the target variable, different lag structures, and additional tests of (conditional) predictability. We argue that the RW-AO model is successful among EMEs because it is a straightforward method to downweight later data, which is a useful strategy when there are unknown structural breaks and model misspecification.

DOI: https://doi.org/10.24149/gwp338


OPEC in the News
Michael Plante
Abstract: This paper introduces a newspaper article count index related to OPEC that rises in response to important OPEC meetings and events connected with OPEC production levels. I use this index to measure how interest in OPEC varies over time and investigate how oil price volatility behaves when the index unexpectedly changes. I find that unexpected increases in the newspaper index are strongly associated with higher levels of oil price volatility, both realized and implied. In some cases, interest levels and price volatility appear to be driven by the OPEC event itself, such as the Iraq invasion of Kuwait. In other cases, such as the oil price collapses in late 2008 and late 2014, price volatility and interest levels in an OPEC event appear to be responding endogenously to developments in the oil market or broader economy. The newspaper index is highly correlated with Google search volume data on OPEC, an alternative measure of the amount of attention paid to OPEC events.

DOI: https://doi.org/10.24149/wp1802


The Death of the Phillips Curve?
Anthony Murphy
Abstract: Are inflation dynamics well captured by Phillips Curve models, or has this framework become less relevant over time? The evidence for the U.S. suggests that the slopes of the price and wage Phillips Curves– the short-run inflation-unemployment trade-offs – are low and have got a little flatter. For example, the recursive estimate of the unemployment coefficient in the core PCE Phillips Curve has fallen a little from -0.09 to -0.07 since the Great Recession. However, the decline is not statistically significant. Dynamic forecasts from the wage and price Phillips Curves estimated using data ending in 2007q4, almost 10 years ago, are pretty close to inflation today. This suggests that (i) low current inflation is not that surprising, and (ii) factors such as increased globalization, increased e-commerce activity, changes in concentration, the aging of the U.S. population and mismeasurement of the NAIRU are not that important (or offset each other). The Phillips Curve is still a useful, albeit imprecise, framework for understanding inflation.

DOI: https://doi.org/10.24149/wp1801

Globalization Institute No. 333

Structural Change and Global Trade (Revised October 2018)
Logan T. Lewis, Ryan Monarch, Michael Sposi and Jing Zhang
Abstract: Services, which are less traded than goods, rose from 58 percent of world expenditure in 1970 to 79 percent in 2015. In a trade model featuring nonhomothetic preferences and input-output linkages, we find that such structural change has restrained the growth in world trade to GDP by 16 percentage points over this period. This magnitude is similar to how much declining trade costs have boosted openness. Moreover, structural change dampens the measured gains from trade by incorporating endogenous responses of expenditure shares to the trade regime. Ongoing structural change implies declining openness, even absent rising protectionism.
Revision 1
Original paper
DOI: https://doi.org/10.24149/gwp333r2