The Federal Reserve Bank of Kansas City's Research staff produces a series of working papers presenting results of the department's economic research. These technical papers cover a wide range of economic research topics.

1997

Moving Endpoints and the Internal Consistency Of Agents' Ex Ante Forecasts
By Sharon Kozicki and P.A. Tinsley (RWP 97-01 April 1997)
Forecasts by rational agents contain embedded initial and terminal boundary conditions. Standard time series models generate two types of long-run "endpoints"--fixed endpoints and moving average endpoints. Neither can explain the shifting endpoints implied by postwar movements in the cross-section of forward rate forecasts in the term structure or by post-1979 changes in survey estimates of expected inflation. Multiperiod forecasts by a broader class of "moving endpoint" time series models provide substantially improved tracking of the historical term structure and generally support the internal consistency of the ex ante long-run expectations of bond traders and survey respondents.

Keywords: Boundary values, expected inflation, term structure.

Asymmetric Persistence in GDP? A Deeper Look at Depth
By Gregory D. Hess and Shigeru Iwata (RWP 97-02 May 1997)
If economic time series behave asymmetrically, then an interpretation of economic fluctuations based on linear time series models could be misleading. Beaudry and Koop (1993) recently argued that for post war U.S. GDP data there exists a statistically significant difference in persistence between negative and positive shocks. Their finding, if true, would be quite interesting since it would bring a new perspective to the literature on business cycle, which has been dominated by two conflicting views: the trend-reverting view of Blanchard (1981) and the permanent view of Campbell and Mankiw (1987). The purpose of this paper is to reexamine the evidence of asymmetric persistence of GDP by analyzing the statistical properties of BK's test. In particular, we show there are two pitfalls for this test: First, the t-statistic for testing asymmetry in persistence does not have a conventional interpretation. Second, a highly significant t-value may come from sources different from asymmetry. Using international data, we also explore the robustness of the BK result across the G-7 countries and find that the evidence is quite varied. Moreover, there appears to be no simple explanation for why countries display similar types of asymmetric behavior.

JEL Classification System: 131, 212
Keywords: business cycle asymmetries, non-standard distributions, random walk

The Effects of Open Market Operations in a Model of Intermediation and Growth Only
By Stacey L. Schreft and Bruce D. Smith (RWP 97-03 May 1997)
This article presents a monetary growth model in which spatial separation and limited communication create a role for banks. Monetary policy interacts with the financial system's liquidity provision to affect the existence, multiplicity, and dynamical properties of equilibria. Moderate levels of risk aversion and tight monetary policy can lead to multiple steady rates. Dynamical equilibria can be indeterminate, with oscillatory paths. Thus financial market frictions are a source of indeterminacies and endogenous volatility. Under plausible conditions, tight monetary policy raises the nominal interest rate and inflation rate and reduces long-run output. Thus, a central bank's liquidity provision can promote growth.

Monetary Actions, Intervention, and Exchange Rates: A Re-examination of the Empirical Relationships Using Federal Funds Rate Target Data
By Catherine Bonser-Neal, V. Vance Roley and Gordon H. Sellon, Jr. (RWP 97-04 July 1997)
In this paper, we re-examine the results of recent empirical studies on the relationships among Federal Reserve monetary-policy actions, U.S. interventions in currency markets, and exchange rates. Our approach differs from those used in other recent studies in several respects. First, we use changes in the Federal Reserve's federal funds rate target as our measure of monetary-policy actions. Second, we use an event-study methodology to estimate exchange-rate responses to monetary policy actions. Finally, we estimate relations using federal funds rate target changes only in periods in which the Federal Reserve used the federal funds rate to implement monetary policy. Our results suggest that the immediate responses of exchange rates to U.S. monetary policy actions are statistically and economically significant in a majority of cases. This result differs from those reported recently using VAR methodologies. Moreover, when we combine our spot and forward exchange-rate responses, we are not able to reject the overshooting hypothesis in seven of eight instances. In contrast, recent VAR studies estimate exchange-rate response patterns inconsistent with overshooting. We also re-examine the interaction between U.S. interventions and Federal Reserve monetary-policy actions. In this case, we obtain results consistent with recent studies. In particular, we cannot reject either the policy-signaling or the leaning-against-the-wind hypotheses of intervention effects. Finally, we find that our estimates of exchange-rate responses to federal funds rate target changes are virtually unaffected when we control for central-bank interventions.

 

The Effect of Monetary Policy Actions on Exchange Rates Under Interest-Rate Targeting
By Catherine Bonser-Neal, V. Vance Roley and Gordon H. Sellon, Jr. (RWP 97-05 July 1997)
One puzzling feature of recent empirical studies of the effects of monetary policy changes on exchange rates is the result that the exchange rate does not adjust immediately to the policy shock. Instead, these studies find that it can take as long as two years for the exchange rate to fully reflect the policy change. In this paper, we specify a model of the exchange-rate response to U.S. monetary policy actions which captures these results. Our model also is capable of generating standard overshooting results. We show that the response pattern of spot and expected future exchange rates depends on the predictability of Federal Reserve actions, the persistence of shocks to the economy, and the reaction of foreign central banks to the U.S. monetary policy shock.

 

Breathing Room for Beta
By Sharon Kozicki and Pu Shen (RWP 97-06 July 1997) This paper argues that a test of beta insignificance, commonly used in empirical studies of the CAPM, predisposes studies toward rejecting the CAPM. Under the null hypothesis of these tests, the CAPM is false. Consequently, insufficient evidence to reject the null is taken as sufficient evidence to reject the CAPM. Simulations suggest that this framework typically leads to false rejection rates of more than 1/2. An alternative test, with a null hypothesis consistent with the CAPM, is proposed. Based on statistics from published studies, the proposed test doesn't reject the CAPM.

Keywords: Capital Asset Pricing Model

Risk Sharing by Households Within and Across Regions and Industries
By Gregory D. Hess and Kwanho Shin (RWP 97-07 October 1997)
Cochrane (1991) and Mace (1991) test if risk sharing across households is complete in the sense that household consumption moves one-for-one with aggregate consumption. In their studies the source of income risk is idiosyncratic, and agents can share risk across the entire economy. Using a sample of households from the Panel Study on Income Dynamics (PSID), we explore whether individuals diversify the risk associated within their industries and regions, as well as across industries and regions. We find that there is stronger evidence of within region and industry risk sharing than across region and industry risk sharing. In neither case, however, is the risk sharing complete.

JEL Classification System: E21
Keywords: Risk Sharing, Quantity Anomaly

Shifting Endpoints in the Term Structure of Interest Rates
By Sharon Kozicki and P.A. Tinsley (RWP 97-08 December 1997)
This paper links the term structure to perceptions of monetary policy. Long-horizon forecasts of short rates needed in empirical term structure models are heavily influenced by the endpoints, or limiting conditional forecasts, of the short rate process. Mean-reversion or unit roots are commonly assumed, but do not provide realistic yield predictions. Failures occur because neither accounts for historical shifts in market perceptions of the policy target for inflation. This paper links endpoint shifts to a learning model where agents must detect shifts in long-term policy goals. With shifting-endpoint short rate processes, models better explain yield fluctuations.

Keywords: Expectations Hypothesis, changepoints, breakpoints, learning.

Do Producer Prices Help Predict Consumer Prices?
By Todd E. Clark (RWP 97-09 December 1997)
This paper reexamines whether producer prices help  predict consumer prices, focusing on model stability and the forecasting performance of time-varying parameter models. In bivariate models, producer price inflation consistently Granger-causes consumer price inflation in-sample but fails to improve out-of-sample forecasts of consumer price inflation. The tests of Nyblom (1989), Andrews (1993), and Andrews and Ploberger (1994) indicate instability pervades the bivariate models. Allowing for a simple form of instability, however, fails to improve the predictive power of producer prices. Even in models using the stochastic coefficients formulation developed by Cooley and Prescott (1973(a), 1973(b), 1976), among others, producer prices do not help to forecast consumer prices.

JEL Nos.: E31, E37, C53

Inverse Productivity: Land Quality, Labor Markets, and Risk
By Russell L. Lamb (RWP 97-10 December 1997)
I test three explanations of the inverse productivity relationship using the ICRISAT data. I reject land quality differences as a cause of the inverse relationship between profits per hectare and farm size. I find that both labor-market imperfections and risk aversion may play a role in explaining the inverse productivity relationship. Smaller farmers use more labor per-hectare than larger farmers, although the relationship is ameliorated somewhat by considering land-quality effects. Risk aversion may cause smaller farmers to over-apply labor to production, but it also fails to fully explain the inverse relationship.

Using Near-VARs to Examine Phase-Dependent Monetary and Fiscal Policy
By Andrew J. Filardo (RWP 97-11 December 1997)
Economic policies are known to have different effects on the economy depending on the size of policy changes and on business cycle conditions. For example, monetary policy might be more stimulative in recessions and around turning points in the business cycle than during expansions. Such dependencies, however, are usually ignored in most empirical research or are placed under the rubric of "long and variable lags." Accounting for phase-dependent policies holds out the possibility not only of better forecasting performance with our macroeconomic models and of more accurate methods to identify policy effects, but also of broadening our view of how to understand business cycles. The phases are estimated using threshold autoregressive (TAR) methods suggested by Hansen (1996).

This paper extends the policy framework of Christiano, Eichenbaum, and Evans (1994), and empirically estimates phase-dependent behavior using a variant of a popular empirical business cycle model. Commonly referred to as the near-VAR (NVAR), this model helps to estimate dynamic interrelationships and to conserve degrees of freedom when dealing with short data samples. Despite the rather simple empirical measures of the business cycle phases, these near-VARs provide a better understanding of the relationship between cyclical phases and monetary and fiscal policies.

JEL Classification: E5, E3, C3

Inflation and Relative Price Variability: Durables vs. Nondurables and Services
By John E. Golob and David G. Bishop (RWP 97-12 December 1997)
Many researchers find a positive relationship between inflation and the variability of relative prices within aggregate price indices. This paper looks at the relationship between inflation and the variability of relative prices for three categories of the consumption deflator: durable goods, nondurable goods, and services. Consistent with previous research on relative price variability within aggregate consumption, we find inflation is positively correlated with relative price variability within both nondurables and services. In contrast, we find a negative correlation between inflation and relative price variability within durables. Monte Carlo simulations verify the statistical significance of the results. The results are consistent with a sticky-price model of relative price variability.