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.


Slow Information Diffusion and the Inertial Behavior of Durable Consumption

By Yulei Luo, Jun Nie, and Eric R. Young (RWP 12-11, March 2013; Revised March 2014)
This paper studies the aggregate dynamics of durable and nondurable consumption under sticky information diffusion (SID) due to noisy observations and slow learning within the permanent income framework. We show that SID can significantly improve the model's predictions on the joint behavior of income, durable, and nondurable consumption at the aggregate level. Specifically, we find that SID can help generate (i) realistic smoothness in durable and nondurable consumption, (ii) the autocorrelation of durable consumption, and (iii) the contemporaneous correlation between durable and nondurable consumption. Furthermore, we show that incorporating a fixed cost into our SID model does a better job of reproducing the infrequent adjustments of durable consumption at the individual level and the slow adjustments at the aggregate level.

Drifting Inflation Targets and Stagflation

By Edward S. Knotek II and Shujaat Khan (RWP 12-10, November 2012)
This paper revisits the phenomenon of stagflation. Using a standard New Keynesian dynamic, stochastic general equilibrium model, we show that stagflation from monetary policy alone is a very common occurrence when the economy is subject to both deviations from the policy rule and a drifting inflation target. Once the inflation target is fixed, the incidence of stagflation in the baseline model is essentially eliminated. In contrast with several other recent papers that have focused on the connection between monetary policy and stagflation, we show that while high uncertainty about monetary policy actions can be conducive to the occurrence of stagflation, imperfect information more generally is not a requisite channel to generate stagflation.

Trend Inflation and Equilibrium Stability: Firm-Specific versus Homogeneous Labor

By Takushi Kurozumi and Willem Van Zandweghe (RWP 12-09, December 2012; Revised August 2015)
In sticky price models based on micro evidence that each period a fraction of prices is kept unchanged, recent studies reach the qualitatively same conclusion that higher trend inflation is a more serious source of indeterminacy of rational expectations equilibrium, regardless of whether labor is firm-specific or homogeneous. This paper shows that the model with firm-specific labor is more susceptible to indeterminacy induced by high trend inflation than the model with homogeneous labor, because these two different specifications of labor lead to distinct representations of inflation dynamics. In addition, the model with firm-specific labor is more susceptible to expectational instability of the equilibrium caused by high trend inflation.

Job Duration, Wages, and the Cleansing and Sullying Effects of Recessions

By Jose Mustre-del-Rio (RWP 12-08, November 2012; Revised September 2014)
Models of on-the-job search imply that recessions both cleanse and sully the labor market by hastening the termination of low quality matches and stifling the formation of better matches. This paper evaluates these predictions using data from the National Longitudinal Survey of Youth (NLSY) under the hypothesis that match duration reflects quality. The results provide no systematic evidence of the cleansing effect, but do support the sullying effect. This suggests that match quality is procyclical. As predicted by theory, this procyclicality is driven by the decline in quality of matches found through job-to-job transitions during recessions.

Labor Market Dynamics with Endogenous Labor Force Participation and On-the-Job Search

By Didem Tuzemen (RWP 12-07, October 2012)
Studies that incorporate endogenous labor force participation, and search and matching frictions in a real business cycle model find that this three-state model generates counterfactual results: labor force participation is very volatile, unemployment is acyclical and highly positively correlated with vacancies. Based on the evidence that job-to-job flows are large in the U.S. labor market, this paper enriches the three-state model with an on-the-job search mechanism which leads to job-to-job flows. The modified model successfully generates countercyclical unemployment and the Beveridge Curve relationship. Quantitatively, business cycle statistics reproduced by the modified model are more in line with their empirical counterparts.

Financial Frictions and Occupational Mobility

By William B. Hawkins and Jose Mustre-del-Rio (RWP 12-06, October 2012)
We study the effects of financial market incompleteness on occupational mobility. Incomplete insurance not only generates an increase in consumption volatility, but also reduces occupational mobility. The correlation of labor supply with occupational productivity is lower than under complete markets. Low-asset workers remain in low-productivity occupations even when the expected value of switching is positive. Negative occupational productivity shocks therefore have larger effects on such workers' future earnings than they would for better insured workers. In a calibrated model, we find that the welfare costs of market incompleteness can be as large as 12 percent of lifetime consumption

Student Loans: Overview and Issues (Update)

By Kelly Edmiston, Lara Brooks, and Steven Shepelwich (RWP 12-05, August 2012; Revised April 2013)
This paper provides a detailed overview of the student loan market, presents new statistics that highlight student loan debt burdens and delinquency rates, and discusses current concerns among many Americans about student loans, including their fiscal impact. The report is intended to enhance awareness of the state of student loan debt and delinquency and highlight issues facing borrowers, creditors, the federal government, and society at large. The clear message is that student loans present problems for some borrowers that are well worth addressing. At the same time, the analysis suggests that student loans do not yet impose a significant burden on society from their fiscal impact.

The State Space Representation and Estimation of a Time-Varying Parameter VAR with Stochastic...

By Taeyoung Doh and Michael Connolly (RWP 12-04, July 2012)
To capture the evolving relationship between multiple economic variables, time variation in either coefficients or volatility is often incorporated into vector autoregressions (VARs). The state space representation that links the transition of possibly unobserved state variables with observed variables is a useful tool to estimate VARs with time-varying coefficients or stochastic volatility. In this paper, we discuss how to estimate VARs with time-varying coefficients or stochastic volatility using the state space representation. We focus on Bayesian estimation methods which have become popular in the literature. As an illustration of the estimation methodology, we estimate a time-varying parameter VAR with stochastic volatility with the three U.S. macroeconomic variables including inflation, unemployment, and the long-term interest rate. Our empirical analysis suggests that the recession of 2007-2009 was driven by a particularly bad shock to the unemployment rate which increased its trend and volatility substantially. In contrast, the impacts of the recession on the trend and volatility of nominal variables such as the core PCE inflation rate and the ten-year Treasury bond yield are less noticeable.

Effects of Credit Scores on Consumer Payment Choice

By Fumiko Hayashi and Joanna Stavins (RWP 12-03, February 2012)
This paper investigates the effects of credit scores on consumer payment behavior, especially on debit and credit card use. Anecdotally, a negative relationship between debit card use and credit score has been reported; however, it is not clear whether that relationship is related to other factors, such as education or income, or whether it is a mere correlation. We use a new consumer survey dataset to examine whether this negative relationship holds after controlling for various consumer characteristics, including demographic and financial characteristics, consumers' perceptions toward payment methods, and card reward status. The results based on a single-year survey as well as on panel data suggest that there is a significant negative relationship between debit card use and credit score even after controlling for various characteristics. We supplement the analysis with evidence from Equifax data. The results indicate that an increase in consumers' cost of debit cards—in response to regulatory changes, for example—would have an adverse effect on low-credit-score consumers (typically those with lower incomes and less education).

We then investigate what credit score implies. If credit score significantly influences consumer access to credit cards, credit limits, or the cost of credit cards, then the negative relationship likely results from supply-side constraints. If a lower credit score is associated with differences in underlying preferences, then the negative relationship is likely due to demand-side effects. Preliminary evidence strongly suggests that supply-side factors play an important role in the cost of credit and in access to credit.

Model Uncertainty, State Uncertainty, and State-space Models

By Yulei Luo, Jun Nie and Eric R. Young (RWP 12-02, January 2012; Revised February 2012)
State-space models have been increasingly used to study macroeconomic and financial problems. A state space representation consists of two equations, a measurement equation which links the observed variables to unobserved state variables and a transition equation describing the dynamics of the state variables. In this paper, we show that a classic linear-quadratic macroeconomic framework which incorporates two new assumptions can be analytically solved and explicitly mapped to a state-space representation. The two assumptions we consider are the model uncertainty due to concerns for model misspecification (robustness) and the state uncertainty due to limited information constraints (rational inattention). We show that the state-space representation of the observable and unobservable can be used to quantify the key parameters on the degree of model uncertainty. We provide examples on how this framework can be used to study a range of interesting questions in macroeconomics and international economics.

Model Uncertainty and Intertemporal Tax Smoothing

By Yulei Luo, Jun Nie and Eric R. Young (RWP 12-01, January 2012; Revised June 2014)
In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and the evolution of debt in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt under RB. Furthermore, we show that introducing RB improves the model’s predictions by generating (i) the observed relative volatility of the changes in tax rates to government spending, (ii) the observed comovement between government deficits and spending, and (iii) more consistent behavior of government budget deficits in the US economy.