Cyclically-Adjusted Measures of Structural Trend Breaks: An Application to Productivity Trends in the 1990s
By Andrew J. Filardo and Paul N. Cooper
RWP 96-14, December 1996

This paper compares several linear trend break models of labor productivity. One empirical problem that arises when estimating trends in macroeconomic data is the influence of cyclical behavior on tests of trend breaks. Using various methods to correct for cyclical influences, this paper finds that a simple linear trend model with a small number of breaks aptly characterizes aggregate productivity. Moreover, this paper confirms previous research that has found that the aggregate productivity trend has not steepened in the 1990s. Econometrically, this paper shows the benefits of using nonparametric bootstrap methods. In particular, a phase-dependent moving block bootstrap method appears well suited to generate small-sample critical values to test for trend breaks in macroeconomic time-series.

Do Stock Prices Follow Interest Rates or Inflation?
By John E. Golob and David G. Bishop
RWP 96-13, December 1996

Market analysts often forecast changes in stock prices by comparing earnings-price ratios on stocks to nominal interest rates. This paper shows that stock prices have followed inflation more closely than interest rates over the last thirty years. This result has implications for recent stock valuations, because the spread between nominal interest rates and inflation has recently been above historic averages. That is, stock prices appear more overvalued when the earnings-price ratio is compared to nominal interest rates than when the earnings-price ratio is compared to inflation. Our result also helps explain the behavior of stock prices during the 1970s.

The Responses of Prices at Different Stages of Production to Monetary Policy Shocks
By Todd E. Clark
RWP 96-12, December 1996

This paper examines the responses of prices at different stages of production to an explicitly identified demand shock: a monetary policy shock. The frameworks of Christiano, Eichenbaum, and Evans (1994, 1996) and Sims and Zha (1995b) are used to identify the policy shock as the innovation to the federal funds rate in a VAR. The adjustment of prices at different stages of production is examined by adding three different sets of prices to the basic VAR model: (a) the PPIs for crude materials, intermediate goods, and finished goods; (b) the newer industry-based PPIs of input and output prices for crude, primary, semifinished, finished, and final goods processors; and (c) the input and output price indexes for manufacturing industries constructed by Roberts, Stockton, and Struckmeyer (1994). The analysis shows that, at earlier stages of production, a monetary tightening causes input prices to fall more rapidly and by a larger amount than output prices. This finding would appear to be consistent with a model in which all price changes are subject to menu costs but some chain structure in production gives rise to prices at earlier stages of production moving more than prices at later stages.

Transaction Costs in an Emerging Market: The Case of Indonesia
By Catherine Bonser-Neal, David Linnan, and Robert Neal
RWP 96-11, December 1996

Despite the dramatic increase in the flow of funds to emerging stock markets, relatively little is known about the cost of transacting on these markets. This paper estimates the execution costs of trading on a representative emerging market stock exchange, the Jakarta Stock Exchange (JSX). We find that execution costs are affected by the difficulty of the trade, the size of the firm traded, and the broker executing the trade. Surprisingly, we find that execution costs on the JSX are only modestly higher than average execution costs in several non-U.S. developed stock markets. In addition, we find that trades initiated by foreigners have a much larger impact on the price than trades initiated by local investors. Since the impact is not reversed following the trade, this raises the possibility that foreign trades may signal future investment flows.

Do Measures of Investor Sentiment Predict Returns?
By Robert Neal and Simon M. Wheatley
RWP 96-10, December 1996

It has long been market folklore that the best time to buy stocks is when individual investors are bearish. We examine the forecast power of three popular measures of individual investor sentiment: the level of discounts on closed-end funds, the ratio of odd-lot sales to purchases, and net mutual fund redemptions. Using data from 1933 to 1993, we find evidence that fund discounts and net redemptions predict the size premiums, the difference between small and large firm returns, but little evidence that the odd-lot ratio predicts returns.

Does Financial Market Development Stimulate Savings? Evidence From Emerging Stock Markets
By Catherine Bonser-Neal and Kathryn L. Dewenter
RWP 96-09, December 1996

This paper examines the empirical relation between financial market development, as measured by the stock market, and gross private savings rates in 16 emerging markets over 1982-1993. With data from all 16 countries, there is evidence of a significant positive relation between savings and stock market size and liquidity. When countries with outlying values for the stock market measures are excluded, however, all significance disappears. The results suggest that we should not assume that a growing or deepening stock market will necessarily be associated with higher savings rates.

JEL Classification: E21, O16
Keywords: savings, emerging markets, financial market development

The Response of the Term Structure of Interest Rates to Federal Funds Rate Target Changes
By V. Vance Roley and Gordon H. Sellon, Jr.
RWP 96-08, December 1996

In this paper, we first specify a theoretical model of the term structure's response to federal funds rate target changes. The model considers not only the immediate response to target changes, but also the response in anticipation of a policy change. The model is then estimated over the 1974-79 and 1987-95 periods, and the model's restrictions cannot be rejected. The results suggest that policy changes have become more predictable since 1987, causing more of the target change to be reflected in market yields before the policy action is taken. The results also suggest that the economic shocks the Federal Reserve chooses to offset are very persistent, if not permanent.

Monetary Policy Shocks and Price Stickiness: An Analysis of Price and Output Responses to Policy in Manufacturing Industries
By Joseph H. Haimowitz
RWP 96-07, December 1996

This paper uses annual data on 450 SIC four-digit manufacturing industries obtained from the NBER Manufacturing Productivity Database to examine how manufacturing industries respond to unanticipated changes in the federal funds rate. The analysis proceeds in three stages. First, industry price and output responses to unanticipated changes in the federal funds rate are examined. Second, the effect of industry characteristics on these responses is analyzed. Finally, the paper assesses whether particular industry characteristics are associated with price rigidity or interest rate sensitivity. The results in this paper support the following conclusions. Durable good industries exhibit larger price and output responses to federal funds rate shocks than nondurable good industries. This suggests that durable good industries are more sensitive to interest rate shocks than nondurable good industries and is consistent with the observation that durable good industries are more cyclical than nondurable good industries. High concentration industries are found to exhibit smaller price responses and larger output responses to unanticipated changes in the federal funds rate than low concentration industries. Thus, price rigidity may be an important determinant of how high concentration industries respond to federal fund rate shocks. Industries with high inventory-to-sales ratios are associated with smaller price and output responses to interest rate shocks than industries with low inventory-to-sales ratios. This suggests that industries whose output is storable are able to smooth price and output responses to demand shocks through inventory adjustment.

JEL Classification: E52, E32, E31, L10
Keywords: policy sensitivity, price rigidity, market structure, durable goods, inventories

Financial Innovations, Money Demand, and Disaggregation: Some Time Series Evidence
By Robert S. Chirinko and Dorsey D. Farr
RWP 96-06, October 1996

This paper explores the instability in estimated money demand functions. Using a new data series on credit card usage, we evaluate the role of financial innovations in stabilizing the M1 demand function over three troubling episodes. We find that our measure of financial innovations improves the short-term predictive ability of the M1 demand function, but does not generate stable long-run elasticities. Structural instability remains even after accounting for seasonal adjustment, the turbulence in the second and third quarters of 1980, and an alternative transactions measure. Financial innovations are likely to have differential effects on the components of M1, and we estimate separate models for currency, demand deposits, other checkable deposits, and total deposits. Our financial innovations series continues to improve short-run predictions, and the currency demand equation is much more stable than the M1 equation. Lastly, we analyze the sluggish adjustment of money holdings as a source of structural instability. We argue that theory fails to identify the adjustment parameter, and establish that minor variations in this parameter lead to minor variations in the likelihood function but major variations in long-run elasticities. We conclude that financial innovations are a useful element in forecasting short-run money demand, but are not the primary cause of money demand instability, which stems from deeper problems with the basic specification. Modeling and estimating the components of M1 (and perhaps M2) appear promising directions for future research.

JEL Classification: E41

Banking Relationships in Germany: Empirical Results and Policy Implications
By Robert S. Chirinko and Julie Ann Elston
RWP 96-05, October 1996

Expanding the range of activities by banks and other financial intermediaries has attracted much attention in the 1990s. Proponents of universal banking point to the benefits of German system of finance. Germany is the prototypical economy where universal banks, which offer a wide-range of financial services, allegedly exert substantial influence over firms and generate beneficial effects for the economy-wide allocation of credit. Arguments for replacing the specialized banking system currently in place in the United States with a universal banking system rely on a favorable evaluation of the German financial system. An empirical evaluation of banking relationships in Germany, however, has been hindered by a lack of data. This study reports an initial set of results based on a rich dataset containing balance sheet and income statement variables supplemented by measures of ownership concentration and bank influence.

Finance Constraints, Liquidity, and Investment Spending: Theoretical Evidence and International Evidence
By Robert S. Chirinko
RWP 96-04, October 1996

Theoretical and empirical models of investment spending have treated financial structure very differently. Recent research has begun to narrow this gap and, based on developments in the economics of information, has drawn theoretical links between investment spending and the frictions and constraints in financial markets. Furthermore, the sensitivity of investment to liquidity and other financial variables has been documented empirically for several industrialized countries. Despite this progress, the theoretical advances have not been exploited fully in econometric work, and questions remain concerning the interpretation of empirical results. To continue to narrow the gap between theoretical and empirical investment models, this paper studies finance constraints in a formal framework, explores their impact on the specification of Q investment equations, and develops two new tests of finance constraints that are evaluated for firms in several countries. While these tests provide some support for the importance of finance constraints, they temper previous conclusions and highlight the critical role for explicit theoretical models in guiding empirical research.

JEL Classification: E22, E44
Keywords: finance constraints, financial structure, liquidity, investment spending

Finite-Sample Properties of Tests for Forecast Equivalence
By Todd E. Clark
RWP 96-03, October 1996

This paper uses Monte Carlo experiments to examine the small-sample properties of some commonly used tests of equal forecast accuracy. The study pays particular attention to test power, evaluated using both asymptotic and empirical critical values. In addition to evaluating different tests, this paper evaluates the performance of different methods of determining the bandwidth used in computing autocorrelation-consistent test statistics. The simulation results show that tests of equal forecast accuracy have somewhat inflated size and modest or even low power. Moreover, the performances of the different tests and the bandwidth selection criteria are broadly similar.

JEL Classification: C53, C12, C52
Keywords: forecast evaluation, Granger causality, size, power

Politics and Exchange Rate Forecasts
By S. Brock Blomberg and Gregory D. Hess
RWP 96-02, October 1996

Standard exchange rate models perform poorly in out-of-sample forecasting when compared to the random walk model. We posit part of the poor performance of these models may be due to omission of political factors. We test this hypothesis by including political variables that capture party-specific, election-specific and candidate-specific characteristics. Surprisingly, we find our political model outperforms the random walk in out-of-sample forecasting at one to twelve month horizons for the pound/dollar, mark/dollar, pound/mark and the trade-weighted dollar, mark, and pound exchange rates.

JEL Classification: F31, G12, H8
Keywords: political economy, exchange rates, asset prices

Multivariate Detrending Under Common Trend Restrictions: Implications for Business Cycle Research
By Sharon Kozicki
RWP 96-01, July 1996

This paper outlines a methodology to detrend multiple time series under common trend restrictions. The same filters used to construct the estimated trend in univariate exercises are shown to be appropriate in multivariate studies with a single common trend. However, to estimate the common trend in the multivariate case, the filter is applied to a linear combination of series rather than to each series individually. An empirical example and simulation exercises illustrate the implications of common trend detrending for measurement of business cycle properties.

JEL Classification: E32, C32
Keywords: Hodrick-Prescott filter, business cycle measurement, common trend