Working papers from the Federal Reserve Bank of Dallas are preliminary drafts circulated for professional comment.

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2004 Working Papers

0406
The Impact of Paying Interest on Reserves in the Presence of Government Deficit Financing
Mark G. Guzman
Abstract: This paper re-examines the impact that paying interest on reserves has on price level indeterminacy, price level volatility, and overall economic well-being. Unlike previous papers which examined these issues, the model developed in this paper allows the return on reserves to equal the return on government securities, which is less than the prevailing return on storage. Equally important, this model also considers how deficit financing changes the impact that paying interest on reserves has on the economy. I show that the number of steady state equilibria are equal to, or greater than, the number that arise when no interest is paid on reserves. In other words, the level of economic indeterminacy is equal to or greater than in an economy without interest payments. When the level of indeterminacy is the same, then economic volatility is reduced with the introduction of interest payments. However, when there exists greater indeterminacy in the interest-on-reserves economy, then there also exists greater volatility. In addition, under certain conditions, paying interest on reserves can be welfare enhancing. When it is not, an appropriate expansionary open market operation can offset the welfare losses associated with interest payments. Finally, under a narrow set of conditions, unpleasant monetarist arithmetic may obtain.

0405
Optimal Monetary Policy in Economies with "Sticky-Information" Wages
Evan F. Koenig
Abstract: In economies with sticky-information wage setting, policymakers legitimately give attention to output stabilization as well as price-level or inflation stabilization. Consistent with Kydland and Prescott (1990), trend deviations in prices are predicted to be negatively correlated with trend deviations in output. A variant of the Taylor rule is optimal if household consumption decisions are forward-looking. Interestingly, it is essential that policy not be made contingent on the most up-to-date estimates of potential output, potential-output growth, or the natural real interest rate. New results on the "persistence problem" and a new rationalization for McCallum's P-bar inflation equation are also presented.

0404
The Impact of E-Business Technologies on Supply Chain Operations: A Macroeconomic Perspective
Amit Basu and Thomas F. Siems
Abstract: New information technologies and e-business solutions have transformed supply chain operations from mass production to mass customization. This paper assesses the impact of these innovations on economic productivity, focusing on the macroeconomic benefits as supply chain operations have evolved from simple production and planning systems to today's real-time performance-management information systems using advanced e-business technologies. While many factors can influence macroeconomic variables, the impact of IT-enabled supply chains should not be overlooked. We find evidence that the impact of e-business technologies on supply chain operations have resulted in a reduced "bullwhip effect," lower inventory, reduced logistics costs, and streamlined procurement processes. These improvements, in turn, have likely helped to lower inflation, reduce economic volatility, strengthen productivity growth, and improve standards of living.

0403
Why Have U.S. Households Increasingly Relied on Mutual Funds to Own Equity?
John V. Duca
Abstract: Since the early 1990s, U.S. households have increasingly used mutual funds to own equity assets. Results indicate that this owes to two developments over the period 1970–2002 that are broadly consistent with the implications of Heaton and Lucas' (2000) model of equity participation. In that model, lower asset transfer costs and lower income risk can induce equity investing by less wealthy households, who—in practice and owing to diversification considerations—are more apt to indirectly hold stocks through mutual funds. The first factor is a pronounced decline in equity mutual fund loads, which are highly negatively correlated with the overall stock ownership rate, which has doubled owing to a rising percentage of households that own stocks only through mutual funds. The second is a general improvement since the 1970s in household expectations about future family financial conditions that may have induced households at the margin to become shareholders.

0402
Accounting for Fluctuations in Social Network Usage and Migration Dynamics
Mark G. Guzman, Joseph H. Haslag and Pia M. Orrenius
Abstract: In this paper, we examine network capital usage and migration patterns in a theoretical model. Networks are modeled as impacting the migration decision in many ways. When young, larger networks reduce the time lost moving from one region to another. In addition networks decrease the time spent searching for a job. Finally, when old, migrants receive transfer payments through the network. We show that the number and properties of steady state equilibria as well as the global dynamics depend crucially on whether the returns to network capital accumulation exhibit constant, increasing, or decreasing returns to scales relative to the level of network capital. With constant returns to scale, migration flows and network capital levels are characterized by either a unique steady state equilibria or by a two-period cycle. The fluctuations in network capital usage exhibited by our model are consistent with recent empirical data regarding the usage of networks by Mexican immigrants. In the case of increasing returns to scale, either there exists a unique, stable steady state equilibria or multiple equilibria which are characterized as either sinks or saddles. When the returns to scale are decreasing, there exists a unique, stable steady state equilibrium. Finally, we show that increasing barriers to migration will result in an increase in the flow of immigrants, contrary to the desired effect, in the constant and increasing returns to scale cases.

0401
A New Monthly Index of the Texas Business Cycle
Keith R. Phillips
Abstract: The timing, length and severity of economic recessions and expansions in a state are important to businesses seeking to set up operations or expand in those areas. Given a limited amount of data at the state level and their sometimes inconsistent movements, it is not straight forward to define a state business cycle. In this article I attempt to measure the Texas business cycle using a technique developed by Stock and Watson (1989,1991) that statistically estimates the underlying comovement in broad indicators of the state’s economy.

The new Texas Coincident Index (TCI) is constructed with the Texas unemployment rate, a quarterly Real Gross State Product measure due to Berger and Phillips (1995), and a nonfarm employment series that is benchmarked quarterly and is seasonally adjusted using the two-step approach described in Berger and Phillips (1993). Use of these components and the Kalman filter, which smoothes across variables as well as over time, results in an index which is much smoother and gives clearer signals of turning points than the old TCI produced by Phillips (1988). The new TCI exhibits cyclical patterns that are highly correlated with those of employment and RGSP, and matches well with recessions and expansions that were independently identified.

2004 Center for Latina American Economics Working Papers

0504
Argentina's Capital Gap Puzzle
Finn E. Kydland and Carlos E. J. M. Zarazaga

0404
The Implications of Capital-Skill Complementarity in Economies with Large Informal Sectors
Pedro Amaral and Erwan Quintin
Abstract: In most developing nations, formal workers tend to be more experienced, more educated, and earn more than informal workers. These facts are often interpreted as evidence that low-skill workers face barriers to entry into the formal sector. Yet, there exists little direct evidence that such barriers are important. This paper describes a model where significant differences arise between formal and informal workers even though labor markets are perfectly competitive. In equilibrium, the informal sector emphasizes low-skill work because informal managers have access to less outside financing, and choose to substitute low-skill labor for physical capital.

0304
Why Do Financial Systems Differ? History Matters
Cyril Monnet and Erwan Quintin
Abstract: We describe a dynamic model of financial intermediation in which fundamental characteristics of the economy imply a unique equilibrium path of bank and financial market lending. Yet we also show that economies whose fundamental characteristics have converged may continue to have very different financial structures. Because setting up financial markets is costly in our model, economies that emphasize financial market lending are more likely to continue doing so in the future, all else equal.

0204
Currency Competition and Inflation Convergence
William C. Gruben and Darryl McLeod
Abstract: All agree partial dollarization or currency substitution is a legacy of past inflation and exchange rate instability. Some argue partial dollarization contributes to exchange rate instability. However, if Central Banks respond to dollarization by lowering money growth and maximizing seigniorage revenue, inflation falls and converges on dollar inflation rates. We present a simple model of currency competition with open capital markets to illustrate these points. Empirical tests for Latin America and about twenty other countries suggest that dollarization is both a legacy of past inflation and a constraint on future inflation. Dollarization may complicate monetary policy and prudential regulation, but one silver lining is that currency competition appears to have accelerated the sharp fall in and convergence of Latin inflation rates over the past decade.

0104
Making Finance Matter
Pedro S. Amaral and Erwan Quintin
Abstract: We present a model in which the importance of financial intermediation for development can be measured. We generate financial differences by varying the degree to which contracts can be enforced. Economies where enforcement is poor employ less capital and less efficient technologies. Yet, accounting for all the observed dispersion output requires a higher capital share or a lower elasticity of substitution between capital and labor than usually assumed. We find that the effects of changes in those technological parameters on output are markedly larger when financial frictions are present. Finance, that is, matters.