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

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2009 Working Papers

0906
Credit Market Shocks: Evidence From Corporate Spreads and Defaults
Roland Meeks
Abstract: Several recent papers have found that exogenous shocks to spreads paid in corporate credit markets are a substantial source of macroeconomic fluctuations. An alternative explanation of the data is that spreads respond endogenously to expectations of future default. We use a simple model of bond spreads to derive sign restrictions on the impulse-response functions of a VAR that identify credit shocks in the bond market, and compare them to results from a benchmark recursive VAR. We find that credit market shocks cause a persistent decline in output, prices and policy rates. Historical decompositions clearly show the negative effect of adverse credit market shocks on output in the recent recession. The identified credit shocks are unrelated to exogenous innovations to monetary policy and measures of bond market liquidity, but are related to measures of risk compensation. In contrast to results found using the benchmark restrictions, our identified credit shocks account for relatively little of the variance of output. Our results are consistent with a role for shocks in financial crises, but also with a lesser but non-zero role in normal business fluctuations.

0905
Measuring Oil-Price Shocks Using Market-Based Information
Tao Wu and Michele Cavallo
Abstract: We study the effects of oil-price shocks on the U.S economy combining narrative and quantitative approaches. After examining daily oil-related events since 1984, we classify them into various event types. We then develop measures of exogenous shocks that avoid endogeneity and predictability concerns. Estimation results indicate that oil-price shocks have had substantial and statistically signicant effects during the last 25 years. In contrast, traditional VAR approaches imply much weaker and insignificant effects for the same period. This discrepancy stems from the inability of VARs to separate exogenous oil-supply shocks from endogenous oil-price fluctuations driven by changes in oil demand.

0904
Preventing a Repeat of the Money Market Meltdown of the Early 1930s
John V. Duca
Abstract: This paper analyzes the meltdown of the commercial paper market during the Great Depression, and relates those findings to the recent financial crisis. Theoretical models of financial frictions and information problems imply that lenders will make fewer noncollateralized loans or investments and relatively more extensions of collateralized finance in times of high risk premiums. This study investigates the relevance of such theories to the Great Depression by analyzing whether the increased use of a collateralized form of business lending (bankers acceptances) relative to that of non-collateralized commercial paper can be econometrically attributable to measures of corporate credit/financial risk premiums. Because commercial paper and bankers acceptances are short-lived, they are more timely measures of the availability of short-term credit than are bank or business failures and the level or growth rate of the stock of bank loans, whose maturities were often longer and were renegotiable. In this way, the study adds to the literature on financial market frictions during the Great Depression, which aside from analyzing securities prices, typically investigates the behavior of credit-related variables that lag current conditions, such as bank failures, bankruptcies, the stock of money, or outstanding bank loans.

In particular, the real level of bankers acceptances and their use relative to noncollateralized commercial paper were strongly and positively related to spreads between corporate and treasury bond yields. Also significant were short-run events, such as the October 1929 stock market crash and the 1933 bank holiday episode that sparked flights to quality in the bond market and a flight to collateral (BAs) in the money market and perhaps away from the loan market. Furthermore, these shifts in the composition of external finance were large, supporting the view that financial frictions and reduced credit availability may have played an important role in depressing the U.S. economy during the 1930s.

The paper also relates these findings to the current financial crisis by examining how the relative use of commercial paper reacted to yield spreads during the current crisis, taking into account Federal Reserve actions to improve liquidity conditions in the money markets. Results suggest that these efforts may have, at least so far, helped prevent the commercial paper market from melting down to the extent seen during the early 1930s.

0903
How Robust Are Popular Models of Nominal Frictions?
Benjamin D. Keen and Evan F. Koenig
Abstract: This paper analyzes three popular models of nominal price and wage frictions to determine which best fits post-war U.S. data. We construct a dynamic stochastic general equilibrium (DSGE) model and use maximum likelihood to estimate each model's parameters. Because previous research finds that the conduct of monetary policy and the behavior of inflation changed in the early 1980s, we examine two distinct sample periods. Using a Bayesian, pseudo-odds measure as a means for comparison, a sticky price and wage model with dynamic indexation best fits the data in the early-sample period, whereas either a sticky price and wage model with static indexation or a sticky information model best fits the data in the late-sample period. Our results suggest that price- and wage-setting behavior may be sensitive to changes in the monetary policy regime. If true, the evaluation of alternative monetary policy rules may be even more complicated than previously believed.

0902
Improving the ACCRA U.S. Regional Cost of Living Index
Keith R. Phillips and Christina Daly
Abstract: The broadest and most commonly used measure of the cost of living across U.S. cities is the American Chamber of Commerce Research Association (ACCRA) index. This index is used by business and government organizations and the media to to rank living standards and real wages across U.S. cities. In this study we reduce the aggregation bias in the index by calculating national average prices for the 59 item prices using population weights instead of the equal weight formula used by ACCRA. This correction results in a decline in the index values for all cities and changes in the rankings and bi-variate comparisons between city pairs. In some high-cost cities the index values decrease by over 25 percent, and in 74 percent of the cities the rank changes by greater than one spot.

0901
Do Immigrants Work in Riskier Jobs?
Pia M. Orrenius and Madeline Zavodny
Abstract: Recent media and government reports suggest that immigrants are more likely to hold jobs with worse working conditions than U.S.-born workers, perhaps because immigrants work in jobs that “natives don’t want.” Despite this widespread view, earlier studies have not found immigrants to be in riskier jobs than natives. This study combines individual-level data from the 2003–2005 American Community Survey with Bureau of Labor Statistics data on work-related injuries and fatalities to take a fresh look at whether foreign-born workers are employed in more dangerous jobs. The results indicate that immigrants are in fact more likely to work in risky jobs than U.S.-born workers, partly due to differences in average characteristics, such as immigrants’ lower English language ability and educational attainment.