The 2005 Summer Workshop on Money, Banking, and Payments: an overview

This PDP summarizes the papers presented at the 2005 Summer Workshop on Money, Banking, and Payments at the Cleveland Fed. Papers covered a wide variety of topics in monetary theory and policy, banking, and payments systems research. Topics ranged from optimal monetary policy, optimal bank contracts, the private supply of money, the coexistence of credit, money, and capital, the design of payment systems, and international currencies. Effort was made to calibrate models and bring them closer to the data. These contributions illustrate the progress made in the field of monetary theory.Monetary policy ; Monetary theory ; Banks and banking ; Payment systems

Three Essays in Macroeconomics

I extract a global factor from cross-country output growth and find that its fluctuations are typically small, with unconditional volatility estimated at 0.06%, but highly persistent, with estimated persistence at 0.99. The data indicate that the volatility of the global factor varies over time and that these movements in global macroeconomic risk are an important driver of international business cycles. My empirical results suggest that the exposure to the global factor is not homogeneous across countries and such heterogeneity enables countries to share global volatility risk. I propose a theoretical framework in which agents fear model misspecification can successfully replicate the volatility-driven dynamics observed in the data. The most recent recessions in Brazil pose a challenge for current business cycle models owing to a key piece of legislation that causes labor to adjust in unconventional ways. We propose a two sector model that resembles the formal and informal sectors in Brazil with the former subject to a termination penalty inspired by said legislation. The informal sector, however, makes labor decisions in a frictionless environment. Our model accurately predicts that recessions preceded by long expansions impact labor levels more severely than downturns following shorter economic booms. Also, the state dependence property of our adjustment cost allows us to replicate the delay between the beginning of an economic downturn and the trough in the formal-sector labor level, a feature observed in the 2014-2016 depression in Brazil. We investigate the impact of firing costs associated with the Brazilian Warranty Fund for Time of Service labor protection law on firms' employment decisions and workers' life-cycle outcomes. We propose an overlapping generations model with search frictions in which firms are subject to severance costs proportional to workers' earnings history. Our main finding is that the severance policy encourages labor-hoarding practices that allow low-productivity long-tenured workers to collect severance-penalty rents, as they would fail to secure employment if they were currently unemployed. This labor-hoarding effect is especially acute for individuals closer to retirement age. However, a drawback for older individuals is an age-discriminant hiring practice when unemployed.Doctor of Philosoph

Dynamic taxation, private information and money

The objective of this paper is to study optimal fiscal and monetary policy in a dynamic Mirrlees model where the frictions giving rise to money as a medium of exchange are explicitly modeled. The framework is a three period OLG model where agents are born every other period. The young and old trade in perfectly competitive centralized markets. In middle age, agents receive preference shocks and trade amongst themselves in an anonymous manner. Since preference shocks are private information, in a record-keeping economy, the planner's constrained allocation trades off efficient risk sharing against production efficiency in the search market. In the absence of record-keeping, the government uses flat money as a substitute for dynamic contracts to induce truthful revelation of preferences. Inflation affects agents' incentive constraints and so distortionary taxation of money may be needed as part of the optimal policy even if lump-sum taxes are available.Money ; Taxation

On the threat of counterfeiting

We study counterfeiting of currency in a search–theoretic model of monetary exchange. In contrast to Nosal and Wallace (2007), we establish that counterfeiting does not pose a threat to the existence of a monetary equilibrium; i.e., a monetary equilibrium exists irrespective of the cost of producing counterfeits, or the ease with which genuine money can be authenticated. However, the possibility to counterfeit ?at money can affect its value, velocity, output and welfare, even if no counterfeiting occurs in equilibrium. We provide two extensions of the model under which the threat of counterfeiting can materialize: counterfeits can circulate across periods, and sellers set terms of trades in some matches. Policies that make the currency more costly to counterfeit or easier to recognize raise the value of money and society’s welfare, but the latter policy does not always decrease counterfeiting.Counterfeits and counterfeiting

A monetary approach to asset liquidity

This paper offers a monetary theory of asset liquidity—one that emphasizes the role of assets in payment arrangements—and it explores the implications of the theory for the relationship between assets’ intrinsic characteristics and liquidity, and the effects of monetary policy on asset prices and welfare. The environment is a random-matching economy where fiat money coexists with a real asset, and no restrictions are imposed on payment arrangements. The liquidity of the real asset is endogenized by introducing an informational asymmetry in regard to its fundamental value.Money ; Payment systems ; Liquidity (Economics)

Money Creation by Banks, Regulation and Optimal long-run Inflation Targets

The three chapters of the dissertation cover three distinct topics in monetary macroeconomics and banking. In chapter 2 I study the welfare implications of money creation by commercial banks and of proposals to limit or prohibit this ability. chapter 3 is about the optimal long-run inflation targets of central banks and chapter 4 treats the optimal financing structure of different bank assets like business loans, mortgages or securities. In the following I briefly outline the motivation and the content of the three chapters. Chapter 2, "Should Banks Create Money?" treats the role of commercial banks in the money supply of an economy. Currently central banks issue cash and reserves and commercial banks issue demand deposits which are claims on central bank money. Typically banks operate under a fractional reserve banking system: they issue demand deposits in excess of the central bank money they hold against redemptions. This system has been consistently criticized, especially after financial crises (1929, 2007/8). Opponents essentially argue that fractional reserve banking (money creation by commercial banks) makes the economy less stable and has no social benefits. As a consequence they want to limit or prohibit this ability of banks with so called "Narrow Banking" proposals. Narrow banks must fully back the money they issue with central bank money and thus the central bank perfectly controls the money supply. An example for a narrow banking proposal is the "Vollgeld" initiative in Switzerland rejected by Swiss voters in June 2018. In chapter 2 I analyze the welfare implications of such proposals. Abstracting from fragility issues I show that fractional reserve banking (money creation by commercial banks) can be preferable to narrow banking. Under fractional reserve banking the lending of banks is less constrained than in a narrow banking system. More loans increase the return on bank assets and competition forces banks to pass this return to the holders of demand deposits in the form of higher interest payments. In an environment with inflation this is beneficial because inflation acts like a tax on real activity. Fractional reserve banking is beneficial compared to narrow banking because it partially compensates the agents against this "inflation tax" through higher interest payments on demand deposits. Chapter 3, "Liquidity, the Mundell-Tobin Effect and the Friedman Rule" (co-authored with Lukas Altermatt), was motivated by the mismatch between theory and practice when it comes to optimal long-run inflation targets. Most monetary macro models find a long-run inflation rate to be optimal where the opportunity costs of holding money are zero (the so called "Friedman rule" after Friedman [1969]) which typically implies a deflationary inflation target. In practice however, no central bank runs the Friedman rule. Actual long-run inflation targets in advanced economies are around 2%. In the paper we want to reconcile theory and practice by providing a theoretical justification for long-run inflation targets above the Friedman rule. The argument we explore is based on the so called "Mundell-Tobin effect". Mundell [1963] and Tobin [1965] argued that money and capital are to some extent substitutes as a store of value and thus changes in inflation can influence investment. For example if the rate of return of money goes down (inflation goes up) agents substitute away from money into capital, i.e. they invest more. Thus at the Friedman rule, where holding money is costless and we have deflation, agents hold more money and invest less than at higher inflation rates. Could it be that agents hold too much money and too little capital at the Friedman rule and thus a higher inflation rate would increase capital investment and welfare? In a model with a fundamental liauidity-return trade-off between money and capital, i.e. capital has a higher return but money is more liquid, we show that indeed, the optimal long-run inflation rate and the Mundell-Tobin effect are related: When there is a Mundell-Tobin effect an inflation rate above the Friedman rule is optimal and without the Mundell-Tobin effect the Friedman rule is optimal. Thus the Mundell-Tobin effect could be a justification for optimal long-run inflation targets above the Friedman rule. Chapter 4, "Optimal Bank Financing with Less Opaque Assets" (co-authored with Kumar Rishabh), was motivated by the recent shift in bank loan portfolios from business loans towards mortgages in advanced economies (Jordà et al. [2016]). For example more than 80% of bank loans in Switzerland currently are mortgages. But mortgages and business loans seem to be quite different assets. One essential difference seems to be the ease with which these two assets can be valued by the bank (and by the investors of a bank). The value of a mortgage, which is backed by real estate, mostly depends on publicly observable factors like interest rates or the location of the building and is therefore relatively easy to value. The value of a business loans however, which is mostly backed by the value of a small or medium-sized, unlisted firm, depends more on factors only observable by the firm like the human capital of the entrepreneurs. This makes them more difficult to value for outsiders. This difference is e.g. apparent in the fact that for mortgages there is platform lending and a secondary market while both is not true for business loans. Mortgages are therefore said to be less "opaque" in the language of banking theory. In chapter 4 we ask the question whether it is useful to finance less opaque assets like mortgages with demandable liabilities (demand deposits) as banks do. In a theoretical model we show the answer is probably no. While demandable liabilities are optimal to finance opaque assets like business loans (in line with the literature on the disciplining role of demandable debt like Calomiris and Kahn [1991]), less opaque assets like mortgages or securities should be financed with non-demandable liabilities like long-term debt or equity. In line with this theory we document a weak positive correlation between opaque assets (business loans) and a suitable measure for demandable liabilities for small and medium sized banks (up to the 75th percentile) using US bank level balance sheet data from 1992 to 2018. But we find no correlation for bigger banks. The reason could be that big banks might enjoy an implicit insurance e.g. in the form of too-big-to-fail guarantees which distorts the choice of their asset and liability structure

ESSAYS ON MACROECONOMIC VOLATILITY AND MONETARY ECONOMICS

My dissertation consists of two independent essays on macroeconomic volatility and monetary economics respectively. The first essay explores the implications of imperfect information on macroeconomic volatility. It offers a micro-founded theory of time variation in the volatility of aggregate economic activity based on rational inattention. I consider a dynamic general equilibrium model in which firms are limited in their ability to process information and allocate their limited attention across aggregate and idiosyncratic states. According to the model, a decrease in the volatility of aggregate shocks causes the firms optimally to allocate less attention to the aggregate environment. As a result, the firms' responses, and therefore the aggregate response, becomes less sensitive to aggregate shocks, amplifying the effect of the initial change in aggregate shock volatility. As an application, I use the model to explain the Great Moderation, the well-documented significant decline in aggregate volatility in the U.S. between 1984 and 2006. The exercise is disciplined by measurements of the changes in aggregate and idiosyncratic volatilities. The model can account for 90% of the observed decline in aggregate output volatility. 67% of the decline is due to the direct effect of the drop in the volatility of aggregate technology shocks and the other 23% captures the volatility amplification effect due to the optimal attention reallocation from aggregate to idiosyncratic shocks. A version of the model without rational inattention can capture the former effect but not the latter. The second essay examines the redistributive effects of monetary policy using a dynamic general equilibrium model with heterogenous agents. I study the long-run effects of inflation on output, consumption and welfare, as well as the distribution of wealth in the economy. Unlike in representative agent models, heterogeneity can potentially allow for beneficial effects of inflation. Increases in the growth rate of money supply can reduce wealth dispersion, increasing output and welfare

Money and competing assets under private information

I study random-matching economies where at money coexists with real assets, and no restrictions are imposed on payment arrangements. I emphasize informational asymmetries about asset fundamentals to explain the partial illiquidity of real assets and the usefulness of at money. The liquidity of the real asset, as measured by its transaction velocity, is shown to depend on the discrepancy of its dividend across states as well as policy. I analyze how monetary policy affects payment arrangements, asset prices, and welfare.Money ; Monetary policy

Savings, asset scarcity, and monetary policy

This paper analyzes optimal monetary policy regarding asset markets in a model where money and savings are essential and asset markets matter. The model is able to explain why different regimes for the correlation of real interest rates and stock price-dividend ratios exist, and offers two explanations why the correlation vanished after 2007: A decrease in inflation or changes in the supply of risky and safe assets. The results on optimal policy show that away from the Friedman rule, fiscal policy can improve welfare by increasing the amount of outstanding government debt. If the fiscal authority is not willing or able to increase debt, the monetary authority can improve welfare of current generations by reacting procyclically to asset return shocks

House Price Dynamics and Traffic Mode Choice:

Diese Arbeit befasst sich mit der Preisdynamik auf Immobilienmärkten, sowie mit der allokativen Effizienz von räumlichen Verkehrsregelungsmaßnahmen.House Price Dynamics; Efficiency Rent; Traffic Mode Choice