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winter/1979
economic review
Repurchase Agreements:
Their Dramatic Growth
The Teenage Labor Market:
Its Distinctive Characteristics
Contents
winter/1979
Repurchase Agreements:
Their Dramatic Growth
The Teenage Labor Market:
Its Distinctive Characteristics
2
14
The Economic Review is published quarterly
by the Research Department of the Federal
Reserve Bank o f Cleveland, Post Office Box 6387,
Cleveland, OH 44101.
Free subscriptions and additional copies in
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Material in the
Economic Review may be
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provide the bank's Research Department with
copies of reprinted materials.
Repurchase Agreements
(t
This article explores the impact of the growth o f RPs on
the structure of financial markets through competition w ith other
sources and uses fo r short-term funds. It also examines the signifi
cance of the rapid growth of the RP market for monetary policy
and some of the factors affecting future market development.
W
Repurchase Agreements:
Their Dramatic Growth
B a rb a ra K. Pence
The market for repurchase agreements, or
RPs, has grown dramatically in recent years. RPs
have long been a traditional source of funds for
government securities dealers for financing their
securities portfolios. In the late 1960s, however,
banks increased their use of the RP market as a
source of funds when rising interest rates and
Regulation Q ceilings caused a runoff of CDs.
Banks' use of RP money jumped a second time
during the 1973—1974 tight money period, and
again in 1976 when bank and dealer borrowings
through RPs increased by more than half. In
addition, other market participants besides dealers
and banks have increasingly resorted to the RP
*The author is now an investment officer at National
City Bank of Cleveland.
2
FRB Cleveland Economic Review/W inter 1979
market as a source of funds through dealers. By
May 1978, total RPs accounted for an estimated
14 percent of total money market instruments
outstanding and were at about $40 billion, twice
the level as at year-end 1975.
This article explores the impact of the
growth of RPs on the structure of financial
markets through competition w ith other sources
and uses for short-term funds. It also examines the
significance of the rapid growth of the RP market
for monetary policy and some of the factors
affecting future market development.
The Instrument
A repurchase agreement is the sale of
securities accompanied by an agreement that the
seller w ill re-buy the securities after a specified
period of time. RPs are essentially a secured means
of borrowing and lending short-term funds.
The major, but not exclusive, borrowers in
the market are commercial banks and U. S.
government securities dealers (see box: Bank and
Dealer Markets). They form two markets for
RPs: a regional one dominated by local banks and
a national market operating through the dealers. In
the regional market, commercial banks—except for
transactions with their correspondent banks and
with government securities dealers—are exclusively
on the borrowing side of the market. The lenders
are the banks' customers, primarily nonfinancial
corporations and state and local governments. In
the national market, dealers are on both the
borrowing and lending sides. In some instances,
dealers borrow to finance their own holdings of
securities; in others, they borrow to finance RP
loans to others.
Another major participant in the national
market for RPs is the Federal Reserve System. In
its day-to-day efforts to offset the effect of market
factors on the supply of bank reserves, the Open
Market Desk of the Federal Reserve Bank of New
Y o rk frequently undertakes sizable repurchase
agreements and matched sale-purchase agreements,
or "reverse” repurchase agreements, with recog
nized government securities dealers and their
customers. Under repurchase agreements (securi
ties are sold to and funds are obtained from the
Federal Reserve), the Desk supplies bank reserves;
under matched sale-purchase agreements (securi
ties are sold and funds o b tain ed by the Federal
Reserve), the Desk withdraws reserves.1
As an investment outlet fo r short-term
funds, repurchase agreements are used primarily
by large investors because of sizable transaction
1 For a more complete discussion, see the author's
"Federal Reserve Repurchase Agreements and Matched
Sale-Purchases," Econom ic C om m entary, Federal Reserve
Bank of Cleveland, November 1, 1976.
Repurchase Agreements — The Basics
A repurchase agreement is the sale of
securities accompanied by an agreement that
the seller w ill re-buy the securities after a
specified period of time. The price at which
the securities are exchanged is fixed, and the
seller, in addition, pays interest fo r use of the
funds acquired. Normally, the price is
somewhat lower than the securities' market
value, thereby protecting the buyer should a
seller default on the repurchase agreement.
The funds acquired are available to the seller,
or borrower of funds, for use on the same
day.
The securities most frequently ex
changed in RPs (the securities are usually
termed “ collateral") are U. S. Government
and U. S. agency securities. Banks must use
these issues as RP collateral in order to
exempt the funds acquired from reserve
requirements. Dealers largely use U. S.
Government and agencies securities, but to a
lesser extent also use and accept large
negotiable CDs or commercial paper as
collateral. The RP markets using the latter
two securities as collateral, however, are much
thinner than those using U. S. Government or
agency securities; investors are reluctant to
accept CDs and commercial paper as collateral
and, additionally, transfer of this type of
collateral from seller to buyer is more
expensive. Treasury securities on a book-entry
basis may currently be transferred fo r a
nominal fee between customers' banks over
the Federal Reserve wire.
L ittle data is available on the m aturity
structure of outstanding RPs. However, a
survey of 46 targe banks, carried out by the
Federal Reserve System in the first week of
December 1977, showed that about half of all
RP borrowings had either a one-day m aturity
or were under continuing contract. The survey
also showed that about 22 percent of banks'
RPs had maturities of more than one week
but less than 30 days, while about 10 percent
(continued on next page)
FRB Cleveland Economic Review/W inter 1979
3
requirements. Government securities dealers gener
ally require $1 m illion minimums or higher, while
banks ask for minimums of about $100,000. RPs
therefore compete in the marketplace w ith other
money market instruments used by these inves
tors, including Treasury bills, commercial paper,
large negotiable certificates of deposit, bankers
acceptances and, finally, demand deposits or
money itself.
RPs offer several advantages to investors.
They represent a high quality asset, second in
safety only to Treasury securities themselves.
Indeed, many investors in RPs choose to show
ownership of U. S. Government securities on their
books rather than ownership of repurchase
agreements.2 This reporting feature is particularly
attractive to institutions such as savings and loan
associations and state and local governments,
required by law to invest a proportion of their
funds in Treasury securities.
^Commercial banks are the exception. They may not
report their RP investments as part of their government
securities holdings.
had maturities of over 30 days. Maturities of
bank RPs thus appear to be generally very
short, but w ith a significant percentage of
sufficiently long maturities to make RPs
competitive w ith short-term money market
instruments other than overnight Federal
funds.
Government securities dealers' data
show only about 5 percent or less o f their un
matched RP borrowings (that is, RP borrow
ings whose maturities are not matched with
those of equivalent RP loans on the dealers'
books) have maturities over 15 days, while 35
to 40 percent o f their RP loans (or "reverse"
RPs) have maturities longer than 15 days.
Thus, in their unmatched RP activities, dealers
borrow short and lend long, a strategy which
exploits the yield spreads in an upward slop
ing yield curve. In their matched m aturity
portfolios, dealers report that 30 to 40 per
cent have maturities o f greater than 15 days.
4
FRB Cleveland Econom ic Review/W inter 1979
RPs offer as another advantage the ability to
tailor maturities precisely to the needs of the
lender, even fo r as short a period as one day. For
finance companies, state and local governments
and corporations, which have no access to the
Federal funds market, the next best alternative
investments are large negotiable CDs, issued for a
minimum of 30 days, and commercial paper and
bankers acceptances, issued for shorter periods
than 30 days but generally not for as short a
period as one day. Even fo r longer periods,
alternative securities w ith the precise m aturity
desired may be d iffic u lt to locate. Prior to the
development of the RP market, firms with very
short-term funds to invest frequently held cash,
preferring to earn no income rather than risk
capital loss by investment in an instrument which
would be sold before m aturity.
RP investments using U. S. Government or
agency securities as collateral are also somewhat
more liquid than CDs, commercial paper or
bankers acceptances. The lender, having received
U. S. securities in exchange fo r funds, may in turn
temporarily sell them through an RP if cash is
RP rates, o f course, are related to those
of competitive money market instruments.
Because overnight RPs are alternatives for
banks and other major money market
institutions to lending or borrowing in the
Federal funds market, their rates tend to fo l
low the Federal funds rate.* Generally, over
night RP rates are somewhat less than the
funds rate because effectively RPs are collater
alized borrowings.
The spread between the funds rate and
the overnight RP rate depends on both the
supply and demand fo r RP funds. On average,
the overnight RP rate tends to fluctuate
between 20 and 25 basis points under the
funds rate. However, the RP rate may be
*Since 1970, certain nonbank institutions have been
allowed to buy or sell Federal funds to banks.
These institutions are U. S. agencies, savings and
loan associations, mutual savings banks and
agencies and branches of foreign banks.
needed prior to the m aturity of the original RP.3
For borrowers, RPs are alternatives to
various other sources of funds, depending on the
borrower. For banks, RPs substitute largely for
Federal funds borrowings and in the case of longer
maturities, fo r large CDs. For government
securities dealers, RPs are an alternative to money
market bank loans which, because they carry a
substantially higher rate than RPs, are used by
dealers only for residual, or last-resort, financing.
Other RP borrowers besides banks and
dealers—such as nonfinancial corporations, savings
and loans, state and local governments, finance
companies, insurance companies, and trust depart
ments of banks—are increasingly becoming in
volved in the market. Dealer lending to these
borrowers has grown from about $5 billion in
^As indicated in the box, “ Repurchase Agreements—The
Basics," an RP market in CDs and commercial paper also
exists, but the market is much thinner and borrowing
costs higher. For that reason, RP investments with govern
ment securities as collateral are more "liquid" than hold
ings of CDs and commercial paper.
higher or lower depending on whether dealers,
major borrowers of RP funds, are holding
larger or smaller inventories o f securities need
ing to be financed. The rate may also rise or
fall if the Open Market Desk o f the Federal
Reserve Bank o f New York, in its frequent
need to temporarily manipulate reserves, finds
itself either borrowing or lending heavily in
the RP market fo r a short period o f time.
RP rates are also influenced by the level
o f Treasury bill rates because RPs provide a
close substitute fo r Treasury bills fo r many
investors excluded from the Federal funds
market. The jo in t influence of the Treasury
bill and Federal funds rates on the RP rate
helps explain why 1973 and 1974 were
watershed years for the development of the
RP market. During the high-interest-rate
periods o f those years, the Federal funds rate
generally exceeded the three-month bill rate
by a substantial margin, reaching as high as
December 1975 to $14 billion in June 1978.4 For
these nonbank borrowers, dealer RPs represent an
alternative to commercial paper issuance, bank
loans, or the outright sale of securities.
RPs offer several advantages to these more
recent market entrants, including a somewhat
lower interest cost of acquiring funds than
commercial paper issuance and bank loans,
primarily, again, because RPs effectively are
collateralized loans. Furthermore, any firm owning
U. S. government or U. S. agency securities may
obtain funds through RPs, while only the larger
and better known firms tend to have access to the
commercial paper market. On the other hand,
commercial paper and bank loans may supply
funds in blocks far smaller than the $1 m illion
minimum obtainable through RPs with dealers.
Furthermore, some potential borrowers may still
prefer bank loans to RPs out of concern for
maintaining relationships established with their
banks. Their continued goodwill and willingness to
^Total RPs held as investments must be estimated because
dealer and bank data available to the Federal Reserve do
not fully reflect total RP activity.
five percentage points. The increased spread
was apparently the combined result o f a rela
tive scarcity o f Treasury bills and a high
demand fo r the type o f investment safety pro
vided by Treasury bills. The overnight RP rate
during this period fluctuated between the two
rates and tended to offer both a substantial
bargain over the Federal funds rate to short
term borrowers, as well as a considerably
more attractive rate relative to Treasury bills
to short-term investors. In 1974, the RP rate
generally lay between one-half and two per
centage points below the Federal funds rate
while standing between one and three and
one-half percentage points above the threemonth Treasury bill rate.**
**F o r further discussion on RPs see Charles M.
Lucas et. al., "Federal Funds and Repurchase
Agreements,” Federal Reserve Bank of New York
Q uarterly Review (Summer 1977), 33—48.
FRB Cleveland Economic Review/W inter 1979
5
lend may be considered crucial during tight money
periods when growing corporate credit needs force
borrowers to turn to their banks fo r financing.
Borrowing funds on RPs also offers an
attractive alternative to selling securities prior to
m aturity, particularly if the rate of interest earned
on the security exceeds the interest cost of
borrowing funds through an RP. The interest rate
on the RP may also be less than the effective
interest cost incurred by selling a security at a
capital loss prior to m aturity. Borrowing funds on
RP against a security is also particularly attractive
if the need fo r funds is very short term, and the
borrower desires to maintain the original invest
ment.
RPs and Market Efficiency
The development of the RP market has led
to increased efficiency in the financial markets.
First, like any new widely accepted instrument,
RPs offer to investors and borrowers alike a
6
FRB Cleveland Economic Review/W inter 1979
combination of risk, m aturity, fle x ib ility , and
liquidity characteristics not previously offered by
other money market instruments. RPs have filled a
market "gap," which, judging by their rapid
growth over the past few years, must have been
substantial.
Further, RPs have increased the liqu id ity of
the instruments eligible as collateral against RP
borrowings, including, as indicated, relatively
long-term instruments. The securities become
more "liq u id ” in the sense that they may be used
to raise funds on short notice w ithout incurring
the risk of capital loss inherent in an outright sale
prior to m aturity. This liqu id ity effect should
increase buyers' willingness to extend the m aturi
ties of their securities holdings, allowing them to
capture the higher interest income generally
available on longer term securities. This increased
liquidity of longer term securities should be
particularly attractive to such investors as insur
ance companies or pension funds which, because
of the long-term nature of their liabilities, prefer
to keep the m aturity of their asset portfolios as
long as possible. The net effect should be a modest
broadening of the market for longer term securi
ties.
Most importantly, perhaps, RPs facilitate
arbitrage between financial instruments, both in
the spot market and the futures market. They
provide a convenient means either to obtain the
funds needed to purchase other instruments or to
obtain the securities desired to undertake short
sales (see box: Money Market Arbitrage). The
enhancem en t o f m o n ey market arbitrage helps
eliminate differentials between interest rates which
would otherwise be unjustified on authentic
Money Market Arbitrage
RPs are used not only as a straightfor
ward source of cash or investment outlet for
short-term funds, but also as a facilitator of
specialized money market trading techniques.
In fact, fo r many money market participants,
that is the primary function of RPs.
Short selling of securities is a specialized
transaction increasingly being facilitated by
the RP. Under short sales, traders either
borrow securities or, in recent years, obtain
them through reverse RPs, and then sell the
securities outright to other customers. Traders
are betting that when the time comes to
return securities to original owners, they w ill
be able to p ro fit by purchasing securities in
the open market for a lower price than they
sold them for.
Increasing participation in the RP
market in recent years has broadened the
sources of securities available to traders active
in "shorting the m arket" when securities
prices are expected to fall. Most prominent
among such traders are the government
securities dealers. The growth of the RP
market has apparently facilitated a sharp surge
in the volume of dealer short sales (see Chart
1). By July 1978, dealer gross short sales
against both U. S. Government and agency
securities had grown to $10.5 billion, almost
four times greater than the maximum of $2.9
billion reached during the 1973—1974 period,
the last comparable period of rising interest
rates. But in that period, the RP market was
far smaller than today.
The recent high volume of gross short
sales by dealers does not necessarily reflect
outright speculation that prices w ill fall.
Dealers' gross "lo n g " position, that is their
holdings of securities, has increased as well,
thereby largely hedging their exposure to the
risk of price increases.* The growth of both
dealer long and short positions therefore
appears to reflect increased dealer arbitrage
between various security issues. Increased
market arbitraging is a hallmark of growing
market efficiency and in this case is largely
attributable to the development of the RP
market.
RPs may also be used to improve the
yield on portfolios by allowing investors,
during a period of rising interest rates, to
invest in higher yielding instruments w ithout
having to sell outright and take a capital loss
on older, lower yielding instruments. Those
instruments may be sold under an RP and the
funds used to purchase the new securities.
Similarly, institutions which must by law hold
substantial amounts o f Treasury securities,
such as savings and loan associations or state
and local governments, may improve yields on
their portfolios by raising funds on RP using
Treasury securities as collateral and purchas
ing higher yielding instruments, such as
negotiable CDs. Accounting methods allow
them to continue to show ownership of
Treasury securities while they actually earn
the higher interest on another instrument.
*This is not to say that individual dealers necessarily
hedged their short positions, but only that all
dealers, on average, had hedged their positions.
FRB Cleveland Economic Review/W inter 1979
7
economic grounds of relative scarcity of particular
instruments or relative characteristics of risk or
liquidity. Prior to the widespread use of RPs, such
differentials might have persisted because of such
barriers to arbitrage as unwillingness to realize
capital losses if other instruments were sold
outright or because of institutional restrictions
lim iting investments to U. S. Government securi
ties.
RPs and Monetary Policy Issues
RPs can affect monetary policy because they
increase the liqu id ity of securities eligible as RP
8
FRB Cleveland Economic Review/W inter 1979
collateral and because the RPs themselves are
highly liquid money market instruments. An
adjustment fo r RPs should thus be made in
liquidity analyses of the economy. The higher the
perceived level of liquidity, the less restrained
borrowers w ill be in incurring more debt or
increasing their current expenditures for real goods
and services.
The estimated volume of RPs being held as
investments exceeded $40 billion by mid-1978,
about half the amount of outstanding negotiable
CDs or Treasury bills and more than half the
amount of commercial paper (see Chart 2).
Bank and Dealer Markets
Typically, only relatively large banks
offer RPs. Minimum transactions reported by
Fourth District banks are about $100,000. To
the extent that bank RPs are undertaken with
non-customers and therefore pull new funds
into the bank, they are also generally a good
alternative to purchases o f Federal funds or
Eurodollars.
Bank borrowings through RPs offer
bank customers a convenient and safe means
of earning interest on short-term balances,
rather than holding funds in non-interestearning demand deposits. For the banks, RPs
w ith customers partly represent a defensive
effort to hold onto balances which might
otherwise be invested in RPs w ith other banks
or w ith dealers. However, RPs with customers
also represent fo r banks a generally attractive
alternative to the issuance of negotiable CDs
since RPs against U. S. Government or agency
securities are not subject to reserve require
ments.
In the national market, government
securities dealers have increasingly come to
use the RP market not only to finance their
own holdings of U. S. Government and agency
securities and o f large negotiable CDs, but also
to lend to customers through "reverse" RPs.*
A reverse RP is an RP viewed from the other
side of the transaction; dealers purchase
securities, rather than sell them, w ith an
agreement to resell them to their original
owners in the future. Thus dealers have
become intermediaries in the RP market, and
through them other market participants have
gained access to the borrowing side of the
market. Dealer customers include banks,
corporations, savings and loan associations,
pension funds, and other financial institu
tions. Rates earned on RPs w ith dealers tend
to be higher than w ith banks because of the
somewhat higher perceived risk involved w ith
dealer transactions rather than w ith bank
transactions and because dealer RPs are not so
conveniently arranged by customers. Further
more, minimum RP transactions with dealers
are for $1 m illion or more.
Dealers pursue tw o strategies in their RP
intermediary activities: they exactly match
the maturities of their RPs (dealer borrow
ings) and reverse RPs (dealer lending) or they
tend to fund longer term reverse RPs with
either longer- or shorter-term RPs, depending
on the shape o f the yield curve, that is,
whether yields on shorter-dated RPs or reverse
RPs are higher or lower than on longer-dated
RPs or reverse RPs. When matching maturi
ties, dealers lock in a p ro fit by lending at a
rate which is slightly higher than the rate at
which they borrow. When financing reverse
RPs with longer- or shorter-term RPs, dealers
may attempt to increase their profits by more
than the simple matched m aturity spread, but
at the risk that shifting rate relationships over
the life o f the RP or reverse RP may eliminate
any profitable spread or even result in a loss.
Many dealers undertake reserve RPs
simply to accommodate their customers and
remain competitive w ith other dealers. They
do not view their RP business as a source of
profit and are thus more likely to match
maturities, and avoid the interest rate risk.
Other more aggressive dealers view their RP
intermediary activities as a p ro fit center fo r
their business. These dealers "make markets"
in RPs by quoting firm rates for either
borrowing or lending RP funds over a broad
range o f maturities and, consequently, are less
likely to match their RP and reverse RP
maturities. That many dealers view their
RP-reverse RP activities as profitable suggests
that dealers have been, and are likely to
continue to be, active in promoting the
growth of the RP market.
*See Christopher J. McCurdy, 'T h e Dealer Market
for United States Government Securities,” Federal
Reserve Bank of New York Q uarterly Review
(Winter 1 9 7 7 -7 8 ), 3 5 -4 7 .
FRB Cleveland Econom ic Review/W inter 1979
9
Nevertheless, RPs are often excluded in analyses of
total short-term credit demands, even though their
growth contributes to pressures on short-term
interest rates in the same way as more
conventional money market instruments.
Of further interest to policymakers is the
impact of RPs on the rate of growth of the
measured money stock. For several years the
growth rate of the money stock, prim arily M-|, has
been used as an intermediate target for monetary
policy goals.5 In 1975 and 1976, the demand
deposit portion of M-| registered unexpectedly
slow growth, evidenced by accumulated prediction
errors of $36 billion or 16 percent for demand
deposits in major econometric models at the end
of 1976. The growth of RPs has been linked with
the puzzling slowdown. The arguments run that
RPs, w ith their extremely short maturities and
thus very high liquidity, substitute not only for
other money market instruments, but also, and
perhaps prim arily, fo r demand deposits of such
holders as nonfinancial corporations, state and
local governments, or financial institutions.
Eileen Mauskopf and Richard Porter re
cently addressed this question. Using a model
developed by Daniel Orr, they demonstrated how
and why RPs have been substituted in firm s'
portfolios fo r both demand deposits and other
money market instruments.6 RPs exhibited unusu
ally rapid growth in 1976, they suggested, as a re
sult of increasing bank and dealer competition for
RP funds and as a result o f technological innova
tions. Both factors tended to lower transaction
costs on RPs and raise interest rates on RPs rela
tive to those on competing instruments. Further,
they argued, the development and use of certain
corporate cash management techniques since the
mid-1970s have increased the demand for RP in
vestments by reducing corporations' uncertainty
with respect to the availability of cash fo r invest
ment over the next business day, although not
necessarily beyond that day. RPs are the most
convenient instrument available to some investors
for one-day investments. This cash management
development has thus increased the demand for
RPs relative to other money market instruments.
The RP market may affect the demand for
demand deposits in another way. The increasing
ability of others besides dealers and banks to
borrow on short notice by putting U. S.
Government securities out on RP reduces the risk
to those investors despite uncertainty over
periodic cash needs. The risk-adjusted rate of
return on Treasury securities thus rises, inducing
firms to substitute Treasury securities fo r demand
deposits, as well as other short-term assets. Treas
ury securities would become more attractive, not
only relative to demand deposits and other money
market instruments, but also relative to RP invest
ments themselves. This effect may explain why the
growth o f RP investments by nonbanks slowed in
1977 and 1978, while RP borrowings by nonbanks
accelerated.
RPs also raise some issues w ith respect to the
type o f demand for funds they reflect. Some RP
borrowings from dealers by nonbanks may simply
reflect money market arbitrage, w ith the RP
borrowings used merely to purchase other
securities. The primary impact o f these trans
actions is on the alignment of interest rates and
thus only indirectly affects goods and services
spending and the economic activity pace.
is presently defined as currency in circulation plus
checking accounts at commercial banks.
However, to the extent that RP borrowings
from dealers are undertaken to raise cash, such
borrowings may directly reflect spending for goods
and services. These RP borrowings, moreover,
would be in lieu of other sources of borrowed
funds, such as bank credit or commercial paper
issuance, measures of which are conventionally
used to reflect the extent of short-term business
credit demands.
^Unpublished manuscript. Richard D. Porter and Eileen
Mauskopf, "Some Notes on the Apparent Shift in the
Demand for Demand Deposits Function," Board of
Governors of the Federal Reserve System, 1978.
An examination of the RP lending and
borrowing activity of corporations suggests that
some of the recent growth in RP borrowings by
nonbanks and nondealers indeed reflected borrow-
10
FRB Cleveland Econom ic Review/W inter 1979
................ ....................................... .................................... ......................................
f
Chart 3
[
Corporate A ctivity in the RP Market
billions of dollars
Corporate borrowing from dealers
Corporate lending to dealers
Total corporate lending
ings for cash. Corporate lending on RPs to both
banks and dealers actually declined between March
and June 1978 (see Chart 3).7 Corporate borrow
ing from dealers, on the other hand, grew from
about $4 billion to $4.8 billion over the same
period, a period which corresponded with similar
rapid growth of other business credit. This pattern
suggests that a significant portion of these RP
borrowings, at least, were for purposes o f raising
cash rather than fo r money market arbitrage.
7 Corporate lending through RPs to banks is estimated as
the proportion of total bank RPs provided by
corporations as found in the Federal Reserve's one-week
surveys conducted in 1974 and 1977.
The growth of the RP market has changed
the relationship between Federal Reserve control
over the supply of bank reserves and the rate of
short-term credit expansion in two ways. First,
banks may finance credit expansion through RPs
w ithout incurring additional reserve requirements.
Unpledged U. S. Government or agency securities
held by banks may be used to obtain RP funds,
which in turn may be used to increase bank loans.
On the other hand, if banks' securities are already
wholly pledged, the ability to undertake RPs will
allow them to purchase more U. S. Government
and agency securities, but not to increase bank
loans.
FRB Cleveland Economic Review/W inter 1979
11
Second, a substantial amount of RP activity
does not pass through the banks at all, but only
through the government securities dealers over
which the Federal Reserve exercises no direct
control. Indeed, growing dealer activity in the RP
market suggests that dealers are beginning to
behave somewhat like banks. That is, dealers
accept short-term liabilities (by borrowing through
RPs) from some customers and lend on short term
through RPs to other customers. To be sure, the
comparison of dealer activities with banking is
limited. The RP liabilities offered by dealers are
imperfect substitutes fo r the money, or demand
deposit, liabilities of banks. Nor are dealer RPs
offered in such small denominations as CDs or
even RPs of the banks. Also, the RP loans that
dealers offer are generally very short term and
available only to customers with the appropriate
collateral who desire to borrow upwards of $1
m illion.
Outlook for the RP Market
The expansion of the RP market over the
past few years can be attributed to several factors.
As a result of the extraordinarily high money
market rates during 1973—1974, market partici
pants, alert to the increasing opportunity cost of
holding cash, were willing to invest the time and
funds to acquaint themselves with the RP market
and establish the market connections necessary to
exploit it. Also, as previously stated, innovations
in cash management techniques may have made
RPs a uniquely suited instrument fo r exploiting
new short-term investment opportunities. Increas
ing interest on the part of several aggressive dealers
in exploiting the p ro fitab ility of the RP market
also has resulted in greater fam iliarity of potential
participants with the market and its opportunities.
Additionally, increasing competition in the market
and the consequent narrowing of spreads between
RP and reverse RP rates have enhanced the
p ro fitab ility of arbitrage activity through RPs, in
turn increasing their use for that purpose. Finally,
transaction costs, in the form of "per tic k e t"
charges of transactors' banks for processing and
effecting the necessary transfer of securities, are
reported to have declined, further increasing the
p rofitability of RP activities by dealers and thus
providing an incentive for their expansion.
12
FRB Cleveland Econom ic Review/W inter 1979
How much further can the RP market
expand? Its rapid growth over the past few years
suggests that participants have already exploited to
a significant degree the special advantages offered
by RPs to both borrowers and lenders of funds.
Nevertheless, certain factors point toward possible
further growth of the RP market over the near
future.
First, dealers' demand fo r RP funds has been
tempered in the last two years by reductions in
their positions in U. S. Government and agency
securities needing to be financed. In 1976, dealer
positions averaged about $8.2 billion daily, while
in 1977 they averaged only $5.8 billion. In the
first six months of 1978, they averaged only $4
billion. Dealers reduced their positions because of
concern over rising interest rates and hence, risks
of capital loss. Their corresponding reduction in
demand for RP funds has thus tempered the
growth of RPs and masked a swell of demand for
RP funds arising from nondealers. Later, when
dealers seek to rebuild their positions, RPs should
exhibit another spurt of growth as dealer financing
needs increase.
Second, rising short-term interest rates and
competition could lead to an expansion into the
RP market by a second tier of money managers
whose use of certain cash management techniques
has remained limited and their incentive to adopt
them tempered, until recently, by relatively low
short-term interest rates. Adoption of those
techniques by a significant number of firms or
institutions should further expand the RP market.
Additional reductions in transactions costs, in
duced perhaps by technological innovations
affecting costs of transferring securities, might also
lead to increased market use.
The amount of collateral eligible for use
against RPs suggests that the market has room to
expand, provided participants receive sufficient
inducement. A t the end of 1977, corporations,
state and local governments, commercial banks
and other private nonbank finance companies,
such as insurance companies and savings and loans,
held over $300 billion of marketable Treasury and
U. S. agency securities. All of these factors should
lead to further expansion of the RP market in the
years ahead.
The Teenage Labor Market
This article describes the teenage labor market and focuses on the
characteristics that distinguish it from the adult market, especially the
seasonal nature of teenage labor force participation, commitment to
education, minimum wage restrictions, and lack of skills and experience.
The Teenage Labor Market:
Its Distinctive Characteristics
M a rk S n id e rm a n
The teenage labor market differs from the
adult market in a number of ways, but certainly
no more visibly than in the level of unemploy
ment.1 Although teens accounted fo r only about
10 percent of the civilian labor force in 1978, they
comprised almost 25 percent of the nation's
unemployed. And because the jobless rate of teens
has always exceeded that of adults, teenage
unemployment has traditionally been regarded as a
problem requiring special attention (see Chart 1).
This article describes the teenage labor
market and focuses on the characteristics that
distinguish it from the adult market, especially the
seasonal nature of teenage labor force participa
tion, commitment to education, minimum wage
restrictions, and lack of skills and experience.
Using unpublished gross-flow data, a model of the
teenage labor market was tested to identify and
explain the forces associated with teen movement
into and out of the labor force. The investigation
considers such policy-related issues as the effect of
minimum wages on teenage labor market activity
and the behavior of teens as "secondary" workers
in a labor market dominated by adults.2
How Teenagers D iffer
Confusion about job preference and lack of
experience and skills put teenagers at a disadvan
*The author thanks Michael Bagshaw for his valuable
contribution on several aspects of this project, Jean
Vanski for providing the gross-flow data and Debby Klein
for some unpublished Bureau of Labor Statistics data.
Roseanne Pajka provided extensive and time-saving
research assistance.
1 Hereinafter, teenagers refer to people 16 through 19
years of age.
^Secondary workers are those whose
allocation is to non-market activity.
14
primary time
FRB Cleveland Econom ic Review/W inter 1979
tage in the labor market. In addition, teenagers
experiment in the labor market by sampling jobs
w ith varying time schedules, skill requirements,
and working conditions. These circumstances—
inadequate preparation and intense job search
activity—produce the same result: high turnover
rates. From the employer's perspective, poor job
training and experience translate into low produc
tiv ity and facilitate discharge from a job; from the
employee's perspective, low wages prompt job
search activity and resignation. Both low produc
tiv ity and market sampling result in continual
flows of teenagers into and out of the labor force
every month.
The factors contributing to high rates of
teenage unemployment are long standing, but
some have become more important as the mix of
jobs and composition of the labor force changed.
Fewer people are now trained on the job; more
workers enter the labor force at a later age with
more education, reflecting the increased skills re
quired for specialized jobs.
Another change occurring in the last 30
years is the composition of households and their
labor supply decisions. Fewer people are either
permanently in or out of the labor force. More
desire part-time participation, preferring to spend
nonworking hours on other activities. Because
teenagers enter and leave the labor market
frequently, they are likely to experience more
unemployment. But this is not to imply that
teenagers are "b e tte r" or "w orse" o ff than adults,
or that their situation relative to adults has im
proved or worsened. Job searching and sampling
often are appropriate behavior patterns fo r this
group and, to some extent, are indicative of a
wealthy society. Only when turnover is involun
tary does teenage unemployment become a social
concern.
Cyclical Aspects of Teenage Labor Markets
The standard framework for examining labor
force participation is the labor-leisure choice
model. Prospective workers compare the value of
selling their labor in a market to the value of
engaging in nonmarket activities, becoming either
primary or secondary workers. Primary workers,
those committed to full-tim e market participation,
are almost always employed during normal labor
market conditions. Even in slack periods when
they become unemployed, only rarely w ill they
leave the labor force.
Secondary workers have less commitment to
work. Some of them enter the labor force only in
tight labor markets, when jobs are readily available
and wages are high. Others enter only during slack
markets, when fam ily workers have lost income
through layoff or reduced work hours. What
distinguishes the tw o types o f secondary workers
is their response to changes in relative wages,
family income, and the value of their time in the
market.3
^The literature of this aspect of labor supply is quite
large. For a good understanding of the issues see Bowen
and Finegan (1969), Mincer (1966), and Fleisher and
Rhodes (1976).
FRB Cleveland Econom ic Review/W inter 1979
15
Teenagers tend to be secondary workers.
About half of all teens participate in the labor
force, even though 70 percent of them are enrolled
in school. Because a large proportion of teenagers
are not committed to full-tim e work, their
employment status may reflect the status of others
in their households. Thus, teenagers may be influ
enced directly and indirectly by cycle conditions:
direct effects operate through job opportunities
for teens; indirect effects operate through adult
labor markets and family income positions.
Seasonal Aspects of Teen Unemployment
For a population whose major activity is
education rather than work, it is only natural that
teenagers exhibit considerable seasonal labor force
participation (see Chart 2). The m onthly transi
tions out of a labor force category frequently
measure 10 percent, and, in some months, are
larger than 20 percent. However, the charted
figures do not tell the entire teen labor market
story, since they do not indicate movement be
tween unemployment and either of the other two
labor market categories. Between May and June, a
substantial number of teenagers enter the labor
force, but do not find jobs. By July, most of those
who will be employed have advanced to that state.
In August, job separations increase, and by Sep
tember the seasonal exodus from the labor force
ends.
Education very strongly influences these
teenage labor market flows. Depending on the
school status, teens will exhibit differences in their
seasonal patterns of labor force activity and the
number of hours worked per week. Furthermore,
the changing proportion of teenagers who are in
school has, in part, altered the race-sex-education
composition of the youth labor force over tim e.4
4 For a more complete description of the unemployment
of teenagers by enrollment status, see Stephen P. Zell,
"The Rising Problem of Teenage Unemployment: A
Reappraisal," Economic Review, Federal Reserve Bank of
Kansas City (March 1978), 12—26. See especially Table 2,
p. 20.
16
FRB Cleveland Economic Review/W inter 1979
For example, the labor force participation rates of
all teen groups changed dramatically during the
1967—1976 period. Participation rates of white
female teens soared from 40.6 to 52.0 percent; for
those in school it went from 29.3 to 43.4 percent.
Among nonwhites, both males and female rates
declined; male out-of-school rates fell from 85.4 to
72.2 percent and female in-school rates dropped
from 26.1 to 18.8 percent. The number of whites
participating in the labor force from 1967 to 1976
increased greatly because of changed female
patterns. In contrast, nonwhite participation
decreased, prim arily because out-of-school males
left the labor force. These trends suggest that
different sex-race groups may be expected to
exhibit different seasonal patterns o f labor supply.
Education is not the only factor causing
seasonal fluctuations in the teenage labor force. In
certain industries, weather affects current and
prospective employment. Agriculture, fo r exam
ple, is a seasonal industry and one in which
teenagers are heavily represented. Retail trade,
another major employer of teenagers, is also
influenced by weather patterns and holiday
shopping periods.
Minimum Wages
Minimum wage legislation also affects the
youth labor market, through research studies sup
port conflicting hypotheses.5 While a standard
theoretical treatment of the issue suggests that in
creases in the minimum wage would reduce em
ployment, the magnitude of the effect on the
labor force is not clear. In their research, Mincer
and Ragan found a minimum wage increase signifi
cantly reduced employment, but they differed on
the impact of the minimum wage on labor force
participation.
^A summary of previous studies and points of contention
can be found in Robert S. Goldfarb, "The Policy Content
of Qualitative Minimum Wage Research," Industrial
Relations Research Association Proceedings (Winter,
1974), 261—268. Since then, other pertinent articles have
been published. See Jacob Mincer, "Unemployment
Effect of Minimum Wages," Journal o f P olitical
E conom y, Vol. 84, (August, 1976, pt. 2), S87—S104,and
James F. Ragan, Jr., "Minimum Wages and The Youth
Labor Market," Review o f Economics and Statistics, Vol.
59 (May 1977), 1 2 9 -1 3 6 .
-------------------
—
——
et Flows From Previous Month
( January '68 - September '7? }
0
E to N
%of E
N to E
% o fN
—
Jan,
849
13.5
550
7.1
Feb.
Mar.
604
10.3
611
7,5
576
9.7
614
7.6
Apr.
644
70.6
726
9.0
May
Jun.
July
Aug,
Sept.
718
7 7.5
808
10.1
619
9.6
1794
22.8
629
8.3
1120
19.5
1988
23.4
629
12.4
2509
30.6
593
70.3
Labor market theory recognizes that the
labor force could either contract or expand as the
minimum wage increases. Formerly employed
teenagers who continue to look fo r work w ill be
unemployed but still in the labor force. If they do
not look for work, they are no longer considered
part of the labor force. To the extent that teens
leave the labor force after losing jobs, their
unemployment rate will be lower than it would be
had they remained in the labor force. Any analysis
of the effect of minimum wages on the labor force
must consider both the participation and employ
ment rate consequences.
Oct.
807
12.8
805
10.4
Nov.
691
10.9
625
8.2
Dec.
623
10.0
601
7.5
Measuring Teenage Labor Force Behavior
Labor force behavior of teenagers generally
is examined through their rate of employment and
unemployment in relation to several other vari
ables, such as the business cycle, season o f the
year, and minimum wage. By focusing only on the
level of employment or unemployment, however,
some important information is lost. A t each point
in time a teenager is either employed (E), unem
ployed (U), or not-in-the-labor-force (N). Teen
FRB Cleveland Economic Review/W inter 1979
17
agers frequently move among these states from
month to month, depending on such variables as
the season and the state of the economy. Concen
tration on the levels o f these labor force states
ignores the size of the flows among the states.
For example, changes in employment levels from
one month to the next measure only net flows
into and out of employment. Gross flows from
one state to another may provide a better mea
suring framework fo r understanding how eco
nomic variables influence teenage labor force
patterns.
Suppose, for example, that in November and
December in a given year, the number of
employed teenagers is 7 m illion. The net
employment change is zero, but from November
to December, one m illion teenagers may have left
the labor force or become unemployed, while an
equal number found jobs. The net change figure
masks the size of the underlying gross flows.
Gross-flow data permit different tests of
some labor market hypotheses. Recently, Smith
and Vanski used gross-flow data in fittin g a model
of the teenage labor market.6 They found strong
trends in both the labor force entry and exit rates
influencing the growth in white teenage participa
tion. Furthermore, they found that entry decisions
are related to business cycle conditions in a way
that reduces participation during recession.
Finally, they confirmed that the extremely large
unemployment rates of teenagers directly result
from their frequent movements among labor force
states.7
®Ralph E. Smith and Jean E. Vanski, "The Volatility of
The Teenage Labor Market: Labor Force Entry, Exit,
and Unemployment Flows," in A Report on Em ploym ent
Statistics and Youth, ed. by R. Taggart and N. Burger
Davidson (Washington, D. C.: U. S. Government Printing
Office, 1978).
7 Stephen T . Marston first decomposed the unemploy
ment rate in this manner. See his "Employment
Instability and High Unemployment Rates," in Brookings
Papers on Econom ic A c tiv ity , (Washington, D. C.: Brook
ings Institution; 1976), pp. 178—188.
18
FRB Cleveland Econom ic Review/W inter 1979
Comparing Adult and Teen Transitions
To show the differences between teenage
and adult labor force activity, the transition pat
terns between labor force states of teens are com
pared to those o f adult while males, the largest
and most stable age-sex-race group (see figure).
Compared are the average m onthly flows fo r
several different groups across labor force states
from July 1967 to December 1973.8 The flows
are standardized to represent the average number
of people progressing from one state to another in
an initial group of 100 people.
An obvious difference between adult white
males and teenagers appears in the proportions
leaving employment. Virtually no employed men
exited from the labor force during this period,
while 12 to 20 teenagers out o f 100 did so.9 These
exits from the labor force increase the rate of
teenage unemployment, since the labor force is
reduced while the number of unemployed does
not change.
Another important difference between the
two age groups is the employed-unemployed flow.
Proportionally, far more teens than adult white
males lose or quit jobs, becoming unemployed.
However, if job leaving is the predominant cause
of employment separation, teenagers may be shop
ping the labor market and comparing jobs. In this
event, a higher jobless rate would result from the
voluntary behavior of the teens. More informed
about the labor market, adults have less tendency
to quit jobs, only to become unemployed.
Other patterns distinguish adult and teenage
labor force activity. Among the unemployed,
adults are far less likely than teens to leave the
labor force. In general, all adults exhibit more
stable labor market behavior and remain in a given
category, while teens tend to change states fre
quently.
^The numbers presented in the figure are based on Table
1, ib id ., p. 175. They differ little from a period extending
to September 1977.
^These figures are rounded. Actually, about 37 out of
10,000 men went from E to N on average.
Figure: Flows Across Labor Market States
employed
(m o n th ly average, July 1967 to December 1973)
unemployed
not-in-the-labor-force
100 persons
initial state
Reference group:
White males
25—59 years
I
terminal state
employed
unemployed
not-in-the-labor-force
100 persons
initial state
White males
16—19 years
1
terminal state
employed
unemployed
not-in-the-labor-force
100 persons
initial state
Nonwhite males
16—19 years
I
terminal state
employed
unemployed
not-in-the-labor-force
employed
unemployed
not-in-the-labor-force
100 persons
initial state
White females
16—19 years
terminal state
100 persons
initial state
Nonwhite females
16—19 years
terminal state
fM M
■Hi
n
This figure shows the average monthly flows across labor force states: Employed, Unemployed, and Not-in-the
Labor-Force. The flows are standardized to represent the average number of people progressing from one state
to another in an initial group of 100 people.
FRB Cleveland Economic Review/W inter 1979
19
Not all " flo w " differences between teens
and adults result in larger teenage unemployment
rates. The large flow o f teenagers from unemploy
ment to not-in-the-labor-force reduces teenage
unemployment rates. However, almost all the
higher unemployment rates of teenagers can be
attributed to their greater probability of leaving
employment.10 These facts correspond with some
widely held concepts about the teenage labor
market.
A Model of the Teenage Labor Market
A model characterizing the relationships
among the gross flows and several variables was
constructed to test several hypotheses concerning
teenage labor market behavior (see box). The
model was estimated for each group of teenagers:
white males, white females, nonwhite males, and
nonwhite females. Twenty-four equations (six
flows per group) were estimated.11
Seasonal Variables—The seasonal dummy
variables overwhelmingly affect teenage flows
from one labor force state to another. A test of
the join t significance of these seasonal variables
substantiates the hypothesis that noncyclical
economic variables strongly influence teenage
labor force behavior (see Table 1).12
I^See Marston, "Employment Instability," p. 181, for a
decomposition of teenage unemployment differentials by
flow.
11"The six flows are E to U, E to N, U to E, U to N, N to
U, and N to E where E, U, and N represent the three labor
market states discussed previously. The estimating
procedure was ordinary least squares. There was a
possibility that error terms across regressions within the
it*1 group might be strongly correlated, in which case
Zellner's seemingly unrelated regressions technique would
be appropriate. T h e . intergroup correlations were not
large, and the dependent variables in each of the
regression "sets" were almost identical so OLS was
retained. For more discussion see J. Johnston, Econo
m etric M ethods, (New York: McGraw-Hill, Inc., 1972),
pp. 2 3 8 -2 4 1 .
12A n F-test determines whether a set of variables exerts
an independent influence on the variable to be explained.
Rather than report the effectiveness of each monthly
seasonal variable here, the F-statistic for the group is
presented.
20
FRB Cleveland Economic Review/W inter 1979
A Model of
The model tested has the
X Y j = f (SEAS .CYC.AFLWS .Ml NW G j.TRND .CONST)
where:* XYj is one of the six independent
gross flows fo r the jth teen group
(e.g., U to E is the unempioymentemployment flow ).
SEAS is a set of seasonal dummy
variables.
CYC is a cyclical variable.
AFLWS is a set o f adult female
gross-flow variables.
MINWG; is a minimum wage variable
fo r the jth group.
TRND is a linear time trend.
CONST is a constant term.
* Definitions of variables and data sources are
contained in the Appendix.
Cyclical Effects—Given the direct relation
ship between seasonal activities and teenage flows,
what independent influences do cyclical condi
tions exert? The answer depends on the particular
race-sex group and labor force flo w considered
(see Table 2).13 In the case of nonwhite males and
females, an increase in economic activity corre
sponds with larger flows from employment to notin-the-labor-force (E to N). As their employed
pool grows, the flow from employment to not-inthe-labor-force increases, but the employed to
unemployed flo w does not change. These flow
patterns, in concert, damage nonwhite unemploy
ment rates. Perhaps nonwhites feel more confident
about sampling jobs in tight labor markets, where
as whites sample regardless of cyclical conditions.
Among white females, tight labor markets are
associated with smaller flows from employment to
unemployment, with no change in the flow from
employment to not-in-the-labor force. This pattern
13
A t-test determines whether an individual variable is
significant in the model. The numbers reported on the
t-test tables are the coefficients on the independent vari
ables in the model. The coefficient shows by how many
thousands of teens per month a flow will change when the
independent variable changes by one unit.
Table 1
F-Statistics o f Seasonal Variables*
Flow:
E to N
E to U
U to N
U to E
N to E
White Males
White Females
Nonwhite Males
Nonwhite Females
50.06
49.40
80.75
50.27
22.11
12.60
7.73
7.82
16.45
18.09
10.22
10.24
61.28
41.79
38.93
26.96
74.31
65.21
24.64
21.97
N to U
105.66
109.21
48.60
37.64
* All variables are significant at the 1 percent level.
somewhat reduces their unemployment rate. Only
employment flows of white males are unaffected
by cyclical activity.
Differences can also be found in the move
ments from unemployment as labor markets
tighten. For all groups except nonwhite males, the
flows from unemployment to not-in-the-labor
force become significantly smaller, as do those
from unemployment to employment, most likely
because of the decreased number of unemployed
persons and the desire of those unemployed to
continue job searching during tight conditions.
Among nonwhite males, however, the number of
people going from unemployment to not-in-thelabor-force is not significantly reduced and the
unemployment to employment transitions actually
increase, indicating that tight labor markets pull
nonwhite males teenagers out of unemployment.
Still, the magnitude of the employment increase is
lessened because, with time, many of these newly
employed will quit or be fired.
Cyclical activity affects the number of
people entering the labor force, but again, this
varies by race and sex. Nonwhite female teens
benefit more than white females from tighter labor
markets. Such markets reduce the number of not
in-the-labor-force to employment changes of white
females, but increase them fo r nonwhite females.
These same conditions, however, do not signifi
cantly affect N to E behavior for males. All groups
of teens, except nonwhite males, benefit through
lower unemployment rates as a result of cyclically
reduced not-in-the-labor-force to unemployment
flows.
What is the cumulative effect on teenage
unemployment of the cyclical influence on the
various flows? The unemployment rate of each
group of teens falls as markets tighten, although
the numerical impact on the unemployment rate
differs by group and by cycle stage.14 Changes in
labor market conditions more strongly affect
nonwhite unemployment rates than those of
^S m all changes in the unemployment rate for any group
can be expressed as a function of the levels of
employment and unemployment and the six flows. The
formula is
U
1
»
d (X H J ) = ( e +U)2{(E+ U )(E U -U E )+ E (N U -U N )- U(NE-EN)}
To calculate an unemployment rate change due to cyclical
change, use the average values for the levels over the
sample period and the estimated coefficients on the
cyclical variable.
Table 2
t-Tests of Cyclical Variables
Flow:
White Males
White Females
Nonwhite Males
Nonwhite Females
E to N
E to U
145.69
-6.98
7 0 .7 6 **
48.58*
19.31
-56.81 *
3.74
10.70
U to N
-1 6 6 .3 3 **
-80.24*
-26.11
-45.24*
U to E
-80.89*
-54.34
30.16*
-24.06
N to E
177.50
-216.49*
45.53
8 4 .5 4 **
N to U
-289.35
-1 66.20
-36.89
-100.22
*Signif icant at the 5 percent level.
^Significant at the 1 percent level.
FRB Cleveland Economic Review/W inter 1979
21
whites. The cyclical variable was highest (.368) in
the spring of 1969 and lowest (.081) in the spring
of 1975. A change of one tenth in the cyclical
variable produced an unemployment rate change
in the opposite direction by .03 percentage points
for white males, .13 percentage points for white
females, .56 percentage points for nonwhite males,
and .35 percentage points for nonwhite females.
According to this method of calculation, a change
of three tenths in the cyclical variable—about the
maximum experienced in the sample period—
would yield unemployment rate changes of three
times these sizes.15
Trend Effects—Although the teenage labor
market is only irregularly affected by cyclical
activity, this market continuously responds to
other factors on a regular basis. The trend variable
in each model captures the influence of many
factors, probably including the effects of changes
in the proportion of students, the location of jobs
and people, skills offered and required, and pref
erences for market versus non-market activities.
Among nonwhite males and females, signifi
cant time trends appear in the movement between
unemployment and not-in-the-labor-force (see
Table 3). For example, other conditions being
equal, an additional 350 male and 350 female
teens drop out of the labor force from unemploy
ment each month. Similarly, an additional 250
nonwhite male and 270 nonwhite female teens
unsuccessfully enter the labor force m onthly.
15Notice from the formula in 14 how the change in the
unemployment rate depends upon the levels of employ
ment and unemployment. The estimates in the text are
based upon the means of E and U; surely, however, the
appropriate E and U when CYC is .368 will differ from
the appropriate E and U when CYC is .081.
These trends indicate growing traffic between notin-the-labor-force and unemployment over time.
The dismal N to U trend for nonwhite female
teens is partially offset by a growing trend into
employment from unemployment of 130 of these
teens per month.
Among the white teens, nearly all trend
variables are significant. Because so many trend
terms are large and significant, the white teens can
be characterized as displaying increased activity in
almost all aspects of labor force behavior. The
largest trends are those from not-in-the-labor-force
to unemployment and from unemployment to
employment, the logical sequence for job seeking.
The movements out of both employment and
unemployment also show strong trends, but only
about one-half the magnitude of the movements
into these two states. On balance, white teens have
greatly improved their ability to move from un
employment to employment.
Minimum Wage—Changes in the minimum
wage affect teenage labor force flows in only 3 out
of 24 models, and none of these instances involve
movements into or out of the labor force (see
Table 4). This finding seems to be at odds with
most current research, which has found that the
minimum wage strongly affects teenage employ
ment.16
In the model specified here, the minimum
wage does not significantly influence any white
male or nonwhite female labor force activity. For
16jypical of this work is that by Ragan. His sample was
quarterly from 1963, first quarter, to 1972, fourth
quarter, and he divided teenagers into student and
non-student groups. Ragan also used a variable for youth
manpower programs in his regressions. The construction
of my minimum wage variable differed slightly from his.
See his "Minimum Wages," p. 129.
Table 3
t-Tests for Trend Variables
Flow:
E to N
E to U
White Males
White Females
Nonwhite Males
Nonwhite Females
.27
.23
.06
-.08
.36*
.43*
.03
.00
*Significant at 1 percent level.
22
FRB Cleveland Economic Review/W inter 1979
U to N
.29*
.33*
.35*
.35*
U to E
N to E
N to U
.75*
.81 *
.03
.13*
.16
-.08
.13
.00
.75*
.68*
.25*
.27*
Table 4
t-Tests of Minimum Wage Variables
Flow:
E to N
E to U
U to N
U to E
N to E
N to U
White Males
White Females
Nonwhite Males
Nonwhite Females
57.47
4.63
-33.41
32.44
-214.36
8.25
-98.99*
-3.49
68.03
-12.91
126.63
42.80
-66.33
218.87*
-120.11*
44.50
-152.46
-173.25
59.60
40.55
228.97
122.97
15.34
14.74
*Significant at the 5 percent level.
white female teens, however, a dollar increase in
the minimum wage produces a flow in this group
of 219,000 from unemployment to employment
each month. Although counter-intuitive, this fin d
ing could reflect employer preference for white
females over some other teens. That is, in those
firms that cannot substitute machinery for labor,
employers may discriminate according to their
perception of productivity differences among
workers. On the other hand, if the actual number
of jobs available shrinks because of a higher m ini
mum wage, white female teens may have better
"connections" to these jobs and find them faster.
An increase in the minimum wage reduces
the numbers of nonwhite male teens who move
from unemployment to employment and from
employment to unemployment. From the em
ployer's perspective, the reduced flow from U to
E is consistent with expectations based on theory,
particularly if employer discrimination is a factor.
Employment to unemployment flows are reduced
because, from the employee's perspective, the cost
of quitting increases when the wage is raised.
A d u lt Influences—If teenagers act as second
ary workers, their movements into and out of the
labor force should be sensitive to adult labor force
activities. Therefore, in the models of teenage
flows into and out of the labor force, three vari
ables reflecting adult patterns were included: flow
from employment to unemployment, reflecting
adult job loss, flo w from unemployment to em
ployment and flow from not-in-the-labor-force to
employment, both reflecting improved job condi
tions for adults. A dult flo w variables pertain only
to females because adult males do not change
states as often and because teenagers are more
likely to compete with adult females than adult
males.17
The adult female flows affected teenage
labor force patterns in only two instances (see
Table 5). A dult female flows, especially those
from employment to unemployment, significantly
influence movement of white male teens from notin-the-labor-force to unemployment. When adult
white females lose or leave jobs and become unem
ployed, fewer w h ite male teens advance from N to
U, indicating perhaps a discouraged-worker effect.
1^The coefficients for individual adult female flows are
not reported here. Rather, the F-statistic for the set is
presented.
Table 5
F-Statistics of A dult Female Flow Variables*
Flow:
E to N
E to U
U to N
U to E
N to E
N to U
White Males
White Females
Nonwhite Males
Nonwhite Females
1.22
1.83
0.62
0.83
NA
NA
NA
NA
1.19
0.65
0.97
0.73
NA
NA
NA
NA
1.25
2 .8 7 t
0.53
1.06
3 .3 4*
2.08
2.43
1.21
*Test results refer to the effect of the adult female flows, current and lagged up to 3 months.
**Significant at the 5 percent level.
tSignif icant at the 1 percent level.
NA — not applicable; no adult female variables in the model.
FRB Cleveland Economic Review/W inter 1979
23
■
The summary statistics o f the models
themselves, R2 and Durbin-Watson, indicate
that the fits o f all 24 regression models are
quite good and the error terms relatively free
o f serial correlation (see Table 6). The most
notable failures in fittin g the equations per
tain to the E to U and U to N flows, particu
larly the E to U flo w fo r nonwhites. This is
regrettable because the changes in status from
employment to unemployment comprise a
large part of the labor force instability o f non
white teenagers. The E to U turnover fo r non
whites cannot be explained by trend or
cyclical variables:
that which can be ex
plained is attributed primarily to seasonal
factors. The average actual flows per month
are presented in Table 6 for better interpreta
tion of the size of the changes that occur in
that flow as a result of trend, minimum wage,
or cycle.
Conclusions
The results indicate that employment
policies designed to ameliorate the high unemploy
ment rates of teens must focus on their large rates
of turnover—voluntary and involuntary. This study
does not directly quantify the proportion of tu rn
over that is voluntary or involuntary, but it con
siders the possible causes o f each. Voluntary
turnover should be accepted, in most instances, as
responsible and appropriate behavior. Involuntary
turnover may result from forces beyond the con
trol of the teens.
A teenage unemployment problem is present
to the extent that job opportunities do not exist
for teens wanting to work, or that teens do not
adequately meet required job skills. Opportunities
and skills are not directly considered here, but the
trends indicate that whites have become adept at
finding jobs, while nonwhites have not.
Much of the aggregate labor force activity of
teenagers can be attributed to seasonal events,
particularly education. Consequently, a large pro
portion of the transitions from one labor force
status to another is voluntary and reflects the fact
that teens are secondary workers whose primary
commitment is not to the labor market.
Against this backdrop of seasonality, cyclical
conditions clearly influence the numbers of teens
changing labor force classifications. Nonwhite
Table 6
Summary Statistics for Flow Models
Flow:
White Males
R2
Durbin-Watson
Average Flow (000)
Average Level (0 0 0 )*
E to N
E to U
U to N
U to E
N to E
N to U
.97
2.43
388.00
3,355.00
.72
1.78
138.00
3,355.00
.70
1.70
159.00
546.00
.89
1.72
1 63.00
546.00
.92
2.21
371.00
2,567.00
.93
1.74
184.00
2,567.00
White Females
R2
Durbin-Watson
Average Flow (000)
Average Level (00 0 )*
.96
2.17
385.00
2,747.00
.70
2.08
81.00
2,747.00
.70
1.85
144.00
464.00
.85
2.14
133.00
464.00
.91
2.56
337.00
3,384.00
.93
2.18
199.00
3,384.00
.94
1.88
55.00
344.00
.44
1.64
22.00
344.00
.67
1.63
49.00
141.00
.80
2.19
27.00
141.00
.77
2.38
50.00
563.00
.86
2.10
54.00
563.00
.91
2.22
48.00
248.00
.41
2.10
10.00
248.00
.72
2.12
51.00
1 34.00
.74
1.76
26.00
1 34.00
.75
2.18
34.00
739.00
.85
2.13
64.00
739.00
Nonwhite Males
R2
Durbin-Watson
Average Flow (000)
Average Level (00 0 )*
Nonwhite Females
R2
Durbin-Watson
Average Flow (000)
Average Level (00 0 )*
* Figures pertain to level of flow origin.
24
FRB Cleveland Econom ic Review/W inter 1979
female teens appear to benefit from tight markets
more than white females; their chances are im
proved for entering the labor market with a job.
Unfortunately, both male and female nonwhites
leave jobs and the labor force as employment con
ditions improve. Whites, however, do not exhibit
to such a degree this form of participation insta
b ility. Tighter markets improve their unemploy
ment rates by reducing unsuccessful labor force
entry.
Finally, the minimum wage exerts a very
small influence on teenage labor force activity
relative to the other variables studied. Only the
behavior of nonwhite males is influenced by the
minimum wage. By increasing the earnings to be
forfeited through resignation, a higher minimum
wage may persuade some teens to remain em
ployed rather than to quit and seek other employ
ment, possibly risking unemployment.
The formula fo r constructing the minimum
. . . . 19
wage variable is:
MINWGj = I j (ljj(pjM P + njM N))/AHE
where:
MINWGj
MP
MN
AHE
Ijj
Pj
Appendix: Data and Sources
The gross flow data used in this study were
supplied by the Urban Institute and adjusted by
the Urban Institute according to the method of
Holt et. a/.18 The unadjusted data are derived
from the m onthly Current Population Surveys of
the Bureau of Labor Statistics. The data used for
AFLWS were the flows of females aged 25—59,
with the appropriate race selected to f it the
particular regression. Little difference resulted
from using females only as opposed to all persons
aged 25—59.
The cyclical variable, CYC, was the Confer
ence Board Help Wanted Advertisement Index
divided by the aggregate unemployment rate, not
seasonally adjusted. Another cyclical variable,
quits minus layoffs in manufacturing, was tested.
Although not reported here, the findings were
similar. An increase in either of these cyclical vari
ables implies an expansion in economic activity.
Before testing these variables, a set of variables
measuring income changes and employment in
retail trade and manufacturing was tried. The
variables in the set were highly colinear.
18charles C. Holt, et at., Labor Markets, In fla tio n , and
M anpower Policies: Final Report, (Washington, D. C.:
Urban Institute, 1975), Appendix C.
nj
i
= the effective minimum wage of
race-sex group j (there are
four groups)
= minimum wage for previously
covered workers
= minimum wage fo r newly covered
workers
= average hourly earnings of
nonsupervisory employees in
the private nonfarm economy,
not seasonally adjusted
= fraction of youth employment
of group j coming from
industry i
= fraction of nonsupervisory
workers in industry i
covered by previous minimum
wage legislation
= fraction o f nonsupervisory
workers in industry i covered
by most recent minimum wage
amendment
= major industry division
(wholesale and retail trade
treated separately)
Using a single minimum wage variable fo r all
teens, constructed similarly to Mincer's, yielded
similar results.20
Employment in industries by race-sex groups
was provided by the Bureau of Labor Statistics.
Coverage data can be found in the Labor Depart
ment's "M inim um Wage and Maximum Hours
Standards."21 The earnings data can be found in
the Bureau of Labor Statistics' Employment and
Earnings. For a description of the "effective m ini
mum wage" concept, see U. S. Bureau of Labor
Statistics Bulletin No. 1657 , pp. 11— 14.
I^See Ragan's "Minim um Wages," p. 129 .
20see "Unemployment Effect of Minimum Wages."
21U. S. Department of Labor, "Minimum Wage and
Maximum Hours Standards Under the Fair Labor
Standards Act," (Washington, D. C.: U. S. Government
Printing Office, 1977 ), pp. 57 — 58 .
FRB Cleveland Econom ic Review/W inter 1979
25
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