Full text of Research Update : Fourth Quarter 2004

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

F

ourth Quarter 2004

Federal Reserve Bank of New York

Update
Research and Statistics Group

www.newyorkfed.org/research

Joseph S. Tracy Is Named New Director of Research
he Research and Statistics Group is
pleased to announce that the Bank’s
Board of Directors has named
Joseph S. Tracy director of research and
executive vice president. During his tenure
at the Bank, Joe has headed the Group’s
Domestic Research and Research Support
areas and has served as the Group’s senior
administrative officer.

T

doctorate in economics from the University
of Chicago.

Joe’s research has focused on housing,
labor economics, unions and collective bargaining, and real estate finance. He has
published in a range of economics and
business journals, including the American
Economic Review (“Strikes and Holdouts in
Wage Bargaining: Theory and Data,” with
Peter Cramton, 1992) and the Journal of
Joe joined the Bank in 1996 as a research
Political Economy (“The Structure of Local
officer in Domestic Research. Previously,
Public Finance and the Quality of Life,”
he was an associate professor of economics
with Joseph Gyourko, 1991). His work in
at Columbia University and Yale University
scholarly volumes includes “Unions,
as well as the Olin Fellow at the National
Bargaining, and Strikes” (in International
Bureau of Economic Research. Joe holds a
Handbook of Trade Unions, 2003) and
bachelor’s degree in political economy from
“Quality of Life and Environmental
the University of Missouri as well as a
Comparisons” (with Joseph
e w R e s e a r c h : O c t o b e r - D e c e m b e r 2 0 0 4 Gyourko and Matthew Kahn,
in Handbook of Regional and
Is there a bubble in the U.S. housing market?
2
Urban Economics, 1999).
U.S. productivity’s likely growth rate
over next ten years
3
For Joe’s bio, visit
Benefits, risks of international capital mobility
w w w. n e w y o r k f e d . o r g
are subject of New York Fed conference
4
/r e s e a r c h / e c o n o m i s t s
Papers recently published by Research Group staff
6
/tracy/index.html.
New Staff Reports
7
Papers presented at conferences
8

N

Research Update

■

Fourth Quarter 2004

Study Finds No Signs of a Bubble in U.S. Home Prices

2

he fast rise in home prices in the
past decade is not indicative of a
bubble in the national housing
market, according to a new study in the
Economic Policy Review (vol. 10, no. 3).
Moreover, a potential decline in regional
housing prices does not expose the aggregate U.S. economy to weakness.

T

prices nationwide. Although home prices
have risen sharply, the study explains,
increases in family income and declines in
nominal mortgage rates have helped keep
prices affordable. Even in periods of weak
economic growth and high nominal interest rates, aggregate real home prices have
decreased only modestly.

In “Are Home Prices the Next
‘Bubble’?” Jonathan McCarthy and
Richard Peach examine recent trends in
the U.S. housing market. They explain
that the sharp rise in home prices since the
mid-1990s has raised concerns over a possible bubble in this market and the vulnerability of home prices to a collapse that
could harm the U.S. economy.

At the regional level, McCarthy and
Peach conclude that housing prices could
potentially soften in states along the east
and west coasts, where home price appreciation has been strongest recently. Prices
in these areas are subject to a possible fall
because housing is relatively inelastic and
home prices historically have been volatile.
However, the authors note that regional
price declines in the past have not had significant negative effects on the broader
economy.

McCarthy and Peach conclude that
such concerns are unwarranted. Instead,
they argue that strong market fundamentals
are responsible for the run-up in housing

Pu b l i c a t i o n s a n d P a p e r s
The Research and Statistics Group produces a wide range of publications:
●

The Economic Policy Review—a policy-oriented journal focusing on economic
and financial market issues.

●

EPR Executive Summaries—online versions of selected Economic Policy Review
articles, in abridged form.

●

Current Issues in Economics and Finance—concise studies of topical economic
and financial issues.

●

Second District Highlights—a regional supplement to Current Issues.

●

Staff Reports—technical papers intended for publication in leading economic
and finance journals, available only online.

●

Publications and Other Research—an annual catalogue of our research output.

Federal Reserve Bank of New York

www.newyorkfed.org/research

U.S. Productivity Growth Should Remain Strong
over the Next Decade
.S. labor productivity growth has
accelerated in recent years, despite
a series of negative economic
shocks that began with the bursting of the
NASDAQ bubble in 2000 and extended
through the current spike in energy prices.
From 1995 to the second quarter of 2004,
productivity grew at a rate of 3.1 percent
per year, more than twice the average rate
of the previous two decades.

U

In a new study in Current Issues in
Economics and Finance (vol. 10, no. 13,
“Will the U.S. Productivity Resurgence
Continue?”), Dale Jorgenson, Mun Ho,
and Kevin Stiroh update their analysis of
the sources of the productivity revival and
offer new projections of productivity’s
likely growth rate over the next ten years.
Specifically, the authors predict that private
sector productivity will grow at a rate of
2.6 percent per year in the next decade—
a significantly faster pace than the 2.2 percent annual rate they predicted in 2002.

According to the study, information technology (IT) continues to play a key role in
the productivity revival. The recent gains
reflect not only technological progress in
the industries that produce IT equipment
and software but also an ongoing shift by
firms toward investment in highly productive and relatively inexpensive IT equipment.
On the negative side, the authors project
that the aging of the workforce and a tapering off of advances in workers’ educational
attainment will temper productivity
growth in the years ahead. In addition,
they caution that the future of productivity
growth will depend critically on hard-topredict factors such as the evolution of
semiconductor technology. Nevertheless,
they conclude that the underlying strength
of information technology makes it highly
unlikely that the U.S. economy will revert
to the slower pace of productivity growth
observed in the 1970s and 1980s.

Ot h e r N e w P u b l i c a t i o n s
■

The Research Group of the Federal Reserve Bank of New York. This online guide,
updated for 2004-05, offers economists interested in joining the Group a fuller
understanding of our activities, our research and policy work, and our staff,
structure, and functions.
www.newyorkfed.org/research/research_group/index.html

■

The Regional Economy of Upstate New York. This newsletter, produced by
the New York Fed’s Buffalo Branch, focuses on issues of importance to upstate
New York. In “The Foundations and Practice of Historic Preservation” (summer/fall
2004), authors Jane Humphreys and Ramon Garcia show why historic preservation
serves as an important—yet sometimes controversial—force in the economy.
www.newyorkfed.org/research/regional_economy/upstatenews.html

Research and Statistics Group

3

Research Update

■

Fourth Quarter 2004

New York Fed Conference Explores Benefits
and Risks of International Capital Mobility
he many potential benefits of
financial globalization include provision of insurance against national
shocks, more efficient global allocation of
resources, and improvements in international standards of living. Nevertheless, the
interconnectedness fostered by globalization increases the exposure of participants
to financial and real shocks and to the risk
that sudden capital reversals may translate
into large-scale economic disruption.

trade balance channel. The authors
explore empirically the interconnections
between financial globalization and
exchange rate adjustment as well as the
policy implications. Discussions by
Michael Dooley and Andrew Rose
followed.

T

4

In December, Linda Goldberg and Paolo
Pesenti organized the New York Fed conference “Financial Globalization,” bringing
together a distinguished group of researchers to explore the benefits and vulnerabilities associated with international
capital mobility. Stanley Fischer, Vice
Chairman of Citigroup, delivered the
keynote address. The conference featured
papers and discussions by economists from
the academic, policy, and financial communities; the papers presented are summarized
below.
■

“Financial Globalization and Exchange
Rates”—Philip R. Lane and Gian Maria
Milesi-Ferretti observe that the rapid
pace of financial globalization in recent
years has brought new challenges to the
international monetary system. In
particular, the large amount of gross
cross-holdings of foreign assets and
liabilities has made the valuation channel
of exchange rate adjustment grow in
importance relative to the traditional

Federal Reserve Bank of New York

■

“An International Financial Transmission
Model”—Michael Ehrmann, Marcel
Fratzscher, and Roberto Rigobon analyze
the degree of financial integration
between money markets, bond markets,
equity markets, and exchange rates
within and between the United States
and the euro area. Their findings
emphasize the importance of U.S.
markets, which on average explain more
than 25 percent of movements in euro
area markets; by comparison, euro area
markets account for only about 8 percent
of U.S. asset price changes. The paper
featured commentaries by Cédric Tille
and Mark Spiegel.

■

“Trade, Production Sharing, and the
International Transmission of Business
Cycles”—Ariel Burstein, Christopher
Johann Kurz, and Linda Tesar examine
the extent to which three observations
about the link between international
trade and international business cycle
synchronization can be reconciled using a
multicountry version of a standard model
of international business cycles. The
observations are: 1) a large increase in
manufactures trade has taken place over

www.newyorkfed.org/research

the past thirty years, 2) a bigger share of
trade between core and periphery regions
relative to core regions has occurred as
production sharing, and 3) cross-country
output correlations have risen between
core and periphery regions relative to
core regions. Qualitatively, the model is
found to account for these observations;
quantitatively, the direct effects from
trade do not generate a large divergence
in output correlations across countries.
Jon Faust and Kei-Mu Yi provided
discussions.
■

■

“The Euro Area and World Interest Rates”—
Menzie Chinn and Jeffrey Frankel
conclude that nominal U.S. interest rates
tend to drive European rates at both the
short and long horizons. Moreover, while
some evidence suggests that U.S. rates
are becoming more influenced by
European rates, the relationship is far
from symmetric, despite European
Monetary Union. Real U.S. interest rates
also influence European rates, although
German rates do not appear to have a
similar effect on U.S. rates. Gian Maria
Milesi-Ferretti and John Rogers offered
their thoughts on the Chinn and Frankel
study.
“Firm-Specific Information and the
Efficiency of Investment”—Anusha
Chari and Peter Blair Henry use a new
firm-level data set to examine the
efficiency of capital investment in
emerging economies. Their main finding
is that in the three-year period following
capital account liberalization, the growth
rate of a typical firm’s capital stock
exceeds its preliberalization mean by an

average of 5.4 percentage points. The
return to capital rises in the postliberalization period, suggesting that the
investment boom does not constitute a
wasteful binge. Comments by Leonardo
Bartolini and Michael Klein complemented
the presentation.
■

■

“Capital Flows in a Globalized World:
The Role of Policies and Institutions”—
Laura Alfaro, Sebnem Kalemli-Ozcan,
and Vadym Volosovych examine the
determinants of international capital
flows and capital flow volatility in the
1970-2000 period. They find that
institutional quality is important in
determining capital flows and that
historical determinants of institutional
quality have a direct effect on flows.
Good fiscal and monetary policies and
capital controls also explain the changes
in capital flows and volatility. Franklin
Allen and Nouriel Roubini followed with
their observations.
“Emerging Markets, Sovereign Debt, and
International Financial Integration:
1870-1913 and Today”—Paolo Mauro,
Nathan Sussman, and Yishay Yafeh add
to the literature on micro- and macroeconomics by analyzing international
capital flows over the 1870-1913 period
and the institutions operating at the
time. Their analysis also considers the
determinants of borrowing costs for
emerging markets before World War I
and today as well as the mechanisms by
which the consequences of past debt
crises were mitigated. Richard Portes and
Alan Taylor offered their insight on the
work.

Research and Statistics Group

5

Research Update

■

■

Fourth Quarter 2004

“Currency Crises, Capital Account
Liberalization, and Selection Bias”—
Reuven Glick, Xueyan Guo, and
Michael Hutchison consider whether
countries with unregulated capital flows
are more vulnerable to currency crises.
After controlling for sample-selection
bias, the authors conclude that countries
with liberalized capital accounts
experience a lower likelihood of crises.
Their findings, which contradict the

Recently Published
6

Arturo Estrella. 2004. “Bank Capital and Risk:
Is Voluntary Disclosure Enough?” Journal of
Financial Services Research 26, no. 2
(October): 145-60.
Linda Goldberg. 2004. Comment on “The Role
of Multinational Corporations in International
Business Cycle Transmission: Skew Lines or
Arbitrage Opportunities?” by Gordon Hansen
and Matthew Slaughter. In Horst Siebert, ed.,
Macroeconomic Policies in the World
Economy, 156-62. Berlin-Heidelberg: SpringerVerlag.
Bart Hobijn. 2004. “Generalizations of the
KPSS Test for Stationarity,” with Philip Hans
Franses and Marius Ooms. Statistica
Neerlandica 58, no. 4 (November): 1-20.
Simon Potter. 2004. “Forecasting in Dynamic
Factor Models Using Bayesian Model
Averaging,” with Gary Koop. Econometrics
Journal 7, no. 2 (December): 550-65.

Federal Reserve Bank of New York

conventional wisdom, suggest that the
benefits of capital market liberalization
for external stability are substantial.
Frederic Mishkin discussed the paper as
well as summarized many of the issues
touched upon at the conference.
Links to the papers can be found at
www.newyorkfed.org/research/conference
/2004/financial_globalization.html.

Til Schuermann. 2004. “Measurement,
Estimation, and Comparison of Credit
Migration Matrices,” with Yusuf Jafry. Journal
of Banking and Finance 28, no. 11
(November): 2603-39.
Kevin Stiroh. 2004. “Discussion of Productivity
Trends and Measurement Issues in Services
Industries.” In Jack E. Triplett and Barry P.
Bosworth, eds., Productivity in the U.S.
Services Sector: New Sources of Economic
Growth, 41-5. Washington, D.C.: Brookings
Institution Press.
Kevin Stiroh. 2004. “Diversification in
Banking: Is Noninterest Income the Answer?”
Journal of Money, Credit, and Banking 36,
no. 5 (October): 853-82.
Giorgio Topa. 2004. “Cooperation as a
Transmitted Cultural Trait,” with Alberto Bisin
and Thierry Verdier. Rationality and Society
16, no. 4 (November): 477-507.

www.newyorkfed.org/research

New Titles in the Staff
Reports Series
The following new Staff Reports are available at www.newyorkfed.org/research
/staff_reports.

Macroeconomics and Growth
No. 195, October 2004

Menu Costs at Work: Restaurant Prices
and the Introduction of the Euro
Bart Hobijn, Federico Ravenna,
and Andrea Tambalotti
Restaurant prices in the euro area saw an
unprecedented increase after the introduction
of the euro. The authors use an extension of
commonly used models of sticky prices and
argue that the increase in restaurant prices can
be explained by menu costs. The extension
they use involves the state-dependent decision
of firms about when to adopt the euro. Two
main mechanisms drive the result. First, the
authors’ model concentrates otherwise staggered price increases around the introduction
of the euro. Second, before the adoption of the
euro, prices do not reflect marginal cost
increases expected to occur after the changeover. This horizon effect disappears as soon as
the new currency is adopted, contributing to a
jump in prices at that time. For realistic
parameter values, the model generates a blip in
inflation of the same magnitude observed in
the data.

Quantitative Methods
No. 196, December 2004

Forecasting and Estimating Multiple ChangePoint Models with an Unknown Number
of Change Points
Gary M. Koop and Simon M. Potter
The authors develop a new approach to
change-point modeling that allows for an
unknown number of change points in the
observed sample. Their model assumes that

regime durations have a Poisson distribution.
The model approximately nests the two most
common approaches: the time-varying parameter model with a change point every period
and the change-point model with a small number of regimes. The authors focus on the construction of reasonable hierarchical priors both
for regime durations and for the parameters
that characterize each regime. A Markov Chain
Monte Carlo posterior sampler is constructed
to estimate a change-point model for conditional means and variances. Koop and Potter
find that their techniques work well in an
empirical exercise involving U.S. inflation and
GDP growth. Empirical results suggest that
the number of change points is larger than previously estimated in these series and the
implied model is similar to a time-varying
parameter model with stochastic volatility.
No. 197, December 2004

Prior Elicitation in Multiple ChangePoint Models
Gary M. Koop and Simon M. Potter
This paper discusses Bayesian inference in
change-point models. Current approaches
place a possibly hierarchical prior over a
known number of change points. Koop and
Potter show how two popular priors have some
potentially undesirable properties, such as allocating excessive prior weight to change points
near the end of the sample. They discuss how
these properties relate to imposing a fixed
number of change points in the sample. Their
study develops a hierarchical approach that
allows some change points to occur out of the
sample. The authors show that this prior has
desirable properties and handles cases with
unknown change points. Their hierarchical
approach can be shown to nest a wide variety
of change-point models, from time-varying
parameter models to those with few or no
breaks. Data-based learning about the parameter that controls this variety occurs because
the authors’ prior is hierarchical.

Research and Statistics Group

7

Research Update

■

Fourth Quarter 2004

Papers Presented
by Economists in
the Research and
Statistics Group
“Lender-of-Last-Resort Breakdowns,” Leonardo
Bartolini. European Central Bank, Frankfurt,
Germany, October 26.
“The Currency Invoicing of International
Trade,” Linda Goldberg. Columbia University
Department of Economics seminar, New York
City, November 10. Also presented at a
Princeton University Department of Economics seminar, November 15. With Cédric Tille.
“Is There a Quantity Puzzle within Countries?” Linda Goldberg. Bank of Canada
Annual Research Conference, Ottawa, Canada,
November 18.

8

“Has Structural Change Contributed to a Jobless Recovery?” Erica Groshen. Conference
cosponsored by the Cato Institute and The
Economist, Washington, D.C., October 7. With
Simon Potter.
“Corporate Cash Holding: Theory and Evidence on a Cash-in-Advance Model,” Charles
Himmelberg. Arizona State University Department of Finance, October 15.
“The Stock Market Impact of CEO Certification of Bank Holding Company Financial
Statements,” Beverly Hirtle. Financial Management Association Annual Meeting, New
Orleans, Louisiana, October 7.
“A Tale of Two States,” Amartya Lahiri. Iowa
State University Department of Economics
seminar, October 8. With Kei-Mu Yi. Also
presented at the University of Iowa Conference on Development Economics, October 9,
and an Indian Statistical Institute seminar,
New Delhi, India, November 25.

Federal Reserve Bank of New York

“Segmented Asset Markets and Optimal
Exchange Rate Regimes,” Amartya Lahiri.
Reserve Bank of India seminar, Mumbai,
India, November 23. With Rajesh Singh and
Carlos Vegh.
“Demand for Fedwire Funds Transfers,” James
McAndrews. Bank Administration Institute
Money Transfer Conference, New York City,
October 28.
“Board Committee Structure, Ownership, and
Firm Performance,” Hamid Mehran. Conference cosponsored by the Journal of Financial
Intermediation and Washington University in
St. Louis, Olin School of Business, Center for
Research in Economics and Strategy, St. Louis,
Missouri, November 12. With Rachel Hayes
and Scott Schaefer.
“Conflicts of Interest in Commercial Banking,” Hamid Mehran. Ohio State University,
Fisher College of Business, Charles A. Dice
Center for Research in Financial Economics
seminar, Columbus, Ohio, December 2.
“Old and New Open-Economy Macroeconomic Models,” Paolo Pesenti. Norges Bank
Annual Meeting of Economists, Oslo, Norway,
October 19.
“The Simple Geometry of Transmission and
Stabilization in Closed and Open Economies,”
Paolo Pesenti. Columbia University Department of Economics lecture, New York City,
December 8. With Giancarlo Corsetti.
“Endogenous Pass-Through and Optimal
Monetary Policy: A Model of Self-Validating
Exchange Rate Regimes,” Paolo Pesenti. Bank
of Canada International Department seminar,
Ottawa, Canada, December 13. With Giancarlo
Corsetti. Also presented at a Vanderbilt
University Department of Economics seminar,
Nashville, Tennessee, December 6.

www.newyorkfed.org/research

“The Use of Copulas in Financial Econometrics,” Joshua Rosenberg. New York University
Stern School of Business conference, New York
City, October 1.
“Intra-Day Trade Clustering and Two-Sided
Markets,” Asani Sarkar. Baruch College,
New York City, November 23. With Robert
Schwartz and Avner Wolf.
“The Role of Industry, Geography, and Firm
Heterogeneity in Credit Risk,” Til Schuermann.
NBER conference, Woodstock, Vermont,
October 23. With M. Hashem Pesaran and
Bjoern-Jakob Treutler.
“The Relationship between Manufacturing
Production and Goods Output,” Charles Steindel.
Bureau of Economic Analysis, Washington, D.C.,
December 2.
“Bank Risk and Revenue Diversification: An
Assessment Using Equity Market Returns,”
Kevin Stiroh. Bank of Spain, Madrid, Spain,
December 2.
“Will the U.S. Productivity Resurgence Continue?” Kevin Stiroh. Universidad Complutense
de Madrid, Madrid, Spain, December 3. With
Dale W. Jorgenson and Mun S. Ho.
“Bank Risk and Revenue Diversification: An
Assessment Using Equity Returns,” Kevin
Stiroh. Federal Deposit Insurance Corporation,
Washington, D.C., December 20.

“Menu Costs at Work: Restaurant Prices and
the Introduction of the Euro,” Andrea Tambalotti.
Wesleyan University Department of
Economics, Middletown, Connecticut,
November 17. With Bart Hobijn and Federico
Ravenna.
“Financial Integration and the Wealth Effect of
Exchange Rate Fluctuations,” Cédric Tille.
Institute of International Economics
conference, Geneva, Switzerland, November 2.
Also presented at the University of Paris I,
Paris, France, November 3; Queens University,
Belfast, United Kingdom, November 5; the
Bank of England, London, England,
November 10; the London School of
Economics, London, England, November 10;
the Swiss National Bank, Zurich, Switzerland,
November 25; and the European University
Institute, Florence, Italy, November 29.
“Place of Work and Place of Residence: Informal Hiring Networks and Labor Market Outcomes,” Giorgio Topa. New York University
Department of Economics, New York City,
December 6. With Patrick Bayer and Stephen L.
Ross.
“Regulation, Capital, and the Evolution of
Organizational Form in U.S. Life Insurance,”
George Zanjani. Georgia State University
seminar, Atlanta, Georgia, November 2.

Research and Statistics Group

9

Research Update

■

Fourth Quarter 2004

Quarterly Review Articles Are Now Online
ll back issues of the Bank’s
Quarterly Review are now available
.at our website.
The Quarterly Review was the New
York Fed’s chief research publication from
1976 to 1994 and is the predecessor to the
Economic Policy Review. The new archive
was created in response to continuing
demand for many of the articles in the
series.

A

Articles are available at www.newyorkfed.
org/research/quarterly_review
/1976.html.

10

Jo i n O u r F r e e E - A l e r t S e r v i c e
Readers interested in learning of our new research quickly and conveniently
are encouraged to join our free Electronic Alert notification service.
As a subscriber to Electronic Alert, you receive an e-mail as soon as new research
publications are posted on our website—enabling you to download research well
before print copies are available.
The e-mails also offer you:
■

full abstracts of the new publications,

■

links to the publications, their press releases, author home pages, and research
on similar topics,

■

access to a range of data and charts on economic and financial conditions,

■

information on upcoming conferences and calls for papers.
Simply visit www.newyorkfed.org/alertservices/ and select “Research Alert.”

Federal Reserve Bank of New York

www.newyorkfed.org/research

Research and
Statistics Group
Publications and Papers:
October-December 2004
Publications are available at www.newyorkfed.org
/research/publication_annuals/index.html.

Economic Policy Review, vol. 10, no. 3
Are Home Prices the Next “Bubble”?
Jonathan McCarthy and Richard W. Peach
The Historical and Recent Behavior
of Goods and Services Inflation
Richard W. Peach, Robert Rich,
and Alexis Antoniades
Origins of the Federal Reserve BookEntry System
Kenneth D. Garbade
Economizing on Liquidity with Deferred
Settlement Mechanisms
Kurt Johnson, James J. McAndrews,
and Kimmo Soramäki

Current Issues in Economics
and Finance, vol. 10
No. 11, November 2004

Recent Innovations in Treasury Cash
Management
Kenneth D. Garbade, John C. Partlan,
and Paul J. Santoro
No. 12, December 2004

New York and New Jersey Poised
for Modest Job Growth in 2005
James Orr and Rae Rosen
Second District Highlights
No. 13, December 2004

Will the U.S. Productivity Resurgence
Continue?
Dale W. Jorgenson, Mun S. Ho,
and Kevin J. Stiroh

Staff Reports
Available only online.
No. 195, October 2004

Menu Costs at Work: Restaurant Prices
and the Introduction of the Euro
Bart Hobijn, Federico Ravenna,
and Andrea Tambalotti
No. 196, December 2004

Forecasting and Estimating Multiple ChangePoint Models with an Unknown Number
of Change Points
Gary M. Koop and Simon M. Potter
No. 197, December 2004

Prior Elicitation in Multiple ChangePoint Models
Gary M. Koop and Simon M. Potter

The views expressed in the publications and papers summarized in Research Update are those
of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York
or the Federal Reserve System.
Research and Statistics Group

11