Full text of Research Update : October 2002

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October 2002

Research
U P D AT E
f ro m t h e Fe d e ra l Re s e r ve B an k of Ne w Yo r k
RESEARCH AND MARKET ANALYSIS GROUP

w w w. n e w y o r k f e d . o r g / r m a g h o m e

EPR Articles Now Available in Convenient Summary Form
Readers can now visit our web site for concise
summaries of Economic Policy Review (EPR)
articles.
Our new on-line publication—EPR Executive
Summaries—enhances the delivery of New
York Fed research by condensing many of the
articles in our flagship journal. Readers of
these summaries will find timely, policyoriented studies that are easier and faster to
absorb, with links to key charts, related articles, and other resources.
The summaries make the technical
research of New York Fed economists more
accessible to policymakers, educators, business and financial leaders, and others. They
aim to promote a fuller understanding of our
research among those in a position to put our
ideas and findings to work.
Summaries are now available for a range of
papers from a recent volume on financial
innovation and monetary transmission:

• Monetary Policy Transmission through the
Consumption-Wealth Channel—Sydney
Ludvigson, Charles Steindel, and Martin
Lettau
• Monetary Policy Transmission to Residential Investment—Jonathan McCarthy and
Richard W. Peach
• On the Causes of the Increased Stability of
the U.S. Economy—James A. Kahn,
Margaret M. McConnell, and Gabriel
Perez-Quiros
• Credit Effects in the Monetary Mechanism—Cara S. Lown and Donald P. Morgan
• Securitization and the Efficacy of Monetary
Policy—Arturo Estrella
www.newyorkfed.org/rmaghome/execsumm
To be notified of new postings, sign up for
our free Electronic Alert service. Simply visit
www.newyorkfed.org/rmaghome and click on
“E-Mail Alert.”

• Are U.S. Reserve Requirements Still Binding?—
Paul Bennett and Stavros
Inside . . .
Peristiani
Why
hasn’t electronic bill presentment
• Assessing Changes in the Moneand payment taken off?
tary Transmission Mechanism:
New Staff Reports
A VAR Approach—Jean Boivin
Papers recently published by RMAG staff
and Marc Giannoni
Papers presented at conferences

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Ne w Research: July–September 2002

Federal Reser ve Bank of Ne w York

Coordination and Cost Problems Hinder Adoption
of Electronic Billing
When electronic bill presentment and payment (EBPP) was introduced in the
mid-1990s, it was widely expected to find
immediate favor. The promised benefits were
compelling—low processing and customer
service costs for billers, savings in time and
postage for customers. Surprisingly, however,
firms and households have been slow to
accept the new technology. Industry estimates suggest that less than 1 percent of
consumer and business-to-business bills in
the United States in 2001 were delivered and
paid over the Internet.
In a new study (“Why Hasn’t Electronic Bill
Presentment and Payment Taken Off?”
Current Issues in Economics and Finance,
vol. 8, no. 7), Chris Stefanadis attributes the
weak reception given electronic billing to the
difficulty of coordinating participants on the
two sides of the billing transaction. “In the
absence of any assurance that most customers will accept the new technology,” the
author writes, “billers have refrained from
adopting it.” By the same token, “customers
have resisted the new systems in the belief
that only some of their billers will implement
EBPP.”

The substantial up-front costs of EBPP
have added to the difficulty of mobilizing
billers and customers, according to
Stefanadis. Billers fear that they will be unable
to recover their large fixed investment in the
technology—ranging from $150,000 to $1 million—because not enough customers will link
to the new systems. Customers, for their part,
are reluctant to commit the time needed to
learn a technology that may give them access
to only a portion of their bills.
To resolve the coordination problem,
Stefanadis suggests, EBPP providers could
step up research and development efforts to
create electronic billing systems so clearly
superior to paper-based systems that they
would win over large numbers of both billers
and customers. Alternatively, providers and
billers could establish standard-setting committees to promote uniformity in EBPP
systems, undertake aggressive advertising
campaigns to alert customers to the benefits
of electronic billing, or offer bonuses and discounts to customers who enroll in the
networks.

Publications and Papers
The Research and Market Analysis Group produces a wide range of publications:
• The Economic Policy Review—a policy-oriented journal focusing on economic
and financial market issues.
• Current Issues in Economics and Finance—a newsletter-style publication offering
concise and timely analyses of economic and financial topics.
• Second District Highlights—a regional supplement to Current Issues covering financial
and economic developments in the Federal Reserve System’s Second District.
• Staff Reports—technical papers intended for publication in leading economic
and finance journals. This series is available only on-line.
• Publications and Other Research—an annual catalogue of the Group’s research output.

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New Titles in the Staff Reports Series
The following new Staff Reports are available

International

at www.newyorkfed.org/rmaghome/staff_rp/.

No. 150

Macroeconomics and Growth
No. 153

Borrowers’ Financial Constraints and the
Transmission of Monetary Policy: Evidence
from Financial Conglomerates
Adam B. Ashcraft and Murillo Campello

Building on recent evidence on the functioning of
internal capital markets in financial conglomerates,
the authors conduct a novel test of the balance-sheet
channel of monetary policy. Specifically, they investigate how the lending response to monetary policy
differs across small banks that are affiliated with the
same bank holding company but operate in different
geographical areas. These banks face similar constraints accessing internal and external sources of
funds, but have different pools of borrowers. Because
the banks typically concentrate their lending with
small local businesses, the authors can exploit crosssectional differences in local economic indicators at
the time of a policy shock to study whether the
strength of borrowers’ balance sheets affects the
response of bank lending. They find evidence that the
negative response of bank loan growth to a monetary
contraction is significantly stronger when borrowers
have weaker balance sheets.

Stop-Loss Orders and Price Cascades
in Currency Markets
C. L. Osler

This analysis of high-frequency exchange rates offers
three main findings to support the hypothesis that
stop-loss orders contribute to rapid, self-reinforcing
price movements, or “price cascades.” Namely, it finds
that: exchange rate trends are unusually fast when
rates reach levels at which stop-loss orders cluster; the
response to stop-loss orders is larger than the
response to take-profit orders, which generate negativefeedback trading and are unlikely to contribute to
price cascades; and the response to stop-loss orders
lasts longer than the response to take-profit orders.
These results indicate that stop-loss orders propagate
trends and are sometimes triggered in waves, contributing to price cascades. Stop-loss-propagated
price cascades may help explain the well-known “fat
tails” of the distribution of exchange rate returns and
the high frequency of large exchange rate moves.

www.ne wyorkfed.org/r maghome

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Federal Reser ve Bank of Ne w York

No. 151

Uncertainty, Exchange Rate Regimes,
and National Price Levels
Christian Broda

Large differences in national price levels exist across
countries. This paper develops a general equilibrium
model predicting that these differences should be
related to countries’ exchange rate regimes. The
empirical findings confirm that countries with fixed
exchange rate regimes have higher national price levels than countries with flexible regimes. At the
disaggregate level, the relationship between exchange
rate regimes and national price levels is stronger for
nontraded goods than for traded goods. The study
also finds that measuring the misalignment in
national price levels around times of regime shifts
without considering a break in its equilibrium value
results in an overestimation of the true misalignment.
No. 152

Self-Validating Optimum Currency Areas
Giancarlo Corsetti and Paolo Pesenti

A currency area can be a self-validating optimal policy regime, even when monetary unification does not
foster real economic integration and intra-industry
trade. In the authors’ model, firms choose the optimal
degree of exchange rate pass-through to export prices
while accounting for expected monetary policies, and
monetary authorities choose optimal policy rules
while taking firms’ pass-through as given. The
authors show that two equilibria exist, each of which
defines a self-validating currency regime. In the first,
firms preset prices in a domestic currency and let

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prices in the foreign currency be determined by the
law of one price. Optimal policy rules then target the
domestic output gap, and floating exchange rates support the flex-price allocation. In the second, firms
preset prices in a consumer currency, and a monetary
union is the optimal policy choice for all countries.
Although a common currency helps synchronize
business cycles across countries, flexible exchange
rates deliver a superior welfare outcome.

Banking and Finance
No. 154

Diversification in Banking: Is Noninterest
Income the Answer?
Kevin J. Stiroh

The U.S. banking industry is steadily increasing its
reliance on nontraditional business activities that
generate fee income, trading revenue, and other types
of noninterest income. This paper assesses potential
diversification benefits from this shift. At the aggregate level, declining volatility of net operating revenue
reflects reduced volatility of net interest income,
rather than diversification benefits from noninterest
income, which is quite volatile and has become more
correlated with net interest income. At the bank level,
growth rates of net interest income and noninterest
income have also become more correlated in recent
years. Finally, greater reliance on noninterest income,
particularly trading revenue, is associated with higher
risk and lower risk-adjusted profits. These results
suggest little obvious diversification benefit from the
ongoing shift toward noninterest income.

Recently Published
Arturo Estrella. 2002. “Dynamic Inconsistencies:
Counterfactual Implications of a Class of Rational
Expectations Models,” with Jeffrey Fuhrer. American
Economic Review 92, no. 4 (September).
Michael Fleming. 2002. “Are Larger Treasury Issues
More Liquid? Evidence from Bill Reopenings.” Journal
of Money, Credit, and Banking 34, no. 3 (August):
707-35.
Michael Fleming. 2002.“U.S. Treasury Securities,” with
Frank J. Fabozzi. In Frank J. Fabozzi, ed., The
Handbook of Financial Instruments, 185-201.
Hoboken, N.J.: John Wiley & Sons.
Andrew Haughwout. 2002. “Public Infrastructure
Investments, Productivity, and Welfare in Fixed
Geographic Areas.” Journal of Public Economics 83,
no. 3: 405-28.
Margaret McConnell. 2002. “Policymakers’ Revealed
Preferences and the Output-Inflation Variability Tradeoff: Implications for the European System of Central
Banks,” with Stephen G. Cecchetti. Manchester School
of Economic and Social Studies 70, no. 4: 596-618.
Donald Morgan. 2002. “Rating Banks: Risk and
Uncertainty in an Opaque Industry.” American
Economic Review 92, no. 4 (September).

Joshua Rosenberg. 2002. “Empirical Pricing Kernels,”
with Robert F. Engle. Journal of Financial Economics
64, no. 3: 341-72.
Til Schuermann. 2002. “Ratings Migration and the
Business Cycle, with Applications to Credit Portfolio
Stress Testing,” with Anil Bangia and Francis Diebold.
Journal of Banking and Finance 26, no. 2-3: 235-64.
Kevin Stiroh. 2002. “The Economic Impacts of
Information Technology.” In Hossein Bidgoli, ed.,
Encyclopedia of Information Systems, 1-15.
Amsterdam: Academic Press.
Kevin Stiroh. 2002. “Investment and Productivity
Growth: A Survey from the Neoclassical and New
Growth Perspectives.” In Someshwar Rao and Andrew
Sharpe, eds., Productivity Issues in a Canadian
Context, 441-79. Calgary: University of Calgary Press.
Kevin Stiroh. 2002. “Measuring Information
Technology and Productivity in the New Economy.”
World Economics 3, no. 1: 43-58.
George Zanjani. 2002. “Pricing and Capital Allocation
in Catastrophe Insurance.” Journal of Financial
Economics 65, no. 2 (August): 283-305.

Paolo Pesenti. 2002. “Can Nontradables Generate
Substantial Home Bias?” with Eric van Wincoop.
Journal of Money, Credit, and Banking 34, no. 1:
25-50.

www.ne wyorkfed.org/r maghome

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Federal Reser ve Bank of Ne w York

Papers Presented by Economists in the Research
and Market Analysis Group
“Modeling Regional Interdependencies,” Til
Schuermann. National Bureau of Economic Research
Summer Institute, Cambridge, Massachusetts,
July 24.With M. Hashem Pesaran and Scott Weiner.

“Reassessing the Role of IT in the Production Function:
A Meta-Analysis,” Kevin Stiroh. National Bureau of
Economic Research Summer Institute, Cambridge,
Massachusetts, July 29.

The authors develop a modeling framework with a
compact representation of factor and regional interdependencies to forecast global macroeconomic and
financial variables.

Using a meta-analysis across twenty studies, Stiroh
finds that methodological differences account for
about 40 percent of the variation in the estimated output elasticity of information technology.

“Deposit Insurance and Risk Management: How
Much? How Safe? Who Pays?” Til Schuermann.
Federal Deposit Insurance Corporation Conference,
Washington, D.C., September 13. With M. Hashem
Pesaran and Scott Weiner.

“How Valuable Is Exchange Rate Flexibility? Optimal
Monetary Policy under Sectoral Shocks,” Cédric Tille.
Society for Economic Dynamics Annual Meeting,
New York University, New York City, June 30.

This paper examines deposit insurance by analyzing a fund’s size, coverage pricing, and ownership of loss. It
finds that funds with reserves sufficient to cover about
99.85 percent of any loss distribution would have a corresponding rating of about BBB+.

The paper analyzes the optimal monetary policy
response to productivity shocks while allowing for
incomplete international specialization. Tille finds that
the value of exchange rate flexibility is significantly
lower than the value found in earlier studies that
assume complete international specialization.

“Exclusive Dealing,” Chris Stefanadis. Western Economic Association Conference, Seattle,Washington, July 1.
The paper argues that free riding—rather than efficiency gains—may be the driving force behind
anticompetitive exclusive dealing.

Ot her New Publicat ions
• The Regional Economy of Upstate New York: This quarterly newsletter, produced by the
New York Fed’s Buffalo Branch, focuses on issues of importance to upstate New York.
In the summer issue, authors Jane Schmitt, Richard Deitz, and Ramon Garcia report on a
recent conference exploring the challenges faced by Buffalo’s manufacturing sector.
www.newyorkfed.org/rmaghome/regional/newsletter.html

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“Can Vertical Specialization Explain the Growth
of World Trade?” Kei-Mu Yi. Centre for Economic
Policy Research Annual European Workshop in
International Trade, University of Munich, Munich,
Germany, June 16.
Yi shows that adding vertical specialization to standard trade models helps produce a more accurate
explanation of world trade growth in the past forty
years.

“A Simple Explanation of the Border Effect,” Kei-Mu Yi.
Society for Economic Dynamics Annual Meeting,
New York University, New York City, June 30.
This paper argues that the border effect—a puzzle
in which the volume of international trade should be
much higher than it is in relation to the volume of
regional domestic trade—can be explained by two
facts: goods are usually made in multiple stages, and
moving these goods at various stages within a region
costs less than moving them across international
borders.

www.ne wyorkfed.org/r maghome

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Federal Reser ve Bank of Ne w York

RESEARCH AND MARKET ANALYSIS GROUP
PUBLICATIONS AND PAPERS:
July-September 2002
Publications are available at www.newyork
fed.org/rmaghome. You can also subscribe
or obtain many back issues from our web site.

Economic Policy Review, Forthcoming
A special volume devoted to policies
to promote affordable housing:
The Twenty-Fifth Anniversary of the
Community Reinvestment Act:
Past Accomplishments and Future
Regulatory Challenges
William C. Apgar and Mark Duda
State of New York City’s Housing
and Neighborhoods: An Overview
of Recent Trends
Michael H. Schill and Glynis Daniels
Government Regulation and Changes
in the Affordable Housing Stock
C. Tsuriel Somerville and Christopher J. Mayer
The Impact of Building Restrictions
on Housing Affordability
Edward L. Glaeser and Joseph Gyourko

Staff Reports
Available only on-line.
No. 150
Stop-Loss Orders and Price Cascades
in Currency Markets
C. L. Osler
No. 151
Uncertainty, Exchange Rate Regimes,
and National Price Levels
Christian Broda
No. 152
Self-Validating Optimum Currency Areas
Giancarlo Corsetti and Paolo Pesenti
No. 153
Borrowers’ Financial Constraints and the
Transmission of Monetary Policy: Evidence
from Financial Conglomerates
Adam B. Ashcraft and Murillo Campello
No. 154
Diversification in Banking: Is Noninterest
Income the Answer?
Kevin J. Stiroh

Current Issues in Economics
and Finance, Vol. 8
No. 7
Why Hasn’t Electronic Bill Presentment
and Payment Taken Off?
Chris Stefanadis

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.