Can financial innovation help to explain the reduced volatility of economic activity?
The stabilization of economic activity in the mid 1980s has received considerable attention. Research has focused primarily on the role played by milder economic shocks, improved inventory management, and better monetary policy. This paper explores another potential explanation: financial innovation. Examples of such innovation include developments in lending practices and loan markets that have enhanced the ability of households and firms to borrow and changes in government policy such as the demise of Regulation Q. We employ a variety of simple empirical techniques to identify links between ...
Taxation of labor income and the demand for risky assets
It is well known that the implicit insurance provided by labor income taxes can reduce total saving. We show that this insurance can change the composition of saving as well, because the reduction in labor-income risk may affect the amount of financial risk that an individual chooses to bear. Given plausible restrictions on preferences, any change in taxes that reduces an individual's labor-income risk and does not make her worse off will lead her to invest more in risky assets. This effect can be quantitatively important for realistic changes in tax rates.
The effect of interest-rate changes on household saving and consumption: a survey
Direct estimates of the interest elasticity of saving suffer from several serious problems. As an alternative, this survey uses an indirect approach that combines models of individual behavior with estimates of certain features of individuals' preferences. The paper examines the effect of interest-rate changes on the consumption and saving of people who follow the lifecycle model, who plan to leave bequests, who save to reach a fixed target, and who have short planning horizons. The models that likely describe the behavior of the people who account for most of aggregate saving imply positive ...
Do provisional estimates of output miss economic turning points?
Initial estimates of aggregate output and its components are based on very incomplete source data, so they may not fully capture shifts in economic conditions. In particular, if those estimates are based partly on trends in preceding quarters, provisional estimates may overstate activity when actual output is decelerating and understate it when actual output is accelerating. We examine this issue using the Real Time Data Set for Macroeconomists, which contains contemporaneous estimates of GNP or GDP and its components beginning in the late 1960s, as well as financial-market information and ...
Declining required reserves and the volatility of the federal funds rate.
Low required reserve balances in 1991 led to a sharp increase in the volatility of the federal funds rate, but similarly low balances in 1996 did not. This paper develops and simulates a microeconomic model of the funds market that explains these facts. We show that reductions in reserve balances increase the volatility of the federal funds rate, but that this relationship changes over time in response to observable changes in bank behavior. The model predicts that a continued decline in required reserves could increase funds-rate volatility significantly.
Financial innovation and the Great Moderation: what do household data say?
Aggressive deregulation of the household debt market in the early 1980s triggered innovations that greatly reduced the required home equity of U.S. households, allowing them to cash-out a large part of accumulated equity. In 1982, home equity equaled 71 percent of GDP; so this generated a borrowing shock of huge macroeconomic proportions. The combination of increasing household debt from 43 to 56 percent of GDP with high interest rates during the 1982-1990 period is consistent with such a shock to households? demand for funds. This paper uses a quantitative general equilibrium model of ...
Should America save for its old age? Population aging, national saving, and fiscal policy
While popular wisdom holds that the United States should save more now in anticipation of the aging of the baby boom generation, the optimal response to population aging from a macroeconomic perspective is not clear-cut. Indeed, Cutler, Poterba, Sheiner, and Summers ("CPSS",1990) argued that the optimal response to the coming demographic transition was more likely to be a reduction in national saving than an increase. In this paper we reexamine this question. In particular, we ask how the optimal saving response depends on the openness of our economy, on how we view the consumption of ...
The evolution of household income volatility
Using data from the PSID, we find that household income has become noticeably more volatile during the past thirty years. We estimate that the standard deviation of percent changes in household income rose one-fourth between the early 1970s and early 2000s. This widening in the distribution of percent changes is concentrated in the tails of the distribution, and especially in the lower tail: Changes between the 25th and 75th percentiles are almost the same size now as thirty years ago, but changes at the 10th percentile look substantially more negative. The boost in volatility occurred ...
The effect of stock prices on the demand for money market mutual funds
During the 1990s, households have sharply increased the share of their portfolios held in equities and mutual funds and sharply reduced the share held in bank accounts. We show that this reallocation has substantially increased the impact of financial-market developments on the demand for money. Specifically, both increases and decreases in the Wilshire 5000 have boosted the demand for money funds during the 1990s, although they had little effect on money funds during the 1980s. The estimated effects in the 1990s are generally statistically significant and economically important.