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This paper uses high-frequency financial data to analyze the effects of US monetary policy—during the conventional and unconventional policy regimes—on international bonds markets. We focus on yields of dollar-denominated sovereign bonds issued by more than 90 countries since the early 1990s, which allows us to abstract from the policy-induced movements in exchange rates that otherwise confound the response of yields on foreign bonds denominated in local currencies. Our results show that yields on dollar-denominated sovereign debt are highly responsive to unanticipated changes in the stance of US monetary policy during both the conventional and unconventional policy regimes, and that the passthrough of unconventional policy actions to foreign bond yields is, on balance, comparable to that of conventional policy actions. In addition, a conventional US monetary easing leads to a significant narrowing of credit spreads on sovereign bonds issued by countries with a speculative-grade credit rating. During the unconventional policy regime, however, yields on speculative-grade sovereign debt move one-to-one with policy-induced fluctuations in yields on comparable US Treasuries. We also examine whether the response of sovereign credit spreads to US monetary policy differs between policy easings and policy tightenings and find no evidence of such asymmetry. This finding casts doubt on the notion that US monetary easings induce excessive risk-taking in international bond markets.

This paper examines the relationship between sovereign bond spreads, local economic activity, and global financial risk. We use secondary-market prices of dollar-denominated sovereign securities to construct yield spreads between sovereign bond yields and yields on the appropriately defined default risk-free securities, constructed using zero-coupon U.S. Treasury yields. We use these spreads to construct country-specific sovereign bond spreads for a sample of almost 50 countries over the 1980-2012 period. We then examine the extent to which movements in sovereign spreads are determined by local risk factors, such as fluctuations in exchange rates and local stock market returns, versus global risk factors that arguably proxy for risk-attitudes that prevail in U.S. financial markets. To measure global risk factors we rely on the excess bond premium constructed by Gilchrist and Zakrajsek (2012). The excess bond premium is a measure of distress in U.S. corporate bond markets and comoves closely with conditions in financial markets. According to GZ, the excess bond premium provides a quantitative measure of the risk-attitudes of financial intermediaries. Our results indicate that a substantial portion of the comovement among sovereign spreads can be accounted for by changes in such global risk factors. We also examine the extent to which, during the 2007-09 financial crisis, such global risk factors were related to perceived default risk in the U.S. financial sector. Next, we extend our methodology to construct credit spreads for euro-denominated sovereign bonds for about 40 countries over the 2000-2012 period, and we examine the implications of our empirical pricing framework for comovement among sovereign spreads during the ongoing turmoil in European sovereign debt markets. Lastly, we study the e§ect of various stabilization policy announcements during the recent financial crisis on sovereign bond spreads through the global risk factors. We also compare the impacts of stabilization policy measures during financial crises in the past. Lastly, we construct a general equilibrium model of sovereign debt and default to rationalize the empirical findings. The model features include a risk-averse global investor, optimal default, and endogenous debt dynamics for multiple countries. The sovereign default and bond prices depend on the borrower's economic conditions as well as the lender's risk aversion and riskiness. We quantitatively examine the link between the financial risk that the lender faces and the distribution of sovereign risk.

We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the corporate bond market in the wake of the Covid-19 shock. The Fed announced the SMCCF on March 23 and expanded the program on April 9. Regression discontinuity estimates imply that these announcements reduced credit spreads on bonds eligible for purchase 70 basis points. We refine this analysis by constructing a sample of bonds—issued by the same set of companies—which differ in their SMCCF eligibility. A diff-in-diff analysis shows that both announcements had large effects on credit spreads, narrowing spreads 20 basis points on eligible bonds relative to their ineligible counterparts within the same set of issuers across the two announcement periods. The March 23 announcement also reduced bid-ask spreads ten basis points within ten days of the announcement. By lowering credit spreads and improving liquidity, the April 9 announcement had an especially pronounced effect on “fallen angels.” The actual purchases lowered credit spreads by an additional five basis points and bid-ask spreads by two basis points. These results confirm that the SMCCF made it easier for companies to borrow in the corporate bond market.

We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the corporate bond market in the wake of the Covid-19 shock. The Fed announced the SMCCF on March 23 and expanded the program on April 9. Regression discontinuity estimates imply that these announcements reduced credit spreads on bonds eligible for purchase 70 basis points. We refine this analysis by constructing a sample of bonds--issued by the same set of companies--which differ in their SMCCF eligibility. A diff-in-diff analysis shows that both announcements had large effects on credit spreads, narrowing spreads 20 basis points on eligible bonds relative to their ineligible counterparts within the same set of issuers across the two announcement periods. The March 23 announcement also reduced bid-ask spreads ten basis points within ten days of the announcement. By lowering credit spreads and improving liquidity, the April 9 announcement had an especially pronounced effect on "fallen angels.'' The actual purchases lowered credit spreads by an additional five basis points and bid-ask spreads by two basis points. These results confirm that the SMCCF made it easier for companies to borrow in the corporate bond market.

Using an international panel data set, we analyse the implications of rising income inequality for aggregate consumption. We document that greater concentration of (after-tax) income in the top decile is associated with a significantly larger and more persistent contraction in consumption in the aftermath of economic downturns. These findings are consistent with lower propensities to consume among wealthier households and imply that disparities in income flows at turning points of the business cycle can significantly influence macroeconomic outcomes.

The extraordinary events surrounding the Great Recession have cast a considerable doubt on the traditional sources of macroeconomic instability. In their place, economists have singled out financial and uncertainty shocks as potentially important drivers of economic fluctuations. Empirically distinguishing between these two types of shocks, however, is difficult because increases in economic uncertainty are strongly associated with a widening of credit spreads, an indication of a tightening in financial conditions. This paper uses the penalty function approach within the SVAR framework to examine the interaction between financial conditions and economic uncertainty and to trace out the impact of these two types of shocks on the economy. The results indicate that (1) financial shocks have a significant adverse effect on economic outcomes and that such shocks were an important source of cyclical fluctuations since the mid-1980; (2) uncertainty shocks, especially those implied by uncertainty proxies that do not rely on financial asset prices, are also an important source of macroeconomic disturbances; and (3) uncertainty shocks have an especially negative economic impact in situations where they elicit a concomitant tightening of financial conditions. Evidence suggests that the Great Recession was likely an acute manifestation of the toxic interaction between uncertainty and financial shocks.

This paper analyzes how US monetary policy affects the pricing of dollar-denominated sovereign debt. We document that yields on dollar-denominated sovereign bonds are highly responsive to US monetary policy surprises--during both the conventional and unconventional policy regimes--and that the passthrough of unconventional policy to foreign bond yields is, on balance, comparable to that of conventional policy. In addition, a conventional US monetary easing (tightening) leads to a significant narrowing (widening) of credit spreads on sovereign bonds issued by countries with a speculative-grade credit rating but has no effect on the corresponding weighted average of bilateral exchange rates for a basket of currencies from the same set of risky countries; this indicates that an unanticipated tightening of US monetary policy widens credit spreads on risky sovereign debt directly through the financial channel, as opposed to indirectly through the exchange rate channel. Durin g the unconventional policy regime, yields on both investment- and speculative-grade sovereign bonds move one-to-one with policy-induced fluctuations in yields on comparable US Treasuries. We also examine whether the response of sovereign credit spreads to US monetary policy differs between policy easings and tightenings and find no evidence of such asymmetry.

We propose an econometric framework for estimating capital shortfalls of bank holding companies (BHCs) under pre-specified macroeconomic scenarios. To capture the nonlinear dynamics of bank losses and revenues during periods of financial stress, we use a fixed effects quantile autoregressive (FE-QAR) model with exogenous macroeconomic covariates, an approach that delivers a superior out-of-sample forecasting performance relative to the standard linear framework. According to the out-of-sample forecasts, the realized net charge-offs during the 2007–09 crisis fall within the multi-step-ahead density forecasts implied by the FE-QAR model, but are frequently outside the density forecasts generated using the corresponding linear model. This difference reflects the fact that the linear specification substantially underestimates loan losses, especially for real estate loan portfolios. Employing the macroeconomic stress scenario used in CCAR 2012, we use the density forecasts generated by the FE-QAR model to simulate capital shortfalls for a panel of large BHCs. For almost all institutions in the sample, the FE-QAR model generates capital shortfalls that are considerably higher than those implied by its linear counterpart, which suggests that our approach has the potential to detect emerging vulnerabilities in the financial system.

Estimating the effect of Federal Reserve’s announcements of Large-Scale Asset Purchase (LSAP) programs on corporate credit risk is complicated by the simultaneity of policy decisions and movements in prices of risky financial assets, as well as by the fact that both interest rates of assets targeted by the programs and indicators of credit risk reacted to other common shocks during the recent financial crisis. This paper employs a heteroskedasticity-based approach to estimate the structural coefficient measuring the sensitivity of market-based indicators of corporate credit risk to declines in the benchmark market interest rates prompted by the LSAP announcements. The results indicate that the LSAP announcements led to a significant reduction in the cost of insuring against default risk—as measured by the CDX indexes—for both investment- and speculative-grade corporate credits. While the unconventional policy measures employed by the Federal Reserve to stimulate the economy have substantially lowered the overall level of credit risk in the economy, the LSAP announcements appear to have had no measurable effect on credit risk in the financial intermediary sector.

Beginning with the publication of this Note, we will provide updated estimates of the EBP and the associated model-implied probability of a U.S. recession every month.

In this FEDS Note, we evaluate the information content for recession risk of a component of credit spreads that is not directly attributable to expected default risk and thus to news about future cash flows.

The depth and duration of the 2007–09 recession serves as a powerful reminder of the real consequences of financial shocks. Although channels through which disruptions in financial markets can affect economic activity are relatively well understood from a theoretical perspective, assessing their quantitative implications for the real economy remains a considerable challenge. This paper examines the extent to which the workhorse New Keynesian model—augmented with the standard financial accelerator mechanism—is capable of producing the dynamics of the U.S. economy during the recent financial crisis. To do so, we employ the methodology of Gilchrist and Zakrajsek (2011) to construct a measure of shocks to the financial sector, which is then used to simulate the model over the crisis period. The results indicate that a reasonably calibrated version of the model can closely match the observed decline in economic activity and can account for the sharp widening of nonfinancial credit spreads, a decline in nominal short-term interest rates, and for the persistent disinflation experienced in the wake of financial disruptions. Given its empirical relevance, we then use this framework to analyze the potential benefits of a monetary policy rule that allows the short-term nominal rate to respond to changes in financial conditions as measured by movements in credit spreads. The results indicate that such a spread-augmented policy rule can effectively dampen the negative consequences of financial disruptions on real economic activity, while engendering only a modest increase in inflation.

Using U.S. data from 1929 to 2013, we show that elevated credit-market sentiment in year t 2 is associated with a decline in economic activity in years t through t+2. Underlying this result is the existence of predictable mean reversion in credit-market conditions. That is, when our sentiment proxies indicate that credit risk is aggressively priced, this tends to be followed by a subsequent widening of credit spreads, and the timing of this widening is, in turn, closely tied to the onset of a contraction in economic activity. Exploring the mechanism, we find that buoyant credit-market sentiment in year t 2 also forecasts a change in the composition of external finance: net debt issuance falls in year t, while net equity issuance increases, patterns consistent with the reversal in credit-market conditions leading to an inward shift in credit supply. Unlike much of the current literature on the role of financial frictions in macroeconomics, this paper suggests that time-variation in expected returns to credit market investors can be an important driver of economic fluctuations.

We quantify the cross-sectional and time-series behavior of the wedge between the cost of external and internal finance by estimating the structural parameters of a canonical debt-contracting model with informational frictions. For this purpose, we construct a new dataset that includes balance sheet information, measures of expected default risk, and credit spreads on publicly traded debt for about 900 U.S. firms over the period 1997Q1 to 2003Q3. Using nonlinear least squares, we obtain precise time-specific estimates of the bankruptcy cost parameter and consistently reject the null hypothesis of frictionless financial markets. For most of the firms in our sample, the estimated premium on external finance was very low during the expansionary period 1997-99, but rose sharply in 2000--especially for firms with higher ratios of debt to equity--and remained elevated until early 2003.

This paper compares the effects of conventional monetary policy on real borrowing costs with those of the unconventional measures employed after the target federal funds rate hit the zero lower bound (ZLB). For the ZLB period, we identify two policy surprises: changes in the two-year Treasury yield around policy announcements and changes in the ten-year Treasury yield that are orthogonal to those in the two-year yield. The efficacy of unconventional policy in lowering real borrowing costs is comparable to that of conventional policy, in that it implies a complete pass-through of policy-induced movements in Treasury yields to comparable-maturity private yields. (JEL E31, E43, E44, E52)

Micro- and macro-level evidence indicates that fluctuations in idiosyncratic uncertainty have a large effect on investment; the impact of uncertainty on investment occurs primarily through changes in credit spreads; and innovations in credit spreads have a strong effect on investment, irrespective of the level of uncertainty. These findings raise a question regarding the economic significance of the traditional "wait-and-see" effect of uncertainty shocks and point to financial distortions as the main mechanism through which fluctuations in uncertainty affect macroeconomic outcomes. The relative importance of these two mechanisms is analyzed within a quantitative general equilibrium model, featuring heterogeneous firms that face time-varying idiosyncratic uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions. The model successfully replicates the stylized facts concerning the macroeconomic implications of uncertainty and financial shocks. By influencing the effective supply of credit, both types of shocks exert a powerful effect on investment and generate countercyclical credit spreads and procyclical leverage, dynamics consistent with the data and counter to those implied by the technology-driven real business cycle models.

In the current regulatory framework, capital requirements are based on risk-weighted assets, but all business loans carry a uniform risk weight, irrespective of variations in credit risk. The proposed new Capital Accord of the Bank for International Settlements provides for a greater sensitivity of capital requirements to credit risk, raising the question of whether, and to what extent, the new capital standards will intensify business cycles. In this paper, we evaluate the potential cyclical effects of the ""standardized approach"" to risk evaluation in the new Accord, which involves the ratings of external agencies. We combine Moody's data on changes in U.S. borrowers' credit ratings since 1970 with estimates of the risk profile of business loans at commercial banks from the Survey of Terms of Business Lending, and also a risk profile estimated by Treacy and Carey (1998). We find that the level of required capital against business loans would be noticeably lower under the new Accord compared with the current regime. We do not find evidence of any substantial additional cyclicality in required capital levels under the standardized approach of the new Accord relative to the current regime.

A core prediction of the Heckscher-Ohlin theory is that countries specialize in goods in which they have a comparative advantage, and that the source of comparative advantage is differences in relative factor supplies. To examine this theory, we use the most extensive dataset available and document the pattern of industrial specialization and factor endowment differences in a broad sample of rich and developing countries over a lengthy period (1970-92). Next, we develop an empirical model of specialization based on factor endowments, allowing for unmeasurable technological differences and estimate it using panel data techniques. In addition to estimating the effects of factor endowments, we also consider an alternative hypothesis that the level of aggregate productivity by itself can explain specialization. Our results clearly show the importance of factor endowments on specialization: relative endowments do matter.

A recent influential paper (O'Connell 1998) argues that panel data evidence in favor of purchasing power parity disappears once test procedures are altered to accommodate heterogenous cross-sectional dependence among real exchange rate innovations. We present evidence to the contrary. First, we modify two extant panel unit root panel unit root tests to eliminate the upward size distortion induced by contemporaneous cross-sectional dependence. Second, we exploit a recently-introduced test, based on SUR techniques, that also remains valid in the presence of cross-sectional dependence. Using the three new tests, we find overwhelming evidence in favor of real exchange rate stationarity during the post-Bretton Woods era among OECD economies, as well as among a larger group of "open" economies. We also find emphatic evidence of stationarity using O'Connell's GLS test. Bias-corrected parameter estimates indicate that deviations from PPP erode more quickly for real exchange rates defined using wholesale rather than consumer price indices. Monte Carlo experiments indicate that several of the tests discussed here have considerable power against the unit root null.

Using confidential product-level price data underlying the U.S. Producer Price Index (PPI), this paper analyzes the effect of changes in firms' financial conditions on their price-setting behavior during the "Great Recession" that surrounds the financial crisis. The evidence indicates that during the height of the crisis in late 2008, firms with "weak" balance sheets increased prices significantly relative to industry averages, whereas firms with "strong" balance sheets lowered prices, a response consistent with an adverse demand shock. These stark differences in price-setting behavior are consistent with the notion that financial frictions may significantly influence the response of aggregate inflation to macroeconomic shocks. We explore the implications of these empirical findings within a general equilibrium framework that allows for customer markets and departures from the frictionless financial markets. In the model, firms have an incentive to set a low price to invest in market share, though when financial distortions are severe, firms forgo these investment opportunities and maintain high prices in an effort to preserve their balance-sheet capacity. Consistent with our empirical findings, the model with financial distortions—relative to the baseline model without such distortions—implies a substantial attenuation of price dynamics in response to contractionary demand shocks.

Estimating the effect of Federal Reserve's announcements of Large-Scale Asset Purchase (LSAP) programs on corporate credit risk is complicated by the simultaneity of policy decisions and movements in prices of risky financial assets, as well as by the fact that both interest rates of assets targeted by the programs and indicators of credit risk reacted to other common shocks during the recent financial crisis. This paper employs a heteroskedasticity-based approach to estimate the structural coefficient measuring the sensitivity of market-based indicators of corporate credit risk to declines in the benchmark market interest rates prompted by the LSAP announcements. The results indicate that the LSAP announcements led to a significant reduction in the cost of insuring against default risk--as measured by the CDX indexes--for both investment- and speculative-grade corporate credits. While the unconventional policy measures employed by the Federal Reserve to stimulate the economy have substantially lowered the overall level of credit risk in the economy, the LSAP announcements appear to have had no measurable effect on credit risk in the financial intermediary sector.

There is a consensus about the increasing exposure to disruptions in the financial system and economic uncertainty over the recent years. Despite their different implications for policy, discriminating empirically between these two sources of economic fluctuations is not an easy task because their available empirical proxies are strongly correlated. We aim at making progress in discriminating financial and uncertainty shocks by means of an atheoretical approach to identification following the penalty function proposed by Uhlig (2003). We conclude that while the uncertainty channel plays a negligible role in the transmission of financial shocks; the financial channel is key in the transmission of uncertainty shocks. Financial shocks generate slowly-building and economically significant recessions followed by slow recoveries. Uncertainty shocks generate similar adverse effects if transmitted through the financial channel; otherwise, they have significantly smaller effects in economic activity.

We propose an econometric framework for estimating capital shortfalls of bank holding companies (BHCs) under pre-specified macroeconomic scenarios. To capture the nonlinear dynamics of bank losses and revenues during periods of financial stress, we use a fixed effects quantile autoregressive (FE-QAR) model with exogenous macroeconomic covariates, an approach that delivers a superior out-of-sample forecasting performance compared with the standard linear framework. According to the out-of-sample forecasts, the realized net charge-offs during the 2007-09 crisis are within the multi-step-ahead density forecasts implied by the FE-QAR model, but they are frequently outside the density forecasts generated using the corresponding linear model. This difference reflects the fact that the linear specification substantially underestimates loan losses, especially for real estate loan portfolios. Employing the macroeconomic stress scenario used in CCAR 2012, we use the density forecasts generated by the FE-QAR model to simulate capital shortfalls for a panel of large BHCs. For almost all institutions in the sample, the FE-QAR model generates capital shortfalls that are considerably higher than those implied by its linear counterpart, which suggests that our approach has the potential for detecting emerging vulnerabilities in the financial system.

Because they engage in maturity transformation, a steepening of the yield curve should, all else equal, boost bank profitability. We re-examine this conventional wisdom by estimating the reaction of bank intraday stock returns to exogenous fluctuations in interest rates induced by monetary policy announcements. We construct a new measure of the mismatch between the repricing time or maturity of bank assets and liabilities and analyze how the reaction of stock returns varies with the size of this mismatch and other bank characteristics, including the usage of interest rate derivatives. Our results indicate that bank stock prices decline substantially following an unanticipated increase in the level of interest rates or a steepening of the yield curve. A large maturity gap, however, significantly attenuates the negative reaction of returns to a slope surprise, a result consistent with the role of banks as maturity transformers. Share prices of banks that rely heavily on core deposits decline more in response to policy-induced interest rate surprises, a reaction that primarily reflects ensuing deposit disintermediation. Results using income and balance sheet data highlight the importance of adjustments in quantities--as well as interest margins--for understanding the reaction of bank equity values to interest rate surprises.

We re-examine the evidence on the relationship between credit spreads and economic activity, by constructing a credit spread index based on an extensive data set of prices of outstanding corporate bonds trading in the secondary market. Compared with the standard default-risk indicators, our credit spread index is a robust predictor of economic activity at both the short- and longer-term horizons. Using an empirical framework, we decompose the index into a predictable component that captures the available firm-specific information on expected defaults and a residual component—the excess bond premium—which we argue likely reflects variation in the price of default risk rather than variation in the risk of default. Our results indicate that the predictive content of credit spreads for economic activity is due primarily to movements in the excess bond premium. Innovations in the excess bond premium that are orthogonal to the current state of the economy are shown to lead to significant declines in economic activity and equity prices. We also show that a deterioration in the creditworthiness of broker-dealers—key financial intermediaries in the corporate cash market—causes an increase in the excess bond premium. These findings support the notion that a rise in the excess bond premium represents a reduction in the e!ective risk-bearing capacity of the financial sector and, as a result, a contraction in the supply of credit with significant adverse consequences for the macroeconomy.

We develop an accounting methodology to map observed differences in borrowing costs into measures of aggregate resource misallocation that may plausibly be attributed to financial market imperfections. Using a log-normal approximation we show that this resource misallocation may be inferred from cross-industry or cross-country information on the dispersion in borrowing costs. We apply our accounting methodology to U.S. Compustat data. Despite fairly large and persistent differences in borrowing costs across firms, our estimates imply relatively modest losses in TFP owing to resource misallocation that is attributable to such differences -- roughly on the order of 1% of total TFP for the United States. We also find that increasing the dispersion in borrowing costs by a factor of 2 only leads to a TFP loss of 3%. To obtain a TFP loss of 17% one must increase the dispersion in borrowing costs by a factor of 10 relative to U.S. data.

Identifying the macroeconomic effects of credit supply disruptions is difficult because many of the same factors that influence the supply of bank loans can also affect the demand for credit. Using bank-level responses to the Federal Reserve's Senior Loan Officer Opinion Survey, we decompose the reported changes in lending standards -- a commonly-used indicator of changes in credit supply conditions -- into a component that captures the change in banks' lending posture in response to bank-specific and macroeconomic factors that also affect loan demand and a residual component, which provides a cleaner measure of fluctuations in the effective supply of bank-intermediated credit. When included in a standard VAR framework, shocks to our measure of loan supply are associated with substantial declines in output and in the capacity of businesses and households to borrow from the banking sector, as well as with a sharp widening of credit spreads and a significant easing of monetary policy. We corroborate the interpretation of our series as movements in the supply of bank loans using a detailed loan-level data set: A regression of individual loan amounts on the corresponding interest rate spreads -- where the latter is instrumented with our bank-level loan-supply shifter -- yields the semi-elasticity of loan demand between 1.0 and 1.5b.

We study the effect of variation in interest rates on investment spending, employing a large panel data set that links yields on outstanding corporate bonds to the issuer income and balance sheet statements. The bond price data -- based on trades in the secondary market -- enable us to construct a firm-specific measure of the user cost of capital based on the marginal cost of external finance as determined in the market for long-term corporate debt. Our results imply a robust and quantitatively important effect of the user cost of capital on the firm-level investment decisions. According to our estimates, a 1 percentage point increase in the user cost of capital implies a reduction in the investment rate of 50 to 75 basis points and, in the long run, a 1 percent reduction in the stock of capital.

We study the effect of variation in interest rates on investment spending, employing a large panel data set that links yields on outstanding corporate bonds to the issuer income and balance sheet statements. The bond price data -- based on trades in the secondary market -- enable us to construct a firm-specific measure of the user cost of capital based on the marginal cost of external finance as determined in the market for long-term corporate debt. Our results imply a robust and quantitatively important effect of the user cost of capital on the firm-level investment decisions. According to our estimates, a 1 percentage point increase in the user cost of capital implies a reduction in the investment rate of 50 to 75 basis points and, in the long run, a 1 percent reduction in the stock of capital.

Despite the recent patch of sluggish growth, the U.S. economy has experienced a period of remarkable stability since the mid-1980s. One popular explanation attributes the diminished variability of economic activity to information-technology-led improvements in inventory management. Our results, however, indicate that the changes in inventory dynamics since the mid-1980s played a reinforcing--rather than a leading--role in the volatility reduction. Movements in the volatility of manufacturing output over the past three decades almost entirely reflect changes in the variability of the growth contribution of sales. Although the volatility of total inventory investment has fallen, the decline occurred well before the mid-1980s and was driven by the reduced variability of materials and supplies. Our analysis does show that since the mid-1980s, inventory dynamics have played a role in stabilizing manufacturing production: Inventory "imbalances" tend to correct more rapidly, and the quicker response of inventories to monetary policy and commodity price shocks buffers production from fluctuations in sales to a greater extent. But more extensive production smoothing and faster dissolution of inventory imbalances appear to be a consequence of changes in the way industry-level sales and aggregate economic activity respond to shocks, rather than a cause of changes in macroeconomic behavior.

Despite the recent patch of sluggish growth, the U.S. economy has experienced a period of remarkable stability since the mid-1980s. One popular explanation attributes the diminished variability of economic activity to information-technology-led improvements in inventory management. Our results, however, indicate that the changes in inventory dynamics since the mid-1980s played a reinforcing---rather than a leading---role in the volatility reduction. Movements in the volatility of manufacturing output over the past three decades almost entirely reflect changes in the variability of the growth contribution of sales. Although the volatility of total inventory investment has fallen, the decline occurred well before the mid-1980s and was driven by the reduced variability of materials and supplies. Our analysis does show that since the mid-1980s, inventory dynamics have played a role in stabilizing manufacturing production: Inventory ``imbalances'' tend to correct more rapidly, and the quicker response of inventories to monetary policy and commodity price shocks buffers production from fluctuations in sales to a greater extent. But more extensive production smoothing and faster dissolution of inventory imbalances appear to be a consequence of changes in the way industry-level sales and aggregate economic activity respond to shocks, rather than a cause of changes in macroeconomic behavior.

The profitability of the U.S. commercial banking industry remained robust in 2000, but returns on equity and on commercial bank assets fell back somewhat from the peak reached in 1999. The falloff reflected a continuation of the decline in net interest margin that dates from the extraordinarily high levels of the early 1990s, a significant increase in loan-loss provisions, and a notable slowing in noninterest income growth. The expansion of bank balance sheets was much stronger in 2000 than in the preceding year, as growth of both loans and securities accelerated. The pickup in loan growth resulted mainly from a marked decline in securitizations, which boosted the growth of consumer loans in bank portfolios, and from business and real estate lending. The faster growth of securities was due to a surge in trading accounts, as runoffs of U.S. Treasury securities damped the growth of investment accounts.

The profitability of the U.S. commercial banking industry remained robust in 2000, but returns on equity and on commercial bank assets fell back somewhat from the peak reached in 1999. The falloff reflected a continuation of the decline in net interest margin that dates from the extraordinarily high levels of the early 1990s, a significant increase in loan-loss provisions, and a notable slowing in noninterest income growth. The expansion of bank balance sheets was much stronger in 2000 than in the preceding year, as growth of both loans and securities accelerated. The pickup in loan growth resulted mainly from a marked decline in securitizations, which boosted the growth of consumer loans in bank portfolios, and from business and real estate lending. The faster growth of securities was due to a surge in trading accounts, as runoffs of U.S. Treasury securities damped the growth of investment accounts.

A core prediction of the Heckscher-Ohlin theory is that countries specialize in goods in which they have a comparative advantage, and that the source of comparative advantage is differences in relative factor supplies. To examine this theory, we use the most extensive dataset available and document the pattern of industrial specialization and factor endowment differences in a broad sample of rich and developing countries over a lengthy period (1970-92). Next, we develop an empirical model of specialization based on factor endowments, allowing for unmeasurable technological differences and estimate it using panel data techniques. In addition to estimating the effects of factor endowments, we also consider the alternative hypothesis that the level of aggregate productivity by itself can explain specialization. Our results clearly show the importance of factor endowments on specialization: relative endowments do matter. JEL code: F1

The U.S. commercial banking industry posted record earnings in 1999. The industry's return on assets and return on equity both rose above the already high level of recent years. Profitability was concentrated at large banks--particularly among the 100 largest--and was driven upward by a surge in noninterest income and a significant slowdown in the growth of noninterest expense. Other sources of improved profitability were a stabilization of net interest income, which had been weakening in recent years, and lower loan loss provisioning permitted by generally good asset quality. The growth of total bank assets slowed slightly relative to 1998, but loans expanded at about the same brisk pace as last year.

We examine inventory adjustment in the U.S. manufacturing sector using quarterly firm-level data over the period 1978-97. Our evidence indicates that the inventory investment process is nonlinear and asymmetric, results consistent with a nonconvex adjustment cost structure. The inventory adjustment process differs over the business cycle: for a given level of excess inventories, firms disinvest more in recessions than they do in expansions. The inventory adjustment process has changed little between the 1980s and 1990s, suggesting that recent advances in inventory control have had little effect on adjustment costs. Nevertheless, the optimal inventory-sales ratio in the durable goods sector has declined significantly during our sample period.

We examine the microeconomic and aggregate inventory dynamics in the business sector of the U.S. economy. We employ high-frequency firm-level data and use an empirically tractable model, in which the aggregate dynamics are derived explicitly from the underlying microeconomic data. Our results show that the microeconomic adjustment function in both the manufacturing and trade sectors is nonlinear and asymmetric, results consistent with firms using (S,s)-type inventory policies. There are differences in the estimated adjustment functions between the two sectors as well as the durable and nondurable goods firms within each sector. The estimated adjustment function is remarkably stable across subperiods, indicating little change in the inventory adjustment process over time. As predicted by our model, higher moments of the cross-sectional distribution of inventory deviations affect aggregate inventory dynamics.

A recent influential paper (O'Connell 1998) argues that panel data evidence in favor of purchasing power parity disappears once test procedures are altered to accommodate heterogeneous cross-sectional dependence among real exchange rate innovations. We present evidence to the contrary. First, we modify two extant panel unit root panel unit root tests to eliminate the upward size distortion induced by contemporaneous cross-sectional dependence. Second, we exploit a recently-introduced test, based on SUR techniques, that also remains valid in the presence of cross-sectional dependence. Using the three new tests, we find overwhelming evidence in favor of real exchange rate stationarity during the post-Bretton Woods era among OECD economies, as well as among a larger group of “open” economies. We also find emphatic evidence of stationarity using O'Connell's GLS test. Bias-corrected parameter estimates indicate that deviations from PPP erode more quickly for real exchange rates defined using wholesale rather than consumer price indices. Monte Carlo experiments indicate that several of the tests discussed here have considerable power against the unit root null.

Recent work in macroeconomics emphasizes the role of credit in the transmission mechanism for monetary policy and as a propagation mechanism of business cycle shocks.1 Wlule much evidence has been gathered, not all researchers agree on the relevance of credit for the transmission of monetary policy nor for its relevance as a propagation mechanism of business cycle shocks. For the most part, every one agrees on the facts at hand but differs on their interpretation. In short, the argument is over identification. The primary purpose of this paper is to clarify the identification issues involved; to highlight those identification schemes that are promising avenues for measuring the importance of credit in aggregate fluctuations; and to provide a discussion of both previous evidence and new evidence in light of the identification schemes proposed.

We examine the behavior of trade inventories using both industry-level and high-frequency firm-level data. The cost structure underlying the firm's optimization problem--convex delivery costs vs. fixed costs of ordering--provides the two competing hypotheses. In the presence of fixed costs (S,s) inventory policies are optimal, and steady-state reduced-form predictions regarding the dynamics of inventories and sales can be used to test the model. The alternative of convex delivery costs is provided by structural estimation of a linear-quadratic (L-Q) model. At the industry level, the results are consistent with the reduced-form predictions of the (S,s) model, and structural parameter estimates obtained from Euler equation estimation indicate that the L-Q model does not fit the data. At the firm level, however, estimates of the structural cost parameters are economically plausible, statistically significant, and generate observationally equivalent dynamics of inventories and deliveries as those predicted by the steady-state reduced-form probability relationships derived from the (S,s) model.

We investigate the implications of capital market imperfections for inventory investment in retail trade, using a new source firm-level data--the micro data underlying the published Quarterly Financial Reports. An error-correction model that includes internal funds and forward-looking expectations for the stochastic process of sales is not rejected by the data. Both the cross-sectional and time-series results are consistent with the existence of significant capital market frictions in the retail trade sector: (1) for firms with limited access to capital markets, internal funds are a significant predictor of inventory investment; (2) the predictive power of internal funds is highly asymmetric over a business cycle, rising considerably in recessions. The quantitative significance of financial factors suggests that a large portion of the observed volatility in aggregate retail inventory investment over a business cycle is due to fluctuations in internal funds