Monetary Economics

March 6, 2015
Janice Eberly of Northwestern University and Arvind Krishnamurthy of Stanford University, Organizers

Marco Del Negro, Federal Reserve Bank of New York, and Christopher A. Sims, Princeton University and NBER

When Does a Central Bank's Balance Sheet Require Fiscal Support?

Using a simple, general equilibrium model, Del Negro and Sims argue that it would be appropriate for a central bank with a large balance sheet composed of long-duration nominal assets to have access to, and be willing to ask for, support for its balance sheet by the fiscal authority. Otherwise its ability to control inflation may be at risk. This need for balance sheet support — a within-government transaction — is distinct from the need for fiscal backing of inflation policy that arises even in models where the central bank's balance sheet is merged with that of the rest of the government.

Efraim Benmelech, Northwestern University and NBER, and Ralf R. Meisenzahl and Rodney Ramcharan, Federal Reserve Board

The Real Effects of Liquidity during the Financial Crisis: Evidence from Automobiles

This paper shows that illiquidity in short-term credit markets during the financial crisis may have sharply curtailed the supply of non-bank consumer credit. Using a new data set linking every car sold in the United States to the credit supplier involved in each transaction, Benmelech, Meisenzahl, and Ramcharan show that the collapse of the asset-backed commercial paper market decimated the financing capacity of captive leasing companies in the automobile industry. As a result, car sales in counties that traditionally depended on captive-leasing companies declined sharply. Although other lenders increased their supply of credit, the net aggregate effect of illiquidity on car sales is large and negative. The researchers conclude that the decline in auto sales during the financial crisis was caused in part by a credit supply shock driven by the illiquidity of the most important providers of consumer finance in the auto loan market: the captive leasing arms of auto manufacturing companies. These results also imply that interventions aimed at arresting illiquidity in credit markets and supporting the automobile industry might have helped to contain the real effects of the crisis.

Òscar Jordà, Federal Reserve Bank of San Francisco; Alan M. Taylor, University of California, Davis and NBER; and Moritz Schularick, University of Bonn

Betting the House (NBER Working Paper 20771)

Is there a link between loose monetary conditions, credit growth, house price booms, and financial instability? This paper analyzes the role of interest rates and credit in driving house price booms and busts with data spanning 140 years of modern economic history in the advanced economies. Jordà, Schularick, and Taylor exploit the implications of the macroeconomic policy trilemma to identify exogenous variation in monetary conditions: countries with fixed exchange regimes often see fluctuations in short-term interest rates unrelated to home economic conditions. The researchers use novel instrumental variable local projection methods to demonstrate that loose monetary conditions lead to booms in real estate lending and house prices bubbles; these, in turn, materially heighten the risk of financial crises. Both effects have become stronger in the postwar era.

Erik Hurst, Amit Seru, and Joseph S. Vavra, University of Chicago and NBER, and Benjamin J. Keys, University of Chicago

Regional Redistribution through the U.S. Mortgage Market

An integrated tax and transfer system together with factor mobility can help mitigate local shocks within monetary and fiscal unions. In this paper Hurst, Keys, Seru, and Vavra explore the role of a new mechanism that may also be central to determining the welfare effects of regional shocks. The degree to which households can use borrowing to smooth location-specific risks depends crucially on the interest rate and how it varies with local economic conditions. In the U.S., the bulk of borrowing occurs through the mortgage market and is heavily influenced by the presence of government-sponsored enterprises (GSEs). The researchers empirically establish that despite large spatial variation in predictable default risk, there is essentially no spatial variation in GSE mortgage rates, conditional on borrower observables. In contrast, the authors show that the private market does set interest rates based in part on regional risk factors and postulate that the lack of regional variation in GSE mortgage rates is likely driven by political pressure. They quantify the economic impact of the national interest rate policy on regional risk by building a structural spatial model of collateralized borrowing to match various features from their empirical analysis. The model suggests that the national interest rate policy has significant ex-post redistributional consequences across regions.

Stefano Giglio, University of Chicago and NBER; Matteo Maggiori, Harvard University and NBER; and Johannes C. Stroebel, New York University

No-Bubble Condition: Model-Free Tests in Housing Markets (NBER Working Paper 20154)

Giglio, Maggiori, and Stroebel test for the existence of classic rational bubbles in housing markets by directly measuring failures of the transversality condition that requires the present value of payments occurring infinitely far in the future to be zero. The researchers study housing markets in the U.K. and Singapore, where residential property ownership takes the form of either leaseholds or freeholds. Leaseholds are finite maturity, pre-paid, and tradable ownership contracts with maturities often exceeding 700 years. Freeholds are infinite maturity ownership contracts. The price difference between leaseholds with extremely long maturities and freeholds reflects the present value of a claim to the freehold after leasehold expiry, and is thus a direct empirical measure of the transversality condition. The authors estimate this price difference, and find no evidence for classic rational bubbles in housing markets in the U.K. and Singapore, even during periods when a sizable bubble was regularly thought to be present.

Stefan Nagel, University of Michigan and NBER

The Liquidity Premium of Near-Money Assets (NBER Working Paper 20265)

In this paper, Nagel proposes a theory that links the liquidity premium of near-money assets with the level of short-term interest rates: Higher interest rates imply higher opportunity costs of money holdings and hence a higher premium for the liquidity service benefits of money substitutes. Consistent with this theory, short-term interest rates in the U.S., U.K., and Canada have a strong positive relationship with the liquidity premium of Treasury bills and other near-money assets. Treasury security supply variables lose their explanatory power for the liquidity premium once short-term interest rates are controlled for, which favors the opportunity-cost-of-money theory over asset supply-driven models.