Studies in this week’s Hutchins Roundup find that weak banks diminish the effectiveness of monetary policy, trade liberalization increases innovation and more.
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Using corporate deposit and loan transaction data for European banks from January 2006 to June 2010, Viral Acharya of NYU Stern School of Business and coauthors find that the European Central Bank’s increase in liquidity provision beginning in October 2008 lowered deposit spreads for both high-risk and low-risk banks, but reduced loan spreads only for low-risk banks. Loan spreads for high-risk banks remain unchanged. This adversely affected the balance sheets of corporate borrowers from high-risk banks, leading to lower dividend payouts, capital expenditures, and employment. “Our results suggest that banks’ capital constraints at the time of an easing of monetary policy pose a challenge to the effectiveness of the bank-lending channel and the effectiveness of the central bank as a lender of last resort,” the authors conclude.
Former Research Analyst - Hutchins Center on Fiscal & Monetary Policy, The Brookings Institution
Former Senior Research Assistant - Hutchins Center on Fiscal & Monetary Policy, The Brookings Institution
Wen-Tai Hsu of Singapore Management University, Raymond Riezman of the University of Iowa, and Ping Wang of Washington University in St. Louis find that trade liberalization incentivizes technological innovation and thus increases growth. In their model, there are two types of innovations: general-purpose technology (GPT) innovation, which advances general knowledge and is beneficial to all products, and differentiated product innovation, which benefits only a specific country’s products. The authors reason that, by increasing global sales, trade liberalization increases the value of GPT, thereby inducing more R&D and faster growth, which in turns promotes further growth of aggregate global sales. They find that the welfare gains from trade are 5.3% compared with autarky, with most of the effect coming from innovation-induced growth. The gains from the authors’ dynamic model are much higher than previous estimates because standard models of trade do not include feedbacks from GPT innovation.
Policymakers are increasingly using value-added measures – how much a given teacher contributes to students’ progress – to evaluate teacher quality. Using data from New York City, Marianne Bitler of University of California-Davis and coauthors showcase the limitations of the value-added measures by evaluating the effect of teacher quality on an outcome teachers cannot affect: student height. They find that a one standard deviation increase in “value-added” results in an increase of 0.65 inches on student height (22% of the standard deviation). This effect on height is quantitively similar to the effect on math and English language arts scores. Further analysis of the data shows that the height effects are due to noise, rather than to any bias due to sorting on unobserved factors. Since it is difficult to account for noise in real-world applications, the authors provide their results as a cautionary tale against the use and interpretation of value-added measures to signal teacher quality.
Source: Wall Street Journal
“The case for increasing the [U.S. budget] deficits at present is not as irresponsible as it may sound first. Suppose that deficits were increased by, say, 1% of GDP, and that to avoid overheating, the Fed increased interest rates by 1%-2%, thus getting further away from the lower bound. The cost of increased debt might be offset by the benefits of increasing the room for action by the Fed, in terms of insurance against the next recession. That case however is sufficiently uncertain that I believe that the current goal should still be to decrease primary deficits. If so, the fiscal strategy should be to decrease them at a speed which allows the Fed to offset the adverse effects of consolidation through lower interest rates. The speed therefore should be contingent on the strength of private demand,” says Olivier Blanchard of Peterson Institute for International Economics.