International Review of Economics and Finance 22 (2012) 1–10
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International Review of Economics and Finance j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / i r e f
Do central banks affect Tobin's q? João Ricardo Faria a, André Varella Mollick b, Adolfo Sachsida c, Le Wang d,⁎ a b c d
MPA Program, University of Texas at El Paso, USA Department of Economics and Finance, University of Texas Pan-American, USA IPEA, Brasília, Brazil Department of Economics, University of New Hampshire, USA
a r t i c l e
i n f o
Article history: Received 4 October 2010 Received in revised form 3 August 2011 Accepted 4 August 2011 Available online 11 August 2011
a b s t r a c t Previous work has documented inflation effects on Tobin's q in the long run. This paper examines whether the FED's different policies and chairmen tenure have an impact on Tobin's q, after a modified stylized AD-AS model shows that central banks affect q. We do find changing responses of q depending on the pre-Volcker and post-Volcker periods. © 2011 Elsevier Inc. All rights reserved.
JEL classification: E31 E44 E58
Keywords: Central bank Tobin's q U.S. Federal Reserve
1. Introduction The stock market and investment are positively correlated (Morck, Schleifer, & Vishny, 1990). The accumulation of fixed capital responds to movements in the stock market. According to Black, Fraser, and Groenewold (2003) the ratio of stock market capitalisation to GDP more than tripled in 10 years up to the year 2000 — from 53.2% in 1990 to over 181% in 2000. They note that stock market not only increased relative to the real economy, but the relation between them has also strengthened. Most economists think of the relationship between the stock market and investment in terms of Tobin's q (Shapiro, 1990). Tobin's q is the ratio of the market valuation of real capital assets to the current replacement cost of those assets (Tobin & Brainard, 1977). 1 For Tobin and Brainard (1990) q is not a real or financial variable but a hybrid variable, the ratio of a financial market price to a commodity market price. The q-theory of investment is a theory of investment that says that a q greater than one stimulates investment, i.e., when capital is valued more highly in the market than it costs to produce it, investment grows (Brainard & Tobin, 1968). For Tobin [(1969), p.29] the q-theory 2 allows monetary policies to affect aggregate demand by changing
⁎ Corresponding author at: Department of Economics, University of New Hampshire, 15 College Road, Durham, NH 03824, USA. Tel.: + 1 603 862 0818; fax: + 1 603 862 3383. E-mail address:
[email protected] (L. Wang). 1 This ratio was previously called valuation ration, v, and defined as the relation of the market value of shares to the capital employed by the corporations (Kaldor, 1966; Reinhart, 1979). 2 There are several q-theories of investment, as the neoclassical of Hayashi (1982), and the post-Keynesian of Crotty (1990). See also Palley (2001). 1059-0560/$ – see front matter © 2011 Elsevier Inc. All rights reserved. doi:10.1016/j.iref.2011.08.003
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the valuations of physical assets relative to their replacement costs. In this sense it is implicit that central banks can affect Tobin's q, mainly through inflation, 3 and ultimately, private investments and the accumulation of capital stock. There is a large literature, mostly theoretical, that studies the effect of inflation on an economy's capital stock. The “Tobin effect” (Tobin, 1965, 1967) refers to the mechanism in which a higher inflation rate reduce the return of holding real money balances and lead agents to substitute out money and into physical capital. Thus increasing inflation results in higher capital accumulation. Sidrauski (1967) develops a dynamic model with real money balances in the utility function and shows that money is superneutral, i.e., inflation does not affect the real variables of the economy, including capital stock. Last, but not least, Stockman (1981) formulates a model in which agents face a cash-in-advance constraint, i.e., money is necessary in advance for the purchase of goods. In this model inflation is a tax on holdings of real money balances and, as a consequence, on capital stock. Empirical results on the relation between inflation and investment and capital stock formation are ambiguous. De Gregorio (1993) estimates a negative impact of inflation on economic growth through its effects on investment. Fischer (1993) presents evidence that inflation negatively affects the formation of real capital stock. Barro (1995) finds that investment–GDP ratio is negatively related to inflation. Crosby and Otto (2000) empirical results show that capital stock is invariant to changes in the inflation rate. One important channel through which inflation can affect investment and the formation of capital stock is the Tobin's q. Although the majority of the literature on Tobin's q does not address or consider the idea that inflation may affect Tobin's q, the literature ignores some issues indicated by Tobin and Brainard (1977) for explaining why inflation matters in practice. Anticipated inflation may affect Tobin's q through non-neutral taxes, and nominal interest rates that are fixed or controlled, while unanticipated inflation will have additional non-neutral effects. In addition, Tobin (1969) showed that there are theoretical reasons, through an extended LM curve, for the expected inflation rate to have a positive impact on q. Faria and Mollick (2010) develop a theoretical model introducing Tobin's q in the IS-LM framework. In theory, the impact of actual inflation on Tobin's q can be either positive or negative. Faria and Mollick (2010) test the hypothesis with U.S. data from 1953 to 2000, and show that there is a negative (long run) impact of inflation on q, while adjusting fast in the short-run dynamics, and controlling for Schumpeterian innovations.4 An explanation for the negative impact of inflation on q lies on the nature of Tobin's q as a hybrid variable. Inflation impacts the financial market price differently from the commodity market price. Thereby inflation is non-neutral on Tobin's q. This paper goes one step further than Faria and Mollick (2010). It assesses whether the Federal Reserve (FED) affects Tobin's q through monetary policy, and it tests, in particular, the effect of the FED chairmen on Tobin's q. The role of FED Chairmen and FED's monetary policies are important to explain American inflation, and has been object of intense scrutiny. Sargent, Williams, and Zha (2006) find that American inflation results from an interaction between the monetary authority's beliefs [updated continuously] and economic shocks. The rise in inflation in the 1970s is attributed to shocks that changed the monetary authority's estimates and made it misperceive the tradeoff between inflation and unemployment. 5 Blinder (1982), Hetzel (1998), and Mayer (1998) find that FED policy in the 1970s had a systematic tendency to translate adverse supply disturbances into persistent changes in the inflation rate. In the 1980s, according to Bomfim and Rudebusch (2000) and Orphanides and Wilcox (2002), the FED acted opportunistically to reduce inflation after favorable supply-side shocks. Another line of explanation, not necessarily opposed to the above, is the view that the FED is plagued by the time-consistency problems, as stressed by Ireland (1999), which explains its unwillingness to prevent inflation from rising after negative shocks and its capacity to reduce inflation after positive supply-side shocks. More recently, Ireland (2007) confirms Friedman's view that inflation is always and everywhere a monetary phenomenon, finding that the bulk of inflation's rise and fall is due to the FED policy.6 In the next section we present a stylized AD-AS model with Tobin's q, showing how the FED can affect Tobin's q. The empirical evidence is presented in Section 3. The concluding remarks appear in Section 4.
2. The model The following model introduces Tobin's q into a stylized AD-AS model (e.g., Sorensen & Whitta-Jacobsen, 2005; Mankiw, 2009). Tobin's q is defined as the ratio of the market valuation of the capital goods, MV, to their replacement costs, V. If the expected earnings, E, are constant, then q is equivalent to the ratio of the marginal efficiency of capital, ρ, to the real rate of return of capital (real interest rate), r: qt = MVt = Vt = ðE = rt Þ = ðE = ρÞ⇒qt = ρ = rt:
ð1Þ
3 Inflation is an important variable in finance. For example, Munk, Sørensen, and Vinther (2004) explain the Samuelson puzzle (Samuelson, 1963), in which investment advisors recommend that younger investors should invest a higher fraction of wealth in stocks than should older investors, by controlling for inflation dynamics in portfolio choices. In another line of research, inflation is found to be one of the determinants of capital structure. For instance, Hatzinikolaou, Katsimbris, and Noulas (2002) find that inflation uncertainty exerts a strong negative effect on a firm's debt-to-equity ratio. 4 For Tobin and Brainard (1977) low and declining average q ratios are consistent with investment booms. This happen in periods in which new capital goods different from existing capital goods render the old ones obsolete (Tobin & Golub, 1998). 5 Cogley and Sargent (2005) explain the apparent failure of FED taking care of the high inflation in the 1970s due to cautious behavior induced by model uncertainty. 6 Friedman wrote several articles in his Newsweek column criticizing the FED, see Meltzer (2010).
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Table 1 Vector ECM of Tobin's q on inflation rates in FM's original specifications. FM
CPI inflation (dp)
PPI inflation (dpfin)
PK inflation (dpk)
(dpk-dp) inflation
(dpk-dpfin) inflation
β1 (productivity)
0.058 (0.023) − 0.135 (0.021) − 0.002 (0.001) 4 − 0.521 (0.115) 0.406
− 0.026 (0.106) − 0.327 (0.076) − 0.001 (0.003) 3 − 0.087 (0.024) 0.271
0.014 (0.112) − 0.497 (0.088) − 0.003 (0.003) 4 − 0.047 (0.021) 0.077
− 0.478 (0.065) − 0.516 (0.117) 0.011 (0.002) 2 − 0.045 (0.018) 0.128
− 0.295 (0.057) − 0.548 (0.113) 0.007 (0.002) 2 − 0.024 (0.026) 0.018
CPI inflation (dp) 0.136 (0.014) 0.084 (0.024) − 0.016 (0.003) 0.034 (0.114) − 0.034
PPI inflation (dpfin) 0.113 (0.005) − 0.019 (0.005) − 0.007 (0.001) 0.025 (0.242) 0.032
PK inflation (dpk) 0.136 (0.008) 0.006 (0.005) − 0.011 (0.001) 0.0001 (0.160) − 0.077
(dpk-dp) inflation 0.125 (0.007) − 0.0001 (0.005) − 0.009 (0.0008) − 0.017 (0.189) − 0.084
(dpk-dpfin) inflation 0.133 (0.008) 0.047 (0.008) − 0.009 (0.0009) − 0.019 (0.156) − 0.037
CPI inflation (dp) − 0.001 (0.018) 0.031 (0.006) 0.002 (0.0002) − 0.728 (0.321) 0.026
PPI inflation (dpfin) − 0.006 (0.017) 0.023 (0.005) 0.002 (0.0002) − 0.653 (0.314) 0.057
PK inflation (dpk) 0.003 (0.015) 0.034 (0.005) 0.002 (0.0002) − 0.676 (0.313) 0.044
(dpk-dp) inflation − 0.023 (0.009) − 0.181 (0.013) 0.002 (0.0001) − 0.392 (0.246) − 0.109
(dpk-dpfin) inflation − 0.023 (0.015) − 0.065 (0.010) 0.002 (0.0002) − 0.532 (0.278) − 0.016
CPI inflation (dp) 0.091 (0.016) − 0.158 (0.018) − 0.340 (0.052) 0.0006 (0.0004) − 0.625 (0.223) 0.141
PPI inflation (dpfin) 0.026 (0.062) − 0.004 (0.042) 0.999 (0.165) − 0.006 (0.002) 0.009 (0.044) − 0.084
PK inflation (dpk) 0.044 (0.011) − 0.091 (0.014) − 0.628 (0.053) 0.002 (0.0004) 0.076 (0.129) − 0.029
(dpk-dp) inflation − 0.918 (0.133) − 1.020 (0.238) − 2.210 (1.274) 0.016 (0.005) − 0.019 (0.008) 0.099
(dpk-dpfin) inflation − 2.547 (0.517) − 4.885 (1.131) 2.775 (2.355) 0.063 (0.013) − 0.004 (0.003) − 0.015
β2 (Δp) β3 (k) Lags EC in VECM Adj. R2 1953–79 β1 (productivity) β2 (Δp) β3 (k) EC in VECM Adj. R2 1980–2000 β1 (productivity) β2 (Δp) β3 (k) EC in VECM Adj. R2 1953–2000 β1 (productivity) β2 (Δp) Δp*D83 β3 (k) EC in VECM Adj. R2
Notes: For the two subperiods one lag was used in the estimations. The longer sample has the lag structure reported in Faria and Mollick (2010). Standard errors are in parenthesis.
The following equations are the demand for goods and services, the Fisher equation, the Phillips curve, adaptive expectations, and monetary policy rule, respectively: 7 Yt = Y t −αrt ð1−qt Þ + εt
ð2Þ
rt = it −Et πt
ð3Þ
+ 1
πt = Et−1 πt + ϕ Yt −Y t + υt
ð4Þ
πt = Et πt
ð5Þ
+ 1
it = πt + ρ + θπ ðπt −πt Þ + θy Yt −Y t
7
Note that αrt(1 − qt) = α(rt − ρ).
ð6Þ
4
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Table 2 Vector ECM of Tobin's q on inflation rates allowing for FED dummies and slope change. 1953–2000
CPI inflation (dp)
PPI inflation (dpfin)
PK inflation (dpk)
(dpk-dp) inflation
(dpk-dpfin) inflation
β1(productivity)
0.076 (0.020) − 0.081 (0.015) 0.092 (0.029) − 0.060 (0.028) − 0.002 (0.0008) 4 − 0.541 (0.151) 0.352
0.018 (0.022) − 0.048 (0.016) 0.199 (0.042) − 0.071 (0.025) 0.0002 (0.0007) 3 − 0.225 (0.108) 0.052
0.039 (0.021) − 0.046 (0.013) 0.156 (0.030) − 0.109 (0.020) − 0.0006 (0.0007) 4 − 0.318 (0.130) 0.056
− 5.616 (0.556) 0.723 (1.366) − 7.438 (1.969) − 23.484 (6.081) 0.092 (0.020) 2 − 0.004 (0.002) 0.050
− 0.611 (0.075) 0.368 (0.177) − 1.535 (0.303) − 0.521 (0.260) 0.014 (0.001) 2 − 0.065 (0.019) 0.192
β2 (Δp) Δp*DMartin Δp*DVG β3 (k) Lags EC in VECM Adj. R2
Notes: Standard errors are in parenthesis.
Where Yt is output, Y t is the natural level of output, α is the responsiveness of the demand for goods and services to the real interest rate, it is the nominal interest rate, Etπt + 1 is expected inflation, πt is actual inflation, πt * is central bank inflation target, εtis the demand shock; υt is the supply shock, θπis responsiveness of the central bank to inflation, and θy is the responsiveness of the central bank to output. Substituting Eqs. (3) and (6) into Eq. (2) yields the dynamic aggregate demand curve: Yt = Y t −
α ½ρ + θπ ðπt −πt Þð1−qt Þ + εt 1 + αθy ð1−qt Þ
ð7Þ
The dynamic aggreagate supply curve is derived by introducing Eqs. (3) and (5) into Eq. (4): πt = πt−1 + ϕ Yt −Y t + υt
ð8Þ
Tobin's q is rewritten by introducing Eqs. (3) and (5) into Eq. (1): qt =
ρ ρ + θπ ðπt −πt Þ + θy Yt −Y t
ð9Þ
In any period t, the short-run equilibrium is represented by Eqs. (7), (8) and (9). These equations determine three endogenous variables: inflation, output and Tobin's q. The direct impact of the central bank [FED] on Tobin's q can be seen through the impact of parameters θπ and θy and effective federal funds rate it: dq dqt dq −1 −1 −1 =A −qt Yt −Y t ; t = A ½−qt ðπt −πt Þ; t = A ½−qt dθy dθπ dit where A = 1 + α θy + ϕθπ ρ + θπ ðπt −πt Þ + θy Yt −Y t . All these signs are ambiguous since the sign of A is ambiguous. Note that in the long run if Yt = Yt ; πt = πt , then q = 1. However, Clarida, Galí, and Gertler (2000) document that θπ N 1 for the Volcker–Greenspan era and θπ b 1 for the pre-Volcker period. According to Ireland (2007) the FED has never explicitly revealed the setting for its inflation target; moreover, the inflation target may vary with the FED Chairman, 8 then assuming πt ≠ πt *, we have A = [1 + α(θy + ϕθπ)][ρ + θπ(πt − πt *)], as a consequence dqt/dθπ ≠ 0,dqt/dit ≠ 0 in the long run. The next section assesses empirically whether the central bank impacts Tobin's q. 3. Empirical evidence In order to estimate the effect of inflation on Tobin's q, we follow Faria and Mollick (2010), allowing for technical progress and the stock of capital: qt = β0 + β1 Ζt + β2 Δpt + β3 Kt + εt ð10Þ where: q is Tobin's q calculated by Laitner and Stolyarov (2003); Z is a control variable for the state of technology and we consider in turn the simple time trend or real GDP adjusted by efficiency hours (PROD/EH) from Francis and Ramey (2009) to allow for demographic effects; Δpt is the inflation rate measured in several different forms (dp for CPI-all items; dpfin for PPI-finished goods; dpk for the price of capital equipment; kcpi = dpk-dp and kppi = dpk-dpfin); and K is the stock of capital to control for 8 Even the output gap is controversial. See Orphanides (2002) account of how mismeasurement of the output gap led Federal Reserve officials to adopt accommodative monetary policy. A recent application of threshold models of the Taylor rule in the context of the “opportunistic model” of monetary policy appears in Bunzel and Enders (2010). Aksoy and Léon-Ledesma (2005) show that both statistics and economic theory based evidence largely rejects the existence of long term relationships between the relevant policy indicators and real output.
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Table 3 Vector ECM of Tobin's q on inflation rates allowing for FED dummies. 1953–2000
CPI inflation (dp)
PPI inflation (dpfin)
PK inflation (dpk)
(dpk-dp) inflation
(dpk-dpfin) inflation
β1(productivity)
.055 (.008) −.023 (.016) .579 (.072) −.596 (.157) .0007 (.0004) 4 −.238 (.342) .0004
.020 (.008) −.002 (.011) .557 (.082) −.360 (.112) .001 (.0003) 3 −.709 (.298) .194
.030 (.002) −.002 (.003) .666 (.030) −.732 (.034) .002 (.0001) 4 .453 (.458) .098
−.224 (.053) −.229 (.073) .661 (.406) −.028 (.388) .006 (.001) 2 −.090 (.031) .185
−.025 (.008) −.115 (.014) .547 (.067) −.191 (.076) .002 (.0002) 2 −.396 (.133) .233
β2 (Δp) DMartin DVG β3 (k) Lags EC in VECM Adj. R2
Notes: Standard errors are in parenthesis.
Table 4 Vector ECM of Tobin's q on FFR allowing for FED dummies. 1955–2000
(1)
(2)
β1 (productivity)
0.074 (0.031) − 0.085 (0.027)
0.042 (0.017) − 0.009 (0.012) 0.489 (0.139) − 0.496 (0.117) 0.001 (0.000) − 0.19 (0.091)
β2 (FFR) DMartin DVG β3 (k) EC in VECM
0.000 (0.001) − 0.07 (0.042)
Notes: Standard errors are in parenthesis.
investment capital. For further robustness, we also use in this paper the federal funds rate (FFR, the monetary policy instrument) instead of inflation in Eq. (10), taken from New York's FRB beginning in 1955. Table A1 (in the Appendix) shows the descriptive statistics of our sample. The average annual inflation rate is 4.016% over the years as measured by the CPI, 3.254% by the PPI, and 3.618% measured by prices of capital goods. PPI inflation shows, however, higher standard deviation than the other inflation rates: 3.746 versus 3.018 in CPI and 3.534 in capital goods. Table A2 splits the sample and explores the differences between pre and post 1980 data. The importance to split the sample is evident when we look at the productivity. There is a clear difference between pre and post 1980 data. The same pattern appears in other variables. For instance, q has a 0.424 standard deviation for the post 1980 period against less than a half of this value for the pre 1980 data. Employing vector error-correction models (VECM), we introduce two modifications to Faria and Mollick (FM henceforth). First, we split the sample to distinguish the Volcker–Greenspan era from the previous FED chairmen.9 The idea is that the aversion to inflation was strong during and after Volcker's tenure, as well documented by Clarida et al. (2000) and confirmed more recently by Mavroeidis (2010).10 Table 1 replicates the results from Faria and Mollick (2010) at the top panel and compares them to ours. FM report negative coefficients for all measures of the inflation rate (Δp), as reproduced in the upper part of Table 1.11 Then, we investigate how the results differ before and after the Volcker–Greenspan era. Since Volcker took office in late 1979 and there might be time lags in the effects of his tenure on policies, we choose 1980 as our cut-off point. When splitting the sample, the results for the period 1953–1979 show that: i) productivity always imply positive and statistically significant coefficients; ii) three out of five inflation coefficients are positive (with two of them statistically significant); and iii) the coefficients on capital stock are negative, yet with different degrees of statistic significance. For the 1980–2000 period the results change dramatically. Among these, three out of five inflation parameters are positive and statistically significant. By and large, this provides preliminary indication that effect of inflation over Tobin's q changes from the results in FM. The problem, however, rests with the credibility of these estimates because of small sample size. 9 The Federal Reserve Chairman Tenure periods addressed in this paper are as follows: Martin 1951–1970; Burns 1970–1978; Miller 1978–1979; Volcker 1979–1987; and Greenspan 1987–2006. 10 Favero and Rovelli (2003), and Dennis (2004) find that there was a one-time shift in the Federal Reserve's inflation target occurring with the appointment of Paul Volcker as FED Chairman in 1979. Christopoulos and Léon-Ledesma (2007) find a shift in the Volcker era in the non-linear relationship between interest rates and inflation. 11 For space constraints we report below only the estimates with productivity with respect to efficiency hours but the tables with the naïve trend are available upon request from the authors.
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QLS 2.4 2.2 2.0 1.8 1.6 1.4 1.2 1.0 0.8 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Fig. 1. Tobin's q in the U.S. (qls) as measured by Laitner and Stolyarov (2003).
In order to address the sample size problem, we also re-estimate the model using the full sample but with the interaction between a dummy variable for the post-1980 period and inflation variables. We again find that the relationship between inflation and Tobin's q changed after 1980. Specifically, four out of five estimations suggest a strong negative effect of inflation over Tobin's q after 1980. Our second modification of FM's specifications is that we include a slope dummy variable to capture the idea that the influence of inflation over q changed after 1982 (the end of the monetary experiment). We re-estimate the model for the whole sample, but with an interaction dummy variable for the post-1983 period (after the monetary experiment of 1979–82) in connection with inflation. The dummy variable (D83) assumes the value of zero until the year of 1983 and the value of one after 1983. The results — at the bottom of Table 1 — support the idea that the effect of inflation over Tobin's q changed after 1983: three out of five estimations suggest a strong negative effect of inflation over Tobin's q after 1983. These two modifications do not necessarily speak to which event, either Volker–Greenspan era or the end of the monetary experiment, may cause the change in the effect of inflation on Tobin's q; however, they both point to the fact that the central banks could exert a significant impact on the relationship between inflation and Tobin's q. In order to analyze the effect of the FED chairmen on Tobin's q, Table 2 further includes two interaction dummies, with the omitted dummy in the estimations capturing the years of the Burns–Miller tenure at the FED. The first interaction dummy represents the Martin period as FED chairman (DMartin), and the second one captures the Volcker and Greenspan (DVG) era. While the effect of inflation over Tobin's q is always negative in columns (1)–(3), in three out of five estimations the interaction dummy variable for the Martin's era is positive. On the other hand, all five signals for the interaction dummy during the Volcker–Greenspan era are negative, suggesting a much more negative response of the Tobin's q to inflation in the more recent period. Alternatively, the strength of the negative response of Tobin's q to inflation increased after Volcker–Greenspan. Table 3 shows the results for FED chairman dummy variables in the intercept. The FED chairman has a significant impact over Tobin's q. For the Martin's era all dummies are positive and statistically significant; in column (4) it is statistically significant at the 10% level. The opposite happens during Greenspan and Volcker era, when Tobin's q responded negatively to the dummy variable of FED chairmanship: the ratio of market value of firms to replacement cost moved down in response to the FED dummy. One interpretation is that the FED started to increase the Federal Funds Rate (FFR) more than the inflation rate as documented by Clarida et al. (2000). This has an immediate negative reaction to the equity value of firms along with higher adjustment costs associated with the replacement of capital stock. Based on the ECM terms, some of the deviations from the long run vector are corrected in the following year, which are statistically significant in 3 out of the 5 cases.
PRODEH 45 40 35 30 25 20 15 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Fig. 2. Real GDP adjusted by efficiency hours (PROD/EH).
J.R. Faria et al. / International Review of Economics and Finance 22 (2012) 1–10
7
16
12
8
4
0
-4 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 DP
DPFIN
DPK
Fig. 3. Inflation Rates in the U.S. by CPI (dp), PPI (dpfin), or capital goods (dpk).
Clarida et al. (2000) document that the responsiveness of the central bank to inflation, θπ N 1, for the Volcker–Greenspan era (2.15 in their baseline estimates) and θπ b 1 for the pre-Volcker period (0.83 in their baseline estimates). If so, without knowing the inflation differentials, we can say that the more aggressive Volcker–Greenspan tenure implied that the inflation term in the denominator of Eq. (9) increases, thus making q go down — all else constant. That is consistent with the negative relationship we find in the estimations for the the Volcker–Greenspan period. Conversely, for (most of the) Martin period θπ b 1, which means that even if inflation was above the target the central banker was accommodative and the overall inflation term in Eq. (9) did not increase by much, implying the positive response we find in the estimations for Martin relative to the Burns–Miller period. To further assess the robustness of our results, we also replace inflation with FFR in previous estimations. The nominal interest rate also contains inflation, and hence by using FFR, we could examine the instrument of monetary policy which the FED use to affect Tobin's q , instead of using inflation, the outcome of the FED's actions. The results are reported in Table 4. Overall, the results are consistent with the findings presented earlier. First, the major instrument of monetary policy has a statistically significant, negative impact over Tobin's q, which is consistent with interest rate increases discounting more aggressively expected cash flows in the more recent period. Second and more interestingly, when both the FED dummies are included in estimations, although the effect of the FFR is still consistently negative, the magnitude of the effect dramatically decreases and it is no longer statistically significant. This result implies that the effect of the FFR largely captures the effects of the FED chair. Turning to the effects of the FED dummies, we again find that while Martin's era had a positive impact over Tobin's q, after Volcker the effect of the FED dummy on Tobin's q becomes predominantly negative. This is consistent with the findings above. 4. Concluding remarks This paper reconsiders the relationship between monetary policy and financial markets, previously captured by Ehrmann and Fratzscher (2004) for a shorter time-span and for the role of financial constraints. By showing how the “hybrid” Tobin's q responds in the long run to FED's policymaking, this paper attempts to fill a gap in the literature on the transmission of monetary policy to financial markets relative to the cost of capital. This paper examines whether FED's monetary policies and tenures of FED's chairmen have an impact on the market value of firms relative to replacement costs. With a modified stylized AD-AS model showing that central banks affect Tobin's q, we do find changing responses of q depending on the pre-Volcker and post-Volcker period. Since there are fundamentally different responses
K2 1,400 1,200 1,000 800 600 400 200 0 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Fig. 4. Capital Stock in the U.S. (k2) used in the empirical estimations.
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of the policy rule over time — as documented by Clarida et al. (2000) and Mavroeidis (2010) — this paper provides evidence that the “hybrid” Tobin's q responds to monetary policy actions in a different way across periods: negatively under the Volcker– Greenspan era and positively under the Martin tenure. One interpretation, along the lines of Caporale and Grier (2005), is that FED Chairs may differ with respect to their preferred equilibrium real interest rate. Acknowledgement We thank Hamid Beladi and an anonymous referee for their helpful comments. The usual disclaimers apply. Appendix A
Descriptive statistics: annual data. Series
Mean
Maximum and minimum
Std. dev.
Skewness
Kurtosis
JB
qls
1.207
0.321
1.568
5.482
dp
4.016
3.018
1.313
4.442
dpfin
3.254
3.746
1.515
4.890
dpk
3.618
3.534
1.623
5.347
kcpi
− 0.397
1.953
1.738
6.408
PROD/EH
30.331
7.263
− 0.223
1.850
kppi
0.364
2.290 0.850 13.500 − 0.400 15.400 − 1.400 15.200 − 0.400 6.200 − 2.900 42.520 17.765 5.100 − 5.800
1.896
− 0.300
4.673
32.004*** [.0000] 17.957*** [.0001] 25.523*** [.0000] 32.106*** [.0000] 47.409*** [.0000] 3.040 [.2186] 6.321*** [.0423]
Notes: This table is Table 1 in Faria and Mollick (2010) p.407. qls is Tobin's q from Laitner and Stolyarov (2003); dp is overall CPI-all items inflation rate; dpfin is PPI-finished goods inflation rate; dpk is the inflation rate for the price of capital equipment; kcpi = dpk-dp and kppi = dpk-dpfin are the relative inflation differences between dpk and either dp or dpfin, respectively; and PROD/EH refers to productivity in terms of efficiency hours as in Francis and Ramey (2009). JB is the Jarque Bera normality test, in which *** rejects the null of normality at 5% of statistical significance. N = 48 for the sample (1953–2000).
Descriptive statistics: split sample. 1953–1979
1980–2000
Series
Mean
Maximum and minimum
Std. dev.
Mean
Maximum and minimum
Std. dev.
qls
1.128
0.182
1.310
3.844
3.199
4.238
dpfin
3.577
4.078
2.838
dpk
4.214
3.913
2.852
kcpi
0.370
2.229
− 1.385
PROD/EH
25.112
4.945
37.040
kppi
0.637
2.118
0.014
2.290 0.850 13.500 1.600 13.400 − 1.400 10.700 − 0.400 0.100 − 2.800 42.520 32.529 3.400 − 2.900
0.424
dp
1.460 0.880 11.300 − 0.400 15.400 − 1.000 15.200 0.300 6.200 − 2.900 32.547 17.765 5.100 − 5.800
2.831 3.320 2.890 0.830 2.855 1.544
Notes: qls is Tobin's q from Laitner and Stolyarov (2003); dp is overall CPI-all items inflation rate; dpfin is PPI-finished goods inflation rate; dpk is the inflation rate for the price of capital equipment; kcpi = dpk-dp and kppi = dpk-dpfin are the relative inflation differences between dpk and either dp or dpfin, respectively; and PROD/EH refers to productivity in terms of efficiency hours as in Francis and Ramey (2009).
Data Appendix Tobin's q in this paper comes from Laitner and Stolyarov (2003): qls and used previously by Faria and Mollick (2010). For clarification, we repeat its construction in detail below. Tobin's q in Laitner and Stolyarov (2003) is equal to “market value of business”/“business fixed capital and inventories”, where “market value of business” comprises assets minus liabilities of several Federal Flow of Funds Levels tables as listed below.
J.R. Faria et al. / International Review of Economics and Finance 22 (2012) 1–10
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The numerator of Tobin's q is “market value of business”, defined as follows: asset minus liabilities of five different tables of Flows of Funds (available in http://www.federalreserve.gov/releases/z1/). The full description is as follows: Total financial assets of Households and Nonprofit Organizations (items 2 to 24): Deposits, foreign deposits, checkable deposits and currency, time and savings deposits, money market fund shares, credit market instruments, open market paper, U.S. government securities (Treasury and Agency), municipal securities, corporate and foreign bonds, mortgages, corporate equities, mutual fund shares, security credit, life insurance reserves, pension fund reserves, investment in bank personal trusts, equity in noncorporate business, and miscellaneous assets; (minus) Total liabilities of Households and Nonprofit Organizations (items 26 to 35): Credit market instruments, home mortgages, consumer credit, municipal securities, bank loans n.e.c., other loans and advances, commercial mortgages, security credit, trade payables deferred and unpaid, life insurance premiums; (minus) Liabilities of Federal Government: credit market instruments; (minus) Liabilities of Federal Government: Treasury currency; (plus) Assets of State and Local Government: U.S. gov. securities; (plus) Assets of State and Local Government: municipal securities; (minus) Liabilities of State and Local Government: credit market instruments; (plus) Assets of Monetary Authority: U.S. gov. securities; (minus) Total Liabilities of Monetary Authority (items 16 to 24): Depository institution reserves, vault cash of commercial banks, checkable deposits and currency (due to federal government, due to rest of the world, and currency outside banks), and miscellaneous liabilities; (plus) Total Financial Assets of Rest of the World (items 2 to 22): Net interbank assets, U.S. checkable deposits and currency, U.S. time deposits, security RP's, credit market instruments, open market paper, U.S. government securities (official holding, Treasury, and Agency), private holdings (Treasury and Agency), U.S. corporate bonds, loans to U.S. corporate business, U.S. corporate equities, trade receivables, security credit, miscellaneous assets (FDI in the U.S. and other); and (minus) Total Liabilities of Rest of the World (items 24 to 41): U.S. official foreign exchange and net IMF position, U.S. private deposits, credit market instruments, commercial paper, bonds, bank loans n.e.c. (official, banks, and other), U.S. government loans, acceptance liabilities to banks, trade payables, security debt, miscellaneous liabilities (U.S. equity in IBRD, etc., U.S. government deposits, U.S. direct investment abroad, and other). The denominator of Tobin's q in Laitner and Stolyarov (2003) is “business fixed capital and inventories”, defined as Nonresidential private fixed assets plus NIPA current dollar business inventories. Fig. 1 graphs Tobin's q as calculated by Laitner and Stolyarov (2003) and used throughout this study as dependent variable. In addition to the naïve time trend, we also allow for a measure of business cycles adjusted for efficiency hours as suggested by Francis and Ramey (2009), who show that prime age individuals work more hours and are more productive than younger and older individuals. They build a theoretical model of a representative household maximizing the present discounted value of utility subject to production constraints. From their key steady-state conditions on labor productivity, Francis and Ramey (2009) show that the model is consistent with the identifying assumption used in empirical work only if productivity is defined in efficiency hours. Therefore, in their model long run changes in the demographics can have effects on steady-state productivity. We allow for this insight in the empirical work on Tobin's q by generating productivity (in terms of efficiency hours) defining real GDP (from BEA website) divided by efficiency hours from Francis and Ramey (2009). Fig. 2 reproduces this series, in which slowdowns of the U.S. economy are visibly noticed in early 1970s and early 1980s. Inflation rates used in this paper are taken from the U.S. BLS website (http://www.bls.gov/bls/inflation.htm) and we explore three different series: overall CPI-all items (dp, series code CUUR0000SA0, U.S. city average, all items 1982–84 = 100); PPIfinished goods stage of processing (dpfin, series code WPUSOP3000); and the price of capital equipment stage of processing (dpk, series code WPUSOP3200). Fig. 3 combines the three inflation series. Following past work that suggests that capital stock should be an important control variable in any empirical examination of Tobin's q model, we take capital stock from the U.S. Fred database (http://research.stlouisfed.org/fred2/), series ID PNFIA, for Private Nonresidential Fixed Investment, annual frequency, billions of USD. The original source is the BEA of the U.S. Department of Commerce. 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