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Risk, Pricing, and Economic Dynamics

Paper Session

Saturday, Jan. 4, 2020 2:30 PM - 4:30 PM (PDT)

Manchester Grand Hyatt, Ocean Beach

Hosted By: Society for Economic Dynamics

Chair: Thomas Winberry, University of Chicago

The Investment Network, Sectoral Comovement, and the Changing U.S. Business Cycle

Christian vom Lehn

,

Brigham Young University

Thomas Winberry

,

University of Chicago

Abstract

We argue that the input-output network of investment goods across sectors is an important propagation mechanism for understanding business cycles. First, we show that the empirical network is dominated by a few "investment hubs" that produce the majority of investment goods, are highly volatile, and are strongly correlated with the cycle. Second, we embed this network into a multisector model and show that shocks to investment hubs have large aggregate effects while shocks to non-hubs do not. Finally, we measure realized sector-level productivity shocks in the data, feed them into our model, and find that hub shocks account for a large and increasing share of aggregate fluctuations. This fact allows the model to match the decline in the cyclicality of labor productivity and other business cycle changes since the 1980s. Our model also implies that investment stimulus policies increase employment throughout the economy but have unequal effects across sectors.

Risk Premium Shocks Can Create Inefficient Recessions

Robert Hall

,

Stanford University

Sebastian Di Tella

,

Stanford University

Abstract

We develop an equilibrium theory of business cycles driven by spikes in risk premiums that depress business demand for capital and labor. The economy is hit by aggregate shocks that increase firms’ uninsurable idiosyncratic risk and raise risk premiums. We show that risk shocks can create quantitatively realistic business cycles, with contractions in employment, consumption, and investment. Economic fluctuations are inefficient—output and employment fall too much during recessions, compared to the constrained-efficient allocation, and consumption should be countercyclical. The optimal allocation requires stimulating employment and consumption during recessions.

Technological Change and Occupations over the Long Run

Dimitris Papanikolaou

,

Northwestern University

Leonid Kogan

,

Massachusetts Institute of Technology

Lawrence Schmidt

,

Massachusetts Institute of Technology

Bryan Seegmiller

,

Massachusetts Institute of Technology

Abstract

We construct occupation-specific indicators of technological change that span two centuries (1840-2010) using textual analysis of patent documents and occupation task descriptions. We build upon Kelly et al (2018) and identify breakthrough innovations based on textual similarity of the patent
to previous and subsequent work: breakthrough patents are highly distinct from previous work but most similar to subsequent innovations. For each patent, we identify the set of occupations it is most closely related to based on the similarity of the patent document to the occupation’s task description. Our occupation-level indices are significantly negatively correlated with future employment and wage growth. Comparing the recent IT revolution to the Second Industrial Revolution (1880s) and the technology wave of the 1920s and 1930s, we note an important difference: the first two waves consisted of innovations that were mainly related to occupations emphasizing (non-interpersonal) manual tasks, while the recent wave is composed of innovations that are significantly more related to cognitive tasks than the previous two waves.

Prudential Monetary Policy

Alp Simsek

,

Massachusetts Institute of Technology

Ricardo Caballero

,

Massachusetts Institute of Technology

Abstract

Should monetary policy have a prudential dimension? That is, should policymakers raise interest rates to rein in financial excesses during a boom? We theoretically investigate this issue using an aggregate demand model with asset price booms and financial speculation. In our model, monetary policy affects financial stability through its impact on asset prices. Our main result shows that, when macroprudential policy is imperfect, small doses of prudential monetary policy (PMP) can provide financial stability benefits that are equivalent to tightening leverage limits. PMP reduces asset prices during the boom, which softens the asset price crash when the economy transitions into a recession. This mitigates the recession because higher asset prices support leveraged, high-valuation investors’ balance sheets. An alternative intuition is that PMP raises the interest rate to create room for monetary policy to react to negative asset price shocks. The policy is most effective when there is extensive speculation and leverage limits are neither too tight nor too slack.

JEL Classifications

E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy
E3 - Prices, Business Fluctuations, and Cycles