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Risk, Investment, and Banking in the Macroeconomy
Sunday, Jan. 3, 2021
10:00 AM - 12:00 PM (EST)
Ohio State University
Growth, Risk and Business Cycles in an Overlapping Generations Economy
We explore business cycles in overlapping generations economies wherein households, with uncertain lifetimes and uninsurable earnings when employed, face cyclical employment risk. Business cycles are driven by persistent shocks to TFP growth and household-level employment. Increases in employment risk cause fluctuations in the unemployment rate and the labour force. In this setting, we introduce elements commonly used to deliver a countercyclical price of risk in production economies. Specifically, households have non-separable utility characterised by high levels of risk aversion; a diminishing marginal productivity of investment leads to a time-varying price of capital. High levels of precautionary savings characterise our model economy. We find that changes in precautionary savings, following aggregate shocks, have important implications for consumption. Persistent negative shocks to TFP growth, associated with increases in unemployment risk, drive large declines in consumption. This helps explain the slowdown observed since the onset of the Great Recession. An empirically consistent, moderate shock to TFP growth rates implies a large and persistent fall, against trend, in aggregate consumption. Moreover, a rise in households' risk of long-term non-employment reduces labour force participation and reconciles the recovery in TFP growth rates with a protracted decline in consumption and output.
Capital Heterogeneity and Investment Prices: How much are Investment Prices Declining?∗
Not as much as you may think. Embodied technological change (or investment-specific technological change, or ISTC), ref l ected in the declining price of new investment goods, has been recognized as an important potential driver of long-run economic growth (Greenwood et al. ), the labor share (Karabarbounis and Neiman ), the equilibrium real rate (Sajedi and Thwaites ), and of business cycle f l uctuations (Greenwood et al. , Fisher ). The basic empirical motivation for ISTC is the dramatic decline in the price of computers. But it turns out that there is a large heterogeneity among capital goods (such as the different types of equipment and of structures) in the decline of these prices: the price declines are concentrated in very few categories. The aggregate importance of these declining prices hence depends importantly on how one aggregates the different capital types. Researchers typically use the indices of the Bureau of Economic Analysis (BEA) national income account deflators. These indices weight each category according their share of investment spending. Our contribution is twofold. First, theoretically, we show the correct aggregation approach, using a simple standard growth model extended for multiple capital goods. Importantly, the correct aggregation depends on the question at stake. Second, empirically, we evaluate the quantitative impact of using the correct aggregation procedure. Our most striking result regards the contribution of ISTC to long-run growth. We show that one should weight capital types according to their share in the rental cost of capital, as this proxies their impact on the marginal product, rather than the investment f l ow, as has been done before. We further show how to simply calculate this rental-weighted index. We f i nd that using the correct index rather than the investment-flow weighted index leads to revise the contribution of ISTC from about 45% to about 20% over the period 1970-2017. Note: In results in progress, we also evaluate the effect of using the correct aggregation for the labor share and the decline of the rate of return, for business cycle dynamics, and for the decline of investment (Gutierrez and Philippon ).
Risk Taking, Capital Allocation and Optimal Stabilization Policy
We study the role of firm heterogeneity in affecting business cycle dynamics and optimal stabilization policy. Firms differ in their degree of cyclicality, and hence, exposure to aggregate risk, leading to firm-specific risk premia that influence resource allocations. The heterogeneous firm economy can be recast in a representative firm formulation, but where total factor productivity (TFP) is endogenous and depends on the resource allocation. The model uncovers a novel tradeoff between the long-run level and volatility of TFP. Inefficiencies distort this tradeoff and result in either excessive volatility or depressed output, implying a role for corrective policy. Embedding this mechanism into a workhorse New Keynesian model, we show that allocational considerations can strengthen the incentives for leaning against the wind, i.e., optimal policy is more strongly countercyclical than in an observationally equivalent economy that abstracts from heterogeneity. A quantitative exercise suggests that the losses from ignoring heterogeneity can be substantial, which stem largely from a less productive allocation of resources and so depressed TFP and output.
Bank Market Power, Customer Capital, and the Speed of Recapitalizations
Banks' loan pricing decisions reflect the fact that borrowers tend to have long-lasting relationships with lenders. Therefore, pricing decisions have an inherently dynamic component: high interest rates may yield higher static profits per unit, but in the long run they erode customer capital and reduce future profitability. We study this tradeoff using a dynamic banking model with deep habits in loan demand which proxy lending relationships. High interest rates imply, on average, lower levels of customer capital going forward, and therefore lower loan demand. When faced with an adverse shock to net worth, banks with high customer capital recapitalize quickly by charging high interest rates and eroding customer capital in the short term, while banks with low customer capital face persistent financial distress. Using Call Report data to measure the franchise value of banks' loan portfolios, we find that this effect has strong implications for how individual banks and the financial sector as a whole recover from shocks.
Capital Regulation and Shadow Finance: A Quantitative Analysis
This paper studies the effects of higher bank capital requirements. Using new firm-lender matched credit data from South Korea, we document that Basel III reform coincided with a 25% decline in credit from regulated banks, and an increase of similar magnitude from non-bank (shadow) lenders. We use our data to provide robust estimates for the elasticity of bank credit with respect to capital requirements, and the spillover effect of the reform on non-bank lending. We estimate a negative elasticity of regulated bank credit with respect to capital requirements, and a positive spillover effect of the reform on non-bank lending. We then build a general equilibrium model with heterogeneous banks that accumulate equity and invest in corporate loans. In addition, wealthy firms may endogenously choose to become a shadow lender. The model replicates the micro estimates and suggests that Basel III can account for most of the observed decrease in regulated bank lending, and about three quarters of the increase in shadow lending. The latter is driven exclusively by general equilibrium effects of the reform.
Interbank Networks in the Shadows of the Federal Reserve Act
Central banks provide public liquidity (through lending facilities and promises of bailouts) with the intent to stabilize the ﬁnancial system. Even though this provision is restricted to member (regulated) banks, an interbank system can provide indirect access to nonmember (shadow) banks. We construct a model to understand how a banking network may change in the presence of central bank interventions and how those changes aﬀect ﬁnancial fragility. We provide evidence showing that the introduction of the Fed’s liquidity provision in 1913 increased systemic risk through three channels; it reduced aggregate liquidity, created a new source of ﬁnancial contagion, and crowded out private insurance for smoothing cross-regional liquidity shocks (manifested through the geographic concentration of networks).
E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy