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A growing literature in macroeconomics and finance has found important economic effects of variations in risk, in particular shocks to the volatility of key macroeconomic variables (such as total factor [...]

Aggregate housing demand shocks are an important source of house price fluctuations in the standard macroeconomic models, and through the collateral channel, they drive macroeconomic fluctuations. These reduced-form shocks, however, fail to generate a highly volatile price-to-rent ratio that comoves with the house price observed in the data (the 'price-rent puzzle'). We build a tractable heterogeneous-agent model that provides a microeconomic foundation for housing demand shocks. The model predicts that a credit supply shock can generate large comovements between the house price and the price-to-rent ratio. We provide empirical evidence from cross-country and cross-MSA data to support this theoretical prediction. JEL classification: E21, E44, G21 Key words: price-rent puzzle, heterogeneity, marginal agent, cutoff point, liquidity premium, price-to-rent ratio, collateral constraint, I. INTRODUCTION The 2008 financial crisis was triggered by a collapse of the U.S. housing market. The empirical macroeconomic literature suggests that housing demand shocks be the primary driving force [...]

The global financial crisis and recession that started in 2007 with the surge of defaults of U.S. subprime mortgages is having a large impact on recent macroeconomic research. The framework [...]

The great recession of 2007-2009 has generated significant external criticism of the way economists study and try to understand aggregate economic outcomes. Modern macroeconomic theory, in particular, has been criticized [...]

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1540-6261.2010.01613.x Byline: HUI CHEN (*) Abstract: ABSTRACT I build a dynamic capital structure model that demonstrates how business cycle variation in expected growth rates, economic uncertainty, and risk premia influences firms' financing policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms' responses to macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the credit spread puzzle and the under-leverage puzzle in a unified framework. The model generates interesting dynamics for financing and defaults, including market timing in debt issuance and credit contagion. It also provides a novel procedure to estimate state-dependent default losses. Article note: *Hui Chen is at the Sloan School of Management, Massachusetts Institute of Technology. The paper is based on my Ph.D. dissertation at the Graduate School of Business, University of Chicago. I am very grateful to the members of my dissertation committee, John Cochrane, Doug Diamond, and Pietro Veronesi, and especially to the committee chair Monika Piazzesi for constant support and many helpful discussions. I also thank Heitor Almeida, Ravi Bansal, Pierre Collin-Dufresne, Darrel Duffie, Gene Fama, Dirk Hackbarth, Lars Hansen, Campbell Harvey (the Editor), Andrew Hertzberg, Francis Longstaff, Jianjun Miao, Erwan Morellec, Stewart Myers, Tano Santos, Martin Schneider, Costis Skiadas, Ilya Strebulaev, Suresh Sundaresen, two anonymous referees, and seminar participants at Carnegie Mellon University, Columbia University, Duke University, Emory University, Hong Kong University of Science and Technology, London Business School, MIT, New York University, Stanford University, University of California at Los Angeles, University of Chicago, University of Illinois, University of Maryland, University of Michigan, University of Rochester, University of Southern California, University of Texas at Austin, University of Toronto, University of Washington, and the 2007 WFA meetings for comments. All remaining errors are my own. Research support from the Katherine Dusak Miller Ph.D. Fellowship in Finance is gratefully acknowledged.

Recent developments in international financial markets have highlighted the role of banks in the transmission of shocks across borders. We employ dynamic panel methods for a sample of OECD countries to analyze whether banks' foreign assets react to macroeconomic shocks at home and abroad. We find that banks reduce their foreign assets in response to a relative increase in domestic interest rates, and they increase their foreign assets when the growth rate of world energy prices rises. The responses are characterized by a temporal overshooting and a dynamic adjustment process that extends over several quarters. JEL codes: F3, F41 Keywords: international banking, macroeconomic shocks, panel VAR models., RECENT DEVELOPMENTS IN international financial markets have highlighted the role of banks in the transmission of shocks across borders. To better understand the nature of this transmission channel, this paper [...]

This article complements the structural New Keynesian macro framework with a no-arbitrage affine term structure model. Whereas our methodology is general, we focus on an extended macro model with unobservable processes for the inflation target and the natural rate of output that are filtered from macro and term structure data. We find that term structure information helps generate large and significant parameters governing the monetary policy transmission mechanism. Our model also delivers strong contemporaneous responses of the entire term structure to various macroeconomic shocks. The inflation target shock dominates the variation in the 'level factor' whereas monetary policy shocks dominate the variation in the 'slope and curvature factors.' JEL codes: E31, E32, E43, E52, G12 Keywords: monetary policy, inflation target, term structure of interest rates, Phillips curve., STRUCTURAL NEW KEYNESIAN MODELS, featuring dynamic aggregate supply (AS), aggregate demand (IS), and monetary policy equations are becoming pervasive in macroeconomic analysis. In this article, we complement this structural macroeconomic [...]

We ask how macroeconomic and financial variables respond to empirical measures of shocks to technology, labor supply, and monetary policy. These three shocks account for the preponderance of output, productivity, and price fluctuations. Only technology shocks have a permanent impact on economic activity. Labor inputs have little initial response to technology shocks. Monetary policy has a small response to technology shocks but 'leans against the wind' in response to the more cyclical labor supply shock. This shock has the biggest impact on interest rates. Stock prices respond to all three shocks. Other empirical implications of our approach are discussed. JEL codes: C32, E32, E52 Keywords: business cycles, identification, impulse responses, vector autoregression., THIS PAPER INVESTIGATES how macroeconomic and financial variables respond to structural economic shocks. We use a relatively new and unexplored identification strategy that simultaneously identifies multiple impulses. Our strategy is [...]

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jimonfin.2009.06.006 Byline: Russell S. Boyer Abstract: Friedman's central contributions to open economy macroeconomics are contained in his essay 'The Case for Flexible Exchange Rates.' The paper describes equilibrium in an open economy in terms of the flow market for domestic currency, and so presents the basic elements of The Monetary Approach to the Balance of Payments, which Mundell and Johnson developed later in the decade. An application of the argument includes the first definitive statement of the criteria which one finds in the literature on Optimum Currency Areas. The essay's model, in a better specified, more modern form, reappears in A Monetary History (with Anna Schwartz), where it serves as a basis for detailed analysis of particular episodes and as a framework for empirical work which continues to this day. Author Affiliation: Department of Economics, Social Science Centre, University of Western Ontario, London, Ontario N6A5C2, Canada

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jimonfin.2008.07.009 Byline: Stuart Landon, Constance E. Smith Abstract: Aggregate and sector-level investment equations are estimated for a panel of 17 OECD countries using an error correction methodology. A real currency depreciation is found to reduce aggregate investment and investment in all nine sectors in the short run, and aggregate investment in the long run. The decline in investment is quite persistent in service sectors, sectors that generally benefit less from an expansion of demand following a currency depreciation. A rise in the real wage has no short run impact on investment in most sectors, but has a significant negative long run effect in six of nine sectors. Author Affiliation: Department of Economics, University of Alberta, 8-14 Tory Building, Edmonton, Alberta T6G 2H4, Canada

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jimonfin.2008.09.005 Byline: William T. Gavin (a), David M. Kemme (b) Abstract: Empirical macroeconomics is plagued by small sample size and large idiosyncratic variation. This problem is especially severe in the case of the transition economies. We utilize a mixed-estimation method incorporating prior information from OECD country data to estimate the parameters of a reduced-form transition economy model. An exactly identified structural VAR model is constructed to analyze monetary policy in the transition economies. The OECD information increases the precision of the impulse response functions in the transition economies. The method provides a systematic way to analyze monetary policy in the transition economies where data availability is limited. Author Affiliation: (a) Research Department, P.O. Box 442, Federal Reserve Bank of St. Louis, St. Louis, MO 63166-0442, USA (b) Department of Economics, University of Memphis, Memphis, TN, USA

The response of hours to a technology shock is a controversial issue in macroeconomics. Part of the difficulty lies in that the estimated response is sensitive to the specification of hours in structural vector autoregressions (SVARs). This paper uses a simple two-step approach to consistently estimate the response of hours. The first step considers a SVAR model with a relevant stationary variable, but excluding hours. Given a consistent estimate of technology shocks in the first step, the response of hours to this shock is estimated in a second step. Simulation experiments from an estimated dynamic stochastic general equilibrium (DSGE) model show that this approach outperforms standard SVARs. When applied to U.S. data, the two-step approach predicts a short-run decrease followed by a hump-shaped positive response. This result is robust to other specifications and data. JEL codes: C32, E32 Keywords: SVARs, long-run restriction, technology shocks, hours worked., THE RESPONSE OF hours to a technology shock is the subject of many controversies in quantitative macroeconomics. The contributions of Gall (1999), Basu, Fernald, and Kimball (2006), and Francis and [...]

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jmoneco.2009.03.013 Byline: Ferre De Graeve (a), Marina Emiris (b), Raf Wouters (b) Abstract: By expanding the macro part of macro-finance models, historical fluctuations in US bond yields turn out to be largely consistent with the rational expectations hypothesis. We estimate a medium-scale macro-finance DSGE model of the term structure to establish this. Our finding contrasts with existing macro-finance models and suggests that their -- small-scale or non-structural -- perspective on the macroeconomy mutes expectations, thereby underestimating the expectations hypothesis' potential. Out-of-sample forecasts are competitive with more flexible term structure models. Given the empirical validation, we interpret various episodes through the lens of the model and investigate which structural shocks cause the yield curve to contain information about future growth. Author Affiliation: (a) Federal Reserve Bank of Dallas, 2200 N. Pearl St., Dallas, TX 75201, USA (b) National Bank of Belgium, Berlaimontlaan 4, 1000 Brussels, Belgium Article History: Received 17 September 2008; Revised 25 March 2009; Accepted 25 March 2009 Article Note: (footnote) [star] We wish to thank the editor, Robert King, an anonymous referee, Wouter den Haan, Hans Dewachter, Gert Peersman, Frank Smets, Rudi Vander Vennet, and seminar participants at the Norges Bank (Central Bank Workshop on Macroeconomic Modelling), CERGE-EI, the 2008 meetings of the Western Finance Association, and the Conference on Computational Economics and Finance for helpful comments and suggestions. Most of this paper was written while Ferre De Graeve was visiting the National Bank of Belgium, whose hospitality is gratefully acknowledged. The views expressed herein do not necessarily reflect those of the National Bank of Belgium, the Federal Reserve Bank of Dallas, or the Federal Reserve System. Supplementary material is available via Science Direct.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jmoneco.2009.03.011 Byline: Meredith J. Beechey (a), Jonathan H. Wright (b) Keywords: Intradaily data; News announcements; Inflation compensation; Real interest rates Abstract: Macroeconomic news announcements move yields and forward rates on nominal and index-linked bonds and inflation compensation. This paper estimates the reactions using high-frequency data on nominal and index-linked bond yields, allowing the effects of news announcements on real rates and inflation compensation to be parsed far more precisely than is possible using daily data. Long-term nominal yields and forward rates are very sensitive to macroeconomic news announcements. Inflation compensation is sensitive to announcements about price indices and monetary policy. However, for news announcements about real economic activity, such as nonfarm payrolls, the vast majority of the sensitivity is concentrated in real rates. Accordingly, most of the sizeable impact of news about real economic activity on the nominal term structure of interest rates represents changes in expected future real short-term interest rates and/or real risk premia rather than changes in expected future inflation and/or inflation risk premia. Such sensitivity of real rates to macroeconomics news is hard to rationalize within the framework of existing macroeconomic models. Author Affiliation: (a) Sveriges Riksbank Monetary Policy Department, 103 37 Stockholm, Sweden (b) Johns Hopkins Department of Economics, Baltimore, MD 21218, USA Article History: Received 13 November 2008; Revised 26 March 2009; Accepted 26 March 2009 Article Note: (footnote) [star] We are grateful to Joseph Gagnon, Alejandro Justiniano, Andy Levin, Clara Vega, Motohiro Yogo and an anonymous referee for helpful comments on an earlier draft. The first version of this paper was written while the authors worked at the Federal Reserve Board. The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other employee of the Federal Reserve System.

There is an extensive body of work devoted to understanding the determinants of asset prices. The cornerstone formula behind most of these studies can be summarized in equation (1). The [...]

We create a model with a distinction between investment in consumer durables and capital goods, as well as energy use by households and firms, to evaluate the importance of energy price shocks for output fluctuations. Simulation results indicate that this economy has a smaller proportion of output fluctuations attributable to energy price shocks than one without durable goods and household energy use. We show that an energy price hike is absorbed by reducing investment in durables more than in fixed capital. This rebalancing effect cushions the hit to future production. Thus, productivity shocks remain the prime driver for output fluctuations. JEL codes: E32, Q43 Keywords: energy prices, business cycles, durable goods., As HAMILTON AND HERRERA (2004) and Hamilton (2008) point out, 9 out of 10 of the U.S. recessions since World War II and every recession since 1973 were preceded by [...]

This paper studies the role of an endogenous time preference on the relationship between inflation and growth in the long run in both the money-inutility-function (MIUF) and transactions-costs (TC) models. We establish a qualitative equivalence between the two models in a setup without a labor-leisure tradeoff. When the time preference is decreasing (or increasing) in consumption and real balances, both the MIUF and TC models are qualitatively equivalent in terms of predicting a negative (or positive) relationship between inflation and growth in a steady state. Both a decreasing and an increasing time preference in consumption are consistent with the arguments found within the literature. While a decreasing time preference in real balances corroborates with empirical evidence, there is no evidence in support of an increasing time preference in real balances. JEL code: 042 Keywords: endogenous time preferences, superneutrality, qualitative equivalence., THE RELATION BETWEEN inflation and growth has been one of the central issues in macroeconomics since the work first performed by Tobin (1965) and Sidrauski (1967). Different approaches of introducing [...]

We document the empirical properties of revisions to major macroeconomic variables in the United States. Our findings suggest that they do not satisfy simple desirable statistical properties. In particular, we find that these revisions do not have a zero mean, which indicates that the initial announcements by statistical agencies are biased. We also find that the revisions are quite large compared to the original variables and they are predictable using the information set at the time of the initial announcement, which means that the initial announcements of statistical agencies are not rational forecasts. JEL codes: C22, C53, C82 Keywords: forecasting, news and noise, real-time data, NIPA variables., MOST MACROECONOMIC VARIABLES are substantially revised by statistical agencies in the months after their initial announcements. These revisions generally reflect the arrival of new information that was not available at [...]

While the relationship between volatility and risk is central to much of the financial literature it has hot been incorporated systematically into assessment of sovereign debt sustainability. This paper attempts to fill this gap by studying how the probability distribution of sovereign debt to GDP ratios depends on the stochastic properties of underlying macroeconomic variables. Using right-hand tail of the distribution as a measure of the risk we are able to show how the volatility of the underlying variables as well as potential interactions between them influence country risk. JEL classification: C15; F34 Keywords: Macroeconomic volatility; Debt dynamics; Sovereign spreads

Modern theories of exchange rate determination typically imply a close relationship between exchange rates and other macroeconomic variables such as output, consumption, and trade flows. The intuition behind this relationship [...]

We present empirical evidence on the forces driving real exchange rates in the long-run. Using data from the US, UK and Italy across different exchange rate regimes, we find support for the hypothesis that productivity and fiscal shocks matter. However, in some cases fiscal shocks cause depreciations, likely triggered by the monetary accommodation of fiscal shocks. We also find that the traditional Harrod-Balassa-Samuelson effect of productivity on real exchange rates is reversed in some cases, which confirms the importance of the distributive sector in driving productivity gains. JEL classification: F31; E44; C32 Keywords: Real exchange rates; Macroeconomic fluctuations; Structural change

In this paper I analyze whether restrictions to capital mobility reduce vulnerability to external shocks. More specifically, I ask if countries that restrict the free flow of international capital have a lower probability of experiencing a large contraction in net capital flows. I use three new indexes on the degree of international financial integration and a large multi-country data set for 1970-2004 to estimate a series of random-effect probit equations. I find that the marginal effect of higher capital mobility on the probability of a capital flow contraction is positive and statistically significant, but very small. Having a flexible exchange rate greatly reduces the probability of experiencing a capital flow contraction. The benefits of flexible rates increase as the degree of capital mobility increases. A higher current account deficit increases the probability of a capital flow contraction, while a higher ratio of FDI to GDP reduces that probability. JEL classification: F30; F32 Keywords: Capital controls; Capital mobility; Contagion; External imbalances; Current account deficits; Sudden stops; Capital flow contractions

A central aspect of the recent debate on global imbalances and the US current account deficit is the role of the exchange rate peg being followed by China and other Asian economies. While one view has stressed the need for Asian currency appreciation, another focuses on the importance of fiscal adjustment and more generally adjustment in relative savings rates in the US and Asian economies. This paper develops a simple two-region open economy macroeconomic model to analyze the alternative impacts of currency appreciation and fiscal adjustment on the current account. We stress a number of structural features of emerging Asian economies that may make currency appreciation an ineffective means of current account adjustment relative to fiscal policy changes. In addition, we note that there may be a welfare conflict between regions on the best way to achieve adjustment. JEL classification: E52; E58; F41 Keywords: Current account; Currency appreciation

Trends and gaps play an important role in macroeconomic discussions. For example, the output gap (the deviation of output from its trend, or potential value) and the unemployment gap (the [...]

We use univariate GARCH models of inflation and output growth and monthly data for the G7 covering the 1957-2000 period to test for the causal effect of real and nominal macroeconomic uncertainty on inflation and output growth, and the effect of inflation on inflation uncertainty. Our evidence supports a number of important conclusions. First, inflation is a positive determinant of uncertainty about inflation. Second, output growth uncertainty is a positive determinant of the output growth rate. Third, there is mixed evidence regarding the effect of inflation uncertainty on inflation and output growth. Hence, uncertainty about the inflation rate is not necessarily detrimental to economic growth. Finally, there is not much evidence supporting the hypothesis that output uncertainty raises inflation. JEL classifications: C22; C51; C52; E0 Keywords: Inflation; Output Growth; Uncertainty; Granger-causality; GARCH models

The extent to which macroeconomic conditions affect firm's credit risk and size of capital structure changes is analyzed.

An equilibrium model to explain demand uncertainty and distribution of capacity utilization rates of firms is discussed.

This paper shows that many Asia-Pacific firms are significantly exposed to foreign exchange risk. Their exposure appears to be much more widespread than is typical for the large, western industrialized economies. The paper also shows that exchange rate pegs appear to do little to alleviate this widespread exposure against currencies other than the peg. The firms studied here are most exposed to fluctuations in the US dollar; the yen and the euro are important in a few countries. The extent of their exchange rate exposure has varied but not diminished over the last decade. The most widespread exchange rate sensitivity (not just the most exchange rate fluctuation) occurred during the Asian crisis period; this is evident even after accounting for the local macroeconomic conditions that affect aggregate local returns. JEL classification: F31; G32; F23; F33 Keywords: Economic exposure; Currency regime; Total exposure; Residual exposure

This paper formulates an affine term structure model of bond yields from a dynamic stochastic general equilibrium model, with observable macro state variables as the term structure factors. Model implications for the joint macro-term structure dynamics are consistent with the empirical patterns from the VAR estimation. Model calibration and simulation exercises also provide clear macroeconomic interpretations of the latent term structure factors as found in the finance literature: most of the 'slope' factor movement can be explained by exogenous monetary policy shocks, and the 'level' factor movement is closely related to the technology shocks. JEL codes: E43, E44, E52 Keywords: macro factors, affine term structure, general equilibrium., THE TERM STRUCTURE of interest rates and macroeconomic activity are closely related. Bond-traders and financial analysts often cite monetary policy as a major factor in term structure movements, and the [...]

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jimonfin.2006.04.001 Byline: Paul R. Bergin (a)(b) Abstract: This paper advances the New Open Economy Macroeconomic literature in an empirical direction, estimating and testing a two-country model. Fit to U.S. and G7 data, the model performs moderately well for the exchange rate and current account. Results offer guidance for future theoretical work. Parameter estimates lend support to the assumption of local currency pricing. Estimates are found for key parameters commonly calibrated in the theoretical literature, such as the elasticity of substitution between home and foreign composite goods, and the response of a country's risk premium to the net foreign asset position. Results also indicate that deviations from interest rate parity are not closely related to monetary policy shocks, as recently hypothesized, but that these deviations are strongly related to shifts in the current account. Author Affiliation: (a) Department of Economics, University of California, One Shields Avenue, Davis, CA 95616-8578, USA (b) NBER, USA