Speculation and recessions
Caballero and Simsek develop a risk-centric macroeconomic model in order to explore the role of the aggregate demand channel and interest rate frictions in causing recessions driven by a rise in the “risk premium”. They then study the impact of financial speculation on the severity of these recessions and derive the implications for macroprudential policy.
In principle, interest rate policy is highly effective in dealing with shocks to asset valuations. However, if monetary policy is constrained, a decline in risky asset valuations generates a demand recession. This reduces earnings and generates a negative feedback loop between asset prices and aggregate demand. In the recession phase, beliefs matter not only because they affect asset valuations but also because they determine the strength of the amplification mechanism.
A Risk-centric Model of Demand Recessions and Speculation
Authors: Ricardo J. Caballero, Alp Simsek
From: MIT
Which propagation mechanism best describes the observed business cycles?
In this paper, Angeletos and al. propose a new strategy for dissecting the macroeconomic time series and provide a template for the propagation mechanism that best describes the observed business cycles. The strategy involves taking multiple cuts of the data. Each cut corresponds to a VAR-based shock that accounts for the maximal volatility of a particular variable over a particular frequency band.
- They find evidence against theories that attribute the bulk of the business cycle to any of the following forces: technology or other shocks that map to TFP movements; news about future productivity; and inflationary demand shocks.
On the contrary, models that contain a non-inflationary, demand shock as the main driver of the business cycle seem a priori consistent with the evidence.
[O]ur findings suggest that the flexible-price core of the mainstream, New Keynesian framework is problematic to start with, in the sense that this core is itself unable to accommodate the kind of non-inflationary demand shock we have documented in the data.
Business Cycle Anatomy
Authors: George-Marios Angeletos, Fabrice Collard, Harris Dellas
From: MIT, Toulouse School of Economics, University of Bern
