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Zombies at Large? Corporate Debt Overhang and the Macroeconomy
With business leverage at record levels, the effects of corporate debt overhang on growth and investment have become a prominent concern. In this paper, we study the effects of corporate debt overhang based on long-run cross-country data covering the near-universe of modern business cycles. We show that business credit booms typically do not leave a lasting imprint on the macroeconomy. Quantile local projections indicate that business credit booms do not affect the economy’s tail risks either. Yet in line with theory, we find that the economic costs of corporate debt booms rise when ...
Working Paper
Global Financial Cycles and Risk Premiums
This paper studies the synchronization of financial cycles across 17 advanced economies over the past 150 years. The comovement in credit, house prices, and equity prices has reached historical highs in the past three decades. The sharp increase in the comovement of global equity markets is particularly notable. We demonstrate that fluctuations in risk premiums, and not risk-free rates and dividends, account for a large part of the observed equity price synchronization after 1990. We also show that U.S. monetary policy has come to play an important role as a source of fluctuations in risk ...
Working Paper
Learning from History : Volatility and Financial Crises
We study the effects of volatility on financial crises by constructing a cross-country database spanning over 200 years. Volatility is not a significant predictor of crises whereas unusually high and low volatilities are. Low volatility is followed by credit build-ups, indicating that agents take more risk in periods of low financial risk consistent with Minsky hypothesis, and increasing the likelihood of a banking crisis. The impact is stronger when financial markets are more prominent and less regulated. Finally, both high and low volatilities make stock market crises more likely, while ...
Working Paper
Leveraged bubbles
What risks do asset price bubbles pose for the economy? This paper studies bubbles in housing and equity markets in 17 countries over the past 140 years. History shows that not all bubbles are alike. Some have enormous costs for the economy, while others blow over. We demonstrate that what makes some bubbles more dangerous than others is credit. When fueled by credit booms,asset price bubbles increase financial crisis risks; upon collapse they tend to be followed by deeper recessions and slower recoveries. Credit-financed housing price bubbles have emerged as a particularly dangerous ...
Journal Article
The Fed and Its Shadow: A Historical View
Central bank policies have always incorporated both a discretionary or active component and a passive component. Successful central banking has required a coordination of the two components. After a period of apparent dormancy, the passive component of monetary policy has emerged from the shadows and become relevant for Federal Reserve policy today.
Working Paper
The impact of risk cycles on business cycles: a historical view
We investigate the effects of financial risk cycles on business cycles, using a panel spanning 73 countries since 1900. Agents use a Bayesian learning model to form their beliefs on risk. We construct a proxy of these beliefs and show that perceived low risk encourages risk-taking, augmenting growth at the cost of accumulating financial vulnerabilities, and therefore, a reversal in growth follows. The reversal is particularly pronounced when the low-risk environment persists and credit growth is excessive. Global-risk cycles have a stronger effect on growth than local-risk cycles via their ...
Working Paper
On the Origins of the Federal Reserve System and Its Structure
The creation of the Federal Reserve System ultimately stemmed from fundamental changes in the banking industry that heightened the risks associated with shifts in the public’s liquidity preferences and that created an atmosphere of distrust between the small, traditional, country banks and the large, transforming, Wall Street banks. The severity of the Panic of 1907 became the proximate factor in the Federal Reserve’s formation. The panic, which the New York Clearing House’s slow, discriminative, and insufficient response characterized, gave credence to concerns of growing financial ...
Working Paper
The Total Risk Premium Puzzle?
The risk premium puzzle is worse than you think. Using a new database for the U.S. and 15 other advanced economies from 1870 to the present that includes housing as well as equity returns (to capture the full risky capital portfolio of the representative agent), standard calculations using returns to total wealth and consumption show that: housing returns in the long run are comparable to those of equities, and yet housing returns have lower volatility and lower covariance with consumption growth than equities. The same applies to a weighted total-wealth portfolio, and over a range of ...
Working Paper
A New Normal for Interest Rates? Evidence from Inflation-Indexed Debt
The downtrend in U.S. interest rates over the past two decades may partly reflect a decline in the longer-run equilibrium real rate of interest. We examine this issue using dynamic term structure models that account for time-varying term and liquidity risk premiums and are estimated directly from prices of individual inflation-indexed bonds. Our finance-based approach avoids two potential pitfalls of previous macroeconomic analyses: structural breaks at the zero lower bound and misspecification of output and inflation dynamics. We estimate that the longer-run equilibrium real rate has fallen ...
Working Paper
How Cyclical Is Bank Capital?
The alleged pro-cyclicality of bank capital (high in good times, low in bad) has received some blame for the recent financial crisis. Others blame the countercyclicality of capital regulations: too low in high times and too high in bad. To address this problem, Basel III has introduced countercyclical capital buffers for large banks. But just how cyclical is bank capital? We look at the question from several vantage points, using both detailed recent data on risk-weighted assets and several sources of annual data going back to 1834. To help understand the historical data, we provide a short ...