Session 17: The Macroeconomics of Uncertainty and Volatility
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- Nicholas Bloom, Stanford University
- Steve Davis, Stanford University
- Jesus Fernandez-Villaverde, University of Pennsylvania
- Zheng Liu, Federal Reserve Bank of San Francisco
- Bo Sun, University of Virginia
- Nancy Xu, Boston College
The session will cover recent work on the causes and effects of changes in volatility and uncertainty in the aggregate economy, which is incredibly topical given the COVID, Monetary and Ukraine volatility and now Middle East situation. Indeed, the most cited economics paper in the last 5-years is on measuring uncertainty and its impact on the US economy. This session will focus on measuring changes in uncertainty, evaluating its impact on the US and global economy, and discussing policy responses. The mix of academics and policy makers - with co-funding from the San Francisco Fed - across multiple institutions reflects this broad interest. The session will aim to include about 20 recent papers on these topics, with as in prior years a mix of theoretical and empirical papers, junior and senior presenters, and gender and demographic mix.
In This Session
Wednesday, September 4, 2024
12:00 pm - 1:00 pm PDT
Registration Check-In and Lunch
1:00 pm - 1:40 pm PDT
Political Risk Everywhere
Country risk premia include compensation for global political risk. Political risk premia drive international returns within and across asset classes, including equities, bonds, and currencies. A strong factor structure in politically sorted portfolios uncovers systematic variations in global political risk (P-factor). The P-factor commands a significant risk premium of 4.44% per annum with a Sharpe ratio of 0.70. Together with the global market portfolio, it explains up to three-quarters of cross-sectional variation in a large panel of asset returns. The P-factor is unspanned by the existing asset pricing factors, manifests in all asset classes, and is related to systematic variations in expected global growth and aggregate volatility.
1:40 pm - 2:20 pm PDT
Geopolitical Risk and Global Banking
This paper shows that internationally active banks play a significant role in propagating geopolitical risk to countries removed from the conflict. Using multiple supervisory datasets spanning the past four decades, we document that (i) geopolitical risk increases the credit risk of U.S. banks exposed through foreign operations; (ii) these banks nonetheless continue to lend to countries experiencing heightened geopolitical risk through their branches and subsidiaries, while their cross-border lending to these countries is reduced; and (iii) U.S. banks do not adjust foreign exposure in similar ways in response to other types of risk. These results indicate that banks face trade-offs and frictions that prevent prompt divestiture of foreign assets in response to geopolitical risk. We show that these forces generate spillover effects: U.S. banks reduce C&I lending and tighten lending standards to domestic firms in response to rising geopolitical risk abroad. The degree of spillovers is greater when the risk stems from countries where banks have affiliates and more geopolitically aligned countries.
2:20 pm - 3:00 pm PDT
Geopolitical Oil Price Risk and Economic Fluctuations
This paper seeks to understand the general equilibrium effects of time-varying geopolitical risk in oil markets. Answering this question requires simultaneously modeling downside risk from disasters, oil storage, and the endogenous determination of oil price and macroeconomic uncertainty. We find that shocks to the probability of geopolitically driven oil production disasters can have sizable effects on the oil market and macroeconomy but are not a major driver of macroeconomic fluctuations. Shocks to the probability of macroeconomic disasters are an important driver of oil price uncertainty, which helps explain why higher oil price uncertainty has been associated with lower real activity.
3:00 pm - 3:30 pm PDT
Break
3:30 pm - 4:10 pm PDT
Bank Competition, Policy Uncertainty, and Racial Disparities in Small Business Lending
We build a new dataset with rich loan-level information and document that, even after accounting for extensive borrower and lender attributes, large racial disparities in loan denial and interest rates exist in small business lending. The unique information structure in small business lending—characterized by the importance of localized, soft information—presents an untapped opportunity to examine the distinct implication from Becker (1957) on the prominent role of new entry in closing racial gaps. Exploiting the chronology of banking deregulation episodes, we fin that an exogenous intensification of bank competition has a quantitatively large effect of narrowing the racial gaps, an effect predominantly driven by entrant banks. Also importantly, such effects are primarily concentrated in the states exhibiting low economic policy uncertainty at the time. The confluence of our results points to the promise of pro-competitive deregulation in reducing the manifestation of prejudice on credit market outcomes, while also revealing policy uncertainty as a factor hindering the realization of such distributional gains.
4:10 pm - 4:50 pm PDT
The Financial Origins of Non-Fundamental Risk
We formalize the idea that the financial sector can be a source of non-fundamental risk. Households’ desire to hedge against price volatility can generate price volatility in equilibrium, even absent fundamental risk. Fearing that asset prices may fall, risk- averse households demand safe assets from leveraged intermediaries, whose issuance of safe assets exposes the economy to self-fulfilling fire sales. Policy can eliminate non- fundamental risk by (i) increasing the supply of publicly backed safe assets, through issuing government debt or bailing out intermediaries, or (ii) reducing the demand for safe assets, through social insurance or by acting as a market maker of last resort.
4:50 pm - 5:30 pm PDT
Credit Surfaces and Economic Uncertainty
Credit is central to the macroeconomy and macroeconomic policy. Traditionally credit spreads are characterized relative to risk-free benchmarks. We argue that the credit surface, i.e., the relative spreads between different borrowers and contract terms, provide a better description of credit markets. We show that when sorted along leverage and creditworthiness the credit surface not only becomes higher when economic uncertainty increases, but it also becomes steeper, that is, the relative spread between two contracts widens, as we observe empirically. These results have important implications for macroeconomic policy and the macroeconomic effects of economic uncertainty through the supply of credit.
5:30 pm - 7:00 pm PDT
Dinner
Thursday, September 5, 2024
8:30 am - 9:00 am PDT
Check-In and Breakfast
9:00 am - 9:40 am PDT
The Effects of Inflation Uncertainty on Firms and the Macroeconomy
We construct measures of inflation uncertainty for 37 countries using data from professional forecasters. Uncertainty rose substantially in most, but not all, countries following the pandemic. First, using vector autoregressions, we study the impact of domestic inflation uncertainty on inflation and industrial production. Next, we use firm-level data and panel local projections to analyze the impact of inflation uncertainty on firms’ real sales, employment, and profit margins. Real sales and employment decrease, while the effect on profit margins is insignificant. These effects are heterogeneous across countries. For example, in countries with low energy imports, firms’ real sales and profit margins increase in response to higher inflation uncertainty, whereas in countries with high energy imports, they decline. In countries with high import or export concentration, real sales decline, whereas in countries with low import or export concentration, real sales increase.
9:40 am - 10:20 am PDT
Causal Effects of Inflation Uncertainty on Households’ Beliefs and Actions
10:20 am - 10:40 am PDT
Break
10:40 am - 11:20 am PDT
Smooth Diagnostic Expectations
We show that the formalization of representativeness (Kahneman and Tversky (1972)) developed by Gennaioli and Shleifer (2010) features an intrinsic connection between uncertainty and overreaction. In the time series domain, this connection emerges in a smooth version of Diagnostic Expectations (DE). Smooth DE implies a joint and parsimonious micro-foundation for key properties of survey data: overreaction to news, stronger overreaction for longer forecast horizons, and overconfidence in subjective uncertainty, and a new stylized fact documented in this paper, namely that overreaction is stronger when uncertainty is high. An analytical Real Business Cycle model featuring Smooth DE accounts for overreaction and overconfidence in surveys, as well as three salient properties of the business cycle: asymmetry, countercyclical micro volatility, and countercyclical macro volatility.
11:20 am - 12:00 pm PDT
Agreed and Disagreed Uncertainty
When agents’ information is imperfect and dispersed, existing measures of macroeconomic uncertainty based on the forecast error variance have two distinct drivers: the variance of the economic shock and the variance of the information dispersion. The former driver increases uncertainty and reduces agents’ disagreement (agreed uncertainty). The latter increases both uncertainty and disagreement (disagreed uncertainty). We use these implications to identify empirically the effects of agreed and disagreed uncertainty shocks, based on a novel measure of consumer disagreement derived from survey expectations. Disagreed uncertainty has no discernible economic effects and is benign for economic activity, but agreed uncertainty exerts significant depressing effects on a broad spectrum of macroeconomic indicators.
12:00 pm - 12:40 pm PDT
HANK’s Response to Aggregate Uncertainty in an Estimated Business Cycle Model
This paper studies a HANK model with agents who respond to both idiosyncratic and aggregate uncertainty. Since aggregate uncertainty is modeled as ambiguity, it affects both the steady state and the linearized dynamics, allowing for fast computation and estimation with linear methods. The estimated model jointly fits cyclical variation in US macro aggregates and asset prices. In the presence of portfolio frictions, aggregate uncertainty shocks are a powerful driver of the business cycle, more so than idiosyncratic uncertainty shocks. Their effect is much stronger than in a representative agent model: portfolio substitution by rich capital owners helps fit investment and return dynamics.
12:40 pm - 1:30 pm PDT
Lunch
1:30 pm - 2:10 pm PDT
Reshoring, Automation, and Labor Markets under Trade Uncertainty
We study the implications of trade uncertainty for reshoring, automation, and U.S. labor markets. Rising trade uncertainty creates incentives for firms to reduce exposure to foreign suppliers by moving production and distribution processes to domestic producers. However, we argue that reshoring does not necessarily bring jobs back to the home country or boost domestic wages, especially when firms have access to labor-substituting technologies such as automation. Automation improves labor productivity and facilitates reshoring, but it can also displace jobs. Furthermore, automation poses a threat that weakens the bargaining power of unskilled workers in wage negotiations, depressing their wages and raising the skill premium and wage inequality. Our model predictions are in line with industry-level empirical evidence.
2:10 pm - 2:50 pm PDT
Workers' Job Prospects and Young Firm Dynamics
This paper investigates how worker beliefs and job prospects impact the wages and growth of young firms and quantifies aggregate implications. Building a heterogeneous-firm directed search model where workers gradually learn about firm types, I find that the learning creates endogenous wage differentials for young firms. High-performing young firms must pay a higher wage than that of equally high-performing old firms, while low-performing young firms offer a lower wage than that of equally low-performing old firms. Higher uncertainty amplifies the wage differentials and hampers firm entry and aggregate productivity. Using U.S. administrative employee-employer linked data, I provide consistent results.
2:50 pm - 3:20 pm PDT
Break
3:20 pm - 4:00 pm PDT
Financial Stress and Economic Activity: Evidence from a New Worldwide Index
This paper uses text analysis to construct a continuous financial stress index (FSI) for 110 countries over each quarter during the period 1967-2018. It relies on a computer algorithm along with human expert check. The new indicator has a larger country and time coverage and higher frequency than similar measures focusing on advanced economies. And it complements existing binary chronologies in that it can assess the severity of financial crises. We use the indicator to assess the impact of financial stress on the economy using both country- and firm-level data. Our main findings are fivefold: i) consistent with existing literature, we show an economically significant and persistent relationship between financial stress and output; ii) the effect is larger in emerging markets and developing economies and (iii) for higher levels of financial stress; iv) we deal with simultaneous causality by constructing a novel instrument—financial stress originating from other countries—using information from the text analysis, and show that, while there is clear evidence that financial stress harms economic activities, OLS estimates tend to overestimate the magnitude of this effect; (iv) we confirm the presence of an exogenous effect of financial stress through a difference-in-differences exercise and show that effects are larger for firms that are more financially constrained and less profitable.
4:00 pm - 4:40 pm PDT
Financial News Production
I establish that financial news production can be strongly influenced by factors un- related to the arrival of, and demand for, information. Fluctuations in real economic activity, such as advertising, generate cash-flow shocks to the media sector, which reacts by changing news quantity and quality. Such endogenous dynamics in news production then shift the levels of uncertainty and information asymmetry about irms, affecting real and financial outcomes. Implementing a within-firm estimator on a comprehensive data set of media advertising revenue, news, and job postings, I compare news production about the same firm by different news media whose advertising revenues are differentially exposed to industry-level advertisement shocks. Financial news production is procyclical at the aggregate level and serves as a channel for economic shock transmission and amplification.
4:40 pm - 5:20 pm PDT
Local Monetary Policy
When Federal Reserve districts experience high inflation but lack voting rights to influence FOMC decisions, Federal Reserve Banks reduce credit extended through the Discount Window (DW). The identification strategy is based on the exogenous rotation of voting rights among Reserve Banks and on within borrower-time and district-time variations in DW loans and Federal Home Loan Bank (FHLB) loans. Our empirical design ensures that factors related to changes in macroeconomic conditions, local credit demand or borrower characteristics do not drive the results. Our findings suggest the existence of Local Monetary Policy (LMP) executed by the Federal Reserve Banks.
6:00 pm - 8:00 pm PDT
Dinner at Nick's House
Friday, September 6, 2024
8:00 am - 8:30 am PDT
Check-In & Breakfast
8:30 am - 9:10 am PDT
The Economic Impact of Fiscal Policy Uncertainty: Evidence from a New Cross-Country Database Presented
Fiscal policy uncertainty (FPU)—ambiguity in government spending and tax plans, as well as in public debt valuation—is widely regarded as a source of economic and financial disruptions. However, assessing its impact has so far been limited to a few large economies. In this paper, we construct a novel database of news-based fiscal policy uncertainty at a global level - encompassing FPU events that garner worldwide attention - and for 189 individual countries. An increase in global fiscal policy uncertainty reduces industrial production and raises sovereign borrowing costs for both advanced and emerging market economies, whose impact is smaller when country-specific fiscal policy uncertainty is used. Furthermore, global fiscal policy uncertainty generates synchronous movements in the global financial variables, even after accounting for US monetary policy shocks.
9:10 am - 9:50 am PDT
Uncertainty Shocks in Monetary Unions
The effects of country-specific and common uncertainty shocks differ in countries that operate in monetary unions. To establish this result, we use time-series data for the countries in the euro area. We find that country-specific shocks—even though they are not accommodated by monetary policy—have milder, not stronger, effects than common shocks, which are accommodated. To rationalize this result, we put forward a model of a monetary union where monetary policy responds to common but not to country-specific shocks. What dampens the effect of country-specific shocks is the nominal anchor that comes with union membership and eliminates inflation risk.
9:50 am - 10:30 am PDT
Measuring Climate Risk Exposure of Insurers
Insurance companies can be exposed to climate-related physical risk through their operations and to transition risk through their $12 trillion of financial asset holdings. We assess the climate risk exposure of property and casualty (P&C) and life insurance companies in the U.S. We construct a novel physical risk factor by forming a portfolio of P&C insurers’ stocks, with each insurer’s weight reflecting their operational exposure to states with high physical climate risk. We then estimate insurers’ dynamic physical climate beta, i.e. their stock return sensitivity to the physical risk factor. In addition, we calculate the expected capital shortfall of insurers under various climate stress scenarios. Validating our approach, we find that insurers with larger exposures to risky states have higher sensitivity to physical risk and insurers holding more brown assets have higher sensitivity to transition risk.
10:30 am - 10:50 am PDT
Break
10:50 am - 11:30 am PDT
Uncertainty and Unemployment Revisited: The Consequences of Financial and Labor Contracting Frictions
This paper revisits how uncertainty affects unemployment. Using Census employer-employee data, it finds that elevated uncertainty increases layoffs in financially constrained firms, an observation not predicted by standard search models where uncertainty freezes layoffs via irreversible search costs. A newly constructed search model can replicate the empirical evidence by incorporating financial and labor contracting frictions, so wage bills act as debt-like commitments, which firms are averse to taking on when uncertainty raises firm default risks. The model captures the increases in unemployment observed during U.S. past recessions, attributing over 70% of uncertainty’s impact on unemployment to the two contracting frictions.
11:30 am - 12:10 pm PDT
Inflation Disagreement Weakens the Power of Monetary Policy
Households often disagree in their inflation outlooks. We present novel empirical evidence that inflation disagreement weakens the power of forward guidance and conventional monetary policy. These empirical observations can be rationalized by a model featuring heterogeneous beliefs about the central banks’ inflation target. An agent who perceives higher future inflation also perceives a lower real interest rate and thus would like to borrow more to finance consumption, subject to borrowing constraints. Higher inflation disagreement would lead to a larger share of borrowing-constrained agents, resulting in more sluggish responses of aggregate consumption to changes in both current and expected future interest rates. This mechanism also provides a microeconomic foundation for Euler equation discounting that helps resolve the forward guidance puzzle.
12:10 pm - 1:00 pm PDT