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Session 9: The Macroeconomics of Uncertainty and Volatility

September 7-9, 2016

Organized by:

  • Nick Bloom (Stanford University)
  • Steve Davis (University of Chicago)
  • Jesus Fernandez-Villaverde (University of Pennsylvania)

Pre-registration is mandatory for all non-presenter attendees. The session will cover recent work on the causes and effects of changes in volatility and uncertainty in the aggregate economy. Many observers, including policymakers such as Bernanke, Summers, and Romer, have highlighted that these have been major driving factors in the recent credit-crunch recession and advanced heuristic arguments of why this might have been the case. Unfortunately, our theoretical and empirical understanding of these topics is limited since only recently have macroeconomists started working on these issues from a more systematic basis. Nevertheless, the preliminary results in the literature suggest changes in volatility and uncertainty similar to the ones observed for the U.S. economy are likely significant factors in business cycle fluctuations. Moreover, the presence of changes in volatility and uncertainty has important implications for the design of optimal monetary and fiscal policies.

See printable program here.

In this Session

Sep 7 | 12:00 pm to 1:00 pm

Check-in and Lunch

Sep 7 | 1:00 pm to 1:40 pm

Uncertainty and Consumer Credit Decisions

Presented by: Rodney Ramcharan (USC Price School of Public Policy)
Co-Author(s): Marco DiMaggio (Columbia Business School), Amir Kermani (UC Berkeley Haas), Edison Yu (Federal Reserve Bank of Philadelphia)
Sep 7 | 1:40 pm to 2:20 pm

The Tail that Wags the Economy: Belief-Driven Business Cycles and Persistent Stagnation

Presented by: Venky Venkateswaran (NYU Stern)
Co-Author(s): Laura Veldkamp (NYU Stern), Julian Kozlowski (New York University)
Sep 7 | 2:20 pm to 3:00 pm

Uncertainty Aversion and Heterogeneous Beliefs in Linear Models

Presented by: Cosmin L. Ilut (Duke University)
Co-Author(s): Pavel Krivenko and Martin Schneider (Stanford University)

This paper proposes a simple perturbation approach for dynamic models with agents who differ in their perception of exogenous hocks. The method characterizes linear dynamics around the steady state, which may differ from any individual agent's long run expectation. It applies when agents agree to disagree, as well as when they differ in aversion to Knightian uncertainty and hence behave as if they hold different worst case beliefs. It thus allows us to study uncertainty in a linear setting. Our leading example looks at precautionary savings and gains from insurance in a borrower-lender model with agents who differ in uncertainty aversion.

Sep 7 | 3:00 pm to 3:30 pm


Sep 7 | 3:30 pm to 4:10 pm

Contractionary Volatility or Volatile Contractions?

Presented by: David Berger and Ian Dew-Becker (Northwestern University), Stefano Giglio (University of Chicago)

Abstract: There is substantial evidence that the volatility of the economy is countercyclical. This paper provides new empirical evidence on the relationship between aggregate volatility and the macroeconomy. We aim to test whether that relationship is causal: do increases in uncertainty about the future cause recessions? We measure volatility expectations using market-implied forecasts of future stock return volatility. According to both simple cross-correlations and a standard VAR, shocks to realized volatility are contractionary, while shocks to expected volatility in the future have no clear effect on the economy. Furthermore, investors have historically paid large premia to hedge shocks to realized volatility, but the premia associated with shocks to volatility expectations are have not been statistically different from zero. We argue that these facts are inconsistent with models in which increases in expected future volatility cause contractions, but they are in line with the predictions of a simple model in which aggregate technology shocks are negatively skewed. The latter view is also consistent with evidence that equity returns and real activity are negatively skewed.

Sep 7 | 4:10 pm to 4:50 pm

Uncertainty and Business Cycles: Exogenous Impulse or Endogenous Response?

Presented by: Sydney Ludvigson (New York University)
Co-Author(s): Sai Ma (New York University), Serena Ng (Columbia University)

Uncertainty about the future rises in recessions. But is uncertainty a source of business cycle fluctuations or an endogenous response to them, and does the type of uncertainty matter? Answer: we find that sharply higher uncertainty about real economic activity in recessions is fully an endogenous response to other shocks that cause business cycle fluctuations, while uncertainty about financial markets is a likely source of the fluctuations. Financial market uncertainty has quantitatively large negative consequences for several measures of real activity including employment, production, and orders. Such are the main conclusions drawn from estimation of three-variable structural vector autoregressions. To establish causal effects, we propose an iterative projection IV (IPIV) approach to construct external instruments that are valid under credible interpretations of the structural shocks.

Sep 7 | 4:50 pm to 5:30 pm

Inequality and Aggregate Demand

Presented by: Adrien Auclert (Stanford University)
Co-Author(s): Matthew Rognlie (MIT)

We explore the quantitative effects of transitory and persistent increases in income inequality on equilibrium interest rates and output. Our starting point is a Bewley-Huggett-Aiyagari model featuring rich heterogeneity and earnings dynamics as well as downward nominal wage rigidities. A temporary rise in inequality, if not accommodated by monetary policy, has an immediate effect on output that can be quantified using the empirical covariance between income and marginal propensities to consume. A permanent rise in inequality can lead to a permanent Keynesian recession, which is not fully offset by monetary policy due to a lower bound on interest rates. We show that the magnitude of the real interest rate fall and the severity of the steady-state slump can be approximated by simple formulas involving quantifiable elasticities and shares, together with two parameters that summarize the effect of idiosyncratic uncertainty and real interest rates on aggregate savings. For plausible parametrizations the rise in inequality can push the economy into a liquidity trap and create a deep recession. Capital investment and deficit-financed fiscal policy mitigate the fall in real interest rates and the severity of the slump.

Sep 8 | 8:30 am to 9:00 am

Check-in and coffee

Sep 8 | 9:00 am to 9:30 am

A New Index of Uncertainty Based on Internet Searches: A Friend or Foe of Other Indicators?

Presented by: Maria Elena Bontempi or Roberto Golinelli (University of Bologna)
Co-Author(s): Matteo Squadrani (University of Bologna)

The preliminary evidence in the literature suggests that changes in uncertainty have a role in shaping the U.S. economic cycle. But what is effectively measured by the different available indicators of uncertainty still remains an "uncertain" issue. This paper has two aims: (i) to introduce a new uncertainty indicator (GT) based on Internet searches; and (ii) to compare the main features and the macroeconomic effects of alternative measures of uncertainty, including our own. Results suggest that GT shocks embody timely information about people's perception of uncertainty and, in some cases, earlier than other indexes. Furthermore, the effect of uncertainty shocks on output is more influenced by parameter breaks due to insample events than by model specification. The consequence is that an all-comprehensive indicator able to weight different sources of uncertainty is preferable.

Sep 8 | 9:30 am to 10:00 am

Measuring Geopolitical Risk

Presented by: Matteo Iacoviello or Dario Caldara (Federal Reserve Board)
Sep 8 | 10:00 am to 10:30 am

Identifying Ambiguity Shocks in Business Cycle Models using Survey Data

Presented by: Anmol Bhandari (University of Minnesota)
Co-Author(s): Jaroslav Borovicka (New York University), Paul Ho (Princeton University)

We develop a macroeconomic framework with agents facing time-varying concerns for model misspecification. These concerns lead agents to interpret the economy through the lens of a pessimistically biased ‘worst-case’ model. We use survey data to identify exogenous fluctuations in the worst-case model. In an estimated New-Keynesian business cycle model with frictional labor markets, these ambiguity shocks explain a substantial portion of the variation in labor market quantities.

Sep 8 | 10:30 am to 11:00 am


Sep 8 | 11:00 am to 11:30 am

Policy Uncertainty and FDI: Evidence from the China-Japan Island Dispute

Presented by: Cheng Chen (University of Hong Kong)
Co-Author(s): Tatsuro Senga (Queen Mary University of London), Chang Sun (Princeton University), Hongyong Zhang (RIETI)
Sep 8 | 11:30 am to 12:00 pm

Policy Uncertainty and Investment: Evidence from the English East India Company

Presented by: Dan Bogart (UC Irvine)
Sep 8 | 12:00 pm to 1:15 pm


Sep 8 | 1:15 pm to 1:45 pm

The Real and Financial Impact of Uncertainty Shocks

Presented by: Iván Alfaro (The Ohio State University), Nicholas Bloom (Stanford University), Xiaoji Lin (The Ohio State University)
Sep 8 | 1:45 pm to 2:15 pm

Uncertainty and International Capital Flows

Presented by: Francois Gourio (Federal Reserve Bank of Chicago), Michael Siemer (Federal Reserve Board), Adrien Verdelhan (MIT Sloan)

Using a large panel of 26 emerging countries over the last 40 years, we show that uncer- tainty, measured using stock market return volatilities, predicts international capital flows. When a country’s stock market volatility increases, net capital inflows decrease. This is driven by a large decline of capital inflows (by foreigners) which is partially offset by a decline of capital outflows (by residents). To isolate a plausibly exogenous component of uncertainty, we construct an instrument for stock market volatility by interacting each country’s commodity exports structure with the price volatilities of the different commodities. We also study one potential explanation for these results: expropriation risk. Empirically, we find that stock market volatility forecasts political risk, and that political risk significantly affects capital flows. In a simple portfolio choice model, assuming that foreigners are more exposed to expropriation risk than local investors, an increase in the probability of expropriation leads foreigners to sell the domestic assets to the local investors, leading to a counter-cyclical home bias. This coincides with higher price volatility under plausible assumptions.

Sep 8 | 2:15 pm to 2:45 pm

Economic Policy Uncertainty and the Credit Channel: Aggregate and Bank Level U.S. Evidence over Several Decades

Presented by: John V. Duca (Federal Reserve Bank of Dallas)
Co-Author(s): Michael D. Bordo (Rutgers University), Christoffer Koch (Federal Reserve Bank of Dallas)

Economic policy uncertainty affects decisions of households, businesses, policy makers and Financial intermediaries. We first examine the impact of economic policy uncertainty on aggregate bank credit growth. Then we analyze commercial bank entity level data to gauge the effects of policy uncertainty on Financial intermediaries' lending. We exploit the cross-sectional heterogeneity to back out indirect evidence of its effects on businesses and households. We ask (i) whether, conditional on standard macroeconomic controls, economic policy uncertainty affected bank level credit growth, and (ii) whether there is variation in the impact related to banks' balance sheet conditions; that is, whether the effects are attributable to loan demand or, if impact varies with bank level financial constraints, loan supply. We find that policy uncertainty has a significant negative effect on bank credit growth. Since this impact varies meaningfully with some bank characteristics – particularly the overall capital-to-assets ratio and bank asset liquidity–loan supply factors at least partially (and significantly) help determine the influence of policy uncertainty. Because other studies have found important macroeconomic effects of bank lending growth on the macroeconomy, our findings are consistent with the possibility that high economic policy uncertainty may have slowed the U.S. economic recovery from the Great Recession by restraining overall credit growth through the bank lending channel.

Sep 8 | 2:45 pm to 3:15 pm


Sep 8 | 3:15 pm to 3:45 pm

Interest Rate Uncertainty, Hedging, and Real Activity

Presented by: Andrea Vedolin (London School of Economics)
Co-Author(s): Lorenzo Bretscher (London School of Economics), Lukas Schmid (Duke University)

Uncertainty about the future path of interest rates is associated with a significant slowing of future economic activity both at the aggregate and firm level. Using a large data set on firms’ interest rate swap usage, we find that 1) interest rate risk management helps firms attenuate the adverse effects of interest rate uncertainty on investment and 2) there are significant cross-sectional differences in swap usage according to asset and financing risk. To interpret these findings, we develop a dynamic model of corporate interest rate risk management in the presence of investment and financing frictions.

Sep 8 | 3:45 pm to 4:00 pm


Sep 8 | 4:00 pm to 5:00 pm

Keynote Address: Understanding the Decline in the Safe Real Interest Rate

Presented by: Bob Hall (Stanford University)

Over the past few decades, worldwide real interest rates have trended downward. The real interest rate describes the terms of trade between risk-tolerant and risk-averse investors. Debt pays off equally across contingencies at a given future date, so debt is valuable to risk-averse investors to smooth consumption across those contingencies. In an equilibrium with trade between investors who differ in attitudes toward risk, the risk-tolerant investors will borrow from the risk-averse ones, shifting the risk to those whose preferences favor taking on risk. In the case where investors have preferences that are additively separable in future states and in time, attitudes toward risk are heterogeneous among investors if they differ in the curvature of their utility kernels and differ in their beliefs about the probabilities of outcomes, especially adverse outcomes. If the composition of investors shifts toward those with higher curvature (higher coeffi- cients of relative risk aversion) and toward investors who believe in higher probabilities of bad events, the real interest rate falls. The paper calculates likely magnitudes of the decline and presents evidence in favor of a shift in the composition of investors toward the more risk-averse. The downward trend in real interest rates is a significant problem for monetary policy but is helpful to heavily indebted countries.

Sep 8 | 6:00 pm

Participants' Dinner

Sep 9 | 8:00 am to 8:30 am

Check-in and coffee

Sep 9 | 8:30 am to 9:10 am

Testing For Policy Affected Uncertainty in Arma-Garch Model

Presented by: Svetlana Makarova (University College London)
Co-Author(s): Wojciech Charemza (University of Leicester), Christian Francq and Jean-Michel Zakoïan (CREST Paris)
Sep 9 | 9:10 am to 9:50 am

Measuring Global and Country-Specific Uncertainty

Presented by: Simon Sheng (American University)
Co-Author(s): Ezgi O. Ozturk (International Monetary Fund)

Using individual survey data from the Consensus Forecast over the period of 1989-2014, we propose a monthly measure of macroeconomic uncertainty covering 46 countries. Our measure is based on market participants and derives from two components: common uncertainty, defined as the conditional volatility of future aggregate shocks and idiosyncratic uncertainty, captured by the disagreement among professional forecasters. Common uncertainty shocks produce the large and persistent negative response in real economic activity, whereas the contributions of idiosyncratic uncertainty shocks are negligible.

Sep 9 | 9:50 am to 10:30 am

The Welfare and Distributional Effects of Fiscal Uncertainty: a Quantitative Evaluation

Presented by: Rudi Bachmann (University of Notre Dame)
Co-Author(s): Jinhui Bai (Washington State University), Minjoon Lee and Fudong Zhang (University of Michigan)
Sep 9 | 10:30 am to 11:00 am


Sep 9 | 11:00 am to 11:40 am

Fluctuations in Uncertainty, Efficient Borrowing Constraints and Firm Dynamics

Presented by: Sebastian Dyrda (University of Toronto)

ABSTRACT This paper quantifies the importance of aggregate fluctuations in microeconomic uncertainty for firm dynamics over the business cycle in economy with endogenously frictional financial markets. To begin, I provide evidence on asymmetric response across age and size groups of firms in the U.S. to the changes in aggregate economic conditions. I argue that age rather than size is a relevant margin for the cyclical employment dynamics; in particular total employment of young firms varies 2.6 times more relative to the old firms. Motivated by these observations, I propose a theory generating endogenously a link between firm's age and size and its ability to obtain financing. A key element of the theory is a financial friction, originated from the firm's private information and long-term, lending contract between firm and financial intermediary, which manifests itself as an efficient borrowing constraint. I show that, for any given size, young firms are more constrained in borrowing relative to the old ones. As the microeconomic uncertainty increases, the financial contract tightens the borrowing constraint to alleviate the cost of differentiating between good and poorly performing firms. This translates the initial impulse into a decline in demand of the constrained firms for production inputs, and further, including general equilibrium effects, into an economic downturn. Mechanism affects young firms disproportionally for two reasons: (i) majority of the constrained firms in the economy is young (ii) the size of new entrants is reduced due to lower initial financing available. A quantitative version of the model explains 50% of the fall in the aggregate employment and 72% of the differential response of employment between young and old firms observed in the US economy during the recent four recessions. In line with the data the economy experiences drop in output, investment and decline of credit to GDP ratio.

Sep 9 | 11:40 am to 12:20 pm

Aggregate Volatility and Current Account Dynamics: Credit Supply Matters

Presented by: Pedro Gete (Georgetown University)
Co-Author(s): Givi Melkadze (Georgetown University)

Changes in country-specific aggregate volatility are positively correlated with current account dynamics while negatively correlated with investment, output and credit flows. An International Real Business Cycle model with time-varying aggregate uncertainty, through a precautionary savings channel, can account for the positive correlation but implies counterfactual comovements for the other variables. Adding a credit supply channel with default and lenders exposed to aggregate risk allows the model to match all the facts. Higher volatility contracts credit supply. The current account turns to surplus because savings increase, but also because investment collapses.