Do long swings in the business cycle lead to strong persistence in output?

This paper investigates how the occasional long swing in the business cycle can produce long-memory behavior in US output. To prove this theoretical relationship, we extend the Hamilton Markov chain regime switching model of real aggregate output to include the occasional long regime. We do this by modeling the duration length of the expansion and recession regimes as draws from a fat-tailed distribution with realized durations that are high in variability and occasionally extreme in value. Empirically, we find that the tail indices for the length of US economic booms and busts correspond with the long-memory parameter estimates of Diebold and Rudebusch [1989. Long memory and persistence in aggregate output. Journal of Monetary Economics 24, 189-209] and Sowell [1992a. Modeling long-run behavior with the fractional ARIMA model. Journal of Monetary Economics 29, 277-302] for real US output. Estimates of our extended regime switching model produce better short- and long-run forecasts of output in comparison to forecasts with a fractionally integrated model. Furthermore, our estimated regime-switching model finds US expansions to be fragile during their infancy, but become more and more likely to continue after surviving the first seven quarters.     

Aggregate Implications of Heterogeneous Households in a Sticky‐Price Model

This paper analyzes the role of heterogeneous households in propagating shocks over the business cycle by generalizing a basic sticky‐price model to allow for imperfect risk sharing between households that differ in labor incomes. I show that imperfectly insured household consumption distorts household incentive to supply labor hours through an idiosyncratic income effect, which in turn generates strategic complementarities in price setting and thus amplifies business cycle fluctuations. This mechanism diminishes the role of nominal rigidities and makes sticky‐price models more consistent with microeconomic evidence on the frequency of price changes.     

Forecasting National Recessions Using State‐Level Data

We investigate whether there is information useful for identifying U.S. business cycle phases contained in subnational measures of economic activity. Using a probit model to forecast the National Bureau of Economic Research expansion and recession classification, we assess the incremental information content of state‐level employment growth over a commonly used set of national‐level predictors. As state‐level data adds a large number of predictors to the model, we employ a Bayesian model averaging procedure to construct forecasts. Based on a variety of forecast evaluation metrics, we find that including state‐level employment growth substantially improves nowcasts and very short‐horizon forecasts of the business cycle phase. The gains in forecast accuracy are concentrated during months of national recession.     

The dynamics of economic growth,oil prices,stock market depth,and other macroeconomic variables: Evidence from the G-20 countries

This paper examines the linkages between economic growth, oil prices, depth in the stock market, and three other key macroeconomic indicators: real effective exchange rate, inflation rate, and real rate of interest. We employ a panel vector autoregressive model to test Granger causality for the G-20 countries over the period 1961–2012. A novel approach to this study is that we clearly demarcate the long-run and short-run relations between the economic variables. The results show a robust long-run economic relationship between economic growth, oil prices, stock market depth, real effective exchange rate, inflation rate, and real rate of interest. In the long run, real economic growth is found to respond to any deviation in the long-run equilibrium relationship that is found to exist between the different measures of stock market depth, oil prices, and the other macroeconomic variables. In the short run we find a complex network of causal relationships between the variables. While the empirical evidence of short-run causality is mixed, there is clear evidence that real economic growth responds to various measures of stock market depth, allowing for real oil price movements and changes in the real effective exchange rate, inflation rate, and real rate of interest.     

Nonlinear equilibrium adjustment dynamics and predictability of the term structure of interest rates

We analyze money market dynamics under a long-run equilibrium framework where commonly-monitored spreads serve as error correction terms, derived from a structural model incorporating autocorrelated risk premia, interest rate smoothing and monetary policy feedback. Using a dataset of monthly observations of the spot next and four-, thirteen-, twenty six- and fifty two-week Treasury Bills rates for the United States, Germany and United Kingdom from January 1999 to April 2016, we investigate the power of the expectations hypothesis theory of interest rates taking into account long-run deviations from equilibrium and inherent nonlinearities. We reveal short-run dynamic adjustments for the term structure of the USA, Germany and the UK, which are subject to regime switches. When forecastability is tested during May 2016–October 2017, the MSIH-VECM outperforms systematically the VECM. This is the first attempt to explore the possibility of parameter instability as a crucial factor in deriving the rejection of the restricted version of the cointegration space. Moreover, we investigate the dynamic out-of-sample forecasts of the term structure to assess the effectiveness of nonlinear MS-VECM modeling in capturing the after-effects of the global crisis. Overall, our results suggest that regime shifts in the mean and variance of the term structure may be intertwined with changes in fundamentals, that play a role in driving interest rate regimes, in particular business cycle and inflation fluctuations.     

Endogenous Growth and Real Effects of Monetary Policy: R&D and Physical Capital Complementarities

We study the real long-run effects of the structural stance of monetary policy and of inflation, in the context of a monetary growth model where R&D is complemented with physical capital accumulation. We look into the effects on a set of real macroeconomic variables that have been of interest to policymakers—the economic growth rate, real interest rate, physical investment rate, capital-to-labor ratio, R&D intensity, and velocity of money. These variables have been previously analyzed from the perspective of different, separated, strands of the theoretical and empirical literature. Additionally, we analyze the long-run relationship between inflation and both the effectiveness of real industrial-policy shocks and the market structure, assessed namely by average firm size. We present novel cross-country evidence on the empirical relationship between the latter and long-run inflation.     

The market price of fiscal uncertainty

Recent fiscal interventions have raised concerns about US public debt, future distortionary tax pressure, and long-run growth potential. We explore the long-run implications of public financing policies aimed at short-run stabilization when: (i) agents are sensitive to model uncertainty, as in Hansen and Sargent (2007), and (ii) growth is endogenous, as in Romer (1990). We find that countercyclical deficit policies promoting short-run stabilization reduce the price of model uncertainty at the cost of significantly increasing the amount of long-run risk. Ultimately these tax policies depress innovation and long-run growth and may produce welfare losses.     

There is a risk-return trade-off after all

This paper studies the intertemporal relation between the conditional mean and the conditional variance of the aggregate stock market return. We introduce a new estimator that forecasts monthly variance with past daily squared returns, the mixed data sampling (or MIDAS) approach. Using MIDAS, we find a significantly positive relation between risk and return in the stock market. This finding is robust in subsamples, to asymmetric specifications of the variance process and to controlling for variables associated with the business cycle. We compare the MIDAS results with tests of the intertemporal capital asset pricing model based on alternative conditional variance specifications and explain the conflicting results in the literature. Finally, we offer new insights about the dynamics of conditional variance.     

Explaining and forecasting the euro/dollar exchange rate through a non-linear threshold model

A linear econometric error correction model (ECM) model is built, based on short interest rates, gross domestic product (GDP) growth expectations and inflation differentials, in order to explain the euro/dollar exchange rate dynamics and provide reliable forecasts. This specification performs well. However, the introduction of non-linear threshold dynamics provides a better understanding of ‘abnormal’ features other than deviations from long-run equilibrium levels, allowing for the possibility of asymmetric behaviour. Empirical evidence of this is found in the actual dynamics of the euro. The non-linear specification performs better than the linear model in both in-sample fitting and out-of-sample forecasting, showing that fundamentals hold, working also through some non-linear mechanism, in explaining the euro/dollar dynamics.     

Terminal valuations, growth rates and the implied cost of capital

We develop a model based on the notion that prices lead earnings, allowing for a simultaneous estimation of the implied growth rate and the cost of equity capital for US industrial sectors. The major difference between our approach and that in prior literature is that ours avoids the necessity to make assumptions about terminal values and consequently about future growth rates. In fact, growth rates are an endogenous variable, which is estimated simultaneously with the implied cost of equity capital. Since we require only 1-year-ahead forecasts of earnings and no assumptions about dividend payouts, our methodology allows us to estimate ex ante aggregate growth and risk premia over a larger sample of firms than has previously been possible. Our estimate of the risk premium being between 3.1 and 3.9 % is at the lower end of recent estimates, reflecting the inclusion of these short-lived companies. Our estimate of the long run growth is from 4.2 to 4.7 %.     

On stock market illiquidity and real-time GDP growth

This study examines whether stock market illiquidity forecasts real UK GDP growth using data over the period 1989q1-2012q2. Apart from standard linear model specifications, we also utilize non-linear models, which allow for regime switching behavior in terms of a liquid versus an illiquid market regime and over the phases of the business cycle. Our findings support a statistically significant negative relationship between stock market illiquidity and future UK GDP growth over and above the usual control variables. This relationship is found to be stronger during periods of highly illiquid market conditions and weak economic growth. Our out-of-sample forecasting analysis indicates that a regime-switching model of illiquid versus liquid market conditions predicts UK growth better than any other model. Actually, this model is the only one to significantly outperform the GDP growth forecasts published in the Bank of England's Inflation Report.     

Current consumption and future income growth: Synthetic panel evidence

Using group means computed from 20 years of high quality survey data, I show a strong and robust relation between households’ consumption growth and subsequent realizations of their income growth, including realizations as distant as six years later. The relation appears in multiple types of variation in income growth: in variation across cohort-education groups, in variation over the life cycle, and in variation over the business cycle. While other explanations are explored, the results are likely due to forward-looking households altering their current consumption in response to information they receive about their income years into the future, information that turns out to be accurate.     

Flight-to-quality,economic fundamentals,and stock returns

We find that the order flow differential (OFD), a flight-to-quality measure constructed as the difference between large- and small-cap stock order flows, strongly and negatively forecasts output growth and interest rates in the U.S. The predictive ability of OFD for future macroeconomic fundamentals is robust to the inclusion of return factors and business cycle predictors, and it is thus a state variable candidate in the spirit of Merton (1973). Consistent with this view, we document that OFD commands a statistically significant negative risk premium in cross-sectional asset pricing tests.     

On the Economic Link Between Asset Prices and Real Activity

Abstract:  This paper presents a model linking two financial markets (stocks and bonds) with real business cycle, in the framework of the Consumption Capital Asset Pricing Model with Generalized Isoelastic Preferences. Besides interest rate term spread, the model includes a new variable to forecast economic activity: stock market term spread. This is the slope of expected stock market returns. The empirical evidence documented in this paper suggests systematic relationships between business cycle's state and the shapes of two yield curves (interest rates and expected stock returns). Results are robust to changes in measures of economic growth, stock prices, interest rates and expectations generating mechanisms.     

Fisher Hypothesis Revisited: A Fractional Cointegration Analysis

This paper investigates the validity of the Fisher hypothesis using data from thirtythree developed and developing countries. Conventional cointegration tests do not provide strong evidence for a relation between nominal interest rates and inflation. Therefore, we use fractional cointegration analysis to test the long-run relationship between the two variables. The results indicate that a long-run relation between nominal interest rates and inflation does not appear for most countries in the sample when the conventional cointegration test is employed. However, fractional cointegration between the two variables is found for a large majority of countries, implying the validity of the Fisher hypothesis. The results also indicate that the equilibrium errors display long memory.     

The Long-Run Elasticity of New Housing Supply in the United States: Empirical Evidence for 1950 to 1994

The long-run price elasticity for alternative specifications of new housing supply is estimated using U.S. annual data for 1950 through 1994. The basic model expresses residential construction as a linear function of new housing price and the prices of construction inputs. Long-run elasticities range from 1.6 to 3.7, suggesting that new housing supply is price elastic. Residential construction responds to both the real interest and expected inflation rates, but other construction cost variables perform poorly. However, the results are sensitive to the time-series processes underlying the variables. A modified model that expresses residential construction as a function of changes in input prices, rather than their levels, produces a long-run elasticity of about 0.8 and a significant inverse relationship between new housing supply and the construction wage rate.     

Estimating the long-run user cost elasticity

The user cost elasticity is a parameter of central importance in economics. If the supply curve for capital is upward sloping (as is more likely in a large economy like the U.S.) and shocks to demand are important (as they are likely to be over the business cycle), estimates of the user cost elasticity that rely on high-frequency movements in the variables will tend to be biased. Applying cointegration techniques to a small, open economy yields an estimate of the long-run user cost elasticity that is about 75% larger (in absolute value) than the best existing estimate.     

The over-optimism of financial analysts and the long-run performance of firms following private placements of equity

We set out to determine whether the over-optimism of analysts has negative impacts on the subsequent long-run performance of firms following private placements of equity (PIPEs). Our results indicate that analysts do tend to make over-optimistic forecasts at the time of PIPEs, and that such over-optimistic forecasts can lead to investors erroneously overstating the value of placement firms, resulting in subsequent revisions of their valuations over time. We further infer that when firms announce their PIPEs, over-optimistic forecasts tend to lead to overstated valuations. The evidence shows that the long-run performance of PIPEs has a negative correlation with over-optimistic forecasts.     

Do Expected Shifts in Inflation Affect Estimates of the Long-Run Fisher Relation?

Recent empirical studies suggest that nominal interest rates and expected inflation do not move together one-for-one in the long run, a finding at odds with many theoretical models. This article shows that these results can be deceptive when the process followed by inflation shifts infrequently. We characterize the shifts in inflation by a Markov switching model. Based upon this model's forecasts, we reexamine the long-run relationship between nominal interest rates and inflation. Interestingly, we are unable to reject the hypothesis that in the long run nominal interest rates reflect expected inflation one-for-one.