Demographic Aging and the New Keynesian Phillips Curve [Updated: October 2024]
Keywords: demographic aging, deep habits, market power, Phillips curveSee also SUERF policy brief here.I document a link between old-age dependency ratios and average markups. I propose that a mechanism whereby households develop deep habits in consumption as they age could explain this feature of the data. I show that when this mechanism is embedded in an overlapping generations New Keynesian model, the slope of the New Keynesian Phillips Curve flattens as the population ages. Further, the contractionary effects of positive monetary policy surprises on output are amplified. Evidence from local projections exploiting the Trilemma in international macroeconomics confirm the model predictions. These results suggest that the challenges faced by monetary policy may become more pronounced as populations age.Global Political Ties and the Global Financial Cycle (with I. Hasan and X. Li)
Keywords: political ties, global financial cycle, international spillovers, stock returnsWe study the implications of forging stronger political ties with the US on the sensitivities of stock returns around the world to a global common factor - the global financial cycle. Using voting patterns at the United Nations as a measure of political ties with the US along with various measures of the global financial cycle, we document evidence indicating that stronger political ties with the US amplify the sensitivities of stock returns in developing countries to the global financial cycle. We explore several channels and find that a deepening of financial linkages along with a reduction in information asymmetries and an amplification of sentiment are potentially important factors behind this result.Monetary Policy Announcements and Sacrifice Ratios (with M. Haavio and N. McClung)
Keywords: monetary policy announcements, sacrifice ratio, cognitive discountingWe show that sacrifice ratios associated with announcements of the most likely course of monetary policy are lower when the implementation date is further out into the future in the basic New Keynesian framework. This is not due to forward guidance puzzle effects and holds even when agents’ expectations feature cognitive discounting. Nevertheless, the rate at which sacrifice ratios fall with the implementation horizon is attenuated by the intensity of cognitive discounting. We also show that our results also hold in a model with additional real and nominal rigidities. These results indicate that telegraphing the most likely course of action for monetary policy attenuates the effects on output relative to inflation.What should the inflation target be? Views from 600 economists (with A. Ferrero, E. Jokivuolle, and K. Ristolainen)
Keywords: Expert survey, inflation target, monetary policyCEPR DP version here. See also VoxEU post here.In a survey of more than 600 economists, most respondents prefer their central bank to have an explicit inflation target. Roughly half want the central bank to keep its current target. Two thirds of the rest want to raise the target, with a median preferred change of one percentage point. In a hypothetical scenario in which the central bank has no prior history of inflation targeting, an additional 12% of the respondents would prefer a different (typically higher) target than the current one. This result suggests that the costs of changing the current target hold some respondents back from wanting an actual target change. Respondents who are worried about the central bank credibility are less likely to support a target raise. Conversely, preference for a target raise is more likely to come from those who are concerned about the zero lower bound on the nominal interest rate. The average estimate of the equilibrium real interest rate in the sample is 0.6%. However, personal views about the equilibrium real interest rate do not predict a preference for a target raise.Inflationary household uncertainty shocks
Keywords: uncertainty, inflation, household expectations, survey data Previous version: Measuring household uncertainty in EU countries (Replication package here ; updated survey indices here) I construct a novel measure of household uncertainty based on survey data for European countries. I use the measure to study the effects of household uncertainty on inflation and find that household uncertainty shocks are inflationary in the Euro area. This result lends support to the importance of inflationary transmission mechanisms such as precautionary pricing. This result is also in contrast to deflationary financial uncertainty shocks in the Euro area indicating that it may be important to distinguish between different sources of uncertainty. The results show that uncertainty shocks do not universally behave like negative demand shocks.Political ties and the yield curve (with I. Hasan)
Keywords: Political ties, yield curve, sovereign borrowingWe examine the effect of political ties with the US on sovereign yields and ratings at various horizons. We find beneficial effects across both short- and long-term yields and ratings. We find that strnoger political ties with the US affect mainly the level of the yield curve of foreign sovereign bonds. These results imply that the market perceives political ties with the US as having both near- and long-term beneficial consequences.Political ties and raising capital in global markets: Evidence from Yankee Bonds (with X. Gu and I. Hasan)
Keywords: Yankee bonds, political ties, bond yield spreadsThis paper examines whether state-to-state political ties help firms obtain better terms when raising funds in global capital markets. Focusing on the Yankee bonds market, we find that issuances by firms from countries with close political ties with the US feature lower yield spreads, higher issuance amounts, and longer maturities. Such an association is more pronounced for firms located in low income and highly indebted countries as well as firms in government-related industries, first-time issuers, and relatively smaller firms. Our study provides evidence supporting the notion that country-level political relationship is an important factor when raising capital in international markets.Euro-area business confidence and Covid-19.
Keywords: business confidence, survey expectations, Covid-19, Euro areaSee also SUERF Policy Brief hereI study the effects of the COVID-19 pandemic on business confidence in 11 Euro area countries and its impact on economic activity. To obtain causal effects, I instrument business confidence with domestic household confidence as well as household confidence in neighboring countries. I find evidence suggesting that the confidence channel was a sizable component to the economic transmission of COVID-19. A one standard deviation drop in business confidence leads to between 5–6 and 9% fall in economic activity in the industrial and wholesale and retail trade sectors, respectively. These results highlight the importance of managing confidence and expectations in crisis episodes.Commitment or Constraint? The Effect of Loan Covenants on Merger and Acquisition Activity (with G. Colak and I. Hasan)
Keywords: mergers and acquisitions, takeovers, loan covenantsWe investigate how loan covenants associated with potential target firms affect takeover deals. We propose two possible channels. Under a discipline channel, the target firm becomes an attractive candidate for takeovers and merger deals are facilitated. Under a constraint channel, covenants hinder merger activity. We find support for the latter channel. Takeover likelihood is lower, deal failures are more common, the likelihood of price renegotiation is higher, and acquisition premium is lower when the target is bound by covenants. Covenant tightness exacerbates this effect.The diplomacy discount in global syndicated loans (with X. Gu, I. Hasan, and P. Politsidis)
Keywords: global syndicated loans, loan pricing, political ties, international relationsThis paper investigates whether state-to-state political ties with the United States affect the pricing of global syndicated loans. We find that a one-standard-deviation improvement in state political ties between the U.S. and the government of a borrower’s home country is associated with a 14.7 basis points lower loan spread, shaving off about 11.8 million USD in interest payments over the duration of the average loan for borrowers. Results also show that the effect of political ties is stronger for narrower and more concentrated loan syndicates, when lead arrangers are U.S. banks, during periods in which the U.S. is engaged in armed conflicts, when the U.S. president belongs to the Republican Party, and for borrowers with better balance sheets and prior lending relationships. Notably, not all firms benefit equally, as cross-listed firms and firms in countries with strong institutional quality and ability to attract institutional investors are much less affected by political ties.Quid pro quo? Political ties and sovereign borrowing (with I. Hasan)
Keywords: Political economy, sovereign borrowing, foreign aid, UN votingPrevious version: Friends for the benefits: The effects of political ties on sovereign borrowing conditions Data and code hereDo closer political ties with a global superpower improve sovereign borrowing conditions? We use data on voting at the United Nations General Assembly along with foreign aid flows to construct an index of political ties and find evidence that suggests stronger political ties leads to both better sovereign credit ratings and lower yields on sovereign bonds. We use heads-of-state official visits and coalition forces troop contributions as additional measures to further reinforce our findings.Keywords: business cycles, credit screening, financial crises, information choice, social learningPrevious version hereI provide a theory of information production and learning that can help account for both the excessive optimism that fueled booms preceding crises and the slow recoveries that followed. In my theory, persistence and the size of expectation errors depend on information production about changes in aggregate fundamentals. In turn information production, via credit screening, tends to fall during both very good and very bad times. The former gives rise to episodes of rational exuberance in which optimistic beliefs may sustain booms even as fundamentals decline. I also document evidence from survey forecasts consistent with the model predictions.What drives discretion in bank lending? Some evidence and a link to private information (with I. Hasan)
Keywords: Bank discretion, credit screening, private information, syndicated loansPrevious version hereWe assess the extent to which discretion, unexplained variations in the terms of a loan contract, has varied across time and lending institutions and show that part of this discretion is due to private information that lenders have on their borrowers. We find that discretion is lower for secured loans and loans granted by a larger group of lenders, and is larger when the lenders are larger and more profitable. Over time, discretion is also lower around recessions although the private information content is higher. The results suggest that bank discretionary and private information acquisition behavior may be important features of the credit cycle.Fear, overconfidence, and fundamental uncertainty shocks
Keywords: overconfidence, survey forecasts, uncertaintySee also here for the corrected version of The real effects of overconfidence and fundamental uncertainty shocks.Data and code for SPF density forecasts hereI study the effects of expected and realized uncertainty on Euro area macroeconomic conditions. I use a range of expected and realized uncertainty measures including those based on survey forecasts and find that the effects of expected uncertainty vanish once realized uncertainty is accounted for when using financial or news media-based measures. On the other hand, shocks to a survey-based measure of expected uncertainty do appear to have dampening effects.Are bank capital requirements optimally set? Evidence from researchers’ views (with I. Hasan, E. Jokivuolle, and K. Ristolainen)
Keywords: Bank regulation, capital requirements, expert surveySurvey results hereWe survey 149 leading academic researchers on bank capital regulation. The median (average) respondent prefers a 10% (15%) minimum non-risk-weighted equity-to-assets ratio, which is considerably higher than the current requirement. North Americans prefer a significantly higher equity-to-assets ratio than Europeans. We find substantial support for the new forms of regulation introduced in Basel III, such as liquidity requirements. Views are most dispersed regarding the use of hybrid assets and bail-inable debt in capital regulation. 70% of experts would support an additional market-based capital requirement. When investigating factors driving capital requirement preferences, we find that the typical expert believes a five percentage points increase in capital requirements would “probably decrease” both the likelihood and social cost of a crisis with “minimal to no change” to loan volumes and economic activity. The best predictor of capital requirement preference is how strongly an expert believes that higher capital requirements would increase the cost of bank lending.Bank Capital Regulation in the Post-Pandemic Era (with I. Hasan and A. Siddique)
Belief polarization and Covid-19 (with I. Hasan)
European household confidence and COVID-19: Lessons for South Korea. (with T.S. Jang)
See also COVID-19 and European Household Expectations (VoxEU article here and updated data here)Dealing with the costs of the Covid-19 Pandemic-what are the fiscal options? (with M. Juselius)
The impact of the Global Financial Crisis on Investment in Finland and South Korea (with T.S. Jang)
Should Bank Capital Requirements Be Less Risk-Sensitive Because of Credit Constraints? (with E. Jokivuolle)
VoxEU article hereBank of Finland Survey on Bank Capital Requirements
VoxEU blog: here and here