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Should We Use Linearized Models To Calculate Fiscal Multipliers?

Jesper Lindé, Mathias Trabandt
Journal of Applied Econometrics, Nr. 7, 2018
Abstract
We calculate the magnitude of the government consumption multiplier in linearized and nonlinear solutions of a New Keynesian model at the zero lower bound. Importantly, the model is amended with real rigidities to simultaneously account for the macroeconomic evidence of a low Phillips curve slope and the microeconomic evidence of frequent price changes. We show that the nonlinear solution is associated with a much smaller multiplier than the linearized solution in long‐lived liquidity traps, and pin down the key features in the model which account for the difference. Our results caution against the common practice of using linearized models to calculate fiscal multipliers in long‐lived liquidity traps.
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EFN Report Autumn 2018: Economic Outlook for the Euro Area in 2018 and 2019

EFN Reports, Nr. 3, 2018
Abstract
• Signs of a slowing world economy are piling up: Since the beginning of the year purchasing manager indices have been declining globally, in summer higher US interest rates led investors to withdraw capital from emerging markets, and as a consequence, capital costs rose and currencies depreciated in many emerging markets economies. In October stock prices decreased markedly worldwide including the US, despite the strong upswing in this country. • As a consequence of the turmoil on financial markets, monetary conditions in many emerging economies are no longer favorable. What ultimately counts for the prospects of the global economy, is, however, the performance of the US, the Euro area, China and Japan. The upswing in the US appears stable enough to continue well into 2019. While at present the rest of the group appears to lose momentum, there is a good chance that production in each of these economies will still expand at rates that are close to their potential growth. Further protectionist rounds are the most important risk to this scenario. • In the first half of the current year the euro area economy expanded at a markedly slower rate than in 2017, about 0.4% per quarter, but still substantial. Rising risk premia on Italian assets will probably force banks in this large country to tighten credit conditions, and a slowing world trade will dent export growth. All in all, we expect GDP growth in the euro area to go down from 2.4% in 2017 to 2.0% in 2018 and to 1.7% in 2019. • Employment continues to expand and vacancy rates are at present higher than in 2017. As a consequence, wages rise more quickly: nominal compensations per employee started accelerating early in 2017, and negotiated wages followed at the beginning of 2018. Wage inflation of slightly below 2.5% and healthy growth in employment raise real labor incomes markedly. • Our forecasts are based on the assumption that rating agencies will continue as-signing investment grade to the Italian government debt, and that the Italian government and the European Commission will find a compromise about the draft budget of the country in the coming weeks. Another assumption is that the UK will not exit the EU in an unorderly way in March 2019.
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Information Feedback in Temporal Networks as a Predictor of Market Crashes

Stjepan Begušić, Zvonko Kostanjčar, Dejan Kovač, Boris Podobnik, H. Eugene Stanley
Complexity, September 2018
Abstract
In complex systems, statistical dependencies between individual components are often considered one of the key mechanisms which drive the system dynamics observed on a macroscopic level. In this paper, we study cross-sectional time-lagged dependencies in financial markets, quantified by nonparametric measures from information theory, and estimate directed temporal dependency networks in financial markets. We examine the emergence of strongly connected feedback components in the estimated networks, and hypothesize that the existence of information feedback in financial networks induces strong spatiotemporal spillover effects and thus indicates systemic risk. We obtain empirical results by applying our methodology on stock market and real estate data, and demonstrate that the estimated networks exhibit strongly connected components around periods of high volatility in the markets. To further study this phenomenon, we construct a systemic risk indicator based on the proposed approach, and show that it can be used to predict future market distress. Results from both the stock market and real estate data suggest that our approach can be useful in obtaining early-warning signals for crashes in financial markets.
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EFN Report Summer 2018: Economic Outlook for the Euro Area in 2018 and 2019

EFN Reports, Nr. 3, 2018
Abstract
• In summer 2018 the cyclical upswing of the world economy is not over, but it appears to be fragmenting. While economic activity in the European Union has lost steam, the upswing in the US has gained pace, and growth in China appears to be robust. • Markets for commodities as well as for capital are at present strongly affected by political movements: oil prices are more than 50% higher than one year ago, as the US exit from the Iran nuclear deal puts the long run oil supply from Iran at risk, and the strongly expansionary US tax reform explains the rise in US long run interest rates. . • Uncertainties about the future international trade system cause firms to slow down or even reverse the globalization of value chains. As an early consequence, world trade in the second half of 2018 and in 2019 will expand at much slower rates than during 2017. • In the euro area growth slowed in the first quarter 2018, due to weaker investment activity in France and Italy and, more importantly, a fall in exports in all larger euro area economies except Spain. However, the drivers of the upswing such as low interest rates for credit and expanding real incomes will still be supportive in the near future, and fiscal policies will be slighly more expansionary. But a slowdown in world trade will dent export growth as well as corporate profits. All in all, we expect GDP growth in the euro area to go down from 2.4% in 2017 to 2.1% in 2018 and to 1.7% in 2019 – a forecast that will only be realized if damages to the international trade system are limited and if the European sovereign debt crisis does not come back. • While wage inflation has been slowly increasing during the past quarters to about 2%, a clear upwards trend of core consumer price inflation is still not detectable. The recent jump of the headline rate to 1.9% is due to higher oil prices. Our forecasts for 2018 and 2019 are close, although still below, 2%.
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Channeling the Iron Ore Super-cycle: The Role of Regional Bank Branch Networks in Emerging Markets

Helge Littke
IWH Discussion Papers, Nr. 11, 2018
Abstract
The role of the financial system to absorb and to intermediate commodity boom induced windfall gains efficiently presents one of the most pressing issues for developing economies. Using an exogenous increase in iron ore prices in March 2005, I analyse the role of regional bank branch networks in Brazil in reallocating capital from affected to non-affected regions. For the period from March 2004 to March 2006, I find that branches directly exposed to this shock by their geographical location experience an increase in deposit growth in the post-shock period relative to non-affected branches. Given that these deposits are not reinvested locally, I further show that branches located in the non-affected region increase lending growth depending on their indirect exposure to the booming regions via their branch network. Even tough, these results provide evidence against a Dutch Disease type crowding out of the non-iron ore sector, further evidence suggests that this capital reallocation is far from being optimal.
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Did the Swiss Exchange Rate Shock Shock the Market?

Manuel Buchholz, Gregor von Schweinitz, Lena Tonzer
IWH Discussion Papers, Nr. 9, 2018
publiziert in: International Review of Finance
Abstract
The Swiss National Bank abolished the exchange rate floor versus the Euro in January 2015. Based on a synthetic matching framework, we analyse the impact of this unexpected (and therefore exogenous) shock on the stock market. The results reveal a significant level shift (decline) in asset prices in Switzerland following the discontinuation of the minimum exchange rate. While adjustments in stock market returns were most pronounced directly after the news announcement, the variance was elevated for some weeks, indicating signs of increased uncertainty and potentially negative consequences for the real economy.
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How Do Insured Deposits Affect Bank Risk? Evidence from the 2008 Emergency Economic Stabilization Act

Claudia Lambert, Felix Noth, Ulrich Schüwer
Journal of Financial Intermediation, January 2017
Abstract
This paper tests whether an increase in insured deposits causes banks to become more risky. We use variation introduced by the U.S. Emergency Economic Stabilization Act in October 2008, which increased the deposit insurance coverage from $100,000 to $250,000 per depositor and bank. For some banks, the amount of insured deposits increased significantly; for others, it was a minor change. Our analysis shows that the more affected banks increase their investments in risky commercial real estate loans and become more risky relative to unaffected banks following the change. This effect is most distinct for affected banks that are low capitalized.
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EFN Report Summer 2016: Economic Outlook for the Euro Area in 2016 and 2017

EFN Reports, Nr. 3, 2016
Abstract
Short run consequences of Brexit for the euro area economy mainly depend on the effects on confidence in the stability of the European Union and the currency area in particular. Anti-European (or indeed anti-globalization) movements are certainly encouraged by the British vote. More important, however, might be a reverse effect: from the perspective of the British turmoil, the euro area might in the near future appear as a zone of relative stability and calm. Against the background of a sluggish world economy, the euro area economy recently performed reasonably well: dynamics have been slowly increasing since 2013, and the rate of expansion in the first quarter of 2016 was one of the highest of the past couple of years. Looking forward, the drivers of the recovery should continue supporting growth in the second half of 2016 and for much of 2017. Our forecast is that euro area GDP will expand by 1.7% in 2016 and by 1.6% in 2017, with only a minor effect from Brexit. This year, like in 2015, average oil prices will probably be markedly lower than they were a year ago, supporting real incomes of private households and lowering production costs of firms, and monetary policy will still be supportive. Labour markets appear to continue improving slowly. Associated with the improved economic conditions, we expect a slight increase in euro area inflation during 2016, 0.3%, with a more marked increase in 2017, 1,3%.
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EFN Report Spring 2016: Economic Outlook for the Euro Area in 2016 and 2017

EFN Reports, Nr. 2, 2016
Abstract
Global growth will stay rather moderate this year. The peak of the upswing in the US appears to be over. For Japan, after three years of “Abenomics”, a prolonged upswing is still elusive. In China low profitability and high debt levels of many government-owned industrial firms continue to drag growth down. The low prices for commodities heighten uncertainty and volatility on financial markets since they increase the risks of financial crises in economies that are dependent on commodity exports. In the euro area, chances for the recovery to continue are good, as this year, like in 2015, oil prices will probably be markedly lower than they were a year ago, supporting real income of private households and lowering production costs of firms. In this context, our forecast is that euro area GDP will expand by 1.6% in 2016 and by 1.7% in 2017. These rates are higher than the rate of potential growth, but they are arguably low given the expansive monetary policy and the strong stimulus from decreased commodity prices. We do not expect an increase in euro area inflation during 2016, but prices will grow by around 1% in 2017, because the dampening effects of decreasing energy prices slowly fade off and the euro remains rather weak. However, risks for this cautiously optimistic forecast are substantial. New shadows on the financial sector, the uncertainty about whether or not the British will vote in favour of membership in the European Union and the lack of a viable political solution for the refugee crisis are some of the main uncertainties behind these forecasts.
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Abnormal Real Operations, Real Earnings Management, and Subsequent Crashes in Stock Prices

Bill Francis, Iftekhar Hasan, Lingxiang Li
Review of Quantitative Finance and Accounting, Nr. 2, 2016
Abstract
We study the impact of firms’ abnormal business operations on their future crash risk in stock prices. Computed based on real earnings management (REM) models, firms’ deviation in real operations (DROs) from industry norms is shown to be positively associated with their future crash risk. This association is incremental to that between discretionary accruals (DAs) and crash risk found by prior studies. Moreover, after Sarbanes–Oxley Act (SOX) of 2002, DRO’s predictive power for crash risk strengthens substantially, while DA’s predictive power essentially dissipates. These results are consistent with the prior finding that managers shift from accrual earnings management to REM after SOX. We further develop a suspect-firm approach to capture firms’ use of DRO for REM purposes. This analysis shows that REM-firms experience a significant increase in crash risk in the following year. These findings suggest that the impact of DRO on crash risk is at least partially through REM.
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