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Housing Wealth Effects: The Long View
We provide new time-varying estimates of the housing wealth effect back to the 1980s. We use three identification strategies: OLS with a rich set of controls, the Saiz housing supply elasticity instrument, and a new instrument that exploits systematic differences in city-level exposure to regional house price cycles. All three identification strategies indicate that housing wealth elasticities were if anything slightly smaller in the 2000s than in earlier time periods. This implies that the important role housing played in the boom and bust of the 2000s was due to larger price movements ...
Working Paper
Financial Stability and Optimal Interest-Rate Policy
We study optimal interest-rate policy in a New Keynesian model in which the economy can experience financial crises and the probability of a crisis depends on credit conditions. The optimal adjustment to interest rates in response to credit conditions is (very) small in the model calibrated to match the historical relationship between credit conditions, output, inflation, and likelihood of financial crises. Given the imprecise estimates of key parameters, we also study optimal policy under parameter uncertainty. We find that Bayesian and robust central banks will respond more aggressively to ...
Discussion Paper
Good News, Leverage, and Sudden Stops
One of the major debates in open economy macroeconomics is the extent to which capital inflows are beneficial for growth. In principle, these flows allow countries to increase their consumption and investment spending beyond their income by enabling them to tap into foreign saving. Periods of such borrowing, however, are associated with large trade deficits, external debt accumulation, and, in some cases, overheating when these economies operate beyond their potential output level for an extended period of time. The relevant question in this context is whether the rate at which a country is ...
Discussion Paper
How Resilient Is the U.S. Housing Market Now?
Housing is by far the most important asset for most households, and, not coincidentally, housing debt dwarfs other household liabilities. The relationship between housing debt and housing values figures significantly in financial and macroeconomic stability, as events during the housing bust of 2006-12 clearly demonstrated. This week, Liberty Street Economics presents five posts touching on various aspects of housing, from the changing relationship between mortgage debt and housing equity to the future of homeownership. In today’s post, we provide estimates of housing equity and explore how ...
Working Paper
Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms
This paper reviews the theoretical literature at the intersection of macroeconomics and finance to draw lessons on the connection between vulnerabilities in the financial system and the macroeconomy, and on how monetary policy affects that connection. This literature finds that financial vulnerabilities are inherent to financial systems and tend to be procyclical. Moreover, financial vulnerabilities amplify the effects of adverse shocks to the economy, so that even a small shock to fundamentals or a small revision of beliefs can create a self-reinforcing feedback loop that impairs credit ...
Working Paper
Understanding Bank and Nonbank Credit Cycles: A Structural Exploration
We explore the structural drivers of bank and nonbank credit cycles using an estimated medium-scale macro model that allows for bank and nonbank financial intermediation. We posit economy-wide aggregate and sectoral disturbances to potentially drive bank and nonbank credit growth. We find that sectoral shocks affecting the balance sheets of entrepreneurs who borrow from the financial sector are important for the business cycle frequency fluctuations in bank and nonbank credit growth. Economy-wide entrepreneurial risk shocks gain predominance for explaining the longer-horizon comovement ...
Working Paper
Endogenous Debt Maturity: Liquidity Risk vs. Default Risk
We study the endogenous determination of corporate debt maturity in a setting with default risk. We assume that firms must access the bond market and they issue debt with a flexible structure (coupon, face value, and maturity). Initially, the firm is in a low growth/illiquid state that requires debt refinancing if it matures. Since lenders do not refinance projects with positive but small net present value, firms may be forced to default in the first phase. We call this liquidity risk. The technology is such that earnings can switch to a higher (but riskier) level. In this second phase firms ...
Working Paper
Levered Returns and Capital Structure Imbalances
We revisit the relation between equity returns and financial leverage through the lens of a dynamic trade-off model with costly capital structure rebalancing. The model predicts that expected equity returns depend on whether a firm's leverage is above or below its target leverage. We provide empirical evidence in support of the model predictions. Controlling for leverage, overlevered (underlevered) firms earn higher (lower) returns. A quantitative version of our model reproduces key facts about capital structure rebalancing and equity returns for U.S. corporations. Overall, our results ...
Working Paper
Credit Supply and Hedge Fund Performance: Evidence from Prime Broker Surveys
Constraints on the supply of credit by prime brokers affect hedge funds' leverage and performance. Using dealer surveys and hedge fund regulatory filings, we identify individual funds' credit supply from the availability of credit under agreements currently in place between a hedge fund and its prime brokers. We find that hedge funds connected to prime brokers that make more credit available to their hedge fund clients increase their borrowing and generate higher returns and alphas. These effects are more pronounced among hedge funds that rely on a small number of prime brokers, and those ...
Newsletter
How the U.S. Treasury Futures Market and the Basis Trade Could Be Affected by the Treasury Clearing Mandate: Part 1—A Primer
A recent mandate by the U.S. Securities and Exchange Commission (SEC) aims to improve the resilience and transparency of markets for U.S. Treasury cash securities and repurchase agreements (repos) by requiring transactions for both be cleared and settled through an authorized central counterparty (CCP). I explore the implications of this mandate for Treasury markets and central clearing in a two-part Chicago Fed Letter series. Part 1 is a primer on Treasury futures and the Treasury cash–futures basis trade—two key features of the Treasury markets that could also be affected by the mandate.