Monetary Economics

March 20, 2009
Laurence Ball and Justin Wolfers, Organizers

Francesco Trebbi , University of Chicago and NBER (Joint with Atif Mian and Amir Sufi)
The Political Economy of the U.S. Mortgage Default Crisis

Mian, Sufi, and Trebbi examine the effects of constituent interests, special interests, and politician ideology on congressional voting behavior in regard to two of the most significant pieces of legislation in U.S. economic history: the American Housing Rescue and Foreclosure Prevention Act of 2008 and the Emergency Economic Stabilization Act of 2008. Representatives from districts experiencing an increase in mortgage default rates are more likely to vote in favor of the AHRFPA, and the response is stronger in more competitive districts. Representatives only respond to mortgage related defaults (not non-mortgage defaults) and are more sensitive to defaults of their own- party constituents. Higher campaign contributions from the financial services industry are associated with an increased likelihood of voting in favor of the EESA, a bill which transfers wealth from tax payers to the financial services industry. Examining the trade-off between ideology and economic incentives, the researchers find that conservative politicians are less responsive to both constituent and special interests. This latter finding suggests that politicians, through ideology, can commit against intervention even during severe crises.

Thomas Philippon, New York University and NBER, and Philipp Sshnabl, New York University
Cost-Efficient Mechanisms Against Debt Overhang

Philippon and Schnabl analyze the relative efficiency of government interventions against debt overhang when the government is either unable or unwilling to hurt long-term debt holders. The researchers first consider three interventions that actually have been used or seriously considered: buying back risky assets, injecting capital, and providing guarantees for new debt issuances. With symmetric information or compulsory participation, all of the interventions are equivalent. Asset buyback and debt guarantee programs are still equivalent with voluntary participation and asymmetric information about the quality of banks’ balance sheets, but they are strictly dominated by equity injections. The authors also find that buying back assets is the worst solution when there is adverse selection across asset classes, and that taking deposit insurance into account significantly reduces the net cost of government interventions. Finally, the authors show how to construct a constrained-efficient mechanism whereby the government makes a junior loan at a subsidized rate in exchange for call options on equity.

Simon Gilchrist, Boston University and NBER, Vladimir Yankov, Boston University, and Egon Zakrajsek, Federal Reserve Board
Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets

To identify disruptions in credit markets, research on the role of asset prices in economic fluctuations has focused on the information content of various corporate credit spreads. Gilchrist and his co-authors re-examine this evidence using a broad array of credit spreads constructed directly from the secondary bond prices on outstanding senior unsecured debt issued by a large panel of nonfinancial firms. An advantage of their “ground-up” approach is that they are able to construct matched portfolios of equity returns, which allows them to examine the information content of bond spreads that is orthogonal to the information contained in stock prices of the same set of firms, as well as in macroeconomic variables measuring economic activity, inflation, interest rates, and other financial indicators. Their portfolio-based bond spreads contain substantial predictive power for economic activity and outperform—especially at longer horizons—standard default-risk indicators. Much of the predictive power of bond spreads for economic activity is embedded in securities issued by intermediate-risk rather than high-risk firms. According to impulse responses from a structural factor-augmented vector autoregression, unexpected increases in bond spreads cause large and persistent contractions in economic activity. Indeed, shocks emanating from the corporate bond market account for more than 20 percent of the forecast error variance in economic activity at the two- to four-year horizon. Overall, these results imply that credit market shocks have contributed significantly to U.S. economic fluctuations during 1990–2007.

Carmen Reinhart, University of Maryland and NBER, and Kenneth S. Rogoff, Harvard University and NBER
Banking Crises: An Equal Opportunity Menace

The historical frequency of banking crises is quite similar in high- and middle-to-low-income countries, with quantitative and qualitative parallels in both the run-ups and the aftermath. Reinhart and Rogoff establish these regularities using a unique dataset spanning the period from Denmark's financial panic during the Napoleonic War to the ongoing global financial crisis sparked by subprime mortgage defaults in the United States. Banking crises dramatically weaken fiscal positions in both groups, with government revenues invariably contracting, and fiscal expenditures often expanding sharply. Three years after a financial crisis, central government debt increases, on average, by about 86 percent. Thus the fiscal burden of banking crisis extends far beyond the commonly cited cost of the bailouts. The new dataset here includes housing price data for emerging markets; these allow the authors to show that the real estate price cycles around banking crises are similar in duration and amplitude to those in advanced economies, with the busts averaging four to six years. Corroborating earlier work, the researchers find that systemic banking crises are typically preceded by asset price bubbles, large capital inflows, and credit booms, in rich and poor countries alike.

Jonathan Parker and Annette Vissing-Jorgensen,Northwestern University and NBER Who Bears Aggregate Fluctuations and How?

The consumption of high-consumption households is more exposed to fluctuations in aggregate consumption and income than that of low-consumption households in the Consumer Expenditure (CEX) Survey. The exposure to aggregate consumption growth of households in the top 10 percent of the consumption distribution in the CEX is about five times that of households in the bottom 80 percent. Given real aggregate per capita consumption growth about 3 percentage points less than its historical mean during the past year, these figures predict that the ratio of consumption of the top 10 percent to the bottom 80 percent has fallen by about 15 percentage points (relative to trend). Using income data from Piketty and Saez (2003), Parker and Vissing-Jorgensen show that the income (especially the wage income) of rich households is more exposed to aggregate fluctuations, so their higher income exposure is a likely contributor to their higher consumption exposure. Finally, the authors find a striking change in the exposure of the incomes of high-income households: prior to the early 1980s, the incomes of high-income households were not more exposed to aggregate fluctuations. Thus, while high-income households currently bear an inordinately large share of aggregate fluctuations, this is a recent occurrence.

Olivier Blanchard, International Monetary Fund
Thoughts on the Financial Crisis

The presentation by Blanchard focused on the effects of the crisis on emerging market countries. It emphasized that they were, to different extents, affected by two main shocks: a collapse of exports, leading to larger current account deficits; and financial home bias on the part of advanced countries investors, making it harder or even impossible to finance those deficits. Focusing in particular on EU central European members, he discussed the policy choices faced by those countries, from pegging or floating, to debt restructuring, to the proper use of fiscal and monetary policy.

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