International Seminar on Macroeconomics

June 26-27, 2015
Jeffrey Frankel of Harvard University, Francesco Giavazzi of Bocconi University, Hélène Rey of London Business School, and Kenneth West, University of Wisconsin, Organizers

Harris Dellas, University of Bern, and Dirk Niepelt, Study Center Gerzensee

Sovereign Debt with Heterogeneous Creditors

Dellas and Niepelt develop a sovereign debt model with heterogeneous creditors (private and official) where the probability of default depends on both the level and the composition of debt. Higher exposure to official lenders improves incentives to repay due to more severe sanctions but carries extra costs in the form of a reduced value of the sovereign's default option. The model can account for the co-existence of private and official lending, the time variation in their shares in total debt as well as the low rates charged on both. It can also shed light on the joint default and debt composition choices observed during the recent sovereign debt crisis in Europe.

Tarek Alexander Hassan, University of Chicago and NBER; Thomas Mertens, New York University; and Tony Zhang, University of Chicago

Not so Disconnected: Exchange Rates and the Capital Stock

Hassan, Mertens, and Zhang investigate the link between stochastic properties of exchange rates and differences in capital-output ratios across industrialized countries. To this end, the researchers endogenize capital accumulation within a standard model of exchange rate determination with non-traded goods. The model predicts that currencies of countries that are more systemic for the world economy (countries that face particularly volatile shocks or account for a large share of world GDP) appreciate when the marginal utility of traded goods is high. These currencies are better hedges against consumption risk faced by international investors because they appreciate in "bad" states of the world. As a consequence, more systemic countries face a lower cost of capital, accumulate more capital per worker, and pay higher wages than less systemic countries. The authors estimate their model using data from seven industrialized countries with freely floating exchange rate regimes from 1984-2010 and show that cross-currency variation in the stochastic properties of exchange rates accounts for 72% of the cross-country variation in capital-output ratios. In this sense, the stochastic properties of exchange rates map to fundamentals in the way predicted by the model.

Luigi Guiso, Einaudi Institute for Economics and Finance; Helios Herrera, HEC Montreal; and Massimo Morelli, Columbia University and NBER

Cultural Differences and Institutional Integration

If citizens of different countries belonging to an economic union adhere to different and deeply rooted cultural norms, when these countries interact their leaders may find it impossible to agree on efficient policies, especially in hard times. Political leaders' actions are bound to express policies that do not violate these norms. This paper provides a simple positive theory and a compelling case study of the importance of cultural clashes when economies integrate, as well as a normative argument about the desirability of institutional integration. Guiso, Herrera, and Morelli argue that a political union, with a common enforcement agency, is more beneficial the greater the cultural diversity in an economic union.

Ina Simonovska, University of California, Davis and NBER, and Joel David, University of Southern California

Correlated Beliefs, Correlated Returns, and the Cross-Section of Stock Market Volatility

Firm-level stock returns exhibit comovement above that in fundamentals, and the gap tends to be higher in developing countries. David and Simonovska investigate whether correlated beliefs among sophisticated, but imperfectly informed traders can account for the patterns of return correlations across countries. The researchers take a unique approach by turning to direct data on market participants' information — namely, real-time firm-level earnings forecasts made by equity market analysts. The correlations of firm-level forecasts exceed those of fundamentals and are strongly related to return correlations across countries. A calibrated information-based model demonstrates that the correlation of beliefs implied by analyst forecasts leads to return correlations broadly in line with the data, both in levels and across countries — the correlation between predicted and actual is 0.63. The authors' findings have implications for market-wide volatility — the model-implied correlations alone can explain 44% of the cross-section of aggregate volatility. The results are robust to controlling for a number of alternative factors put forth by the existing literature.

Anton Korinek, Johns Hopkins University and NBER, and Damiano Sandri, International Monetary Fund

Capital Controls or Macroprudential Regulation?(NBER Working Paper No. 20805)

Korinek and Sandri examine the desirability of capital controls versus macroprudential regulation in a small open economy model in which there is excessive borrowing and financial fragility because of externalities associated with contractionary exchange rate depreciations. The researchers find that it is desirable to employ both types of instruments: macroprudential regulation reduces the indebtedness of leveraged borrowers whereas capital controls induce precautionary behavior for the economy as a whole, including for savers. This reduces crisis risk by shoring up aggregate net worth and mitigating the transfer problem that occurs during crises. In advanced countries where the risk of large contractionary depreciations is more limited, the role for capital controls subsides. However, macroprudential regulation remains essential to mitigate booms and busts in asset prices.

Javier Bianchi, University of Wisconsin, Madison and NBER; Enrique G. Mendoza, University of Pennsylvania and NBER; and Chenxin Liu, Wisconsin

Phases of Global Liquidity, Fundamentals News, and the Design of Macroprudential Policy

The unconventional shocks and non-linear dynamics behind the high volatility of financial markets present a challenge for the implementation of macroprudential policy. In this paper, Bianchi, Liu, and Mendoza introduce two of these unconventional shocks, news shocks about future fundamentals and regime changes in global liquidity, into a quantitative non-linear model of financial crises. The model is then used to examine how these shocks affect the design and effectiveness of optimal macroprudential policy. The results show that both shocks contribute to strengthen the amplification mechanism driving financial crisis dynamics. Macroprudential policy is effective for reducing the likelihood and magnitude of financial crises, but the optimal policy requires significant variation across regimes of global liquidity and realizations of news shocks. Moreover, the effectiveness of the policy improves as the precision of news rises from low levels, but at high levels of precision it becomes less effective (financial crises are less likely, but the optimal policy does not weaken them significantly).

Lorenzo Bretscher and Christian Julliard, London School of Economics, and Carlo Rosa, Federal Reserve Bank of New York

Human Capital and International Portfolio Diversification: A Reappraisal

Bretscher, Julliard, and Rosa study the implications of human capital hedging for international portfolio choice. First, the researchers show that, given the high degree of international GDP correlations in the data, very small domestic redistributive shocks can skew portfolios toward domestic assets. Second, the authors find that the empirical evidence supporting the belief that the international diversification puzzle is worsened if they consider the human capital hedging motive, is driven by an econometric misspecification rejected by the data. Third, they find that if the set of assets that can be used to hedge aggregate human capital is restricted to publicly traded stocks, the human capital hedging motive has a negligible impact on optimal portfolio choice in a frictionless market setting. Fourth, calibrating a heterogeneous agent model in which households face short selling constraints and labor income risk, in the form of both uninsurable shocks and a common aggregate component, the researchers show that: a) investors that enter the stock market will initially specialize in domestic assets, b) individual portfolios become gradually more internationally diversified only as the level of asset wealth increases, and c) most importantly, the implied aggregate portfolio of domestic investors shows a large degree of home bias.

Stephen Hansen, Universitat Pompeu Fabra, and Michael McMahon, University of Warwick

Shocking Language: Understanding the Macroeconomic Effects of Central Bank Communication

Hansen and McMahon explore how different information released by the FOMC has effects on both market and real economic variables. Using tools from computational linguistics, the researchers measure the information released by the FOMC on the current state of economic conditions, as well as how clearly they guide markets about future monetary policy decisions. Employing these measures within a FAVAR framework, the authors find that shocks to forward guidance are more important than the FOMC communication of current economic conditions in terms of their effects on market and real variables. Nonetheless, neither communication has particularly strong effects on real economic variables.

NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us