Does deglobalisation make economies more resilient to recessions?

Marco Garofalo

Are less open economies more resilient to downturns? There is general agreement on the benefits of openness, but its adverse link to volatility is ambiguous. On the one hand, globalisation makes countries less sensitive to domestic disturbances, yet it also makes them more exposed to foreign shocks. In this post, I use local projections (LP) to show that international business cycles since 1870 appear to support a positive effect of openness on the economic resilience of a country, and that we may thus expect the current international slowbalisation trend to worsen future recessions.

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Financial shocks, reopening the case

David Gauthier

Since the tumultuous events of 2007, much work has suggested that financial shocks are the main driver of economic fluctuations. In a recent paper, I propose a novel strategy to identify financial disturbances. I use the evolution of loan finance relative to bond finance to proxy for firms’ credit conditions and single out the shocks born in the financial sector. I apply and test the method for the US economy. I obtain three key results. First, financial shocks account for around a third of the US business cycle. Second, these shocks occur around precise events such as the Japanese crisis and the Great Recession. Third, the financial shocks I obtain are predictive of the corporate bond spread.

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Uncovering uncovered interest parity: exchange rates, yield curves and business cycles

Simon Lloyd and Emile Marin

The textbook uncovered interest parity (UIP) condition states that the expected change in the exchange rate between two countries over time should be equal to the interest rate differential at that horizon. While UIP appears to hold at longer horizons (around 5-10 years), it is regularly rejected at shorter ones (0-4 years). In a recent paper, we argue that interest rates at other maturities — captured in the slope of the yield curve — reflect information about the pricing of ‘business cycle risks’, which can help explain departures from UIP. A country with a relatively steep yield curve slope will tend to experience a depreciation in excess of the UIP benchmark, at business cycle frequencies especially.

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UK productivity growth from 2008 to 2018: weakness was structural, not cyclical

Marko Melolinna

Monetary policy makers need to know whether the economy is operating above or below its supply capacity. If the economy is operating above its supply capacity, inflation is likely to rise, and vice versa. A crucial component of supply capacity is the labour productivity trend but we cannot observe this directly. We have to estimate it. Thankfully, there are ways of splitting observed macroeconomic time series into estimated trend and cyclical components. Using a variety of methods on UK data, I find that UK productivity growth over the period 1991 to 2018 has been structurally, rather than cyclically, weak since the financial crisis. And, UK trend productivity has been strongly correlated with trend productivity in other advanced economies.

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Interregional mobility and monetary policy

By Daniela Hauser and Martin Seneca

According to conventional wisdom, a currency area benefits from internal labour mobility. If independent stabilisation policies are unavailable, the argument goes, factor mobility helps regions respond to shocks. Reasonable as it sounds, few attempts have been made to test this intuition in state-of-the-art macroeconomic models. In a recent Staff Working Paper (also available here), we build a DSGE model of a currency area with internal migration to go through the maths. So does the old intuition hold up? The short answer, we think, is yes. Internal labour mobility eases the burden on monetary policy by reducing regional labour markets imbalances. But policymakers can improve welfare by putting greater weight on unemployment. Effectively, interregional migration justifies a somewhat higher ‘lambda’.

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Home grown financing: How small business owners use their own houses to support investment

Saleem Bahaj, Angus Foulis and Gabor Pinter

Apocalypse Now is widely regarded as a masterpiece of the new Hollywood era. Director Francis Ford Coppola displayed audacious vision and a willingness to take risks. But we don’t just mean artistic risk. Mr Coppola gambled financially too: he staked his Napa Valley house and vineyard on the film, pledging it order to get the $32 million in loans necessary to keep the production on the road. While his movie was exceptional, there is nothing unusual about Mr Coppola’s financial strategy. Small business owners worldwide use their personal assets, and often their house, to back loans to their firms: in a new paper, we use microdata for several thousand firms to show how important this can be for UK investment.

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