Mood Swings and Business Cycles: Evidence from Sign Restrictions

Transcription

1 Mood Swings and Business Cycles: Evidence from Sign Restrictions Deokwoo Nam 1 Jian Wang 2 1 Hanyang University 2 Chinese University of Hong Kong (Shenzhen) October 216

2 Introduction What drives business cycles?

3 Introduction What drives business cycles? Instant changes in productivity: classic RBC models

4 Introduction What drives business cycles? Instant changes in productivity: classic RBC models Expectations: Optimism/pessimism or sentiment

5 Introduction What drives business cycles? Instant changes in productivity: classic RBC models Expectations: Optimism/pessimism or sentiment Sources of changes in expectations Only psychological factors that are unrelated to fundamentals

6 Introduction What drives business cycles? Instant changes in productivity: classic RBC models Expectations: Optimism/pessimism or sentiment Sources of changes in expectations Only psychological factors that are unrelated to fundamentals Related to subsequent changes in fundamentals (e.g., TFP) Self-fulfilling feedback loop: Farmer and Guo (1994) News: Cochrane (1994a, 1994b), Beaudry and Portier (24, 26)

7 Introduction What drives business cycles? Instant changes in productivity: classic RBC models Expectations: Optimism/pessimism or sentiment Sources of changes in expectations Only psychological factors that are unrelated to fundamentals Related to subsequent changes in fundamentals (e.g., TFP) Self-fulfilling feedback loop: Farmer and Guo (1994) News: Cochrane (1994a, 1994b), Beaudry and Portier (24, 26) In this paper, we identify an optimism shock and study its role in driving US business cycles.

8 Identifying Optimism Shocks An increase in stock prices and consumption that is NOT driven by an improvement in TFP or expansionary monetary policy. Beaudry and Portier (26).

9 Identifying Optimism Shocks An increase in stock prices and consumption that is NOT driven by an improvement in TFP or expansionary monetary policy. Beaudry and Portier (26). The sign restrictions method in Arias et al. (216)

10 Identifying Optimism Shocks An increase in stock prices and consumption that is NOT driven by an improvement in TFP or expansionary monetary policy. Beaudry and Portier (26). The sign restrictions method in Arias et al. (216) Main findings: A broad boom in output, investment, consumption, and hours worked follows a positive optimism shock.

11 Identifying Optimism Shocks An increase in stock prices and consumption that is NOT driven by an improvement in TFP or expansionary monetary policy. Beaudry and Portier (26). The sign restrictions method in Arias et al. (216) Main findings: A broad boom in output, investment, consumption, and hours worked follows a positive optimism shock. Optimism shocks accounts for over 3% of the FEV of hours and output at business-cycle frequencies.

12 Identifying Optimism Shocks An increase in stock prices and consumption that is NOT driven by an improvement in TFP or expansionary monetary policy. Beaudry and Portier (26). The sign restrictions method in Arias et al. (216) Main findings: A broad boom in output, investment, consumption, and hours worked follows a positive optimism shock. Optimism shocks accounts for over 3% of the FEV of hours and output at business-cycle frequencies. A positive optimism shock is followed by an eventual increase in TFP 2 to 3 years after the shock.

13 Additional Results Consistent with business-cycle properties of the labor market Extensive margins vs intensive margins for total hours Job finding rate and job separation rate

14 Additional Results Consistent with business-cycle properties of the labor market Extensive margins vs intensive margins for total hours Job finding rate and job separation rate Robustness checks Different subsamples Other variables of interest such as Real wages and inventories Survey measures of confidence Different sets of sign restrictions

15 Identifying Optimism Shocks Sign Restrictions Method Data and Imposed Sign Restrictions Main Results

16 Sign Restrictions Method Identify a structural shock by imposing restrictions on the impulse response functions of a set of variables.

17 Sign Restrictions Method Identify a structural shock by imposing restrictions on the impulse response functions of a set of variables. For instance, following a contractionary monetary shock, the interest rate rises; prices decline; output declines.

18 Sign Restrictions Method Identify a structural shock by imposing restrictions on the impulse response functions of a set of variables. For instance, following a contractionary monetary shock, the interest rate rises; prices decline; output declines. In our application, we impose sign restrictions and zero impact restriction from our definition of optimism shocks.

19 Sign Restrictions Method Mountford and Uhlig (29)

20 Sign Restrictions Method Mountford and Uhlig (29) Arias, Rubio-Ramirez and Waggoner (216) Sign restrictions implicitly imposed additional restrictions Biased IRF and narrow CI

21 Sign Restrictions Method Mountford and Uhlig (29) Arias, Rubio-Ramirez and Waggoner (216) Sign restrictions implicitly imposed additional restrictions Biased IRF and narrow CI Proposed new numerical algorithms for Bayesian inference

22 Data and Imposed Sign Restrictions Sample period: 1955Q1 to 212Q4

23 Data and Imposed Sign Restrictions Sample period: 1955Q1 to 212Q4 Five-variable benchmark system TFP: Factor-utilization-adjusted TFP (Basu, Fernald, and Kimball, 26)

24 Data and Imposed Sign Restrictions Sample period: 1955Q1 to 212Q4 Five-variable benchmark system TFP: Factor-utilization-adjusted TFP (Basu, Fernald, and Kimball, 26) Stock price: End-of-period S&P 5 composite index (Wall Street Journal)

25 Data and Imposed Sign Restrictions Sample period: 1955Q1 to 212Q4 Five-variable benchmark system TFP: Factor-utilization-adjusted TFP (Basu, Fernald, and Kimball, 26) Stock price: End-of-period S&P 5 composite index (Wall Street Journal) Consumption: Real consumption expenditures on nondurable goods and services (BEA)

26 Data and Imposed Sign Restrictions Sample period: 1955Q1 to 212Q4 Five-variable benchmark system TFP: Factor-utilization-adjusted TFP (Basu, Fernald, and Kimball, 26) Stock price: End-of-period S&P 5 composite index (Wall Street Journal) Consumption: Real consumption expenditures on nondurable goods and services (BEA) Hours: Hours of all persons in the non-farm business sector (BLS)

27 Data and Imposed Sign Restrictions Sample period: 1955Q1 to 212Q4 Five-variable benchmark system TFP: Factor-utilization-adjusted TFP (Basu, Fernald, and Kimball, 26) Stock price: End-of-period S&P 5 composite index (Wall Street Journal) Consumption: Real consumption expenditures on nondurable goods and services (BEA) Hours: Hours of all persons in the non-farm business sector (BLS) The real interest rate: The effective federal funds rate (FRB) minus CPI inflation rate (BLS)

28 Data and Imposed Sign Restrictions Sample period: 1955Q1 to 212Q4 Five-variable benchmark system TFP: Factor-utilization-adjusted TFP (Basu, Fernald, and Kimball, 26) Stock price: End-of-period S&P 5 composite index (Wall Street Journal) Consumption: Real consumption expenditures on nondurable goods and services (BEA) Hours: Hours of all persons in the non-farm business sector (BLS) The real interest rate: The effective federal funds rate (FRB) minus CPI inflation rate (BLS) Stock price, consumption, and hours are transformed in per capita terms.

29 Data and Imposed Sign Restrictions Other variables Investment: Real gross private domestic investment (BEA)

30 Data and Imposed Sign Restrictions Other variables Investment: Real gross private domestic investment (BEA) Output: Real output in the non-farm business sector (BLS)

31 Data and Imposed Sign Restrictions Other variables Investment: Real gross private domestic investment (BEA) Output: Real output in the non-farm business sector (BLS) Relative price of investment: PPI for capital equipment/ppi for consumption goods (BLS)

32 Data and Imposed Sign Restrictions Other variables Investment: Real gross private domestic investment (BEA) Output: Real output in the non-farm business sector (BLS) Relative price of investment: PPI for capital equipment/ppi for consumption goods (BLS) Real wage: Non-farm business hourly compensation (BLS)/GDP deflator (BEA)

33 Data and Imposed Sign Restrictions Other variables Investment: Real gross private domestic investment (BEA) Output: Real output in the non-farm business sector (BLS) Relative price of investment: PPI for capital equipment/ppi for consumption goods (BLS) Real wage: Non-farm business hourly compensation (BLS)/GDP deflator (BEA) Consumer confidence: Michigan Survey of Consumers

34 Data and Imposed Sign Restrictions Other variables Investment: Real gross private domestic investment (BEA) Output: Real output in the non-farm business sector (BLS) Relative price of investment: PPI for capital equipment/ppi for consumption goods (BLS) Real wage: Non-farm business hourly compensation (BLS)/GDP deflator (BEA) Consumer confidence: Michigan Survey of Consumers Investment and output are transformed in per capita terms.

35 Sign Restrictions Table 1 Sign Restrictions TFP Stock Price Consumption Real Interest Rate Hours Investment Identification I + Identification II + + Identification III The impulse responses of variables are restricted to be zero () on impact, non-negative (+) on impact, or unrestricted (blank) in either the five-varia Stock Price, Consumption, Real Interest Rate, Hours), the seven-variable system with (TFP, Stock Price, Consumption, Real Interest Rate, Hours, Inves eight-variable system where an additional variable of interest is added to the seven-variable system.

36 Results for Adjusted TFP.6 Adjusted TFP 8 Stock Price Consumption 1.2 Real Interest Rate Hours Investment Output

37 Results for Non-adjusted TFP.6 Non Adjusted TFP 8 Stock Price Consumption 1.2 Real Interest Rate Hours Investment Output

38 Results in the Benchmark Five-variable System Table 2: The Share of Forecast Error Variance Attributable to Optimism Shocks Panel A: Adjusted TFP h = h = 4 h = 8 h = 16 h = 24 h = 4 h = TFP Stock Price Consumption Real Interest Rate Hours Investment Output [.,.] [.1,.5] [.1,.6] [.2,.1] [.3,.2] [.6,.34] [.,.] [ [.1,.74] [.15,.75] [.14,.73] [.13,.65] [.11,.58] [.1,.48] [.1,.72] [ [.2,.54] [.1,.68] [.12,.71] [.13,.69] [.12,.65] [.1,.59] [.2,.46] [ [.1,.48] [.3,.44] [.4,.45] [.5,.43] [.6,.41] [.8,.38] [.1,.47] [ [.1,.43] [.6,.58] [.7,.63] [.7,.6] [.7,.54] [.9,.47] [.1,.39] [ [.1,.35] [.8,.56] [.11,.6] [.13,.59] [.13,.58] [.14,.56] [.1,.29] [ [.1,.27] [.8,.6] [.14,.63] [.17,.62] [.15,.61] [.12,.55] [.1,.18] [ 39 Notes: This table reports the share of the forecast error variance attributable to optimism shocks ide TFP is measured by adjusted TFP (Panel A) or non-adjusted TFP (Panel B). The share of the for is obtained in the system with each of investment and output in place of hours. The numbers represe the confidence intervals with the 16th and 84th quantiles. The letter h refers to the forecast horizon i

39 Results for labor-market variables 1.2 Total Hours.4 Hours per Worker Unemployment Rate.2 Labor Force Participation Rate

40 Results for labor-market variables 2 Job Finding Rate.1 Job Seperation Rate Job Vacancies 16 Vacancy Unemployment Ratio

41 Results of Variance Decomposition Table 3: The Share of Forecast Error Variances of Labor Market Variables Attributable to Optimism Shocks h = h = 4 h = 8 h = 16 h = 24 h = 4 Total Hours Hours per Worker Unemployment Rate Labor Force Participation Rate Job Finding Rate Job Separation Rate Job Vacancies Vacancy-Unemployment Ratio [.1,.43] [.6,.58] [.7,.63] [.7,.6] [.7,.54] [.9,.47] [.1,.45] [.4,.5] [.4,.52] [.4,.44] [.4,.35] [.5,.3] [.1,.42] [.6,.63] [.1,.64] [.12,.6] [.12,.56] [.12,.51] [.1,.41] [.2,.39] [.2,.38] [.2,.37] [.2,.36] [.3,.37] [.1,.46] [.8,.61] [.9,.65] [.9,.65] [.9,.64] [.1,.61] [.1,.47] [.4,.52] [.4,.52] [.4,.5] [.5,.49] [.5,.47] [.2,.52] [.5,.64] [.6,.64] [.7,.6] [.8,.57] [.8,.53] [.2,.58] [.6,.67] [.8,.66] [.9,.64] [.9,.63] [.9,.61] Notes: This table reports the share of the forecast error variance of each of eight labor market variables attributable to identified optimism shocks. Each share is estimated in the benchmark five-variable system, (Adjusted TFP, Stock Price, Consumption, Real Interest Rate, Each Labor Market Variable). The numbers represent the median shares, and the numbers in brackets are the confidence intervals with the 16th and 84th quantiles. The letter h refers to the forecast horizon in terms of the unit of quarter.

42 l displays the impulse responses of four variables of interest to the identified optimism shock. Each of these four Subsample Results s to an Optimism Shock: Other Variables of Interest and Two Subsample Periods erest Subsample Periods Inflation Rate.6 Adjusted TFP 8 Stock Price Consumption 1.2 Real Interest Rate Consumer Confidence Hours Investment Output Full Sample Pre 1978 Subsample Post 1983 Subsample

43 Results for other variables Figure 3: Impulse Responses to an Optimism Shock: Other Variables of Intere Other Variables of Interest Su.6 Real Wages.8 Inflation Rate.6 Adjusted TFP Consumption Inventories 8 6 Consumer Confidence Hours Output.4 1 2

44 Discussions Beaudry and Portier (26) Sign restrictions method is more flexible Labor-market variables

45 Discussions Beaudry and Portier (26) Sign restrictions method is more flexible Labor-market variables Barsky and Sims (211, 212) TFP rises before aggregate variables. RBC model is consistent with news TFP shocks Our findings support expectation-driven business cycles.

46 Discussions Beaudry and Portier (26) Sign restrictions method is more flexible Labor-market variables Barsky and Sims (211, 212) TFP rises before aggregate variables. RBC model is consistent with news TFP shocks Our findings support expectation-driven business cycles. Levchenko and Pandalai-Nayar (215) Sentiment shocks that are orthogonal to TFP Short-run movements in expectations

47 Conclusion Identify optimism shocks using sign restrictions Optimism shocks play an important role in US business cycles. Optimism shocks proceed an eventual increase in TFP.