the future of macroeconomics macro theory and models at the bank of england abstract the adoption as policy models by central banks of representative agent new keynesian dynamic stochastic general equilibrium models has been widely criticised including for their simplistic micro foundations at the bank of england the previous generation of policy models is seen in its 1999 medium term macro model mtmm instead of improving that model to correct its considerable flaws many shared by other non dsge policy models such as the federal reserve s frb us it was replaced in 2004 by the dsge based beqm though this clearly failed during and after the global financial crisis it was replaced in 2011 by the dsge compass complemented by a suite of models we provide a general critique of dsge models for explaining forecasting and policy analyses at central banks and suggest new directions for improving current empirical macroeconomic models based on empirical modelling broadly consistent with better theory rather than seeking to impose simplistic and unrealistic theory

credit booms debt overhang and secular stagnation abstract why do economies fall into prolonged periods of economic stagnation particularly in the aftermath of credit booms we study the interactions between household debt liquidity and asset prices in a model of persistent demand shortage we show that financially more deregulated economies are more likely to experience persistent stagnation credit booms or asset price booms mask this structural aggregate demand deficiency however the resulting debt overhang permanently depresses spending in the long run hence the contractionary long run effects of relaxing lending standards are the opposite of their expansionary short run effects these findings are in line with the macroeconomic developments in japan during its lost decades and other advanced economies before and during the great recession

no price like home global house prices 1870 2012 how have house prices evolved in the long run this paper presents annual house price indices for 14 advanced economies since 1870 based on extensive data collection we are able to show for the first time that house prices in most industrial economies stayed constant in real terms from the 19th to the mid 20th century but rose sharply in recent decades land prices not construction costs hold the key to understanding the trajectory of house prices in the long run residential land prices have surged in the second half of the 20th century but did not increase meaningfully before we argue that before world war ii dramatic reductions in transport costs expanded the supply of land and suppressed land prices since the mid 20th century comparably large land augmenting reductions in transport costs no longer occurred increased regulations on land use further inhibited the utilization of additional land while rising expenditure shares for housing services increased demand

great expectations financialization and bank bailouts in democracies accelerating financialization and rising societal wealth have meant that democratic governments increasingly provide bailouts following banking crises using a new long run data set we show that despite frequent and virulent crises before world war ii bank bailouts to protect wealth were then exceptionally rare in recent decades by contrast governments have increasingly opted for extensive bailouts well before the major interventions of 2007 2009 we argue that this policy shift is the consequence of the great expectations of middle class voters overlooked in existing accounts associated with the growing financialization of wealth rising leverage and accumulating ex ante financial stabilization commitments by governments these expectations are suggestive of substantially altered policy preferences and political cleavages since the 1970s when severe banking crises returned as an important threat to middle class wealth this pressure from below has led elected governments to provide increasingly costly bailouts with no historical precedent

some defaults are deeper than others understanding long term mortgage arrears abstract the 2007 2008 financial crisis yielded a significant number of delinquent mortgage loans which ordinarily would have faced foreclosure and repossession however given the negative externalities of repossession policy response has shifted towards forbearance and mortgage modification which has led to longer spells in default for delinquent mortgage holders it is therefore imperative to move beyond binary models of default towards an understanding of the factors that drive the depth of default spells exploiting a highly detailed dataset on financially distressed households in ireland in 2012 and 2013 we are able to identify the impact of a range of current household level factors generally not available in loan level studies of mortgage default on the probability of entering early and deep states of mortgage default our results suggest that high loan to value ratios consumer credit growth shocks to mortgage affordability and unemployment should all trigger serious concerns among policy makers regarding subsequent stability in the mortgage market with these measures all shown to have differentially large impacts on entry to deep relative to early stage arrears

when credit bites back using data on 14 advanced countries between 1870 and 2008 we document two key facts of the modern business cycle relative to typical recessions financial crisis recessions are costlier and more credit intensive expansions tend to be followed by deeper recessions in financial crises or otherwise and slower recoveries we use local projection methods to condition on a broad set of macro economic controls to study how past credit accumulation impacts key macro economic variables such as output investment lending interest rates and inflation the facts that we uncover lend support to the idea that financial factors play an important role in the modern business cycle

the great mortgaging housing finance crises and business cycles this paper unveils a new resource for macroeconomic research a long run dataset covering disaggregated bank credit for 17 advanced economies since 1870 the new data show that the share of mortgages on banks balance sheets doubled in the course of the twentieth century driven by a sharp rise of mortgage lending to households household debt to asset ratios have risen substantially in many countries financial stability risks have been increasingly linked to real estate lending booms which are typically followed by deeper recessions and slower recoveries housing finance has come to play a central role in the modern macroeconomy

housing really is the business cycle what survives the lessons of 2008 09 the downturn of 2008 09 has confirmed that i housing is the single most critical part of the u s business cycle ii the proper conduct of monetary policy needs to be cognizant that choices made at one point in time affect the options later and iii the best time to intervene in the housing cycle is when the volume of building is above normal and growing more so what was different this time was the rapid and substantial decline in home prices

how does credit supply expansion affect the real economy the productive capacity and household demand channels credit supply expansion can affect an economy by increasing productive capacity or by boosting household demand in this study we develop a test to determine if the household demand channel is present and we implement the test using both a natural experiment in the united states in the 1980s and an international panel of 56 countries over the last several decades consistent with the importance of the household demand channel we find that credit supply expansion boosts nontradable sector employment and the price of nontradable goods with limited effects on tradable sector employment such credit expansions amplify the business cycle and lead to more severe recessions

interest rate changes mortgages and consumption evidence from italy summaryusing the italian survey of household income and wealth we study whether the drop in interest rates following the great recession was associated with an increase in consumption for households with adjustable rate mortgages arm relative to those with fixed rate mortgages frm after the reduction in mortgage payments consumption of arm holders increases relative to frm but the implied marginal propensity to consume is not statistically different from zero we suggest three explanations for the weak consumption response to the income shock first cash on hand and debt heterogeneity may attenuate the consumption response second borrowers believe that the income shock was short lasting and that interest rates would likely increase in the future implying a small effect on consumption third the shock is offset partly by a reduction in income from financial assets owned by mortgagors the findings have implications for the conduct of monetary policy interventions and the credibility of the future path of interest rates pass through of monetary policy and design of the mortgage market

cost benefit analysis of leaning against the wind abstract an obvious cost of leaning against the wind is a weaker economy if no financial crisis occurs possible benefits are lower probabilities and smaller magnitudes of crises a second cost less obvious previously overlooked but higher is a weaker economy if a crisis occurs for representative estimates costs exceed benefits by substantial margins overturning the result requires policy rate effects on the probability and magnitude of crises more than 5 40 standard errors larger than representative estimates higher probabilities larger magnitudes or longer durations of crises typical consequences of ineffective macroprudential policy increase the margin of costs over benefits

on the long run evolution of inheritance france 1820 2050 this paper attempts to document and account for the long run evolution of inheritance we find that in a country like france the annual flow of inheritance was about 20 25 of national income between 1820 and 1910 down to less than 5 in 1950 and back up to about 15 by 2010 a simple theoretical model of wealth accumulation growth and inheritance can fully account for the observed u shaped pattern and levels using this model we find that under plausible assumptions the annual bequest flow might reach about 20 25 of national income by 2050 this corresponds to a capitalized bequest share in total wealth accumulation well above 100 our findings illustrate the fact that when the growth rate g is small and when the rate of return to private wealth r is permanently and substantially larger than the growth rate say r 4 5 vs g 1 2 which was the case in the 19th century and early 20th century and is likely to happen again in the 21st century then past wealth and inheritance are bound to play a key role for aggregate wealth accumulation and the structure of lifetime inequality contrarily to a widely spread view modern economic growth did not kill inheritance

post crisis business investment in the euro area and the role of monetary policy business investment in the euro area strongly declined during the global financial crisis and the sovereign debt crisis it has not yet rebounded to its pre crisis trend despite the very expansiona

what if supply side policies are not enough the perverse interaction of flexibility and austerity abstract in this work we develop a set of labour market and fiscal policy experiments upon the labour and credit augmented schumpeter meeting keynes agent based model the labour market is declined under two institutional variants the fordist and the competitive set ups meant to capture the historical transition from the post wwii toward the post thatcher reagan period inside these two regimes we study the different effects of supply side active labour market policies almps vs demand management passive labour market ones plmps in particular we analyse the effects of almps aimed at promoting job search and at providing training to unemployed people next we compare the effects of these policies with unemployment benefits meant to sustain income and therefore aggregate demand considering the burden of unemployment benefits in terms of the public budget we link such provision with the objectives of the european stability and growth pact our results show that i an appropriate level of skills is not enough to sustain growth when workers face adverse labour demand ii supply side policies are not able to reverse the negative interaction between flexibility and austerity iii plmps outperform almps in reducing unemployment and workers skill deterioration and iv demand management policies are better suited to mitigate inequality and to sustain long run growth

what explains the speed of recovery from banking crises abstract while a large body of research has explored the causes and effects of banking crises less is known about what determines recovery from banking crises despite large variations in post crisis performances across countries in order to identify local and global factors that determine the length of recovery i e the time it takes until countries reach their pre crisis level of per capita gdp this exploratory paper employs event history analysis on 138 incidents of banking crises between 1970 and 2012 regarding domestic factors the simultaneous occurrence of currency crises large financial sectors overvalued currencies and large primary deficits are associated with later recovery whereas higher debt to gdp ratios or inflation levels do not exhibit a negative effect on post crisis performances regarding external factors a low growth of world trade as well as indicators of uncertainty in financial markets are correlated with later recovery global interest rate shocks are particularly harmful for the speed of recovery among middle income countries with a strong reliance on external capital the results are similar when using the length of recessions as an alternative indicator of post crisis performances

institutions household credit composition and the business cycle we show that the negative effect of household credit growth on subsequent economic growth documented in the recent literature is not the same across countries the effect is stronger in countries with weak institutions where the fraction of consumer credit in total household credit is greater that is an important nuance as consumer credit is a sizable part of household credit in many emerging markets and its rapid buildup should be observed with the same caution as a rapid buildup in housing credit jel g21 e32 e44

explaining the boom bust cycle in the u s housing market a reverse engineering approach we use a quantitative asset pricing model to reverse engineer the sequences of shocks to housing demand and lending standards needed to replicate the boom bust patterns in u s housing value and mortgage debt from 1993 to 2015 conditional on the observed paths for u s real consumption growth the real mortgage interest rate and the supply of residential fixed assets a specification with random walk expectations outperforms one with rational expectations in plausibly matching the patterns in the data counterfactual simulations show that shocks to housing demand housing supply and lending standards were important but movements in the mortgage interest rate were not

business housing and credit cycles summary we use multivariate unobserved components models to estimate trend and cyclical components in gross domestic product gdp credit volumes and house prices for the usa and the five largest european economies with the exception of germany we find large and long cycles in credit and house prices which are highly correlated with a medium term component in gdp cycles differences across countries in the length and size of cycles appear to be related to the properties of national housing markets the precision of pseudo real time estimates of credit and house price cycles is roughly comparable to that of gdp cycles

the top 1 percent in international and historical perspective world top incomes database at http topincomes parisschoolofeconomics eu and has represented a challenge to the economics profession stories based on the and has represented a challenge to the economics profession stories based on the supply and demand for skills are not enough to explain the extreme top tail of supply and demand for skills are not enough to explain the extreme top tail of the earnings distribution nor is it enough to look only at earned incomes different the earnings distribution nor is it enough to look only at earned incomes different approaches are necessary to explain what has happened in the united states over approaches are necessary to explain what has happened in the united states over the past century and also to explain the differing experience in other high income the past century and also to explain the differing experience in other high income countries over recent decades we begin with the international comparison in the countries over recent decades we begin with the international comparison in the fi rst section and then turn to the causes and implications of the evolution of top fi rst section and then turn to the causes and implications of the evolution of top income shares income shares

sticky prices in the euro area a summary of new micro evidence this paper summarises the vast evidence on micro price setting recently obtained for euro area countries we consider studies with micro data on consumer and producer prices as well as survey information the main findings are 1 prices in the euro area are sticky and stickier than in the us 2 downward price rigidity is only slightly more marked than upward price rigidity 3 heterogeneity and asymmetries are observed in price setting and 4 the relevance of theories that explain price stickiness such as implicit or explicit contracts marginal costs and coordination failure is confirmed whereas menu costs pricing thresholds and costly information explanations are judged much less relevant by firms jel c25 d40 e31

credit cycle coherence in the eurozone was there a euro effect this paper examines effects of the euro introduction on credit cycle coherence in the eurozone through six channels we construct and describe credit cycles for total bank credit household mortgages and non financial business loans for 16 emu economies over 1990 2015 credit cycle coherence is measured by synchronicity of cycle movements and similarity of their amplitudes we find that the effect of euro introduction runs through elimination of currency risk and higher capital flows which decrease coherence of total credit and mortgage credit cycles but increase coherence of business credit cycles falling interest rates contribute to the convergence of total and mortgage credit cycles financial deregulation and legal harmonization are associated with lower coherence of all credit cycles while trade openness has the opposite impact the findings impinge on monetary policy effectiveness in the eurozone with implications for macroprudential policy

bubbles and crises the role of house prices and credit this paper utilizes quarterly panel data for 20 oecd countries over the period 1975 q1 2014 q2 to explore the importance of house prices and credit in affecting the likelihood of a financial crisis

does the law of one price hold in a high inflation environment a tale of two cities in turkey this study addresses the price convergence in two cities in turkey istanbul and ankara using annual data over the three quarters of the twentieth century 1922 1998 characterized by prevailing high inflation rates for most of the period in contrast to the rest of the literature addressing convergence in price levels with a typical result of extremely slow convergence rates at best we argue that convergence is much easier detected in growth rates rather than levels of prices we suggest using the bounds testing procedure of pesaran et al 2001 for this purpose we find a clear cut evidence on the existence of a common driving force behind inflation dynamics in istanbul and ankara a finding that is in contrast with the results typically reported in related literature

do capital flows change domestic credit allocation since the 1990s domestic bank credit has been reallocated away from lending to non financial business and toward households an expanding literature discusses negative effects on growth and stability of this change in credit allocation we research its drivers we hypothesize that if foreign capital flows into economies with few investment opportunities it may substitute for domestic bank lending to non financial business so that bank balance sheets become more dominated by household lending in gmm estimations on data for 36 economies over 1990 2011 we find evidence consistent with this mechanism foreign capital inflows into the non bank sector but not into the bank sector are associated with lower shares of business lending in domestic bank portfolios the association is weaker in economies with more investment opportunities whether proxied by investment shares current account surpluses or emu membership our results highlight the importance of sectoral destination in determining the effects of capital flows

institutional causes macroeconomic symptoms volatility crises and growth countries that have pursued distortionary macroeconomic policies including high inflation large budget deficits and misaligned exchange rates appear to have suffered more macroeconomic volatility and also grown more slowly during the postwar period does this reflect the causal effect of these macroeconomic policies on economic outcomes one reason to suspect that the answer may be no is that countries pursuing poor macroeconomic policies also have weak institutions including political institutions that do not constrain politicians and political elites ineffective enforcement of property rights for investors widespread corruption and a high degree of political instability this paper documents that countries that inherited more extractive institutions from their colonial past were more likely to experience high volatility and economic crises during the postwar period more specifically societies where european colonists faced high mortality rates more than 100 years ago are much more volatile and prone to crises based on our previous work we interpret this relationship as due to the causal effect of institutions on economic outcomes europeans did not settle and were more likely to set up extractive institutions in areas where they faced high mortality once we control for the effect of institutions macroeconomic policies appear to have only a minor impact on volatility and crises this suggests that distortionary macroeconomic policies are more likely to be symptoms of underlying institutional problems rather than the main causes of economic

bank bias in europe effects on systemic risk and growth europe s financial structure has become strongly bank based far more so than in other economies we document that an increase in the size of the banking system relative to equity and private bond markets is associated with more systemic risk and lower economic growth particularly during housing market crises we argue that these two phenomena arise owing to an amplification mechanism by which banks overextend and misallocate credit when asset prices rise and ration it when they drop the paper concludes by discussing policy solutions to europe s bank bias which include reducing regulatory favouritism towards banks while simultaneously supporting the development of securities markets

comparative national balance sheets a study of twenty countries 1688 1978 raymond w goldsmith has combined his experience good sense and flair with figures to construct this groundbreaking comparative study of the balance sheets of twenty of the largest nations a pioneer in the field of national accounts goldsmith now presents a work that will be a valuable tool in tracking the economic progress of and between nations the majority of the balance sheets were created especially for this project their components gleaned from fragmentary and heterogeneous data there are approximately 3 500 entries each measuring the value of one type of tangible or financial asset or liability at a given date goldsmith s estimates are keyed to fifteen benchmark dates in the economic progress of the cited nations and for twelve nations he was able to construct balance sheets dating back to the nineteenth century or earlier combined worldwide balance sheet are included for 1950 and 1978 comparative national balance sheets will provide an essential basis for the quantitative analysis of the long term financial development of these nations in addition to national balance sheets for all large countries except brazil and china sectoral balance sheets for france germany great britain india japan and the united states in the postwar period are also included

who bears interest rate risk we study the allocation of interest rate risk within the european banking sector using novel data banks exposure to interest rate risk is small on aggregate but heterogeneous in the cross section contrary to conventional wisdom net worth is increasing in interest rates for approximately half of the institutions in our sample cross sectional variation in banks exposures is driven by cross country differences in loan rate fixation conventions for mortgages banks use derivatives to partially hedge on balance sheet exposures residual exposures imply that changes in interest rates have redistributive effects within the banking sector received october 31 2017 editorial decision august 30 2018 by editor philip strahan authors have furnished an internet appendix which is available on the oxford university press web site next to the link to the final published paper online

the costs of macroprudential policy abstract central banks increasingly rely on macroprudential measures to manage the financial cycle however the effects of such measures on the core objectives of monetary policy to stabilise output and inflation are largely unknown in this paper we quantify the effects of changes in maximum loan to value ltv ratios on output and inflation we rely on a narrative identification approach based on detailed reading of policy makers objectives when implementing the measures we find that over a four year horizon a 10 percentage point decrease in the maximum ltv ratio leads to a 1 1 reduction in output as a rule of thumb the impact of a 10 percentage point ltv tightening can be viewed as roughly comparable to that of a 25 basis point increase in the policy rate however the effects are imprecisely estimated and the effect is only present in emerging market economies we also find that tightening ltv limits has larger economic effects than loosening them at the same time we show that changes in maximum ltv ratios have substantial effects on credit and house price growth using inverse propensity weights to rerandomise ltv actions we show that these effects are likely causal

the rate of return on everything 1870 2015 what is the aggregate real rate of return in the economy is it higher than the growth rate of the economy and if so by how much is there a tendency for returns to fall in the long run which particular assets have the highest long run returns we answer these questions on the basis of a new and comprehensive data set for all major asset classes including housing the annual data on total returns for equity housing bonds and bills cover 16 advanced economies from 1870 to 2015 and our new evidence reveals many new findings and puzzles