Financial News, Banks, and Business Cycles

Abstract

In a model where banks face a capital sufficiency requirement, we demonstrate that news about a fall in the expected return on a portfolio of international long bonds held by a bank leads to an immediate and persistent fall in economic activity. Even if the news never materializes, economic activity falls below steady state for several periods, followed by a recovery. The portfolio adjustment induced by the capital sufficiency requirements leads to a rise in loan rates and tighter credit conditions, which trigger the fall in activity. We contribute to the news-shock literature by showing that imperfect signals about future financial returns can create business cycles without relying on the usual suspects—shocks to technology, preferences, or fiscal policy—and to the emerging economy business cycle literature in that disturbances in world financial markets can cause domestic business cycles without shocks to the world interest rate or to country spreads.

Overaccumulation, Interest, and Prices

“…See Leeper, Richter, and Walker (), Gortz and Tsoukalas (), Gunn and Johri (, ), and Christiano, Motto, and Rostagno (), Guo, Sirbu, and Weder (), Ben Zeev and Khan () for models with non‐TFP–related news.…”

On the Expectational Stability of Rational Expectations Equilibria in News-Shock Dsge Models

“…Assessments of the quantitative importance of news shocks using estimated DSGE models can be found in a variety of papers including Schmitt-Grohe and Uribe (2012), Khan and Tsoukalas (2012), Beaudry and Portier (2014), and Sims ( 2016), yet determining the empirical relevance of anticipated shocks remains an active area of research. Furthermore, the scope of shocks considered has been expanded beyond traditional supply-side shocks: Ramey (2011) and Born, Peter and Pfeifer (2013) reveal the anticipation of fiscal policy to be an important source of macroeconomic volatility , news about monetary policy as in Milani and Treadwell (2012) and Keen, Richter and Throckmorton (2017) and Gunn and Johri (2018) show news about future returns on assets held by financial institutions can generate business cycle fluctuations via a credit channel.…”

Financial Shocks, Supply-Chain Relationships, and the Great Trade Collapse

“…Our news shocks differ from these in that fluctuations are driven by financial news shocks whereas most models in this literature contain TFP news shocks (see Beaudry and Portier (2014) for a literature review and Schmitt-Grohé and Uribe ( 2012) for an estimated model with news shocks to several processes.). An exception in which a news shock to bank balance sheets can cause a recession can be found in Gunn and Johri (2015). News shocks in a model with financial enforceability constraints can also be found in Gortz and Tsoukalas (Forthcoming).…”