Adverse Macroeconomic Shocks Research Articles

The Russian labor market: Long-term trends and short-term fluctuations

This paper provides a statistical portrait of the Russian labor market during the latest period of 2010–2022. The analysis delves into both the long-term trends in its evolution and short-term fluctuations associated with its adjustment to economic downturns. The most noteworthy among the long-term changes are a gradual shrinkage of the labor force and employment, the transition to record low unemployment, a sharp acceleration in worker turnover, and the emergence of an extensive overhang of unfilled job vacancies. During the period under review, the Russian economy experienced three strong adverse macroeconomic shocks — the first sanctions crisis in 2014–2015, the corona crisis in 2000–2021, and the second sanctions crisis, which began in 2022 and is still far from over. The paper provides the evidence that the Russian labor market has retained the same algorithm for accommodation to economic downturns, which it developed back in the 1990s. A distinctive feature of this specific model is that the negative shocks are absorbed predominantly through declines in wages and reductions in working hours, rather than through contraction of employment and surge in unemployment. The general conclusion is that the Russian labor market is undergoing a transition from a functional regime marked by tight labor demand to another characterized by tight labor supply.

Complexity and the default risk of mortgage-backed securities

We study the impact that lower complexity in bank securitisations has on mortgage quality and the securitisation structure. We find that mortgages issued after the announcement of new European regulation that aims to reduce deal complexity are characterised by up to 0.38% lower annual delinquency rates than in the pre-regulation period. Similarly, we show that mortgage securitisations that meet the new ‘simplicity, transparency and standardisation’ (STS) criteria have 0.77% lower annual delinquency rates and are more resilient to adverse macro-economic shocks. We find that the increased quality of the underlying loans outweighs the potential negative effects of thinner subordinated tranches in securitisations that comply with the new regulation. Overall, our findings suggest that the new European securitisation regulation has contributed to improving credit quality in the securitisation market in Europe.

The Role of Informality in Moderating the Impact of Adverse Macroeconomic Shocks

The Role of Informality in Moderating the Impact of Adverse Macroeconomic Shocks

Proposals for the reform of EU fiscal rules

The aim of this paper is to contribute to the ongoing debate regarding the reform of the EU fiscal framework, with a special focus on fiscal sustainability for Greece. Our key policy proposals for the EU fiscal rules draw on lessons from past experience, the conclusions of relevant studies and the fiscal sustainability risks faced by Greece and other high-debt countries in the euro area. To this end, we use the European Fiscal Board’s Compliance Tracker Dataset to assess compliance with the existing SGP framework. Moreover, we employ the Bank of Greece’s Debt Sustainability Analysis (DSA) model to identify possible fiscal sustainability risks for Greece over the medium- to long-term horizon, taking into account alternative economic policy scenarios (including a debt rule scenario). Our main findings indicate that the revised fiscal framework should focus on the need to enhance sustainability of public debt as a key priority, by setting a debt anchor as a medium-term fiscal objective, with a single operational expenditure rule that promotes countercyclicality of fiscal policy. The current benchmark levels could be maintained and complemented with the appropriate flexibility in the rate of debt reduction to address cross-country heterogeneity and avoid self-defeating effects of fiscal policy. In the case of Greece, despite the favourable characteristics of public debt, fiscal policy in the short and medium term should focus on accelerating debt reduction. The exposure of Greece’s public debt dynamics to market and interest rate risks will gradually increase, as official sector debt is replaced by market financing, thereby changing the structure of public debt and highlighting the need to create fiscal buffers in order to increase its resilience to future adverse macroeconomic shocks.

Population Dynamics, Macroeconomic Risks, and the Future of Pensions in Finland

The hybrid pay-as-you-go system currently in use in Finland could become increasingly untenable in the longer run, should macroeconomic developments turn out weaker than expected. Unfavorable population trends would amplify the effects of adverse macroeconomic shocks on the Finnish pension system and its financial health. Although Finnish government has demonstrated willingness to respond to challenges facing the pension system and has been successful in building consensus for necessary pension reforms, a more strategic approach would serve policymakers and retirees (current and future) better in the longer run. This study focuses on risks to productivity and investment returns and how they would impact the longer-term health of the Finnish pension system, given unfavorable population dynamics. In order to protect the longer-term finances of the pension system, government should transition away from the pay-as-you-go model to an arrangement where pensions are fully funded from investment returns instead of being dependent on the contributions of current working-age population. We suggest alternative options to achieve that but at the same time emphasize that the authorities need to be mindful of burden-sharing between workers and pensioners in their considerations, as pension cuts would hurt retirees while contribution rates are already quite high.

When banks punch back: Macrofinancial feedback loops in stress tests

In the presence of adverse macroeconomic shocks, simultaneous capital losses in multiple banks can prompt them to contract their balance sheets. These bank responses generate externalities that propagate in the form of macrofinancial feedback loops. This paper develops a credit response and externalities analysis model (CREAM) that integrates a disaggregated banking sector into an otherwise standard macroeconomic structural vector autoregressive model. It shows that accounting for macrofinancial feedback loops can significantly affect macroeconomic outcomes and bank-specific stress test results. The heterogeneity in bank lending responses matters: it determines how each bank fares under adverse conditions and the external effects that banks impose on each other and on economic activity. The model can thus be used to assess the contributions of individual banks to systemic risk along the time dimension.

Macroeconomic shocks and racial labor market differences

AbstractWe investigate the effects of three structural macroeconomic shocks (monetary, demand, and supply) on the labor market outcomes of black and white Americans using a factor‐augmented vector autoregression (FAVAR) framework with 136 U.S. macroeconomic indicators from 1973 to 2017. Our results indicate that adverse macroeconomic shocks have differential effects on labor market outcomes for blacks and whites, hurting blacks disproportionately more than whites. Black Americans' labor market outcomes appear to be significantly more sensitive to macroeconomic shocks than are the outcomes for white Americans. Our findings indicate that business‐cycle costs are disproportionately borne by black Americans and that racial inequality in the labor market rises in recessions. The strongest effects occur in recessions caused by supply side disturbances. Our results suggest policymakers should take these heterogeneous effects into account when designing policy.

Currency Wars? Unconventional Monetary Policy Does Not Stimulate Exports

AbstractI investigate whether countries that use unconventional monetary policy (UMP) experience export booms. I use a popular gravity model of trade which requires neither the exogeneity of UMP, nor instrumental variables for UMP. In practice, countries that engage in UMP experience a drop in exports vis‐à‐vis countries that are not engaged in such policies, holding other things constant. Quantitative easing is associated with exports that are about 10% lower to countries not engaged in UMP; this amount is significantly different from zero and similar to the effect of negative nominal interest rates. Thus, there is no evidence that countries have gained export markets through UMP; currency wars that have been launched have also been lost. UMP is also associated with a comparable drop in imports and exchange rates, suggesting that countries engage in UMP when they are experiencing adverse macroeconomic shocks concurrent with those that eviscerate international trade.

Comments on Default Probability by Employment Status in South Korea

Comments on Default Probability by Employment Status in South Korea

The Credit Line Channel

Aggregate U.S. bank lending to firms expands following several adverse macroeconomic shocks, such as the outbreak of COVID-19 or a monetary policy tightening. Using loan-level supervisory data, we show that these dynamics are driven by draws on credit lines by large firms. Banks that experience larger drawdowns during the COVID-19 crisis restrict term lending more, crowding out credit to smaller firms. A structural model indicates that credit lines are central to reproducing this flow of credit toward less constrained firms. While credit lines increase total credit growth in bad times, their redistributive effects can exacerbate the fall in investment.

Dynamic risk sharing in the Central African Economic and monetary community

Abstract. In contrast to the first Optimum Currency Area (OCA) theory which was mostly about preventing currency areas’ exposure to asymmetric shocks, the second model introduced by Robert A. Mundell (1973) focuses on risk sharing across member states when facing adverse macroeconomic shocks. This paper explores how risk is shared across the six member states of the Central African Economic and Monetary Community (CEMAC). Using dynamic panel VAR, we measure disposable income and consumption smoothing of negative output shocks. We find that more than 72 percent of GDP idiosyncratic shocks remain unsmoothed in the case of the Central African currency area from 1986 to 2018. Keywords. Optimal currency area, International risk-sharing, Dynamic panel VAR, Fiscal consolidation, Currency devaluation, Shock smoothing. JEL. C32, E41, E21, F32, F45.

Stressing the Fed Stress Tests Against COVID-19

COVID-19 is a new type of shock that is likely to produce losses on loans and financial assets higher and more correlated than historical adverse macroeconomic shocks unless policy stabilization efforts are successful. Further, the sudden economic stop caused by the need for social distancing requires bridge financing to support existing contractual arrangements for employment, debt service, and a range of other obligations. Society has resources in the form of taxation of future income that it can move to the present to provide bridge financing and absorb losses from defaulting loans and ensure that existing forms of capital (physical, human and intangible) remain available for production after the COVID-19 virus wanes. For the US this is taking the form of transfers, direct loans and equity from the US Treasury (UST), and UST “capital” used to back the Federal Reserve’s various lending facilities under its 13(3) authority. The goal of this note is to provide a simple framework to analyze how much UST capital is needed to back the Fed Facilities to achieve the stabilization goal. Simply put, what should be the aggregate capacity (leverage) of the facilities, and how much capital will be available in tail outcomes where the private banking system faces losses greater than its substantial capital buffer? We will bootstrap recent Federal Reserve stress test results to illustrate some possible answers to these questions. This is the notion of how we are stressing the stress tests.

When Banks Punch Back

In the presence of adverse macroeconomic shocks, simultaneous capital losses in multiple banks can prompt them to contract their balance sheets. These bank responses generate externalities that propagate in the form of macro-financial feedback loops. This paper develops a credit response and externalities analysis model (CREAM) that integrates a disaggregated banking sector into an otherwise standard macroeconomic structural vector autoregressive model. It shows that accounting for macro-financial feedback loops can significantly affect macroeconomic outcomes and bank-specific stress tests results. The heterogeneity in bank lending responses matters: it determines how each bank fares under adverse conditions and the external effects that banks impose on each other and on economic activity. The model can thus be used to assess the contributions of individual banks to systemic risk along the time dimension.

The response of hedge fund tail risk to macroeconomic shocks: A nonlinear VAR approach

We study how downside risk taken by hedge fund strategies responds to macroeconomic and financial shocks. Using new empirical measures of systematic tail risk, we find that the impulse response functions of strategies’ multi-moment risk display an asymmetric behavior, being much more significant and nonlinear during the subprime crisis than during the recent expansion period. Our results indicate that managers of hedge fund strategies seek to monitor their tail risk during crises, in the sense that their portfolios seem to behave as puts, which are kurtosis reducers in times of turmoil. However, while some strategies (e.g., futures) succeed quite well in controlling their tail risk during crises, others (e.g., equity market neutral) have difficulties to do so. This is an important result for institutional investors who think that hedge funds are “hedged” and thus immunized against adverse macroeconomic shocks—especially market volatility shocks.

Macroeconomic Shocks and Racial Labour Market Differences in the U.S.

Using 136 United States macroeconomic indicators from 1973 to 2017, and a factor augmented vector autoregression (FAVAR) framework with sign restrictions, we investigate the effects of three structural macroeconomic shocks - monetary, demand, and supply – on the labour market outcomes of black and white Americans. Our results indicate that adverse macroeconomic shocks have differential effects on labour market outcomes for blacks and whites, hurting blacks disproportionately relative to whites. Black Americans appear to be significantly more sensitive to macroeconomic shocks than white Americans. Evidence from our FAVAR model, which uses information on contractionary initiatives by the Federal Reserve, indicates that the employment-population ratio among black Americans falls close to twice as much as that among white Americans, primarily due to an increase in their unemployment rate and not a decline in labour force participation rate. Policymakers should take account of these heterogeneous effects across racial groups when implementing disinflationary guiding policy.

The switching impact of financial stability and economic growth in Qatar: Evidence from an oil-rich country

This paper investigates the relationship between financial stability and economic growth in the Qatar economy over the period 1980:Q1–2013:Q4. The paper estimates the short- and long-run impact of real GDP growth on real loan provisions using a Vector Error Correction Model (VECM) with structural breaks. Moreover, the empirical analysis includes an impulse response analysis to evaluate Qatar banking sectors’ resilience to adverse macroeconomic shocks so as to check whether financial instability may impede economic growth or vice versa. To this end, the empirical results indicate that there is a long-run relationship with a shift in the cointegration vector between real loan provisions and real GDP growth and other explanatory variables. The empirical findings show that real GDP growth has a long-run negative impact and a moderate short-run positive impact on real loan provisions. This negative relationship indicates that an increase in real GDP growth may lead to less defaults on loans. Furthermore, the impulse response test indicates that unexpected shocks in real GDP growth have a negative impact on real loan provisions with the largest contribution in real loan provision changes coming mainly from changes in real GDP growth.

How Vulnerable are Commercial Banks to Macroeconomic Shocks? The Case of Bangladesh

Innovative financial products and services of commercial banks increase the exposure to liquidity, market and operational risks resulting in the banks facing vulnerable circumstances. Even the smallest unexpected loss, with a low capital to assets ratio, tends to jeopardise the survival of the banks in developing economies. In addition, banking crises due to financial instability can be very costly for any economy in terms of systematic disruption and contraction of activities in other industries. In view of these concerns, this study examines the impact of macroeconomic dynamics on credit risk of commercial banks in Bangladesh and assesses the extent of default rate in the banking system as a result of adverse macroeconomic shocks. In order to identify the comprehensiveness of structural shocks, applying a VAR model in this study we impose sign-restricted 99th percentile value to disseminate shocks for each variable. The study finds that in extreme adverse inflation situations, contractionary monetary policy, and unexpected increase in exchange rate gap can boost the default rate by over 1%, 0.57% and 0.92% respectively. In addition, if all the extreme historical events occur for all macroeconomic variables, the default rate would increase by 2.52% after a lag. It indicates, adverse economic condition can threaten the banking sector in Bangladesh. From the operational and regulatory perspective of banks, our findings are motivating. The results might help the policy makers to focus on the key macro variables for smooth operation and stability of the banking system.

Stress-Testing para carteras de crédito del Sistema Bancario Mexicano

The aim of this paper is to present a scheme to assess vulnerability to adverse macroeconomic shocks in aggregate loan portfolios of the Mexican banking system. The used database consists of monthly aggregate information of the radius between nonperforming loans and total loans, for the period 2000-2014, for a total of 65 financial institutions. Through the Seemingly Unrelated Regressions (SUR) methodology, we estimated an equations system to link the default probability and macroeconomic factors, the obtained system was used to estimate the probability distributions, unconditional and conditional upon the occurrence of particular shocks in relevant macroeconomic variables. The outcome indicates that the estimated loss from the different distributions under stress does not increase significantly, so, we conclude that the risk in this sector is moderate under the selected scenarios. The most important result of the work is the obtained relation between default probabilities and stressed macroeconomic factors, but these results are limited by the probability of ocurrence of these induced stress scenarios and the horizon of the estimated econometric model.

Household resilience to adverse macroeconomic shocks: evidence from Czech microdata

We develop a methodology for identifying financially distressed households and use it for testing the responses to shocks to the unemployment rate, the interest rate and prices of essential expenditure in the Czech Republic. We extend the approach of Johansson and Persson (2006) for Sweden and Albacete and Fessler (2010) for Austria in the literature to allow for full labour market transitions between employment and unemployment, and, due to data availability, to account for heads and spouses within households. This improvement may lead to a higher response of household distress incidence, due to the unemployment rate shock, than in both Sweden and Austria, while the effects due to the interest rate shock are of similar size as in Austria. We illustrate the use of our approach for stress testing households’ ability to pay their debts using macroeconomic scenarios from the CNB’s official forecast and from the CNB’s Financial Stability Report. The results highlight the importance of using micro-level datasets in the analysis of household distress incidence, as the impact of shocks is more pronounced among lower-income households.

Unemployment Risk and Over-Indebtedness

We study how unemployment affects the over-indebtedness of households using the new European Household Finance and Consumption Survey (HFCS). First, we assess the role of different labor market statuses (i.e. employed, unemployed, disabled, retired, etc.) and other household characteristics (i.e. demographics, housing status, household wealth and income, etc.) to determine the likelihood of over-indebtedness. We explore these relationships both at the Euro area level and through country-specific regressions. This approach captures country-specific institutional effects concerning all the different factors which can explain household indebtedness in its most severe form. We also examine the role that each country’s legal and economic institutions play in explaining these differences. The results of the regressions across all countries show that the odds of being over-indebted are much higher in households where the reference person is unemployed. These odds ratios remain fairly stable across different over-indebtedness indicators and specifications. Interestingly, we find similar results for secured debt only. Turning to country specific results, the role of unemployment varies widely across countries. In Spain, France or Portugal, for example, the odds ratio for the unemployed group is just below 2, whereas in Austria, Belgium, or Italy the odds ratio is higher than 4. Secondly, we situate the analysis in a macro-micro frame to identify households and countries that are especially vulnerable to adverse macroeconomic shocks in the labor market. For the Euro area, we find that the percentage of households plagued by over-indebtedness increased by more than 10%, suggesting that another unemployment shock could have a major impact on the financial solvency of Euro area households. Finally, the impact of this shock on single-headed households is much higher than on couple-headed ones.