Future Output Growth Research Articles

Financial conditions, macroeconomic uncertainty, and macroeconomic tail risks

This paper investigates how financial conditions and macroeconomic uncertainty jointly affect macroeconomic tail risks. We first document that tight financial conditions decrease all conditional quantiles of future output growth in the near term, while high macroeconomic uncertainty only stretches the interquartile range. Because financial conditions and uncertainty comove substantially, the conditional means and variances shift simultaneously in the opposite direction. Consequently, the downside risk varies much more than the upside risk. A quantile impulse response analysis indicates that both financial and uncertainty shocks are responsible for the asymmetric behaviors in the downside and upside risks.

Consumption-led expansions lead to lower future output growth

When assessing future growth prospects, does the current structure of demand matter, i.e. does it affect the future growth? This question is analysed in our paper by using global and EU panel data. The result is quite striking: consumption-led growth either in terms of private or public or total consumption is slower than investment-led or exports-led growth. The same qualitative result is obtained irrespectively of the length of the past growth period (lag window), yet the more often the past is characterised by consumption-led growth, the slower the growth rate is in the future. In this context, our research provides important insights from the point of view of both structural and cyclical policies.

Equity Returns, Bond Spreads, and Economic Activity in Emerging Countries

While simultaneously accounting for the effects of sovereign and corporate bond spreads, we document that emerging market economy (EME) equity returns have a strong predictive power for future output growth and account for a significant fraction of output fluctuations in these countries. Our results are based on the environment of Caballero, Fernandez, and Park (2019), who show that corporate bond spreads are a better driver of EME economic activity than sovereign bond spreads. We find that equity returns, a proxy of domestic and external financial conditions, play a more important role for EME output growth than both types of bond spreads. We attribute this difference to the effectiveness of equity returns in transmitting global financial risk shocks to EMEs and to the role of equity issuance in international capital flows in EMEs.

The (pro-) cyclicality of government consumption in the EU and official expectations of future output growth: new evidence

Data from member states’ Stability and Convergence Programmes from 2011 to 2018 are used to assess the cyclicality of government consumption in the EU after the European Semester took effect. Econometric estimations, which address endogeneity issues, find the intended (ex-ante) fiscal policy to be pro-cyclical in nature. Government consumption is also found to be pro-cyclical ex-post but to a much lesser extent than ex-ante. This appears to be largely owing to a forecasting bias on the part of official forecasters occurring, despite the purported improvements to EU member states’ surveillance and forecasting mechanisms that have been put in place in recent years to address such bias.

Growth forecast revisions over business cycles: Evidence from the Survey of Professional Forecasters

This paper studies how expectations regarding current and future output growth are revised as the state of the economy evolves. We study this issue using GDP growth forecasts from the Survey of Professional Forecasters. We find an asymmetric relationship between forecast revisions and GDP growth. Forecasters make larger forecast revisions during contractions than during expansions when the deviation of the economy from its normal state is controlled for.

On the effects of macroprudential policies on Growth-at-Risk

The Growth-at-Risk (GaR) measure for financial stability indicates how severe a recession could become in an extreme situation where future output growth falls into the 5th percentile of the distribution. In this letter, we estimate the effects of macroprudential policies on GaR by combining quantile regressions with local projections in a panel data setting. Our results indicate that the effect of macroprudential measures on GaR could be significant in the medium term. Tightening the loan-to-value limit narrows the whole GDP distribution, while doing the same to loan-loss provisions just moves the left tail of the distribution upward, reducing only the intensity of a potential crisis.

Predicting GDP growth with stock and bond markets: Do they contain different information?

AbstractThis paper examines the ability of bond and stock markets to predict subsequent GDP growth over a range of horizons for 12 international countries. The results, using linear, probit, time‐ and regime‐varying in‐sample regressions and out‐of‐sample forecasting, confirm the view that both financial markets exhibit predictive power for future output growth. Moreover, there is notable variation within the strength of the predictive relation, for example, predictive power increases during the financial crisis period. Results suggest that while the term structure arguably exhibits stronger predictive power, both series contain distinct predictive information. Notably, predictive power emanating from the stock return series appears stronger over shorter (up to four‐quarter) time horizons, while the term structure series exhibits more consistent predictive power over a range of horizons. Considering different regimes, we observe that the bond market exhibits greater predictive power for a flatter yield curve and lower stock prices relative to fundamentals, while the stock market exhibits greater predictive power for a steeper yield curve and higher relative stock prices. This suggests that the two financial markets exhibit different information content for future output growth. This view is further supported by forecast results whereby a model that includes both financial series outperforms a model that only includes one. Forecast encompassing tests further support the view that stock returns contain additional information over that presented by the term structure alone.

Is the future really observable? A practical approach to model monetary policy rules

We take a practical approach to model the forward-looking monetary policy rule. Unlike existing studies, we recognize that the forward-looking components—future inflation and output growth—are intrinsically unobserved at the time policy formulation. Using the unobserved components framework, we extract the latent components of the policy rule from the short-term and long-term Greenbook forecasts, both individually and in combination, and jointly estimate the policy parameters. We also consider correlations between different components and combine the forecasts from the survey of professional forecasters and the inflation index bonds market. Evidence suggests that the Federal Reserve follows an inflation-tilted policy rule and the long-term state of economy gets a higher weight than the short term. Also, the policy reaction is more aggressive when interconnections between different components of the policy rule are considered.

Leaning Against the Wind

This paper takes a new approach to assess the costs and benefits of using different policy tools—macroprudential, monetary, foreign exchange interventions, and capital flow management—in response to changes in financial conditions. The approach evaluates net benefits of policies using quadratic loss functions, estimating policy effects on the full distribution of future output growth and inflation with quantile regressions. Tightening macroprudential policy dampens downside risks to growth stemming from loose financial conditions, and is beneficial in net terms. By contrast, tightening monetary policy entails net losses, calling for caution in the use of monetary policy to “lean against the wind.” These findings hold when policies are used in response to easing global financial conditions. Buying foreign-exchange or tightening capital controls has small net benefits.

The Information Effect of Monetary Policy: Self-Defeating or Optimal?

As the Federal Reserve has become more transparent about its decisions on the federal funds target rate, the general public has begun to regard the rate as not only a benchmark interest rate, but also as a signal about the state of the economy. However, the specific information considered by the public to be revealed is not clearly understood. We investigate this question and find that the information revealed by monetary policy decisions is regarding future output growth, not inflation, and that such an information effect is theoretically optimal and does not make interest-rate policies self-defeating.

The information content of US stock market factors

PurposeThe purpose of this paper is to consider the economic information content within several popular stock market factors and to the extent to which their movements are both explained by economic variables and can explain future output growth.Design/methodology/approachUsing US stock portfolios from 1964 to 2019, the authors undertake three related exercises: whether a set of common factors contain independent predictive ability for stock returns, what economic and market variables explain movements in the factors and whether stock market factors have predictive power for future output growth.FindingsThe results show that several of the considered factors do not contain independent information for stock returns. Further, most of these factors are neither explained by economic conditions nor they provide any predictive power for future output growth. Thus, they appear to contain very little economic content. However, the results suggest that the impact of these factors is more prominent with higher macroeconomic risk (contractionary regime).Research limitations/implicationsThe stock market factors are more likely to reflect existing market conditions and exhibit a weaker relation with economic conditions and do not act as a window on future behavior.Practical implicationsFama and French three-factor model still have better explanations for stock returns and economic information more than any other models.Originality/valueThis paper contributes to the literature by examining whether a selection of factors provides unique information when modelling stock returns data. It also investigates what variables can predict movements in the stock market factors. Third, it examines whether the factors exhibit a link with subsequent economic output. This should establish whether the stock market factors contain useful information for stock returns and the macroeconomy or whether the significance of the factor is a result of chance. The results in this paper should advance our understanding of asset price movement and the links between the macroeconomy and financial markets and, thus, be of interest to academics, investors and policy-makers.

Sources of current account fluctuations in Taiwan: 1989–2015

In this paper, we use a small open economy model with nontradable goods and time-varying interest rates to investigate the sources of fluctuations in Taiwan’s current account. The correlation coefficient between the implied path of the current account generated from our model and the actual current account data exceeds 0.9, while tests of the cross-equation restrictions also support the model-implied present value relationship between the current account and other macroeconomic variables. We find the consumption smoothing channel, based on the discounted sum of the expected future net output growth, is the main channel for current account adjustment in Taiwan. Expected changes in the real effective exchange rate also account for much of the variation in the current account.

Leaning Against the Wind: A Cost-Benefit Analysis for an Integrated Policy Framework

This paper takes a new approach to assess the costs and benefits of using different policy tools-macroprudential, monetary, foreign exchange interventions, and capital flow management-in response to changes in financial conditions. The approach evaluates net benefits of policies using quadratic loss functions, estimating policy effects on the full distribution of future output growth and inflation with quantile regressions. Tightening macroprudential policy dampens downside risks to growth stemming from loose financial conditions, and is beneficial in net terms. By contrast, tightening monetary policy entails net losses, calling for caution in the use of monetary policy to 'lean against the wind.' These findings hold when policies are used in response to easing global financial conditions. Buying foreign-exchange or tightening capital controls has small net benefits.

Two Types of (Slight) Flexibility in Bank of Canada Projections, 2003–2019

Central bankers and other economists sometimes describe the inflation targeting practiced in Canada as flexible. This flexibility refers to deferring the planned return of the Consumer Price Index (CPI) inflation rate to the 2 percent target. In this article, I outline two ways to measure flexibility: by seeing whether the forecast for future inflation varies with either (1) current values of inflation or output growth or (2) the forecast for future output growth. The latter correlation would suggest that the Bank of Canada aims to stabilize output growth in addition to stabilizing the inflation rate. I describe how to detect evidence of these two types of flexibility in the Bank of Canada’s own forecasts (also known as projections) from its quarterly Monetary Policy Report. However, there is little sign of economically significant flexibility between 2003 and 2019.

Predicting firm level stock returns: Implications for asset pricing and economic links

We examine the predictive ability of stock price ratios, stock return dispersion and distribution measures for firm level returns. Analysis typically focusses on market level returns, however, for the underlying asset pricing model to hold, firm-level predictability should be present. Additionally, we examine the economic content of predictability by considering whether the predictive coefficient has the theoretically correct sign and whether it is related to future output growth. While stock returns reflect investor expectations regarding future economic conditions, they are often too noisy to act as predictor. We use the time-varying predictive coefficient as it reflects investor confidence in the predictive relation. Results suggest that a subset of stock price ratios have predictive power for individual firm stock returns, exhibit the correct coefficient sign and has predictive power for output growth. Each of these ratios has a measure of fundamentals divided by the stock price and has a positive relation with stock returns and output growth. This implies that as investors expect future economic conditions to improve and earnings and dividends to rise, so expected stock returns will increase. This supports the cash flow channel as the avenue through which stock return predictability arises.

Optimism, pessimism, and short-term fluctuations

Economic theory offers several explanations as to why shifting expectations about future economic activity affect current demand. Abstracting from whether changes in expectations originate from swings in beliefs or fundamentals, we test empirically whether optimism and pessimism about the economy trigger short-term fluctuations in private consumption and investment. Under the assumption that cyclical movements in private consumption and investment growth are exogenous to potential output growth forecasts far into the future, our results are consistent with the idea of private economic agents learning about future potential output growth and adjusting their current demand accordingly. We also propose a simple Keynesian model to illustrate that revisions in expected future income can affect short-term equilibria, in line with the results of the empirical analysis.

IS BUSINESS CYCLE ASYMMETRY INTRINSIC IN INDUSTRIALIZED ECONOMIES?

We consider a model-averaged forecast-based estimate of the output gap to measure economic slack in 10 industrialized economies. Our measure takes changes in the long-run growth rate into account and, by addressing model uncertainty using equal weights on different forecast-based estimates, is robust to different assumptions about the underlying structure of the economy. For all 10 countries in the sample, we find that the estimated output gap has much larger negative movements during recessions than positive movements in expansions, suggesting business cycle asymmetry is an intrinsic characteristic of industrialized economies. Furthermore, the estimated output gap is always strongly negatively correlated with future output growth and unemployment and positively correlated with capacity utilization. It also implies a convex Phillips Curve in many cases. The model-averaged output gap is reliable in real time in the sense of being subject to relatively small revisions.

Predicting GDP Growth with Stock and Bond Markets: Do They Contain Different Information?

This paper examines the ability of bond and stock markets to predict subsequent GDP growth over a range of horizons for twelve international countries. The results, using linear, probit, time- and regime-varying in-sample regressions and out-of-sample forecasting, confirm the view that both financial markets exhibit predictive power for future output growth. moreover, there is notable variation within the strength of the predictive relation, for example, predictive power increases during the financial crisis period. Results suggest that while the term structure arguably exhibits stronger predictive power, both series contain distinct predictive information. Notably, predictive power emanating from the stock return series appears stronger over shorter (up to four-quarter) time horizons, while the term structure series exhibits more consistent predictive power over a range of horizons. Considering different regimes, we observe that the bond market exhibits greater predictive power for a flatter yield curve and lower stock prices relative to fundamentals, while the stock market exhibits greater predictive power for a steeper yield curve and higher relative stock prices. This suggests that the two financial markets exhibit different information content for future output growth. This view is further supported by forecast results whereby a model that includes both financial series outperforms a model that only includes one. Forecast encompassing tests further support the view that stock returns contain additional information over that presented by the term structure alone.

Intuitive and Reliable Estimates of the Output Gap from a Beveridge-Nelson Filter

Abstract The Beveridge-Nelson decomposition based on autoregressive models produces estimates of the output gap that are strongly at odds with widely held beliefs about transitory movements in economic activity. This is due to parameter estimates implying a high signal-to-noise ratio in terms of the variance of trend shocks as a fraction of the overall forecast error variance. When we impose a lower signal-to-noise ratio, the resulting Beveridge-Nelson filter produces a more intuitive estimate of the output gap that is large in amplitude and highly persistent, and it typically increases in expansions and decreases in recessions. Notably, our approach is also reliable in the sense of being subject to smaller revisions and predicting future output growth and inflation better than other trend-cycle decompositions that impose a low signal-to-noise ratio.

Optimism, Pessimism, and Short-Term Fluctuations

Economic theory offers several explanations as to why shifting expectations about future economic activity affect current demand. Abstracting from whether changes in expectations originate from swings in beliefs or fundamentals, we test empirically whether more optimistic or pessimistic potential output forecasts trigger short-term fluctuations in private consumption and investment. Relying on a dataset of actual data and forecasts for 89 countries over the 1990-2022 period, we find that private economic agents learn from different sources of in- formation about future potential output growth, and adjust their current demand accordingly over the two years following the shock in expectations. To provide a theoretical foundation to the empirical analysis, we also propose a simple Keynesian model that highlights the role of expectations about long-term output in determining short-term economic activity.