Recessionary Shocks Research Articles

Targeted Reserve Requirements for Macroeconomic Stabilization

We study the effectiveness of targeted reserve requirements (RR) as a policy tool for macroeconomic stabilization. Targeted RR adjustments were implemented in China during both the 2008-09 global financial crisis and the recent COVID-19 pandemic. We develop a model in which firms with idiosyncratic productivity can borrow from two types of banks---local or national---to finance working capital. National banks provide liquidity services, while local banks have superior monitoring technologies, such that both types coexist. Relationship banking is modeled in terms of a fixed cost of switching lenders, and banks choose to switch only under sufficiently large shocks. Reducing RR on local banks boosts leverage and aggregate output, whereas reducing RR on national banks has an ambiguous output effect. Following a large recessionary shock, a targeted RR policy that reduces RR for local banks relative to national banks can lower costs of switching lenders, stabilizing macroeconomic fluctuations. However, targeting RR in that manner also boosts local bank leverage, increasing risks of default and related liquidation losses. Our model's mechanism is supported by bank-level empirical evidence.

The Impact of State Fiscal Policy on States’ Resilience Exiting the Great Recession

This study employs a state-level model of recovery and a comprehensive set of tax- and expenditure-related variables to explore the effect that the states’ fiscal policy decisions had on their recoveries after the Great Recession in the United States. In addition, we combine those findings with our resistance results from two earlier studies to identify the structural and fiscal-policy factors that consistently strengthened or weakened the states’ economic resilience entering, during, and exiting that recession. Although our analysis indicates that resistance and recovery are distinctly different economic resilience phenomena, states that avoided sales and corporate income taxes, and that committed a greater share of their resources to public welfare expenditures, fared better than others throughout. This knowledge may aid state governments’ fiscal policy decision making as they prepare for future recessionary shocks.

Human Capital and Labour Market Resilience: A Regional Analysis for Portugal

This paper investigates labour market resilience for seven Portuguese NUTS-2 regions over the period 1995–2018 detailing its relationship with levels of education and highlighting the period following the 2007–08 financial and economic crisis. We define resilience as the ability of regional employment to recover from a recessionary shock over an entire business cycle. Our results point to the existence of labour market resilience to the different business cycles for the different regions in terms of total hours worked. The same conclusion applies to employment of workers with different levels of educational attainment, low, medium and high, defined according to the highest level of education completed by employees. Investigating in more detail the potential differentiated impact of the Portuguese Great Recession (PGR), covering the period after the 2007–08 crisis, our findings suggest however no resilience in terms of total hours worked and employment of workers with low levels of education, corresponding so far to a situation of jobless economic recovery. The conclusions are mixed for employment of workers with medium levels of education, while we found evidence of labour market resilience to the PGR for employment of workers with high levels of education. The strong negative impact of the PGR at the economic level thus seems to have hindered labour market resilience for employees and regions less endowed with human capital.

How regional economic structure matters in the era of COVID-19: resilience capacity of U.S. states.

The COVID-19 pandemic is an unexpected-extreme event and has considerably impacted the national and regional economies. This paper emphasizes the importance of industrial structure for a region’s resistance to the recessionary shock. Two significant factors that may determine the regional industrial structures in this ongoing recession include the relative composition of essential/non-essential sectors and the intensity of face-to-face interactions. Considering these factors, we focus on two groups of industries: essential industry with low interpersonal interactions and non-essential industry with high interpersonal interactions. The specialization in these industries is associated with the regional economic resistance to the COVID-19 induced recession. Estimation results from the ordinal logistic regression models show that essential industries with low interpersonal interactions, especially the retail and service sectors––for instance, non-store retailers and financial and professional service––are significantly related to regional economic resistance, and their relationship intensifies compared to other sectors during the COVID-19 pandemic. However, states specialized in the non-essential industries with high interpersonal interactions are less likely to resist economically during the lockdown-COVID and until the stabilizing-COVID period. In addition, a state that quickly recovered from the 2001 recession is more likely to resist the pandemic shock during early- and lockdown-COVID periods. Findings in this paper indicate the importance of regional industrial structure to determine the level of vulnerability to unexpected recessionary shocks. Additionally, identifying the vital factors to determine the industrial structure based on the type of shock is found to be crucial.Supplementary InformationThe online version contains supplementary material available at 10.1007/s00168-022-01134-w.

Automation of Tasks and Knowledge-Intensive Services: A Sectorial Approach to the Impact of Covid 19 in Argentina

The covid 19 pandemic led to an economic collapse and multiple impacts upon Argentina's labour dynamics. As well as in other parts of the region, falls in employment rates (both due to an increase in unemployment and significant withdrawals from the labour force) were combined with wage reductions for those who were able to keep their jobs. Thus, two important processes for the labour market complimented each other: a structural shock associated with a tasks automation as a reorganisation and substitution of factors, with a cyclical recession caused by the pandemic. The international experience shows the amplifying impact the latter has on the former, generating long-term consequences mainly in routine-intensive jobs. However, the knowledge-intensive services sector appears to be the most capable of cushioning the recessionary shock (both in terms of wages and labour absorption), even with nuances within the sector depending on the extent of the shutdown measures and its capability to switch to remote work. Finally, the task approach is decisive in capturing the ability to adapt both the cyclical and structural processes, absorbing a large part of the explanatory potential that sectoral classifications tend to bring about.

A Model of Endogenous Risk Intolerance and LSAPs: Asset Prices and Aggregate Demand in a “COVID-19” Shock

We theoretically investigate the interaction of endogenous risk intolerance and monetary policy following a large recessionary shock. As asset prices dip, risk-tolerant agents’ wealth share declines. This decline reduces the market’s risk tolerance and triggers a downward loop in asset prices and aggregate demand when the interest rate policy is constrained. In this context, large-scale asset purchases are effective because they transfer unwanted risk to the government’s balance sheet. These effects are sizable when the model is calibrated to match the estimates of aggregate asset demand inelasticity. The COVID-19 shock illustrates the environment we seek to capture.

Fixed income mutual fund performance during and after a crisis: a Canadian case

This study investigates the performance of the fixed income mutual funds industry, focusing on Canadian fixed income funds before, during, and after the 2008 global financial crisis. After recessionary shocks, investors look for ways to diversify their systematic risks. We investigate Canadian fixed income funds’ excess returns and dollar fund flow and show that the funds significantly underperform bond markets throughout the study period after controlling for fund characteristics and macroeconomic factors. Consistent with previous studies, we find that this underperformance is more apparent during market downturns. Indicating a spiral relationship, these results suggest that institutional investors perform poorly during financial crises, which is also observable in the volatility patterns in dollar fund flow. We also find that the flow is positively related to the crisis period, indicating that the dollar fund flow in fixed income funds reported a positive value during the recession, signifying an inflow.

Analysis of hysteresis in convergence after global financial crisis of 2007

Researchers of hysteresis outline the long-term change in growth paths of economies. It entails the post-crisis change in growth paths of economies through the change of macroeconomic indicators, such as employment and output. Recessionary shocks might have positive or negative impacts on economies’ growth paths which in turn affects convergence and divergence in economies. In this research, hysteresis is explored in convergence across 110 countries induced by the global financial recession of 2007. Findings suggest that as a post-crisis change, hysteresis in convergence is in place. The difference arises in adaptability of economies to changes. The reason for convergence of poor and rich countries might be more intensive foreign investments in developing nations. These investments have a positive influence on economic performance in developing countries by increasing employment rates.

Flexible inflation targeting with active fiscal policy

This paper studies optimal time‑consistent monetary policy in a simple New Keynesian model with long‑term nominal government debt. Fiscal policy is ‘active’, so that stabilisation of the government debt stock is a binding constraint on monetary policy. Away from the lower bound on the monetary policy rate, optimal monetary policy cannot fully offset the effects of shocks to the natural rate of interest, reducing welfare. At the lower bound, recessionary shocks increase the real value of government debt, generating the anticipation of higher future inflation to stabilise real debt. Higher inflation expectations reduce real interest rates, mitigating the effects of recessionary shocks. If debt duration is long enough, improved performance at the lower bound may outweigh higher welfare losses in normal times, compared with the case in which fiscal policy is ‘passive’.

Local resistance to rising unemployment in the context of the COVID‐19 mitigation policies across Great Britain

AbstractPolicies to arrest the rapid spread of the COVID‐19 pandemic resulted in whole sectors of the economy and social life being either entirely locked down or severely curtailed in the Spring of 2020. This paper uses a resilience framework to analyse two aspects of ability to resist rising unemployment at local level across Great Britain during the early part of the COVID‐19 pandemic when full “lockdown” measures were in place: (i) level of pre‐lockdown unemployment; and (ii) share of employment in sectors most affected by the lockdown. Findings reveal that pre‐lockdown unemployment is a stronger predictor than sector mix of the rise in unemployment in the first month of the lockdown. This finding underlines the importance of spatially rebalancing the UK economy, including strong local and regional economic development policies, in order to build resilience to future recessionary shocks.

Regional economic resilience in the European Union: a numerical general equilibrium analysis

ABSTRACT Using a spatial general equilibrium model, this paper investigates the resilience of European Union regions under three alternative recessionary shocks, each activating different economic adjustments and mechanisms. We measure the vulnerability, resistance and recoverability of regions and identify key regional features affecting the ability of regions to withstand and recover from unexpected external shocks. The analysis reveals that the responses of regions vary according to the nature of the external disturbance and to the pre-shock regional characteristics. Finally, it seems that resilience also depends on factor mobility. The analysis, although designed before the onset of the Covid-19 pandemic, offers interesting insights into how to use a general equilibrium framework to study resilience in such a context.

The utilization of cluster externalities and recessionary shocks

AbstractIn this article, we examine the impact of cluster externalities on the economic performance of firms. Specifically, we focus on how the utilization of these externalities by firms is affected by the macroeconomic instability caused by the recessionary shock of 2008/2009 and on how the impact of the crisis affects firms with different combinative capabilities. Using data from more than 16,000 manufacturing and business service firms located in 390 German regions, we employ within-firm regression techniques to estimate the impact of cross-level interactions between firm- and cluster-level determinants on phase-related differences in firm performance between a pre-crisis (2004–2007) and a crisis period (2009–2011). Our empirical results suggest that firms particularly benefit from the interaction of broad combinative capabilities and variety-driven cluster externalities, thereby implying that externalities are effectively utilized by firms. Furthermore, the results indicate that both strength and direction of these cross-level interactions strongly depend on the prevailing macroeconomic cycle: while the utilization of cluster externalities works best within a stable macroeconomic environment (2004–2007), it is seemingly interrupted when being exposed to economic turmoil (2009–2011). Yet, the crisis-induced interruption of the utilization is mainly restricted to the national recession in 2009. As soon as the macroeconomic pressure diminishes (2010–2011), we observe a reversion of the utilization mechanisms to the pre-crisis level.

Recessions and total factor productivity: Evidence from sectoral data

The recent COVID-19 crisis has generated a concern that productivity (which was already at historically low levels) may further decline. From a theoretical standpoint, the recessions-total factor productivity (TFP) nexus is ambiguous à priori. This paper empirically examines the dynamic impact of recessions on TFP. We compute a new measure of utilization-adjusted productivity from a sample of 24 industries in 18 advanced economies between 1970 and 2014. Resorting to the local projection method we trace out the dynamic short to medium-term impact of such recessionary shocks. We find that deep recessions lead to a permanent deterioration in the level of total factor productivity. This effect is driven by the increase in resource misallocation across different sectors.

A Model of Asset Price Spirals and Aggregate Demand Amplification of a 'COVID-19' Shock

In this paper we: (i) provide a model of the endogenous risk intolerance and severe asset price and aggregate demand contractions following an adverse real (non-financial) shock; and (ii) demonstrate the effectiveness of Large Scale Asset Purchases (LSAPs) in addressing these contractions. The key mechanism stems from heterogeneous risk tolerance: as a recessionary shock hits the economy and brings down asset prices, risk-tolerant agents' wealth share declines and their leverage rises endogenously. This reduces the market's risk tolerance and generates downward pressure on asset prices and aggregate demand. When monetary policy is unconstrained, it can offset the decline in risk tolerance with an interest rate cut that boosts the market's Sharpe ratio. However, if the interest rate policy is constrained, new contractionary feedbacks arise: recessionary shocks lead to further asset price and output drops, which feed the risk-off episode and trigger a downward loop. In this context, LSAPs improve asset prices and aggregate demand by transferring risk to the government's balance sheet, which reduces the market's required Sharpe ratio and reverses the contractionary feedbacks. Quantitatively, we show that aggregate shocks and LSAPs have large impacts on asset prices when the model is calibrated to fit the inelastic demand for aggregate assets uncovered in recent literature. We also show that heterogeneity in risk tolerance explains part of the demand inelasticity in normal times, and further reduces the elasticity after a recessionary shock. The COVID-19 shock and the large response by all major central banks provide a vivid illustration of the environment we seek to capture.

The role of national settings in the economic resilience of regions—Evidence from recessionary shocks in Europe from 1990 to 2014

AbstractThis paper focuses on the particular role of the national setting for the economic resilience of regions during the resistance and recovery phase. Our empirical set‐up introduces a spatial hierarchy of 249 NUTS‐2 regions nested in 22 European countries while it includes numerous recessionary shocks from 1990 to 2014. Our results suggest that the impact of the national setting is strongest during the resistance phase when the national level accounts for up to 44.9% of the variance in regional GDP development. During recovery, however, the national share decreases but still amounts to no less than 22.0%. Apart from the direct effects that originate from, for example, regulatory density and fiscal policy measures, the national impact takes the form of cross‐level moderation effects. These indirect effects indicate that the regional patterns of resilience are additionally shaped by the inter‐linkages of country‐specific institutional factors and regional determinants. Taking all this into account, regional economic resilience is anything but just a matter of regional capacities.

How Does Financial Vulnerability Amplify Housing and Credit Shocks?

In this paper we study how households’ financial vulnerability affects the propagation of housing and credit shocks. First, we estimate a non-linear model generating impulse responses that depend on the evolution of households' Debt to Service Ratio, i.e. the fraction of income that households use to pay back their debt. Second, we use sign restrictions to jointly identify a wide set of financial and economic shocks. We find that financial vulnerability: i) amplifies the response of the economy to housing shock, ii) makes the response to expansionary credit shocks less persistent and even negative after the first year since the arrival of the shock. Finally, overall recessionary shocks have larger effects with respect to expansionary ones of the same size.

Endogenous TFP, Business Cycle Persistence and the Productivity Slowdown in the Euro Area

This paper analyses the endogeneity of euro area total factor productivity and its role in business cycle amplification by estimating a medium-scale DSGE model with endogenous productivity mechanism on euro area data. In this framework, total factor productivity evolves endogenously as a consequence of costly investment in R&D and adoption of new technologies. We find that the endogeneity of TFP induces a high degree of persistence in the euro area business cycle via a feedback mechanism between overall economic conditions and investment in productivity-enhancing technologies. As to the sources of the euro area productivity slowdown, we conclude that a decrease in the efficiency of R&D investment is among the key factors generating the pre-crisis productivity slowdown, while starting from the Great Recession a shock to liquidity demand is identified as the most important driving force. The endogenous technology mechanism further exerts a dampening effect on the inflation response following a recessionary shock and hence has important implications for both the negligible fall in inflation during the Great Recession, as well as the sluggish increase of inflation in the subsequent recovery. JEL Classification: E24, E32, O31

Firms, Failures, and Fluctuations: The Macroeconomics of Supply Chain Disruptions

This paper studies how firm failures and the resulting disruptions to supply chains can amplify negative shocks. We develop a non-competitive model where customized supplier-customer relations increase productivity, and the relationship-specific surplus generated between firms and their suppliers is divided via bargaining. Changes in productivity alter the distribution of surplus throughout the economy and determine which firms are at the margin of failure. A firm’s failure may spread to its suppliers and customers and to firms in other parts of the production network. We provide existence, uniqueness, and a series of comparative statics results, and show how the response of the equilibrium production network may propagate recessionary shocks.

Bad weather ahead: Pre-recession characteristics and the severity of recession impact

This paper addresses a simple question: why are some firms more severely affected by recessions than others? Using the Norwegian financial crisis of 2008 as an empirical setting, I find that firms pursuing pre-recession strategies with a high emphasis on innovation or cost-cutting are less likely to experience reduced demand during the recession. In the other direction, I find that firms pursuing a pre-recession strategy emphasizing quality, firms with high pre-recession growth, firms with many competitors, and firms selling durable goods are more likely to experience reduced demand during the recession. These findings imply that recessionary shocks are not randomly assigned to firms, which is valuable for future research on firm behavior and performance over the business cycle and for managers wishing to analyze the vulnerability of their own firms (or competing firms) to recessions.

Economic resilience of metropolitan, old industrial, and rural regions in two subsequent recessionary shocks

ABSTRACTIn this paper, we focus on the question of how particular types of regions react to economic shocks. Drawing on a case study of Czech microregions, we aim to determine if the old industrial regions differ significantly from other types of regions (metropolitan, urban, rural) in (post)crisis economic development. Two aspects of regional resilience (measured by unemployment growth) were considered: recession and recovery. We focused on the comparison of two subsequent recessionary shocks: the 2008–2010 global recession and the 2012–2013 austerity crisis. Metropolitan regions showed relatively stable economic development. Old industrial regions were more resilient than expected. Rural regions exhibited highly diverse reactions: lower resistance was characteristic for regions specialized (mostly) in automotive and some labour-intensive industries. The first wave of recession increased unemployment mostly in (rural) regions dependent on export-oriented manufacturing, the second wave especially hit larger cities with metropolitan functions. Regions that experienced a sharp unemployment increase in the first recession were generally more resistant in the second wave. All types of regions were internally highly diverse in their reactions to economic crises, which points to the importance of micro-regional variations of economic resilience, the performance of individual local firms and subsidiaries, and extra-regional factors of regional development.