IDEAS home Printed from https://ideas.repec.org/p/bis/biswps/733.html
   My bibliography  Save this paper

A risk-centric model of demand recessions and macroprudential policy

Author

Listed:
  • Ricardo Caballero
  • Alp Simsek

Abstract

When investors are unwilling to hold the economy's risk, a decline in the interest rate increases the Sharpe ratio of the market and equilibrates the risk markets. If the interest rate is constrained from below, risk markets are instead equilibrated via a decline in asset prices. However, the latter drags down aggregate demand, which further drags prices down, and so on. If investors are pessimistic about the recovery, the economy becomes highly susceptible to downward spirals due to dynamic feedbacks between asset prices, aggregate demand, and potential growth. In this context, belief disagreements generate highly destabilizing speculation that motivates macroprudential policy.

Suggested Citation

  • Ricardo Caballero & Alp Simsek, 2018. "A risk-centric model of demand recessions and macroprudential policy," BIS Working Papers 733, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:733
    as

    Download full text from publisher

    File URL: https://www.bis.org/publ/work733.pdf
    File Function: Full PDF document
    Download Restriction: no
    File URL: https://www.bis.org/publ/work733.htm
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Albagli, Elias & Ceballos, Luis & Claro, Sebastian & Romero, Damian, 2019. "Channels of US monetary policy spillovers to international bond markets," Journal of Financial Economics, Elsevier, vol. 134(2), pages 447-473.
    2. Fisher, Franklin M, 1969. "The Existence of Aggregate Production Functions," Econometrica, Econometric Society, vol. 37(4), pages 553-577, October.
    3. Fisher, Irving, 1907. "The Rate of Interest," History of Economic Thought Books, McMaster University Archive for the History of Economic Thought, number fisher1907.
    4. Avi J. Cohen, 2003. "Retrospectives: Whatever Happened to the Cambridge Capital Theory Controversies?," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 199-214, Winter.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Ricardo Caballero & Güneş Kamber, 2019. "On the global Impact of risk-off shocks and policy-put frameworks," BIS Working Papers 772, Bank for International Settlements.
    2. Phurichai Rungcharoenkitkul & Claudio Borio & Piti Disyatat Author-X-Name_First: Piti, 2019. "Monetary policy hysteresis and the financial cycle," BIS Working Papers 817, Bank for International Settlements.
    3. Mr. Niels-Jakob H Hansen & Signe Krogstrup, 2019. "Recent Shifts in Capital Flow Patterns in Korea: An Investor Base Perspective," IMF Working Papers 2019/262, International Monetary Fund.
    4. Sebastian Di Tella & Robert E. Hall, 2020. "Risk Premium Shocks Can Create Inefficient Recessions," NBER Working Papers 26721, National Bureau of Economic Research, Inc.
    5. Gadi Barlevy, 2018. "Bridging Between Policymakers’ and Economists’ Views on Bubbles," Economic Perspectives, Federal Reserve Bank of Chicago, issue 4, pages 1-21.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Robert W. Dimand, 2012. "The Roots of the Present are in the Past: The Relation of Postwar Developments in Macroeconomics to Interwar Business Cycle and Monetary Theory," Chapters, in: Thomas Cate (ed.), Keynes’s General Theory, chapter 5, Edward Elgar Publishing.
    2. Bergheim, Stefan, 2007. "Pair-wise cointegration in long-run growth models," Research Notes 24, Deutsche Bank Research.
    3. Carlo Milana, 2024. "Refuting Samuelson’s capitulation on the re-switching of techniques in the Cambridge capital controversy," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 37(2), pages 179-197, June.
    4. Carlo Milana, 2019. "Solving the Reswitching Paradox in the Sraffian Theory of Capital," Applied Economics and Finance, Redfame publishing, vol. 6(6), pages 97-125, November.
    5. Jesus Felipe & F. Gerard Adams, 2005. ""A Theory of Production" The Estimation of the Cobb-Douglas Function: A Retrospective View," Eastern Economic Journal, Eastern Economic Association, vol. 31(3), pages 427-445, Summer.
    6. Avi J. Cohen & Geoffrey C. Harcourt, 2010. "Reswitching and Reversing in Capital Theory," Chapters, in: Mark Blaug & Peter Lloyd (ed.), Famous Figures and Diagrams in Economics, chapter 24, Edward Elgar Publishing.
    7. Thomas Fredholm & Stefano Zambelli, 2013. "Production Functions Behaving Badly - Reconsidering Fisher and Shaikh," ASSRU Discussion Papers 1305, ASSRU - Algorithmic Social Science Research Unit.
    8. Jesus Felipe & John S.L. McCombie, 2013. "The Aggregate Production Function and the Measurement of Technical Change," Books, Edward Elgar Publishing, number 1975.
    9. Yashin, Pete, 2014. "The Golden Rule of Capital Accumulation and Global Recession. Aggregate Production Function and the Cambridge Capital Controversy," MPRA Paper 58570, University Library of Munich, Germany.
    10. G. C. Harcourt, 2015. "On the Cambridge, England, Critique of the Marginal Productivity Theory of Distribution," Review of Radical Political Economics, Union for Radical Political Economics, vol. 47(2), pages 243-255, June.
    11. David Laidler, 2011. "Natural Hazards: Some Pitfalls on the Path to a Neutral Interest Rate," C.D. Howe Institute Backgrounder, C.D. Howe Institute, issue 140, July.
    12. Christian Johnson & George G Kaufman, 2007. "Un banco, con cualquier otro nombre…," Boletín, CEMLA, vol. 0(4), pages 185-199, Octubre-d.
    13. Matteo G. Richiardi & Luis Valenzuela, 2024. "Firm heterogeneity and the aggregate labour share," LABOUR, CEIS, vol. 38(1), pages 66-101, March.
    14. Brendan Markey†Towler, 2017. "The Oxford Handbook of Post†Keynesian Economics, Volume 1: Theory and Origins," The Economic Record, The Economic Society of Australia, vol. 93(303), pages 659-661, December.
    15. Irving Fisher Committee, 2003. "Abstracts of papers to be presented at the 54th ISI Session, Berlin, August 2003," IFC Bulletins, Bank for International Settlements, number 15.
    16. David Card, 2009. "Immigration and Inequality," American Economic Review, American Economic Association, vol. 99(2), pages 1-21, May.
    17. Mazouch, P. & Krejčí, I., 2016. "The Analysis of the Age Structure of Regional Fixed Capital in the Agriculture," AGRIS on-line Papers in Economics and Informatics, Czech University of Life Sciences Prague, Faculty of Economics and Management, vol. 8(2), pages 1-13, June.
    18. Navarrete, Eduardo, 2012. "Modeling optimal pine stands harvest under stochastic wood stock and price in Chile," Forest Policy and Economics, Elsevier, vol. 15(C), pages 54-59.
    19. Blair Fix, 2019. "The Aggregation Problem: Implications for Ecological and Biophysical Economics," Biophysical Economics and Resource Quality, Springer, vol. 4(1), pages 1-15, March.

    More about this item

    Keywords

    risk gap; output gap; risk-premium shocks; aggregate demand; liquidity trap; rstar; Sharpe ratio; monetary and macroprudential policy; heterogeneous beliefs; speculation; endogenous volatility;
    All these keywords.

    JEL classification:

    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • G00 - Financial Economics - - General - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bis:biswps:733. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Martin Fessler (email available below). General contact details of provider: https://edirc.repec.org/data/bisssch.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.