We show that particularly weak German banks used the European Central Bank’s very long-term refinancing operations (VLTROs) to evergreen exposures to zombie firms. Zombie firms that obtain more credit after the introduction of the VLTROs had a substantially elevated subsequent default probability. This suggests that either positive private information did not materialize or the decision to engage in zombie lending was not driven by any such private information. At the time of loan extension, banks that resort to the VLTRO report lower borrower-specific probabilities of default, reduce loan loss provisions and lower their credit standards relative to banks who lend to the same firm but have not resorted to the VLTRO. Zombie firms, which obtained additional funding from banks relying to a larger extent on VLTRO funding, in turn increase their accounts payable and advance payments received from downstream and upstream firms. This suggests that suppliers relying on banks’ lending decisions as a signal about borrowers’ credit quality might be misled by banks’ zombie lending to extend more trade credit to zombie firms exposing suppliers to elevated contagion risk.
We study whether a central bank should deviate from its objective of price stability to promote financial stability. We tackle this question within a textbook New Keynesian model augmented with capital accumulation and microfounded endogenous financial crises. We compare several interest rate rules, under which the central bank responds more or less forcefully to inflation and aggregate output. Our main findings are threefold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, a central bank can both reduce the probability of a crisis and increase welfare by departing from strict inflation targeting and responding systematically to fluctuations in output. Third, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.
We confront competing theories of expectation formation and asset pricing with causal evidence on beliefs and portfolios. Using a randomized information experiment we show that: i) Individuals do not revise their beliefs in line with Rational Expectations asset pricing models. Instead, they form pro-cyclical beliefs, both about capital gains and about earnings growth. ii) Individuals are heterogenous at the information acquisition and at the information processing stage. Their reaction to stock-market news depends on their preference for the type of news received. iii) Beliefs and portfolios are not only correlated, but causally linked. iv) The sensitivity of portfolio shares with respect to expected returns appears puzzlingly low, especially when accounting for individuals’ low perceived variance of stock returns. This puzzle can be resolved when considering non-linear constraints on individuals’ portfolio decisions. These results provide guidance on promising causal mechanisms for macro-finance models.
Economists widely rely on measures of inflation expectations and uncertainty elicited via density forecasts. This approach, which asks respondents to assign probabilities to pre-specified ranges, has proven highly informative, but also faced criticism in recent periods of elevated and volatile inflation. We propose a new method to elicit the full distribution of inflation expectations, which is rooted in decision theory and can be implemented in standard surveys. In two large surveys and a laboratory experiment, we demonstrate that the proposed method leads to well-defined expectations that fulfil both subjective and objective quality criteria. The method is neither perceived as more difficult nor does it take more time to complete compared to the current standard. In contrast to density forecasts, the method is robust to differences in the state of the economy and thus allows comparisons across time and across countries. The method is portable and can be applied to elicit different macroeconomic expectations.
In a structural dynamic model that incorporates two broad production sectors with different carbon emissions, we find that climate policy uncertainty (CPU) shocks (i) lower the market value of the highly carbon-emitting sector relative to the low carbon-emitting sector, and (ii) reduce real investment and the capital stock in the highly carbon-emitting sector, while real investment in the sector with low carbon emissions tends to fare better. To apply the theoretical predictions to the data, we employ a news article-based measure of climate policy uncertainty to identify CPU shocks as well as quarterly balance sheet data of listed firms in the United States. In line with the predictions from the theoretical model, we find that in response to CPU shocks (i) financial markets markedly revalue strongly carbonemitting firms relative to firms with low carbon emissions, and (ii) substantial investment reallocation takes place, in particular from the manufacturing sector towards services.
