Summary: Service Exports and the US Trade Deficit

A trade deficit is defined by the amount by which a country’s imports exceeds the value of its exports. The US has consistently held a trade deficit since the 1970s; as of the end of 2016, the deficit had risen to $502 billion. This trade deficit has been a “political hot potato,” particularly with respect to China, on the assumption that a sustained deficit weakens the overall economy. But is that accurate? In this B-School for Public Policy Seminar Summary, Professor Gomes takes a closer look at the economics of boosting service exports as a means of rebalancing the US trade deficit and, in the process, sheds new light on policy discussions regarding the future of America\u27s trade agreements.https://repository.upenn.edu/pennwhartonppi_bschool/1000/thumbnail.jp

Summary: The Decline of U.S. Corporate Investment

U.S. corporations over the past decade have shied away from making large-scale capital investments. Given their reticence, does it make economic sense for the government to pursue major investments in infrastructure at this time?https://repository.upenn.edu/pennwhartonppi_bschool/1008/thumbnail.jp

Equilibrium Asset Pricing with Leverage and Default

We develop a general equilibrium model linking the pricing of stocks and corporate bonds to endogenous movements in corporate leverage and aggregate volatility. The model has heterogeneous firms making optimal investment and financing decisions and connects fluctuations in macroeconomic quantities and asset prices to movements in the cross-section of firms. Empirically plausible movements in leverage produce realistic asset return dynamics. Countercyclical leverage drives predictable variation in risk premia, and debt-financed growth generates a high value premium. Endogenous default produces countercyclical aggregate volatility and credit spread movements that are propagated to the real economy through their effects on investment and output

Durability of Output and Expected Stock Returns

The demand for durable goods is more cyclical than that for nondurable goods and services. Consequently, the cash flows and stock returns of durable-good producers are exposed to higher systematic risk. Using the benchmark input-output accounts of the National Income and Product Accounts, we construct portfolios of durable-good, nondurable-good, and service producers. In the cross-section, an investment strategy that is long on the durable-good portfolio and short on the service portfolio earns a risk premium exceeding 4 percent annually. In the time series, an investment strategy that is long on the durable-good portfolio and short on the market portfolio earns a countercyclical risk premium. We explain these findings in a general equilibrium asset-pricing model with endogenous production.

Investment without Q

We estimate investment policy functions under general assumptions about technology and markets. Policy functions are easy to estimate and summarize the key predictions of any dynamic investment model. Because our method does not rely on Tobin\u27s Q, it does not require information about market values and can be readily applied to study private firms. In addition, unlike Tobin\u27s Q, we show that investment policy functions account for a large fraction of the variation in corporate investment. As such they are much better suited to evaluate and estimate dynamic investment models. Using this superior characterization of firm investment behaviour we then use indirect inference methods to estimate deep parameters of a structural model of investment featuring decreasing returns to scale and generalized adjustment cost functions

Equilibrium Unemployment

A search-theoretic model of equilibrium unemployment is constructed and shown to be consistent with the key regularities of the labor market and business cycle. The two distinguishing features of the model are: (i) the decision to accept or reject jobs is modeled explicitly, and (ii) markets are incomplete. The model is well suited to address a number of interesting policy questions. Two such applications are provided: the impact of unemployment insurance, and the welfare costs of business cycles

Asset Pricing Implications of Firms’ Financing Constraints

We use a production-based asset pricing model to investigate whether financing constraints are quantitatively important for the cross-section of returns. Specifically, we use GMM to explore the stochastic Euler equation imposed on returns by optimal investment. Our methods can identify the impact of financial frictions on the stochastic discount factor with cyclical variations in cost of external funds. We find that financing frictions provide a common factor that improves the pricing of cross-sectional returns. Moreover, the shadow cost of external funds exhibits strong procyclical variation, so that financial frictions are more important in relatively good economic conditions

Asset Prices and Business Cycles With Costly External Finance

This paper asks whether the asset pricing fluctuations induced by the presence of costly external finance are empirically plausible. To accomplish this, we incorporate costly external finance into a dynamic stochastic general equilibrium model and explore its implications for the properties of the returns on key financial assets, such as stocks, bonds and risky loans. We find that the mean and volatility of the equity premium, although small, are significantly higher than those in comparable adjustment cost models. However, we also show that these results require a procyclical financing premium, a property that seems at odds with the data

Sticky Leverage

We develop a tractable general equilibrium model that captures the interplay between nominal long-term corporate debt, inflation, and real aggregates. We show that unanticipated inflation changes the real burden of debt and, more significantly, leads to a debt overhang that distorts future investment and production decisions. For these effects to be both large and very persistent, it is essential that debt maturity exceeds one period. We also show that interest rate rules can help stabilize our economy

Improving Future Policy Responses to Foreseeable Bank Risk-Taking

This brief offers new perspectives on the behavior of banks during the financial crisis of 2007-08 and the limited success of unconventional monetary policies in stimulating bank credit to the private sector during the subsequent economic recovery. The common narrative about the financial crisis is that it was caused by a large credit expansion with overly risky loan-granting behavior by banks. We argue, however, that banks actually made optimal financial decisions in the lead-up to the crisis, based on their calculation of their franchise value. The brief explains the mechanics of franchise value—how it led banks to shift their portfolios toward riskier household loans before the crisis, as well as how it dampened the impact of quantitative easing and other novel monetary policies meant to stimulate the investment of capital into the private sector. Policymakers have failed to recognize the role that franchise value plays in all bank decisions. If they wish to devise appropriate fiscal or monetary policies to prevent or mitigate a future crisis, they need to properly account for how franchise value drives the decision-making of bank managers.https://repository.upenn.edu/pennwhartonppi/1068/thumbnail.jp