Last week I wrote some thoughts about Jonathan Levy’s new book Ages of American Capitalism. My copy of the book arrived, but I have been too busy with classes to get to it. I did, however, find it interesting that a new working paper from the NBER presented a model of business cycles that (to me at least) sounded very similar to Levy.
Here is how I described Levy’s theory:
“My reading of Levy’s second and third theses together is that he thinks that a preference for holding wealth in a liquid form needs to be overcome to get capitalists to put their assets in things like new farms and factories etc. That this something extra can come from government or culture or both, but it tends to come and go in booms and busts, and growth is a result of the booms. I think there is a lot to this as a story of American economic history, business cycles are certainly one of the central features of American economic history, but I think this story is missing important elements as well.”
The new paper is Risky Business Cycles by Basu, Susanto, Giacomo Candian, Ryan Chahrour, and Rosen Valchev. No. w28693. National Bureau of Economic Research, 2021.
Here is the abstract:
“We identify a shock that explains the bulk of fluctuations in equity risk premia and show that the shock also explains a large fraction of the business-cycle comovements of output, consumption, employment, and investment. Recessions induced by the shock are associated with reallocation away from full-time permanent positions, towards part-time and flexible contract workers. A real model with labor market frictions and fluctuations in risk appetite can explain all of these facts, both qualitatively and quantitatively. The size of risk-driven fluctuations depends on the relationship between the riskiness and productivity of different stores of value: if safe savings vehicles have relatively low marginal products, then a flight to safety will drive a larger aggregate contraction.”
This is from the conclusion, and I think it is much clearer than the abstract or introduction:
“This paper shows that fluctuations in risk premia can be major drivers of macroeconomic fluctuations. Our empirical analysis suggests the possibility of a major causal pathway flowing from risk premia to macroeconomic fluctuations, and our theory embodies one such a pathway. In our model, heightened risk premia cause recessions because they drive reallocation of saving towards safer stores of value, which simultaneously have low instantaneous marginal products. Thus, our theory contrasts with many business cycles models that emphasize the effects of intertemporal substitution, and instead puts risk premia and their effects on precautionary saving at the center of macroeconomic propagation. In this respect, our model bridges a gap between the tradition of risk-driven business cycles `a la Keynes and the central lessons of modern macro-finance summarized in Cochrane (2017)”