Working Paper: NBER ID: w22839
Authors: Geert Bekaert; Eric Engstrom; Andrey Ermolov
Abstract: We extract aggregate supply and aggregate demand shocks for the US economy from macroeconomic data on inflation, real GDP growth, core inflation and the unemployment gap. We first use unconditional non-Gaussian features in the data to achieve identification of these structural shocks while imposing minimal economic assumptions. We find that recessions in the 1970s and 1980s are better characterized as driven by supply shocks while later recessions were driven primarily by demand shocks. The Great Recession exhibited large negative shocks to both demand and supply. We then use conditional (time-varying) non-Gaussian features of the structural shocks to estimate "macro risk factors" for supply and demand shocks that drive "bad" (negatively skewed) and "good" (positively skewed) variation for supply and demand shocks. The Great Moderation, a general decline in the volatility of many macroeconomic time series since the 1980s, is mostly accounted for by a reduction in the good demand variance risk factor. In contrast, the risk factors driving bad variance for both supply and demand shocks, which account for most recessions, show no secular decline. Finally, we find that macro risks significantly contribute to the variation in yields, bond risk premiums and the term premium. While overall bond risk premiums are counter-cyclical, an increase in bad demand variance is associated with lower risk premiums on bonds.
Keywords: macro risks; term structure; interest rates; supply shocks; demand shocks
JEL Codes: E31; E32; E43; E44; G12; G13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| supply shocks (E39) | recessions in the 1970s and 1980s (E65) |
| demand shocks (E39) | later recessions (E65) |
| bad demand variance (R22) | lower risk premiums on bonds (G12) |
| macroeconomic uncertainty (D89) | variations in bond yields (E43) |
| demand supply variance (J20) | lower expected returns on bonds (G12) |
| Good demand variance reduction (C69) | decline in macroeconomic volatility (E32) |
| bad demand variance (R22) | persistent risk in economic downturns (E32) |
| supply and demand shocks (E39) | expected returns on bonds (G12) |