Research Review | 21 April 2017 | Business Cycle Analysis

Is the Next Recession Around the Corner? Probably Not
Anton Cheremukhin (Federal Reserve Bank of Dallas)
January 2017
A “profits recession” often predicts a real recession. A view of recessions as gluts of competition explains why this time a real recession is not imminent.

Time-Varying Risk Premiums and Economic Cycles
Thomas Raffinot (Millesime IS)
April 2017
Asset returns are not correlated with the business cycle but are primarily caused by the economic cycles. To validate this claim, economic cycles are first rigorously defined, namely the classical business cycle and the growth cycle, better known as the output gap. The description of different economic phases is refined by jointly considering both economic cycles. It improves the classical analysis of economic cycles by considering sometimes two distinct phases and sometimes four distinct phases. The theoretical influence of economic cycles on time-varying risk premiums is then explained based on two key economic concepts: nominal GDP and adaptive expectations. Simple dynamic investment strategies confirm the importance of economical cycles, especially the growth cycle, for euro and dollar-based investors. At last, this economic cyclical framework can improve strategic asset allocation choices.

Macroeconomic News in the Cross Section of Asset Growth
Yu Hou (Queen’s University), et al.
March 2017
Firms make forward-looking decisions. We provide evidence that firms’ investment decisions contain news about future aggregate conditions. This information is best extracted by dimension-reduction techniques. The investment-based signal improves upon the widely-used GDP forecasts found in the Survey of Professional Forecasters. We appeal to news-driven business cycle theory to explain our result, suggesting that these investment decisions contain firms’ information about future productivity shocks. This theory also helps us to understand why accounting-based measures of investment reveal the news while market-based measures of value do not.

Words are the New Numbers: A Newsy Coincident Index of Business Cycles
Leif Anders Thorsrud (BI Norwegian Business School)
December 2016
I construct a daily business cycle index based on quarterly GDP and textual information contained in a daily business newspaper. The newspaper data are decomposed into time series representing newspaper topics using a Latent Dirichlet Allocation model. The business cycle index is estimated using the newspaper topics and a time-varying Dynamic Factor Model where dynamic sparsity is enforced upon the factor loadings using a latent threshold mechanism. The resulting index is shown to be not only more timely but also more accurate than commonly used alternative business cycle indicators. Moreover, the derived index provides the index user with broad based high frequent information about the type of news that drive or reflect economic fluctuations.

Does the Fed’s Unconventional Monetary Policy Weaken the Link between the Financial and the Real Sector?
Yimin Xu and Jakob de Haan (University of Groningen)
November 2016
After the global financial crisis, several central banks introduced unconventional monetary policies, such as QE. If QE increases asset prices, but does not boost the real economy to the same extent, the relationship between the financial and the real sector will weaken. This study investigates this issue for the US using the predictive power of the credit spread for future employment growth as measure for the strength of the real-financial link in a moving-window framework. Our results suggest that the real-financial link is lower during bubbles and recessions. We also find that the relationship weakened after the Fed introduced QE.

Source: The Capital Spectator