Highlighting a Few Key Ideas and Issues

 Demand-Side Shocks & Amplifiers  Consumer Spending (as cause, not effect)  Inflexibility in prices (especially wages) amplify

 Demand-Side Shocks & Amplifiers  Consumer Spending (cause, not effect)  Inflexibility in prices (especially wages) as amplifier  Supply-Side Shocks and Amplifiers  Tech/Structural Shifts; Oil Price Spikes  Incentive effects as amplifiers

 Demand-Side Shocks & Amplifiers  Consumer Spending (cause, not effect)  Inflexibility in prices (especially wages)  Supply-Side Shocks and Amplifers  Tech/Structural Shifts; Oil Price Spikes  MacroFinancial Shocks and Amplifers  Shocks to Risk Perceptions ▪ Bubbles, Crashes ▪ Asset Prices, Debt Growth, FX

 1970s Thinking: All About The Numerator  Finance: Expected earnings (numerator) drives asset prices, P/E ratios  Macro: Expected earnings, expected income same thing, so whatever driving changes in incomes, driving changes in asset prices  2000s Thinking: All About The Denominator ▪ Finance: Perception of risk (denominator) drives asset prices, P/E ratios ▪ Very High P/E = current risk assessment overly optimistic ▪ Very Low P/E = current risk assessment overly pessimistic ▪ Macro: Consumer spending too?

Using Market Information to Gauge Market Risk

 Natural Experiments  Think “Twin Studies”

 Natural Experiments  Think “Twin Studies”  Example: LIBOR, Fed Funds, TBills ▪ Very short term loans between (usually) reliable parties ▪ Normally, rates within small fractions of 1 percent ▪ Unusual differences implies something amiss in important short term lending markets

 Natural Experiments  Think “Twin Studies”  Example: LIBOR, Fed Funds, TBills ▪ Very short term loans between (usually) reliable parties ▪ Normally, rates within small fractions of 1 percent ▪ Unusual differences implies something amiss in important short term lending markets  Example: 10 Year Treasury – 3 Month Treasury ▪ Both loans to U.S. government ▪ Average difference about 1.5% ▪ Unusually differences imply something divergent views near term and longer term

 Treasury Spreads & Treasury Yield Curve:  Steep: High growth expected  Flat/Inverted: Low growth expected  Warning: these expectations hinge on steady inflation expectations US Treasury Site

Few False Positives or False Negatives Recessions in Grey

Libor – TBill blue Commercial Paper – Tbill red :

Nominal 10- Inflation Indexed Rate Nominal Rate