Risk and Macroeconomic Activity

• Published in: Southern economic journal Vol. 78; no. 1; pp. 149 - 166
• Main Author: Cover, James Peery
• Format: Journal Article
• Language: English
• Published: College of Business Administration, University of Tennessee at Chattanooga, Chattanooga, TN 37403 Southern Economic Association 01.07.2011
• Subjects: Aggregate demand; Analysis; Business cycles; Capitalism; Corporate bonds; Default; Demand shocks; E32; E43; E44; Economic activity; Economic conditions; Economic forecasts; Economic growth; Economic indicators; Economic recessions; Federal funds rate; Federal Reserve Bank; Financial risk; Financial risks; Government bonds; Government securities; Growth rate; Inflation; Interest rates; Macroeconomics; Market structure; Monetary policy; Output rate; Political economy; Prepayments; Production level; Recessions; Risk management; Risk premiums; Statistical variance; Stock exchanges; Studies; Supply shocks; Vector-autoregressive models; United States; United States > US
• ISSN: 0038-4038; 2325-8012
• DOI: 10.4284/0038-4038-78.1.149

This article explores the macroeconomic role that risk plays using the BAA-AAA spread as the measure of risk. First, it shows that meaningful upward movements in this spread are associated with recessions and their severity. Second, it includes the BAA-AAA spread in a structural vector-autoregression (VAR) to identify a shock-to-risk and finds that it causes a statistically significant and economically important decrease in output as well as increased holdings of real-money balances. Third, it uses historical decompositions to show that the shock-to-risk explains an important part of the declines in output during four post-1970 recessions. Notably, the shock-to-risk explains almost none of the decline in output during 2001 prior to the September 11, 2001, terrorist attacks but does clarify why the recovery was relatively weak afterwards, and it explains the bulk of the decline in output during 2008 and 2009.