Discount-rate variation is the central organizing question of current asset-pricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with ...variation in price-dividend ratios due to variation in expected cashflows. Now it seems all price-dividend variation corresponds to discount-rate variation. We also thought that the cross-section of expected returns came from the CAPM. Now we have a zoo of new factors. I categorize discount-rate theories based on central ingredients and data sources. Incorporating discount-rate variation affects finance applications, including portfolio theory, accounting, cost of capital, capital structure, compensation, and macroeconomics.
Macro-Finance Cochrane, John H
Review of Finance,
05/2017, Letnik:
21, Številka:
3
Journal Article
Recenzirano
Odprti dostop
Macro-finance addresses the link between asset prices and economic fluctuations. Many models reflect the same rough idea: the market's ability to bear risk is greater in good times, and less in bad ...times. Models achieve this similar result by quite different mechanisms. I contrast their strengths and weaknesses. I highlight directions for future research, including additional facts to be matched, and limitations of the models that should prod future theoretical work. I describe how macro-finance models can fundamentally alter macroeconomics, by putting time-varying risk premiums and risk-bearing capacity at the center of recessions rather than variation in the interest rate and intertemporal substitution.
If returns are not predictable, dividend growth must be predictable, to generate the observed variation in divided yields. I find that the absence of dividend growth predictability gives stronger ...evidence than does the presence of return predictability. Long-horizon return forecasts give the same strong evidence. These tests exploit the negative correlation of return forecasts with dividend-yield autocorrelation across samples, together with sensible upper bounds on dividend-yield autocorrelation, to deliver more powerful statistics. I reconcile my findings with the literature that finds poor power in long-horizon return forecasts, and with the literature that notes the poor out-of-sample R² of return-forecasting regressions.
•Many new-Keynesian models produce large and paradoxical predictions at the zero bound.•The predictions are strongly affected by which equilibrium the researcher selects.•Other equilibria predict ...small inflation, output, and policy effects.•They also produce a smooth frictionless and horizon limits.•Fiscal considerations suggest the alternative equilibria.
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Many new-Keynesian models produce a deep recession with deflation at the zero bound. These models also make unusual policy predictions: Useless government spending, technical regress, capital destruction, and forward guidance can raise output. Moreover, these predictions are larger as prices become less sticky and as changes are expected further in the future. I show that these predictions are strongly affected by equilibrium selection. For the same interest-rate path, equilibria that bound initial jumps predict mild inflation, small output variation, negative multipliers, small effects of far-off expectations and a smooth frictionless limit. Fiscal policy considerations suggest the latter equilibria.
The new-Keynesian, Taylor rule theory of inflation determination relies on explosive dynamics. By raising interest rates in response to inflation, the Fed induces ever-larger inflation, unless ...inflation jumps to one particular value on each date. However, economics does not rule out explosive inflation, so inflation remains indeterminate. Attempts to fix this problem assume that the government will choose to blow up the economy if alternative equilibria emerge, by following policies we usually consider impossible. The Taylor rule is not identified without unrealistic assumptions. Thus, Taylor rule regressions do not show that the Fed moved from “passive” to “active” policy in 1980.
Fiscal Histories Cochrane, John H.
The Journal of economic perspectives,
10/2022, Letnik:
36, Številka:
4
Journal Article
Recenzirano
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The fiscal theory states that inflation adjusts so that the real value of government debt equals the present value of real primary surpluses. Monetary policy remains important. The central bank can ...set an interest rate target, which determines the path of expected inflation, while news about the present value of surpluses drives unexpected inflation. I use fiscal theory to interpret historical episodes, including the rise and fall of inflation in the 1970s and 1980s, the long quiet zero bound of the 2010s, and the reemergence of inflation in 2021, as well as to analyze the gold standard, currency pegs, the ends of hyperinflations, currency crashes, and the success of inflation targets. Going forward, fiscal theory warns that inflation will have to be tamed by coordinated monetary and fiscal policy.
Mean-variance portfolio theory can apply to streams of payoffs such as dividends following an initial investment. This description is useful when returns are not independent over time and investors ...have nonmarketed income. Investors hedge their outside income streams. Then, their optimal payoff is split between an indexed perpetuity—the risk-free payoff—and a long-run mean-variance efficient payoff. "Long-run" moments sum over time as well as states of nature. In equilibrium, long-run expected returns vary with long-run market betas and outside-income betas. State-variable hedges do not appear.
I use the valuation equation of government debt to understand fiscal and monetary policy in and following the great recession of 2008–2009. I also examine policy alternatives to avoid deflation, and ...how fiscal pressures might lead to inflation. I conclude that the central bank may be almost powerless to avoid deflation or inflation; that an eventual fiscal inflation can come well before large deficits or monetization are realized, and that it is likely to come with stagnation rather than a boom.
Our central banks set interest rates, and do not even pretend to control money supplies. How do interest rates affect inflation? We finally have a complete economic theory of inflation under interest ...rate targets and unconstrained liquidity. Its long-run properties mirror those of monetary theory: Inflation can be stable and determinate under interest rate targets, including a peg, analogous to a k-percent rule.
Uncomfortably, stability means that higher interest rates eventually raise inflation, just as higher money growth eventually raises inflation. Sticky prices generate some short-run non-neutrality: Higher nominal interest rates can raise real rates and lower output. A model in which higher nominal interest rates temporarily lower inflation, without a change in fiscal policy, is a harder task. I exhibit one such model, but it paints a more limited picture than standard beliefs. Generically, without a change in fiscal policy, monetary policy can only move inflation from one time to another.
The last decade has provided a near-ideal set of natural experiments to distinguish the principal theories of inflation. Inflation did not show spirals or indeterminacies at the long zero bound. The large monetary-fiscal expansion of the covid era produced a temporary spurt of inflation. The same money unleashed in quantitative easing had no such effect.
•Fiscal theory produces a complete theory of inflation under interest rate targets.•Inflation is stable and determinate under a peg, analogous to a k-percent rule.•The economy is long-run neutral; higher interest rates eventually raise inflation.•Higher interest rates can lower inflation, but only by raising inflation later.•The last decade has seen ideal experiments that distinguish theories of inflation.
The fiscal roots of inflation Cochrane, John H.
Review of economic dynamics,
July 2022, 2022-07-00, Letnik:
45
Journal Article
Recenzirano
•Unexpected inflation devalues debt.•Thus, unexpected inflation corresponds to lower surpluses or higher discount rates.•I decompose inflation shocks to surplus and discount rate components in a ...VAR.•Discount rate variation accounts for much unexpected inflation.•In a recession, deficits rise, but inflation declines. Why? Discount rates decline.
Unexpected inflation devalues nominal government bonds. It must therefore correspond to a decline in expected future surpluses, or a rise in their discount rates, so that the real value of debt equals the present value of surpluses. I measure each component using a vector autoregression, via responses to inflation, recession, surplus and discount rate shocks. Discount rates account for much inflation variation, for the cyclical pattern of inflation, and why persistent deficits often do not cause inflation. Long-term debt is important. In response to a fiscal shock, smooth inflation slowly devalues outstanding long-term bonds.
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