July 21, 2017
The 2017 MFM Summer Session for Young Scholars was held at Bretton Woods, NH. Below are Lars Peter Hansen’s reflections from the conference:
It was my great privilege to participate in the 2017 Macro Financial Modeling Summer Session for Young Scholars held at the Omni Hotel at Mt. Washington in Bretton Woods, NH. This was my first visit to Bretton Woods.
The location has much history attached to it. In 1944, 730 delegates from 44 countries participated in a forum to reshape the commercial and financial interactions around the world. Prominent economists such as John Maynard Keynes were actively involved in the conversations. Coming out of Bretton Woods were a set of rules and institutions to oversee the international monetary system. The International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) were created, the gold standard was embraced, and it set the stage for fixed exchange rate regimes. The gathering was at the same hotel, the Mt. Washington Hotel, as this year’s summer camp.
It was my pleasure to participate. The lectures covered a wide variety of topics including liquidity, financial network modeling, histories of financial crises and exchange rate regimes, housing finance, along with methods for estimation, inference and model comparison. Many elite scholars gave informative lectures. A lot (perhaps too much) was packed into the first two days of the camp. Two of the speakers, Maryam Farboodi and Luigi Bocola were 2013 MFM fellowship awardees.
Like last year, my co-director Andy Lo and I found value in having private sector and public sector panels with research support leaders adding their perspectives on the important policy challenges and open research questions. Leo Melamed, CME Group Chairman Emeritus’ talk was a real highlight, as he provided a personalized discussion of the breakdown of the fixed exchange rate regime and the resulting emergence of derivative claims markets.
I was particularly impressed with the student engagement, both formal and informal. There were some terrific poster sessions and some nice short talks given by MFM scholars. The MFM project has provided research support for 61 graduate students, and the camp provided an opportunity for some of this research to be presented. Dinners were fun for me because they were engaging. I enjoyed talking to many of the students. I even joined them at the Mt. Washington Hotel bar, The Cave, but embarrassed myself in my attempts to table shuffleboard. It is truly terrific to see such young and energetic talent enter the macrofinance field, and I look forward to watching them develop in the future.
— by Lars Peter Hansen
June 20, 2017
CME Group Chairman Emeritus Leo Melamed Speaks at 2017 MFM Summer Session
Leo Melamed, Chairman Emeritus of the CME Group, was invited to the 2017 MFM Summer Session for Young Scholars at Bretton Woods, NH.
Below is his full speech from the conference, as posted on his website.
Allow me to begin by applauding the Becker Friedman Institute for initiating this Macro Financial Modeling Project and to congratulate its two Project Directors, Lars Peter Hansen, of the U of C and Andrew W. Lo of MIT.
While I congratulate them and agree that identifying the root causes of the 2008 crisis and similar calamities—in a quest to discover a canary for the financial mineshaft—is a noble mission, I feel compelled to tell them that their task is daunting. They are attempting to defy what Georg Wilhelm Hegel sadly told us two hundred year ago: “Experience and History,” he stated, “teach us that people and governments never have learned anything from history, or acted on principles deduced from it.”
Hegel’s admonition stands nearly unblemished.
That said, I feel honored to support this innovative initiative by offering some brief thoughts. I assume that one reason for my invite here is that much of my life is intertwined with Bretton Woods. As everyone knows, it was here in Bretton Woods, at the Mount Washington Hotel, in 1944, that there was an assembly of 730 delegates from 44 Allied Nations in order to re-establish financial order in a war-torn world after the Second World War. No, I was not present. I was just a child at that time and had just arrived to this country.
The squeaky wheel at Bretton Woods
The Conference lasted three weeks, from July 1 to July 22. The agreement established a system of fixed exchange rates in which world currencies became pegged to the dollar, with the dollar itself convertible into gold. Its two principal architects were John Maynard Keynes, representing the British Treasury, and Harry Dexter White, representing the U.S. Treasury. The Articles of Agreement were hailed as a seminal achievement and ratified on December 27, 1944. It ambitiously prescribed open markets but with fixed exchange rates.
There was but one squeaky wheel. A single voice defying the near-unanimous applause for this achievement. The voice belonged to Milton Friedman. He argued that Bretton Woods was doomed to failure. It tried to achieve incompatible objectives: freedom for countries to pursue an independent internal monetary policy; fixed exchange rates; and relatively free international movement of goods and capital.
Allow me to digress. The world eventually learned that Milton Friedman’s opinions were not to be ignored. That truism was adroitly described by Milton’s very good friend, Nobel Laureate, George Stigler, on the occasion of 1976 Nobel Prize celebration for Milton Friedman. Professor Stigler introduced Friedman in the following fashion:
Milton, he said, will begin a debate by asking you to grant him three simple assumptions. For instance: That $2 is better than $1; That the law of diminishing returns is valid; And, that individuals do not have complete knowledge of the future.
Simple, undeniable assumptions, right? My fundamental advice,” said Professor Stigler, “Do not grant him these assumptions. For if you do, you will find yourself led, by inexorable logic, to conclusions such as these:” That the Federal Reserve System should be abolished; that the Board of Governors of the Federal Reserve should be put on Social security; and that Social Security should be abolished.
During the first decade of Bretton Woods, the system worked fine and it looked as if Friedman was wrong. Trouble was the 44 nations grew up. Some of them on a fast track who became competitive to each other and to the U.S. In practice, maintaining announced parities became a matter of prestige and political controversy. Foreign exchange became a competitive tool. Countries held on to parity as long as they could, in the process letting minor problems grow into major crises and then making large changes. Friedman’s prediction was coming true.
The information era and its implications for the fixed exchange rate system
Then, beginning in the late 1950s, the curtain opened on the “Information Era.” Technology created the transistor—perhaps the greatest invention of the 20th Century. With the transistor communication was revolutionized and information began to flow globally in minutes rather than in days or weeks. The technological revolution which is still very much alive, enabled markets to learn facts before finance ministers could gather to react. It became impossible for a fixed exchange rate system to cope with continual changes in currency values resulting from the daily flows of political and economic information. By the late 1960s, the Bretton Woods fixed exchange rate system had become a joke.
As it happened, I was then the chairman of an insignificant, back-water, pork-belly futures market, the Chicago Mercantile Exchange. My good friend, Adlai Stevenson, the former US Illinois Senator, likes to tell the story this way. One day in August of 1971, as Chairman of the Senate Subcommittee on International Finance, he received a note that the President, Richard Nixon, had closed the gold window. Stevenson says he had no idea what this meant. In fact, in his view nobody in Congress knew what it meant. And maybe, he goes on to say, no one in the US— except this one guy at the Chicago Mercantile Exchange.
That is a bit of an overstatement but several things are certain. It wasn’t easy. What the modern world needed, I thought, was a system that would allow currency values to adjust in an ongoing fashion. In other words—at a futures market in financial instruments —where prices reflected continuous changes as demanded by the constant flow of new information. Such a system would allow risks to be hedged and opportunities to be captured in real time.
Futures in finance? “Fuhgeddaboudit!”
In early 1971, my suggestion for a futures market in foreign exchange was met by derision and contempt, not only by my board of directors, but by practically the whole financial world. The idea prompted a prominent New York banker to laughingly say, that “foreign exchange couldn’t be entrusted to a bunch of pork belly crapshooters in Chicago.”
As some in Chicago were apt to say, “Futures in Finance, fuhgeddaboudit.”
Besides, I was a lawyer, not an economist. To achieve a measure of credibility I went directly to Milton Friedman. Not only did he like the idea, at my request, he authored a feasibility paper embracing the concept. That paper proved magical. His fee was $5,000. The International Monetary Market, IMM, was launched by the CME on May 16, 1972 and merged with the CME in 1976. Some will tell you that today the CME has a street value of perhaps $100 billion. Now that’s what I call a pretty good trade.
Actually Friedman also tried to defy Hegel’s law by urging President Nixon to abandon fixed exchange rates directly after his election in 1968. Nice try! By the time Nixon acted on August 15, 1971, world currency values were so screwed up, they were nearly beyond repair, and the US was about to go broke selling gold to the whole world at $35 an ounce.
I must admit our timing was lucky. If one could ordain the perfect backdrop for the creation of a new futures exchange designed to manage the risk in instruments of finance, one could not have bettered what actually happened. The decade that followed can be described as a “Perfect Financial Storm,” — turmoil that tested the very foundations of western civilization.
The U.S. dollar plunged precipitously; U.S. unemployment reached in excess of 10%; oil prices skyrocketed from about $7 a barrel to $39; the Dow fell to 570; gold, from its $35 base, reached $800 an ounce; U.S. inflation climbed to an unprecedented peacetime rate of 20%; interest rates went even higher.
The IMM went from currency futures to interest rates to stock indexes and to derivatives across the entire financial spectrum. We were copied by every industrial nation in the world. Not to brag, but in 1986, Nobel Laureate, Merton Miller called financial futures the most important financial invention of the past twenty years.
So, what did history teach us over the past five or so decades? Well, yes, that necessity is the mother of invention. And yes, that timing is everything. But we also learned that when it comes to innovation, the US is the place to be. Could the Internet, Google, Apple, Microsoft, Facebook, or Amazon, to name but a few, have been created somewhere else? I have grave doubts. Could the IMM have been initiated in another country? Same answer.
The U.S. as the world’s crucible for innovation
Thomas Friedman said it best: America, he wrote, allows “extreme freedom of thought, an emphasis on independent thinking, a steady immigration of new minds, and a risk-taking culture with no stigma attached to failure.” Yes, those are the precise attributes that make our nation exceptional. We are the world’s crucible for innovation.
This Becker Friedman undertaking is another example. It is an initiative within the academic sciences which to my knowledge has not been undertaken anywhere else. An innovative effort to jointly advance our understanding of the links between financial markets and the macro-economy. To construct more comprehensive models for assessing systemic risk. To foster discussion and research. To collect resources for analysis and study. And, to the extent possible, to create and share a data-bank of economic information.
In short: To learn from history and act on principles deduced from it, and finally prove Georg Wilhelm Hegel wrong. I wish you luck.
— by Leo Melamed
June 16, 2017
Macro Financial Modelers Make Good
Former MFM Fellows launch successful careers probing sources of financial instability that impact the economy
Two 2013 MFM dissertation fellowship awardees are well on their way to establishing themselves as top scholars. For Maryam Farboodi and Luigi Bocola, their research potential was affirmed their job market success and by their participation in the 2014 Review of Economic Studies Tour. This prestigious opportunity selects top candidates on the job market to visit and present their work to multiple schools in Europe.
Both economists are now engaged in a variety of interesting research projects, so we took the opportunity to interview them and gain a better appreciation of their successes.
Maryam Farboodi initially embarked on a PhD program in computer science with a focus on theoretical work, after earning undergraduate and master’s degress in that area from Sharif University of Technology in Tehran, Iran and the University of Maryland. While she found the work interesting and mentally stimulating, she came to view that angle as a bit too narrow and detached from problems found in the world around her.
“I wanted to do something a bit more significant that allowed me to think about relatively abstract problems with real-world implications,” Farboodi explained.
She decided that pursuing economics would entail broad, interdisciplinary work across various fields she found particularly appealing, so she switched her doctoral studies from computer science to economics, pursuing her degree at the University of Chicago. After graduating in 2014 with interests in banking, financial macroeconomics, and mechanism design, Farboodi accepted an opportunity as an assistant professor at Princeton University.
At Princeton, Farboodi has further focused her research agenda more specifically on financial intermediation.
Bringing the tools of micro and finance to macroeconomics
“Intermediation is a broad field, and many different aspects of it can be studied to provide insights pertaining to the financial sector and the various setbacks that can potentially occur,” she explained. “I am particularly interested in inter-financial institution market structure, information consequences of interactions in the financial sector, market power, and spill over to the real economy.”
One strand of her research focuses on technological choices of financial institutions and their welfare implications with a focus on interbank intermediation. In another sequence of papers, she uses information economics to study the long-run impact of advances in financial technology on economic growth and various types of misallocation that can arise from the interaction of financial and real sector. In another project, she explores the strategic incentives of banks, which is a central concern for enhancing our understanding of systemic risk in the financial sector.
“I believe that the strategic nature of the interaction between financial institutions is actually really important,” she said. “In one of my recent projects, I focus on how these strategic incentives change a lot of factors, such as opacity of the portfolio in order for banks to make themselves gain market power.”
Newer themes in her work bring in microeconomic and corporate finance tools to study questions which traditionally have had a macroeconomics focus, such as sovereign debt.
Receiving an MFM fellowship allowed Farboodi to concentrate only on her job market paper without having to teach. The financial support and the extra time it freed up is one benefit the MFM provided. “The most unique quality of the MFM program is its commitment to promoting young researchers and to expose them to high-quality talks by elite, senior researchers who actively participate and help young scholars evolve their research,” Farboodi concluded.
“I was incredibly lucky to have the opportunity to present at the October 2013 Young Scholars meeting just before I went out on the job market,” she explained. “The exposure that I got from that particular meeting contributed to all of the interviews that I was offered, and this exposure remains invaluable to me.”
This opportunity allowed her to present her work among elite scholars and young researchers and to gain valuable feedback from them.
Probing the sources of instability
Luigi Bocola, another 2013 MFM dissertation fellowship recipient who is now an assistant professor of economics at Northwestern University, derived similar benefits from his MFM support. In addition to the financial stipend, the fellowship gave him the opportunity to present his work in various early stages in front of distinguished researchers. This was instrumental in the completion of his dissertation, according to Bocola.
“What I found most unique about the MFM program is that it was essentially understood that everything presented at the conference was simply a work in progress. That understanding enabled feedback about which components of the work were genuinely worth pursuing and which weren’t,” he explained.
Bocola’s dissertation studied a key aspect of the debt crisis in Europe, namely the negative spillovers that sovereign default risk had on financial intermediation and the real economy. He developed a macroeconomic model in which banks are exposed to risky sovereign debt, and applied the model to Italian data. His work also made progress on the empirical analysis of this class of models, which are inherently nonlinear.
His dissertation was the recipient of the William Polk Carey Prize in Economics, which is awarded annually to the best doctoral dissertation in the Economics Department at the University of Pennsylvania.
Much of Bocola’s research focus since has remained the same, with a continuing emphasis on the exploration of linkages between macroeconomics and finance in an international framework. His recent work has two objectives in mind: identifying sources of financial crises in modern economics and understanding what government policies can do to make the financial sector more stable.
In a recent joint work with Guido Lorenzoni of Northwestern University, Bocola studies the sources of financial instability for emerging markets and the constraints that an open capital account imposes on the lender of last resort.
“We believe our research can shed light on the motivations behind the large accumulation of foreign currency reserves by emerging market over the past 20 years,” Bocola concluded.
Given the successful launch of their professional careers, both Maryam Farboodi and Luigi Bocola were recruited to present their perspectives on important lines of research at the 2017 Macro Financial Modeling Summer Session for Young Scholars in Bretton Woods, New Hampshire, June 18-22, 2017.
— by Diana Petrova
May 23, 2017
Lenel to Pursue Macro Finance Studies as a Chicago Research Fellow
May 2, 2017
Fourteen Scholars Awarded Fellowships to Study Macrofinance
The Becker Friedman Institute’s Macro Financial Modeling Initiative has announced the recipients of this year’s dissertation fellowships. Thirteen promising new scholars from universities across the United States and Europe were chosen from a highly competitive pool of applicants to receive funding for their MFM research. The project, supported by the Alfred P. Sloan Foundation , CME Group Foundation and Fidelity Management & Research Company, provides dissertation support for doctoral students who are working to advance macroeconomic models with financial sector linkages.
The 2017 awardees are studying an impressive range of research questions, with dissertation subjects including bank consolidation and credit expansion, household finance, institutional risk management, and corporate debt and transmission of unemployment risk.
“Supporting early career scholars is one of the key goals of the Macro Financial Modeling Program,” says Lars Peter Hansen, the David Rockefeller Distinguished Service Professor in Economics, Statistics, and the College and Research Director of the Becker Friedman Institute for Research in Economics. “These awards recognize the contributions that graduate students are making in the field of macroeconomics and finance, and the fellowship process serves as a vehicle to preview some of the cutting-edge work in the field. We look forward to learning more about their progress and potential breakthroughs in their dissertations.”
Sasha Indarte, a PhD candidate at Northwestern University and one of this year’s grantees, says the funding will ease her teaching burdens and allow her to focus on her research studying the effect of bank consolidation on lending standards.
As high school student in Minnesota during the 2008 financial crisis, Indarte saw people she knew losing their jobs and heard disturbing discussions of another Great Depression. That experience inspired her to pursue a career investigating elements of financial crises.
Her current research, which she hopes will be the cornerstone of her dissertation, evaluates large declines in the number of U.S. banks – down more than 50 percent since the 1980s – despite a growing population. Alongside this banking trend, researchers have observed interesting changes in household credit; lower income borrowers are seeking more credit for different types of activities. “My aim is to understand if consolidation is one of the reasons credit has expanded to riskier populations by looking at how borrower and loan characteristics change after bank mergers,” she explains.
Daniel Green, a PhD student in finance at the Sloan School of Management at MIT, was similarly troubled by the 2008 financial crisis and fascinated by the slew of policies that injected billions of dollars into the financial sector, affecting not only financial markets, but the broader economy as well.
Green’s MFM project examines how the type of information available to credit institutions affects lending decisions. For instance, does information about the broader economy versus individual contracts affect the types of industry or the riskiness of projects that a lender will finance, and do those decisions have aggregate implications for the overall economy?
Quentin Vandeweyer is taking a slightly different, more computational approach to his research, illustrating the breadth and diversity of activities supported by the MFM fellowship initiative. As part of his PhD work at Sciences Po in Paris, he is working on an innovative methodology to account for heterogeneous incentives and behaviors that the financial sector may have as both a creator of liquidity and a manager of risk.
Vandeweyer’s research interests position him at the intersection of macro, finance, and monetary economics. As an MFM Summer Camp alumnus (2016), he is setting his roots firmly within the MFM community. “I am, of course, delighted to win the fellowship. A big part of growth in research is the interaction you have with different people along the way. The MFM initiative provides a forum for discussion and exchange of ideas between very smart people with similar concerns and interests.”
In addition to Indarte, Green, and Vandeweyer, 2017-18 awardees include:
Carlos Avenancio-Leon, University of California, Berkeley
Sarita Bunsupha, Harvard University
Cristian Fuenzalida, New York University
Paul Ho, Princeton University
Adam Jorring, University of Chicago
Yann Koby, Princeton University
Anton Petukhov, Massachusetts Institute of Technology Sloan School of Business
Julian Richers, Boston University
Samuel Rosen, University of North Carolina at Chapel Hill
Tianyue Ruan, NYU Stern School of Business
Ishita Sen, London Business School
—by Tina A. Cormier
Macro Financial Modeling dissertation support is provided annually to doctoral students who are working toward improved and more comprehensive models of systemic risk in the financial sector that can impact the broader economy. The application deadline for the next round of funding is February 10, 2018.
February 1, 2016
Students Trace the Causes, Impact of Systemic Financial Crisis
Turbulent times make for compelling research questions
Young scholars funded through the Macro Financial Modeling initiative are adding to our understanding of the macroeconomic effects rippling out from each of these areas. They shared their research in progress at the January 2016 meeting.
N. Aaron Pancost, a doctoral student at the University of Chicago, used data from India to explore the question of whether and to what extent financial development increases economic growth. Aggregate labor productivity in India growing at about six percent a year, and the financial sector is also growing. Is access to capital driving investment that boosts firms’ productivity?
No, Pancost showed. “What I find is that it’s a common shock to productivity across the board, not financial development, that explains cross-sectional productivity. His results show that firms that are unproductive don’t borrow, while productive firms choose a higher leverage and grow faster on average.
Credit Markets and Liquidity
Two students focused on problems in the financial sector during the recent crisis, presenting work addressing issues of liquidity and credit provision.
Credit market disruptions in the recent crisis were devastating to economy, so Alexander Rodnyansky of Princeton University, in joint work with Olivier Darmouni, looked at how unconventional monetary policy affected bank lending. They found that in the US, the first and third rounds of quantitative easing had a large effect on lending, particularly in real estate, commercial, and industrial lending. QE2 had no significant effect on banks.
The results show that the type of asset used in QE—not just the quantity—makes a difference, Rodnyansky said.
While debt-laden banks stopped lending in the crisis, many also faced insolvency when depositors and investors reclaimed their funds. New Basel rules tried to stabilize the financial system by requiring banks to hold enough assets to withstand a one-month run.
University of Chicago student Fabrice Tourre studied the influence of portfolio liquidity composition on run behavior of banks’ creditors. Taking his model to data, he found that cash can play a novel role in corporate finance, as a run deterrent. Currently liquidity regulations are too conservative for certain firms, and not conservative enough for others, he showed. And it’s not always the case that issuing more long-term debt makes the firm less run-prone.
“The takeaway is that regulators, as opposed to focusing on capital on one side and liquidity on other, should think about them together; the two regulatory regimes talk to each other,” Tourre said.
The Housing Boom Before the Bust
Jack Liebersohn, a Massachusetts Institute of Technology student, shared work that tried to explain the nationwide variation in the severity of the housing bust that precipitated the financial crisis. The standard model holds that local differences in housing supply shocks, mediated by differences in elasticity of the supply response explained the variation. Liberson added a demand shock to the model.
He hypothesized that areas with a large manufacturing sector would have lower payrolls in general and therefore lower demand for housing that would keep prices lower. He comparing areas with high and low manufacturing concentration but also high and low supply elasticity. He found that housing prices rose and fell dramatically in low-manufacturing cities, and less so in cities with greater manufacturing employment. High elasticity dampened the housing price effect, he found.
To see whether higher housing prices led to more consumption, he looked at auto sales, as measured by employment in the auto industry. He found that wages had a much stronger effect on auto sales than housing prices did.
Turning to more methodological issues, Elisabeth Pröhl of the University of Geneva demonstrated a promising approach to using numerical algorithms to solve a labor income risk model with aggregate risk.
Work from Former Grantees
Zachary Stangebye, an assistant professor of economics at the University of Notre Dame, presented theoretical work on sovereign debt motivated by the recent European debt crises. He presented a model in which such a crisis arises, driven by the sovereign’s inability to commit to future debt issuance.
The intuition behind the model is that when investors anticipate high borrowing in the future, they demand a dilution premium on long-term bonds. That forces the sovereign to borrow more today because they can’t borrow as much tomorrow. As a result, high current borrowing causes need for high rollover, which indeed leads the sovereign to borrowing more in the future, fulfilling expectations.
Stangebye’s model imposes a commitment on borrowing, and finds that multiple financing trajectories arise as result of coordination failures with long-term debt
When the model is calibrated to Ireland’s results, it accounts for about 85 percent of the increase in debt-to-GDP ratio seen in the crisis.
Marco Machiavelli of the Federal Reserve Board presented work on the role of dispersed information in pricing default. Studying modern bank runs with data from the recent crisis, he showed that if forecasts about a bank’s viability are bad, lower dispersion of beliefs about a bank’s prospects greatly increases default risk, and amplifies the reaction to changes in market expectations. In other words, more precise and consistent shared information coordinates bank runs, as all investors respond to the information in the same way.
Her work focused on the process of intermediation that provides access to assets and turns risky illiquid assets into safe and liquid ones. In a model with households, banks, and shadow banks, she found that increasing capital requirements on regulated banks caused an increase in shadow bank activity. It also led to higher prices of intermediated assets but reduced default risk for both types of banks.
—by Toni Shears