Abstract: We introduce a new indicator of fiscal capacity—the "austerity threshold": the debt-to-GDP level above which the government must raise fiscal surpluses to ensure debt safety. In a model with realistic risk premia, nominal rigidities, and an intermediary sector, calibrated to the U.S., we estimate this threshold at 189%. We highlight the roles of safety premia and intermediation-driven convenience yields. The threshold varies with the source of surpluses: spending cuts reduce inflation and allow low interest rates, while tax increases distort labor supply and raise inflation. Uncertainty over the austerity regime -- spending cuts or tax increases -- sharply lowers fiscal capacity. The expected austerity regime affects asset prices and macro outcomes even when debt-to-GDP is well below the threshold.
Discussant: Lukas Schmid, University of Southern California
Gill Segal, University of North Carolina-Chapel Hill
Chao Ying, Chinese University of Hong Kong
Zhonghao Li, Nanjing University
Abstract: We provide a unified resolution for prominent conditional asset-pricing puzzles through “innovation-driven contractions.” Empirically, we document two stylized facts: (1) technological innovations initially cause significant labor contractions and have negligible impact on capital, and (2) puzzling disconnections— between stock returns and either investment growth or hiring surprises—intensify under stickier prices. To quantitatively tie these facts, we develop a two-sector New Keynesian model. Our core mechanism relies on the interaction between endogenous markup fluctuations and the division of production into investment and consumption sectors. These model-implied dynamics explain the anomalous negative correlation between stock returns and contemporaneous investment returns, the negative market reactions to favorable labor market news, and the procyclical equity yield term-structure slope. Finally, investment-based dividend yields filtered from our model strongly predict future returns, underscoring our mechanism’s empirical applicability.
Discussant: Lars Lochstoer, University of California-Los Angeles
Abstract: This paper develops a New Keynesian model in which asset-price wealth effects drive consumption dynamics. Due to information frictions, aggregate asset-price movements driven by discount rates are misperceived as idiosyncratic shocks to individual wealth. The marginal propensity to consume (MPC) out of capital gains and the MPC out of income jointly determine equilibrium consumption. With MPCs calibrated to their empirical estimates and driven directly by realized asset prices, the model closely replicates US consumption during the 1998--2019 cycle. The framework offers a unified mechanism for the transmission of discount-rate shocks, in which aggregate MPCs and realized asset prices serve as sufficient statistics for consumption dynamics. Applied to monetary policy, it reconciles the gap between micro and macro estimates of the elasticity of intertemporal substitution (EIS). It provides a tractable approach to monetary policy that targets asset valuations. Asset prices determine aggregate demand and balance-sheet policies are modeled via an Asset-Price Taylor rule. A heterogeneous-agent extension reveals that inequality is a key determinant of macroeconomic volatility, in contrast to standard HANK models. Policies reducing inequality also stabilize the macroeconomy.
Discussant: Jules van Binsbergen, University of Pennsylvania
Abstract: We study the role of firm heterogeneity in state ownership and productivity in monetary policy transmission in China. We develop and estimate a dynamic model with heterogeneous firms—state-owned enterprises (SOEs) and privately owned enterprises (POEs)—featuring monetary supply shocks and financial frictions. We show that firms' responses to monetary supply shocks and risk premiums vary substantially both within and across SOEs and POEs, consistent with the data. Through counterfactual analysis, we show that more severe frictions in accessing debt markets for POEs exacerbate capital misallocation in times of contractionary monetary shocks, leading to sizable losses in aggregate productivity and output
Discussant: William Cassidy, Washington University-St. Louis
