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
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. A two-sector New-Keynesian model quantitatively ties these facts, explaining the anomalous negative correlation between stock-returns and investment-returns, the negative market reactions to favorable labor market news, and the procyclical equity yield term-structure slope. 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 wealth effects drive consumption dynamics. Due to information frictions, agents cannot perfectly distinguish aggregate from idiosyncratic asset-price movements, leading to wealth illusion. The marginal propensity to consume (MPC) out of capital gains and the MPC out of income jointly determine equilibrium consumption. With MPCs calibrated directly to their empirical estimates, the model closely replicates U.S. consumption during the 1998--2018 boom-bust cycle. The framework offers a unified mechanism for the transmission of discount-rate shocks, in which realized asset prices serve as sufficient statistics for consumption responses. Applied to monetary policy, it reconciles the gap between micro and macro estimates of the elasticity of intertemporal substitution (EIS). Second, 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. Third, 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 investigate how firm heterogeneity in state ownership and productivity shapes monetary policy transmission in China. We develop a dynamic model featuring heterogeneous firms -- state-owned (SOEs) and private-owned enterprises (POEs) -- along with money supply shocks and financial frictions. Our estimation reveals that responses to monetary shocks and risk premia vary significantly both within and across sectors, matching empirical patterns. Counterfactual analysis demonstrates that POEs’ severe debt-financing frictions exacerbate capital misallocation during monetary contractions, causing sizable losses in aggregate productivity and output.
Discussant: William Cassidy, Washington University-St. Louis
