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Risk and Macroeconomic Activity

James Cover

Southern Economic Journal, 2011, vol. 78, issue 1, 149-166

Abstract: 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.

Date: 2011
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Handle: RePEc:wly:soecon:v:78:y:2011:i:1:p:149-166