Interview with John Cochrane
There are many interesting bits from the interview, sometimes polemic bits too, here is one excerpt:
EF: What do you think are the biggest barriers to our own economic recovery?
Cochrane: I think we’ve left the point that we can blame generic “demand” deficiencies, after all these years of stagnation. The idea that everything is fundamentally fine with the U.S. economy, except that negative 2 percent real interest rates on short-term Treasuries are choking the supply of credit, seems pretty farfetched to me. This is starting to look like “supply”: a permanent reduction in output and, more troubling, in our long-run growth rate.
This part reminds me of some ideas in my own Risk and Business Cycles:
There is a good macroeconomic story. In a business cycle peak, when your job and business are doing well, you’re willing to take on more risk. You know the returns aren’t going to be great, but where else are you going to invest? And in the bottom of a recession, people recognize that it’s a great buying opportunity, but they can’t afford to take risk.
Another view is that time-varying risk premiums come instead from frictions in the financial system. Many assets are held indirectly. You might like your pension fund to buy more stocks, but they’re worried about their own internal things, or leverage, so they don’t invest more.
A third story is the behavioral idea that people misperceive risk and become over- and under-optimistic. So those are the broad range of stories used to explain the huge time-varying risk premium, but they’re not worked out as solid and well-tested theories yet.
The implications are big. For macroeconomics, the fact of time-varying risk premiums has to change how we think about the fundamental nature of recessions. Time-varying risk premiums say business cycles are about changes in people’s ability and willingness to bear risk. Yet all of macroeconomics still talks about the level of interest rates, not credit spreads, and about the willingness to substitute consumption over time as opposed to the willingness to bear risk. I don’t mean to criticize macro models. Time-varying risk premiums are just technically hard to model. People didn’t really see the need until the financial crisis slapped them in the face.
I’ve long believed the risk premium is the underexplored variable in macroeconomics and finally this is being rectified.