Preparation, Perception, and Policy

• Main Author: Sundaresan, Savitar Vadul
• Language: English
• Published: 2016
• Subjects: Prejudices; Financial risk management; Capital investments; Emergency management; Economics; Finance
• Online Access: https://doi.org/10.7916/D8513Z5W

Chapter 1, "Emergency Preparedness: Rare Events and the Persistence of Uncertainty," develops a framework to understand how uncertainty might spike and persist after low-probability events occur. Unexpected events can have lasting effects on financial uncertainty, which in turn affects the real economy. This chapter uses a model in which the realizations of ex-ante unlikely events endogenously result in lower levels of private information. Lower levels of information propagate within the model, as uncertainty makes it harder for agents to acquire information about future periods, resulting in uncertainty persistence. This model of uncertainty is applied to an economy with a financial market. Uncertainty reduces asset demand and expected wealth, while increasing dispersion of beliefs. It also reduces investment and output, and results in higher credit spreads. Data on financial uncertainty, dispersion of beliefs, risk appetite, and credit spreads confirm the predictions of the model. Chapter 2, "Inattentive Valuation and Belief Polarization," uses a similar motivation to think about how two agents can disagree on the truth after seeing the same data. Based on the recent literature in inattention, we build a model allowing identical agents, shown the same set of signals from an objective state of the world, to permanently diverge in their posteriors. The inattentive framework allows for two effects: a confirmation and a confidence effect. The former states that agents who have a bias arrange their attention to perceive signals that agree with that bias. The latter states that agents pay less attention to any signal the more biased they are. These effects allow for permanent polarization of posteriors, even on issues with objective truth. Chapter 3, "The Real Consequences of Countercyclical Capital Controls," looks at the consequences of capital controls on investment and consumption in Brazil. Brazil is the most preeminent case of controls being imposed countercyclically. We find that capital controls have a significant negative impact on investment. The macro analysis uses a synthetic control method and finds that investment could have been approximately 20% higher if controls had not been put in place. The micro analysis uses a panel data approach and finds that the controls reduced the investment to assets ratio by as much as 40%, with some of its effects mitigated by the extension of subsidized credit by the government through the development bank. These results indicate that the renewed support for controls since the Great Financial Crisis should be more cautiously evaluated as it might harm the potential growth rate of Emerging Economies for a long-lasting period.