Macro Roundup

Key evidence, “…A decline in interest rates boosts the value of industry leaders relative to followers, and this effect snowballs as the level of the interest rate becomes lower. We now explore mechanism through which industry leaders gain relative to industry followers when interest rate declines. We first explore whether the decline in economywide interest rates such as the 10 year Treasury rate has been associated with a differential decline in the cost of debt financing for industry leaders relative to followers. A stronger pass-through of lower Treasury rates into the cost of debt financing for industry leaders represents another advantage of a low interest rate environment for leaders relative to followers. As before, industry leaders are defined as the largest 5% of firms in each Fama-French industry, measured by market capitalization. We define each firms borrowing cost as the ratio of interest expense to total liabilities, which is simply average rate of interest paid on it’s liabilities. We treat the largest 5% of borrowing costs in the sample as missing in order to exclude any outliers in the data. Figure 6 plots the evolution of the median borrowing cost faced by both leaders and followers, displaying both a clear downward trend and also a stark increase in spreads since 1980. The spread in the 1980s was 31 basis points whereas the spread in the 2010s is 127 basis points.The interest rate spread between market leaders and market followers widened even though the level of interest rate fell considerably. We present estimates of the effect of a decline in interest rates as defined by the monetary policy shocks discussed in Section 3 on the cost of debt financing for industry leaders versus followers. As above, we measure borrowing costs using the average interest rate paid by the firm on all debt. We calculate this as the total interest expense divided by total debt. We exclude the top 5% observed values of borrowing costs, due to the presence of implausibly large values….”

Note this builds off their “Low Interest Rates, Market Power, and Productivity Growth” which argued that low interest rates reduce business dynamism as market leaders gain share as market followers cut investment to a greater degree then they do in face of low rates (attached)

Thomas Kroen, Ernest Liu, Atif Mian and Amir Sufi, “Falling Rates and Rising Superstars,” National Bureau Of Economic Research, October 2021, https://www.nber.org/papers/w29368

Mian and Sufi find that falling interest rates disproportionately help industry leaders, particularly in low rate environments. They find that spreads (borrowing) btw industry followers versus the leaders is stable and the borrowing capacity of leaders growths Mian characterizes it as “snowballs” as interest rates approach 0. They find that as rates go down the market value of leaders rises more than followers (superstar effect) and their borrowing cost (relative to followers) fall. That allows cheaper leverage, buybacks, capex and acquisitions making effect more pronounced. “…we find that falling interest rates boost the relative valuation of industry leaders relative to industry followers, and the relative valuation effect becomes largest as the initial interest rate approaches zero. This result is robust to the use of high frequency monetary policy shocks as a source of variation in economy-wide interest rates. A decline in the interest rate disproportionately lowers the cost of borrowing of industry leaders, who take advantage of the lower cost of borrowing to raise additional debt financing, increase leverage, repurchase shares, boost capital investment, and conduct acquisitions. All of these effects snowball as the level of the interest rate decline; that is, a decline in interest rates has a stronger effect on all of these outcomes of leaders relative to followers when the initial level of the interest rate is already low.The findings provide empirical support to the idea that extremely low interest rates may be a culprit in explaining the rise of superstar firms in the U.S. economy…

The basic dynamic, “…This paper formally investigates the empirical relationship between economy wide interest rates and the rise of superstar firms in the United States using the merged CRSP-Compustat data set from 1962 to 2019. We begin by analyzing the stock market reaction to an interest rate decline for industry leaders versus industry followers, where we define the top 5 percent of firms by value in an industry as “leaders” and the rest as “followers”. We construct a “leader portfolio” that goes long industry leaders and shorts industry followers, and we examine the portfolio’s performance in response to changes in the ten year U.S. Treasury rate (r). We find that the leader portfolio exhibits higher returns in response to a decline in r, and, more importantly, this response becomes stronger, or snowballs, when the initial r is low. We control for the price to earnings ratio as a measure of implied duration, showing that the snowballing effect is not mechanically driven by industry leaders having higher duration. This suggests that lower r impacts relative firm valuations not only through changing the discount rate but also through possible endogenous changes in expected future cash flows that favor the current industry leader – a finding consistent with the strategic competition channel above. Interest rate changes are endogenous to changes in the overall economy, and there is an obvious concern that omitted variables may be responsible for the results. For example, the interest rate decline is naturally correlated with negative news about future demand; if industry leaders have a larger option value on future demand, then the spurious correlation between the interest rate movement and expected demand will lead us to underestimate the true differential impact of the interest rate decline on industry leaders….”
Impact is stronger at lower interest rates, “…Since the impact is stronger at low levels of r, for expositional purposes we always report the predicted magnitude of our estimates at an interest rate of r = 2%. We find that a 10 basis point reduction in r when r = 2% translates into a 0.53 percentage point larger increase in the market valuation of industry leaders relative to industry followers. We investigate the possible reasons and mechanisms that lead to lower rates boosting the relative valuation of industry leaders. We find that a fall in r exhibits a stronger pass-through to the borrowing costs of industry leaders relative to industry followers, and this effect snowballs at lower r. In terms of magnitudes, a 10 basis point decline in r leads to a 14 basis point relative decline in the borrowing cost of industry leaders relative to followers at r = 2%. When the initial r is very close to the zero lower bound, a 10 basis point decline in r leads to a 24 basis point relative decline. Industry leaders take advantage of the lower cost of debt financing. There is a large relative increase in debt issued by industry leaders relative to industry followers, and the book leverage ratio of leaders also increases. The effects of a decline in r on these two financial outcomes also exhibit the snowballing effect: the effect of a decline in r is larger when the initial interest rate is lower. When the economy is close to the zero lower bound, a 10 basis point decline in r leads to a 5.2 percent relative increase in debt issued, and a 1 percentage point relative rise in the leverage ratio for industry leaders. Some of the additional debt raised is used to buy back shares, which also contributes to the rise in leverage we observe….”

“…The final set of results concern the relative real effects of lower interest rates on industry leaders versus followers. These results largely follow the stock market and financial effects described above. We find that a decline in r leads to a relative increase in capital expenditures, cash acquisitions, and property, plants, and equipment (PPE) for industry leaders relative to followers. These real effects, like the valuation and financial effects, also snowball at lower levels of the initial interest rate. The results on investment provide empirical support to the prediction in Liu et al. (2021) that industry leaders respond more aggressively to a decline in the interest rate in order to “go for the kill” to ensure their claim on the more valuable future cash flows. Interestingly, one of the strongest results is on cash acquisitions, which suggests that industry leaders may be more likely to target their rivals when interest rates fall from very low levels. Overall, our results have important implications for the broad literature on persistently low interest rates (or r*) and their implications for the macroeconomy, including the literature on “secular stagnation” (e.g., Summers (2014)). Most of the work in this literature has focused on possible causes for the low interest rate, with explanations ranging from demographics, inequality, and low productivity growth. Our work suggests that there is a potentially important feedback effect from low r back to the real economy through market structure and industry competition….”

Table 2 “…The estimates reported in columns (1) and (2) confirm earlier results. A decline in the interest rate is associated with positive returns for the leader portfolio, and this positive return response to a decline in the interest rate is larger in magnitude when the interest rate is lower.Column (3) uses the 10-year real interest. rate level as before. The coefficient on the interaction between the real rate and the change in interest rate is even stronger than in Table 1. Column (4) shows that the results are driven by both positive and negative changes in interest rates. In particular, the excess return results are materially unchanged whether only positive changes in interest rates or only negative changes in interest rate are used. Column (5) shows that the results are not driven by industry leaders that may have higher duration of cash flows for mechanical or spurious reasons. If industry leaders had higher duration for spurious reasons, then they would have a higher price to earnings (PE) ratio and the difference in the PE ratio between the industry leader and follower at the time of interest rate shock would explain our asymmetric valuation response to a decline in r. Column (5) controls for a “PE portfolio” that is long the top 5% of firms by PE in an industry and short the rest. Inclusion of the PE portfolio return does not change the coefficients of interest, and the return of the leader-minus-follower portfolio is itself negatively correlated with the return of the PE portfolio.4 This result shows that lower r impacts relative rm valuations. not only through changing the discount rate but also through the endogenous changes in future cash flows that favor the current leader…”

“…. Figure 2 helps visualize the snowballing effect, and the critical interest rate at which the snowballing effect becomes active. More specifically, the figure reports non-parametric estimates of the effect of a change in interest rates on the leader portfolio ( ) at various grid points for it1, which is the lagged 10-year nominal Treasury rate. Moving from right to left in the figure, the coefficient estimate of becomes statistically significantly negative when the level of the nominal interest rate it1 falls into the 5 and 6% region. The 10 year nominal U.S. Treasury rate has been below 5% since 2000, with only a few exceptions….”

Using evidence from Quebec in the late 1990s when, "...extension of full-time kindergarten to all 5 year olds and the provision of childcare at an out-of pocket price of $5 per day to all 4 year olds. This $5 per day policy was extended to all 3 year olds in 1998, all 2 year olds in 1999, and finally all children aged less than 2 in 2000..."
The paper finds, "....Our results are striking. The introduction of universal childcare in Quebec led to a very large increase in the use of care. The proportion of 0-4 year olds in care rose by 14 percentage points in Quebec relative to the rest of the country, or roughly one-third of the baseline childcare utilization rate. This rise in childcare was associated with a sizeable increase in the labor force participation of married women. Participation rose by 7.7 percentage points in Quebec, or about 14.5% of the baseline. The difference between the rise in participation and the rise in childcare utilization primarily reflectsreduced use of informal childcare arrangements, or the “crowd out” of informal childcare by this new subsidized childcare. Partly as a result of this large “crowd out”, the taxes generated by the new maternal labor supply fallfarshort of paying for the costs of the increased childcare subsidies. We also find consistent and robust evidence of negative effects of the policy change on child outcomes, parenting, and parent outcomes.Child outcomes are worse for a variety of parent-reported measures, such as hyperactivity, inattention, aggressiveness, motor/social skills, child health status, and illness. Parental interactions with children are worse along all measured dimensions, and there is some evidence of deterioration in parental health and a reduction in parental relationship quality. These are subjective measures, but the consistency of the results suggests that more access to childcare is bad for these children (and, at least along some dimensions, for these parents). There are, however, interpretations of these findings which are more benign. While some of these explanations appear inconsistent with the data, we cannot rule out the possibility that our findings represent a short term adjustment to childcare, and not a long-run negative impact...."

Michael Baker, Jonathan Gruber and Kevin Milligan, "Universal Childcare, Maternal Labor Supply and Family Well-Being," National Bureau Of Economic Research, December 2005, https://www.nber.org/system/files/working_papers/w11832/w11832.pdf

Supporting Evidence on child outcomes, “….Table 4 presents the results for child outcomes for the difference-in-differences specification. We consider several summary scores of the individual behavioural measures: hyperactivity-inattention; general anxiety; separation anxiety; physical aggressiveness / opposition; motor and social development; and theppVT score. Appendix C shows how the indices are constructed from the underlying survey questions, and also provides estimates on the individual components using the same specification as we use for the scores. We also consider five measures of health: an indicator for excellent health; indicators for the child never having nose/throat or ear infections; an indicator for having an asthma attack in the last 12 months; and an indicator for injury in the last 12 months….”

Supporting Evidence on labor supply impact, “..Table 3 reports the effects of this policy on the labor supply of married women.27 The first two columns consider mothers of 0-4 year old children. There is a rise in the employment of married women in Quebec, relative to the rest of Canada, of 7.7 percentage points, or 14.5% of baseline participation. In subsidy terms, we find that each 10% subsidy raises maternal work by 2.4%. Given the 1996 Quebec price mean of 0.528 and employment mean of 0.530, this implies an elasticity of maternal work with respect to childcare costs of 0.236, which is towards the low end of estimates in the literature on labor supply effects of childcare costs. As Figure 4 shows, this change in labor force participation once again represents a trend break for Quebec relative to the rest of Canada: whereas female participation in Quebec was 5-6 percentage points below that in the rest of Canada before the policy, it is higher after the policy. There is also a large rise in other measures of labor supply for married women. Average weeks of work rose by 3.5, or more than 13% of baseline, for an elasticity of weeks of work with respect to childcare prices of 0.217. The next three rows show the effect on part-time vs. fulltime work. There is an increase in the odds of women working more than 20 and more than 30 hours per week that is comparable to the entire rise in employment, but no effect on the odds of working more than 40 hours per week, suggesting that women were moving from no work to full-time work as a result of this policy change. Finally, there is no effect on the odds that the mother is enrolled in school…”

Baker/Gruber/Milligan build off their 2005 Quebec paper and finds the negative impacts of the Quebec program are persistent. Unsurprisingly outcomes were worse for the already marginal students and negative effects are primarily driven by boys, largest negative impact was in non-cognitive outcomes and criminality relative to cognitive outcomes

Core of paper, "...Our analysis extends the study of the impact of this universal child care program to children at older ages, looking for any persistence of the contemporaneous impacts in four spheres: noncognitive development, cognitive development, health, and crime. We begin our investigation by replicating previous results showing that exposure to the Quebec program increased use of child care among children age 0- 4 and led to lower noncognitive outcomes at those ages. We then proceed to our examination of persistence. We provide new evidence for children aged 5-9, showing the program’s negative effect on noncognitive skills do not appear to have faded by those ages—and in some cases are even stronger. In this way, our results are a mirror-image of the Perry Preschool and Head Start evidence. We also extend previous evidence of the heterogeneous contemporaneous impact of the program. At older ages the primary, negative impact of the program is on children who are already struggling. We next explore the impacts of this child care intervention on outcomes in the preteen and teenage years. The oldest children who were eligible for the Quebec program are currently in their early 20s, and those who received full treatment are now in their teens. We therefore focus, as the data allow, on their cognitive achievement and health at these ages. We ask whether any early negative impacts of the program on these children’s cognitive development fade out, as has been found in evaluations of other early years programs? The program also led to earlier exposure to infections and diseases and increases in early childhood anxiety and aggression, and we investigate whether these provide any immunity against maladies or have any consequences for life satisfaction and mental health, respectively, at older ages. Finally, we also look for any longer term impacts of the early childhood deficits in noncognitive development on criminal activity. This line of inquiry is guided by the evidence from programs such as Perry Preschool, which have shown how positive, early childhood impacts on noncognitive development result in more positive interactions with various social institutions including the criminal justice system. Our results find no consistent evidence of a lasting impact of the Quebec program on cognitive test scores; the available data give opposing answers for math scores and show little effect on English or science scores. We do, however, find a significant decline in self-reported health and in life satisfaction among teens. Most strikingly, we find a sharp and contemporaneous increase in criminal behavior among the cohorts exposed to the Quebec program, relative to their peers in other provinces. We illustrate graphically a monotonic increase in crime rates among cohorts with their exposure to the child care program, andwe show in regression analysis that exposure led to a significant rise in overall crime rates. We also report that these effects are primarily for boys, who also see the largest deterioration in noncognitive skills….”

"...In the first row are estimates of the program effect on the probability of the child being enrolled in child care at ages zero to four. At just under 15 percentage points, the estimate using waves 1, 2, 3, and 4 almost exactly matches the estimate in our previous paper (0.146). Extending the sample by the additional cycles of the NLSCY and the SYC leads to a larger estimate, which might be expected as the supply of subsidized child care spaces expanded as the program matured. This latter estimate represents an increase in child care use of just over 40 percent of the baseline rate. In the next four rows are the estimates of the program impact on standardized noncognitive outcomes at ages 2-3. In each case, we have created the variable so that a higher score indicates a poorer outcome. The components of each score are listed in the online Appendix. The estimates using cycles 1, 2, 4, and 5 show statistically significant estimates for anxiety and aggression, but not for hyperactivity and separation anxiety. They are marginally smaller in magnitude than the estimates in our previous paper, although not enough to qualitatively change our inference. Adding the additional waves of data leads to a statistically significant estimate for hyperactivity and maintains the inference for anxiety and aggression. Also, the estimates are generally stable in magnitude across the two samples, except for aggression, which is just under 50 percent larger. In the last row is the estimated impact of the program on a measure of cognitive development—PPVT—at ages 4 and 5. We report a statistically significant decline of 11 to 14 percent of a standard deviation depending on the sample. This result, while consistent with Haeck, Lefebvre, and Merrigan (2015), is different than the estimate in Baker, Gruber, and Milligan (2008), which used a different age range.20The results in Table 1 demonstrate that the main conclusions of Baker, Gruber, and Milligan (2008) for young children of two-parent families extend to the full sample of young children from all family types, and persist as the program has matured. The Quebec program led to a substantial increase in the use of child care and increases in children’s levels of anxiety and aggression. We do not pursue analysis of heterogeneity for these contemporaneous outcomes, but Kottelenberg and Lehrer (2017) provides evidence of a positive boost to child development for children from disadvantaged, single- parent families, with more negative outcomes from two-parent families. In addition, Kottelenberg and Lehrer (2018) finds significant differences between boys and girls...."

“….We group the cohorts by the number of years of eligibility, ranging from 0 before 1993 birth year to 5 for those born in 2000 or later. The differences are negative, indicating lower accusation rates in Quebec than in the rest of Canada. The pattern across cohorts is striking— the gap between Quebec and the rest of Canada shrinks for the cohorts most exposed to eligibility for the Quebec program. In the online Appendix, we repeat the analysis for convictions and separately for four specific crime types with similar monotonic shifts across birth cohorts consistent with the degree of exposure. In Table 5, we formalize this inference with regression estimates. Column 1 presents the simple difference-in-differences results, controlling for fixed effects for province, year, age, and gender. In addition, we include a set of dummies for crime type in the pooled regression for all crime types. In column 2, a richer specification includes the full set of second-order interactions between province, age, and gender (and crime type in the aggregate rate regressions). Finally, in column 3, we add controls for province × year trends (and crime type × province × year in the aggregate rate regressions) to allow for province-specific trends. The estimates are generally consistent with the graphical evidence: exposure to the Quebec program leads to higher rates of crime. Looking first at all crime counts, the estimates from the simple difference-in-differences specification indicate increases in both the rates of accused and convictions that is statistically significant. The coefficient of 514 for accused is a 27 percent increase on the overall mean of 1,872 accusations per 100,000. The coefficient of 208 for convictions is of a similar magnitude relative to the mean conviction rate. This estimate for rates of accused does not change much when we add the second order province/age/gender interactions in the second column, but there is an increase in the estimates for convictions. In column 3, the estimate for accused falls but remains sizable and highly significant, while the estimate for convictions returns to the level seen in column 1. The estimates from the richest specifications indicate sizeable effects on crime rates. For accused across all categories, we estimate a rise of 353 per 100,000 children, compared to a mean of 1,872 accusations. This is a rise of 19 percent. The result is slightly higher in percentage terms for convictions at 22 percent. The remaining rows of the table show the results for each type of crime. The impact of exposure to the Quebec program is largest for property crime; the estimates from the richest specification show an increase in accusations of these crimes of 602 per 100,000 children, or 19 percent of the mean, and for convictions for these crimes of 342 per 100,000, or about 25 percent of the mean. The estimated impacts on other criminal code violations are almost as large. Slightly smaller are the estimated impacts on crimes against persons, at 16 percent of the mean for both accusations and convictions. Finally, the impact for drug crimes is 14 percent of the mean for accusations but over 23 percent of the mean for convictions... The estimates indicate larger absolute impacts on the crime rates for boys, particularly for other criminal code violations and drugs.28 In fact, in our richest specification, some of the estimates for girls are substantively smaller and lose some statistical significance. Therefore, the gender differences in the impacts of the Quebec program on crime rates line up with the gender differences in the impact of the program on noncognitive development...”

Noncognitive Outcomes, "...In Table 2, we present the results for noncognitive outcomes at ages 5-9. The details on each measure’s construction are provided in the online Appendix. We again normalize the noncognitive scores to have zero mean and unit standard deviation. The first four measures show that the Quebec program’s negative effects on noncognitive skills appear to strongly persist into school years, and in some cases are larger than at younger ages. For anxiety, the impact is now just over one quarter of a standard deviation, which is more than twice as large as for 2-3-year-olds, while for aggression, the estimate is very similar to the result for the younger age group. Hyperactivity shows an increase of 13 percent of a standard deviation. For the two new indices we see a statistically significant impact on indirect aggression of 19 percent of a standard deviation, while the result for pro-social behavior is very close to zero. For the older children, we also have an alternative measure of behavior: a parent- reported indication of how the child gets along with his/her teacher at school. The variable is coded 0/1, where one indicates the child gets along very well with his/her teacher (there are no problems). The estimate for this variable is in the last row of Table 2. It is consistent with the results for the noncognitive indices, indicating exposure to the Quebec program leads to a statistically significant worse outcome..”

The Core Evidence: