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Incorpora(ng Financial Stability in Policy Analysis
Garcia Cicco et al. Discussion by
Michael B. Devereux
BIS-‐CCA Research Network Conference Mexico City Jan 28/29, 2015
Discussion of project • Document describes a basic OE NK model with FF and reports results of es(ma(on and simula(on of similar shocks for – Chile, Columbia, Mexico and Peru – Adapts NK-‐FF model to incorporate commodity effects
• Ambi(ous and highly produc(ve project – Document reveals a huge coordinated effort that has already borne fruit
– Substan(al coherence in policy frameworks • Reconcilia(on of models needs to be done
– Promises to offer major insights into monetary and macro-‐pruden(al policy for LAM
Discussion
• Model and es(ma(on too detailed to get into the nuts and bolts
• More general comments, quibbles, sugges(ons, observa(ons
Plan of discussion
• Discuss the basic modeling template used – Compare with other FF models
• Implica(ons for macro-‐pruden(al policy • Comment on assump(ons about financial market structure
• Comment on nature of capital flows • Sugges(on for extending the model to a richer theory of interna(onal financial intermedia(on
How does model compare with other FF models?
The current model (assuming only one intermediary)
Budget constraint of household
Ct + (1 +⌥t)Dt + Bt = WtHt + ⇤t + RDt Dt�1 + RtBt
⌥t = ⌥⇣QtKt+1
Nt
⌘�is external to household and ⌥
0() > 0.
Nt is intermediaries net worth.
Gives a spread on loan rate over the safe government rate
RDt = (1 +⌥t)Rt
Intermediaries borrow and lend at same rate
RKt+1 = RDt
Models with explicit intermediation structure (e.g.
Gertler Karadi)
Enforcement constraint Nt � QtKt+1
Equilibrium spread is
RKt+1 � RDt � �(
QtKt+1
Nt)
�0() > 0
Intermediaries choose deposits and investment subject to
enforcement constraint (spread is internalized).
Conclusion in simula(on
• Has very similar aggregate IRFs
0 5 10 15 20 25 30 35 400
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8Spread
GKACMRBC
Calibrate so shock to spread is the same (here a TFP shock)
0 5 10 15 20 25 30 35 40−1.8
−1.6
−1.4
−1.2
−1
−0.8
−0.6
−0.4
−0.2
0Capital Stock
GKACMRBC
Both models have a financial accelerator which looks alike
Conclusion in simula(on
• Has very similar aggregate IRFs
• Does this mean it has same implica(ons for macro-‐pruden(al policies?
• Perhaps not? – Contract structure in financial intermedia(on may be very important for response to pruden(al regula(on
With externali(es
Individual return
Aggregate Return
Investment
Example: with explicit balance sheet effects, decisions may lead to more risk-‐taking with no-‐loss guarantees
(may show up only at higher order approx. though)
Aggregate Distribu(on
Individual Distribu(on
Guarantee
Some more comments on the model
• Domes(c Households have full access to domes(c bank deposits, government securi(es and foreign bonds
• Is this reasonable for the countries involved? • Maybe not – Measures of financial market access for these countries are far lower than for high-‐income countries
– See following graph
0
10
20
30
40
50
60
70
80
90
100
Peru Mexico Columbia Chile High Income
*Global Findex Database, World Bank
Adults with Account at Financial Ins<tu<on
Male
Female
How much difference could this make?
• Perhaps a lot – Response to external interest rate shocks may differ (see below)
– Ability to ac(vely use sterilized interven(on – May affect the dynamics of financial accelerator?
• Also, the extent of `financial inclusion’ may affect the conduct of monetary policy – See recent BIS wp by Mehrotra and Yetman 2015
Interest rate shocks for Chile and Colombia
• Expansionary, as in Mundell Fleming model Figure 5: Impulse responses to a foreign interest rate shock: Chile.
10 20 30 40−5
0
5
10x 10−3 R!
! y
10 20 30 400
2
4
6
8x 10−3 R!
! c
10 20 30 40−0.02
−0.01
0
0.01
0.02R!
! i
10 20 30 40−0.5
0
0.5
1R!
! !c, a.b.p.
10 20 30 40−0.5
0
0.5
1R!
! R, a.b.p.
10 20 30 40−0.05
0
0.05
0.1
0.15R!
! q
10 20 30 400
0.02
0.04
0.06R!
! a
10 20 30 40−0.01
0
0.01
0.02R!
! l
10 20 30 40−0.05
0
0.05
0.1
0.15R!
! spr, a.b.p.
10 20 30 40−0.02
0
0.02
0.04R!
! levE
10 20 30 40−0.02
0
0.02
0.04R!
! levB
10 20 30 40−0.06
−0.04
−0.02
0R!
! rcap
10 20 30 40−0.01
0
0.01
0.02R!
! ltv
10 20 30 400
0.02
0.04
0.06
0.08R!
! R!
No MPPβcap=−50
βcap=−500
βltv=50
βltv=500
Note: This figure shows the impulse responses of selected variables to a 1% foreign interest rate shock in period 1. Theimpulse responses are computed at the posterior mean of the estimated parameters when the only policy variable at workis the short-term interest rate (“No MPP”) and when in conjunction to the policy rate capital requirements and LTVlimits are used (using one instrument at the time) according to the feedback rule INST
t
= INST+�(VARt
�VAR), whereINST
t
and VARt
are the alternative policy instruments and the variable to react, respectively, in logs. In this case, VARt
is the total credit spread.
[4] Henrıquez, C. (2008), “Capital Stock in Chile (1985-2005): Methodology and Results” (in Spanish),Studies in Economic Statistics 63, Central Bank of Chile.
[5] Medina, J. P., and C. Soto (2007), “The Chilean Business Cycles Through the Lens of a StochasticGeneral Equilibrium Model,” Central Bank of Chile Working Papers 457.
[6] Roberts, G. O., A. Gelman, and W. R. Gilks (1997), “Weak convergence and optimal scaling of randomwalk Metropolis algorithms,” Annals of Applied Probability, vol. 7(1), pp. 110–120.
11
Figure 4: Impulse responses to a negative commodity price shock: Colombia.
10 20 30 40-0.1
0
0.1
0.2
0.3pCo!
! y
10 20 30 40-0.7
-0.6
-0.5
-0.4
-0.3
-0.2pCo!
! c
10 20 30 40-1
-0.5
0
0.5
1pCo!
! i
10 20 30 402
4
6
8
10
12
14
16pCo!
! !c, a.b.p.
10 20 30 400
5
10
15
20pCo!
! R, a.b.p.
10 20 30 401
1.5
2
2.5
3
3.5pCo!
! q
10 20 30 40-5.5
-5
-4.5
-4
-3.5
-3
-2.5
-2pCo!
! a
10 20 30 40-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1pCo!
! l
10 20 30 40-40
-30
-20
-10
0
10pCo!
! spr, a.b.p.
10 20 30 40-2
-1.5
-1
-0.5
0
0.5pCo!
! levE
10 20 30 40-1
-0.5
0
0.5
1
1.5
2pCo!
! levB
10 20 30 40-6
-5
-4
-3
-2
-1
0pCo!
! rcap
10 20 30 40-2
0
2
4
6
8pCo!
! ltv
10 20 30 40-120
-100
-80
-60
-40
-20
0pCo!
! pCo!
No MPP
"cap
=10
"cap
=100
"ltv
=-10
"ltv
=-100
Note: This figure shows the impulse responses of selected variables to a negative one-standard deviation
commodity price shock in period 1. The impulse responses are computed at the posterior mean of the
estimated parameters when the only policy variable at work is the short-term interest rate (“No MPP”)
and when in conjunction to the policy rate capital requirements and LTV limits are used (using one
instrument at the time) according to the feedback rule INSTt
= INST+ �(VARt
�VAR), where INSTt
and VARt
are the alternative policy instruments and the variable to react, respectively, in logs. In this
case, VARt
is real credit.
10
Solu(ons?
• Incorporate working capital, as in Neumeyer-‐Perri (2004)?
• Can easily combine into a model with financial fric(ons – Mendoza 2010, etc.
• But more generally, financial linkages may be much more complicated?
Financial linkages
• Banks here all financed with domes(c deposits
• Three implica(ons – No direct exposure to currency risk due to maturity mismatch
– No direct vulnerability to external funding shocks (global financial cycle)
– With foreign funding of banks, gross capital flows may mager
Restricted
3/10
home jurisdictions. Therefore, much of intraregional bank expansion, both in the
Southern Cone as well as in Central American countries, has tended to reflect
corporate banking activities. Against this background, trade was cited as an
important driver in the Latin American region as well. However, with only about a
quarter of trade flows being intraregional, compared to about half in Asia, the pace
of accompanying financial integration among Latin American economies has been
slower. The integration process has also been more concentrated, with Brazilian and
Colombian banks being among the most regionally active institutions, given the
rising regional presence of large corporates from both countries.
Among the other important drivers mentioned at both workshops was
macroeconomic and institutional convergence, with a broad trend towards better
institutions, more predictable policies and independent central banking facilitating
banks’ cross-border expansion. In Latin America, in particular, workshop participants
highlighted that South-South macroeconomic integration continued to be on the
rise, as illustrated by FDI flow patterns, and that this would tend to support financial
integration. In addition, participants at both workshops mentioned the (temporary,
in some cases) retrenchment of advanced economy banks from non-core EME
locations and business lines as a key catalyst for the most recent round of
intraregional bank expansion. Saturation of domestic markets and various “soft”
factors (such as geographical and cultural proximity) were also highlighted as
additional determinants of regional expansion.
Bank credit to Latin America and the Caribbean Graph 1B
International claims on the region1
USD bn
Share in international claims on the region
Per cent
1 Sum of all cross-border claims and locally extended claims in foreign currency.
2 Intraregional share is the sum of international claims
on the emerging Latin America and Caribbean region of regional banks (Brazil, Chile and Mexico) and Caribbean offshore banks (Panama)
divided by total international claims on the emerging Latin America and Caribbean region.
Source: BIS consolidated banking statistics (immediate borrower basis).
Constraints on further regionalisation. Private sector participants at both
workshops stressed that achieving meaningful growth in foreign markets can be
very challenging. One of the reasons why participants thought regional integration
would likely be slower, and more selective on a country-by-country basis, than
anticipated in the CGFS report was the risk of uneven regulatory implementation
0
100
200
300
400
500
02 03 04 05 06 07 08 09 10 11 12 13 14Intraregional banks2
US banksUK banksOther reporting banks
Swiss banksOther euro area banksSpanish banks
0
6
12
18
24
30
02 03 04 05 06 07 08 09 10 11 12 13 14Intraregional banks2
US banksUK banks
Swiss banksOther euro area banksSpanish banks
Chile: Gross Inflows/Ouilows (IFS)
-‐0.1
-‐0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
2005Q1 2006Q3 2008Q1 2009Q3 2011Q1 2012Q3
Inflows
Ouilows
Model with explicit role for gross flows, foreign intermediaries
• Devereux and Lombardo, 2015 • Global banks – funding for emerging market banks – Balance sheet constraints at both levels
• US policy shocks affect BS of global banks, reduce lending to EME banks, shrinking in BS for both – Coordinated increase in spreads
• Similar to Bruno and Shin 2014
GDP response: With financial fric(ons at both levels, policy (ghtening in US causes a global downturn Without FF, does not
−0.0698
−0.0506
−0.0314
−0.0122
0.007GDP C
−0.1091
−0.0743
−0.0395
−0.0048
0.03GDP E
−0.0196
−0.0078
0.004
0.0158
0.0276Real Exchange Rate
−0.0936
−0.0677
−0.0418
−0.016
0.0099Banks Total Assets C
−0.1058
−0.0697
−0.0336
0.0025
0.0386Banks Debt E
−0.1598
−0.1098
−0.0597
−0.0097
0.0403Households NFA
BenchmarkNo FFPegLCD
Policy Shock C
−0.0698
−0.0506
−0.0314
−0.0122
0.007GDP C
−0.1091
−0.0743
−0.0395
−0.0048
0.03GDP E
−0.0196
−0.0078
0.004
0.0158
0.0276Real Exchange Rate
−0.0936
−0.0677
−0.0418
−0.016
0.0099Banks Total Assets C
−0.1058
−0.0697
−0.0336
0.0025
0.0386Banks Debt E
−0.1598
−0.1098
−0.0597
−0.0097
0.0403Households NFA
BenchmarkNo FFPegLCD
Policy Shock C
Contrac(on in Capital inflows and ouilows Fall in capital inflows to EM banks Fall in capital ouilows to US US dollar denomina(on makes a difference
−0.0698
−0.0506
−0.0314
−0.0122
0.007GDP C
−0.1091
−0.0743
−0.0395
−0.0048
0.03GDP E
−0.0196
−0.0078
0.004
0.0158
0.0276Real Exchange Rate
−0.0936
−0.0677
−0.0418
−0.016
0.0099Banks Total Assets C
−0.1058
−0.0697
−0.0336
0.0025
0.0386Banks Debt E
−0.1598
−0.1098
−0.0597
−0.0097
0.0403Households NFA
BenchmarkNo FFPegLCD
Policy Shock C
−0.0698
−0.0506
−0.0314
−0.0122
0.007GDP C
−0.1091
−0.0743
−0.0395
−0.0048
0.03GDP E
−0.0196
−0.0078
0.004
0.0158
0.0276Real Exchange Rate
−0.0936
−0.0677
−0.0418
−0.016
0.0099Banks Total Assets C
−0.1058
−0.0697
−0.0336
0.0025
0.0386Banks Debt E
−0.1598
−0.1098
−0.0597
−0.0097
0.0403Households NFA
BenchmarkNo FFPegLCD
Policy Shock C
−0.1186
−0.0854
−0.0521
−0.0189
0.0144Asset Price C
−0.4151
−0.3011
−0.1872
−0.0732
0.0408Asset Price E
−0.0821
0.0542
0.1905
0.3268
0.4631Leverage C
0.0249
0.3458
0.6668
0.9878
1.3087Leverage E
−2.3456
3.0807
8.5071
13.9334
19.3597x 10−3 spread C
0
0.0205
0.0409
0.0614
0.0818spread E
BenchmarkNo FFPegLCD
Policy Shock C
−0.1186
−0.0854
−0.0521
−0.0189
0.0144Asset Price C
−0.4151
−0.3011
−0.1872
−0.0732
0.0408Asset Price E
−0.0821
0.0542
0.1905
0.3268
0.4631Leverage C
0.0249
0.3458
0.6668
0.9878
1.3087Leverage E
−2.3456
3.0807
8.5071
13.9334
19.3597x 10−3 spread C
0
0.0205
0.0409
0.0614
0.0818spread E
BenchmarkNo FFPegLCD
Policy Shock C
You also get a common increase in spreads, in both core and periphery
Implica(ons
• Poriolio posi(ons and gross flows may be important in environment of financial fric(ons
Implica(ons for policy?
• Op(mal coopera(ve monetary policy can sharply reduce co-‐movement of financial shocks
−4.0562
−2.9368
−1.8175
−0.6981
0.4212x 10−3 GDP−E
−1.5881
−0.6241
0.3399
1.3039
2.2679x 10−3 GDP−C
−9.18
−6.0836
−2.9872
0.1092
3.2056x 10−4 RER
−4.1758
−2.9414
−1.7071
−0.4727
0.7616x 10−3 Bank Assets C
5 10 15 20 25 30 35 40−4.1126
−2.9983
−1.8839
−0.7696
0.3447x 10−3 Bankdebt E
5 10 15 20 25 30 35 40−10.1023
−7.7237
−5.3451
−2.9666
−0.588x 10−3 Household NFA−E
Financial Shock C: Solid=Benchmark; Dashed=Ramsey
−4.0562
−2.9368
−1.8175
−0.6981
0.4212x 10−3 GDP−E
−1.5881
−0.6241
0.3399
1.3039
2.2679x 10−3 GDP−C
−9.18
−6.0836
−2.9872
0.1092
3.2056x 10−4 RER
−4.1758
−2.9414
−1.7071
−0.4727
0.7616x 10−3 Bank Assets C
5 10 15 20 25 30 35 40−4.1126
−2.9983
−1.8839
−0.7696
0.3447x 10−3 Bankdebt E
5 10 15 20 25 30 35 40−10.1023
−7.7237
−5.3451
−2.9666
−0.588x 10−3 Household NFA−E
Financial Shock C: Solid=Benchmark; Dashed=Ramsey
Benchmark vs. Ramsey policy
Other issues
• Fiscal side is minimized – Interac(on between commodity cycle and fiscal balances may be important for some countries
– How pro-‐cyclical is fiscal policy? • Need to incorporate commodity sector more explicitly into consump(on and investment sectors? – There may be important distribu(onal effects of commodity shocks • across sectors and regions
Big picture issues
• Allowing for risk, non-‐lineari(es, crises, sudden stops – May be very important for evalua(on of macro-‐pruden(al policy
– More easily done in small models – But some results with full mul(-‐country DSGE models • Devereux and Yu, 2015
Conclusions
• All these sugges(ons are more for general background
• Current project has made major strides • Look forward to seeing future developments
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