Debt constraints and monetary policy

In the present paper we show how simple monetary policies can mitigate real effects of credit frictions. We consider stationary overlapping generations economies in which consumers are not equally efficient in producing capital and cannot commit to repay loans. The presence of money in itself does not mitigate the real effects of credit frictions. Equilibrium allocations are generally not Pareto optimal unless the returns on money and capital production are identical for more productive consumers. However, printing money and distributing it to young consumers increase their incomes allowing young more productive consumers to produce more capital. Consequently money printing increases output.     

Endogenous risk in a DSGE model with capital-constrained financial intermediaries

This paper proposes a perturbation-based approach to implement the idea of endogenous financial risk in a standard DSGE macro-model. Recent papers, such as Mendoza (2010), Brunnermeier and Sannikov (2012) and He and Krishnamurthy (2012), that have stimulated the research field on endogenous risk in a macroeconomic context, are based on sophisticated solution methods that are not easily applicable in larger models. We propose an approximation method that allows us to capture some of the basic insights of this literature in a standard macro-model. We are able to identify an important risk-channel that derives from the risk aversion of constrained intermediaries and that contributes significantly to the overall financial and macroeconomic volatility.     

Introducing financial frictions and unemployment into a small open economy model

Which are the main frictions and the driving forces of business cycle dynamics in an open economy? To answer this question we extend the standard new Keynesian model in three dimensions: we incorporate financing frictions for capital, employment frictions for labor and extend the model into a small open economy setting. We estimate the model on Swedish data. Our main results are that (i) a financial shock is pivotal for explaining fluctuations in investment and GDP. (ii) The marginal efficiency of investment shock has negligible importance. (iii) The labor supply shock is unimportant in explaining GDP and no high frequency wage markup shock is needed.     

DSGE forecasts of the lost recovery

The years following the Great Recession were challenging for forecasters. Unlike other deep downturns, this recession was not followed by a swift recovery, but instead generated a sizable and persistent output gap that was not accompanied by deflation as a traditional Phillips curve relationship would have predicted. Moreover, the zero lower bound and unconventional monetary policy generated an unprecedented policy environment. We document the actual real-time forecasting performance of the New York Fed dynamic stochastic general equilibrium (DSGE) model during this period and explain the results using the pseudo real-time forecasting performance results from a battery of DSGE models. We find the New York Fed DSGE model’s forecasting accuracy to be comparable to that of private forecasters, and notably better for output growth than the median forecasts from the FOMC’s Summary of Economic Projections. The model’s financial frictions were key in obtaining these results, as they implied a slow recovery following the financial crisis.     

The implications of financial frictions and imperfect knowledge in the estimated DSGE model of the U.S. economy

In this paper, I study how alternative assumptions about expectation formation can modify the implications of financial frictions for the real economy. I incorporate a financial accelerator mechanism into a version of the Smets and Wouters (2007) DSGE framework and explore the properties of the model assuming, on the one hand, complete rationality of expectations and, alternatively, several learning algorithms that differ in terms of the information set used by agents to produce the forecasts. I show that the implications of the financial accelerator for the business cycle may vary depending on the approach to modeling the expectations. The results suggest that the learning scheme based on small forecasting functions is able to amplify the effects of financial frictions relative to the model with Rational Expectations. Specifically, I show that the dynamics of real variables under learning is driven to a significant extent by the time variation of agents’ beliefs about financial sector variables. During periods when agents perceive asset prices as being relatively more persistent, financial shocks lead to more pronounced macroeconomic outcomes. The amplification effect rises as financial frictions become more severe. At the same time, a learning specification in which agents use more information to generate predictions produces very different asset price and investment dynamics. In such a framework, learning cannot significantly alter the real effects of financial frictions implied by the Rational Expectations model.     

The federal funds market,excess reserves,and unconventional monetary policy

Following the bankruptcy of Lehman Brothers, interbank borrowing and lending dropped, whereas reserve holdings of depository institutions skyrocketed, as the Fed injected liquidity into the U.S. banking sector. This paper introduces bank liquidity risk and limited market participation into a real business cycle model with ex ante identical financial intermediaries and shows, in an analytically tractable way, how interbank trade and excess reserves emerge in general equilibrium. Investigating the role of the federal funds market and unconventional monetary policy for the propagation of aggregate real and financial shocks, I find that federal funds market participation is irrelevant in response to standard supply and demand shocks, whereas it matters for “uncertainty shocks”, i.e. mean-preserving spreads in the cross-section of liquidity risk. Liquidity injections by the central bank can absorb the effects of financial shocks on the real economy, although excess reserves might increase and federal funds might be crowded out, as a side effect.     

Active intermediation in a monetary overlapping generations economy

This paper establishes that the profit-seeking activities of private intermediaries can ensure Pareto efficiency in the standard pure-exchange monetary overlapping generations economy without the need for government monetary or fiscal policy intervention. Moreover, these profit-seeking activities are shown to rule out all aperiodic and k-periodic cycles for k greater than 2. Contrary to much recent work on intermediation, the profit opportunities that arise for intermediaries in this context are not due to assumed frictions or asymmetric information. Rather, they are due to the dynamic open-ended structure of the economy, which permits debt roll-over.     

Forecasting the UK economy: Alternative forecasting methodologies and the role of off-model information

How did DSGE model forecasts perform before, during and after the financial crisis, and what type of off-model information can improve the forecast accuracy? We tackle these questions by assessing the real-time forecast performance of a large DSGE model relative to statistical and judgmental benchmarks over the period from 2000 to 2013. The forecasting performances of all methods deteriorate substantially following the financial crisis. That is particularly evident for the DSGE model’s GDP forecasts, but augmenting the model with a measure of survey expectations made its GDP forecasts more accurate, which supports the idea that timely off-model information is particularly useful in times of financial distress.     

The effects of financial openness and financial efficiency on Chinese macroeconomic volatilities

This paper builds an open-economy DSGE model to study the effects of financial openness and financial efficiency on the macroeconomic volatilities and estimate the model with the Bayesian method and Chinese quarterly data from 2001Q1 to 2017Q4. We further test the validity of model predictions with panel analyses of Chinese provincial data from 1987 to 2016 and various robustness tests. The results show that: first, further financial openness will lead to an increase in output volatility but U-shaped changes in consumption and investment volatilities. Second, financial efficiency improvement helps to reduce the macroeconomic volatilities but has a diminishing marginal benefit. Third, our estimates of China's degree of financial openness and financial efficiency are both at the medium level close to the thresholds. It implies that further financial openness will dramatically increase the macroeconomic volatilities but whether financial efficiency improvement can mitigate instability is uncertain.     

金融危机背景下美联储的非常规货币政策操作

面对金融危机,关联储不仅非常规地使用传统货币政策工具,而且还采取大量激进的非常规措施,通过购买各种证券向市场注入流动性以及运用信息沟通引导市场预期降低长期借贷成本的方式缓解金融市场紧缩局面。非常规货币政策是应对非常时期的非常措施,随着经济的复苏,各国经济刺激政策如何寻找安全退出路径是这一时期全球央行的主要任务。     

Optimal monetary policy rules,financial amplification,and uncertain business cycles

This paper studies optimal monetary policy in the presence of ‘uncertainty’, time-variation in cross-sectional dispersion of firms׳ productive performance. Using a model with financial market imperfections, the results suggest that (i) optimal policy is to dampen the strength of financial amplification by responding to uncertainty (at the expense of creating mild degree of fluctuations in inflation). (ii) Higher uncertainty makes the welfare-maximizing planner more willing to relax financial constraints. (iii) Credit spreads are a good proxy for uncertainty. Hence, a non-negligible response to credit spreads – together with a strong anti-inflationary policy stance – achieves the highest aggregate welfare possible.     

Taking financial frictions to the data

We estimate a Dynamic Stochastic General Equilibrium (DSGE) model with various financial frictions and analyze how well the model explains the Great Recession. Predictive analysis shows that the model can only slightly better explain the large deviation from trend during the crisis relative to a model without financial frictions. Specifically, the risk premium shock, which is a shock to the external finance premium of the entrepreneurs׳ leverage, explains the largest part of the investment downfall during the crisis. However, the ‘balance sheet’ channel of financial frictions in the model, which structurally links balance sheet conditions of financial intermediaries and nonfinancial borrowers to their borrowing rates, is estimated to be weak. We examine alternative prior specifications for how the financial frictions enter the model and continue to find a limited role for these frictions. Rolling-window estimation provides evidence for substantial time variation in parameters governing financial frictions. We conclude that the well-known financial frictions studied in this paper are not able to explain the financial crisis in a linearized and estimated model.     

The effective of China's monetary policy: Quantity versus price rules

This paper deduces an open economic DSGE model and explores two monetary policy rules for China, the quantity and price rule. The empirical results indicate that (1) monetary policy with money supply as instrument seems increasingly difficult to conduct in China than before, (2) the linkage between money supply and output becomes weaker over time, and (3) the effects of a price rule on the economy seem to have become more significant than those of a quantity rule. The findings seem to favor the government’s intention of liberalizing interest rates and making a more active use of the price instrument as the economy becomes more market-oriented in recent years.     

Slow recoveries: Any role for corporate leverage?

This paper examines whether financial conditions of the non-financial corporate sector can explain why the recovery from recessions in the United States is slower since the mid-1980s. Leverage by the corporate sector has increased significantly since the financial deregulation of the mid-1980s. Empirical evidence shows that slow recoveries are associated with a significant drop in the growth rates of investment and bank loans, and with a surge in the growth rates of corporate bonds. In an estimated dynamic stochastic general equilibrium model with a financial accelerator, counterfactual experiments based on estimates of two samples – 1965–1983 and 1984–2007 – show that the non-financial corporate indebtedness affects only marginally the speed of the recovery in the two samples.     

Optimal dividend policy with random interest rates

Several recent papers have studied the impact of macroeconomic shocks on the financial policies of firms. However, they only consider the case where these macroeconomic shocks affect the profitability of firms but not the financial markets conditions. We study the polar case where the profitability of firms is stationary, but interest rates and issuance costs are governed by an exogenous Markov chain. We characterize the optimal dividend policy and show that these two macroeconomic factors have opposing effects: all things being equal, firms distribute more dividends when interest rates are high and less when issuing costs are high.     

The role of banks in the monetary policy transmission in the new EU member states

This paper aims to enrich the knowledge on the monetary policy transmission mechanism in the new European Union member states with empirical evidence on the impact of monetary policy on bank lending. This work is based on individual bank balance sheet data and covers a sample of commercial banks from 10 Central and Eastern European countries over the period 1998–2006. We follow the approach suggested by Kashyap and Stein (1995) and control for cross-section heterogeneities among banks. The results indicate the existence of asymmetric adjustment of loan quantities with respect to specific bank characteristics. Our findings indicate the existence of a functioning bank-lending channel through small banks. This applies in the short-run to several, but not all, of the analysed banks.     

The impact of credit and fiscal policy under a liquidity trap

This study examines the interaction of non-conventional credit policy and fiscal policy when adverse financial conditions drive the economy to a deep contraction and conventional monetary policy becomes ineffective as the policy interest rate reaches its effective lower bound. Consistent with other studies, under counter-cyclical financial intermediation costs, credit easing policies aimed at reducing credit spread ameliorate the response of the economy and lead to a faster recovery. More importantly, I find that expansionary fiscal policy during an episode of liquidity trap is associated with a large multiplier effect that prevents an otherwise deeper and longer recession. Moreover, the large impact of expansionary fiscal policy is maintained even if credit policy is already in place.     

Identifying credit demand,financial intermediation,and supply of funds shocks: A structural VAR approach

In this paper, we identify three exogenous shocks to credit market: demand for credit, supply of funds into the financial system, and the willingness to lend of financial institutions (financial intermediation), and also, determine the contribution of these shocks to fluctuations in the credit market and overall economic activity. We estimate a structural vector autoregression model where the three credit shocks are identified with a set of sign restrictions motivated by a simple partial equilibrium model of financial intermediation. We find that the credit demand shock explains significantly the variations in the long-term loan rate proxied by the Moody’s Baa corporate bond yield, while the supply of funds shock contributes to most of the fluctuations in the short-term commercial paper rate. The financial intermediation shock drives most of the fluctuations in the quantity of loans as well as the spread between the Baa and commercial paper rates. Of the credit shocks, we find that the financial intermediation shock has the largest impact on real economic activity. In fact, our analysis implies that the sharp decline in output during the 2007–2009 financial crisis is largely attributable to the financial intermediation shock, along with shocks originating outside of the financial system.     

Coordination and non-coordination risks of monetary and macroprudential authorities: A robust welfare analysis

This study compares a central bank’s leaning against the wind approach with a mix of monetary and macroprudential policies under parameter uncertainty in an estimated DSGE model with two financial frictions. We show that uncertainty of the economic environment is an essential constituent in properly designing macroprudential policy. Although coordination between monetary and macroprudential policies minimizes the policymakers’ Bayesian risk, coordination and non-coordination risks threaten the goals of both authorities. The former describes the situation where the authorities partly resign from implementing the monetary policy objectives to stabilize macroprudential risk. The latter is when conducting a non-coordinated macroprudential policy induces higher total Bayesian risk than when only the central bank minimizes the expected total welfare loss. The robust Bayesian macroeconomic rules show that when financial shocks shrink the banks’ or entrepreneurial net worth, a contractionary macroprudential policy should be combined with an expansionary monetary policy. However, if capital adequacy ratio or risk shocks strike the economy, such a conflict in macroeconomics policy instruments disappears, thus synchronizing both policies.     

Search frictions,real wage rigidities and the optimal design of unemployment insurance

In this paper, we study the optimal unemployment benefits financing scheme when the economy is subject to labor market imperfections characterized by real wage rigidities and search frictions. The US unemployment insurance financing is such that firms are taxed proportionately to their layoffs to finance unemployment benefits. Using DSGE methodology, we investigate how policy instruments should interact with labor market imperfections. It is shown that wage rigidities in a search and matching environment cause welfare costs, especially in the absence of an incentive-based unemployment insurance. This cost is mainly due to the distorting effect of wage rigidities which generate inefficient separations. We show that the optimal unemployment benefits financing scheme – corresponding to the Ramsey policy – offsets labor market imperfections and allows implementation of the Pareto allocation. The second-best allocation brings the economy close to the Ramsey allocation. The implementation of the optimal policies clearly highlights the role of labor market institutions for short-run stabilization.