Phases of Global Liquidity, Fundamentals News, and the Design of Macroprudential Policy (original) (raw)
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Fundamentals news, global liquidity and macroprudential policy
Journal of International Economics, 2015
We study optimal macroprudential policy in a model in which unconventional shocks, in the form of news about future fundamentals and regime changes in world interest rates, interact with collateral constraints in driving the dynamics of financial crises. These shocks strengthen incentives to borrow in good times (i.e. when "good news" about future fundamentals coincide with a low-world-interest-rate regime), thereby increasing vulnerability to crises and enlarging the pecuniary externality due to the collateral constraints. Quantitatively, an optimal schedule of macroprudential debt taxes can lower the frequency and magnitude of financial crises, but the policy is complex because it features significant variation across interest-rate regimes and news realizations.
The Macroeconomics of Financial Crises: How Risk Premiums and Liquidity Traps Affect Policy Options
International Advances in Economic Research, 2011
The paper shows that structural models of the IS-LM and Mundell-Fleming variety have a lot to tell about the macroeconomics of the current global crisis. In addition to demonstrating how the emergence of risk premiums in money and capital markets may drive economies into recessions, it shows the following: (1) Liquidity traps may occur not only when interest rates approach zero but at positive and/or rising rates as well; (2) Fiscal policy works even in a small, open economy under flexible exchange rates when the country is stuck in a liquidity trap; (3) Near the fringe of liquidity traps, the risk arises of perfect traps, in which neither monetary nor fiscal policy works when used in isolation, but policy coordination is called for; and (4) Massive financial crises in the domestic money market may even destabilize the economy.
Investigation of the dynamics between monetary and macroprudential policies
2016
This thesis studies the interaction between monetary and macroprudential policy using a DSGE model with real and financial frictions under government and financial shock scenarios. Countercyclical capital requirements are used as a macroprudential policy tool combined with a Taylor rule for monetary policy. In the case of the government shock, our findings indicate that policies' coordination reduces the volatility of the output vis-à-vis a "monetary policy only" regime. Analysis of financial shocks indicates that monetary policy alone can suffice to ensure financial stability. Lastly, welfare analysis suggests there is no optimal policy combination for all agents and highlights a redistributive effect of both shocks, showing that policy that is beneficial for one group of agents can decrease welfare for another.
A macroeconomic model of liquidity crises
2013
We develop a macroeconomic model in which liquidity plays an essential role in the production process, because firms have a commitment problem regarding factor payments. A liquidity crisis occurs when firms fail to obtain sufficient liquidity, and may be caused either by self-fulfilling beliefs or by fundamental shocks. Our model is consistent with the observation that the decline in output during the Great Recession is mostly attributable to the deterioration in the labor wedge, rather than in productivity. The government's commitment to guarantee bank deposits reduces the possibility of a self-fulfilling crisis, but it increases that of a fundamental crisis.
Applied Financial Economics, 2010
In this article, we investigate the hypothesis of efficiency of central bank intervention policies within the current global financial crisis. We firstly discuss the major existing interventions of central banks around the world to improve liquidity, restore investor confidence and avoid a global credit crunch. We then evaluate the short-term efficiency of these policies in the context of the UK, the US and the French financial markets using different modelling techniques. On the one hand, the impulse response functions in a Structural Vector Autoregressive (SVAR) model are used to apprehend stock market reactions to central bank policies. On the other hand, since these reactions are likely to be of an asymmetric and nonlinear nature, a two-regime Smooth Transition Regression-Generalized Autoregressive Conditional Heteroscedasticity (STR-GARCH) model is estimated to explore the complexity and nonlinear responses of stock markets to exogenous shifts in monetary policy shocks. As expected, our findings show strong repercussions from interest rate changes on stock markets, indicating that investors keep a close eye on central bank intervention policies to make their trading decisions. The stock markets lead monetary markets, however, when central banks are slow to adjust their benchmark interest rates.
The role of liquidity in financial crises
Available at SSRN 1268367, 2008
The purpose of this paper is to use insights from the academic literature on crises to understand the role of liquidity in the current crisis. We focus on four of the crucial features of the crisis that we argue are related to liquidity provision. The first is the fall of the prices of AAA-rated tranches of securitized products below fundamental values. The second is the effect of the crisis on the interbank markets for term funding and on collateralized money markets. The third is fear of contagion should a major institution fail. Finally, we consider the effects on the real economy.
Monetary and macro-prudential policies: an integrated analysis
2012
This paper studies monetary and macro-prudential policies in a simple model with both a nominal rigidity and a financial friction that give rise to price and financial stability objectives. We find that lowering the degree of nominal rigidity or increasing the strength of the interest rate response to inflation is always welfare increasing in the model, despite a tradeoff between price and financial stability that we document. Even though crises become more severe as the economy moves toward price flexibility, the cost of the nominal rigidity is always higher than the cost of the financial friction in welfare terms in the model. We also find that macro-prudential policy implemented by augmenting traditional monetary policy with a reaction to debt is always welfare increasing despite making crises more severe. In contrast, implementing macro-prudential policy with a separate tax on debt is always welfare decreasing despite making crises relatively less severe. The key difference lies in the behaviour of the nominal exchange rate, that is more depreciated in the economy with the tax on debt and increases the initial debt burden.
Monetary Policy, Financial Crises, and the Macroeconomy: Introduction
2017
The crisis of 2007/08 has debunked the widely held belief that economic crisis and depressions are a thing of the past as wishful thinking. The papers in this volume discuss some recently suggested measures for central banks’ responses to liquidity shortages and to the liquidity trap, methods for assessing the potential of crisis contagion via the interbank network, and the interaction between micro- and macro-prudential regulation. They compare different approaches for solving the Eurozone sovereign-debt problem and provide a new and intriguing explanation for rising income inequality. In this introduction, we survey these contributions and explain how they are related.
THE INTERACTION OF MONETARY AND MACROPRUDENTIAL POLICIES EXECUTIVE SUMMARY
The recent crisis showed that price stability does not guarantee macroeconomic stability. In several countries, dangerous financial imbalances developed under low inflation and small output gaps. To ensure macroeconomic stability, policy has to include financial stability as an additional objective. But a new objective demands new tools: macroprudential tools that can target specific sources of financial imbalances (something monetary policy is not well suited to do). Effective macroprudential policies (which include a range of constraints on leverage and the composition of balance sheets) could then contain risks ex ante and help build buffers to absorb shocks ex post. Experience and knowledge on the effectiveness of macroprudential policies, their calibrations, interactions among financial distortions and macroprudential tools, and interactions of those tools with monetary policy ones are still limited at this juncture. With this caveat in mind, the analysis in this paper provides the following findings:
Macro-prudential policy on liquidity: What does a DSGE model tell us?
Journal of Economics and Business, 2011
The financial crisis has led to the development of an active debate on the use of macro-prudential instruments for regulating the banking system, in particular for liquidity and capital holdings. Within the context of a micro-founded macroeconomic model, we allow commercial banks to choose their optimal mix of assets, apportioning these either to reserves or private sector loans. We examine the implications for quantities, relative non-financial and financial prices from standard macroeconomic shocks alongside shocks to the expected liquidity of banks and to the efficiency of the banking sector. We focus on the response by the monetary sector, in particular the optimal reserve-deposit ratio adopted by commercial banks over the business cycle. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold a greater stock of liquid assets, such as reserves, but also to provide incentives to increase the cyclical variation in reserves holdings as this acts to limit excessive procyclicality of lending to the private sector.