Fluctuations. Roberto Motto

Transcription

1 Financial Factors in Economic Fluctuations Lawrence Christiano Roberto Motto Massimo Rostagno

2 What we do Integrate t financial i frictions into a standard d equilibrium i model and estimate the model using Euro Area and US data. Asymmetric information and costly state verification (Townsend (1978), Bernanke-Gertler-Gilchrist (1999)) Endogenous determination of financial liabilities, like M1 and M3 (Chari-Christiano-Eichenbaum (1995)) Decompose 14 aggregate data series into shocks and propagation mechanisms: A new shock, a risk shock A new source of propagation: non-state contingent nominal rates of interest.

3 Outline Sketch the basic ingredients of the model. Results

4 Standard Model consumption Y t Firms 1 1 f,t Investment goods Yjt f,t dj,1 f,t, 0 Y jt t K jt z t l jt 1 Supply labor other t oil a u t K t G t C t I t,t Y t. Rent capital Households Backyard capital accumulation: K t 1 1 K t G i,t,ii t,ii t 1 u c,t E t c,t u c,t 1 k R t 1 t 1 k R t 1 1 r k u t 1r t 1 1 P k,t 1 P k,t

5 Assets: Financial Sector Working capital loans Loans to entrepreneurs for purchasing capital Liabilities: Provide utility to households Neoclassical bank production function Results: features on the liability side of banks do not add shocks or propagation to business cycle dynamics Features on the asset side do matter particularly loans to entrepreneurs

6 Entrepreneur Buys capital from capital producers using own resources and loans from bank Rents capital to intermediate good producers.

7 Banks, Households, Entrepreneurs ~F, t, E 1 entrepreneur entrepreneur Households Bank entrepreneur entrepreneur entrepreneur Standard debt contract

8 density Economic Impact of Risk Shock lognormal l distribution: ib ti 20 percent jump in standard deviation σ σ *1.2 Larger number of entrepreneurs in left tail problem for bank Banks must raise interest rate on entrepreneur Entrepreneur borrows less Entrepreneur buys less capital, investment drops, economy tanks idiosyncratic shock

9 Risk Shocks and News Finding: Economic effects of risk shocks operate Economic effects of risk shocks operate primarily via advance information, or news.

10 Risk Shock and News Assume log t log t 1 iid, Wold innovation in log t ut Agents have advance information about pieces of u t u t t t 1... t 8 i t i i ~iid, E t i 2 2 i i t i ~piece of u t observed at time t i

11 Monetary Policy Nominal rate of interest function of: Anticipated i t level l of inflation and change. Slowly moving inflation target. Deviation of output growth from ss path. Growth of credit in case of EA. Monetary policy shock.

12 Estimation EA and US data covering 1985Q1-2008Q2 Δ log per capita stock market index t P t GDP deflator inflation t log per capita hours t Δ log per capita credit t P t Δ log per capita GDP t Δ log Hourly compensation t P t Δ log per capita investment t X t Δ log per capita M1 t P t Δ log per capita M3 t P t Δ log per capita consumption t Risk Spread t R long e t R t R t e Δ log P It ) Δ log real oil price t per capita Bank Reserves t Δ log P t Standard Bayesian methods P

13 Summary of results Risk shocks: important source of fluctuations. news on the risk shock important. Assumption of state non-contingent interest rates has an important impact on shock propagation. Money demand d and inside id money: relatively unimportant as a source of shocks modest contribution to forecast ability Out-of-Sample evidence suggests the model deserves Out of Sample evidence suggests the model deserves to be taken seriously.

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16 Risk Shocks Important Why are they important? t? What shock do they displace, and why?

17 Figure: Year-over-year GDP Growth Rate - Data (black) versus what data would have been with only the risk shock US Risk shock important EA

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20 Variance Decomposition of Financial Shocks, US Data Important t for output and investment Very important for financial variables risk shock, t Output 19 Investment 38 Consumption 5 Risk Spread 97 RealVl Value of Stock Market 80

21 Although the data like signals on standard technology shocks, they prefer signals on risk.

22 Why Risk Shock is so Important A. Our econometric estimator thinks risk spread ~ risk shock. B. In the data: the risk spread is strongly negatively correlated with output. C. In the model: bad risk shock generates a response that resembles a recession. A+B+C suggests risk shock important.

23 Correlation (risk spread(t),output(t-j)), HP filtered data, 95% Confidence Interval The risk spread is significantly negatively correlated with output and leads a little. Notes: Risk spread is measured by the difference between the yield on the lowest rated corporate bond (Baa) and the highest rated corporate bond (Aaa). Bond data were obtained from the St. Louis Fed website. GDP data were obtained from Balke and Gordon (1986). Filtered output data were scaled so that their standard deviation coincide with that of the spread data.

24 Another Reason the Risk Shock is so Important Positive shock to risk triggers what looks Positive shock to risk triggers what looks like a recession

25 percent basis points percent percent percent percent US, Impulse Response to Riskiness Shock (contemporaneous) Credit procyclical, risk spread countercyclical Output Investment Consumption Real Net Worth Premium Risk spread (Annual (AR) Rate) Total Loans (Real)

26 What Shock Does the Risk Shock Displace, and why? The risk shock crowds out some of the role of the marginal efficiency of investment t shock.

27 Business Cycle Frequencies Model risk shock, t survival, t marginal efficiency of investment, it Output Baseline CEE-SW na na 46 Investment Baseline CEE-SW na na 91 Consumption Baseline CEE-SW na na 3 Risk shock appears Externalto Finance crowd out Premium the Baseline marginal 97 efficiency 3 of investment shock 0 CEE-SW na na na Real Value of Stock Market Baseline CEE-SW na na na

28 Why does Risk Crowd out Marginal Efficiency of Price of capital Investment? t? Supply shifter: marginal efficiency of investment, i,t Demand shifters: risk shock, t ; wealth shock, t Quantity of capital

29 Marginal efficiency of investment shock can account well for the surge in investment and output in the 1990s, as long as the stock market is not included in the analysis. When the stock market is included, d then explanatory power shifts to financial market shocks.

30 Variance Decomposition of Inside Money Shocks Business Cycle Frequencies Bank demand for excess reserves, t Bank technology shock, x t b Household money demand shock, t Output Investment Consumption Risk spread Real value of stock market Contribution to variance: trivial

31 Out of Sample RMSEs There is not a loss of forecasting power with the additional complications of the model. The model does well on everything, except the risk spread. Calculations for 1,2,,12 ahead forecasts: First date of forecast, 2001Q3 DSGE models re-estimated every other quarter BVAR re-estimated each quarter (standard Minnesota priors).

32 Other support for the model Model predicted default rates positively correlated with measures of default in the data Default Probability (lhs) Expected Default Probability, NFC (rhs) Q1 1993Q1 1996Q1 1999Q1 2002Q1 2005Q1 2008Q1

33 Our Measure of Idiosyncratic Risk, versus Bloom, et al Series1 Series4 Riskiness Shock (3-quarter MA) Cross-firms Sale Growth Spread (3-quarter MA) Q2 1986Q2 1991Q2 1996Q2 2001Q2 2006Q2 0.2

34 Conclusion Incorporating financial frictions changes inference about the sources of shocks and of propagation risk shock. New nominal rigidity: nominal non-state contingent interest rate Models with financial frictions can be used to ask interesting ti policy questions: When there is an increase in risk spreads, how should monetary ypolicy respond? How should monetary policy be structured to avoid excess asset market volatility? What are the pro s and con s of unconventional monetary policy?