International Credit Flows,

Transcription

1 International Credit Flows and Pecuniary Externalities Markus K. Brunnermeier & Princeton University International Credit Flows, Yuliy Sannikov Bank of International Settlement Basel, August 29 th, 2014

2 Motivation Old Washington consensus in decline Free trade: flow of goods/services intratemporal Free finance: flow of capital intertemporal When does full capital account liberalization reduce (capital controls/macropru regulation improve) welfare? 1. Liquidity mismatch can lead to sudden stop runs Technological illiquidity: Market illiquidity: Funding illiquidity: irreversibility (adjustment costs) redeployability/specificity not in this paper short-term debt, hot money Type of capital flow matters: FDI, portfolio flows (equity), long-term debt 2. Terms of trade hedge (Cole-Obstfeld) can be undermined when Industry s output is not easily substitutable. Consumers cannot easily find substitutes No strong competitors in other countries Natural resources: oil, copper for Chile, Hard drives in Thailand, Bananas in Ecuador 2

3 Asset side Motivation Old Washington consensus in decline Free trade: flow of goods/services intratemporal Free finance: flow of capital intertemporal When does full capital account liberalization reduce (capital controls/macropru regulation improve) welfare? 1. Sudden stop including runs due to liquidity mismatch Technological illiquidity: Market illiquidity: irreversibility (adjustment costs) redeployability/specificity not this paper Funding illiquidity: short-term debt, hot money Type of capital flow matters: FDI, portfolio flows (equity), long-term debt 2. Terms of trade hedge (Cole-Obstfeld) can be undermined when Industry s output is not easily substitutable. Consumers cannot easily find substitutes No strong competitors in other countries Natural resources: oil, copper for Chile, Hard drives in Thailand, Bananas in Ecuador 3

4 Liability Asset side Motivation Old Washington consensus in decline Free trade: flow of goods/services intratemporal Free finance: flow of capital intertemporal When does full capital account liberalization reduce (capital controls/macropru regulation improve) welfare? 1. Sudden stop including runs due to liquidity mismatch Technological illiquidity: Market illiquidity: Funding illiquidity: irreversibility (adjustment costs) redeployability/specificity not this paper short-term debt, hot money Type of capital flow matters: FDI, portfolio flows (equity), long-term debt 2. Terms of trade hedge (Cole-Obstfeld) can be undermined when Industry s output is not easily substitutable. Consumers cannot easily find substitutes No strong competitors in other countries Natural resources: oil, copper for Chile, Hard drives in Thailand, Bananas in Ecuador 4

5 Motivation Old Washington consensus in decline Free trade: flow of goods/services intratemporal Free finance: flow of capital intertemporal When does full capital account liberalization reduce (capital controls/macropru regulation improve) welfare? 1. Sudden stop including runs due to liquidity mismatch Technological illiquidity: Market illiquidity: Funding illiquidity: irreversibility (adjustment costs) redeployability/specificity not in this paper short-term debt, hot money Type of capital flow matters: FDI, portfolio flows (equity), long-term debt 2. Terms of trade hedge (Cole-Obstfeld) can be undermined when Industry s output is not easily substitutable. Consumers cannot easily find substitutes No strong competitors in other countries Natural resources: oil, copper for Chile, Hard drives in Thailand, Bananas in Ecuador 5

6 Model setup - symmetric Preferences E 0 e rt c 1 γ t 1 γ dt Same preference discount rate r saving out of constraint Two output goods y a and y b - imperfect substitutes y t = 1 2 y s 1 a t s + 1 s 1 s/(s 1) 2 y b s t (Comparative) advantages: Good a Good b Country A ak t ak t Country B ak t ak t 12

7 Two country/sector model World capital shares: ψ t Aa + ψ t Ab + ψ t Ba + ψ t Bb = 1 World supply of (output) goods: Y t a = ψ t Aa a + ψ t Ba a K t Y t b = ψ t Bb a + ψ t Ab a K t Price of output goods a and b in terms of price of y P t a = 1 2 Y t Y t a 1/s and Pt b = 1 2 Y t Y t b 1/s Terms of trade P t a /P t b 13

8 Two country/sector model Capital evolution for dk t = Φ ι t δ k t dt + σ A k t dz t A in country A dk t = Φ ι t δ k t dt + σ B k t dz t B in country B Φ concavity technological illiquidity Single type of capital Investment in composite good Shocks are Two dimensional Affect global capital stock dz t A + dz t B Redistributive (initial shock + amplification) affects wealth share, η t Example: Apple vs. Samsung lawsuit 14

9 Market structures Trade Finance Markets Complete Markets Full integration/first Best Open credit account (equity home bias) Closed credit account Output y a, y b Physical capital K Debt Equity X X X X X X X X X Add taxes/capital controls intratemporal intertemporal 15

10 Returns on physical capital dk t /k t = Φ ι t Postulate dq t /q t δ dt + σ A k t dz t A = μ t q dt + σ t qa dz t A + σ t qb dz t B Returns from holding physical capital Ito product rule: d X t Y t = dx t Y t + X t dy t + σ X σ Y dt dr t Aa = ap t a ι t q t + μ t q + Φ ι t δ + σ A σ t qa dt + + σ A + σ t qa dz t A + σ t qb dz t B dr t Ab = ap t b ι t q t + μ t q + Φ ι t δ + σ A σ t qa dt + + σ A + σ t qa dz t A + σ t qb dz t B 16

11 market structure specific For any market structure The 3 step solution procedure 1. Derive equilibrium conditions Optimality and asset pricing conditions (from postulated processes) Consumption with log-utility: c t = rn t (no precautionary savings) Asset pricing (from above) with log-utility: Sharpe Ratio of asset = volatility of net worth Internal investment rate ι t : qφ ι t 1 = 0 Market clearing conditions 2. Derive evolution of state variable η t = N t q t K t 3. Express in terms of ODE All μ postolated and σ postulated are expressed in terms of q (η), q (η), 17

12 Market structures Trade Finance Markets Complete Markets Full integration/first Best Open credit account (equity home bias) Closed credit account Output y a, y b Physical capital K Debt Equity X X X X X X X X X Add taxes/capital controls intratemporal intertemporal 22

13 Market structures 1. Complete markets First best 2. Incomplete markets (equity home bias) Levered short-term debt financing Sudden stops: (varying technological illiquidity) Amplification Runs due to sunspots 3. Closed capital account: capital controls (no equity, no debt) 4. Welfare analysis 23

14 1. Complete markets: First Best Remarks Perfect capital allocation + perfect risk sharing Prices are constant and independent of shocks Economy shrinks/expands with (multiplicative) shocks Elasticity of substitution, s, has no impact on prices 27

15 Market structures 1. Complete markets First best 2. Incomplete markets (equity home bias) Levered (short-term) debt financing Sudden stops: (varying technological illiquidity, irreversibility) Amplification Runs due to sunspots 3. Closed capital account: capital controls (no equity, no debt) 4. Welfare analysis 33

16 2. Equilibrium characterization: state variable Equilibrium is a map Histories of shocks {Z s A, Z s B, s t} prices allocation q t, ψ t Aa, ι t A, ι t B, ζ t A, ζ t B wealth distribution η t = N t q t K t 0,1 A s wealth share ψ Aa t + ψ Ab t + ψ Ba t + ψ Bb t = 1 and C A t + C B t = Y t ι t K t ψ Aa Portfolio weights: t, ψ Ab t, 1 ψ t Aa +ψ Ab t η t η t η t Consumption rates: ζ A t = C A t /N t ζ B t = C B t /(q t K t N t ) 35

17 2. State variable: 3 regions Wealth share η Three regions Full specialization A produces a Full specialization a a, b B produces a, b b b Symmetric 0 1 1/2 ψ t Aa = η t ψ t Bb = 1 η t ψ t Ba = ψ t Ab = 0 η 39

18 2. Capital share, terms of trade, price of capital Numerical: r = 5%, a = 14%, a = 4%, δ = 5%, κ = 2, σ A = σ B = 10% wealth share Three different elasticities of substitution: s = {.5,1, } 40

19 TOT: Supply vs. demand shock Supply versus demand shock TOT improve for A as η t declines for η t η,. 5 can be due to dz A < 0: Negative supply shock World recession dz B > 0: Positive demand shock World boom TOT: Output price but fire-sale of (physical) capital stock k t 41

20 2. Stability, Phoenix Miracle for different s Stationary distribution drift volatility Masspoint at {0,1} Phoenix miracle Three different elasticities of substitution: s = {.5,1, } wealth share Difference to Cole & Obstfeld 1994: persistence of capital, δ < 42

21 Overview 1. Complete markets First best 2. Incomplete markets (equity home bias) Levered short-term debt financing Sudden stops: (varying technological illiquidity) Amplification Runs due to sunspots 3. Closed capital account: capital controls (no equity, no debt) 4. Welfare analysis 44

22 2. Amplification σ t ηa = Aa ψ t (1 η η t ) t 1 [ψ t Aa η t ] q (η t) q η t σ A Leverage effect Loss spiral ψ Aa t /η t 1/{1 ψ Aa q t η η t t } q η t (infinite sum) Technological illiquidity (κ, δ) market illiquidity q η (dis)investment adjustment cost 46

23 2. Amplification leverage σ t ηa = Aa ψ t (1 η η t ) t 1 [ψ t Aa η t ] q (η t) q η t σ A Leverage effect Loss spiral ψ Aa t /η t 1/{1 ψ Aa q t η η t t } q η t (infinite sum) Technological illiquidity (κ, δ) market illiquidity q η (dis)investment adjustment cost 47

24 2. Amplification leverage σ t ηa = Aa ψ t (1 η η t ) t 1 [ψ t Aa η t ] q (η t) q η t σ A Market illiquidity (price impact) Leverage effect ψ t Aa /η t Loss spiral 1/{1 ψ t Aa η t q η t q η t } (infinite sum) chnological illiquidity (κ, δ) market illiquidity q η (dis)investment adjustment cost 48

25 2. Amplification leverage σ t ηa = Aa ψ t (1 η η t ) t 1 [ψ t Aa η t ] q (η t) q η t σ A Market illiquidity (price impact) Leverage effect ψ t Aa /η t Loss spiral 1/{1 ψ t Aa η t q η t q η t } (infinite sum) Technological illiquidity (κ, δ) market illiquidity q η (dis)investment adjustment cost 49

26 2. Technological (κ, δ) market illiquidity q η Quadratic adjustment cost Investment rate of Φ + 1 κ Φ2 generates new capital at rate Φ Φ ι = 1 κ 1 + 2κι 1 Three cases κ = 0 q = 1 κ = 2 κ ι<0 = 100 and κ ι>0 = 2 52

27 Sudden stops: amplification & runs Sudden stop Adverse fundamental triggers %-decline in debt that exceeds %-decline in net worth; (ψaa η) η > 1 ψ Aa > ψaa η ψ Aa η η η pro-cyclical leverage hyperbola 54

28 Sudden stops: amplification & runs Sudden stop Adverse fundamental triggers %-decline in debt that exceeds %-decline in net worth; (ψaa η) η > 1 ψ Aa > ψaa η ψ Aa η η η pro-cyclical leverage Slope of tangent vs. secant hyperbola 55

29 Sudden stops: amplification & runs Sudden stop Adverse fundamental triggers %-decline in debt that exceeds %-decline in net worth; (ψaa η) η > 1 ψ Aa > ψaa η ψ Aa η η η pro-cyclical leverage σ t Debt A = 1 + ψ t Aa η t / η t η t ψ t Aa η t + ψ t Aa η t (1 η t ) 1 [ψ t Aa η t ] q (η t) q η t σ A An unanticipated sunspot triggers a sudden capital price drop from q to q, accompanied by a drop in η to η. q η = max ηq + ψ Aa q q, 0 58

30 Sudden stops: amplification & runs Sudden stop Adverse fundamental triggers %-decline in debt that exceeds %-decline in net worth; (ψaa η) η > 1 ψ Aa > ψaa η ψ Aa η η η pro-cyclical leverage σ t Debt A = 1 + ψ t Aa η t / η t η t ψ t Aa η t + ψ t Aa η t (1 η t ) 1 [ψ t Aa η t ] q (η t) q η t σ A An unanticipated sunspot triggers a sudden capital price drop from q to q, accompanied by a drop in η to η. q = max ηq + ψaa q q, 0 hyperbola η 59

31 Sudden stop due to sunspot 60

32 Sudden stop due to sunspot: Zoomed in 61

33 Overview 1. Complete markets First best 2. Incomplete markets (equity home bias) Levered short-term debt financing Sudden stops: (varying technological illiquidity) Amplification Runs due to sunspots 3. Closed capital account: capital controls (no equity, no debt) 4. Welfare analysis 62

34 Market structures Trade Finance Markets Complete Markets Full integration/first Best Open credit account (equity home bias) Closed credit account Output y a, y b Physical capital K Debt Equity X X X X X X X X X Add taxes/capital controls intratemporal intertemporal 64

35 3. Credit account: open vs. closed r = 5%, a = 14%, a = 4%, δ = 5%, κ = 2, σ A = σ B = 10%, s = 1 Capital price lower Lower input price Destabilizes balance sheet 65

36 3. Credit account: open vs. closed r = 5%, a = 14%, a = 4%, δ = 5%, κ = 2, σ A = σ B = 10%, s = 1 More stability Less growth Phoenix miracle slightly smaller Stability 66

37 Overview 1. Complete markets First best 2. Incomplete markets (equity home bias) 3. Closed capital account: capital controls (no equity, no debt) 4. Welfare analysis Pecuniary externalities Welfare calculations + Pareto improving redistributions 68

38 4. When are credit flows excessive? Constrained inefficiency (in incomplete market setting) due to pecuniary externalities Price of capital: Price of output good: Price taking behavior undermined this hedge fire sale externality if leverage is high terms of trade hedge restrained competition shock automatic hedge Price taking behavior 69

39 4. When are credit flows excessive? Constrained inefficiency (in incomplete market setting) due to pecuniary externalities Price of capital: Price of output good: fire sale externality if leverage is high terms of trade hedge restrained competition Price taking behavior undermined this hedge Complete market insurance shock 70

40 4. Welfare comparison r = 5%, a = 14%, a = 4%, δ = 5%, κ = 2, σ A = σ B = 10%, Full specialization 75

41 4. Welfare comparison r = 5%, a = 14%, a = 4%, δ = 5%, κ = 2, σ A = σ B = 10%, Inefficiency at the extremes: Role for redistributive Policy default/bail-out/debt-relief Full specialization Pareto improving Intuition: Other country s output price is high 76

42 4. Welfare comparison r = 5%, a = 14%, a = 4%, δ = 5%, κ = 2, σ A = σ B = 10%, Full specialization 77

43 4. Welfare comparison Any monotone transformation of η would be equally good state variable Normalization: take CDF of η Uniform stationary distribution! 79

44 normative positive Conclusion Sudden stops Amplification of fundamental shock Runs due to sunspots vulnerability region Phoenix miracle Tradeoff between capital allocation & risk sharing Terms of trade hedge When are short-term credit flows excessive? When can capital controls (financial liberalization) be welfare enhancing (reducing)? Pecuniary externality Price of physical capital Price of output goods: fire-sales externality technological illiquidity terms of trade hedge externality Bailout/Restructuring Redistributive policy can be Pareto improving if one country is sufficiently balance sheet impaired Reduces output good price 83