Asset Price Bubbles and Monetary Policy in a Small Open Economy

Transcription

1 Asset Price Bubbles and Monetary Policy in a Small Open Economy Martha López Central Bank of Colombia Sixth BIS CCA Research Conference 13 April 2015 López (Central Bank of Colombia) (Central A. P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 1 / 24

2 López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 2 / 24 Outline 1 Motivation 2 Bernanke-Gertler Closed Economy Model 3 Small Open Economy Model 4 Summary

3 Motivation Motivation The liberalization of financial markets and the globalization of capital markets have improved the provision of financial services and the allocation of resources But they have also related to more pronounced financial cycles. Financial cycles have usually came hand in hand with strong movements in asset prices, some times ending in banking and exchange market crises. This scenario is an especial concern for policy makers. López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 3 / 24

4 Motivation López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 4 / 24 Asset prices and net capital inflows

5 Motivation Goals Bernanke and Gertler (1999) address the question of how central bankers ought to respond to asset price volatility, in the context of an overall strategy for monetary policy Their findings show that it should not react to asset prices per se. I extended their model to account for capital inflows and real exchange rate appreciation in the context of a small open economy model (SOEM). I have two main goals: Analyze if the conclusions of Bernanke and Gertler (1999) remain in the case of a SOEM Compare the results in terms of macroeconomic volatillity of the case of a CEM versus the SOEM. López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 5 / 24

6 Bernanke-Gertler Closed Economy Model Bernanke-Gertler Model: Closed Economy Model (CEM) The model is a DSGE new Keynesian model with financial frictions and an exogenous bubble. Agents Household sector: infinitely lived and decide labor supply, consumption and savings. Business sector: Enterpreneurs (investment decisions, wholesale goods and adcquisition of capital) Retailers (differentiate the wholesale good and make price setting a la Calvo). Government (conducts fiscal and monetary policy) López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 6 / 24

7 Bernanke-Gertler Closed Economy Model Bernanke-Gertler Model: Closed Economy Model (CEM) Flow of funds: Households demand bonds issued by entrepreneurs. Enterpreneurs finance purchases of capital partly with their own net worth and partly by issuing debt. Credit market frictions give rise to an external finance premium that depends on the levearage ratio of firms. It depends on the evolution of net worth and asset prices. r s t+1 R t = ψ(s t + k t n t ) (1) Financial accelerator mechanism: A monetary policy shock will have a multiplier effect through the additional effects of asset prices and net worth. López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 7 / 24

8 Bernanke-Gertler Closed Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 8 / 24 Adding Exogenous Asset Price Bubbles (I) Investment is related to the fundamental value of capital, Q t. The fundamental value of capital is the present value of dividends the capital is expected to generate: } Q t = E t {[D t+1 + (1 δ)q t+1 ]/Rt+1 Q (2) Observed price of capital, S t, may temporarily differ from fundamental values because of bubbles. A bubble exist whenever S t Q t 0. It is assumed that if a bubble exist at date t, it persist with probability p and grows as follows (with p < a < 1) : S t+1 Q t+1 = (a/p)(s t Q t )R Q t+1 (3) When a is close to one this bubble specification can be made arbitrarily close to a rational bubble.

9 Bernanke-Gertler Closed Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015Research 9 / 24 Adding Exogenous Asset Price Bubbles (II) It is possible to derive an expression for the evolution of the market price of capital inclusive of the bubble: {[ S t = E t Dt+1 + (1 δ)s t+1 /Rt+1 s ]} (4) The return on capital stock, Rt+1 S, is related to the fundamental return on capital, RQ t+1, by (with b a(1 δ)): [ Rt+1 S = Rt+1 Q b + (1 b) Q ] t (5) S t When there is a positive bubble, S t > Q t, therefore the expected return on market price will be below the fundamental return, R S t+1 < RQ t+1.

10 Bernanke-Gertler Closed Economy Model Macroeconomic responses under alternative policy rules The model is calibrated with some parameters of the Colombian economy in order to do simulations and to compare them with the SOEM. The model is closed with two alternative policy rules: The baseline policy rule is a Taylor rule that responds only to inflation: R t = α π π t (6) The alternative monetary policy rule responds to the once-lagged log level of the stock price, relative to its steady-state value: ( ) St 1 R t = α π π t S (7) Accomodative: α π = 1.4 Aggressive: α π = 3.0 López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 10 / 24

11 Bernanke-Gertler Closed Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 11 / 24 Effects of an asset bubble when monetary policy only responds to inflation (accomodative) Figura 4

12 Bernanke-Gertler Closed Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 12 / 24 Effects of an asset bubble when monetary policy responds to both asset prices and inflation

13 Small Open Economy Model Small Open Economy Model: SOEM Financial market imperfections and also the macroeconomics effects of the exchange rate in a small open economy. We introduce a small friction in the world capital market (Schmitt-Grohe and Uribe (2001)). Households demand Domestic bonds from entrepreneurs and Foreign bonds from abroad: foreign interest rate and country external finance premium. The later depends on the net foreign indebtedness in the economy. The first order condition for the foreign bonds along with the one for domestic bonds results in an uncovered interest parity condition. The consumption bundle is composed by domestic and foreign goods (CPI index). López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 13 / 24

14 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 14 / 24 Small Open Economy Model: SOEM Foreign sector: we distinguish between The wholesale (import) price of foreign goods and the retail price in the domestic market by allowing for imperfect competition and pricing-to-market in the local economy. We assume that foreign demand for the home tradable good depends on international prices and external real output gap.

15 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 15 / 24 Aggregate Demand ((1 γ)q 1 1)c t = γλ t + (q 2 (r ss 1)/r ss )(b t + (γ 1)m t ) γe t (8) λ t+1 = λ t R + π t+1 (9) (γ R t /r ss 1) = b t + c t + m t (10) h ss h t = (1 h ss )(w t λ t + xt h ) (11) ct h = c t xt h (12) ct f = c t xt f (13) c t = α h c h t + (1 α h )ct f (14) q t = χ(i t k t 1 ) xt h (15) x f xt 1 f = πf t π t (16)

16 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 16 / 24 Aggregate Demand R t π t+1 = premf + R t + rer t+1 rer t (17) dev t π t = rer t rer t 1 (18) c h t = ν(τxt h + yt ) + (1 ν)ct 1 h (19) x h t = x h t rer t (20) y ss y h t = c h ss c h t + c h ss c h t + i ss i t (21) b ss b t + (x h ss c h ss )(x h t c h t ) (x f ss c f ss )(x f t c f t ) = (b ss r ss )(b t 1 + R t 1 + premf t 1 + rer t rer t 1 ) ( b ) premf t = Ω rer t t bss + epremf t (22) y t epremf t = 0.4epremf t 1 + ε premf (23) y = y h t + ap h t (24)

17 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 17 / 24 Returns to Stocks and Capital r q t = rkss f ss (rk t + x h t ) + ((1 δ)/f ss )q t q t 1 (25) r s t = rkss f ss (rk t + x h t ) + ((1 δ)/f ss )s t s t 1 (26) rt s = rt q (1 b)(st qt ) (27) r s t+1 = Rt π t+1 + ψ(s t + k t n t ) (28) Equation (25) defines the fundamental return to capital as the sum of the current return to capital and the increase in fundamental value, where rk t is the real rental rate of capital in terms of domestic goods and x h t = ph t pt. (26) defines the returns to stocks analogously. (27) describes the expected evolution of the bubble. Equation (28) links the spread between safe returns and stock returns to firm leverage, where n t is the log-deviation of firms internal equity from its steady-state value.

18 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 18 / 24 Aggregate Supply ( πt h β = (1 + βγ h ) ( πt f β = (1 + βγ f ) y = αk t 1 + (1 α)h t + (1 α)a t (29) )π ht+1 + ( )π ft+1 + ( w = y + mc h t h t (30) r k t = y + mc h t k t 1 (31) γ h (1 + βγ h ) γ f (1 + βγ f ) ) ) ( ) πt 1 h (1 φ)(1 βφ) + φ(1 + βγ h mct h (32) ) ( ) πt 1 f (1 φ)(1 βφ) + φ(1 + βγ h mct f (33) ) mc f t = rer t x f t + p f t (34) π t = α h π h t + (1 α h t )π f t (35)

19 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 19 / 24 State variables and policy rule Evolution of state variables and shock processes k t+1 = δi t + (1 δ)k t (36) 1 Λ ss f ss n t = kss n ss r s t ( kss n ss 1)(R t 1 π t ) ψ( kss n ss 1)(k t 1 + s t 1 ) + (ψ( kss n ss 1) + 1)n t 1 (37) Monetary Policy rule and Interest rate determination R t = α π π t + α s s t + e R t (38) r = R π t+1 (39) Key parameter values b = 0.3(1 δ), Ω = , υ = 0.25, γ f = 0.5, γ h = 0.5, γ = 0.14, χ = 0.57, φ = 0.15, α = 0.33, ψ = 0.05, α h = 0.76, τ = 0.75, h ss = 0.29, y ss = , c h ss = , c h ss = , b ss = 1.2, x h ss = , x f ss = , c f ss = 0.213, c ss = 0.53, k ss = , i ss = The description of the variables and any parameters not reported here are presented in López, Prada and Rodríguez (2009).

20 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 20 / 24 Effects of an asset bubble when monetary policy responds only to inflation(accomodative) Figura 2

21 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 21 / 24 Effects of an asset bubble when monetary policy responds to both inflation and asset prices

22 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 22 / 24 Effects of an asset boom followed by an asset bust

23 Small Open Economy Model López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 23 / 24 Effects of an asset boom followed by an asset bust Table 1 Bubble Shocks Only Policy Rule (π,s,y) σ y σ π 1.4, 0, , 0.05, , 0.1, , 0, , 0, , 0.05, , 0.1, , 0, , 0,

24 Summary Summary The presence of capital inflows results in an appreciation of the real exchange rate that causes a higher response of market asset prices relative to a CEM. This makes emerging markets more vulnerable to the bubble. However as in the CEM the monetary authority should not react to asset prices. If the asset bubble is followed by a crash in asset prices generating a negative asset price bubble the response of the monetary authority to asset prices generates higher output losses. Models like the one presented here call for the introduction of capital controls imposed for macroprudential reasons. Recently: Brazil in Oct. 24, 2009 after experiencing a 36 percent appreciation of its currency. Taiwan in November, 2009 and similarly in Colombia in May of 2007 López (Central Bank of Colombia) (Central A.P. Bubbles Bankand ofmp Colombia Sixth BIS CCA CCA 2015 Research 24 / 24