A dynamic model of financial balances for the United Kingdom

Transcription

1 A dynamic model of financial balances for he Unied Kingdom Sephen urgess Oliver urrows and Sephen Millard (ank of England) Anoine Godin (Kingson Universiy) and Sephen Kinsella (Universiy of Limerick) 24 h Augus 206

2 Plan Moivaion Relevan lieraure Model overview Some simulaions

3 Moivaion () inancial balances frequenly used as a lens for sudying macrofinancial developmens. Example: Marin Wolf (T): The balance shee recession in he US noes ha he US privae secor financial balance swung by.2pp of GDP beween 2007 and Huge implicaions for associaed financing flows Source: hp://blogs.f.com/marin-wolf-exchange/202/07/9/he-balance-shee-recession-in-he-us/

4 Moivaion (2) Mervyn King Tweny Years of Inflaion Targeing The Samp Memorial Lecure 202: The dominan new Keynesian model of moneary economics lacks an accoun of financial inermediaion so ha money credi and banks play no meaningful role

5 Moivaion (2) UK gross deb by secor relaive o GDP Secoral deb/gdp Q 994 = 00 Households Governmen PNCs Source: ONS. PNC = privae non-financial corporaions. Deb securiies and loans are boh included.

6 Aims uild a racable macroeconomic model for he UK which explains he evoluion of financial imbalances As well as he usual real economy variables we wan o undersand financing flows behind hem Wih asse prices endogenous we can also rack capial gains and losses and finally he overall balance shee asses and liabiliies of each secor.

7 Aims Can use his model for several purposes: (i) Tes wheher a paricular pah for he real economy is explosive (ii) Scenario analysis (eg: real economy effecs of financial shocks) (iii) More deailed sudy of banks and asse managers for macroprudenial policy and sress esing.

8 Plan Moivaion Relevan lieraure Model overview Some simulaions

9 Lieraure Godley and Lavoie (2007) Moneary Economics: An inegraed approach o credi money income producion and wealh (2 nd Ediion) or a good overview see: Caverzasi & Godin (205): Pos-Keynesian sock-flow consisen modelling: a survey Cambridge Journal of Economics Vol. 39 pp57-87 Accouning ideniies (as in naional accouns) are crucial o mainain consisency: see Copeland (949).

10 Model overview Dynamic macroeconomic model of financial balances for he Unied Kingdom using flow of funds daa from 997 o he presen. The model conains seven secors: households privae non-financial companies he governmen banks cenral bank pension funds and a simplified res of he world. Model is backward-looking wih adapive expecaions. Mos parameers are esimaed using OLS.

11 Households Various sources of disposable income which hey spend on consumpion and housing invesmen. Only financial liabiliy is morgages borrowed from banks. Any surplus income is invesed in deposis. YD W H i Mor Pens i D Mor D H T H Ann C E YD 2NWH NW H D H penswlh P H h Mor NL YD Pens C H I h ΔD H = NL H + Mor new Mor rep Pens

12 Pension unds (ICPs) Households inves in ICPs and also draw down annuiies. ICPs play a key role in he model as he main domesic asse managers. They allocae funds across five asse classes: V V G ICP ICP RoW ICP RoW A A A V A V A G ICP ICP ICP ICP RoW ICP ICP ICP RoW ICP ICP 0 ICP 20 ICP 30 ICP 40 ICP 50 ICP ICP 2 ICP 3 ICP 4 ICP 5 ICP 2 ICP 22 ICP 32 ICP 42 ICP 52 ICP 3 ICP 23 ICP 33 ICP 43 ICP 53 ICP 4 ICP 24 ICP 34 ICP 44 ICP 54 ICP 5 ICP 25 ICP 35 ICP 45 ICP 55 r r E r r r G RoW V V RoW E A ICP See rainard and Tobin (968)

13 Privae Non-inancial Corporaions (PNCs) PNCs are assumed o produce all domesic oupu. They have a desired capial sock which deermines heir invesmen some of which is financed by issuing equiy. Equiies are held by ICPs and which receive dividends. Any oher financing needs are me hrough bank borrowing. GDP W X G I I C Y H R L r u Y k i i k GDP k k k g D L D i L i T W M Y I Div NL V V P E I v v V D v P NL NPL L L

14 Governmen The governmen spends money on domesic oupu and collecs axes. Any financing defici is made up hrough issuing bonds which are held by ICPs and cenral bank who all receive ineres on hose asses. The price of governmen bonds is deermined endogenously by demand and supply. Yields are a funcion of prices. NL P G G b H G G G T i G 2 * P G H T i G G C

15 ank of England Simple balance shee wih governmen bond holdings mached by non-ineres-bearing reserves. Ses shor-erm raes via a nominal growh argeing rule wih ineria. G C R i C G G C i lni lngdp ln R 2 R 2 3

16 anks anks lend o firms and households (via morgages) and ake deposis. Any funding shorfall is covered by ne bond issuance. anks also issue equiy which evolves depending on profis and NPLs. There is a regulaory minimum. If banks are above / below arge hey adjus lending raes. NL i Mor i L i D D i Div b V Div H Mor L D b Mor NL V i D = χ 0D i R χ D L NPL D H D E V P NL NPL ills i L = χ 0L + χ. E i D + χ 2. E i + χ 3. E r V ξ 2. 2 T. ( V V )

17 Expors are assumed exogenous. Ne lending depends on he rade balance and ne invesmen income. oreign invesors allocae funds across hree domesic asses in a similar way o ICPs. Exchange rae moves o equalise bond reurns. Res of he world G G ICP i i Div Div Div i Div X M NL V G G G A E r r r E A V A A V RoW G RoW RoW G G RoW r r r e e

18 Plan Moivaion Relevan lieraure Model overview Some simulaions

19 Some simulaions Run a hands-free baseline forecas ou en years and hen inroduce wo separae scenarios: () A fiscal expansion where governmen spending is 0% higher han in he baseline (2) A capial ouflows scenario wih a 20% fall in overseas demand for domesic asses

20 iscal expansion scenario Raise governmen spending (exogenous variable) by 0% and race he implicaions for he real economy asse prices financial imbalances and balance shees Nominal governmen spending and GDP relaive o base Difference from baseline % Governmen spending GDP

21 iscal expansion scenario The governmen defici widens. The sock of governmen bonds increases (held by pension funds and ). The price of bonds falls and he yield rises. In our model invesors absorb mos of he change: he curren accoun defici widens. inancial balances relaive o base Difference from baseline pp of GDP Governmen bond socks prices and yields Difference from baseline pp Difference from baseline % Households NCs Governmen anks Ins comps & pens funds Res of world ICP holding of gov bonds (RHS) Quaniy of governmen bonds (RHS) holding of gov bonds (RHS) Price of gov bonds (RHS) Eff rae on gov bonds (LHS) -0

22 Capial ouflows scenario Consider a financial shock: overseas invesors demand for domesic asses falls by 20% Akin o a sudden sop (Calvo and Reinhar (2002)) Movemens in asse prices Change from baseline % Assume he demand shock is persisen. Lower demand for domesic asses leads direcly o lower asse prices ank bond prices NC equiy prices Governmen bond prices

23 Capial ouflows scenario Domesic ineres raes rise paricularly on bonds. The exchange rae herefore falls. orces a closing in he curren accoun defici. Ne lending of governmen and pension funds is higher. Movemens in ineres raes Changes in financial balances Household deposi raes Governmen bond yields ank bond yields NC loan raes Change from baseline pp Change from baseline pp of GDP Households NCs Governmen anks Ins comp & pens funds Res of world

24 uure work Share model and daa more widely wih oher researchers More sophisicaed esimaion echniques More sensiiviy esing around parameer esimaion Exensions o he model for example: - Commercial real esae secor; - Corporae bonds as well as bank loans - oreign direc invesmen - More deailed housing marke (perhaps wih several generaions of households)

25 Summary We have buil a large bu racable sock-flow-consisen model of he UK and esimaed i on UK flow of funds daa. We have demonsraed he model can be a valuable ool for scenario analysis.