Financial Heterogeneity and Monetary Union

Transcription

1 Financial Heterogeneity and Monetary Union S. Gilchrist R. Schoenle J. Sim 3 E. Zakrajšek 3 Boston University Brandeis University Federal Reserve Board 3 Cambridge University April 9th, 6

2 Disclaimer The views expressed should not be interpreted as reflecting the views of the Federal Reserve System or its staff.

3 Eurozone Crisis (9?) Classic balance-of-payment crisis: The mix of overvalued RERs and cheap credit fueled by economic optimism led to over- and mal-investment. After the Global Financial Crisis came a sudden stop. Resolution of the crisis: Realignment of overvalued RERs. The mix of deflation in the south and reflation in the north. Surprisingly hard to achieve why?

4 Lessons from the Financial Crisis in the U.S. Gilchrist, Raphael, Sim & Zakrajšek [5] Empirics: Theory: Firms with strong balance sheets slashed prices. Firms with weak balance sheets raised prices. Develops a GE model that can replicate such patterns. Emphasizes the interaction between financial market frictions and firms pricing decisions in customer markets.

5 What accounts for the resilience of inflation in the face of significant and long-lasting economic slack? Producer Price Inflation In particular, the absence of more substantial deflationary pressures during the "Great Recession" is difficult to square with the Phillips curve common to most macroeconomic models. Cyclical Dynamics of Producer Prices and Industrial Production Core producer prices* Industrial production* Percentage points Percentage points Peak: Jan98 Peak: Jul98 Peak: Jul99 Peak: Mar Peak: Dec7-5 - Peak: Jan98 Peak: Jul98 Peak: Jul99 Peak: Mar Peak: Dec Months to and from business cycle peaks * Deviations from a linear trend estimated over the 4 months preceding the specified recession Months to and from business cycle peaks * Deviations from a linear trend estimated over the 4 months preceding the specified recession. -3 Our answer Economic forces that dampen the response of inflation to adverse demand or financial shocks reflect the interaction between customer markets and financial frictions:

6 Relative Inflation Financially unconstrained vs constrained firms 3-month moving average Percent 4 - Low liquidity firms High liquidity firms Note: Weighted average monthly inflation relative to industry (-digit NAICS) inflation.

7 Inflation Response to Liquidity Estimate +/- S.E. Coefficient

8 QUIDITY AND FIRMS PRICING BEHAVIOR IN 8 ntile regression estimates Quantile Response to Liquidity During Crisis Estimate 95% confidence interval OLS estimate Quantile

9 - Indicator of current financial conditions - excess bond premium (EBP) Coefficients on EBP and commodity Inflation price inflation vary Response across 4-digit industry to EBP groups. - Is variation in industry-specific EBP coefficients related to the likelihood of financial co across industries? - Use industry-specific size-age index to identify the likelihood of financial constraints 4 -month PPI inflation and financial conditions By industry-specific indicator of financial constraints Coefficient on EBP (4-digit NAICS) Median Size-Age Index (4-digit NAICS) p <. p >=. β ^ =. t = 4.88 R-sq =.9 Note: Smaller values of the size-age index indicate a smaller likelihood of financial constraints.. -month PPI inflation and commodity prices By industry-specific indicator of financial constraints S)

10 Output Response to EBP Figure 7: Sensitivity of Industry-Level Output to Financial Conditions, (By Industry-Specific Indicator of Financial Constraints) Coefficient on EBP Median Size-Age Index p <. p >=. β ^ = -.88 t = R-sq =. Note: No. of (4-digit NAICS) industries = 5. The figure shows the relationship between the median SA-index of financing constraints at the 4-digit NAICS level during the period and the corresponding industry-specific estimates of the coefficient on the EBP; the dependent variable is log IP i,t+, the log-difference of IP in (5- or 6-digit NAICS) industry i from t to t + (see the text and notes to Table 3 for details). Observations plotted as diamonds ( ) indicate

11 Inflation and Output Dynamics in the Eurozone Core GIIPS Core GIIPS Avg. inflation (%) Avg. output gap (%) Panel-version of the NK Phillips curve: π it =.449 (.5) E tπ i,t (.49) π i,t +.4 (.48) (y it ȳ it ) + ˆη i + ˆɛ it AUT, DEU, BEL, FIN, FRA, NLD, GRC, IRL, ITA, ESP, PRT Annual data: 97 4 (unbalanced panel, Obs. = 49) Is lack of deflationary pressures related to financial strains?

12 Inflation and Output Dynamics in the Eurozone Core GIIPS Core GIIPS Avg. inflation (%) Avg. output gap (%) Panel-version of the NK Phillips curve: π it =.449 (.5) E tπ i,t (.49) π i,t +.4 (.48) (y it ȳ it ) + ˆη i + ˆɛ it AUT, DEU, BEL, FIN, FRA, NLD, GRC, IRL, ITA, ESP, PRT Annual data: 97 4 (unbalanced panel, Obs. = 49) Is lack of deflationary pressures related to financial strains?

13 Inflation Dynamics and Financial Strains Sample Period: GIIPS Core Inflation Residuals at t+ (pct.) Sovereign (5-year) CDS Spreads at t (pps., log scale)

14 Heterogeneity as Propagation Mechanism In this paper, we extend the theoretical framework to two-country GE. Study the consequences of forming a currency union among countries with heterogeneous financial conditions. Price War During periphery s liquidity crisis, core has a strong incentive to slash markup to gain market share both home and abroad. In contrast, periphery is forced to raise prices to secure cashflow, cannibolizing its own future market share. Self-Reinforcing Crisis Possibility of RERs to appreciate for periphery rather than for core, a feedback loop that reinforces the liquidity crisis of periphery.

15 Policy Options Fiscal Union: Trading state-contingent bonds among heterogeneous countries. Highly beneficial to periphery but requires large transfers from core. Are the costs of fiscal union bearable by core countries? Fiscal Devaluation: Certain mixes of fiscal instruments replicate the devaluation. When can a unilateral fiscal devaluation be beneficial to core? Depends on the strength of externality created by financial friction.

16 Preferences Two countries: home (h = south) and foreign (f = north) Continuum of households in each country: j N c [, ] { home goods (h) : c j Two types of goods: i,h,t, i N h [, ] foreign goods (f ) : c j i,f,t, i N f [, 3] CRRA in habit-adjusted consumption basket x j t : E t β s U(xt+s j, hj t+s ); j [, ] s= labor (h) is immobile

17 Deep Habits Ravn, Schmitt-Grohe & Uribe [6] Armington-Ravn-Schmitt-Grohe-Uribe aggregator: x j t = [ k=h,f [ ] /ɛ ] /(/ɛ) ( ω k c j ) /ηdk /η i,k,t N sθ i,k,t k η = elasticity of substitution within a type of goods ɛ = elasticity of substitution between types of goods θ > governs the strength of deep habits < ωk < governs the degree of home bias in consumption Law of motion for deep habits: s i,k,t = ρs i,k,t + ( ρ) c j i,k,t dj; N c k = h, f Keeping up with the Joneses at the good level.

18 Deep Habits Ravn, Schmitt-Grohe & Uribe [6] Armington-Ravn-Schmitt-Grohe-Uribe aggregator: x j t = [ k=h,f [ ] /ɛ ] /(/ɛ) ( ω k c j ) /ηdk /η i,k,t N sθ i,k,t k η = elasticity of substitution within a type of goods ɛ = elasticity of substitution between types of goods θ > governs the strength of deep habits < ωk < governs the degree of home bias in consumption Law of motion for deep habits: s i,k,t = ρs i,k,t + ( ρ) c j i,k,t dj; N c k = h, f Keeping up with the Joneses at the good level.

19 Technology Continuum of monopolistically competitive firms producing variety of differentiated goods of type h and type f. Production function (labor input, fixed operating costs): ( ) α y it = c i,h,t + ci,h,t = At h a it φ; i N h ( < α ) it At = persistent aggregate technology shock ait = i.i.d. idiosyncratic shock w/ log a it N(.5σ, σ ) φ = servicing cost of fixed coupon long-term debt Heterogeneity in financial capacity: φ > φ =

20 Frictions Financial frictions: costly external equity financing New shares sold at a discount because of asymmetric information e claim raises only e( ϕ t ) of funds Lemons premium ϕt AR() financial shock Makes expected shadow value of internal funds, E a t [ξ it ] > Nominal rigidities: quadratic cost of adjusting nominal prices Local currency pricing: law of one price does not apply

21 Beggar Thy Neighbor at the Micro Level Deep habits make investment in market share profitable: Investment takes the form of low markups, which exposes firms to liquidity risk. Optimal pricing strategy strikes the right balance. Price war: Liquidity crisis in the South is a good time for firms in the North to steal market share by undercutting competitors prices in the south. Mr. Marchionne and other auto executives accuse Volkswagen of exploiting the crisis to gain market share by offering aggressive discounts. It s a bloodbath of pricing and it s a bloodbath on margins, he said. The New York Times, July 5,

22 Beggar Thy Neighbor at the Micro Level Deep habits make investment in market share profitable: Investment takes the form of low markups, which exposes firms to liquidity risk. Optimal pricing strategy strikes the right balance. Price war: Liquidity crisis in the South is a good time for firms in the North to steal market share by undercutting competitors prices in the south. Mr. Marchionne and other auto executives accuse Volkswagen of exploiting the crisis to gain market share by offering aggressive discounts. It s a bloodbath of pricing and it s a bloodbath on margins, he said. The New York Times, July 5,

23 Optimal Pricing without Deep Habits Assume flexible prices and no customer markets. When α =, optimal pricing (home market) p i,h,t = η η }{{} Ea t [ξ it a it ] E a t [ξ it] accounting markup }{{} economic markup [ ] wt /p h,t A t }{{} real marginal cost Financial frictions E a t [ξ it a it ] E a t [ξ it] = + Cov[ξ it a it ]

24 Optimal Pricing with Deep Habits Bring back customer markets (still flexible prices!) Growth-adjusted, compounded discount rate: s β t,s m h,s+ /s h,s ρ s,s+ ρ s t j= [ ρ + χ s h,t+j /s h,t+j ρ ρ Optimal pricing η E p i,h,t = a [ ] t [ξ it a it ] wt /p h,t η E a t [ξ it] A t χ η E t [ s=t+ β t,s E a s [ξ i,s ] E a t [ξ i,t] ] m t+j,t+j ( p h,s w ) ] s/p h,s A s

25 Optimal Pricing with Deep Habits Bring back customer markets (still flexible prices!) Growth-adjusted, compounded discount rate: s β t,s m h,s+ /s h,s ρ s,s+ ρ s t j= [ ρ + χ s h,t+j /s h,t+j ρ ρ Optimal pricing η E p i,h,t = a [ ] t [ξ it a it ] wt /p h,t η E a t [ξ it] A t χ η E t [ s=t+ β t,s E a s [ξ i,s ] E a t [ξ i,t] ] m t+j,t+j ( p h,s w ) ] s/p h,s A s

26 Calibration Key Model Parameters Value Preferences & Technology deep habit (θ).9 persistence of deep habit (ρ).9 elasticity of substitution b/w and w/in goods (η, ɛ).,.5 fixed operating costs (φ, φ ).8,. Nominal Rigidities price adjustment cost (γ p ). wage adjustment cost (γ w ) 3. Financial Frictions equity dilution cost (ϕ), E a [ξ i ] =.,.3 idiosyncratic volatility, a.r. (σ). persistence financial shock (ρ ϕ ).9

27 Implications of a Financial Shock in the South In a monetary union (φ =.8, φ =.) (a) GDP, pct (b) consumption, pct (c) hours, pct 4 (d) int rate, pp 4 (e) RER( ), NER(.), pct 3 4 (f) inflation, pp 4 (g) exports, pct (h) CA, pct of GDP 4 Red = Foreign (North), Blue = Home (South) NER ( ) and RER ( ) are Home/Foreign

28 Implications of a Financial Shock in the South Under floating exchange rates (φ =.8, φ =.) (a) GDP, pct 4 (e) RER( ), NER(.), pct (b) consumption, pct 4 (f) inflation, pp 4 3 (c) hours, pct 4 (g) exports, pct 3 4 (d) int rate, pp 4 (h) CA, pct of GDP 4 Red = Foreign (North), Blue = Home (South) NER ( ) and RER ( ) are Home/Foreign

29 Price War and Market Shares Prices and Market Shares Figure: Financial Shock, Relative Prices and Market Shares (a) relative price home markets, pct (c) market share, home markets, pct.5 (e) wage inflation, pp (b) relative price foreign markets, pct (d) market share foreign markets, pct (f) markup, pct 4 home, floating foreign, floating home, union foreign, union

30 Some Evidence: Market Share Dynamics During the Crisis Figure 8: Euro-zone Market Share Dynamics Q= Portugal Export to Germany GDP Germany Export to Portugal GDP Italy Export to Germany GDP Germany Export to Italy GDP Greece Export to Germany GDP Germany Export to Greece GDP Spanish Export to German GDP German Export to Spanish GDP

31 Heterogeneity As a Propagation Mechanism Alternative calibration: φ = φ =.8 Financial shocks in both North and South. In a monetary union.5 (a) Home GDP, percent.4 (b) Home consumption, percent (c) Foreign GDP, percent.6 (d) Foreign consumption, percent Alternative = ( ) and Baseline = ( )

32 FINANCIAL HETEROGENEITY AND MONETARY UNION Results Monetary Union under Complete Risk Sharing Monetary Union under Complete Risk Sharing Dramatic reduction in consumption volatility Requires large wealth transfers from the north to the south Figure: Financial Shock, Monetary Union and Complete Risk Sharing (a) GDP, pct.5.5 (b) Consumption, pct Home, baseline Foreign, baseline Home, Complete Foreign, Complete.5 (c) RER, pct (d) Contingent TR, pct.5.5.5

33 Gains vs Losses of Fiscal Union Table: Costs and Benefits of Complete Risk Sharing Welfare Con Equiv MU (A) Risk Sharing (B) Percent Home country Foreign country Joint welfare Note: The consumption equivalent is the required minimum increase in average consumption per period holding labor hours constant to make the representative agent living in the economy under the floating exchange rate regime no worse off by transitioning to the currency union.

34 Fiscal Devaluation We consider a simple VAT-payroll subsidy swap rule: VAT(τ V t ) + payroll subsidy(ς P t ) FD rules that are linear in the resource gap of the home country: ( ) yt τt V = α FD log ȳ Is there a parameter region that is mutually beneficial to both home and foreign countries?

35 Fiscal Devaluation vs Flexible Exchange Rates Optimal Rule vs Flexible Allocations α FD = arg max α FD{U(x t δ t, h t ) + βe t [V(s t+ )]} Figure: Monetary Union w/ and w/o optimal FD vs Floating 3 (a) Monetary Union w/o FD 3 (b) Optimal FD 3 (c) Flexible Home, y Foreign, y Home, c Foreign, c 4 3 4

36 Welfare Difference in welfare from the baseline w/o FD ΔW ΔW * 5 5 α FD

37 Welfare for the Core As financial frictions in the periphery change.5 (a) The effect of fixed cost φ=. φ=.5 φ=. φ=.5.8 (a) The effect of issuance cost ϕ=. ϕ=. ϕ=. ϕ= ΔW * ΔW * α FD α FD

38 Concluding Remarks When firms engage in market share competitions, differences in financial capacity across countries imply strong amplification mechanism: beggar-thy-neighbor at the micro-level. Monetary union impedes adjustment of RERs and exacerbates the downturn in response to an adverse financial shock. Unilateral fiscal devaluation by periphery may be welfare improving for both periphery and core.