PERUVIAN ECONOMIC ASSOCIATION. Mortgage Credit: Lending and Borrowing. Constraints in a DSGE Model

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1 PERUVIAN ECONOMIC ASSOCIATION Morgage Credi: Lending and Borrowing Consrains in a DSGE Model Elmer Sánchez León Working Paper No. 5, July 8 The views expressed in his working paper are hose of he auhor(s) and no hose of he Peruvian Economic Associaion. The associaion iself akes no insiuional policy posiions.

2 Morgage Credi: Lending and Borrowing Consrains in a DSGE Model Elmer Sánchez León July, 8 Absrac This paper develops a Dynamic Sochasic General Equilibrium (DSGE) model ha evaluaes he relaive imporance of he easing of lending and borrowing consrains in morgage credi markes for business cycle flucuaions in a small open emerging economy. Credi markes are characerized by parial dollarizaion and are subjec o demand shocks, innovaions o sochasic loan-o-value raios (borrowing consrains) imposed on borrowers, and supply shocks, innovaions o sochasic bank capial-o-asse raios (lending consrains) imposed on financial inermediaries. In addiion, he model feaures a se of real and nominal domesic shocks o demand, produciviy, and fiscal and moneary policy, as well as foreign shocks. A hisorical decomposiion conduced on household leverage raios reveals ha hese variables cyclical dynamics were mainly driven by borrowing consrain shocks or credi demand shifs, while lending consrain shocks played a residual role. JEL classificaion: E37, E44, E5. Keywords: Financial fricions, DSGE model, banking secor. I would like o hank Professor Rahul Mukherjee, as well as seminar paricipans a The Graduae Insiue in Geneva for heir useful commens. The auhor is also graeful o César Carrera for his relevan commens. Head of Price Saisics Deparmen a Banco Cenral de Reserva del Perú (Cenral Reserve Bank of Peru). elmer.sanchez@bcrp.gob.pe

3 Inroducion Housing and morgage markes played an imporan role in he financial crisis ha affeced mos developed economies. Prior o he Grea Recession, many of hose counries experienced increasing housing prices and curren accoun deficis along wih massive capial flows and credi booms. The consequences were grim: in he US, for example, he financial crisis precipiaed he wors recession since he Grea Depression. Counries in oher regions, such as Lain America, have been experiencing mos of hose paerns for more han a decade, leading o valid concerns abou he poenial formaion of financial insabiliy. I is known ha he fas growh of morgage loans may creae financial insabiliy and governmens should improve heir knowledge abou his phenomenon. In his conex, i is imporan o sudy he deerminans of morgage credi growh. The radiional lieraure associaes sharp credi expansions wih relaxed borrowing consrains as in he seminal paper of Kiyoaki and Moore (997). Iacoviello (5), Iacoviello and Neri (), and Gerali e al. () assume ha a collaeral consrain limis households abiliy o borrow agains real esae; under his view, credi grows fas when hese consrains are relaxed, for example when households have access o morgages wih higher iniial loan-o-value raios. Jusiniano, Primiceri, and Tambaloi (5) inroduce a novel approach by firs drawing a disincion beween supply and demand for credi as drivers of credi growh. They inerpre he easing of borrowing consrains as a credi demand driver, and of lending consrains as a credi supply shifer. Under heir view, he borrowing consrains are modeled as usual while he lending consrains, which capure a combinaion of echnological and insiuional facors ha resrain he flow of funds from savers o morgage borrowers, are modeled as a leverage resricion on financial insiuions or lenders. These consrains may be relaxed as he flow of funds o morgage loans expands due o a financial inermediaion innovaion, such as he diffusion and more inensive use of securiizaion and marke-based financial inermediaion ha occurred in he US in he s. Inflows of foreign funds ino morgage producs are isomorphic o an easing of he domesic lending consrain, resuling in a shif in he amoun of funds available o (morgage) borrowers. I follow his approach and build a Dynamic Sochasic General Equilibrium (DSGE) model ha allows deerminaion of he relaive imporance of he relaxaion of lending and borrowing consrains as drivers of morgage credi business cycle flucuaions. In paricular, I develop a large-scale DSGE model for a small open economy wih parially dollarized credi markes, characerisic of a ypical emerging marke. In his sense, his paper provides a comprehensive and rigorous ool ha allows for he disenanglemen and assessmen of he role of shifs in credi supply and demand on credi and macroeconomic flucuaions. This is a key issue for moneary policy and macroprudenial regulaion, since differen drivers require he implemenaion of supply- or demand-side policies o efficienly moderae he effecs of credi boom-bus cycles on he economy. As Walsh () argues, credi marke imperfecions (like borrowing and lending conrains) play a role in deermining how he economy responds o nominal and real shocks and condiions he way hese disurbances propagae. In his sense, a general equilibrium model helps o assess he qualiaive and quaniaive imporance of credi channels and financial consrains. The model is buil in he spiri of Gerali e al. () and Brzoza-Brzezina and Makarski (). I is an exended small open economy new Keynesian model (i includes monopolisically compeiive markes and nominal rigidiies in goods and labor markes) wih a financial secor and heerogeneous agens (savers and borrowers), where some of hem ake deb denominaed in foreign currency. The banking secor serves as an inermediary beween lenders and borrowers. The producion secor is sandard. There are enrepreneurs ha combine capial and labor o produce wholesale homogenous goods; nex, inermediary producers differeniae hose goods and sell hem in monopolisically compeiive markes. Then, domesic and foreign inermediae goods are combined ino final goods in a wo-sep aggregaion.

4 In applicaion, I use he DSGE model o deermine wheher he easing of borrowing or lending consrains has been he main driver of he Peruvian morgage credi business cycle dynamics since he early s. I sudy Peru because of daa availabiliy issues, and because is morgage and housing markes exhibi similar paerns as hose in he res of Lain America. Conducing a hisorical shock decomposiion on Peruvian household leverage raios (morgage credi-o-collaeral value raios), allows me o decompose heir business cycle dynamics in erms of he srucural shocks. Furhermore, o analyze he relaive srengh of he lending and borrowing consrain shocks affecing hose leverage raios, I run counerfacual simulaions by urning off hose shocks. The hisorical shock decomposiion on household leverage raios reveals ha hese variables business cycle flucuaions were mainly driven by borrowing consrains shocks, while he lending consrain shocks have a secondary role. The counerfacual simulaion exercises provide srong evidence in favor of his argumen: while urning off he borrowing consrains shocks, he counerfacual household leverage raio flucuaions end o aenuae. These resuls differ from conclusions of Jusiniano, Primiceri, and Tambaloi (5) who repor ha he credi boom ha preceded he inernaional financial crisis in he US economy was driven by a loan supply expansion, following an easing of lending consrains. In his case, he findings reveal ha he Peruvian morgage credi flucuaions were driven mainly by credi demand shifs, suppored by an encouraging macroeconomic sabiliy and morgage credi demand-boosing public programs. The secondary role of credi supply shocks is aligned wih he fac ha Peruvian financial inermediaries did no experience an imporan innovaion as had occurred in US. This paper relaes o he lieraure which sudies he deerminans of credi booms and housing prices. Mos of ha lieraure has concenraed on he relaion beween credi and borrowing limis, following he approach inroduced in Kiyoaki and Moore (997). For insance, Iacoviello (5) develops and esimaes a DSGE model wih heerogeneous households and collaeral consrains ied o housing value. Using his model, he finds ha moneary policy shock effecs on he economy are amplified and propagaed over ime because of he endogenous relaxaion of he borrowing consrain (due o he increase in housing prices). An imporan disincion beween his paper and Jusiniano, Primiceri, and Tambaloi (5) and oher lieraure ha focuses on borrowing consrains is ha hese auhors inerpre a financial liberalizaion and an inflow of foreign funds ino credi markes as alernaive drivers of credi growh. These economiss follow his new approach because in models wih collaeral consrains, as in Kiyoaki and Moore (997), looser borrowing requiremens lead o an ouward shif in he demand for credi and a subsequen increase heerogeneous in he ineres rae, which is no compaible wih credi growh accompanied by decreasing morgage raes. As Gambacora and Signorei (4) sae, hose radiional models consider financial fricions only on he borrower s side of credi markes while credi supply effecs derived from financial inermediaries behavior are compleely negleced. Based on his, Jusiniano, Primiceri, and Tambaloi (5) use a sylized model and idenify some key variables whose paerns help deermine wheher a credi boom is driven by an easing of lending or borrowing consrains. The reference o looser collaeral requiremens as a credi demand shock migh sound surprising, since credi conrac erms are se by financial inermediaries, and hence hey are usually aken o reflec credi supply condiions. However, I impose hese resricions direcly on he borrowers or final users of credi, affecing he credi demand. The lending consrains are imposed on he oher side of he credi marke and affec jus is supply. The DSGE model considers borrowing consrain shocks resricions imposed on borrowers as sochasic loan-o-value raios. A posiive innovaion o hese sochasic processes capures a borrowing consrain relaxaion, meaning a greaer abiliy of households o ake deb, which in urn leads o an exogenous credi expansion driven by a demand movemen upward. This reacion incremenally increases housing demand 3

5 and real housing prices, which in urn eases he collaeral requiremens even more, increasing oher ypes of credi. This endogenous easing represens an amplificaion mechanism closely relaed o he one inroduced in Kiyoaki and Moore (997) and Iacoviello (5). The model also considers he main driver of an easing of lending consrains menioned by Jusiniano, Primiceri, and Tambaloi (5): financial inermediaion innovaions. This mechanism is modeled by inroducing sochasic leverage resricions given by bank capial-o-asse raios (resricions imposed on lenders). In his case, a negaive innovaion o hese raios generaes looser lending consrains, i.e., increases banks abiliy o gran loans, which leads o an exogenous loan expansion driven by a supply shif. Specifically, hese innovaions reduce he cos of graning loans relaive o a given level of bank capial. Differen from he previous ype of shock, his one booss only a paricular ype of credi. The paper is also relaed o he lieraure ha inroduces financial consrains in DSGE models wih heerogeneous agens. In he model, here are households who are ne savers and ohers who are ne borrowers (among hem, here are agens who hold deb denominaed in foreign currency). Gerali e al. () sudy he role of credi facors in he Eurozone in a DSGE framework considering an imperfecly compeiive banking secor and sochasic borrowing consrains. I follow heir way of modeling he sochasic collaeral consrains. However, I exend heir framework by considering explici shocks o credi supply and by allowing banks o obain funds from inernaional financial markes. Brzoza-Brzezina and Makarski () develop an open economy DSGE model wih a banking secor and borrowing consrained agens o analyze he impac of a credi crunch in Poland. My model is differen because i inroduces sochasic bank leverage resricions modeled as capial-o-asse raios, which are inerpreed as exogenous loan supply expansion drivers; addiionally, i considers borrowers who hold foreign currency denominaed deb and face exchange-rae risk. In his way, his paper is also linked o he lieraure ha models parially dollarized economies in a DSGE environmen as in Casillo, Monoro, and Tuesa (3), who esimae a model of his ype for he Peruvian economy. Carrera and Vega () inroduce an inerbank marke in a general equilibrium model by considering wo ypes of privae banks and a cenral bank. They use heir DSGE model o analyze he effecs of reserve requiremens (a macroprudenial ool) and radiional moneary ool. The auhors show ha he inroducion of a complex banking sysem allows a beer idenificaion of he final effecs of differen ype of shocks in he economy. The res of he paper is organized as follows. Secion shows some moivaing evidence abou Peruvian markes, he applicaion case counry. Secion 3 describes he DSGE model in deail. Secion 4 presens he calibraion and esimaion of he model. Secion 5 sudies some dynamic properies of he model. Secions 6 and 7 presen he hisorical shock decomposiion and he counerfacual simulaions resuls, respecively, which allow for a deerminaion of he role of he srucural shocks on he business cycle dynamics of morgage credi in Peru. Finally, Secion 8 offers some final remarks. Moivaing Evidence Lain American counries have been experiencing some of he paerns in housing and credi markes ha developed economies exhibied before he oubreak of he inernaional financial crisis: for example, oal credi has increased a fairly high raes someimes a hisorical raes during some periods since he early s. Wihin he credi increase in Lain America here has been a noable expansion in morgage loans, as he Inernaional Moneary Fund (IMF) poined ou in is Wesern Hemisphere Regional Economic Oulook 4

6 of April. In hese counries, morgage loans have expanded a higher average raes han oher ypes of credis. However, in erms of GDP, hese economies banking sysems and morgage markes are sill small compared o developed-economy sandards. I is also worh menioning hose counries morgage credi is parially dollarized and heir final users (borrowers) usually face exchange-rae risks. Given his background, I use he developed DSGE model o sudy he morgage credi business cycle flucuaions of a Lain American economy. I choose Peru as a counry of sudy because of daa availabiliy concerns and because i exhibis he common rends and feaures lised in he previous paragraph (suggesing ha one may generalize his paper s findings). Thus, in his secion I presen some moivaing evidence of he evoluion of morgage credi in ha counry. In Peru, morgage credi markes were srongly affeced by he hyperinflaion of he 98s bu sared recovering in he early s. According o he view of Jusiniano, Primiceri, and Tambaloi (5), he morgage credi growh migh be caused by supply and/or demand deerminans. On he supply side, Peruvian financial inermediaries benefied from lower ineres raes due o a decreasing counry risk premium and access o inernaional financial markes; he credi supply may also have expanded because of growing compeiion in he banking indusry. The appearance of morgage bonds, managemen companies, and securiizaion firms during he s also represens innovaions in credi markes, however none of hem have had he impac of he boom in morgage-backed securiies in US. This is undersandable since overall, he Peruvian financial markes are no as developed and sophisicaed as he American marke. Neverheless, he increasing compeiion in he bank indusry and he access of inermediaries o inernaional financial markes migh also shif loan supply. On he demand side, macroeconomic sabiliy, increasing GDP per capia, and increasing employmen raes incremened he abiliy of Peruvian households o borrow; hese facors, joinly wih he naional housing shorage, boosed credi demand. Public funds and programs such as Fondo MiVivienda, Crédio MiHogar, and Techo Propio have played an imporan role in he morgage credi marke s recovery by allowing lowand middle-class households o access morgage credi markes for he firs ime and/or wih more favorable conrac erms han he exising radiional morgage credi. These looser condiions included new credi lines wih higher loan-o-value raios, longer mauriies, and condiional direc subsidies o reduce paymens. Thus, in he Peruvian case, an easing of borrowing consrains resuled from his easing of credi erms. Regarding long-erm rends, from 3 o 5, he oal credi graned by he Peruvian banking sysem increased a an average annual rae of 3 percen. Toal credi represened percen of GDP in 3, and 4 percen in 5. Of all ypes of credi, morgages were he mos dynamic, expanding a an average annual rae of 9 percen, and commercial credi grew a an average rae of percen. The graph on he lef-hand side of Figure depics he evoluion of oal and morgage credi, boh expressed in index 3Q=. In his form, he differences in he cumulaive expansion raes of hese wo financial variables are noiceable. To be consisen wih he DSGE analysis conduced in he nex secions, which express variables as percen deviaions from seady-sae, I show he business cycle dynamics 3 of oal and morgage credi in he righhand side of Figure. Despie he fac ha morgage credi expanded a greaer raes, oal credi s business cycle exhibis a volailiy wice as large as morgage credi s volailiy. This las plo also shows he oupu gap. Noe ha morgage credi did no fall during he domesic recession associaed wih he inernaional financial crisis, bu i did fall a few quarers afer ha, showing a srong resilience. Among hem, Fondo MiVivienda has had he larges impac on credi markes. The fund sared operaing in 998, bu is credis grew exponenially in he s. In 6 for example, he fund s credis accouned for he 5 percen of oal morgage credi. In Peru, he bank eniies gran more he 95 percen of he morgage credi. 3 The business cycle flucuaions are obained using a wo-sided Hodrick-Presco Filer, as is usual in he DSGE lieraure. 5

7 Figure : Morgage and Toal Credi Index 3Q= Morgage Credi Toal Credi.5. Business Cycle Oupu 3Q 5Q3 8Q Q3 3Q 5Q4. 3Q 5Q3 8Q Q3 3Q 5Q4 As in oher Lain American counries, Peruvian credi markes are parially dollarized. As Casillo, Monoro, and Tuesa (3) indicae, his is a paricular feaure of economies wih a hisory of high inflaion. According o he Cenral Reserve Bank of Peru s (BCRP) daabase, he banking sysem s credi had a dollarizaion raio of 3 percen a he end of 5; in he case of morgage markes, he dollarized credi sill represened 4 percen. Noe ha he DSGE model accouns for his paricular feaure by considering he kind of households ha hold deb denominaed in foreign currency. This is an imporan disincion from he models of Gerali e al. () and Brzoza-Brzezina and Makarski (). Figure depics he evoluion of he shares of GDP of morgage credi denominaed in domesic (PEN) and foreign (USD) currency and commercial credi, 4 he hree ypes of credi considered in he DSGE model. The graph shows no only he acceleraing rend of morgage credi growh, bu also he change in is composiion by currency of denominaion, and specially he expansion of morgage credi denominaed in domesic currency. Figure : Credi by Types: Share of GDP.5. Morgage in DC Morgage in FC Commercial For simpliciy, I assume ha all commercial credi is denominaed in domesic currency. 6

8 Figure 3 presens boh he 3Q= indexes and he business cycle flucuaions of he hree ypes of credi. Given he high accumulaed growh rae of domesic currency denominaed morgage credi (,83 percen), is index is presened on a secondary verical axis. The plo on Figure 3 s righ-hand side shows ha morgage credi in domesic currency has he mos volaile and persisen business cycle among he hree ypes of credi. In addiion, he second graph of Figure 3 allows idenificaion of credi boom-bus cycles. The morgage denominaed in domesic currency s bus of he firs half of he s and is boom of he second half are he larges deviaions from seady-sae levels. Figure 3: Credi By Types 6 5 Index 3Q= Comercial Credi Morgage in FC Morgage in DC (RHS).3.. Business Cycle Oupu 3Q 5Q3 8Q Q3 3Q 5Q4.5 3Q 5Q3 8Q Q3 3Q 5Q4 Furhermore, i is relevan o noice ha he wo ypes of morgages have a negaive correlaion, as shown in Table, which means ha hey respond o differen deerminans. Independenly from hese deerminans he negaive correlaion may be induced by households porfolio choices or public policies and banking regulaions ha discourage aking deb in foreign currency his empirical fac necessiaes having he wo ypes of morgage credi in he DSGE model and no jus one, as is common in he lieraure. Table : Credi By Types: Conemporaneous Correlaions Sample Period: 3-5, Cyclical componens Type of Credi Correlaion Morgage in domesic currency. Morgage in foreign currency -.3. Commercial GDP The Model This is a small open economy model wih financial fricions and heerogeneous agens. For he mos par, i closely follows he frameworks developed in wo papers. The modeling of heerogeneous agens and he real 7

9 secor is based on he model of Brzoza-Brzezina and Makarski (), neverheless I also consider households ha hold deb denominaed in foreign currency. Addiionally, he explicily modeled banking secor is based on he wholesale banking unis inroduced in Gerali e al. (), alhough I exend heir seup by allowing banks o collec funds from abroad. The economy is populaed by paien households, impaien households, and enrepreneurs. The heerogeneous paience degree is modeled by differen discoun facors. Paien households, who have he highes discoun facor, consume, accumulae housing sock, save, and work. Impaien households consume, accumulae housing sock, borrow, and work. There are wo ypes of impaien households: hose who ake deb denominaed in domesic currency and hose who hold foreign currency denominaed deb and face exchangerae risk. Enrepreneurs, who are impaien agens, produce homogeneous inermediae goods using capial purchased from capial good producers and labor supplied by households. There are also capial good and housing producers, who use final consumpion goods o produce capial or housing wih a echnology ha is subjeced o an invesmen adjusmen cos. The adjusmen cos allows for he price of capial and housing o differ from he price of consumpion goods. Boh paien and impaien households supply heir differeniaed labor services hrough labor unions ha se heir wages o maximize members uiliy, facing wage sickiness. Labor is sold o a compeiive inermediary who supplies undiffereniaed or aggregae labor services o enrepreneurs. There are hree sages of producion. Firs, enrepreneurs produce homogeneous inermediae goods ha are sold in perfecly compeiive markes o reailers. Nex, reailers, who face sicky prices, brand hem a no cos and sell differeniaed inermediae goods in monopolisically compeiive markes o aggregaors. Final good producers aggregae domesic inermediae differeniaed goods and foreign impored differeniaed goods ino one final domesic good. Two ypes of one-period financial insrumens, supplied by he banking sysem, are available o agens: saving asses (deposis) and loans. Following Kiyoaki and Moore (997) and Iacoviello (5) when aking on a bank loan, agens face a borrowing consrain ied o he value of nex period collaeral holdings: households can borrow agains heir sock of housing while enrepreneurs borrowing capaciy is ied o he value of heir physical capial sock. This consrain s resriciveness is sochasically disurbed in he form of a shock o he required loan-o-value (LTV) raio. In his sense, a posiive innovaion o his sochasic process would imply an exogenous borrowing consrain relaxaion and generae a subsequen credi expansion driven by a credi demand shif. The banking secor is composed of a bank ha finances is loans o impaien households and enrepreneurs wih deposis from paien agens, reinvesed profis (bank equiy), and funds obained in he inernaional financial marke a an ineres rae subjec o a risk premium. There is a cos o banking aciviy relaed o he capial or leverage posiion. Specifically, he bank pays a quadraic cos whenever is leverage raios, given by capial-o-asse raios, move away from opimal values. There are differen desired capial-o-asse raio levels (one for each ype of loan), which are sochasically disurbed. Following Jusiniano, Primiceri, and Tambaloi (5), exogenous reducions in hese raios would imply an easing of lending consrains and creae a credi expansion driven by an exogenous loan supply shif. There is also a cenral bank ha conducs moneary policy by seing he inerbank ineres rae according o a sandard Taylor rule. The governmen uses lump sum axes o finance public expendiure. Following Pedersen and Ravn (3), he foreign secor has a semi-srucural New Keynesian modeling given ha here exiss a foreign ineres rae ha evolves according o a Taylor Rule, bu I assume a simplificaion by considering ha foreign demand and foreign inflaion follow firs-order auoregressive processes. 8

10 3. Households and Enrepreneurs The economy is populaed by impaien households and enrepreneurs who ake deb in domesic currency, impaien households who assume deb in foreign currency, and paien households who are savers. The measures of hese agens are γ IDC, γ E, γ IF C, and γ P, respecively (he measure of all agens in he economy is one, so γ IDC + γ E + γ IF C + γ P = ). The imporan difference beween agens is he value of heir discoun facors: he discoun facor of paien households β P is higher han he discoun facors of impaien households and enrepreneurs (β IDC, β IF C and β E ). 3.. Paien Households The represenaive paien household ι chooses consumpion c P, he sock of housing h P and deposis d P. The decision on he labor supply n P is no made by he household bu by a labor union, whose problem is deailed laer. The expeced lifeime uiliy of a represenaive household is: [( c U P = E βp P (ι) ζc P (ι) ) σ c ] h P (ι) σh + ε h, np (ι) σn () σ c σ h σ n =o where he preferences exhibi inernal habi formaion wih parameer ζ, and ε h, are housing preference shocks ha randomly disurb he marginal uiliy of housing and hus he housing demand. According o Iacoviello (5) hese shocks are a parsimonious way o assess he macro effecs of an exogenous disurbance on housing prices. This process has an AR() represenaion wih i.i.d. normal innovaions: ε h, = ε ρ h h, expϖ h,, ϖ h, N (, σ h ) () The flow of expenses includes curren consumpion, accumulaion of housing services, and deposis o be made his period d P. Resources are composed of labor income W n P, dividends from real and financial secor firms Π P (all he firms are owned by he paien households), and deposis from he previous period d P muliplied by he gross ineres rae on household deposis R d and lump sump axes T. The represenaive paien household s budge consrain is expressed in nominal erms: P c P + P h ( h P ( δ h ) h P ) + d P W n P + R d d P T + Π P (3) where P and P h denoe he nominal price of final consumpion goods and he nominal price of housing, δ h is he depreciaion rae of he housing sock, and W is he nominal wage. The firs-order condiions of hese and he oher agens are presened in he Appendix A. 3.. Impaien Households who Hold Domesic Currency Denominaed Deb In conras o paien households, he households are borrowers, no lenders, in he neighborhood of he seady-sae. A represenaive impaien household of his class ι chooses consumpion c IDC, he sock of housing h IDC and loans b IDC. As for paien households, labor supply decisions are made by a labor union. Impaien households maximize he following expeced uiliy: [( c U IDC = E βidc IDC (ι) ζc IDC (ι) ) σ c ] h IDC (ι) σ h + ε h, nidc (ι) σn (4) σ c σ h σ n =o 9

11 where ε h, is he same preference shock ha affecs he uiliy of paien households and ζ is he same parameer ha governs he inernal habi formaion in consumpion. Impaien household decisions have o mach he following budge consrain, expressed in nominal erms: P c IDC + P h ( h IDC ( δ h ) h IDC ) + R bidc b IDC W n IDC + b IDC T (5) in which resources spen for consumpion, accumulaion of housing services and reimbursemen of pas borrowing R bidc b IDC have o be financed wih wage income and new borrowing. Furhermore, impaien households face a borrowing consrain: he expeced value of heir housing sock a period mus be sufficien o guaranee deb repaymen. This collaeral consrain is consisen wih sandard lending crieria used in he morgage marke. The consrain is: R bidc b IDC m IDC E [ P h + ( δ h )h IDC ] (6) As in Gerali e al. (), m IDC normal innovaions: is he loan-o-value raio which follows an AR() process wih i.i.d. m IDC = ( ρ IDC m ) m IDC + ρ IDC m m IDC + ϖ m IDC,, ϖ m IDC, N (, σ m IDC ) (7) where m IDC is he calibraed seady-sae loan-o-value raio of his ype of credi. A posiive innovaion o his process implies an exogenous relaxaion of borrowing resricions, and a greaer abiliy of households o obain credi. The effec is a credi expansion driven by a demand shif ha creaes, as usual, an increase in he relevan price, in his case, he morgage ineres rae Impaien Households who Hold Foreign Currency Denominaed Deb These kind of impaien households are also ne borrowers in he neighborhood of he seady-sae. A represenaive impaien household of his ype ι chooses consumpion c IF C, he sock of housing h IF C and loans b IF C which are denominaed in foreign currency. Thus, hese agens face exchange-rae risk. This modeling ries o capure parially dollarized credi markes, such as he Peruvian morgage markes. Casillo, Monoro, and Tuesa (3) develop a DSGE model ha considers his phenomenon. The labor supply decision is made by a labor union. These impaien households maximize he following expeced uiliy: U IF C = E βif C =o [( c IF C (ι) ζc IF C (ι) ) σ c h IF C (ι) σ h + ε h, nif C σ c σ h σ n (ι) σn Impaien households decisions have o mach he following budge consrain, expressed in nominal erms: ] (8) P c IF C + P h ( h IF C ( δ h ) h IF C ) + R bif C S b IF C W n IF C + S b IF C T (9) As in he previous case, resources spen for consumpion, accumulaion of housing, and reimbursemen of pas borrowing mus be financed wih wage income and new borrowing. However, in his case, borrowing and deb service are affeced by he nominal exchange rae S. These impaien households also face a borrowing consrain: he expeced value of heir housing sock a period mus be sufficien o guaranee deb repaymen, which is now denominaed in foreign currency. The consrain is: R bif C S b IF C m IF C [ E P h + ( δ h )h IF C ] ()

12 where m IF C is he IFC households loan-o-value raio, which follows an AR() process wih i.i.d. normal innovaions: m IF C = ( ρ IF C m ) m IF C + ρ IF m C m IF C + ϖ m IF C,, ϖ m IF C, N (, σ m IF C ) () This problem is similar o he one in he previous secion, however he presence of he exchange-rae implies ha hese agens face exchange rae risk. In paricular, an unexpeced nominal depreciaion increases he amoun of deb hey have o serve in he nex period, ighening heir borrowing resricion Enrepreneurs Enrepreneurs draw uiliy only from heir consumpion c E : U E = E =o (β E ) (( c E (ι) c E (ι) ) σ c σ c ) () In order o finance consumpion hey run firms o produce homogeneous inermediae goods y W, using capial and labor supplied by he households. They use he following echnology: y W, (ι) = A [u (ι) k (ι)] α n (ι) α (3) where u [, ) is he capial uilizaion rae and k is he capial sock and n is he labor inpu. A, he oal facor produciviy, follows an exogenous AR() process: A = A ρ A exp (ϖ A, ), ϖ A, N (, σ A ) (4) The capial uilizaion rae can be changed bu only a a cos ψ (u ) k, which is expressed in erms of consumpion unis. The funcion ψ (u) saisfies ψ () =, ψ () > and ψ () > (here is no capial uilizaion adjusmen cos in he deerminisic seady-sae). I is convenien o define Ψ = ψ () ψ (). Such parameerizaion is sandard in he lieraure, see for example Chrisiano, Eichenbaum, and Evans (5) and Smes and Wouers (3). In order o finance heir expendiures on consumpion, labor services, capial accumulaion, capial uilizaion rae adjusmen coss and repaymen of deb R b E E, enrepreneurs use he revenue from heir oupu sales (he inermediae good produc is sold in a compeiive marke a wholesale price P W ) and new loans b E. Enrepreneurs flow budge consrain is he following (expressed in nominal erms): P c E + W n + P k (k ( δ k ) k ) + P ψ (u ) k + R be b E = P W y W, + b E (5) where P k is he nominal capial price and δ k is he depreciaion rae of physical capial. For simpliciy, I assume ha enrepreneurs have access only o loan conracs denominaed in domesic currency, which can be inerpreed as commercial credi. As wih he impaien household case, I assume ha he amoun of resources ha he bank is willing o lend o enrepreneurs is consrained by he value of heir collaeral, which is given by heir holdings of physical capial. This assumpion is aken from Gerali e al. () and differs from Iacoviello (5) where enrepreneurs borrow agains housing (inerpreable as commercial real esae credis). The borrowing consrain is hus: R be b E m E [ E P k + ( δ k )k E ] (6)

13 where m E is he firm s loan-o-value raio, which follows an AR() process wih i.i.d. normal innovaions. m E = ( ρ E m) m E + ρ E mm E + ϖ m E,, ϖ m E, N (, σ m E ) (7) Again, a posiive innovaion ϖ me, would imply a greaer abiliy of enrepreneurs o ake on or ask for deb and an exogenous easing of enrepreneurs borrowing consrains Labor Supply Following Brzoza-Brzezina and Makarski () and o moivae labor marke fricions, i is assumed ha each household has a coninuum of labor ypes of measure one, h [, ]. Moreover, for each ype h here is a labor union ha ses he wage for is labor ype W (h). Each household belongs o all labor unions, i.e., each union includes γ P paien and γ IDC + γ IF C impaien households. Labor services are sold o perfecly compeiive aggregaors who pool all he labor ypes ino one undiffereniaed labor service wih he following funcion: [ (γ n = P + γ IDC + γ IF C) ] +µw n (h) +µw dh (8) The problem of he aggregaor gives he following demand for labor of ype h: [ ] W (h) (+µw ) µw n (h) = γ P + γ IDC + γ IF C n (9) W where: ( W = W (h) µw dh ) µw () is he aggregae or average wage in he economy. The union s discoun facor is he weighed average of hose of is members: β = γ P γ P + γ IDC + γ IF C β P + γ IDC γ P + γ IDC + γ IF C β IDC + γ IF C γ P + γ IDC + γ IF C β IDC () Each union ses he wage according o a sandard Calvo scheme, i.e., wih probabiliy θ w i receives a signal o re-opimize and hen ses is wage o maximize he uiliy of is average member subjec o he demand for labor services, and wih probabiliy θ w does no receive he signal and indexes is wage according o he following rule: W + (h) = (( ζ w ) π + ζ w π ) W (h) () where π is he seady-sae inflaion rae and ζ w [, ]. 3. Producers This secion closely follows a similar chaper of Brzoza-Brzezina and Makarski (). There are hree secors in he economy: capial goods, housing and consumpion goods. The capial goods producers and housing producers operae in perfecly compeiive markes. In he consumpion goods secor here are enrepreneurs, who sell heir undiffereniaed goods o reailers who hen brand or differeniae hose goods and sell hem o aggregaors a home and abroad. Aggregaors combine differeniaed domesic inermediae goods and differeniaed foreign inermediae goods ino a single final good.

14 3.. Capial Goods Producers As Gerali e al. () indicae, considering capial goods producers is a modeling device o derive a marke price for capial, which is necessary o deermine he value of enrepreneurs collaeral. Capial goods producers operae in a perfecly compeiive marke and use final consumpion goods o produce capial goods. Each period a capial goods producer buys i k, of final consumpion goods and ( δ k )k old undepreciaed capial from enrepreneurs. Nex, she ransforms he old undepreciaed capial one-o-one ino new capial, while he ransformaion of he final goods is subjec o adjusmen cos S k (i k, /i k, ). I adop he specificaion of Chrisiano, Eichenbaum, and Evans (5) and assume ha in he deerminisic seady-sae here are no capial adjusmen coss (S k () = S k () = ), and he funcion is concave in he neighborhood of ha deerminisic seady-sae (S k () = /κ k > ). Thus he echnology o produce new capial is given by: ( ( )) ik, k = ( δ k ) k + S k i k, i k, Afer new capial is sold o enrepreneurs i can be used in he nex period s producion process. The real price of capial is denoed as q k = P k /P. 3.. Housing Producers Here, housing producers ac in a similar fashion as capial good producers. This approach differs from he housing marke modeling of Iacoviello (5) and Gerali e al. () who consider an exogenously fixed housing supply sock in he economy. Thus, a housing producer secor allows incorporaion of housing s business cycle flucuaions. The sock of new housing evolves according o: ( ( )) ih, h = ( δ h ) h + S h i h, (3) i h, where he funcion describing adjusmen cos S h (i h, /i h, ) saisfies S h () = S h () = and S h () = /κ h >. The real price of housing is denoed as q h = P h /P. 3.3 Final Good Producers Final good producers play he role of aggregaors. They buy differeniaed goods from domesic reailers y H, (j H ) and imporing reailers y F, (j F ) and aggregae hem ino a single final good, which hey sell in a perfecly compeiive marke. The final good is produced according o he following echnology: y = [ η µ +µ y +µ H, + ( η) µ +µ +µ yf, ] +µ (4) where: [ ] +µh [ ] +µf +µ y H, = y H, (j H ) H +µ dj H and y F, = y F, (j F ) F dj F (5) µ governs he elasiciy of subsiuion beween domesic and foreign goods. η is he home bias parameer. 3

15 The problem of he aggregaor enails he following demands for differeniaed goods: ( PH, (j H ) y H, (j H ) = P H, ) (+µ H ) µ H y H, and y F, (j F ) = ( PF, (j F ) P F, ) (+µ F ) µ F y F, (6) where: y H, = η ( PH, P ) (+µ) µ y and y F, = ( η) ( PF, P ) (+µ) µ y (7) and he aggregaed price indexes are: [ ] µh [ P H, = P H, (j H ) µh dj H and P F, = P F, (j F ) µf dj F ] µf (8) These wo indexes, joinly wih he echnology represened in Equaion 4, define he inflaion rae as: + π = [ η ( ) µ (π H, P H, P ) µ + ( η) ( ) µ (π F, P F, P ) µ ] µ (9) 3.3. Domesic Reailers There is a coninuum of domesic reailers of measure one idenified by j H. They purchase undiffereniaed inermediae goods from enrepreneurs, brand hem hus ransforming hem ino differeniaed goods and sell hem o aggregaors. They operae in a monopolisically compeiive environmen and se heir prices according o a sandard Calvo scheme. In each period each domesic reailer receives wih probabiliy θ H a signal o re-opimize and hen ses her price o maximize he expeced profis. When she does no receive he signal, she indexes her price according o he following rule: P H,+ (j H ) = P H, (j H ) (( ζ H ) π + ζ H π ) (3) where ζ H [, ] Imporing Reailers There is a coninuum of imporing reailers of measure one denoed by j F. Like domesic reailers, hey purchase undiffereniaed goods (from foreign markes), ransform hem ino differeniaed goods, and sell hem o aggregaors. They operae in a monopolisically compeiive environmen and se heir prices according o he sandard Calvo scheme. Prices are re-opimized wih probabiliy ( θ F ) and wih probabiliy θ F prices are indexed according o he following rule: P F,+ (j F ) = P F, (j F ) (( ζ F ) π + ζ F π ) (3) where ζ F [, ]. I assume ha prices are sicky in domesic currency, which is consisen wih an incomplee pass hrough of exchange rae changes in impor prices. 4

16 3.3.3 Exporing Reailers There is also a coninuum of exporing reailers of measure one denoed by jh. Reailers purchase domesic undiffereniaed goods, brand hem and sell hem abroad a a price PH (j H ), which is expressed in erms of foreign currency. Prices are sicky in foreign currency. The demand for expored goods is given by: y H, (j H) = ( P H, (j H ) P H, ) (+µ H ) µ H y H, (3) where yh, (j H ) denoes he oupu of he reailer j H, y H, is defined as: [ yh, = yh, (jh) +µ H dj H ] +µh (33) and P H, as: [ PH, = ] µh PH, (jh) µ H dj H (34) Moreover, he demand abroad is given by: ( P yh, = ( η H, ) P ) (+µ H ) µ H y (35) Exporing reailers re-opimize heir prices wih probabiliy θh or index hem according o he following formula: PH,+ (jh) = PH, (jh) ( ( ζh) π + ζhπ ) (36) wih probabiliy θh where ζ H [, ]. Foreign variables modeling (foreign demand, ineres rae, and inflaion) is described laer. 3.4 Banking Secor The banking secor plays a cenral role in he model since i inermediaes all financial ransacions beween agens in he model: he only saving insrumen available o paien households is bank deposis, and he only way for impaien households and enrepreneurs o borrow is by applying for a bank loan. Here, in conras o Gerali e al. (), he banking sysem is composed by only one bank owned by all paien households. This eniy can finance is domesic currency denominaed loans o IDC households B IDC and enrepreneurs B E, as well as he loans denominaed in foreign currency o IFC households L IF C using deposis colleced from paien agens D, funds obained in he inernaional marke B, or bank equiy K b. These relaions are summarized in he bank balance shee ideniy: B IDC + S B IF C + B E = D + S B + K b (37) where B IDC = γ IDC b IDC, B IF C = γ IF C b IF C and B E = γ E b E are he oal loans graned o impaien households and enrepreneurs. Similarly, D = γ P d P are he aggregae deposis colleced from paien households. 5

17 The financing sources are perfec subsiues from he poin of view of he balance shee, ha is why i is necessary o inroduce some non-lineariy o pin down he choices of he bank. In order o do ha, I assume ha here exis hree (exogenously given) opimal capial-o-asse (i.e., leverage) raios for he bank, one for each ype of loan, such ha he bank pays a quadraic cos whenever hese raios move away from heir desired levels. Moreover, hese opimal raios follow sochasic processes. Negaive innovaions o hese processes generae loose lending consrains since hey reduce he coss of raising credis relaive o a given amoun of bank capial and creae a supply-driven credi expansion. Following he inerpreaion of Jusiniano, Primiceri, and Tambaloi (5), his easing of lending consrains also represens a credi expansion driver. Bank capial K b,n (in nominal erms) is accumulaed each period ou of reained earnings according o: K b,n = ( δ b )K b,n + ω bj b,n (38) where J b,n are he profis made by he bank expressed in nominal erms, ( ω b) summarizes he dividend policy of he bank, and δ b measures he resources used in managing bank capial and conducing banking inermediaion. The dividend policy is assumed o be exogenously fixed, so ha bank capial is no a choice variable for he bank. The problem of he bank is o choose he amoun of he hree ypes of loans B IDC B IF C and B E, deposis D and foreign funding B so as o maximize profis, subjec o a balance shee consrain: B IDC max E Λ P,B IF C,B E,,B,D = [ R bidc B IDC + R bif C S B IF C + R be B E R d D R b S + B K b CK IDC CK IF C CK E ], (39) subjec o: where: B IDC CK IDC CK IF C + S B IF C + B E = D + S B + K b (4) CK E = κ K bidc = κ K bif C = κ K E ( K b B IDC ) v IDC, K b (4) ( K b S B IF C ) v IF C, K b (4) ( K b B E v E, ) K b (43) are he quadraic cos funcions and v IDC,, v IF C, and v E, are he sochasic capial-o-asse raios ha follow hese AR() processes: v IDC, = ( ρ vidc ) v IDC + ρ vidc v IDC, + ϖ vidc,, ϖ vidc, N (, σ vidc ) (44) v IF C, = ( ρ vif C ) v IF C + ρ vif C v IF C, + ϖ vif C,, ϖ vif C, N (, σ vif C ) (45) v E, = ( ρ ve ) v E + ρ ve v E, + ϖ ve,, ϖ ve, N (, σ ve ) (46) 6

18 where v IDC, v IF C and v E are he desired or opimal capial-o-asse raios ha are calibraed such ha: v IDC = K b B IDC, v IF C = K b S B and IDC v E = K b B E (47) The firs-order condiions of he bank s problem deliver equaions linking he spreads beween loan and deposi ineres raes o leverage raios B s /K b, s {IDC, IF C, E} of he bank. Addiionally, in order o close he model i is assumed ha banks can inves any excess funds hey have in a deposi faciliy a he cenral bank, remuneraed a rae R, so ha R d = R, which is he moneary policy ineres rae. The equaions ha arise from he firs-order condiions are: R bidc R bif C ( K b = R κ K bidc B IDC )( v IDC, ( K b = R κ K bif C S B IF C )( v IF C, R be = R κ K be ( K b B E v E, )( K b B E K b B IDC K b ) (48) ) (49) S B IF C ) (5) These equaions highligh he role of bank capial in deermining loan supply condiions. In paricular, hey can be rearranged o highligh he inverse relaionship of he spreads beween loan and deposi raes and bank leverage raios. Addiionally, noe ha negaive innovaions o he v processes, which lower he cos of graning credi for a given amoun of bank capial and cause loose lending consrains, generaing spread reducions. Those negaive shocks can be inerpreed as financial inermediaion developmen shocks, while narrower ineres spreads can be hough of as indicaors of greaer financial secor efficiency. Furhermore, a UIP condiion can be derived from hese condiions. In his sense, he exchange rae is deermined endogenously in he model. The bank has access o he foreign inerbank marke and obains funds a a rae R b, which is modeled as he inernaional risk-free ineres rae RF muliplied by an ineres rae premium ρ. The descripion of hese las wo variables is examined in he following secion. The UIP equaion is he following: [ ] R S + R b = E (5) S Furher, using he real exchange rae definiion q = SP P, he UIP condiion can be expressed as: [ ] R q + π + R b = E q π+ (5) The bank s profis are given by: J b = (R bidc )B IDC + (R bif C )S B IF C + (R be )B E (R )D (R b )S B CK IDC CK IF C CK E (53) 3.5 Foreign Secor I assume ha foreign demand and inflaion follow AR() processes. However, he inernaional risk-free ineres rae RF b is deermined by a foreign moneary policy auhoriy whose behavior is described by his 7

19 Taylor Rule: RF RF = ( RF ) ( ζrf, (π ) ζrf, ( ) ) ζrf y ζrf,,3 RF π ȳ ϖ rf, (54) ζ rf, and ζ rf,3 are he weighs of inflaion and oupu sabilizaion, respecively. ε rf, are i.i.d. normal moneary policy innovaions wih sandard deviaion σ rf. The foreign secor provides financial resources o he domesic economy hrough he banking sysem. In he model, he bank collecs funds from he foreign markes a a rae R b, which is defined as he inernaional risk-free rae muliplied by an ineres rae premium, which is a funcion of he foreign deb-o-gdp raio. As Schmi-Grohe and Uribe (3) indicae, his specificaion induces he saionariy of he small open economy model: R b = ρ RF (55) The ineres premium ρ is defined as: ρ = exp ( ϱ S B P ỹ ) ε ρ, (56) where ε ρ, has an AR() represenaion wih ϖ ερ, i.i.d. innovaions wih sandard deviaion σ ερ. ỹ denoes real GDP. 3.6 The Governmen The governmen uses lump sum axes o finance governmen expendiure. Public budge consrain is given by: g = ( γ P + γ IDC + γ IF C) T (57) where g denoes governmen expendiure. For simpliciy, I assume ha he governmen budge is balanced and ha governmen expendiures are driven by a simple auoregressive process: g = ( ρ g )ḡ + ρ g g + ϖ g, (58) wih ϖ g, are i.i.d. normal innovaions wih sandard deviaion of σ g. 3.7 The Cenral Bank Moneary policy is conduced according o a Taylor rule ha arges deviaions from he deerminisic seady-sae inflaion and GDP, allowing for ineres rae smoohing: R R = ( R R ) φr ( (π π ) ) ) φr φy φπ (ỹ ϖ R, (59) ỹ where π = P P, and ϖ R, are i.i.d. normal moneary policy innovaions wih sandard deviaion σ R. φ R is a persisence parameer. φ π and φ y are he weighs of inflaion and oupu sabilizaion, respecively. R is he seady-sae policy ineres rae. 8

20 3.8 Marke Clearing, Balance of Paymens, and GDP In order o close he model, i is needed marke-clearing condiions for he final and inermediae goods markes and he housing marke, as well as he balance of paymens and he GDP definiions. In he final goods marke, he marke-clearing condiion is: c + i k, + i h, + g + ψ(u )k = y (6) where c = γ P c P + γ IDC c IDC + γ IF C c IF C + γ E c E The marke clearing condiion in he inermediae homogenous goods marke is: y H, (j)dj + y H,(j)dj = y W, (6) The marke clearing condiion in he housing marke is given by: γ P h P + γ IDC h IDC γ IF C h IF C = h (6) The balance of paymens, expressed in domesic currency, has he following form: P F, (j F )y F, (j F )dj F + R S b B = S PH,(j H)y H,(j H)dj H + S B (63) Finally, he nominal GDP P ỹ is defined as follows: P ỹ = P y + S PH, (jh) yh, (jh) dj H P F, (j F ) y F, (j F ) dj F (64) 4 Calibraion and Esimaion Following he DSGE lieraure, I parly calibrae and parly esimae he model s parameers. The calibraed parameers are mainly seady-sae raios (average raios of he period 3-5) ha can be found from Peruvian daa and parameers esablished and broadly used in he lieraure. I also calibrae some parameers o mach some seady-sae raios. The esimaed coefficiens are srucural parameers ha affec he dynamics of he model and parameers ha govern he shock processes (auocorrelaion parameers and sandard deviaions of shocks). 4. Calibraion The model is calibraed o mach characerisics of he counry of sudy. The enire se of calibraed parameers and seady-sae raios are shown in Appendix C in Tables and 3, respecively. Following Brzoza-Brzezina and Makarski (), I assume differen measures for paien and impaien agens. In his line, he proporion of paien households is se o γ P =.5, and he measures of he oher agens are γ IDC =.5, γ IF C =., and γ E =.5. 9

21 I se he paien household s discoun facor β P =.998 o mach a seady-sae annual real moneary policy rae of percen, in line wih he 3-5 average of he inerbank marke ineres rae (my proxy for he moneary policy ineres rae) of R = 3.8 percen and a long-erm average inflaion rae of π =.9 percen. The subjecive discoun facors of boh ypes of impaien households β IDC and β IF C are se o.975. Following Iacoviello (5), he enrepreneur s discoun facor β E is larger han he impaien households and equal o.98. The discoun facor of he impaien agens is in he range suggesed by Iacoviello (5) and Iacoviello and Neri (), ensuring ha he borrowing consrains are binding in he seady-sae. The depreciaion rae of physical capial is se o δ k =.5, as is generally used in he lieraure. The housing depreciaion rae δ h is calibraed a.5 (which implies a annual depreciaion rae of 5 percen). I se his value o mach he real esae depreciaion rae used by he Peruvian ax regulaor. The elasiciy of oupu wih respec o capial is se o α =.3, a value broadly used in he DSGE lieraure. The parameer µ w of he labor aggregaor is se o. implying a seady-sae markup over wages of percen. Regarding he real secor, he parameer µ is se o so ha he Armingon elasiciy of subsiuion beween domesic and foreign goods equals o +µ µ =, as is consisen wih Ruhl (8). The home bias parameer is se o η =.77, according o he Peruvian average impors-o-absorpion raio for he period 3-5. The seady-sae loan-o-value raios are calibraed using he maximum values required by he Peruvian banking regulaor o domesic currency denominaed morgage credi ( m IDC =.8) and foreign currency denominaed morgages ( m IDC =.7). The calibraion of enrepreneurs loan-o-value m E is problemaic, as commercial loans are ypically no collaeralised credis. However, I se a value of m E =.6 following Ribeiro (5), who calibraes his coefficien for he Peruvian economy. The enrepreneur loan-o-value raios found in he lieraure Brzoza-Brzezina and Makarski () and Gerali e al. () calibrae i and Chrisensen e al. (7) esimae i are mosly smaller han he morgage loan-o-value raios. For he remaining parameers of he banking sysem, I se θ b =.5, which measures he resources used in managing bank capial. I ake his value from Ribeiro (5) and i is aligned wih he operaing margin of he banking eniies of Peru. The hree differen capial-o-asse raios are calibraed considering a longerm aggregae capial-o-asse raio of.3 and heir shares in he oal amoun of credi. The calibraed values are v IDC =.69, v IF C =.38 and v E =.6. The parameers ha conrol he adjusmen cos of he bank s capial-o-asse raios, he κ K parameers, are esimaed given ha hese direcly affec he credi raes dynamics and here are no consensual esimaes available in he lieraure. The seady-sae foreign inflaion π is se o. percen annually, in line wih he long-erm average inflaion of he main rade parners of Peru. The foreign inflaion rae RF is calibraed o. percen annually, which is consisen wih he 3-5 average of he -monh Libor. The coefficiens of he foreign Taylor Rule, as well as he parameers of he foreign inflaion and foreign demand processes (auocorrelaion and shocks sandard deviaion parameers) come from he MPT Model (Quarerly Projecion Model), described in Winkelried (3) and MEGAD Model (esimaed DSGE wih parial dollarizaion model) presened in Casillo, Monoro, and Tuesa (3). The las wo models are used by he BCRP. The seady-sae expor-, impor-, consumpion-, invesmen-, governmen expendiure-, and foreign debo-gdp raios as well as morgage and commercial credi-o-gdp raios are calibraed o be consisen wih long-erm averages observed in he Peruvian daa. The remaining calibraed raios are derived from seadysae relaionships.