Coordinating Monetary and Financial Regulatory Policies

Coordinating Monetary and Financial Regulatory Policies Alejandro Van der Ghote European Central Bank May 2018 The views expressed on this discussion are my own and do not necessarily re ect those of the European Central Bank The views expressed on this discussion are my own and do not necessarily re ect those of the European Central Bank 3rd Annual ECB Macroprudential Policy and Research Conference The views expressed on this discussion are my own and do not necessarily re ect those of the European Central Bank The views expressed on this discussion are my own and do not necessarily re ect those of the European Central Bank Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 1 / 11

Introduction What I do Study coordination between monetary and macro-prudential policies Emphasis! coordination throughout the economic cycle Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 2 / 11

Introduction What I do Study coordination between monetary and macro-prudential policies Emphasis! coordination throughout the economic cycle How I do it Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 2 / 11

Introduction What I do Study coordination between monetary and macro-prudential policies Emphasis! coordination throughout the economic cycle How I do it. Model: New Keynesian framework + Balance-sheets uctuations. Policy exercise: Contrast btw traditional and coordinated mandates Main results Trad. MoPo! mimic natural rate of return MacroPru! replicate constrained e. policy of exible price econ. Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 2 / 11

Introduction What I do Study coordination between monetary and macro-prudential policies Emphasis! coordination throughout the economic cycle How I do it. Model: New Keynesian framework + Balance-sheets uctuations. Policy exercise: Contrast btw traditional and coordinated mandates Main results Trad. MoPo! mimic natural rate of return MacroPru! replicate constrained e. policy of exible price econ. Coor. MoPo! deviate from natural rate of return MacroPru! soften relative to traditional mandate Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 2 / 11

Introduction What I do Study coordination between monetary and macro-prudential policies Emphasis! coordination throughout the economic cycle How I do it. Model: New Keynesian framework + Balance-sheets uctuations. Policy exercise: Contrast btw traditional and coordinated mandates Main results Trad. MoPo! mimic natural rate of return MacroPru! replicate constrained e. policy of exible price econ. Coor. MoPo! deviate from natural rate of return MacroPru! soften relative to traditional mandate SW Coordinated Traditional by 0.07% annual consumption equivalent Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 2 / 11

Roadmap Model economy! 2 building blocks Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 3 / 11

Roadmap Model economy! 2 building blocks I. Nominal price stickiness Firms adjust their nominal price infrequently! Calvo (1983) Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 3 / 11

Roadmap Model economy! 2 building blocks I. Nominal price stickiness Firms adjust their nominal price infrequently! Calvo (1983) II. Financial intermediation and the macroeconomy Financial intermediaries good at providing nancing to rms, but subject to nancing constraints (due to moral hazard prob.)! Brunnermeier and Sannikov (2014), Gertler and Karadi/Kiyotaki (2010) Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 3 / 11

Roadmap Model economy! 2 building blocks I. Nominal price stickiness Firms adjust their nominal price infrequently! Calvo (1983) II. Financial intermediation and the macroeconomy Financial intermediaries good at providing nancing to rms, but subject to nancing constraints (due to moral hazard prob.)! Brunnermeier and Sannikov (2014), Gertler and Karadi/Kiyotaki (2010) Model economy! competitive equilibrium Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 3 / 11

Roadmap Model economy! 2 building blocks I. Nominal price stickiness Firms adjust their nominal price infrequently! Calvo (1983) II. Financial intermediation and the macroeconomy Financial intermediaries good at providing nancing to rms, but subject to nancing constraints (due to moral hazard prob.)! Brunnermeier and Sannikov (2014), Gertler and Karadi/Kiyotaki (2010) Model economy! competitive equilibrium Identify sources of ine ciency. De ne mandates for policy Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 3 / 11

Roadmap Model economy! 2 building blocks I. Nominal price stickiness Firms adjust their nominal price infrequently! Calvo (1983) II. Financial intermediation and the macroeconomy Financial intermediaries good at providing nancing to rms, but subject to nancing constraints (due to moral hazard prob.)! Brunnermeier and Sannikov (2014), Gertler and Karadi/Kiyotaki (2010) Model economy! competitive equilibrium Identify sources of ine ciency. De ne mandates for policy Policy exercise! contrast btw traditional and coordinated mandates Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 3 / 11

Firms Firms produce intermediate goods out of labor and capital services y j,t = A t l α j,t k1 α j,t with j 2 [0, 1] A t! evolves locally stochastically, da t /A t = µ A dt + σ A dz t Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 4 / 11

Firms Firms produce intermediate goods out of labor and capital services y j,t = A t l α j,t k1 α j,t with j 2 [0, 1] A t! evolves locally stochastically, da t /A t = µ A dt + σ A dz t CES aggregator transforms intermediate goods into nal cons. good Z 1 y t = 0 ε y ε ε 1 ε 1 j,t dj with ε > 1 Firms reset nominal price p j,t sluggishly according to Calvo (1983) ) h R i 1 1 1 ε agg. price level p t = dj evolves locally deterministically, dp t /p t = π t dt + 0dZ t 0 p1 j,t ε Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 4 / 11

Financial Intermediaries and Households Fin. intermediaries and households provide capital services to rms, k t = a k t, with a f > a h! n. intermediaries better than households Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 5 / 11

Financial Intermediaries and Households Fin. intermediaries and households provide capital services to rms, k t = a k t, with a f > a h! n. intermediaries better than households Fin. intermediaries maximize their franchise value V t max k f,t,b t E t Z γe γ(s t t) Λ s Λ t n f,s ds, subject to... BC q t k f,t = b t + n f,t FC1 q t k f,t λv t =) q t k f,t λv t n f,t Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 5 / 11

Financial Intermediaries and Households Fin. intermediaries and households provide capital services to rms, k t = a k t, with a f > a h! n. intermediaries better than households Fin. intermediaries maximize their franchise value V t max k f,t,b t E t Z γe γ(s t t) Λ s Λ t n f,s ds, subject to... BC q t k f,t = b t + n f,t FC1 q t k f,t λv t =) q t k f,t λv t n f,t FC2 q t k f,t Φ t n f,t Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 5 / 11

Financial Intermediaries and Households Fin. intermediaries and households provide capital services to rms, k t = a k t, with a f > a h! n. intermediaries better than households Fin. intermediaries maximize their franchise value V t max k f,t,b t E t Z γe γ(s t t) Λ s Λ t n f,s ds, subject to... BC q t k f,t = b t + n f,t FC1 q t k f,t λv t =) q t k f,t λv t n f,t FC2 q t k f,t Φ t n f,t LoM dn f,t = [a f r k,t dt + dq t ] k f,t (i t π t ) b t dt Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 5 / 11

Financial Intermediaries and Households Fin. intermediaries and households provide capital services to rms, k t = a k t, with a f > a h! n. intermediaries better than households Fin. intermediaries maximize their franchise value V t max k f,t,b t E t Z γe γ(s t t) Λ s Λ t n f,s ds, subject to... BC q t k f,t = b t + n f,t FC1 q t k f,t λv t =) q t k f,t λv t n f,t FC2 q t k f,t Φ t n f,t LoM dn f,t = [a f r k,t dt + dq t ] k f,t (i t π t ) b t dt Households! consume c t, supply labor l t, and invest in b t, k h,t Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 5 / 11

Competitive Equilibrium (CE) Standard de nition. Physical capital in xed supply: k h,t + k f,t = k Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 6 / 11

Competitive Equilibrium (CE) Standard de nition. Physical capital in xed supply: k h,t + k f,t = k R1 Leverage constraint q t k f,t min fλv t, Φ t g n f,t occasionally binds binds () min fλv t, Φ t g n f,t < q t k R2 If Φ t = +, competitive equilibrium is constrained-ine cient Pecuniary externalities: distributive, binding-constraint, and dynamic R3 Aggregate production function! y t = ζ t A t l α t k 1 α, with... Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 6 / 11

Competitive Equilibrium (CE) Standard de nition. Physical capital in xed supply: k h,t + k f,t = k R1 Leverage constraint q t k f,t min fλv t, Φ t g n f,t occasionally binds binds () min fλv t, Φ t g n f,t < q t k R2 If Φ t = +, competitive equilibrium is constrained-ine cient Pecuniary externalities: distributive, binding-constraint, and dynamic R3 Aggregate production function! y t = ζ t A t l α t k 1 α, with... R3 ζ t at 1 α /ω t, a t k a h k h,t + a f k f,t, and ω t y t R 1 0 y j,tdj Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 6 / 11

Competitive Equilibrium (CE) Standard de nition. Physical capital in xed supply: k h,t + k f,t = k R1 Leverage constraint q t k f,t min fλv t, Φ t g n f,t occasionally binds binds () min fλv t, Φ t g n f,t < q t k R2 If Φ t = +, competitive equilibrium is constrained-ine cient Pecuniary externalities: distributive, binding-constraint, and dynamic R3 Aggregate production function! y t = ζ t A t l α t k 1 α, with... R3 ζ t at 1 α /ω t, a t k a h k h,t + a f k f,t, and ω t y t R 1 SW Utility ows are: 0 y j,tdj (1 α) ln a t + ln 1 ω t + α ln l t χ 1 1 + ψ l 1+ψ t + ln A t + (1 α) ln k Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 6 / 11

Policy Exercise Traditional Mandate Separate objectives and no cooperation! Nash equilibrium (NE) Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 7 / 11

Policy Exercise Traditional Mandate apru Separate objectives and no cooperation! Nash equilibrium (NE) R max E0 Φ 0 e ρt (1 α) ln a t dt, subject to CE & i t t Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 7 / 11

Policy Exercise Traditional Mandate apru MoPo Separate objectives and no cooperation! Nash equilibrium (NE) R max E0 Φ 0 e ρt (1 α) ln a t dt, subject to CE & i t t max i t n R h E 0 0 e ρt ln 1 ω t + α ln l t χ 1 1+ψ l 1+ψ t i dt, subj. to CE & Φ t o Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 7 / 11

Policy Exercise Traditional Mandate apru MoPo Separate objectives and no cooperation! Nash equilibrium (NE) R max E0 Φ 0 e ρt (1 α) ln a t dt, subject to CE & i t t n R h E 0 0 e ρt ln 1 ω t + α ln l t χ 1 1+ψ l 1+ψ t i dt, subj. to CE & Φ t o max i t! Policy has commitment. Policy rules are designed at t = 0 NE i t! mimic natural rate of return =) π t = 0, ω t = 1, l t = l Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 7 / 11

Policy Exercise Traditional Mandate apru MoPo Separate objectives and no cooperation! Nash equilibrium (NE) R max E0 Φ 0 e ρt (1 α) ln a t dt, subject to CE & i t t n R h E 0 0 e ρt ln 1 ω t + α ln l t χ 1 1+ψ l 1+ψ t i dt, subj. to CE & Φ t o max i t! Policy has commitment. Policy rules are designed at t = 0 NE i t! mimic natural rate of return =) π t = 0, ω t = 1, l t = l NE Φ t! replicate constrained e cient policy of ex. price econ. =) 3.6 3.4 Leverage Multiple and Invariant Distribution 0.1 0.08 3.2 3 2.8 0.06 0.04 2.6 0.02 2.4 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 7 / 11

Macro-prudential Policy in Flexible Price Economy Bene ts #distributive externality [Fig. 1] "binding-constraint externality [Fig. 2] # co-movement btw a t and intermediary wealth share shift invariant distribution rightward [both Figs., RHS] 0.82 0.81 0.8 0.79 0.78 Price of Capital Constrained Efficient Laissez faire Invariant Distribution 0.5 0.4 0.3 1.5 1.45 1.4 1.35 Tobin"s Q 0.5 0.4 0.3 0.77 0.76 0.75 0.74 0.2 0.1 1.3 1.25 1.2 0.2 0.1 0.73 0.1 0.2 0.3 0.4 0 1.15 0.1 0.2 0.3 0.4 0 Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 8 / 11

Policy Exercise (cont.) Coordinated Mandate n R h i o max E 0 i t,φ 0 e ρt (1 α) ln a t + ln 1 ω t + α ln l t χ 1 1+ψ l 1+ψ t, s.t. CE t Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 9 / 11

Policy Exercise (cont.) Coordinated Mandate n max i t,φ t R h E 0 0 e ρt (1 α) ln a t + ln 1 ω t + α ln l t χ 1 Optimal policy 3 2 1 0 1 2 3 4 5 6 10 3 Employment Gap Coordinated Mandate Traditional Mandate Invariant Distribution 0.1 0.2 0.3 0.4 0.25 0.2 0.15 0.1 0.05 0 3.6 3.4 3.2 3 2.8 2.6 2.4 Leverage Multiple 0.1 0.2 0.3 0.4 1+ψ l 1+ψ t 0.25 0.2 0.15 0.1 0.05 0 i o, s.t. CE Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 9 / 11

Policy Exercise (cont.) Coordinated Mandate n max i t,φ t R h E 0 0 e ρt (1 α) ln a t + ln 1 ω t + α ln l t χ 1 Optimal policy 3 2 1 0 1 2 3 4 5 6 10 3 Employment Gap Coordinated Mandate Traditional Mandate Invariant Distribution 0.1 0.2 0.3 0.4 0.25 0.2 0.15 0.1 0.05 0 Leverage Multiple 0.1 0.2 0.3 0.4 a f r k,t q t dt + dq t q t (i t π t ) dt, with q t! PDV of r k,t 3.6 3.4 3.2 3 2.8 2.6 2.4 1+ψ l 1+ψ t 0.25 0.2 0.15 0.1 0.05 0 i o, s.t. CE Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 9 / 11

Contrast between Traditional and Coordinated Mandates Quantitative Analysis Baseline calibration Parameter Values a h λ γ µ A σ A α ε θ ρ ψ χ 70% 2.5 10% 1.5% 3.5% 65% 2 ln 2 6/5 2% 3 2.8 Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 10 / 11

Contrast between Traditional and Coordinated Mandates Quantitative Analysis Baseline calibration Parameter Values a h λ γ µ A σ A α ε θ ρ ψ χ 70% 2.5 10% 1.5% 3.5% 65% 2 ln 2 6/5 2% 3 2.8 Social welfare gains in annual consumption equivalent Coordinated Mandate over Traditional Mandate Present Discounted Value of ln 1 ω ln l α χ l 1+ψ 1+ψ ln a 1 α Ut. Flows Baseline calibration 0.04% 0.00% +0.11% +0.07%... but with a h = 60% 0.05% 0.01% +0.15% +0.09%... but with θ = ln 2 4/5 0.06% 0.01% +0.20% +0.13%... but with ε = 4 0.05% 0.00% +0.07% +0.02% Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 10 / 11

Conclusion Traditional Mandate MoPo! mimic natural rate of return MacroPru! replicate constrained e. policy of exible price econ. Coordinated Mandate MoPo! deviate from natural rate of return MacroPru! soften relative to traditional mandate Social Welfare Gains Coordinated Traditional by 0.07% annual consumption equivalent Van der Ghote (European Central Bank) Monetary and Financial Regulatory Policies 05/18 11 / 11