Credit frictions and optimal monetary policy
Cúrdia and Woodford
Discussion
Frank Smets
Towards an integrated macro-finance framework for
monetary policy analysis
Brussels, 16-17 October 2008
Summary
•
Nice, elegant (once you get through several pages of
algebra) extension of the basic New Keynesian (NK)
model;
•
Includes heterogeneous consumers (with different
saving behaviour) which gives rise to lending and
borrowing in equilibrium;
•
Financial intermediation is costly, giving rise to an
external finance premium; possibility of financial
mark-up.
•
As a result, the basic NK IS and Phillips curves are
amended with a term (financial wedge) that acts like
a cost-push shock.
Policy implications
•
The principles of optimal monetary policy are not
changed much.
•
The NK targeting criteria is still very much in place;
identical with exogenous finance premium:
•
What has changed is the transmission process:
financial frictions do affect how shocks and policy
affect output and inflation;
•
However, in the benchmark calibration these effects
are quite small.
•
So, more or less business as usual.
Modification of the IS and Phillips curves
•
A higher wedge (lower deposit rate, higher borrowing
rate) leads to more consumption by lender and less
consumption by borrower. As lender consumes less,
the aggregate effect on consumption is typically
negative (but small).
•
A higher wedge leads to lower labour supply by
lenders and more work by borrower. As lenders work
relatively more, the lower labour supply by lenders
will dominate in the aggregate (but small).
Responses to a financial shock
What about the role of financial frictions?
What about the role of financial frictions?
What about the role of financial frictions?
•
Two observations:
–
The variation in the interest rate spread is minimal in
response to all aggregate shocks (only a few basis
points). Is this just a calibration issue and thus solvable
or a more fundamental problem? In reality, the external
finance premium is much more volatile.
–
There is a clear positive correlation between the
interest rate spread and credit. In the data the finance
premium is countercyclical, there is a negative
correlation.This will be difficult to solve with different
calibration.
Two main comments
• The CW form of financial friction does not appear
compatible with the countercyclical external
finance premium in the data?
– The premium is partly modelled as an exogenous markup and partly as covering an ad-hoc cost-function.The
intermediation (monitoring) costs are a function of the
amount of lending.
• What financial frictions may be appropriate?
– The financial sector is not explicitly modelled.There are
no explicit banks that maximise profits and face
asymmetric information problems, the possibility of
defaults or capital adequacy constraints, …
Some evidence (Christiano et al, 2008)
External finance premium in the euro area
– Low in booms, high in recessions
Alternative financial frictions
• Financial accelerator and procyclical credit
worthiness: broad balance sheet effect
• Bank lending channel: liquidity and capital of banks
• Risk-taking channel: the attitude towards risk is
procyclical.
Broad balance sheet effects
• Most modelling has focused on broad balance
sheet effects (BGG, KM, Iacoviello, …)
• Financial accelerator can lead to a countercyclical
external finance premium:
– Higher productivity, higher profitability, higher economic
activity, higher asset prices increase the net worth of
households and firms, which reduces the external finance
premium, …
• Pro-cyclical creditworthiness:
– A booming economy implies lower risks of default, lower
risk premia, higher asset prices, … and lower risk premia.
Banks versus firms/households?
• Normal times: limited bank lending channel;
securitisation further reduces this channel.
• Recently, most of the variation has been in
premium paid by banks
firms-euribor
firms-T BILL
euribor-T BILL
3
2.5
2
1.5
1
0.5
20
03
M
ar
20
03
Ju
n
20
03
Se
p
20
03
D
ec
20
04
M
ar
20
04
Ju
n
20
04
Se
p
20
04
D
ec
20
05
M
ar
20
05
Ju
n
20
05
Se
p
20
05
D
ec
20
06
M
ar
20
06
Ju
n
20
06
Se
p
20
06
D
ec
20
07
M
ar
20
07
Ju
n
20
07
Se
p
20
07
D
ec
20
08
M
ar
20
08
Ju
20
n
08
Ju
lA
ug
0
Risk-taking channel
Maddaloni, Peydró-Alcalde and Scopel (2008)
Credit standards
Loans to enterprises
EONIA t-1
(1)
20.7
8.0 ***
GDP growth t-1
Inflation t-1
Country risk t-1
(2)
20.6
9.2 ***
-2.8
3.7 ***
1.7
1.1
-0.2
0.0
Loans to households
for house purchase
(3)
(4)
(5)
11.5
9.3
12.6
7.7 ***
6.5 ***
6.3 ***
-5.3
-5.4
6.8 ***
5.0 ***
1.3
2.8
1.1
1.5
19.9
25.6
1.8 *
1.7 *
% variable rate housing loan t-1 * EONIAt-1
% variable rate housing loan t-1
% variable rate consumer loan t-1 * EONIA t-1
# of observations
# of countries
(6)
8.3
4.7 ***
-5.8
5.4 ***
1.8
0.9
24.3
1.6
0.1
3.0 ***
0.3
2.6 ***
276.0
12.0
276.0
12.0
276.0
12.0
Based on Bank Lending Survey data.
276.0
12.0
254.0
12.0
254.0
12.0
Different sectors respond differently
• Giannoni, Lenza and Reichlin (2008):
– Large BVAR with money/credit aggregates and associated
interest rates
• Some findings:
– Credit to non-financial firms increases following a
monetary policy tightening; credit to households falls. See
also De Haan et al (2007).
– Lending rates are sticky
• Why?
Credit Aggregates
Loans to NFC up to 1 year
Loans to NFC over 1 year
0.5
0.4
0.3
0.2
0.1
0
-0.1
-0.2
0.5
0.4
0.3
0.2
0.1
0
-0.1
-0.2
0
4
8
12
16
20
0
4
Months after the Shock
8
12
16
20
Months after the Shock
Consumer Loans
Loans for House Purchases
0.5
0.4
0.3
0.2
0.1
0
-0.1
-0.2
0.5
0.4
0.3
0.2
0.1
0
-0.1
-0.2
0
4
8
12
16
20
0
4
Months after the Shock
Note: Dashed lines represent the 68% confidence interval.
8
12
16
Months after the Shock
20
Lending rates
Lending rate, Loans to NFC up to 1 year
0.2
0.15
0.1
0.05
0
-0.05
-0.1
0
4
8
12
16
20
Months after the Shock
Lending rate, Loans for House Purchases
Lending rate, Consumer Loans
0.2
0.2
0.15
0.15
0.1
0.1
0.05
0.05
0
0
-0.05
-0.05
-0.1
-0.1
0
4
8
12
16
20
0
4
Months after the Shock
Note: Dashed lines represent the 68% confidence interval.
8
12
16
Months after the Shock
20
Conclusions
• Elegant paper
• Financial frictions do not appear to be
quantitatively important and do not fundamentally
change the principles of monetary policy
• Is likely to be model-dependent:
– Other financial frictions (or shocks) are necessary to
explain the procyclicality of the external finance
premium;
– Interaction with investment (rather than consumption) is
missing.