Macro-prudential Policy:
Heterogeneity and Welfare
Evaluation
Caterina Mendicino •
Economist DEE
10 February 2015
House Prices, Household Debt and the Financial Crisis
Developments in house prices and mortgage market: seen by many as
the primary cause of the recent …nancial crisis.
During the boom years, U.S. house prices rose faster in areas where
subprime and exotic mortgages were more prevalent (Tal 2006; Mian
and Su… 2009; Pavlov and Wachter 2011).
U.S. homeowners borrowed heavily against the rising value of their
homes and defaulted massively when house prices faltered/they were
no longer able to re…nance =) Household defaults sparked the recent
…nancial crisis.
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February 10, 2015
1 / 16
House Prices, Household Debt and the Financial Crisis
Areas which experienced the largest run-ups in household leverage
tended to experience the most severe recessions, as measured by the
subsequent fall in durables consumption or the subsequent rise in the
unemployment rate (Mian and Su… 2010).
U.S household debt exceed 100% of GDP only twice in the last
century: in 1929 (installment loans related to automobile/consumer
durables purchases) and in 2006 (subprime mortgages).
Imbalances in real estate often preceded systemic …nancial crises
(overview Crowe et al. 2013)
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February 10, 2015
2 / 16
Q1 2002
Q2 2002
Q3 2002
Q4 2002
Q1 2003
Q2 2003
Q3 2003
Q4 2003
Q1 2004
Q2 2004
Q3 2004
Q4 2004
Q1 2005
Q2 2005
Q3 2005
Q4 2005
Q1 2006
Q2 2006
Q3 2006
Q4 2006
Q1 2007
Q2 2007
Q3 2007
Q4 2007
Q1 2008
Q2 2008
Q3 2008
Q4 2008
Q1 2009
Q2 2009
Q3 2009
Q4 2009
Q1 2010
Q2 2010
Q3 2010
Q4 2010
Q1 2011
Q2 2011
Q3 2011
Q4 2011
Q1 2012
Q2 2012
Q3 2012
Q4 2012
Residential Property Prices EA
Levels normalised to 100 for Q1 2002
210.00
190.00
170.00
150.00
130.00
110.00
90.00
Source: ECB calculations and DataStream
Austria
Belgium
Finland
Germany
Greece
Ireland
Italy
Netherlands
Portugal
Spain
2002Q1
2002Q2
2002Q3
2002Q4
2003Q1
2003Q2
2003Q3
2003Q4
2004Q1
2004Q2
2004Q3
2004Q4
2005Q1
2005Q2
2005Q3
2005Q4
2006Q1
2006Q2
2006Q3
2006Q4
2007Q1
2007Q2
2007Q3
2007Q4
2008Q1
2008Q2
2008Q3
2008Q4
2009Q1
2009Q2
2009Q3
2009Q4
2010Q1
2010Q2
2010Q3
2010Q4
2011Q1
2011Q2
2011Q3
2011Q4
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
Households Total Loans to GDP EA
amount outstanding (2002Q1=100)
280
260
240
220
200
180
160
140
120
100
80
Belgium
Germany
Spain
Finland
France
Ireland
Italy
Netherlands
Austria
Portugal
Source: ECB calculations and DataStream
House Prices, Household Debt and the Financial Crisis
The recent …nancial crisis questioned the traditional (micro) focus of
…nancial supervision and regulation, and suggested the need to
strengthen the preventive (macro-prudential) aspects of …nancial
stability policies.
EU: The institutional framework has been revised and now explicitly
addresses both macro- and micro-prudential supervision.
- The new European System of Financial Supervision: European
Supervisory Authorities (EBA, EIOPA, ESMA); European Systemic
Risk Board.
- Banking Union: Single Supervisory Mechanism (SSM); Single
Resolution Mechanism (SRM)
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February 10, 2015
3 / 16
Real Estate and Macroprudential Regulatory Instruments
Targeting banks (Sectorial capital requirements, Risk Weights, Loss
given default)
Targeting borrowers (Loan-to-value limits, Loan-to-income,
debt-to-income limits or debt-service-to-income limits)
Broader instruments against the build-up of widespread …nancial
imbalances (Countercyclical capital bu¤er, Leverage ratio...)
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February 10, 2015
4 / 16
Fast Growing Literature on E¤ects and Implementation of
Macroprudential tools
At this stage: urgent need to understand how/if these policies work
Empirical evidence on e¤ectiveness these policies:
- case-studies
- main challenge: limited sample and use of instruments (especially
for industrialized countries).
Modelling and understanding the transmission mechanism:
- challenging combine key ingredients: micro-founded …nancial
intermediation, endogenous default, heterogeneity (propensity to
borrow and consume), systemic distress/shocks
- especially di¢ cult in General Equilibrium: essential to assess the
importance of macro-prudential policies!
=) both empirical and theoretical results helpful to shed light on
macroeconomic/welfare/redistributive and side e¤ects of such policies!
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February 10, 2015
5 / 16
This talk:
Explores the e¤ects of changes in capital regulatory tools though the
lens of a quantitative macro model of …nancial intermediation.
Focuses on a particular angle: assessing potential heterogeneity in
welfare/macroeconomic e¤ects on households with di¤erent
propensity to borrow/consume
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February 10, 2015
6 / 16
This talk:
"Capital Regulation in a Macroeconomic Model with Three Layers of
Defaults" with Laurent Clerc (BdF), S. Moyen (Bundesbank), A. Derviz
(CNB), K. Nikolov and L. Stracca (ECB) J. Suarez (Cem…), A. Vardoulakis
(now FRB).
– Collective ESCB e¤ort: MaRs (macro-prudential research network)
launched in Spring 2010 by the European System of Central Banks (27
European Union (EU) national central banks and the ECB)
– Speci…c focus on capital requirements (CRs): qualitative assessment
"Designing Capital Regulation in a Quantitative Macroeconomic
Model" with K. Nikolov (ECB), J. Suarez (Cem…), D. Supera (ECB)
– Fit to EA data, Stochastic Welfare
– policy simulations and analysis
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February 10, 2015
7 / 16
Model Structure
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February 10, 2015
8 / 16
Overview Model
HH, NFC and Banks features default risk due to a combination of iid
and aggregate factors (real and …nancial shocks that a¤ect asset
prices and riskiness of borrowers). Default causes bankruptcy costs
Banks, have their leverage limited by a regulatory capital
requirement.
Deposits are formally insured, providing an implicit subsidy to
lending made by risky banks.
Despite DI, depositors su¤er transaction costs when banks fail =)
deposit risk premium raises banks funding costs when APD high
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February 10, 2015
9 / 16
"Capital Regulation in a Macroeconomic Model with Three
Layers of Default"
There is generally an optimal level of CRs
Hump-shaped relationship between CRs and social welfare gains )
re‡ecting existence of a trade-o¤!
Higher capital requirements reduce bank leverage: reduces banks’
defaults & supply of credit
(Welfare Analysis based on ad-hoc Social Welfare function/ Pareto
Weights; Steady state analysis)
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February 10, 2015
10 / 16
"Designing Capital Regulation in a Quantitative
Macroeconomic Model"
Explore the trade-o¤:
- welfare heterogeneity
- stochastic quantitative model
Fit to EA data:
- reproduces salient features of EA data (2001:1-2013:4) such as
ratios and volatilities of House prices, HH loans, NFC loans, Spreads,
Write-O¤s.
- Capital regulatory tools calibrated to average bank capital holding of
EA 100 largest banks 2001-2007 (average bank capital 9.5%,
minimum (φt 2std ) 8%, rw=0.5)
Macroprudential Policy Tools: Capital requirements, Capital bu¤er,
Risk weights/Sectorial Requirements
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February 10, 2015
11 / 16
Capital Regulation Policy
The macro-prudential authority sets the reference capital
requirements applicable in period t using the formula
φt = φ̄ + φb log
bt
b
where is φ̄ the reference requirement and φb captures the existence of
some cyclical adjustments which are assumed be a function of
deviations of total loans, bt , from its long-run mean.
The sector speci…c capital requirements are established as proportions
of the reference requirement φt as φH ,t = τ φ φt , φF ,t = φt ,
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February 10, 2015
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Optimization
Optimization: φ̄ the reference requirement; +φb cyclical adjustments;
mortgage risk weight τ φ
Maximize Social Welfare Function
Ṽt
[ζVst + (1
ζ ) Vmt ] ,
(1)
where ζe [0, 1] determines the Pareto Weights
Vjt = fVst , Vmt g denotes the welfare (expected lifetime utility) of the
savers and borrowers households
Solution: we constrain the social welfare maximization problem so as
to ensure that the optimized policies deliver a Pareto improvement
relative to the baseline policy.
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February 10, 2015
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Optimal Macroprudential Tools w.r.t. Pareto Weights
(A) Average Bank Capital Requirement
φ
0.2
t
(C) Risk Weight τ
t
φ +2std( φ )
0.9
t
capital
conservation
buffer
+
countercyclical
buffer
implied
by
the
optimized
policy
rule.
Average value
implied CR
0.15
0.8
0.7
0.6
0.5
0
1
0.1
b
0.2
0.4
0.6
0.8
ζ
(D) Cyclical Response φ
1
b
0.8
0.6
φ -2std( φ )
t
t
0.4
minimum CR
implied by the optimized
policy rule
0.05
0
0.2
()
0.4
ζ
0.6
0.8
0.2
1
0
0
0.2
0.4
ζ
0.6
0.8
1
February 10, 2015
14 / 16
Welfare Trade-O¤s
Welfare Level Savers
Welfare Level Savers
78
Welfare Level Savers
77.5
77
76.95
77
76
76.9
75
76.5
74
73
0.1
0.15
φ
0.2
76.85
76
0.4
Welfare Level Borrowers
0.6
τφ
0.2
0.8
Welfare Level Borrowers
35
φb
0.6
0.8
Welfare Level Borrowers
35
34.5
0.4
35
34.9
34.95
34
34.8
33.5
0.15
φ
0.1
(A) Capital
Requirements
Level
0.2
34.7
0.5
0.6 τ 0.7
φ
(B) Risk
Weight
0.8
34.9
0.2
0.4 φb0.6
0.8
(C) Cyclical
Response
Ceteris Paribus Changes w.r.t. optimal policy that implies the same
welfare gains (consumption equivalent) for Savers and Borrowers
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February 10, 2015
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Conclusion
Our results document heterogeneity in welfare e¤ect of capital
regulation
The policy maker ends up facing a trade-o¤ between the welfare of
the two types of agents
Capital regulation policies can turn out to be optimal by bene…ting
one group of households at the detriment of the other
What about
......redistributive e¤ects? inequality?
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February 10, 2015
16 / 16
Proportion of Indebted Households EA
Source:
2008-2010 SURVEY Household Finance and Consumption Network (HFCN)
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
AT
BE
CY
DE
ES
FI
FR
GR
IT
LU
MT
NL
PT
SI
SK
Total
Share of Wage Income of Indebted
HH EA
Share of Housing Wealth (primary
residence) of Indebted HH EA
90.00%
90.00%
80.00%
80.00%
70.00%
70.00%
60.00%
60.00%
50.00%
50.00%
40.00%
40.00%
30.00%
30.00%
20.00%
20.00%
10.00%
10.00%
0.00%
0.00%
AT BE DE ES
FI
FR GR IT
LU MT NL PT
SI
SK EA