Financial intermediation and the real
economy: implications for monetary and
macroprudential policies
Stefano Neri
Banca d...
Outline
1. The financial crisis and the debate on
modelling
2. Towards a new framework?
3. Monetary and macroprudential po...
Pre-crisis consensus on macro modelling
• New Keynesian framework
 Representative agent cash-less economy
 nominal rigid...
The financial crisis
• The crisis showed how
 important are the links between financial
markets and the real economy
 ma...
Intense debate on the lessons of the crisis
for economics and economic modelling
• Buiter, Goodhart, Cecchetti, Spaventa a...
• Crisis as opportunity to modify current framework
• Since Kiyotaki and Moore (1997) and Bernanke et
al. (1999), few pape...
• Setting up a new framework that takes into
account the critiques that have been raised will
require time
• Policy-makers...
I use the model developed in Gerali et al. (2010) and
modified in Angelini et al. (2011) to answer questions
related to mo...
• Based on Gerali, Neri, Sessa and Signoretti (2010)
“Credit and Banking in a DSGE model of the euro area”
• Medium-scale ...
• Project started in September 2007
• Model has been estimated using Bayesian
methods and data for the euro area over the
...
• Monetary policy:
 interest rate rule à la Taylor
• Macroprudential policy:
 bank capital requirements rule
 Xt can be...
What was the impact of the financial crisis
on economic activity in the euro area?
•The recession in
2009 was almost
entir...
Should monetary and macroprudential
policies co-operate?
•In “normal” times
macroprudential
policy yields small
benefits
•...
Should macroprudential policy lean against
financial cycles?
•Agents expect a
reduction in aggregate
risk in one year time...
Aggressive monetary policy can help mitigating
negative impact of shocks to banking sector
Monetary and macroprudential ...
• DSGE models have undergone severe criticism
• No doubt that models must be improved, but
working alternative missing
• I...
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Finan inter 2

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  • Finan inter 2

    1. 1. Financial intermediation and the real economy: implications for monetary and macroprudential policies Stefano Neri Banca d’Italia SUERF/Deutsche Bundesbank/IMFS Conference The ESRB at 1 Berlin, 8-9 November 2011 sual disclaimer applies www.StudsPlanet.com
    2. 2. Outline 1. The financial crisis and the debate on modelling 2. Towards a new framework? 3. Monetary and macroprudential policies in a model with financial intermediation www.StudsPlanet.com
    3. 3. Pre-crisis consensus on macro modelling • New Keynesian framework  Representative agent cash-less economy  nominal rigidities → role for monetary policy  no financial frictions and no intermediaries • “The paradigm that has emerged […] is one that is clearly applicable to normal times […] in developed, stable economies”, J. Galí (interview for EABCN, 2009) • Estimated models (e.g. Smets and Wouters, 2007) used for policy analysis (e.g. RAMSES at Riksbank ) www.StudsPlanet.com
    4. 4. The financial crisis • The crisis showed how  important are the links between financial markets and the real economy  many of the assumptions that characterized the new Keynesian framework were wrong  financial markets are far from being efficient  financial markets matter in originating and propagating shocks www.StudsPlanet.com
    5. 5. Intense debate on the lessons of the crisis for economics and economic modelling • Buiter, Goodhart, Cecchetti, Spaventa and De Grauwe to mention some of critics of DSGE models • Main missing elements:  financial intermediation  insolvency and default  liquidity  regulation of intermediaries and markets  booms and busts in asset markets www.StudsPlanet.com
    6. 6. • Crisis as opportunity to modify current framework • Since Kiyotaki and Moore (1997) and Bernanke et al. (1999), few papers have considered financial intermediation in general equilibrium • Intensive research ongoing since 2009  Angeloni and Faia, Curdia and Woodford, Gertler and Kiyotaki, Bianchi and Mendoza, Jeanne and Korinek,… • They all fall short of modelling systemic risk The crisis as an opportunity www.StudsPlanet.com
    7. 7. • Setting up a new framework that takes into account the critiques that have been raised will require time • Policy-makers are confronted with questions that require timely answers • Researchers in both academia and central banks to cooperate and develop new models • In the meantime, one possibility is to modify current models and use them for policy analysis Towards a new framework? www.StudsPlanet.com
    8. 8. I use the model developed in Gerali et al. (2010) and modified in Angelini et al. (2011) to answer questions related to monetary and macroprudential policies 1) What was the impact of the financial crisis on economic activity in the euro area? 2) Should monetary and macroprudential policies co-operate? (BI Discussion paper, no. 801, 2011) 3) Should macroprudential policy lean against financial cycles? Monetary and macroprudential policies in a model with financial intermediation www.StudsPlanet.com
    9. 9. • Based on Gerali, Neri, Sessa and Signoretti (2010) “Credit and Banking in a DSGE model of the euro area” • Medium-scale model with:  real and nominal rigidities (Smets and Wouters, 2007)  financial frictions à la Kiyotaki and Moore (1997)  monopolistic competition in banking sector  slow adjustment of bank rates to policy rate  role for bank capital  time-varying risk weights in bank capital regulation  policy rule for bank capital requirement The model www.StudsPlanet.com
    10. 10. • Project started in September 2007 • Model has been estimated using Bayesian methods and data for the euro area over the period 1998-2009 • The model has also been used to study:  impact of a credit crunch on euro-area economy  impact of higher capital requirements (Basel 3) • Model has some of the limitations that I have discussed The model (cont’d) www.StudsPlanet.com
    11. 11. • Monetary policy:  interest rate rule à la Taylor • Macroprudential policy:  bank capital requirements rule  Xt can be any macroeconomic variable relevant for macroprudential authority ( ) ( ) [ ( ) ( ) ] 1111 −− +−+−−+−= tRttytRRt RyyRR ρχππχρρ π Modelling monetary and macroprudential policies ( ) ( ) 111 −+−+−= ttt X νρχρνρν νννν www.StudsPlanet.com
    12. 12. What was the impact of the financial crisis on economic activity in the euro area? •The recession in 2009 was almost entirely caused by adverse shocks to banking sector •The sharp reduction of policy rates attenuated the strong and negative effect of the crisis on the euro-area economy www.StudsPlanet.com
    13. 13. Should monetary and macroprudential policies co-operate? •In “normal” times macroprudential policy yields small benefits •If two authorities do not cooperate, policy tools are extremely volatile •Benefits are sizeable when economy is hit by financial shocks and when two authorities cooperate 0 10 20 30 40 8.7 8.8 8.9 9.0 9.1 Capital requirements 0 10 20 30 40 -0.08 -0.06 -0.04 -0.02 0.00 0.02 Policy rate 0 10 20 30 40 8.00 8.25 8.50 8.75 9.00 Capital/assets ratio 0 10 20 30 40 -0.1 0.0 0.1 0.2 0.3 Loan rate 0 10 20 30 40 -0.6 -0.4 -0.2 0.0 0.2 Loans-to-output ratio quarters after shock 0 10 20 30 40 -0.3 -0.2 -0.1 0.0 Output quarters after shock Cooperative Non cooperative Only monetary policy www.StudsPlanet.com
    14. 14. Should macroprudential policy lean against financial cycles? •Agents expect a reduction in aggregate risk in one year time •For a given target for leverage, this provides an incentive for banks to increase lending •Shock does not materialize •Tighter capital requirements can be effective in containing expansion of lending 0 5 10 15 20 8.90 9.00 9.10 9.20 9.30 9.40 9.50 Capital requirements 0 5 10 15 20 -0.6 -0.4 -0.2 0.0 0.2 Policy rate (dev. from steady state) 0 5 10 15 20 0.00 0.05 0.10 0.15 0.20 0.25 Output (% dev. from steady state) quarters after shock 0 5 10 15 20 0.0 0.5 1.0 1.5 2.0 Loans-to-output ratio (dev. from steady state) quarters after shock Active macroprudential policy No macroprudential policy www.StudsPlanet.com
    15. 15. Aggressive monetary policy can help mitigating negative impact of shocks to banking sector Monetary and macroprudential policies should closely co-operate  Benefits of macroprudential policy can be sizeable when economy is hit by financial shocks  Risk of coordination failure Macroprudential policy can be effective in leaning against financial cycles Implications for monetary and macroprudential policies www.StudsPlanet.com
    16. 16. • DSGE models have undergone severe criticism • No doubt that models must be improved, but working alternative missing • Intensive research ongoing • Modeling systemic risk is key • Meanwhile, we can adapt current models with a role for financial intermediation to address questions related to monetary and macroprudential policies Conclusions www.StudsPlanet.com
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