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FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND
MACROECONOMIC INTERDEPENDENCE
Galip Kemal Özhan
University of St Andrew...
INTRODUCTION
Table: Domestic credit outstanding at the end of the period - per GDP
Germany Ireland Spain Portugal
2000 106...
CURRENT ACCOUNT AND ALLOCATION OF CREDIT
Longer series
Source: Eurostat and Bank of Spain. Notes: Tradables include indust...
SHARES OF SECTORS IN OVERALL GVA
Longer series
Source: Eurostat. Notes: Non-tradables include construction, wholesale and ...
INTERPRETATIONS
Optimism about the future state of the economy (Blanchard, 2006,
Blanchard and Giavazzi, 2002, Constâncio,...
QUESTIONS
What is the role of the financial sector in affecting domestic resource
allocation and cross-border capital flows?...
WHAT I DO (1)
Developing a two-country quantitative macro model with a financial
sector, in which intermediaries lend funds...
WHAT I DO (2)
Conducting experiments when agents are optimistic about future value of
capital and capturing non-traded-sec...
WHAT I DO (3)
Studying unconventional monetary policy (UMP) conducted by a
common central bank: Direct asset purchases and...
NEW INSIGHTS
Model’s non-linear solution that captures the state dependent fluctuations is
crucial for explaining the conse...
NEW INSIGHTS
Model’s non-linear solution that captures the state dependent fluctuations is
crucial for explaining the conse...
PREVIEW OF THE MODEL OUTCOME
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 11
PREVIEW OF THE MODEL OUTCOME (CONT’D)
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPE...
THE MODEL
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 13
HOUSEHOLDS
g fraction of household members are bankers, 1 g are workers
Workers and bankers bring their wages and profits t...
HOUSEHOLDS
Expected intertemporal utility:
E0
1X
t=0
t
2666664
C
1 ⇢
t
1 ⇢
$*.
,
L
1+'1
T,t
1+ '1
+
L
1+'2
NT,t
1+ '2
+/
-...
FIRMS
Goods producers:
Yi,t = eai,t
(e i,t
Ki,t )↵
Li,t
1 ↵
Expected discounted profits:
Et
P1
s=t
s⇤s,s+1[RPii,s+1Yi,s+1 +...
FIRMS
Capital producers:
Objective:
MaxIi,t Qi,tKi,t+1 Qi,t (1 )e i,t
Ki,t Ii,t
Constraint:
Ki,t+1 = (1 )e i,t
Ki,t +Ii,t ...
FINANCIAL INTERMEDIARIES
Balance sheet:
QT,tST,t (j) +QNT,tSNT,t (j) = Bt+1(j) +B⇤
t+1(j) +Nt (j) (1)
Evolution of net wor...
FINANCIAL INTERMEDIARIES
Expected discounted value at the time:
MaxSi,t,Bt+1,B⇤
t+1
Vt (j) = Et ⇤t,t+1 [(1 )Nt+1(j) + V t+...
FINANCIAL INTERMEDIARIES
Guess and verify: Vt (j) = ⌫tNj,t
FOCs:
Et [⇤t,t+1⌦t+1(rk,T,t+1 rt+1)] = µt T
Et [⇤t,t+1⌦t+1(rk,N...
FINANCIAL INTERMEDIARIES
µt = max
(
1
Et [⇤t,t+1⌦t+1(1+rt+1)Nt]
T QT,tST,t + NT QNT,tSNT,t
!
,0
)
With µt = 0 8t, banking ...
FINANCIAL INTERMEDIARIES
The IC places a restriction on the size of the bank’s portfolio relative to its net
worth:
QT,tST...
BELIEF-DRIVEN DYNAMICS
The shock specification assumes an anticipated (uA
i,t n) and an unanticipated
component (uU
i,t ):
...
CALIBRATION
Parameter Value Comments
Discount factor 0.995 Standard RBC value
Risk aversion coefficient ⇢ 2 Standard RBC va...
CALIBRATION (CONT’D)
Adjust the expected valuation in assets to match the cumulative banking
exposure to traded and non-tr...
MODEL PERFORMANCE
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 26
MODEL PERFORMANCE (CONT’D)
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 27
THREE MODEL VERSIONS
No banking, under financial autarky
RPH,tC⇤
H,t =
RPF,t
⇠t
CF,t
Domestic banking, under financial autar...
INSPECTING THE MECHANISM (1)
Key mechanism:
QT,tST,t +
NT
T
QNT,tSNT,t =
⌫t
T
Nt
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATIO...
INSPECTING THE MECHANISM (2)
Linear vs Non-linear Wage differentials Percent contributions
GALIP KEMAL OZHAN FINANCIAL INT...
INSPECTING THE MECHANISM (3)
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 31
UNCONVENTIONAL MONETARY POLICY
ECB used its powers as a lender of last resort in reaction to the crisis
I Conducted twenty...
UNCONVENTIONAL MONETARY POLICY
ECB used its powers as a lender of last resort in reaction to the crisis
I Conducted twenty...
PRIVATE ASSET PURCHASES
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 33
PRIVATE ASSET PURCHASES
CB balance sheet:
QT,tSg
T,t
+QNT,tSg
NT,t
= Bg
t + ⇠tB⇤g
⇤,t
where Sg
T,t
= 'ump
T,t
ST,t, and Sg...
PRIVATE ASSET PURCHASES (CONT’D)
Bank balance sheets:
QT,tSp
T,t
(j) +QNT,tSp
NT,t
(j)
| {z }
Private Assets
+ Bg
t (j)
|{...
PRIVATE ASSET PURCHASES (CONT’D)
Private asset purchases relax bank balance sheet constraints:
µt = max
8><
>
:
1 *
,
Et [...
LIQUIDITY FACILITIES
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 37
LIQUIDITY FACILITIES
Bank balance sheets:
QT,tST,t (j) +QNT,tSNT,t (j) +B
g
t (j) = Bt+1(j) +B⇤
t+1(j) + Mt+1(j)
| {z }
Di...
LIQUIDITY FACILITIES (CONT’D)
Liquidity injections relax bank balance sheet constraints:
µt = max
(
1
Et [⇤t,t+1⌦t+1(1+rt+...
MODEL PERFORMANCE UNDER UMPS
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 40
MODEL PERFORMANCE UNDER UMPS (CONT’D)
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPE...
UMP COMPARISON
Relaxation of binding constraints (AP)
Relaxation of binding constraints (LF)
GALIP KEMAL OZHAN FINANCIAL I...
CONCLUSIONS
The model is successful at producing a boom-bust cycle that is
reminiscent of the recent situations in Spain
T...
CURRENT ACCOUNT IMBALANCES: CORE VS PERIPHERY
(BN USD)
Source: IMF World Economic Outlook, October 2015. Notes: Core inclu...
SECTORAL UNIT LABOR COSTS: LOG DIFFERENCES
2000-08
Source: IMF World Economic Outlook
Back
GALIP KEMAL OZHAN FINANCIAL INT...
CURRENT ACCOUNT AND THE ALLOCATION OF CREDIT
Back
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MAC...
SHARES OF SECTORS IN OVERALL GVA
Back
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPE...
FINANCIAL INTERMEDIARIES
Aggregation:
Nt = Nx,t +Nn,t
with
Nx,t = [(1+rk,T,t )QT,t 1ST,t 1 + (1+rk,NT,t )QNT,t 1SNT,t 1
(1...
STEADY-STATE LEVERAGE
Back
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 49
THE ROLE OF OCCASIONALLY BINDING CONSTRAINTS
Back
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MAC...
WAGE DIFFERENTIALS
Back
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 51
% CONTRIBUTIONS
Boom Regime
YT YNT
Barebone 45.4% 88.8%
+Banking 8.7% 1.9%
+Int fin markets 45.8% 9.2%
Bust Regime
YT YNT
B...
EUROSYSTEM LIABILITIES
Source: European Central Bank
Back
GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION,...
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Financial Intermediation Resource allocation and macroeconomic interdependence

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Presented at part of the ADEMU Project at the Macroeconomic and Financial Imbalances and Spillovers Workshop June 2017

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Financial Intermediation Resource allocation and macroeconomic interdependence

  1. 1. FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACROECONOMIC INTERDEPENDENCE Galip Kemal Özhan University of St Andrews June 8, 2017 Barcelona GSE Summer Forum GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 1
  2. 2. INTRODUCTION Table: Domestic credit outstanding at the end of the period - per GDP Germany Ireland Spain Portugal 2000 106 100 87 110 2004 101 126 111 124 2008 95 202 171 151 Source: Giavazzi and Spaventa (2010) Current account imbalances Sectoral unit labor costs GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 2
  3. 3. CURRENT ACCOUNT AND ALLOCATION OF CREDIT Longer series Source: Eurostat and Bank of Spain. Notes: Tradables include industry (excluding construction), agriculture, and fisheries. Non-tradables include construction and services. GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 3
  4. 4. SHARES OF SECTORS IN OVERALL GVA Longer series Source: Eurostat. Notes: Non-tradables include construction, wholesale and retail trade, transport, accommodation, food service and real estate activities. Tradables include industry (excl. const.), agriculture, forestry and fishing. GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 4
  5. 5. INTERPRETATIONS Optimism about the future state of the economy (Blanchard, 2006, Blanchard and Giavazzi, 2002, Constâncio, 2005) I Investment and output boom I Large current account deficits financed by bank lending Increase in the value of non-financials starting from 1998 (Bris, Koskinen, and Nilsson, 2009, 2012) The Global Financial Crisis raised suspicions (Eichengreen, 2010, Giavazzi and Spaventa, 2010, Merler and Pisani-Ferry, 2012) I Capital flow reversals, collapse of bank lending and output GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 5
  6. 6. QUESTIONS What is the role of the financial sector in affecting domestic resource allocation and cross-border capital flows? Does domestic allocation of foreign borrowing matter for the current account? What are the implications of unconventional policy when the economy is suffering from sudden reversals of capital flows? GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 6
  7. 7. WHAT I DO (1) Developing a two-country quantitative macro model with a financial sector, in which intermediaries lend funds to be invested in traded or non-traded sector capital, and borrow from households in both countries I Distinguishing between goods produced in each country I Incomplete international financial markets (deposits) I Asset heterogeneity within an economy I Occasionally binding endogenous leverage constraints (Benigno and Thoenissen, 2008, Corsetti, Dedola, and Leduc, 2008, Gertler and Karadi, 2011, Gertler and Kiyotaki, 2010) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 7
  8. 8. WHAT I DO (2) Conducting experiments when agents are optimistic about future value of capital and capturing non-traded-sector-led boom-bust cycles (similar to formulation in Beaudry and Portier, 2006, Christiano et al., 2010) I Anticipations about higher value of assets (capital): Borrowing and credit expansion I News turn out to be incorrect: Collapse in investment, bank lending, output; jump in credit spreads Fluctuations based solely on optimism and disappointment (Pigou, 1927, Keynes, 1936; Abreu and Brunnermeier, 2012, Brunnermeier and Oehmke, 2013) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 8
  9. 9. WHAT I DO (3) Studying unconventional monetary policy (UMP) conducted by a common central bank: Direct asset purchases and liquidity facilities I In response to unfulfilled expectations I Toward sector-specific conditions I Funded by interest-bearing reserves GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 9
  10. 10. NEW INSIGHTS Model’s non-linear solution that captures the state dependent fluctuations is crucial for explaining the consensus narrative. When leverage constraints bind: Stronger financial accelerator: demand channel Bank portfolio problem: intra-national spillover channel International incomplete markets: international spillover channel GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 10
  11. 11. NEW INSIGHTS Model’s non-linear solution that captures the state dependent fluctuations is crucial for explaining the consensus narrative. When leverage constraints bind: Stronger financial accelerator: demand channel Bank portfolio problem: intra-national spillover channel International incomplete markets: international spillover channel UMPs in response to unfulfilled news are successful at preventing output to fall further GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 10
  12. 12. PREVIEW OF THE MODEL OUTCOME GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 11
  13. 13. PREVIEW OF THE MODEL OUTCOME (CONT’D) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 12
  14. 14. THE MODEL GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 13
  15. 15. HOUSEHOLDS g fraction of household members are bankers, 1 g are workers Workers and bankers bring their wages and profits to their household Perfect consumption insurance within households To limit the bankers’ ability to overcome financial constraints: I with probability 1 , bankers switch occupation every period I new bankers receive start-up funds from their household GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 14
  16. 16. HOUSEHOLDS Expected intertemporal utility: E0 1X t=0 t 2666664 C 1 ⇢ t 1 ⇢ $*. , L 1+'1 T,t 1+ '1 + L 1+'2 NT,t 1+ '2 +/ - 3777775 Consumption baskets: Ct =  a 1  T C ( 1)  T,t + (1 aT ) 1  C ( 1)  NT,t   1 CT,t =  a 1 ! H C (! 1) ! H,t + (1 aH ) 1 ! C (! 1) ! F,t ! ! 1 Budget constraint: Ct +Bt+1 + ⇠tB⇤,t+1 + ⌘ 2 ⇠t (B⇤,t+1)2 = (1+rt )Bt + (1+r⇤ t )⇠tB⇤,t +wT,tLT,t +wNT,tLN,t +⇧t +Tf ⇤ t +Tt GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 15
  17. 17. FIRMS Goods producers: Yi,t = eai,t (e i,t Ki,t )↵ Li,t 1 ↵ Expected discounted profits: Et P1 s=t s⇤s,s+1[RPii,s+1Yi,s+1 +Qi,s+1(1 )e is+1 Ki,s+1 wi,s+1Li,s+1 (1+rk,i,s+1)Qi,sKi,s+1] FOCs: Et [⇤t,t+1 1+ri,k,t+1 ] = Et 2666664 ⇤t,t+1 *. , RPii,t+1↵ Yi,t+1 Ki,t+1 + (1 )e i,t+1 Qi,t+1 Qi,t +/ - 3777775 RPii,t+1(1 ↵) Yi,t+1 Li,t+1 = wi,t+1, where ⇤t,t+1 = UC (t+1) UC (t) , and i 2 {T,NT } and ii 2 {H,NT }. GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 16
  18. 18. FIRMS Capital producers: Objective: MaxIi,t Qi,tKi,t+1 Qi,t (1 )e i,t Ki,t Ii,t Constraint: Ki,t+1 = (1 )e i,t Ki,t +Ii,t f Ii,t e i,t Ki,t ! e i,t Ki,t Q relation for investment: Qi,t = 1 1 fI ✓ Ii,t e i,t Ki,t ◆ e i,t Ki,t (Bocola, 2015 and Mimir, 2015) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 17
  19. 19. FINANCIAL INTERMEDIARIES Balance sheet: QT,tST,t (j) +QNT,tSNT,t (j) = Bt+1(j) +B⇤ t+1(j) +Nt (j) (1) Evolution of net worth: Nt+1(j) = (1+rk,T,t+1)QT,tST,t (j) + (1+rk,NT,t+1)QNT,tSNT,t (j) (1+rt+1)(Bt+1(j) +B⇤ t+1(j)) (2) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 18
  20. 20. FINANCIAL INTERMEDIARIES Expected discounted value at the time: MaxSi,t,Bt+1,B⇤ t+1 Vt (j) = Et ⇤t,t+1 [(1 )Nt+1(j) + V t+1(j)] s.to (1), (2), and (IC) Incentive constraint (IC): V t (j) T QT,tST,t (j) + NT QNT,tSNT,t (j) where ⇤t,t+1 = UC (t+1) UC (t) . GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 19
  21. 21. FINANCIAL INTERMEDIARIES Guess and verify: Vt (j) = ⌫tNj,t FOCs: Et [⇤t,t+1⌦t+1(rk,T,t+1 rt+1)] = µt T Et [⇤t,t+1⌦t+1(rk,NT,t+1 rt+1)] = µt NT where ⌦t ⌘ [(1 ) + ⌫t] GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 20
  22. 22. FINANCIAL INTERMEDIARIES µt = max ( 1 Et [⇤t,t+1⌦t+1(1+rt+1)Nt] T QT,tST,t + NT QNT,tSNT,t ! ,0 ) With µt = 0 8t, banking is frictionless and ⌦t = 1 With µt > 0, IC is binding and the cost of capital is higher than in the frictionless case GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 21
  23. 23. FINANCIAL INTERMEDIARIES The IC places a restriction on the size of the bank’s portfolio relative to its net worth: QT,tST,t (j) + NT T QNT,tSNT,t (j) Nt (j)  ⌫t T Bank leverage is constrained at the point where the gain from running away with assets is balanced with the cost of default Aggregation GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 22
  24. 24. BELIEF-DRIVEN DYNAMICS The shock specification assumes an anticipated (uA i,t n) and an unanticipated component (uU i,t ): i,t = ⇢ i,t 1 +uA i,t n +uU i,t If uU i,t = uA i,t n at t = n, then anticipations are not realized (Beaudry and Portier, 2006, Christiano et al. 2010) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 23
  25. 25. CALIBRATION Parameter Value Comments Discount factor 0.995 Standard RBC value Risk aversion coefficient ⇢ 2 Standard RBC value Relative weight of labor $ 5.584 Gertler and Kiyotaki (2010) Frisch elasticity (T Sector) '1 0.276 Gertler and Karadi (2011) Frisch elasticity (NT Sector) '2 0.276 Gertler and Karadi (2011) Deposit adjustment ⌘ 0.025 Standard RBC value Elasticity of substitution between Home and Foreign goods ! 1.2 Standard RBC value Elasticity of substitution between traded and non-traded goods  1 Drozd and Nosal (2010) Investment adjustment 'K 5 BGG (1999) Depreciation 0.025 Standard RBC values Home bias aH 0.55 To match the data Share of tradable sector aT 0.55 To match the data Share of capital in production ↵ 0.333 Standard RBC value Exit probability of banks 0.975 Bank survival of 10-years Fraction of start-up funds " 0.0001 To min the effect of bank entry T sector moral hazard T 0.4126 Steady state excess return in NT sector of 50bps, NT sector moral hazard NT 0.2063 in T sector of 100bps GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 24
  26. 26. CALIBRATION (CONT’D) Adjust the expected valuation in assets to match the cumulative banking exposure to traded and non-traded sectors between 1999:QIV-2008:QI Adjustment implies a 25.5% expected valuation in NT assets (with a 0.55 correlation with T assets) Qualitative results not dependent on this specific calibration Steady state leverage GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 25
  27. 27. MODEL PERFORMANCE GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 26
  28. 28. MODEL PERFORMANCE (CONT’D) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 27
  29. 29. THREE MODEL VERSIONS No banking, under financial autarky RPH,tC⇤ H,t = RPF,t ⇠t CF,t Domestic banking, under financial autarky QT,tST,t (j) +QNT,tSNT,t (j) = Bt+1(j) +Nt (j) RPH,tC⇤ H,t = RPF,t ⇠t CF,t International deposit market integration QT,tST,t (j) +QNT,tSNT,t (j) = Bt+1(j) +B⇤ t+1(j) +Nt (j) CAt = ⇠t B⇤,t+1 B⇤,t ⇣ B⇤ t+1 B⇤ t ⌘ GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 28
  30. 30. INSPECTING THE MECHANISM (1) Key mechanism: QT,tST,t + NT T QNT,tSNT,t = ⌫t T Nt GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 29
  31. 31. INSPECTING THE MECHANISM (2) Linear vs Non-linear Wage differentials Percent contributions GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 30
  32. 32. INSPECTING THE MECHANISM (3) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 31
  33. 33. UNCONVENTIONAL MONETARY POLICY ECB used its powers as a lender of last resort in reaction to the crisis I Conducted twenty LTROs with three and six month maturity between April 2008 and October 2011 I Additional program of outright purchases of asset-backed-securities on November 21, 2014 GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 32
  34. 34. UNCONVENTIONAL MONETARY POLICY ECB used its powers as a lender of last resort in reaction to the crisis I Conducted twenty LTROs with three and six month maturity between April 2008 and October 2011 I Additional program of outright purchases of asset-backed-securities on November 21, 2014 UMP substitutes central bank intermediation for private bank intermediation I Central bank is more efficient in raising funds: Barro-Sargent-Wallace Irrelevance Proposition CB issues debt to banks to fund the UMP: Interest-bearing reserves Eurosystem balance sheet GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 32
  35. 35. PRIVATE ASSET PURCHASES GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 33
  36. 36. PRIVATE ASSET PURCHASES CB balance sheet: QT,tSg T,t +QNT,tSg NT,t = Bg t + ⇠tB⇤g ⇤,t where Sg T,t = 'ump T,t ST,t, and Sg NT,t = 'ump NT,t SNT,t Rule: ˆ'ump NT,t = ⇢' ump NT ˆ'ump NT,t 1 +uump NT,t GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 34
  37. 37. PRIVATE ASSET PURCHASES (CONT’D) Bank balance sheets: QT,tSp T,t (j) +QNT,tSp NT,t (j) | {z } Private Assets + Bg t (j) |{z} Interest-Bearing Claims = Bt+1(j) +B⇤ t+1(j) +Nt (j) IC: Vt (Nt (j)) T QT,tST,t (j) + NT QNT,tSNT,t (j) + ECBBg t (j) UMP friction does not apply to Foreign banks: Home may exit the EZ and Home banks divert assets in that case GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 35
  38. 38. PRIVATE ASSET PURCHASES (CONT’D) Private asset purchases relax bank balance sheet constraints: µt = max 8>< > : 1 * , Et [⇤t,t+1⌦t+1(1+rt+1)Nt] T QT,tSp T,t + NT QNT,tSp NT,t + ECBBg t + - ,0 9>= > ; If the constraint is not binding, CB purchases are neutral, and therefore inefficient GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 36
  39. 39. LIQUIDITY FACILITIES GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 37
  40. 40. LIQUIDITY FACILITIES Bank balance sheets: QT,tST,t (j) +QNT,tSNT,t (j) +B g t (j) = Bt+1(j) +B⇤ t+1(j) + Mt+1(j) | {z } Discount Window Lending +Nt (j) IC: Vt (Nt (j)) T QT,tST,t (j)+ NT (QNT,tSNT,t (j) Mt+1)+ ECB (B g t (j) Mt+1(j)) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 38
  41. 41. LIQUIDITY FACILITIES (CONT’D) Liquidity injections relax bank balance sheet constraints: µt = max ( 1 Et [⇤t,t+1⌦t+1(1+rt+1)Nt] T QT,tST,t + NT QNT,tSNT,t + ECBBg t ( ECB + NT )Mt+1 ! ,0 ) Mt+1: Central bank loans that are carried into t +1 GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 39
  42. 42. MODEL PERFORMANCE UNDER UMPS GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 40
  43. 43. MODEL PERFORMANCE UNDER UMPS (CONT’D) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 41
  44. 44. UMP COMPARISON Relaxation of binding constraints (AP) Relaxation of binding constraints (LF) GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 42
  45. 45. CONCLUSIONS The model is successful at producing a boom-bust cycle that is reminiscent of the recent situations in Spain Three main channels in explaining the mechanism: I Demand Channel I Bank Spillover Channel I International Deposit Market Channel ECB-type UMP is successful at mitigating the fall in bank lending and output A rigorous treatment of the consensus view of what caused the EZ Crisis (Baldwin and Giavazzi (2015)) I “Capital flows fed non-traded portion of the economy, and the effects of sudden-reversals were amplified due to bank dominance” GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 43
  46. 46. CURRENT ACCOUNT IMBALANCES: CORE VS PERIPHERY (BN USD) Source: IMF World Economic Outlook, October 2015. Notes: Core includes Austria, Finland, Germany, and the Netherlands. Periphery includes Greece, Italy, Portugal, Spain, and Ireland. Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 44
  47. 47. SECTORAL UNIT LABOR COSTS: LOG DIFFERENCES 2000-08 Source: IMF World Economic Outlook Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 45
  48. 48. CURRENT ACCOUNT AND THE ALLOCATION OF CREDIT Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 46
  49. 49. SHARES OF SECTORS IN OVERALL GVA Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 47
  50. 50. FINANCIAL INTERMEDIARIES Aggregation: Nt = Nx,t +Nn,t with Nx,t = [(1+rk,T,t )QT,t 1ST,t 1 + (1+rk,NT,t )QNT,t 1SNT,t 1 (1+rt )(Bt +B⇤ t )], Nn,t = "(1 )[(1+rk,T,t )QT,t 1ST,t 1 +(1+rk,NT,t )QNT,t 1SNT,t 1] Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 48
  51. 51. STEADY-STATE LEVERAGE Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 49
  52. 52. THE ROLE OF OCCASIONALLY BINDING CONSTRAINTS Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 50
  53. 53. WAGE DIFFERENTIALS Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 51
  54. 54. % CONTRIBUTIONS Boom Regime YT YNT Barebone 45.4% 88.8% +Banking 8.7% 1.9% +Int fin markets 45.8% 9.2% Bust Regime YT YNT Barebone 10.1% 68% +Banking 52.9% 13% +Int fin markets 36.9% 18.9% Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 52
  55. 55. EUROSYSTEM LIABILITIES Source: European Central Bank Back GALIP KEMAL OZHAN FINANCIAL INTERMEDIATION, RESOURCE ALLOCATION, AND MACRO INTERDEPENDENCE 53

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