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A Dynamic Model of Financial Balances for the United Kingdom


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Models of Economic Policy session at 12th International Conference

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A Dynamic Model of Financial Balances for the United Kingdom

  1. 1. A dynamic model of financial balances for the United Kingdom Antoine Godin1 THE 12TH INTERNATIONAL POST KEYNESIAN CONFERENCE, Sept 26, 2014. 1University of Limerick, Ireland.
  2. 2. Joint work with I Oliver Burrows and Stephen Millard, Bank of England. I Stephen Kinsella and Sean Ryan, University of Limerick. I Views expressed are ours and not those of the Bank of England.
  3. 3. What we want to do I We are building a new dynamic macroeconomic model of financial balances for the United Kingdom using flow of funds data from 1987 to the present. I The model contains six sectors: households, non-financial firms, the government, banks, insurance companies and pension funds, and a simplified rest of the world. I Using forecasts for key macroeconomic driving variables, we plan to show how we can use our model to perform medium-term scenario analyses on developments in the housing market, the supply of credit, demographic change, and changes in portfolio allocation between multiple financial assets.
  4. 4. Motivation I Need to modify and augment standard modeling approaches post-crisis. There is no model ‘to rule them all’ anymore. Models should be interoperable and empirically-based. I Clearly we need coherent incorporation of financial and real stocks and flows via the Flow of Funds into the apparatus of modern Bank models. I Need to understand portfolio effects, housing markets, debt and demographic change simultaneously. I Understanding the relationship between developments in the real economy and in financing flows, balance sheets and asset prices when looking for financial vulnerabilities. I . . . which clearly syncs with forecasts from COMPASS, the BoE’s suite of DSGE models.
  5. 5. Questions we’re asking (and able to ask): I How do changes in the portfolio allocation of sector i affect financial stability and output? I How do credit quality and funding shocks to banks affect the real economy and financial system, through supply of credit to households and firms? I How does bank credit creation (including via mortgage lending) affect the evolution of the real economy and financial system? I How do changes in demand in subsectors of the housing market (i.e. changes in the share of BtL / movers / FtBs) affect housing market dynamics and the broader evolution of the financial system? I How do changes in import/export propensity affect the financial system?
  6. 6. Directed Acyclic Graph of the 6 sector model: ROW Stock Banks' Stock Central Bank's Stock ICPF Stock Households' Stock Firms' Stock Assets Price Nominal Demand of Assets Inputs Exogenous flows Demographics Expectations Expectations Pension Contribution Government Deficit Taxes Households' income Government expenditure Capital Account Current Account Current account flows Households' Labor Market Expectations consumption Firms' profits Sales Output Investment and targets Interest rate settings Expectations Housing market Demographics EExxppeeccttaattiioonnss Real Supply of Liabilities Expectations Endogenous flows End of Period Stock Legend Dynamic feedback Figure 1: Directed Acyclic Graph
  7. 7. Aggregate Balance Sheet of the Economy Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities Assets Liabilities !m_HH +m_b +l_f !l_f +d_HH !d_b +d_icpf !adv +adv +res !res Item Deposits Advances Reserves Bank !B_b +B_b_icpf +B_b_w Government !B_g +B_g_cb +B_g_icpf +B_g_w Foreign +B_w_icpf !B_w Private !eq_b +eq_b Firms !E_f +E_f_icpf +E_f_w Foreign +E_w_icpf !E_w Inventories +invent Houses +h_HH ITR +itr_HH !itr Bonds Equities Real@Assets Central@Bank Firms ICPF ROW Mortgages Loans Households Banks Government Figure 2: Balance Sheet
  8. 8. Housing, Debt, and Demographic structure are related Figure 3: Demography drives housing demand/supply
  9. 9. Housing market price dynamics pH,X = min 2 4 DSRX rS YDeX SHY , rentX + cgeX iM,X,−1 + μ1,X 3 5 pH,A = X wipH,i peH ,X = pH,X,−1(1 + dpeH ,A)
  10. 10. ICPF and retirment Ann = DITRMR + pHM · SHRM − pR · SHMR ap = Ann X20 i=1 (1 + iCB)i AR = X20 i=1 ap,−i ITR = X Pcon,i+FICPF−DITRMR−AR+pHM·SHRM−pHR·SHMR
  11. 11. Closing the model: The current account-capital account nexus I Trade Balance and Current Account of Balance of Payment endogenously determined (except exports) I Assuming no change in reserves and no change in exchange rate, Capital account = current account I First, ROW buys all remaining Government bonds then allocates the residual between domestic bank bonds and domestic firms’ equities, given the nominal demand from domestic banks in foreign bonds and equities
  12. 12. Households’ Balance Sheet: Figure 4: Assets, Liabilities, residual
  13. 13. Banks’ Balance Sheet: Figure 5: Assets, Liabilities, residual
  14. 14. Non Financial Corporates’ Balance Sheet: Figure 6: Assets, Liabilities, residual
  15. 15. ICPF’ Balance Sheet: Figure 7: Assets, Liabilities, residual
  16. 16. Government Balance Sheet: Figure 8: Assets, Liabilities, residual
  17. 17. Calibration and next steps I Model takes parameter values from COMPASS and other econometric studies. I Equation system c. 250 Identity, Balancing, and Behavioral equations. I Calibration ongoing (roughly 90% of the process done), taking each experiment we discussed above into account.
  18. 18. Thanks I Comments and questions most welcome to