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Leaning against the wind, but how? Monetary policy versus macro-prudential measures F Gulcin Ozkan University of York and Filiz Unsal IMF

19 September 2012

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Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 1 / 28

Plan of the talk

Motivation - ’ lean versus clean’debate prior to and in the aftermath of the 2008-2009 global …nancial crisis (GFC) An overview of how our basic model works Basic model Simulation Results Welfare analysis and optimal policy Conclusions

(University of York)

Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 2 / 28

Main motivation
2008/2009 experience led to a serious re-think of how monetary policy should be conducted. The conventional wisdom prior to GFC was ’ better to clean up after the buble bursts’so clean rather than lean due to the di¢ culty in identifying which asset prices to target the di¢ culty in identifying the ’ right’prices to target the di¢ culty in trading o¤ multiple goals agains the policy rate and the notion that the cost of cleaning up after the buble bursts would not be too large.

The GFC was preceeded by …nancial vulnerabilities particularly in the housing and credit markets. Role of monetary policy in the build up of the asset price buble. (University of York) Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 3 / 28

Main motivation cont.
It is now recognized that price stability is not su¢ cient for …nancial stability. Potential costs of …nancial crises (as documented by Reinhart and Rogo¤, 2009) point to the importance of preserving …nancial stability. Macro-prudential measures are recommended to reduce the systemic risk - procyclical behaviour of …nancial markets. EMs experiences - following their own crisis experiences throughout 1990s New arrangements in mature economies; How best to design macro policy: monetary versus macroprudential tools.

(University of York)

Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 4 / 28

(University of York)

Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 5 / 28

Prior to the crisis

(University of York)

Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 6 / 28

During the crisis

(University of York)

Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 7 / 28

Some examples

(University of York)

Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 8 / 28

Basic model

DSGE model - building upon Bernanke et al. (1999), Devereux et al. (2006) and Gertler et al. (2007). Existence of …nance frictions Explicit trade and …nancial channels between the ROW and the SOE Incorporating …nancial intermediaries to explore monetary versus macro-prudential policy

(University of York)

Leaning against the wind, but how? Monetary policy versus September 2012 measures 19 macro-prudential 9 / 28

Households
A representative household is in…nitely-lived and seeks to maximize: ! 1+ ϕ ∞ Ct1 σ Ht t , E0 ∑ β 1 σ 1+ϕ t =0

(1)

where U (Ct , Ht ) is the period utility function. Ht denotes hours of work and Ct is a composite of domestically produced goods and imported goods, de…ned by: h 1 i 1 (γ 1 )/γ (γ 1 )/γ γ/(γ 1 ) Ct = α γ CH ,t + (1 α) γ CM ,t , (2) where CH ,t and CM ,t are CES indices of consumption of domestic and imported goods, given by: CH ,t = Z 1

0 λ/(λ 1 )

CH ,t (j )(λ

1 )/λ

dj

; CF ,t =

Z 1
0

λ/(λ 1 )

(Ci ,t )(λ

1 )/λ

di

,

where j 2 [0, 1] indicates the goods varieties and λ > 1 is the elasticity of substitution among goods produced within a country. (University of York) Leaning against the wind, but how? Monetary policy...
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