30057-2015-second-week-200215
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SyllabusTRANSCRIPT
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International Economics:
Before the Crisis: The Great Deviation
International Economics Second Week
2014/2015
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Summing Up • Understanding the Great Crisis, analyzing the Great
Moderation (GM) • The GM Economics: The Efficient Markets View • Crucial Policies: Financial Deregulation and Monetary
Policy • Financial Deregulation = Changing Face of Finance
(Leverage) • Micro: Finance = Dimension, Complexity,
Interconnections • Macro: output growth ok, inflation ok • Any imbalances? 1) AU (House prices)? NO • 2) RU (Trade)? NO … • 3) Monetary Policy
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3 3 Fonte: Ferrero,
FED New York 2012
The Great Moderation: Any Con? 3) Lax Monetary Policy?
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Deregulation and MP
• In order to design and implement deregulation you have to finance it =
• In order to increase the overall leverage the interest rates have to be low and stable
• Deregulation and Monetary Policy = Two Faces of the same Coin
• How to evaluate the US MP?
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Evaluating the US MP
• US MP and • Greenspan, • the Wizard
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Evaluating the US MP
• Which Wizard?
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Evaluating the MP: Which is our benchmark?
• To evaluate the MP action, we need a benchmark :
• In general we can discuss two different MP strategies, given the existent demand for money L …
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MP: Quantitative Policy
• The central bank sets the money supply, and the market determines the interest rate level
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i
m M
i*
L
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MP: Interest Rate Policy
• The central bank sets the interest rate level, and the market determines the money supply
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i
m M
i*
L
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MP Strategies
• Is there any difference? Yes, with uncertainty on L:
• Interest rate policies smooth interest rate volatility
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??? ???
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Evaluating the US MP: the Taylor Rule
• We will work with the more common (usual, normal) RBMP – Rule Based MP - strategy:
• Flexible Rule Based MP = the Taylor Rule:
• It’s a Rule, but it is also Flexible (state contingent)
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Building up the Taylor Rule: Assumptions
• Assumptions: • 1) In the long run
equilibrium the Fisher Equation holds:
• 2) But in short/medium run supply shocks and demand shocks can occur
• 3) Causing deviations from the optimal (potential) output growth y* and inflation growth π*
π+= ri
)();( ** yy −−ππ
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The Taylor Rule and the CB
• In each country: • 1) The Central Bank knows the values of: • The optimal output growth y* and inflation growth π* ;
• 2) The parameters α and β,representing their relative importance (=weights)
• 3) He/she can use the interest rate policy to implement the optimal monetary policy. Therefore the rule will be:
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The Taylor Rule
• Note: the simplest specification, with r=π*=y* =2 and α=β=0.5, is:
)()( ** yyriT −+−++= βππαπ
yiT 5.05.1 += π
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First Remark: The Taylor Rule and the Central Bank Governance
• The Taylor Rule can be implemented in different central bank settings
• Central Bank Governance = rules defining central bank goals and tools
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• We can link the MP actions with the CB settings
• Ex: the CBs Mandates are different
• Most Important Cases : • A) Single Mandate (Monetary
Stability) (ECB) • B) Dual Mandate (Monetary
Stability and Employment) (FED)
Examples: Taylor Rules and CBs
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ECB Mandate
• Single Mandate: Monetary Stability Goal • The EU Treaty establishes that the primary
objective of the ECB is the price stability • Today Goal: Price stability is a yearly increase
in the Consumer Price for the Euro Area below but closed to 2%
• Therefore in a TL: • and π*=2%
)()( ** yyri −+−++= βππαπ
•α>β
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FED Mandate • Dual Mandate: Monetary Stability and Employment • The FED Act establishes that the objectives of the FED
are maximum employment, stable prices and moderate interest rate
• Recent Goal: Low Interest rates until unemployment falls below 6.5 % or inflation rises above 2.5%
• Therefore in a TL: • • and π*=2.5%
)()( ** yyri −+−++= βππαπ
•α=β
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Second Remark: The Taylor Rule in Open Economy
• Is it possible to use the Taylor Rule as the Monetary Policy Rule in a open economy?
• Yes, with: a) perfect capital mobility; b) flexible exchange rates;
)()( ** yyri −+−++= βππαπ
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The Taylor Rule in Open Economy
• In fact if the two above assumptions hold: • Each external shock can hit the output growth
and/or the inflation, triggering changes in the monetary policy stance:
)()( ** yyri −+−++= βππαπ
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The Taylor Rule in Open Economy
• One Important Effect follows: • Financial Interconnections - a) + b) –
produce the Harmonization (Convergence) of the Monetary Policy Rules
• Which substitutes the “old” Monetary Policy Coordination
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Third Remark: The Taylor Rule and the ZLB
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ZLB Missing (FT, 13,2015)
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Extraordinary Times: negative interest rates and CB losses
ASSETS
LIABILITIES
• PUBLIC ASSETS
• FOREIGN ASSETS
• MONETARY BASE:
• A)CASH • B) BANK
RESERVE
* CAPITAL:
• In ET it is possible that:
• CB interest rates are negative
• CB losses occur
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)()( ** yyri −+−++= βππαπ
US MP: The Taylor Critique
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US MP: The Taylor Critique
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US MP: The Taylor Critique
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EU MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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UK MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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J MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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D MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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IT MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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FR MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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ES MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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IR MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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PR MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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GR MP: The Taylor Critique
i Taylor = bold line; source: Ahrend, 2010
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The Taylor Critique: MP & Housing Bubble
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The Taylor Critique: MP & HB
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The Taylor Critique: MP & AB
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The Taylor Critique: MP & AB
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The Taylor Critique: MP & AB
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The Taylor Critique: MP & AB
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The Taylor Critique: MP & Financial Crisis
• On top of that: • If we assume that: • Financial Crisis = F(lax
monetary policy) • and we use as FC proxy the
fiscal costs of bank rescue • We can see that…
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The Taylor Critique: MP & Financial Crisis
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The US MP as a Great Deviation
• The Taylor Critique: The US MP was a Great Deviation (respect to the standard rules = Taylor Rules ),
• Triggering the Great Crisis
• Disagreement: Criticizing the Taylor Critique…
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Lax Monetary Policy? No, low inflation π
0,00
1,00
2,00
3,00
4,00
5,00
6,00
7,00
1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 64 67 70 73 76 79 82
Tito
lo a
sse
FED rates and inflation rates (bold) (2000-2006, monthly data)
Serie1
Serie2
)()( ** yyri −+−++= βππαπ
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Lax Monetary Policy? No, Noises
)()( ** yyeeri −+−++= βππαπ
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Lax Monetary Policy? No, Low Real Rate
• Assuming that the real rate r is the clearing price in the saving market:
• Where Investment I= Demand for Saving = I(r) Saving S = Supply for Saving = S(r)
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r
I,S
I
S
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Lax Monetary Policy? No, Low Real Rate = Saving Glut
• If a saving glut occurs:
• A downward shift of the S curve triggers
• Higher I,S • Lower r
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r
I,S
I
S
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Lax Monetary Policy? No, Saving Glut (World Data, 2002-
2004)
saving
investment
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Saving Glut? Be Sure? (World Data, 1970-2004)
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Summing Up: The US MP as a Great Deviation
• The US MP was a Great Deviation (respect to the standard rules = Taylor Rules ),
• Effect: Overlook financial instability signal • More generally….
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The Great Deviation in FR and MP
• The years before the GC = The Great Deviation
• Financial Regulation = Deviation from the Standard Regulation = De – Regulation
• Monetary Policy = Deviation from the Standard Monetary Rules = Lax Monetary Policies
• Effect: To overlook instability signals …
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Summing up: Overlooked Instability Signals
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Summing Up: Overlooked Instability Signals
• In general: • Housing Price Bubble = Asset Price
Movements = Financial Phenomenon = Negligible
• Current Account Deficit = Aggregate Demand Phenomenon = Negligible
• Monetary Policy Laxity = Aggregate Demand Phenomenon = Negligible
• Why? It depends on the GM economics …
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The Economics of the Great Moderation: The Efficient Markets View
• The Economics of the GM: The Efficient Markets View (EMV)
• EMV: If the micro market structure is efficient in producing and distributing goods and services :
• The macro performances are automatically good
•
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The Efficient Markets View and the Supply Side Economics
• In the Efficient Markets View which are the optimal economic policies?
• Aggregate Demand Policies? NO • Supply Side Policies? YES • Why? Any change in AD can be permanent or
temporary
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The Efficient Markets View and the Supply Side Economics
• Why? Any change in AD can be permanent or temporary
• If an AD change is permanent: the efficient producers anticipate it, changing his/her choices
• If an AD change is temporary: the efficient producers doesn’t change his/her choices
• Therefore just the producers’ choices (Supply Side) matter
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Supply Side Economics and Economic Policies
• Therefore economic policy is effective if and only if trigger efficiency
• Efficiency = productivity • Which policies can increase productivity?
Supply Side Policies, as : • - antitrust policy = changes in the markets for
goods and services • - flexibility policy = changes in the labour
markets • Macro Effects …
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Supply Side Economics, Growth and Inflation
• In the Supply Side Economics: • 1) Growth depends on Productivity • 2) It is possible to have more Growth without
Inflation = The Phillips Curve disappears • 3) It is possible to have Growth and Stability • In fact…
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GC: Just Productivity matters …
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GM: … The end of the Phillips curve
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GM: … growth stability and …
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GM: … inflation stability
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Summing Up: the GM and its Policies
• If you assume that the EMV – Efficient Markets View = Supply Side Economics - holds:
• In general, just the Supply Policies matter. • Regarding the financial markets: • Deregulation + Lax Monetary Policy is an Effective
Policy Mix • In general, instability phenomena – if any – are
negligible • Therefore …
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GM: The Quiet before the Storm (GC)
FINANCIAL IMBALANCES CA
IMBALANCES
MONETARY IMBALANCES
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… The Storm (GC)
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Explaining the GC
• The FC as a domino effect, with monetary policy and regulation as triggers/catalysts
• The domino effect: from a single market default to a systemic crisis …..
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Explaining the GC
WORLD FINANCIAL MARKETS
WORLD BANKING
MARKETS
US
FINANCIAL MARKETS
US
BANKING
MARKETS
US SUBPRIME
MARKETS
US MORTGAGE
MARKETS
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Market default: the US sub-prime market
• DEREGULATION EFFECT: • US sub-prime (SP) market: a huge and rapid growth • Micro: number of SP contracts: from 624000 (2001)
to 2.646.000 (2006). Value on Average: from $ 151.000 (2001) to $ 259.000 (2006).
• Macro: SP Market Absolute Value: from $ 94 billion (2001) to $ 685 billion (2006); stock (2001-2006): $ 2.601 trillion
• Market Relative Value: SP market/ overall mortgage market: from 8% (2001) to 20% (2006).
• SP Market Evolution: Boom and Bust …
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the US sub-prime market: boom and bust
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Default Drivers
• Leverage = f (interest rate, collateral value) • MONETARY POLICY EFFECT: LOW INTEREST
RATES (LEVERAGE DEMAND TRIGGER) • DEREGULATION EFFECTS : LOW COLLATERAL
REQUIREMENT (LEVERAGE SUPPLY TRIGGER) • DEREGULATION EFFECT: HIGH COMPETITION
(LEVERAGE SUPPLY TRIGGER)
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• Bad loans in the SP market: about 10% • Credit boom and bad allocation: nothing more, nothing
less, nothing new
• But…
the US sub-prime market: just a bubble …
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• From single market default (snow ball) to system financial instability (avalanche)
• THE Uncertainty CHAIN: THE FINANCIAL SYSTEM FEATURES …
the US sub-prime market: … no, let’s start the Armageddon!
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UNCERTAINTY CHAIN = FINANCE FEATURES
=
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Externality: US systemic uncertainty
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Externality: overall systemic uncertainty
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the GC final effect
WORLD FINANCIAL MARKETS
WORLD BANKING
MARKETS
US
FINANCIAL MARKETS
US
BANKING
MARKETS
US SUBPRIME
MARKETS
US MORTGAGE
MARKETS