M A -L L I , O I P R D E W O M O - S , O P D W P AC CR RO IN NK KA AG GE ES IL L RI IC CE ES S A AN ND D EF FL LA AT TI IO ON N OR RK KS SH HO OP J A 6– –9 9, , 20 00 09 9 J 6 2 AN NU UA AR RY Y Credit and Banking in a DSGE Model A. Gerali, S. Neri, L. Sessa, and F. Signoretti
Credit and Banking in a DSGE Model A. GERALI, S. NERI, L. SESSA, F. SIGNORETTI Banca d’Italia IMF Research Department Macro Modeling Workshop Washington D.C. January 8 th , 2009
WHAT is the paper about? � This paper is an attempt to (meaningfully?) introduce a banking sector into a DSGE model
WHY is it interesting? Banks are (still) very important in the funding of real 1. activity � Bank loans/total firm non-equity finance � 90% in the Euro Area � 60% in the US Thus, bank rates are the relevant interest rates for a large part of the → economy Retail bank rates differ from policy rate 2. Slow pass-through to retail rates of changes in the policy rate (Lown i. and Morgan, 19XX) Banks actively set credit-supply terms and conditions (interest rates, ii. LTV) during the cycle So, loan spreads move over the cycle → Bank B-S items display cyclical movements, e.g. … 3.
WHY is it interesting? Banks are (still) very important in the funding of real 1. activity � Bank loans/total firm non-equity finance � 90% in the Euro Area � 60% in the US Thus, bank rates are the relevant interest rates for a large part of the → economy Retail bank rates differ from policy rate 2. Slow pass-through to retail rates of changes in the policy rate (Lown i. and Morgan, 19XX) Banks actively set credit-supply terms and conditions (interest rates, ii. LTV) during the cycle So, loan spreads move over the cycle → Bank B-S items display cyclical movements, e.g. … 3.
FACTS Banks are (still) very important in the funding of real 1. activity � Bank loans/total firm non-equity finance � 90% in the Euro Area � 60% in the US Thus, bank rates are the relevant interest rates for a large part of the → economy Retail bank rates differ from policy rate 2. Slow pass-through to retail rates of changes in the policy rate (de i. Bondt, 2005; Kok-Sorensen and Werner, 2006) Banks actively set credit-supply terms and conditions (interest rates, ii. LTV) during the cycle So, loan spreads move over the cycle → Bank B-S items display cyclical movements, e.g. … 3.
FACTS Banks are (still) very important in the funding of real 1. activity � Bank loans/total firm non-equity finance � 90% in the Euro Area � 60% in the US Thus, bank rates are the relevant interest rates for a large part of the → economy Retail bank rates differ from policy rate 2. Slow pass-through to retail rates of changes in the policy rate (Lown i. and Morgan, 19XX) Banks actively set credit-supply terms and conditions (interest rates, ii. LTV) during the cycle So, loan spreads move over the cycle → Bank B-S items display cyclical movements, e.g. … 3.
US GDP growth and Credit Conditions (y ‐ o ‐ y % change; net percentage of respondents) 6.0 70 GDP SLOS ‐ C&I loans (r ‐ axis)) 60 5.0 50 4.0 40 3.0 30 2.0 20 10 1.0 0 0.0 ‐ 10 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 ‐ 1.0 ‐ 20 ‐ 2.0 ‐ 30 Source: Federal Reserve
FACTS Banks are (still) very important in the funding of real 1. activity � Bank loans/total firm non-equity finance � 90% in the Euro Area � 60% in the US Thus, bank rates are the relevant interest rates for a large part of the → economy Retail bank rates differ from policy rate 2. Slow pass-through to retail rates of changes in the policy rate (Lown i. and Morgan, 19XX) Banks actively set credit-supply terms and conditions (interest rates, ii. LTV) during the cycle So, loan spreads move over the cycle → Bank B-S items display cyclical movements, e.g. … 3.
US Policy Rate and Short ‐ term Loan Spread (percentage points) 11.0 3.0 Fed Funds C&I Loan spread (r ‐ axis) 2.5 9.0 2.0 7.0 1.5 5.0 1.0 3.0 0.5 1.0 0.0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 ‐ 1.0 ‐ 0.5 Source: Federal Reserve
FACTS Banks are (still) very important in the funding of real 1. activity � Bank loans/total firm non-equity finance � 90% in the Euro Area � 60% in the US Thus, bank rates are the relevant interest rates for a large part of the → economy Retail bank rates differ from policy rate 2. Slow pass-through to retail rates of changes in the policy rate (Lown i. and Morgan, 19XX) Banks actively set credit-supply terms and conditions (interest ii. rates, LTV) during the cycle So, loan spreads move over the cycle → Bank B-S items display cyclical movements, e.g. … 3.
US Commercial Banks' Balance ‐ sheet Items and Asset Prices (y ‐ o ‐ y % change) 30 30 20 20 10 10 0 0 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 ‐ 10 ‐ 10 ‐ 20 ‐ 20 Asset prices Loans and Leases ‐ 30 ‐ 30 Source: Federal Reserve and BIS
Objectives/what do we want to study? Have a model that accounts for stylized facts in 1. credit/financial markets and their interactions with the real economy Answer questions such as: 2. How do bank rate-setting decisions affect the monetary 1. policy transmission mechanism? What are the effects of a credit-supply shock in a model with 2. an explicit role for banks? How do banking capital react to various types of shocks? 3. Financial stability and monetary policy: should CBs respond 4. to asset prices, credit or bank equity [work in progress]?
Objectives/what do we want to study? Have a model that accounts for stylized facts in 1. credit/financial markets and their interactions with the real economy Answer questions such as: 2. How do bank rate-setting decisions affect the monetary 1. policy transmission mechanism? What are the effects of a credit-supply shock in a model with 2. an explicit role for banks? How do banking capital react to various types of shocks? 3. Financial stability and monetary policy: should CBs respond 4. to asset prices, credit or bank equity [work in progress]?
The Rest of the Talk The Model 1. Applications 2.
The model: two key ingredients Financial frictions and heterogeneous agents, to 1. generate credit flows in the first place (Kyotaki and Moore, 1998; Iacoviello, 2005) Monopolistic competition in the banking sector, so 2. that banks make decisions when setting interest rates
Related work � Christensen et. al (2007) � Cúrdia and Woodford (2008) � Andrés and Arce (2008) –Nice micro-foundation of monopolistic competition � Christiano et al. (2007); Goodfriend and McCallum (2007) � …many other central banks
The Model in a Nutshell Entrepreneurs Impatient HH E B BH R BE H R B IB R Banks Central bank M K b H D R kb D R Patient HH Bankers
Two types of Households � Consume, enjoy housing services and work T = { Patient , Impatient } � Budget constraint is � Housing (in fixed supply) is also used as collateral for bank loans (Kyotaki and Moore, 1998), i.e. borrowing constraint is:
Entrepreneurs � Consume, choose labor, K and utilization rate Max s.t. and a borrowing constraint, tied to the value of capital
Banks � Obtain funding from � HH deposits ( D ) � Central Bank or Interbank market ( M ) � Issue loans to HHs and Entrepreneurs � Production function for loans = + B f ( D M ) t t t
Banks (& Bankers) � Obtain funding from � HH deposits ( D ) � Central Bank or Interbank market ( M ) � Reinvested earnings ( K b ) To introduce bank capital, we model ‘Bankers’. Bankers own the banks (get the profits), consume, and accumulate bank capital � Issue loans to HHs and Entrepreneurs � Production function for loans
time t time t-1 time t+1 Decisions are made on how much to • consume ( c p t , c i t , c e t , c b t ) Banks: produce B t =f(D t , M t , K b t ) • labor supply/demand ( l t ) (borrowing M t from CB) • produce ( y e t ) SHOCKS Patients: deposit D t to the Banks Bankers: accumulate K b t Banks: pay r d t-1 * D t-1 r b t-1 * B t-1 Impatients: borrow B h t from the Banks r bk t-1 * K b t-1 Entrepreneurs: borrow B e t from the Banks profits J b t
The Banking Sector (1) � Monopolistic competition à la Dixit-Stiglitz � They collect D t , borrow M t and accumulate K tB � So, banks fix rates on � Deposits -> as a mark-down over policy rate � Loans -> as a mark-up over marginal cost
The Banking Sector (2) In the benchmark model, we assume imperfect rate pass-through (quadratic adjustment costs to change rates) Rates are then set according to: Deposits Loans
The Banking Sector (3) What determines MC t bank (bank marginal cost?) We assume, CES loan production function For ω ->1 ( Cobb-Douglas), we have
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