Discussion of "The Great Escape? A Quantitative Evaluation of - PowerPoint PPT Presentation

Discussion of "The Great Escape? A Quantitative Evaluation of the Fed's Non-Standard Policies" Pierpaolo Benigno September 30, 2010

Great work which merges three strands of the literature: 1. New-Keynesian models with sticky prices and sticky wages 2. Models with credit frictions � a la Kiyotaki and Moore 3. Zero-lower bound models and solution methods � a la Eggertsson

Address questions which are not only relevant to understand past events but also to direct current and future policy interventions. At this stage policymakers are particularly interested in understanding: � whether monetary and �scal policies and in particular unconventional monetary policy have been e�ective in avoiding another Great Depres- sion; � what are the quantitative e�ects of di�erent types of unconventional policy; � whether there is a need of more unconventional policies in the next months and of which type.

Bernanke (2010) speech at Jackson Hole \ One risk of further balance sheet expansion arises from the fact that, lacking much experience with this option, we do not have very precise knowledge of the quantitative e�ect of changes in our holdings on �nancial conditions. In particular, the impact of securities purchases may depend to some extent on the state of �nancial markets and the economy; for example, such purchases seem likely to have their largest e�ects during periods of economic and �nancial stress, when markets are less liquid and term premiums are unusually high".

Key features of the model: � Agents are heterogeneous with respect to consumption and portfolio choices: entrepreneurs (with or without investment opportunities) and workers. � Entrepreneurs are subject to two constraints: 1)Borrowing constraint on new equity ( � ) ; 2) Resaleability constraint on own equity ( � ) (This is the critical constraint to capture the �nancial crisis) � Government in normal times issues real debt to make transfers to the private sector. Under stress (when � falls) government buys private- sector assets and �nances them through an expansion of the balance sheets issuing more real debt.

Questions: � With incomplete markets and heterogenous agents, do we really need credit frictions to be able to depart from Wallace's irrelevance result? What are the minimal requirements to get rid of the irrelevance result? (Perhaps just non-negative constraints on asset holdings can make it) � Very rich model of portfolio choices. Three agents making optimizing portfolio choices: 1-2) two types of entrepreneurs, 3) workers. { In standard models, portfolio allocations depend on returns and pricing kernels. { Here instead, the portfolio allocation is a corner solution for most of the assets and agents. Is this just a model for bad times?

Which kind of unconventional policy? � Three groups (Bernanke's speech at LSE) 1. Lending to �nancial institutions (TAF, TSLF and PDCF) 2. Providing Liquidity to key credit markets 3. Purchasing longer-term securities � This paper aims at modelling 1), but it looks like it is modelling 3), a generic purchase of private assets.

2500000 2500000 2500000 2500000 2500000 2500000 2500000 2000000 2000000 2000000 2000000 2000000 2000000 Fed Agency Debt Mortgage ‐ Backed Securities Fed Agency Debt Mortgage ‐ Backed Securities Fed Agency Debt Mortgage ‐ Backed Securities Fed Agency Debt Mortgage ‐ Backed Securities Fed Agency Debt Mortgage ‐ Backed Securities 1500000 1500000 1500000 1500000 1500000 Purch Purch Purch Purch Purch Liquidity to Key Credit Markets Liquidity to Key Credit Markets Liquidity to Key Credit Markets Liquidity to Key Credit Markets Liquidity to Key Credit Markets Lending to Financial Institutions Lending to Financial Institutions Lending to Financial Institutions L Lending to Financial Institutions di Fi i l I i i 1000000 1000000 1000000 1000000 Long Term Treasury Purchases Long Term Treasury Purchases Long Term Treasury Purchases Long Term Treasury Purchases Traditional Security Holdings Traditional Security Holdings Traditional Security Holdings 500000 500000 500000 0 0 01/03/2007 1/03/2007 02/21/07 02/21/07 4/11/2007 04/11/2007 05/30/07 05/30/07 07/18/07 07/18/07 9/05/2007 09/05/2007 10/24/07 10/24/07 2/12/2007 12/12/2007 01/30/08 01/30/08 03/19/08 03/19/08 05/07/2008 5/07/2008 06/25/08 06/25/08 08/13/08 08/13/08 0/01/2008 10/01/2008 11/19/08 11/19/08 01/07/2009 1/07/2009 02/25/09 02/25/09 04/15/09 04/15/09 6/03/2009 06/03/2009 07/22/09 07/22/09 9/09/2009 09/09/2009 10/28/09 10/28/09 1/06/2010 01/06/2010 03/17/10 03/17/10 05/05/2010 5/05/2010 06/23/10 06/23/10 08/11/2010 8/11/2010

How should we expect unconventional monetary policy of type 1) to work? � Entrepreneurs with investment opportunity struggle to raise equity to �nance their investment. � They should sell their assets, but the private asset markets are frozen. � By intervening, the government can exchange illiquid assets for liquid assets and therefore help the entrepreneurs with investment opportu- nity to relax their constraints.

But: � It looks like that investing entrepreneurs do not hold liquid assets in equilibrium. They are not directly a�ected by the injection of liquidity. � The non-investing entrepreneurs instead exchange illiquid assets for more liquid assets. � Moreover, government transfers wealth to either the non-investing en- trepreneurs or the workers.

� This is why the intervention is most e�ective on consumption (through a wealth e�ect) rather than on investment. � This why the assumption of sticky prices matters (via an intertemporal substitution e�ect). � Credit frictions are only relevant for shaping the fall in investment, but they are not important for explaining the e�ect of the intervention on output.

Some other observations � Model predicts a signi�cant drop in the in�ation rate, but this is not in the data. � Model predicts a small improvement in credit spreads after the inter- vention, but perhaps it was larger � Model predicts a drop in investment of the same magnitude as output. But in the data is larger, and the more is on residential investment rather than on non-residential investment � Model predicts a drop in the real rate after the intervention. But real rates went up �rst and then fell. Did consumption increase because of �scal policy?

‐ 0 06 ‐ 0,06 ‐ 0,04 ‐ 0,04 ‐ 0,02 ‐ 0,02 ‐ 0,02 0,02 0,02 0,02 0,02 0,02 0,04 0,04 0,04 0,04 0,04 0,06 0,06 0,06 0,06 0,06 0,06 0,08 0,08 0,08 0,08 0,08 0,08 0,08 0,12 0,12 0,12 0,12 0,12 0,12 0,12 0,12 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0,1 0 0 0 0 01/06/2007 01/06/2007 01/06/2007 2007 01/07/2007 01/07/2007 01/07/2007 2007 01/08/2007 01/08/2007 01/08/2007 2007 01/09/2007 01/09/2007 01/09/2007 2007 01/10/2007 01/10/2007 01/10/2007 2007 01/11/2007 01/11/2007 01/11/2007 2007 01/12/2007 01/12/2007 01/12/2007 2007 01/01/2008 01/01/2008 01/01/2008 2008 01/02/2008 01/02/2008 01/02/2008 2008 01/03/2008 01/03/2008 01/03/2008 2008 01/04/2008 01/04/2008 01/04/2008 2008 01/05/2008 01/05/2008 01/05/2008 2008 01/06/2008 01/06/2008 01/06/2008 2008 01/07/2008 01/07/2008 01/07/2008 2008 01/08/2008 01/08/2008 01/08/2008 2008 01/09/2008 01/09/2008 01/09/2008 2008 01/10/2008 01/10/2008 01/10/2008 2008 01/11/2008 01/11/2008 01/11/2008 2008 01/12/2008 01/12/2008 01/12/2008 2008 01/01/2009 01/01/2009 01/01/2009 2009 01/02/2009 01/02/2009 01/02/2009 2009 01/03/2009 01/03/2009 01/03/2009 2009 01/04/2009 01/04/2009 01/04/2009 2009 01/05/2009 01/05/2009 01/05/2009 2009 01/06/2009 01/06/2009 01/06/2009 2009 01/07/2009 01/07/2009 01/07/2009 2009 01/08/2009 01/08/2009 01/08/2009 2009 01/09/2009 01/09/2009 01/09/2009 2009 01/10/2009 01/10/2009 01/10/2009 2009 01/11/2009 01/11/2009 01/11/2009 2009 01/12/2009 01/12/2009 01/12/2009 2009 01/01/2010 01/01/2010 01/01/2010 2010 01/02/2010 01/02/2010 01/02/2010 2010 01/03/2010 01/03/2010 01/03/2010 2010 01/04/2010 01/04/2010 01/04/2010 2010 01/05/2010 01/05/2010 01/05/2010 2010 01/06/2010 01/06/2010 01/06/2010 2010 01/07/2010 01/07/2010 01/07/2010 2010 01/08/2010 01/08/2010 01/08/2010 2010 01/09/2010 01/09/2010 01/09/2010 2010 RR 1 ‐ month RR 1 ‐ month RR 1 ‐ month RR 1 ‐ month RR 1 ‐ month RR 1 ‐ year RR 1 ‐ year RR 1 ‐ year RR 1 ‐ year RR 1 ‐ year

2003 1.5 US Real Rates /(TIPS 10Y Yield) % 3.5 3 2.5 2 1 2004 2011 2010 2009 2008 2007 2006 2005 10Y TIPS Yields

Conclusion � The recent �nancial crisis, the associated Great Recession and Great Escape are all complex phenomena � This paper goes in the right direction to understand them � There is a need of further (urgent!) work along these lines to under- stand the di�erent quantitative contributions of monetary and �scal policy interventions.