Fiscal Multipliers and Financial Crises Miguel Faria-e-Castro - PowerPoint PPT Presentation

Fiscal Multipliers and Financial Crises Miguel Faria-e-Castro Federal Reserve Bank of St. Louis 49th Konstanz Seminar Reichenau, May 2018 The views expressed on this presentation do not necessarily reflect the positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. 0 / 15

Fiscal policy response to the 2008 financial crisis • “Conventional” fiscal stimulus 1. Govt purchases (Drautzburg & Uhlig ’11; Conley & Dupor ’13) 2. Transfers to households (Oh & Reis ’12; Parker et al. ’13; Kaplan & Violante ’14) • Financial sector interventions 3. Equity injections (Blinder & Zandi ’10; Philippon & Schnabl ’13) 4. Credit guarantees (Philippon & Skreta ’12; Lucas ’16) Large debate on the effectiveness and composition of the response This paper: 1. How important was the fiscal policy response? 2. Which tools were the most important? 1 / 15

Approach and Results 1. Structural model of fiscal policy • Potential stabilization roles for each of the tools • State dependent effects of shocks and policies 2. Quantitative Exercise • Calibrated model + data on fiscal policy response • Estimate structural shocks given policy response • Study counterfactuals Crisis and Great Recession without fiscal response • 3. Results: • Aggregate consumption falls by twice as much w/o policy • Transfers and equity injections most important • Fiscal multipliers extremely state dependent • New transmission channels for fiscal policy 2 / 15

Model Nominal Rigidities = ⇒ Government purchases Incomplete Markets = ⇒ Transfers (Frictional) Financial Sector = ⇒ Bank Recaps. Credit Risk & Default = ⇒ Credit Guarantees Government Transfers, T b Recaps., x k Guarantees, s d Purchases, G Savers Banks Borrowers Deposits Loans Labor Labor Cons. Cons. Housing Firms/Goods Market 3 / 15

Model: Key Ingredients Borrowers Detail Borrow in long-term debt B b 1. t , purchase houses h t 2. Family construct i ∈ [0 , 1], housing quality shocks ν ( i ) ∼ F t 3. Fraction of borrowers m has to move every period Prepay debt + sell house if B b t − 1 ≤ p h 3.1 t ν t ( i ) h t − 1 , or 3.2 Default + lose house 4. New borrowing subject to LTV constraint ≤ θ LTV p h B b , new t h t t Banks Detail 1. Invest in mortgages, financed w/ deposits and retained earnings 2. Subject to iid shock on portfolio return, default if V t ≤ 0 3. Market leverage constraint κ Q b t B b t ≤ V t Government Rest of the Model 4 / 15

Impulse and Propagation • Aggregate shocks: 1. TFP A t 2. Financial shock σ t + + Household Default Rate t = f ( LTV t , σ t ) • Financial shock: defaults ↑ 1. Bank equity ↓ 2. If bank constraint binds ⇒ spreads rise, lending falls 3. Disposable income for borrowers ↓ 4. If borrower constraint binds ⇒ aggregate consumption ↓ Shock transmission depends on bank leverage and household leverage 5 / 15

State Dependence: Financial Shock with Low Leverage 0.5 0 0 -2 -0.5 -4 -1 -4 -2 0 2 4 6 -4 -2 0 2 4 6 0.3 0 0.2 -2 0.1 -4 -4 -2 0 2 4 6 -4 -2 0 2 4 6 6 / 15

State Dependence: Financial Shock with High Leverage 0 0 -1 -5 -2 -3 -10 -4 -2 0 2 4 6 -4 -2 0 2 4 6 0.4 0 0.3 0.2 -5 0.1 -10 -4 -2 0 2 4 6 -4 -2 0 2 4 6 7 / 15

Quantitative Exercise 1. Calibrate model to U.S. pre-crisis • Match moments on household and bank balance sheets Calibration 2. Use data to estimate sequences of structural shocks { A t , σ t } T =2015 Q 4 t =2000 Q 1 Y T ≡ Observed Macro Variables T = { C t , spread t } T • t Ω T ≡ Observed Fiscal Policy Response T = � � T G t , T b t , x k t , s d • t t � � T t make the model match Y T given Ω T ? ˆ 3. What A t , ˆ σ t � � T ˆ t to study counterfactual paths for Ω T 4. Use estimated A t , ˆ σ t 8 / 15

Fiscal Policy Data • G t : ARRA ’09 contracts, Medicaid and Education spending T b • t : ESA ’08 tax rebates, HERA ’08 tax credits + NSP + Cash for Clunkers, ARRA ’09 social transfers + tax cuts, TARP ’08 housing programs (MHA, HHF, FHA-Refi) x k • t : TARP ’08 equity injection programs (CPP, CDCI, PPIP, AIG, BofA/Citi), auto bailout (AIFP, ASSP), GSE bailout (PSI) s d • t : TARP ’08 credit guarantees (TABSLF, BofA/Citi), TLGP ’08 credit guarantees 9 / 15

Fiscal Policy Response Data 8 6 % of 2007 GDP 4 2 0 2007q1 2008q3 2013q4 Govt. Purchases Transfers Equity Injections Temp. Guarantees 10 / 15

Main Counterfactual: No Fiscal Policy 11 / 15

Policy Decomposition 4 2 0 -2 -4 -6 -8 2007Q1 2008Q3 2012Q4 12 / 15

Time Series for Fiscal Multipliers 13 / 15

State Dependent Multipliers: Mechanism Two channels: 1. Borrower Constraint ⇒ standard MPC channel 2. Borrower Const. + Bank Const. ⇒ new channel • Transfers ⇒ house prices ↑ (only when borrowers are constrained) • Default rates fall, banks post fewer losses • Lending ↑ , spreads ↓ (only when banks are constrained) • Disposable income ↑ New channel active when both constraints bind 14 / 15

Conclusion This Paper • Analysis of fiscal policy response to the Great Recession • Structural Model + Data • BANK + MONK Contribution • Conventional stimulus and financial sector interventions • Quantitative evaluation • Important for normative analysis • New transmission channels for fiscal policy • Household-bank balance sheet interactions • State dependent effects 15 / 15

Appendix

Borrowers: Debt and Default Face value B b • t − 1 , coupon rate γ • Family construct (Landvoigt, 2015) 1. Borrower enters period with states h t − 1 , B b t − 1 2. Continuum of members i ∈ [0 , 1], each with h t − 1 , B b t − 1 , ν t ( i ) where ν t ( i ) ∼ F b t ∈ [0 , ∞ ) 3. Each agent i has to move with prob. m , she can: Prepay if B b t − 1 ≤ ν t ( i ) p h 3.1 t h t − 1 , sell house or 3.2 Default, lose collateral Back

Borrower Family Problem t ) + ξ b log( h t ) + β E t V b � � V b t ( B b u ( c b t , n b t − 1 , h t − 1 ) = max t +1 c b t , n b t , h t , B b t ,ι ( ν ) subject to budget constraint � t + γ B b t − 1 c b (1 − m ) + m [1 − ι ( ν )] d F b t ( ν ) + p t h t ≤ Π t ���� � �� � house purchase debt repayment � t B b , new (1 − τ t ) w t n b t + m Q b (1 − m ) ν + m ν [1 − ι ( ν )] d F b T b + p t h t − 1 t ( ν ) + t t � �� � ���� � �� � new debt Transfers sale of non-foreclosed houses and borrowing constraint B b , new ≤ θ max ltv p t h t t Back

Borrower Default Default iff ν ≤ ν ∗ t , B b t − 1 ν ∗ t = ≃ Loan-to-Value Π t p t h t − 1 f b t , pdf F b t = Beta(1 , σ b • t ) 5 Normal 4.5 σ b Crisis • t ∼ two-state Markov 4 3.5 • Mean preserving spread 3 2.5 ν ∗ 2 1.5 1 0.5 0 0.7 0.75 0.8 0.85 0.9 0.95 1 ν Lenders earn (per unit of debt)    Resource Cost      � ν ∗ � �� �   ν p t h t − 1 t Z loans = (1 − m )[ γ + (1 − γ ) Q b 1 − F b (1 − λ b ) d F b t ] + m t ( ν ∗ t ) + t t B b t − 1 / Π t   � �� � � �� � 0     not moving  movers repay � �� �  movers default

Financial Intermediaries • Fixed income portfolios, maturity transformation, risky deposits • Fraction 1 − θ of earnings paid out as dividends every period • Invest in loan securities b t , raise deposits d t Problem for intermediary j ∈ [0 , 1] with current earnings e j , t       � � �� V k Λ s 0 , V k t ( e j , t ) = max (1 − θ ) e j , t + E t t , t +1 max t +1 ( e j , t +1 ) b j , t , d j , t   � �� � � �� � � �� �   current mkt value dividend ex-dividend value subject to � � flow of funds : Q b θ e j , t (1 + x k + Q d t b j , t = t ) − Govt Payments t t d j , t � � �� capital req. : κ Q b Λ s 0 , V k t b j , t ≤ E t t , t +1 max t +1 ( e j , t +1 ) LoM earnings : e j , t +1 = ( u j , t +1 Z loans t +1 b j , t − d j , t ) / Π t +1 Back

Financial Intermediaries u j , t ∼ F d ⊆ [ u , ¯ • u ] • Default iff d j , t − 1 u j , t < u ∗ t ≡ ≃ Leverage Z loans b j , t − 1 t • Aggregation ⇒ representative bank � � Λ s �� � t , t +1 0 , V k E t max t +1 ( e j , t +1 ) d j ≡ Φ t θ E t Π t +1 [0 , 1] • Spreads reflect Credit Risk + Current + Future binding constraints • Long-term debt ⇒ Pecuniary Externalities ⇒ Financial Accelerator • Payoff per unit of deposits,       � u ∗    u Z loans B b  t Z deposits s d +(1 − s d 1 − F d ( u ∗ + (1 − λ d ) t t − 1 d F d = t ) t ) t t D t − 1 ����  � �� �  0     � �� � guaranteed repaid   liquidated Back

Closing the Model Standard DSGE model w/ nominal rigidities • Producers → Phillips Curve • Savers → Euler Equation (IS) • Housing in fixed supply, h t = 1 • Central Bank → Taylor Rule � Π t � φ π � Y t � φ y 1 = 1 ¯ Q t Π Y Q • Aggregate resource constraint, C t + G t + DWL Default t = A t N t [1 − d (Π t )] � �� � � �� � = Y t Menu Costs Back