Monetary Policy Rules in the Presence of an Occasionally Binding - PowerPoint PPT Presentation

Monetary Policy Rules in the Presence of an Occasionally Binding Borrowing Constraint Punnoose Jacob Christie Smith Fang Yao Oct 2014, Wellington Reserve Bank of New Zealand.

Research Question How does an occasionally-binding Loan-to-Value Ratio (LVR) constraint affect the conduct of monetary policy in terms of an interest rate rule?

Local Context New Zealand’s LVR restrictions were introduced on 1 October 2013, responding to

Local Context New Zealand’s LVR restrictions were introduced on 1 October 2013, responding to � Annual NZ house price inflation reached 10 percent, December 2013 (16% in Auckland).

Local Context New Zealand’s LVR restrictions were introduced on 1 October 2013, responding to � Annual NZ house price inflation reached 10 percent, December 2013 (16% in Auckland). � The proportion of high LVR lending exceeded 30% in early 2013.

Local Context New Zealand’s LVR restrictions were introduced on 1 October 2013, responding to � Annual NZ house price inflation reached 10 percent, December 2013 (16% in Auckland). � The proportion of high LVR lending exceeded 30% in early 2013. Housing market led to financial stability concerns

Local Context New Zealand’s LVR restrictions were introduced on 1 October 2013, responding to � Annual NZ house price inflation reached 10 percent, December 2013 (16% in Auckland). � The proportion of high LVR lending exceeded 30% in early 2013. Housing market led to financial stability concerns Reluctance to use the interest rates: concerns about low inflation and elevated exchange rate.

Contribution We start from Iacoviello (2005)

Contribution We start from Iacoviello (2005) � Housing market

Contribution We start from Iacoviello (2005) � Housing market � Patient and impatient households

Contribution We start from Iacoviello (2005) � Housing market � Patient and impatient households � Borrowing constraint on loans

Contribution We start from Iacoviello (2005) � Housing market � Patient and impatient households � Borrowing constraint on loans Our extensions

Contribution We start from Iacoviello (2005) � Housing market � Patient and impatient households � Borrowing constraint on loans Our extensions � Open economy DSGE model for NZ

Contribution We start from Iacoviello (2005) � Housing market � Patient and impatient households � Borrowing constraint on loans Our extensions � Open economy DSGE model for NZ � Occasionally-binding borrowing constraint

Contribution We start from Iacoviello (2005) � Housing market � Patient and impatient households � Borrowing constraint on loans Our extensions � Open economy DSGE model for NZ � Occasionally-binding borrowing constraint � We study optimal monetary policy rules

Main Findings Imposing an occasionally-binding LVR makes the economy respond asymmetrically to positive and negative shocks.

Main Findings Imposing an occasionally-binding LVR makes the economy respond asymmetrically to positive and negative shocks. The LVR affects macro volatilities and hence changes monetary policy.

Main Findings Imposing an occasionally-binding LVR makes the economy respond asymmetrically to positive and negative shocks. The LVR affects macro volatilities and hence changes monetary policy. The optimal monetary policy rule under an LVR constraint transfers welfare from savers to borrowers.

Main Findings Imposing an occasionally-binding LVR makes the economy respond asymmetrically to positive and negative shocks. The LVR affects macro volatilities and hence changes monetary policy. The optimal monetary policy rule under an LVR constraint transfers welfare from savers to borrowers. Removing the LVR results in gradual adjustment.

THE MODEL

Households’ problem Maximise expected utility subject to Budget constraint 1

Households’ problem Maximise expected utility subject to Budget constraint 1 Collateral constraint 2 � � R l , t L � q h , t + 1 P c , t + 1 h � t ≤ µ E t t

The Rest of the Model Banks channel savings from domestic and foreign savers to borrowers. Home good produced with capital and Labour Sold at home and abroad Foreign output, inflation and the interest rate: New Keynesian closed economy model

Monetary and LVR Policy Interest rate rule � R t − 1 � r r �� π c , t � r π � y t � r ∆ y � 1 − r r R t R = exp ω r , t ¯ ¯ R π c ¯ y t − 1

Monetary and LVR Policy Interest rate rule � R t − 1 � r r �� π c , t � r π � y t � r ∆ y � 1 − r r R t R = exp ω r , t ¯ ¯ R π c ¯ y t − 1 LVR policy � � R l , t L � q h , t + 1 P c , t + 1 h � t ≤ µ LVR E t t

Parameter Values Most of structural parameters are calibrated to match NZ data. The rest are estimated using Bayesian methods Sample period:1993 Q4 to 2013 Q3 before the LVR restriction was introduced. The estimated model does not have the borrowing constraint. 9 data series : � GDP growth, Consumption growth, Residential investment growth, Business investment growth, Housing loan growth, 90-day rate, CPI inflation, House price Inflation, Mortgage spread.

Occasionally-Binding Solution

Occasionally-binding Solution We use the "OccBin" Toolbox developed by Guerrieri and Iacoviello (2014) A piecewise-linear approximation of occasionally binding constraints It is able to deal with large models with many predetermined variables.

Asymmetric IRFs: Monetary Policy Shock Contractionary 90-Day Rate House Price Loan Output CPI Inflation 2 1 0 0 0 -0.5 % from S.S. 1 0 -1 -1 -0.5 0 -1 -2 -1.5 -1 -2 -3 -2 -1 0 4q 8q 0 4q 8q 0 4q 8q 0 4q 8q 0 4q 8q Occasionally-binding Perpetually-binding

Asymmetric IRFs: Monetary Policy Shock C o n tr a c tio n a r y 90-Day Rate House Price Loan Output CPI Inflation 2 1 0 0 0 % from S.S. 1 0 - 1 - 1 - 0 .5 0 - 1 - 2 - 1 - 2 - 3 - 2 - 1 0 4 q 8 q 0 4 q 8 q 0 4 q 8 q 0 4 q 8 q 0 4 q 8 q O c c a s io n a lly - b in d in g Pe r p e tu a lly - b in d in g Ex p a n s io n a r y 90-Day Rate House Price Loan Output CPI Inflation 1 2 3 2 1 % from S.S. 0 1 2 1 0 .5 - 1 0 1 - 2 - 1 0 0 0 0 4 q 8 q 0 4 q 8 q 0 4 q 8 q 0 4 q 8 q 0 4 q 8 q

Stochastic Simulation

Stochastic Simulation

Stochastic Simulation Comparing Moments from the Perpetually- and Occasionally-binding Models Binding Frequency Output S.D. (%) CPI Inflation S.D. (%) LVR Occasional Perpetual Occasional Perpetual Occasional Perpetual 0.90 10.4% 100% 0.77 1.13 0.19 0.21 0.70 12% 100% 0.75 0.87 0.18 0.19

Optimal Policy

Optimal Monetary Policy Rules Taylor Rules R t = 0 . 80 ˆ ˆ R t − 1 + 0 . 2 ( 1 . 89 ˆ π c , t + 0 . 32 ∆ ˆ y t ) Estimated: R t = 0 . 80 ˆ ˆ π c , t − ∆ ˆ R t − 1 + 0 . 2 ( 1 . 1 ˆ y t ) Occ.binding optimal: R t = 0 . 80 ˆ ˆ R t − 1 + 0 . 2 ( 3 ˆ π c , t − ∆ ˆ y t ) Always binding optimal:

Optimal Monetary Policy Rules Taylor Rules R t = 0 . 80 ˆ ˆ R t − 1 + 0 . 2 ( 1 . 89 ˆ π c , t + 0 . 32 ∆ ˆ y t ) Estimated: R t = 0 . 80 ˆ ˆ π c , t − ∆ ˆ R t − 1 + 0 . 2 ( 1 . 1 ˆ y t ) Occ.binding optimal: R t = 0 . 80 ˆ ˆ R t − 1 + 0 . 2 ( 3 ˆ π c , t − ∆ ˆ y t ) Always binding optimal: Extend Taylor rule to include house price inflation and credit growth

Welfare Evaluation Welfare Level (Gain in terms of consumption) Taylor Rules Saver Borrower Social Estimated: -84.83 -101.42 -1.912 -85.88 ( − 1 . 04 % ) -100.71 ( 0 . 71 % ) -1.910 ( 0 . 002 % ) Occ.binding: -75.4 ( 9 . 8 % ) -113.12 ( − 11 . 6 % ) -2.01 ( − 0 . 2 % ) Always binding:

Temporary LVR Tightening Loan-to-Value Ratio 0.92 Occasionally-binding Perpetually-binding 0.91 0.9 l e v e L 0.89 0.88 0.87 0 8q 16q 24q 32q 40q 48q

Temporary LVR Tightening Loan-to-Value Ratio Loans House Price 0.92 1 0.1 0.91 0.5 0 % from S.S. % from S.S. 0.9 Level 0 -0.1 0.89 -0.5 -0.2 0.88 0.87 -1 -0.3 0 8q 16q 24q 32q 40q 48q 0 8q 16q 24q 32q 40q 48q 0 8q 16q 24q 32q 40q 48q Output Inflation Policy rate 0.5 0.3 5.4 0.2 Annualised Level in % 5.2 0 Annualised % % from S.S. 0.1 5 -0.5 0 4.8 Occasionally-binding Perpetually-binding -1 -0.1 4.6 0 8q 16q 24q 32q 40q 48q 0 8q 16q 24q 32q 40q 48q 0 8q 16q 24q 32q 40q 48q

Conclusion We study macro dynamics under an occasionally-binding LVR . The LVR makes the economy respond asymmetrically to positive and negative shocks and hence changes macro volatilities and monetary policy. Future Research: � Extend monetary policy rule to include house price inflation and credit growth � Endogenise LVR policy � Open economy dimensions