Financial Integration and International Shock Transmission -- The Terms of Trade Channel

WiSo-HH Working Paper Series No. 80

What are the effects of financial integration on global comovement? Using a standard two-country DSGE model, I show that in response to country-specific supply shocks higher exposure to foreign assets leads to lower cross-country output correlations, while the opposite is true for country-specific demand shocks. I argue that an important, yet overlooked, transmission channel originates in the interplay between financial integration and terms of trade movements in response to the shocks hitting the economy. The transmission channel is independent of whether the agents who hold the foreign assets are financially constrained or not.

Macroprudential Policy Shocks, Non-Bank Financial Intermediation and Systemic Risk in Europe, with Akhilesh K Verma

WiSo-HH Working Paper Series No. 79

How does macroprudential regulation affect financial stability in the presence of non-bank financial intermediaries? We estimate the contributions of traditional banks vis-a-vis nonbank financial intermediaries to changes in systemic risk – measured as ΔCoVaR – after macroprudential policy shocks in European countries. We find that while tighter macroprudential regulation, generally, decreases systemic risk among traditional banks, it has the opposite effect on systemic risk in the non-bank financial intermediation sector. For some types of regulations, the latter effect is even stronger than the former, indicating that macroprudential tightening increases systemic risk in the entire financial system, through leakages between the traditional and the non-bank financial intermediation sectors.

Macroprudential Policy, Monetary Policy and Financial Turmoil, with Jelena Živanovic

Accepted (April 2024) at Economic Modelling | Preprint available here 

How should capital requirements be designed in order to reduce the frequency and severity of financial crises? What is the role of monetary policy in this context? We develop a New-Keynesian DSGE model in which the economy endogenously switches between normal times and financially turbulent times, depending on the degree of leverage in the banking system. Banks do not internalize the effects of equity issuance on the crisis probability. This creates a role for bank capital regulation. We find that countercyclical capital buffers are more effective in reducing the probability and length of financial crises than constant capital buffers. All capital buffers reduce the size of the financial and non-financial sector. Monetary policies which are more accommodative during financially turbulent times, can moderate the economic downturn and reduce the time spent in periods of financial distress. A combination of a small countercyclical capital buffer and accommodative monetary policy during crises increases welfare.

Unconventional Monetary Policy in a Monetary Union

BDPEMS Working Paper Series # 2018-01 | Local copy (December 2023)

I analyze the adoption of unconventional monetary policy measures in a monetary union. To this end, I lay out a two-country monetary union model with balance-sheet constrained financial intermediaries and central bank credit policy. The framework is used to compare the welfare implications of union-wide versus country-specific optimal simple unconventional monetary policy rules. It is shown that - despite the presence of country-specific shocks - country-specific rules are not necessarily associated with higher welfare from the viewpoint of a structurally symmetric union. Instead, to the extent that the central bank reacts to indicators which are highly correlated between countries, union-wide rules can be preferable. When considering structural asymmetries between countries, there is evidence that the introduction of unconventional monetary policy affects incentives to reform financial structures from the viewpoint of a financially less stable country, however, not necessarily in a negative way.

Household Inequality and the Transmission of QE in Euro Area Countries

Work in Progress | Paper available on request

We estimate the effects of a high-frequency identified union-wide quantitative easing (QE) shock on various macroeconomic variables of single euro area countries and the role of asset and labor market parameters therein. We document that effects of QE are very heterogenous across countries as regards size, significance and timing, especially with respect to GDP and unemployment. Some countries even display negative GDP responses and increases in the unemployment rate in reaction to expansionary shocks. We further show that the size of the effects of QE on real GDP is positively related to the fraction of liquidity-constrained household in a country. Furthermore, we provide evidence that the size of frictions in the financial system has a positive effect on the effectiveness of QE. 

Geopolitical Risk and Bank Systemic Risk: The Role of the Macroprudential Policy Stance, with Akhilesh K Verma

Work in Progress | Paper available on request

Based on a panel dataset of European banks over the period 2005 to 2019, we show that, first, changes in geopolitical risk significantly contribute to changes in systemic risk, and that, second, a tighter macroprudential policy stance is associated with smaller effects of geopolitical risk shocks on systemic risk in the respective country. In our estimations we rely on the Geopolitical Risk Index (GPR) developed by Caldara and Iacoviello (2022). Systemic risk is measured as ΔCoVaR. To make sure that our measure of macroprudential policy does not suffer from the issue of reverse causality, we identify the macroprudential policy stance of a country  as the part of policy which is orthogonal to observables.