Macroprudential Policy and Financial Crises, with Jelena Živanovic
We analyze the effectiveness of macroprudential policy with respect to reducing the frequency and severeness of financial crises and the role of monetary policy in this context. To this end, we develop a New Keynesian DSGE model in which the economy fluctuates between two regimes which are characterized by different degrees of financial frictions. In particular, the two regimes are calibrated such that the model moments match macro and finance data from "normal times" and "financially turbulent times", respectively. The probability of a regime switch is determined endogenously based on indicator variables which are supposed to capture systemic risk in the financial sector, e.g., the external finance premium. Well designed macroprudential policy can reduce the frequency and severeness of financial crises by appropriately affecting these indicator variables. Monetary policy interacts with macroprudential policy insofar as its transmission differs between regimes and as monetary policy itself can influence the frequency and severeness of financial crises.
We plan to estimate the model with US data and to extend the model to a two-country setup which will allow us to analyze macroprudential policy spillovers and potential incentives to freeride.
Unconventional Monetary Policy in a Monetary Union
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.
Financial Integration and International Comovement – The Terms of Trade Channel
I propose a theoretical framework to think about the effects of financial integration on the global comovement in real and financial variables. First, it is shown that, conditional on supply shocks, higher exposure to foreign assets leads to lower cross-country output correlations, while conditional on demand shocks it leads to higher output correlations. This result can be explained by opposing terms of trade movements depending on whether a shock hits the demand or the supply side of the economy. The transmission channel is independent of whether the agents who hold the foreign assets are balance-sheet-constrained or not. Second, it is shown that conditional on supply shocks, higher exposure to foreign assets through leveraged financial institutions is associated with lower cross-country correlations in financial variables, while conditional on demand shocks, the effect of financial integration through banks on the cross-country correlations in financial variables, depends on the specific nature of the demand shock.
Endogenous Portfolio Choice by Banks and the International Risk-Sharing Puzzle – A Role for Macroprudential Policy?
International consumption risk-sharing is relatively low compared to what theoretical models would predict given the high level of international financial market integration. I show that a model in which leverage-constrained financial intermediaries undertake the international portfolio choice decision instead of households can explain this puzzle. The optimal portfolio composition choosen by financial intermediaries does, in general, not provide the highest possible degree of consumption risk sharing. In particular, financial intermediaries choose to hold too many home assets. This result is driven by an agency problem which causes the motives of bankers and households to diverge. Conditional on the nature of the shocks, macroprudential policy can decrease the wedge between actual and potential risk-sharing.