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28 October 2010

Discussion on“The Financial Accelerator under Learning

and the Role of Monetary Policy”by Caputo, Medina and Soto

CEPR/ESI 14th Annual Conference

Harun ALP Central Bank of Turkey

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The Paper

• Financial accelerator on the demand side of credit market is modelled by using BGG (1999) framework.

• Borrow at a premium over the risk free rate, which is a function of the leverage of the borrower.

• Departure from Rational Expectation assumption.

• Adaptive Learning: Agents in economy act like econometricians.

• Past data is discounted when agents update their expectations.

• Combination of the two elements generates a sizable drop in output and asset prices in response to a negative shock.

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• Consider negative productivity shock under alternative monetary policy rules responding asset prices.

• The expectations formation mechanism endogenously generates a significant deviation of asset prices from their fundamental values.

• Responding aggressively only to inflationary pressures is still efficient in this environment.

The Paper

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Calibration

• Learning itself introduces a lot of inertia.

• Milani (2005, 2007): In a New Keynesian model with learning, the estimated degrees of habits and indexations are close to zero.

• Parameter values for indexations may be too high.

• Estimate the model to see whether financial accelerator and learning are accepted by data.

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Instrument Rules

• React to the level of asset prices or change in the asset prices.

• Some fluctuations in asset prices are efficient in the presence of technology shocks.

• React to the deviations of asset price from its fundamental value (flexible price with no financial frictions)

• Technology shocks lead to changes in natural rate of interest.

• React to the natural rate of interest.

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Instrument Rules

• Optimized simple instrument rules under an ad-hoc loss function

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• More formal welfare analysis

• Consider optimal policy as a benchmark and look at whether simple instrument rules close to optimal.

• The central bank tries to stabilize two distortions with one instrument (sticky price and wage vs. financial friction ).

Optimal Policy

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• Paper considers only technology shocks.

• Under a different shock

• How learning affects asset price behavior?

• Are deviations from RE still large?

• How different instrument rules perform?

• The size of the shock affect the propagation in a nonlinear way due to the learning.

• Consider the policy exercise under different values of shocks.

• May affect the coefficients of the instrument rules.

Shocks

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Discussion on“The Financial Shocks and Monetary

Reactions in a New Keynesian Model”by de Walque and Pierrard

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The Paper

• Extend a standard New Keynesian model to incorporate a banking sector including interbank market.

• Modelling the supply side of credit market.

• No borrowing friction in firm-bank relationship

• Key features of the model:

• Maturity mismatch.

• Risk of default on interbank borrowing.

• Collateralized borrowing from central bank.

• Consider both conventional and unconventional monetary policy.

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Borrowing from the Central Bank

• At equilibrium, no borrowing from central bank.

• It is difficult to consider collateral requirements in a market which the borrowing does not exist at equilibrium.

• Role for money may be needed.

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Interbank Market

• Interbank loans are increasing following a negative security quality shock.

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Maturity Mismatch

• 1-period borrowing from interbank and central bank vs. long-term lending to firms.

• How the maturity mismatch affects the propagation of shocks?

•The fire sale of the long-term assets.

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• Looser requirements for the quality of the collateral.

• No cost of reducing the quality of collateral.

• Why central banks do not use the unconventional policy in normal times?

• Some cost needed.

Unconventional Monetary Policy

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• Reacting to a banking variable is beneficial.

• Consider aggressive reaction to inflation in policy rule.

• Consider rigorous welfare analysis.

• In this model, central bank has two instrument.

• Look at the optimal policy to see

• How unconventional policy behave optimally?

• How two instruments interact?

• Benefits of using two instrument.

Conventional Monetary Policy

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To sum up

• Both papers are very interesting and helpful in understanding the current financial crisis.

• Both papers introduce a second friction for monetary policy to concern.

• Depending on the model structure and the nature of the shock, the trade-off between two frictions may be significant.

• Using additional instrument is beneficial.