incorporating financial stability considerations into …incorporating financial stability...
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Incorporating financial stability considerations into central bank models October 29, 2013
Rhys Mendes Deputy Chief, Canadian Economic Analysis Department
Bank of Canada
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Outline
BoC work on incorporating FS considerations
Selected challenges
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Incorporating financial stability considerations into macro models at the Bank of Canada
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FS in BoC models of Canadian economy
BoC analysis built around main projection model: – QPM: Early 1990s – 2005 – ToTEM I: 2006 – 2012 – ToTEM II: 2012 – Present
Prior to ToTEM II main models largely ignored real-financial
linkages – Relied on satellite models
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FS in BoC models of Canadian economy
Historical satellite models: – Meh and Moran (2004): Banking sector financial frictions – Christensen and Dib (2006): BGG-type frictions – Basant Roi and Mendes (2007): HH sector financial
frictions
Current work aims to bring these together
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FS in BoC models of Canadian economy
ToTEM II introduces some minimal real-financial linkages: – Independent role for long rates – Risk spreads – Residential investment and housing stock – Link between consumption and “financial wealth”
Benefits:
– Can address broader range of policy questions – Improved fit – Foundation for future enhancements
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FS in BoC models of global economy
GEM: IMF’s Global Economy Model
BoC-GEM: Bank of Canada’s version of IMF’s Global
Economy Model
BoC-GEM-Fin: BoC-GEM + financial frictions
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FS in BoC models of global economy
BoC-GEM-Fin financial frictions along the lines of Dib (2010):
– Financial accelerator • Leverage affects firms’ cost of finance • Debt-deflation effect
– Banking sector
• Bank capital • Cross-border lending
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Assessing FS risks from household debt
Models discussed so far do not allow for impact of HH default
on financial system – Where HH borrowing is modelled, patient/impatient device
is used => no default
To capture effect of HH default on the financial system, we use a reduced-form satellite model – Household Risk Assessment Model (HRAM)
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Assessing FS risks from household debt
Three steps in stress-testing exercise: 1. Use ToTEM to generate macro scenario
• Aggregate income, employment, credit • Interest rate path
2. Use HRAM to calculate implied cross-sectional
distribution of household debt service ratios
3. Estimate impact on bank loan portfolios
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Example: Unemployment rate assumptions
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Example: Share of vulnerable households
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Example: Share of debt held by vulnerable households
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Example: Rate of household loans in arrears
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Assessing FS risks from household debt
ToTEM HRAM
Macro scenario
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Assessing FS risks from household debt
ToTEM HRAM
Macro scenario
DSR distribution
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Assessing FS risks from household debt
ToTEM HRAM
Macro scenario
DSR distribution
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Selected challenges and areas for future research
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Many FS considerations are low frequency developments
0.8
0.9
1.0
1.1
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1.7Ratio
Ratio of debt to incomeLast observation: 2013Q2 Source: Statistics Canada
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Greater focus on trends needed
Current approach usually involves linearized models designed to explain detrended data
Need to integrate analysis of trends and cycle
Near-term options: – Use perfect foresight methods to study transitions between
steady states – Use small models that are amenable to global RE solution
methods (useful for building intuition)
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Market structure in financial sector
Need to take market structure seriously
– Can affects FIs’ incentives
Examples: – Canada: Oligopoly – Japan: Keiretsu – US: Repeal of Glass-Steagall
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Modelling needs more empirical guidance
More micro data, more micro studies
Experimental approach could also prove useful: – BoC has complemented its model-based work on
monetary policy with laboratory experiments – Has yielded useful evidence on nature of expectations
formation that will influence modelling – Potential for applications in FS research
• Can help to fill gaps in data
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Thank you