Financial Intermediation and Credit Policy. Business Cycle Analysis

Transcription

1 Financial Intermediation and Credit Policy In Business Cycle Analysis Mark Gertler and Nobuhiro Kiyotaki NYU and Princeton October 29

2 Old Motivation (for BGG 1999) Great Depression Emerging market crises over the past quarter century. 1

3 New Motivation (for GK 29) Global economy during Bernanke s tenure as Fed Chair 2

4 Figure 1: Selected Corporate Bond Spreads Basis points Quarterly NBER Q4. Peak Avg. Senior Unsecured Medium-Risk Long-Maturity Baa Note: The black line depicts the average credit spread for our sample of 5,269 senior unsecured corporate bonds; the red line depicts the average credit spread associated with very long maturity corporate bonds issued by firms with low to medium probability of default (see text for details); and the blue line depicts the standard Baa credit spread, measured relative to the 1-year Treasury yield. The shaded vertical bars denote NBER-dated recessions.

5 real GDP growth (right) lending standards (left)

6 Challenges for Writing a Handbook Chapter Much of the relevant literature predates August 27 Most of the work afterwards is still in preliminary working paper form. 3

7 Our Approach: Look both Forward and Backward Present Canonical Framework relevant to thinking about current crisis. Not a comprehensive or complete description Only a first pass at organizing thinking Goal is to lay out issues for future research Build heavily on earlier research. 4

8 Aspects of the Current Crisis We Try to Capture Disruption of Financial Intermediation Much of the recent macro literature has emphasized credit frictions on nonfinancial borrowers and has treated intermediaries largely as a veil. Unconventional Monetary Policy 5

9 Unconventional vs. Conventional Monetary Policy Conventional: The central bank adjusts the short term rate to affect the market structure of interest rates. Unconventional: The central bank lends directly in private credit markets. Section 13.3 of the Federal Reserve Act: "In unusual and exigent circumstances.. the Federal Reserve may lend directly to private borrowers to the extent it judges the loans to be adequately secured." 6

10 Federal Reserve Assets Trillions of Dollars Repo Treasury Securities Other AMLF Maiden Lane I, II, III Other Credit (&AIG ext) PDCF, Other Broker-dealer TAF Primary Credit Currency Swaps Agency MBS Agency Debt TALF CPFF Trillions of Dollars.5.5 Aug-7 Oct-7 Dec-7 Feb-8 Apr-8 Jun-8 Aug-8 Oct-8 Dec-8 Feb-9 Apr-9 Federal Reserve Liabilities 2.5 Treasury, SFA Reserve Balances Treasury, ga Reverse Repo Other Currency Source: H41, Bloomberg Aug-7 Oct-7 Dec-7 Feb-8 Apr-8 Jun-8 Aug-8 Oct-8 Dec-8 Feb-9 Apr-9.5

11 Liquidity Facilities CPFF and Commercial Paper Outstanding Billions of Dollars 1,9 1,8 1,7 Total (left axis) Source: Federal Reserve Board, Haver, FDIC Federal Reserve Net Holdings (right axis) Billions of Dollars Mar 31: ,6 Apr 17: FDIC TLGP 1,5 (right axis) Apr 17: 1, Mar-8 Jun-8 Sep-8 Dec-8 Mar month CP Rates over OIS Basis Points AA Financial Apr 17: A2/P2/F Non-Financial Apr 17: 61. Apr 17: 27. AA Asset-Backed ABCP CPFF Fee AA Non-Financial Unsecured CPFF Fee -1 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Source: Federal Reserve Board, Haver, Bloomberg Apr 17: 6. Basis Points TSLF Schedule 1 & 2 Total Outstanding Overnight Financing Spreads Billions of Dollars 15 Billions of Dollars 15 Basis Points 25 Basis Points 25 1 Schedule 2 Apr 15: Agency MBS Agency Debt Schedule 1 Apr 16: Apr 17: 8. Apr 17:. 1 5 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Source: Federal Reserve Board -5-5 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Note: Spreads are between overnight agency debt and Source: Bloomberg MBS and Treasury general collateral repo rates Agency MBS Transactions Agency MBS to Average 5y and 1y Yields Billions of Dollars 3 2 Outright Purchases Apr 15: Billions of Dollars 3 2 Basis Points 3 25 Fannie Mae Basis Points Temporary OMO Accepted Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Source: Federal Reserve Board, Haver Apr 17:. 1 2 Apr 17: Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Note: Spreads are agency 3 year on-the-run Source: FRB, Haver, Bloomberg coupon to average of 5 and 1 year yields 15

12 What We Do Develop a quantitative DSGE model that allows for financial intermediaries that face endogenous balance sheet constraints. Use the model to simulate a crisis that has some of the features of the current downturn. Assess how unconventional monetary policy (direct central bank intermediation.) could moderate the downturn. Discuss Open Issues and Extensions 7

13 Model: Physical Environment Firm dispersed across islands, with perfectly mobile labor: Y t = A t K α t L 1 α t I.I.D. prob. π i of arrival of investment opportunities across islands. Resource Constraint K t+1 = [ψ t (I t + π i (1 δ)k t )] + [(1 π i )ψ t (1 δ)k t ] = ψ t [I t +(1 δ)k t ] Y t = C t +[1+f( I t I t 1 )]I t + G t Preferences E t X i= β i [ln(c t+i hc t+i 1 ) χ 1+ϕ L1+ϕ t+i ] 8

14 Beginning of the period Retail financial market Households Banks Deposit

15 During the period Investing regions Non-investing regions Bank with fund shortage Interbank market Banks with surplus fund New and old loans Old loans Firms with new investment opportunity Firms without new investment opportunities

16 Households Within each household, 1 f "workers" and f "bankers". Workers supply labor and return their wages to the household. Each banker manages a financial intermediary and also transfers earnings back to household.. Perfect consumption insurance within the family. 9

17 Households (con t) To limit bankers ability to save to overcome financial constraints: With i.i.d prob. 1 σ, a banker exits next period. (average survival time = 1 1 σ ) Upon exiting, a banker transfers retained earnings to the household and becomes a worker. Each period, (1 σ)f workers randomly become bankers, keeping the number in each occupation constant Each new banker receives a "start up" transfer from the family. 1

18 Households (con t) X max E t β i [ln(c t+i hc t+i 1 ) i= χ 1+ϕ L1+ϕ t+i ] s.t. C t = W t L t + Π t + T t + R t D t D t+1 D t short term bonds (intermediary deposits and government debt) Π t payouts to the household from firm ownership net the transfer it gives to its new bankers. 11

19 Financial Intermediaries: Case of No Idiosyncratic Risk (i.e. π =1) (equivalent to π<1 with perfect interbank market) Intermediary Balance Sheet Evolution of Net Worth Q t s t = n t + d t n t+1 = R kt+1 Q t s t R t+1 d t = (R kt+1 R t+1 )Q t s t + R t+1 n t 12

20 Financial Intermediaries (con t) X V t = maxe t (1 σ)σ i Λ t,t+i (n t++i ) i=1 X = maxe t (1 σ)σ i Λ t,t+i [(R kt+i R t+i )Q t+i s t+i i=1 With Frictionless Capital Markets: E t Λ t,t+1+i (R kt+1+i R t+1+i )= With Capital Market Frictions: E t Λ t,t+1+i (R kt+1+i R t+1+i ) + R t+i n t+i ] 13

21 Financial Intermediaries (con t) Agency Problem: After the banker/intermediary borrows funds at the end of period t, it may divert the fraction θ of total assets back to its family. If the intermediary does not honor its debt, depositers can liquidate the intermediate and obtain the fraction 1 θ of initial assets Incentive Constraint: V t θq t s t 14

22 Financial Intermediaries (con t) One can show: V t = μ t Q t s t + ν t n t with ν t = E t Ω t+1 μ t = E t Λ t,t+1 (R kt+1 R t+1 )Ω t+1 where Ω t+1 is the shadow value of a unit of net worth at t +1. Ω t+1 =1 σ + σ(ν t+1 + φ t+1 μ t+1 ) 15

23 Financial Intermediaries (con t) Re-writing the incentive constraint: μ t Q t s t + ν t n t θq t s t = Endogenous leverage constraint: Q t s t φ t n t with φ t = Maximum leverage ratio φ t = ν t θ μ t 16

24 Financial Intermediaries (con t) Since the leverage ratio φ t does not depend on firm-specific factors, we can aggregate: Q t S pt = φ t N t S pt total assets privately intermediated N t total intermediary capital Evolution of Net Worth:: N t = σ[(r kt R t )φ t + R]N t 1 + ξr kt Q t 1 S t 1 where ξ is the fraction of gross assets transferred to new entrepreneurs 17

25 Credit Policy (Case of Direct Lending) Central bank intermediation supplements private intermediation: Q t S t = Q t S pt + Q t S gt The central bank issues government debt that pays R t+1 and then lends to nonfinancial firms at R kt+1. Efficiency cost of τ per unit of gov t credit provided. Unlike private intermediaries, the central bank is not "balance-sheet" constrained. 18

26 Credit Policy (con t) Q t S gt = ϕ t Q t S t = Q t S t = Q t S pt + Q t S gt = φ t N t + ϕ t Q t S t = Q t S t = 1 1 ϕ t φ t N t Q t S t is increasing in the intensity of credit policy, as measured by ϕ t. 19

27 Goods Producers: Non-financial Firms Issue state-contingent claims (equity) S t = K t+1 R kt+1 = ψ t+1 [Z t+1 +(1 δ)q t+1 ]/Q t with Z t = α Y t K t Hire Labor (1 α) Y t L t 2

28 Non-financial Firms (con t) Capital producers: X max E t Λ t,τ (Q i τi τ τ=t " 1+f à Iτ I τ 1!# I τ ) Investment increasing in Q t : Q i t =1+f à It I t 1! + I t I t 1 f ( I t I t 1 ) E t Λ t,t+1 ( I t+1 I t ) 2 f ( I t+1 I t ) 21

29 Government Budget Constraint and Credit Policy Government Budget Constraint G + τψ t Q t K t+1 = T t +(R kt R t )B gt 1 Credit Policy (contingent on a "crisis") ψ t = ν[e t (R kt+1 R t+1 ) (R k R)] 22

30 Table 1: Parameter Values for Baseline Model Households β.99 Discount rate γ.5 Habit parameter χ Relative utility weight of labor ϕ.333 Inverse Frisch elasticity of labor supply Financial Intermediaries π i.25 Probability of new investment opportunities θ.383 Fraction of assets divertable: Perfect interbank market.129 Fraction of assets divertable: Imperfect interbank market ξ.3 Transfer to entering bankers: Perfect interbank market.2 Transfer to entering bankers: Imperfect interbank market σ.972 Survival rate of the bankers Intermediate good firms α.33 Effective capital share δ.25 Steady state depreciation rate Capital Producing Firms If /f 1. Inverse elasticity of net investment to the price of capital Government G Y.2 Steady state proportion of government expenditures 41

31 ψ Figure 1. Crisis Experiment: Perfect Interbank Market 5 x 1 3 r.2 E(r k ) r y k net worth c labor investment q Perfect Interbank Market RBC

32 ψ Figure 3. Lending Facilities: Perfect Interbank Market r.1.15 E(r k ) r y k net worth c labor fraction of government assets investment ν g = RBC q ν g =1

33 Liquidity Risk (π i < 1) and Imperfect Interbank Market Asset returns on "investing" islands exceed returns on "non-investing" islands The spread between inter-island returns increases during a crisis. 23

34 Liquidity Risk (π i < 1), con t for h = i, n Q h t s h t = n h t + b h t + d t. where b h t is interbank borrowing net worth: n h t =[Z t +(1 δ)q h t ]ψ t Q h 1 t 1 s t 1 R bt b h t 1 R td t 1, R h 1h kt = [Z t +(1 δ)q h t ]ψ t Q h 1 t 1 24

35 Liquidity Risk (π i < 1), con t objective V t = E t X i=1(1 σ)σ i 1 Λ t,t+i n h t+i, the bank chooses d t before liquidity risk realized; s h t,bh t after. incentive constraint V (s h t,b h t,d t ) θ(q h t s h t ωb h t ). where ω [, 1] measures the efficiency of the interbank market 25

36 Perfect Interbank Market (ω =1) arbitrage Q i t = Qn t = Q t E t R hh kt+1 = E tr kt+1 = ψ t+1 Z t+1 +(1 δ)q t+1 Q t incentive constraint Q t s t b h t = φ t n t where φ t = ν t θ μ t = the case of no liquidity risk 26

37 Perfect Interbank Market (ω =1) aggregating and given b i t + bn t =, Q t S t = φ t N t liquidity risk and a perfect interbank market no liquidity risk case results from perfect arbitrage in the inter-bank market E t Λ t,t+1 R kt+1 Ω t+1 = E t Λ t,t+1 R bt+1 Ω t+1 >E t Λ t,t+1 R t+1 Ω t+1. 27

38 Imperfect Interbank Market (ω =) Imperfect arbitrage Q i t <Qn t A lower asset price on the investing island, of course, means a higher expected return. Let μ h t be the excess value of assets on a type h island μ i t >μ n t. with μ h t = E t Λ t,t+1 (Rkt+1 hh R t+1)ω h t+1 ; h = i.n h 28

39 Imperfect Interbank Market (ω =) Q i ts i t = φ i tn i t Q n t S n t φ n t N n t, and (Q n t S n t φ n t N n t ) μ n t =, with φ h t = ν t θ μ h t E t Λ t,t+1r ih h kt+1 Ωh t+1 > E t Λ t,t+1r nh h kt+1 Ωh t+1 E t Λ t,t+1r bt+1 Ω h h t+1 = E t Λ t,t+1r t+1 Ω h h t+1. 29

40 Credit Policy with Imperfect Inter-bank Market Q h t S h t = Q h t (S h pt + S h gt) S h gt = ϕ h t S h t where ϕ h t may be thought of as an instrument of central bank credit policy. Q i tst i = 1 1 ϕ i φ i tnt i t Q n t S n t = 1 1 ϕ n t Q n t S n t φ n t N n t iff μ n t >. = Q n t S n pt + ϕ n t Q n t S n t,iffμ n t = with St n asset demand consistent with μ n t =. 3

41 ψ Figure 2. Crisis Experiment: Imperfect Interbank Market 5 x 1 3 r.6 spread y k net worth c labor Imperfect Interbank Market (π i =.25) RBC Perfect Interbank Market investment q

42 ψ Figure 4. Lending Facilities: Imperfect Interbank Market r.1.6 spread y c.1 investment k labor.5 q net worth fraction of government assets ν g = RBC ν g =1

43 Discount Window Policy with Imperfect Inter-bank Market with m h t. Q h t s h t = n h t + b h t + m h t + d t. V (s h t,b h t,m h t,d t ) θ ³ Q h t s h t ω g m h t. 31

44 Discount Window Policy with Imperfect Inter-bank Market define μ mt = E t Λ t,t+1 (R mt+1 R t+1 )Ω h h t+1. discount rate set according to μ mt = ω g μ i t set R mt+1 >R bt+1 = R t+1 (Bagehot s principle) in the aggregate Q i ts i pt = φ i tn i t + ω g M t. 32

45 Equity Injections (case of perfect interbank market) s t = s pt + s get Q t s t = n t + b h t + d t + n gt n gt = Q t s get 33

46 Equity Injections (case of perfect interbank market) μ gt = E t Λ t,t+1 (R gkt+1 R t+1 )Ω t+1 where R gkt+1 ross return on a unit of government equity injected at time t is: with, Q gt º Q t. R gkt+1 = ψ t+1 Z t+1 +(1 δ)q t+1 Q gt n t =[Z t +(1 δ)q t ]ψ t s pt 1 R bt b t 1 R t d t 1 +(Q gt Q t )[s get (1 δ)ψ t s get 1 ] where (Q gt Q t )(s gt s gt 1 ) is the "gift" to the basnk from new government equity purchases. 34

47 Equity Injections (case of perfect interbank market) V (s t s get,,b t,d t ) θ(q t (s t s get ) b t ). Q t S t = φ t N t + N gt N t =(σ+ξ)[z t +(1 δ)q t ]ψ t S pt 1 σr t D t 1 +.(Q gt Q t )[S get (1 δ)ψ t S get 1 ] 35

48 .Issues 1. Idiosyncratic Asset Risk and Default 2. Illiquidity and Market Thinness 3. Maturity Structure 4. Bank Equity 5. Capital Requirements and Regulation, and so on... 36