Comments on The Great Escape? A Quantitative Evaluation of the Fed's Non-Standard Policies

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Comments onThe Great Escape? A Quantitative
Evaluation ofthe Fed's Non-Standard Policies

• Luis F. Cespedes
• Central Bank of Chile
• October 2010

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Main questions of the paper

• What are the potential effects of the
  non-standard open market operations undertaken by
  the Fed in the recent global financial crisis?
• Answer of the paper The effects can be large,
  especially at the ZLB.
• Moreover, the authors argue that they were key to
  avoid a Great Depression-style collapse.
• Very nice paper.

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The Model

• They extend the model of Kiyotaki and Moore
  (2008) which features differences in liquidity
  across assets.
• Non-standard open market operations in private
  assets conducted by the government are relevant.
• In each period a fraction of the entrepreneurs
  receives an investment opportunity.
• The arrival of such opportunity is randomly
  distributed across entrepreneurs through time.

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The Model

• Because not all entrepreneurs can invest in each
  period, there is a need to transfer resources
  from those who do not have an investment
  opportunity to those who do.
• To finance investment entrepreneurs sell equity
  claims to the future returns from the newly
  produced capital.

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The Model

• A crucial feature of the model (KM 2008) is that,
  because the investing entrepreneur cannot
  precommit to work throughout its life, he is able
  to pledge only a fraction q of future returns
  from the new capital.
• As the investing entrepreneur can only issue new
  equity up to fraction of his investment, he
  faces a borrowing constraint.

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The Model

• Because of the borrowing constraint, the
  investing entrepreneur needs to finance
  investment partly by selling his holding of
  liquid assets and equity of the other agents.
• The other key feature of the model is that the
  existing equity (the claim to the return of the
  existing capital stock) cannot be sold as quickly
  as liquid assets.
• Specifically, they assume that, in any given
  period t, an agent can sell only a fraction ft of
  his equity holding (resaleability constraint).

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The Model

• Liquid assets are hold only if q and f are low
  enough.
• Rate of return of liquid assets is low, less than
  return on equity.
• Nevertheless, entrepreneurs hold liquid assets in
  their portfolio because in the event they receive
  an investment opportunity they will be liquidity
  constraint and liquid assets are more liquid
  than equity.

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The Model

• A shock to f reduces resaleability of equity
  which reduces the amount investing entrepreneurs
  can uses as downpayment which reduces investment.
  
• Also, lower resaleability reduces the price of
  equity flight to liquidity
• This increases the size of the required
  downpayment which feedbacks into the economy
• Government can exchange liquid assets for equity,
  increasing liquidity in the economy and
  mitigating the effects of the negative shock.

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The Government

• The government sets the nominal interest rate
  according to a rule
• The intervention is modeled as a swap of liquid
  (real bonds) for illiquid assets.
• Where

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The Model

• The rest of the model is somehow standard
• Entrepreneurs.
• The Government.
• Capital Goods Producers.
• Final Good Producers.
• Intermediate Goods Producers.
• Workers.

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Calibration One Key Variable

• Liquidity share

f
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Results

• Non-standard policy can have large effects under
  price and wage rigidity.
• This is particularly true at zero interest rates.
• Model economy generates a collapse of the same
  order as the Great Depression in the absence of
  non-standard government policies.

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Comments

• What was the original shock? Decline in real
  estate values? (deterioration in entrepreneurs
  (financial intermediaries) balance sheets?)
• This is important because it determines which
  constraints are more relevant.
• But also because reduces the dependency of the
  results on price and wage rigidity.
• Obviously the initial shock may have triggered
  additional shocks (uncertainty, resaleability,
  etc)

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Comments

• Given the way in which the resaleability shock is
  constructed may include other type of shocks that
  are different in nature (quality of capital for
  example) and future policy actions.

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Comments

• In KM (2008) an important driver of the non
  output losses under flexible prices was due to
  income effect on entrepreneurs of price decline.
  It seems that here too.
• Under flexible prices, does the central bank
  follows a Taylor rule? (remember than under
  flexibles prices money matters in this model)
• Non conventional actions could have made
  announcements of lower interest rates for a
  long period of time more credible.

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Comments

• The non conventional policies had different
  dimensions (expanded discount window operations,
  direct lending in high grade credit markets,
  equity injections), is the one trillion a measure
  of the intervention that wants to be evaluated?
• Related with the previous point, the great
  escape may have worked not only through other
  channels but also may include other actors
  (fiscal policy?)
• Need more information on calibration. Consumption
  share of entrepreneurs with respect to
  consumption of workers.

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The Changing International Transmission of
Financial Shocks Evidencie from a Classical
Time-Varying FAVAREickmeier, Lemke Marcellino

• Luis F. Céspedes
• Central Bank of Chile

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Introduction - Very good paper - Very
interesting in using the methodology in three
aspect - Factor Augmented framework, to reduce
large amount of information related with
financial aspects. - Time varying framework, to
measure variations in the impact of FCI on
relevant variables. - Use of the New FCI
published by Hatzius et al 2010, allows to take
into account new finance indicators and measure
new effects than previous measurements could not
do.
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• The goals of the paper are interesting and key.
• How large is the impact of US financial shocks on
  the major advanced countries, and have their size
  and transmission changed over time?
• Through what channels are US financial shocks
  both domestically and internationally
  transmitted, and can we identify changes in the
  transmission mechanism over time?
• How strongly were the major advanced economies
  affected by the global financial crisis and
  through which channels?

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• The paper
• How large is the impact of US financial shocks on
  the major advanced countries, and have their size
  and transmission changed over time?
• Positive US financial shocks have a considerable
  positive impact on the nine countries under
  analysis.
• The transmission to GDP growth in the euro-area
  countries and in Japan has increased gradually
  since the 1980s.

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• The paper
• Through what channels are US financial shocks
  both domestically and internationally
  transmitted, and can we identify changes in the
  transmission mechanism over time?
• US Evidence indicates that FCI shocks raise
  credit and equity and house prices. They increase
  investment and consumption. Particularly in the
  period 1987-2007.
• Two hypothesis monetary policy or structural
  changes in financial markets.
• Trade channel imports in most countries
  increase.
• Exchange rate depreciate in Japan and Germany
  and appreciate for the rest.

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Comments What about terms of trade? Authors
argue that it is questionable whether exchange
rates and terms of trade played an important role
for the international transmission of US
financial shocks. Therefore, trade reactions
can probably be explained with trade openness
rather than with relative price movements.
Would like to see the complete impulse
response of imports and exports. Relative price
movements may have a more reduced impact on
impact but may be relevant in medium term
horizons. .
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• The paper
• How strongly were the major advanced economies
  affected by the global financial crisis and
  through which channels?
• Exceptionally deep recent worldwide recession
  was mostly due to a large negative US financial
  shock combined with a strong propagation of that
  shock.
• The transmission of the global financial crisis
  was unusual in a number of respects. In most
  countries including the US the GDP response to a
  same-size FCI shock was not particularly large by
  historical standards.
• Germany, Japan and Spain are exceptions in the
  sense that their GDPs were much more strongly hit
  by US financial shocks over the 2008-2009 crisis
  than ever before.
• Initial conditions matter

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• Comments
• What are these financial shocks? Preferences,
  expected productivity, uncertainty, monetary
  policy shocks?
• Depending on the nature of the shock, monetary
  policy reaction is likely to be different
  (monetary policy is different if shock is due to
  expected productivity or some aggregate demand
  driver shock)
• Given that there are different shocks behind
  the FCI shocks, differences across time could be
  related to changes in the shocks configurations
  rather than changes in transmission mechanisms.
• Transmission of financial shocks from the US to
  the rest of the world. Could it be the other way
  around? Global uncertainty shocks or emerging
  market shocks that generates flight to quality
  may affect financial conditions in the US. Maybe
  less relevant for the group of countries
  considered in the sample. But maybe important in
  the recent global financial crisis.

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• Comments
• If financial variables included in the FCI are
  forward looking you may be identifying expected
  changes in variables under study.
• Financial globalization also may imply changes
  in the way in which financial variables are
  combined within the FCI.
• Regarding the transmission mechanisms and the
  different responses across countries there are
  conjectures but no clear evidence.
• The variance share explained by FCI shocks is
  closely related to the time varying FCI shock
  volatility. Episodes of uncertainty (Bloom 2009)
  have significant impact on output dynamics across
  countries.
• FCI may be affected by policy changes.