reassessing macroeconomics from a monetary … and financial cycle intertwined 11 example 1 credit...
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Reassessing Macroeconomics from aReassessing Macroeconomics from a Monetary Perspective
byPiti Disyatat
B k f Th il dBank of Thailand
November 28, 2013
M i Th iMain Thesis
Failure of mainstream theory comes from underlying conceptual framework that gives no meaningful role for money and finance
“Real” versus “monetary” analysis
Three examples
Money and credit creation
Current account and capital flows
Potential output
2
3
Wh D W N d M ?Why Do We Need Money?
Frictions in the process of exchange
Double coincidence of wants
• Inter‐ and intra‐temporal dimension
Limited commitment
• Transferability of contracts
Imperfect record‐keeping
“Evil is the root of all money” (Kiyotaki and Moore (2002))
4
C l P di f R l A l iConceptual Paradigm of Real Analysis
Walrasian Auctioneer
Frictionless process of exchange
• No informational and trade frictions
N d f lt• No default
• Exchange occurs only once, after equilibrium price determined
Schumpeter “veil of money”; Money neutrality
Perfect barter: No role for money
5
C l P di f R l A l iConceptual Paradigm of Real Analysis
Money artificially grafted on
Short‐cuts for role of money
• Money in utility function
M i d ti f ti• Money in production function
• Cash in advance constraint
Introduction of money reduces set of feasible allocations!Introduction of money reduces set of feasible allocations!
Merely a unit of account
Real models disguised as monetary ones
6
C l P di f R l A l iConceptual Paradigm of Real Analysis
Rational representative agent
No meaningful interaction
• Trade with own budget constraint
N h di di ti f il• No herding or coordination failures
Stable with shocks
A h d t ilib iAnchored to equilibrium
• Negative feedback loops
Focus on flowsFocus on flows
• Little role for stock imbalances and balance sheets
Absence of bubbles, financial imbalances, financial cycles, financial crises
7
Wh I M E i ?Where Is My Engine?
8
Monetary AnalysisMonetary Analysis
Money is not a “veil”
F i ti i f h h l i tFrictions in process of exchange have real impact
• Boom/bust cycles, coordination failures
Di ilib iDisequilibrium
Dynamic
T di t “f l i ”Trading at “false prices”
• Not continuous market clearing
Importance of stocksImportance of stocks
• Cumulative processes (imbalances)
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Monetary AnalysisMonetary Analysis
Inherently unstable
Capacity for self‐regulation limited
• Positive feedback loops
Complex dynamical systemComplex dynamical system
• Externality and fallacy of composition
Endogenously generated instabilityEndogenously generated instability
Finance and real economy inextricably intertwined
10
Real and Financial Cycle IntertwinedReal and Financial Cycle Intertwined
11
Example 1
Credit and Money Creation
Money multiplier and the transmission mechanism
Disyatat (2008, 2010); Borio and Disyatat (2010)
“Real” model of lending
Must acquire resource before lending
• Constraint on lending is deposits or reserves
• Credit and money driven by real factors
“Monetary” model of lending
Loan creates deposits (purchasing power)
• No quantitative constraint on lending except through capital requirementsrequirements
Credit drives real economy
12
Financial system elasticity
AWorld of Credit
Example 1
A World of CreditPublic debt and bank credit to private non‐financial sector for 17 advanced countries
13Source: Jordà, Ò., M. Schularick and A. Taylor (2013)
Current Account and Capital Flows
Example 2
Current Account and Capital Flows
“Real” intermediation model extended to open economy
Y = C + I + G + NXY = C + I + G + NX
Y – C – G – I = NX
S – I = NX = Current AccountS Cu e t ccou t
“Excess saving” view
• Global imbalances cause of crisis (King (2010), Bernanke (2009), Krugman (2009))
• Global saving glut (Bernanke 2005))
S f t h t (C b ll t l (2010))• Safe asset shortage (Caballero et al. (2010))
Focus on current account and net capital flows
• Countries with roughly balanced current account exert• Countries with roughly balanced current account exert neutral influence on dynamics of global financial flows
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Global Imbalances
Example 2
Global ImbalancesCurrent account balance as a % of world GDP
2.50%
1.50%
2.00%Oil Exporting Euro Area
EMA United States
Japan China
0.50%
1.00%
‐0.50%
0.00%
‐1.50%
‐1.00%
‐2.00%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
15
1 2 2 2 2 2 2 2 2 2 2 2 2 2
Source: IMF; Emerging market Asia = China, Taiwan, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand
E S i Vi C i i
Example 2
Excess Saving View: Critique
Focus on current account misplaced
Current account captures only trade‐related flows
Gross flows are much larger
• All financial transactions generate offsetting gross flows
16
Gross Capital Flows
Example 2
p(percent of world GDP)
35
40
Oil exporters
25
30Emerging Europe
Emerging Asia
Advanced economies
15
20
5
10
-5
0
5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2
19
9
19
9
19
9
19
9
19
9
20
0
20
0
20
0
20
0
20
0
20
0
20
0
20
0
20
0
20
0
20
1
20
1
20
1
Source: IMF
Bulk of cross‐border gross flows involve advanced economies
17
g
Unlikely that EM flows determine global financial conditions
US Capital Flows
Example 2
US Capital Flows(As a percentage of US GDP)
20 Gross Outflow
10
15Gross Inflow
Current Account
0
5
10
‐5
0
‐15
‐10
97 97 98 99
00 00 01 02
03 03 04 05
06 06 07 08
09 09 10 11
12 12
Jan‐9
Oct‐9
Jul‐9
Apr‐9
Jan‐0
Oct‐0
Jul‐0
Apr‐0
Jan‐0
Oct‐0
Jul‐0
Apr‐0
Jan‐0
Oct‐0
Jul‐0
Apr‐0
Jan‐0
Oct‐0
Jul‐1
Apr‐1
Jan‐1
Oct‐1
Gross inflows roughly 3 times larger than net before the crisis
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Gross inflows roughly 3 times larger than net before the crisis
Net inflows fell by $20 billion in 2008, gross inflows fell by $1.6 trillion!
US Capital Flows
Example 2
Gross capital inflows by region
(As a percentage of US GDP)
15
10
5
5
0
Japan OPEC China Canada
‐10
‐5 China Canada United Kingdom Euro area
Most important source was Europe not emerging markets
Oct‐99
Jul‐00
Apr‐01
Jan‐02
Oct‐02
Jul‐03
Apr‐04
Jan‐05
Oct‐05
Jul‐06
Apr‐07
Jan‐08
Oct‐08
Jul‐09
Apr‐10
Jan‐11
Oct‐11
Jul‐12
Most important source was Europe, not emerging markets
Flows from Asia stabilising force during crisis 19
B i C B d B ki
Example 2
Boom in Cross‐Border Banking
18USD Trillions
14
16
Developed Europe (non-euro)
Euro
10
12Euro
Other Developed
Developing
4
6
8
0
2
4
0
Dec
.95
Sep
.96
Jun
.97
Mar
.98
Dec
.98
Sep
.99
Jun
.00
Mar
.01
Dec
.01
Sep
.02
Jun
.03
Mar
.04
Dec
.04
Sep
.05
Jun
.06
Mar
.07
Dec
.07
Sep
.08
Jun
.09
Mar
.10
Dec
.10
Sep
.11
Jun
.12
Mar
.13
20
External claims (loans and deposits) of BIS reporting country banks on borrowers in country group listed. (Source: BIS Locational Banking Statistics, Table 7A)
E S i Vi C i i
Example 2
Excess Saving View: Critique
Focus on current account misplaced
Reveal little about global financing patterns
• An economy running a balanced current account can t ll b d i l l i t di ti ti itactually be engaged in large‐scale intermediation activity
Crisis was not driven by a disorderly unwinding of global imbalances but dislocation in the global intermediation chaing
F l b l fi i l bili li i ddFor global financial stability, policies to address current account imbalances cannot be the priority
21
E i i P i l O
Example 3
Estimating Potential Output
Potential output as sustainable level of activity
Prevailing measures focus on inflation
But unsustainable credit boom may not result in inflation
• Outward supply shifts often accompany credit cycle
• Appreciation tames price pressure
• Sectoral misallocation• Sectoral misallocation
22
E i i P i l O
Example 3
Estimating Potential Output
Incorporating financial factors
Credit availability determines elasticity of financial system
• Financial cycle and real activity intertwined
i i l il i d d h d i d• Financial tailwinds and headwinds
Small sate‐space system
S f HP filt• Same frequency as HP filter
∆ 1 ∆ 0 (1) ∆ 1 ∆ 0, (1)
1 1 2, (2)
Finance‐neutral potential output
,
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US O G
Example 3
4Percent
US Output Gap
2
3
4
0
1
2
‐1
0
un‐80
eb‐82
Oct‐83
un‐85
eb‐87
Oct‐88
un‐90
eb‐92
Oct‐93
un‐95
eb‐97
Oct‐98
un‐00
eb‐02
Oct‐03
un‐05
eb‐07
Oct‐08
un‐10
eb‐12
‐3
‐2 Ju Fe O Ju Fe O Ju Fe O Ju Fe O Ju Fe O Ju Fe O Ju Fe
‐5
‐4
Finance Neutral HP Filter
‐624
Th i O G
Example 3
15Percent
Thai Output Gap
10
5
0
93 94
95
96 97
98
99 00 01 03 04
05 06
07
08 09
10
11 12
‐5 Mar‐9
Apr‐9
May‐9
Jun‐9
Jul‐9
Aug‐9
Sep‐9
Oct‐0
Nov‐0
Jan‐0
Feb‐0
Mar‐0
Apr‐0
May‐0
Jun‐0
Jul‐0
Aug‐1
Sep‐1
Oct‐1
‐10
Finance Neutral HP Filter
‐1525
Real time Performance: US
Example 3
As a percentage of potential output Graph 1
IMF OECD
Real‐time Performance: US
0
3
0
3
–6
–3
–6
–3
HP Finance-neutral
–9
01 02 03 04 05 06 07 08 09 10 11
–9
01 02 03 04 05 06 07 08 09 10 11
0
3
0
3
–6
–3
–6
–3
–9
01 02 03 04 05 06 07 08 09 10 11
–9
01 02 03 04 05 06 07 08 09 10 11
Real-time Ex-post 26
Example 3
T l R l US8
Percent Taylor Rules: US
6
7
4
5
2
3
0
1
‐2
‐1 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Policy Rate Taylor‐HP
‐3Taylor‐Finance Neutral Taylor‐Production
27
P li i li i
Example 3
Policy implications
Financial factors contain substantial information about cyclical output
Financial cycle matters for judgment about state of business cycle and its sustainabilitycycle and its sustainability
Short‐cut to factoring in financial factors
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T k A
Conclusion
Take Aways
Financial cycle matters
Ability to create purchasing power means that finance can drive real economy
li h ld id fi i l l i iPolicy should consider financial system elasticity
Macroeconomics must return to monetary roots
Stock imbalances and balance sheets
Endogenous financial cycle
b• Booms cause busts
Disequilibrium
Essence of macro is aggregation of interaction between heterogenous agents under imperfect information and markets
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markets
ReferencesReferencesBernanke, B (2005): “The global saving glut and the U.S. current account deficit,” speech at the Sandridge Lecture,Richmond, March 10.
______ (2009): “Financial reform to address systemic risk,” Speech at the Council on Foreign Relations, Washington,______ ( ) y , p g , g ,D.C, 10 March.
Borio, C. and P. Disyatat (2011): “Global Imbalances and the Financial Crisis: Link or No Link?” BIS Working Papers.No. 346.
(2010) “Unconventional Monetary Policies: An Appraisal ” The Manchester School Vol 78(s1) pp 53 89______ (2010), Unconventional Monetary Policies: An Appraisal, The Manchester School, Vol 78(s1), pp. 53–89.
Borio, C, P Disyatat and M Juselius (2013), “Rethinking Potential Output: Embedding Information from the FinancialCycle”, BIS Working Papers, No. 404.
Caballero R (2010): “The “other” imbalance and the financial crisis,” NBER Working Paper, no. 15636.
Disyatat, P (2008): “Monetary policy implementation: Misconceptions and their consequences,” BIS Working Papers,no 269, December.
______ (2010): “The bank lending channel revisited,” Journal of Money, Credit, and Banking, Vol. 43 (4), pp. 711‐734734.
King, M (2010): Speech delivered to the University of Exeter Business Leaders’ Forum, 19 January.
Kiyotaki N and J Moore (2002), “Evil is the root of all money,” American Economic Review, Vol. 92 (2), pp. 62‐75.
Krugman, P (2009): “Revenge of the glut,” The New York Times, 1 March.g , ( ) g g , ,
Wolf, M (2008): “Global monetary and financial disorder: the role of global imbalances,” speech delivered at the 7thBIS Annual Conference, June 27.
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