1. standard fiscal measures and bank rescue measures
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1. Standard fiscal measures and bank rescue measures. - PowerPoint PPT PresentationTRANSCRIPT
The Effects of Bank Rescue Measures in the recent Financial Crisis
Jan in 't Veld DG-ECFIN, European Commission
Werner Roeger DG-ECFIN, European Commission
September, 2011
The views expressed in this paper are those of the authors and should not be attributed to the European Commission.
1. Introduction There has been an intense debate about the effects of fiscal measures in the recent
financial crisis.
The Debate concentrates on the effects government purchases and transfers to
households, and of tax cuts (see, e.g., Coenen et al. (2010), Corsetti et al. (2010)
and Drautzburg and Uhlig (2010)).
However, a key dimension of the fiscal policy response to the crisis were sizable
government interventions in the banking system, in the form of bank asset
purchases, loan guarantees and bank recapitalization.
As documented below, these ‘unconventional’ fiscal interventions were actually larger
than the changes in standard fiscal instruments enacted during the crisis.
Surprisingly, the macro-economic effects of these unconventional fiscal measures
directed at the financial sector have, so far, received little attention in the literature.
This paper seeks to fill this gap, by analyzing the effect of state-aid to banks, using
the Commission's macroeconomic model QUEST III augmented by a financial sector.
Our Approach:
We make a simple extension of a standard DSGE model by distinguishing between
three types of households
1 Risk averse savers (deposits, government bonds)
2 Less risk averse savers (equity of banks and non financial firms)
3 (Mortgage) Debtors
Losses originate from debtor households and are borne by equity owners.
Government intervention may be helpful in spreading risks across all households
Other Approaches: There are other models which emphasise moral hazard (Gertler and Karadi (2010)), adverse selection (Ikeda (2011)), asymmetric information and monitoring costs (Hirakata et al. (2009))
Also Angeloni and Faia (2010) have build a Diamond/Rajan (2000) banking model
into a DSGE model and have used it for analysing alternative fiscal and monetary
policies
Krishnamurthy (2009) provides an overview of the various models.
He makes a distinction between two alternative amplification channels, namely via
balance sheet effect and via uncertainty (as emphasised by Caballero (2009) or
Bean (2010)).
Standard fiscal measures
US: American Recovery and Reinvestment Act (ARRA) – about 2% of GDP ,
EU: European Economic Recovery Plan (EERP)- about 0.8% of GDP
Table 1: Conventional fiscal stimulus measures (as % of GDP) US EU 2009 2010 2009 2010 Total fiscal stimulus 1.98 1.77 0.83 0.73 of which Government expenditure 0.67 0.80 0.30 0.15 Transfers 0.64 0.20 0.24 0.09 Tax reductions 0.67 0.77 0.29 0.49 Source: Coenen et al (2010).
1. Standard fiscal measures and bank rescue measures
Government support to banking sector
(1) recapitalisation
(2) guarantees on banks' liabilities
(3) purchases of toxic or impaired assets, "bad banks".
Recapitalisations and asset purchases combined amounted to roughly 5% of EU GDP
in total over the crisis.
Liability guarantees were much larger almost 8% at its peak.
Table 2: State aid for financial sector (as % of GDP)
Feb-09 May-09 Aug-09 Dec-09 Oct-10 Dec-10 Apr-11 IAR 0.43 0.45 0.75 2.84 2.15 2.00 1.94 Recap 1.09 1.45 1.67 1.88 2.17 2.21 2.11 Guarantees 6.56 7.30 7.95 7.79 5.80 5.61 5.07 Total 8.08 9.19 10.38 12.51 10.12 9.82 9.12
Source: Commission services (survey based)
3. The Model
2 Regions, the EU and the RoW.
Standard DSGE Model with:
Three types of households: savers, investors/equity holders and debtors.
Corporate sector consists of banks and non financial firms.
3.1 Corporate Sector
3.1.1 Non Financial Corporate Sector
Production function with capital tK and labour tN
(1) Y
tttt ZNKY
1
, .
Dividends
(2) tItttt
NFt JpNwYdiv )(
Max problem:
(3)
10
0 0
100
)1(
)1(
tJttt
tt
NFjt
t
t
j
Ejt
NF
KZJKE
divrEVMax
3.1.2 The banking sector
(2)
))())((
)()1()(
)()1(
))(1(())((
2
11111
111
11111
BGjt
BPjtjt
Gjtjtjt
jtGtjtjt
Djt
Gjtjtjt
Gjtjt
Pjtjt
Ajt
Gjt
Gjtjt
Ljtt
BGjt
BPjt
Bjtt
SSqLLD
DLLDrLLguar
LLdefLdefrtox
LLrESSdivE
Government bailout policies:
Recapitalisation measures take the form of a purchase of newly issued bank shares
at the current market price ( 0 Gtt Sq ).
Government purchases of toxic assets consists of purchasing loans ( GjtL ) and taking
over loan losses at rate Gjtrtox
Guarantees on loans at rate jtguar provide insurance to the banking system.
Max problem:
(3) jt
Bjt
t
t
j
Ejt
B SdivrEVMax
1
0 0
100 )1(
.
From these FOCs we obtain the following loan interest rate rule (5) D
tE
tL
t rrr 1)1(
3.2.1 Savers
(8)
10
0
,1
,
00
0,
11
11,
0
000
)1(
)1(
)1(
)1(
),,,(
tLandt
Landtt
ts
t
st
st
sHt
HsHt
st
ts
t
st
st
ts
tsH
tHt
Landt
Lt
stt
st
Dt
stt
sst
Constrt
sHt
Ht
st
Cttss
t
t
st
st
st
sst
stss
LandgJLand
HJH
TJpJpNwDr
BrDBJJpCp
DHNsCUVMax
t
Savers have preferences over consumption, labour, housing and deposits (liquidity
service.)
Savers supply banking system with deposits.
3.2.2 Debtors
1) Higher rate of time preference ( sc )
2) Collateral constraint on their borrowing tL .
3) Banks impose a loan to value ratio tcc
t z .
Max problem
(13)
ct
Ht
ct
Lt
tct
ct
ct
HcHt
ct
tc
t
ct
ct
t
ct
cttt
At
Ltt
cHt
Ht
ct
Ct
tcct
t
ct
ct
ct
ctcc
HpLrE
HJH
TNwLdefrLJpCp
HNCUVMax
t
)1(
)1(
))1(
),1,(
,0
1,
00
01
,0
000
3.2.3 Equity owners
et
ct
NFt
NFt
BPt
Bt
Bt
BPt
Bt
tet
et
e
t
teE CpdivqSqdivSqECUEVMax )1()()( 111,
00
,00
(Inverse of the) stochastic discount factor for corporate investment
(17) )1(11,
, Etec
te
tC
ct
etC
t rpU
pUE
Note: Dividends are not exogenous to the equity owners. Corporate sector makes
decisions in order to optimise the dividend stream. However, optimisation is
constrained by capital adjustment costs (NFF) and capital requirements (Banks).
3.5 Fiscal Policy
Standard, except for income and expenditures related to bank rescue measures.
Gt
Lt
Gttt
Gt
Bt
Gt
Gtttttt LrSdivTSqDEFLGUARGBrB 11111 )1(
4. Calibration
For the non-financial sector we use parameter estimates from Ratto et al. (2009) and
In 't Veld et al. (2011) for the Euro area and the US respectively.
Skewed wealth distribution:
10% equity owners, savers and debtors represent 45% of the population.
Luxembourg Wealth Study: top 10% of the population in the EU own roughly 50% of
total net worth (financial assets + dwellings + consumer durables - liabilities)
The equity owners in the model own roughly 65% of total net worth. (Note: we do not
consider consumer durables).
Individual household types have different rates of time preference and risk aversion
parameters:
Savers and equity owners have the same discount factor of 0.99 but differ in their
degree of risk aversion.
Savers have a 1h , while equity owners are slightly less risk averse ( 75.h ).
Debtors have a higher discount factor ( 75.0c ) but log utility like savers.
5. Simulations
5.1 Baseline (no government intervention scenario)
1) Risk Premium Shock on housing investment: bursting of the housing bubble.
2) Tightening of lending conditions.
3) Default Shock on matured loans.
EU: EUR 500bn, (around 4% of EU GDP).
RoW EUR 900bn, (around 2.5% of GDP).
4) Panic: perceived losses (1 year ahead)
Table 4: Crisis scenario : no government intervention 2008 2009 2010 2011 2012 2020 GDP -2.3 -8.17 -6.89 -3.9 -3.04 -4.89 Consumption -1.91 -4.9 -4.44 -3.18 -3.28 -6.18 Corp. investment -12.96 -48.82 -38.21 -15.39 -4.93 -2.55 Res. Investment -3.22 -9.12 -9.54 -10.03 -10.45 -9.53 Real wages -0.76 -4.23 -5.05 -3.74 -2.28 -0.23 Employment -1.85 -6.8 -5.15 -2.17 -1.35 -3.71 Value of banks -34.88 -61.62 -39.3 -21.28 -14.45 -12.09 Real interest rate (5y) (bps) 286.32 378.88 312.9 77.6 7.1 -17.78 Labour income tax (pp) 0.19 1.55 2.67 3.15 3.47 7.25 Gov. debt (% of GDP) 2.12 10.76 13.36 12.3 12.33 22.15
Note: % deviations from baseline values, or basispoints (bps). Table 3 : Stylised facts: EU27 2008 2009 2010 GDP growth 0.5 -4.2 1.8 Consumption growth 0.7 -1.7 0.8 Corp.investment growth 2.3 -20.0 4.3 Res. investment growth 1.2 -9.3 -5.2 Employment growth Debt/GDP
0.9 62.3
-1.9 74.4
-0.5 80.2
5.2 Bank rescue measures Asset purchases Governments buy assets (loans) from banks and take over a share of losses associated
with these loans.
By partially taking over bank losses, the government can effectively smoothen the
dividend stream of corporate banks, provide more consumption smoothing and
consequently a smaller increase in the equity premium.
In contrast to standard fiscal measures, which tend to crowd out private investment, these
state aid measures support corporate investment.
In terms of effectiveness, the fiscal multiplier of state support in the form of asset
purchases is positive but well below one. Total asset purchases amounting to roughly
2.8% of GDP boost GDP by around 1%.
Table 6: Government intervention: asset purchases
2008 2009 2010 2011 2012 2020 GDP 0.27 0.97 0.43 -0.36 -0.31 0.03 Consumption 0.26 0.6 0.31 -0.19 -0.14 0.15 Corp. investment 2.44 12.29 5.83 -1.16 -1.33 -0.23 Res. Investment 0.06 0.11 0.11 -0.01 -0.09 0.05 Real wages 0.11 0.68 0.81 0.46 0.19 0.04 Employment 0.21 0.73 0.16 -0.53 -0.47 -0.02 Value of banks 8.9 11.47 2.38 -1.17 -0.54 0.22 Real interest rate (5y) (bps) -38.33 -63.06 -36.64 12.05 9.7 1.3 Labour income tax (pp) -0.02 0.56 0.86 0.7 0.55 0.01 Gov. debt (% of GDP) -0.24 1.35 2.69 2.55 1.89 -0.35
Note: % difference from no-intervention
Recapitalisations
Government recapitalisation measures have similar effects compared to asset
purchases (Table 7).
Both measures have different distributional consequences:
The fiscal costs of asset purchases will be shared equally across all household types,
while the purchase of bank stock and the subsequent sale shifts the burden of the
fiscal costs more onto equity owners and increases the equity premium and reduces
investment.
In terms of effectiveness, a "stimulus" in the form of recapitalisations of around 2.2 %
of GDP at its peak, give a positive GDP effect of 1.7%.
Table 7: Government intervention: recapitalisations
2008 2009 2010 2011 2012 2020 GDP 0.49 1.7 0.45 -0.13 -0.08 0.24 Consumption 0.33 1.01 0.4 0.05 0.13 0.31 Corp. investment 3.33 14.23 3.01 -1.79 -1.99 -0.01 Res. Investment 0.19 0.9 1.03 0.78 0.67 0.12 Real wages 0.13 0.66 0.61 0.25 0.03 -0.09 Employment 0.4 1.38 0.27 -0.28 -0.2 0.24 Value of banks 1.64 3.49 0.56 -0.53 -0.42 0.11 Real interest rate (5y) (bps) -60.76 -89.58 -20.01 12.31 11.52 2.42 Labour income tax (pp) -0.03 0.1 0.17 0.13 0.03 -0.4 Gov. debt (% of GDP) -0.41 -0.79 0.31 0.57 0.18 -1.34
Note: % difference from no-intervention
Conventional fiscal stimulus measures
Table 5 Fiscal multipliers of conventional stimulus measures EU
Without
collateral constraint
s.
With
collateral constraint
s .
With collateral constraint
s and
monetary accommo
-dation government purchases 0.78 0.81 1.03
general transfers 0.20 0.41 0.53
transfers targetted to collateral-constrained hh.
- 0.67 0.86
labour tax 0.22 0.44 0.55
Source: Roeger and in 't Veld (2010)
Government guarantees:
We restrict ourselves to analysing the effect of government guarantees in a
segmented financial market.
Essentially the value added of government guarantees in such an environment
consists of redistributing losses from a fraction of households (shareholders,
households owning risky assets) to all households (and thereby effectively removing
the market segmentation).
This has a macroeconomic benefit in terms of reducing the increase of the bond rate,
but it has also costs because the government support has to be financed by
distortionary taxes.
Given that EU governments have guaranteed bonds in the order of magnitude of 8%
of GDP, we create a default scenario where the financial sector expects loan losses
to accumulate to 8% of GDP
We compare two extreme cases.
1) No government guarantees are given,
2) Government guarantees to take over all future losses.
As can be seen from these tables, the government guarantees can prevent economic
activity from collapsing in the first two years.
However, these guarantees also have negative effects as higher labour taxes have a
negative impact on employment and corporate investment in the medium term.
Table 8: No Government Guarantees 2009 2010 2011 2012 2020 GDP -6.93 -3.46 -0.68 -0.84 -1.2 Consumption -6.25 -2.93 -0.73 -1.09 -1.5 Corp. investment -31.56 -15.96 -1.8 -0.61 -1.26 Res. Investment -2.16 -2.27 -1.16 -0.98 -0.78 Real wages -1.83 -2.58 -1.34 -0.58 -0.32 Employment -5.55 -2.73 -0.01 -0.14 -0.62 Value of banks -31.31 -8.28 -1.18 -1.43 -1.61 Real interest rate (5y) (bps) 503.62 144.2 -22.74 -5.69 2.38 Labour income tax (pp) 0.71 1.38 1.29 1.23 1.53 Gov. debt (% of GDP) 6.95 6.6 4.25 3.99 4.1
Note: % difference from no-defaults baseline
Table 9.: Defaults with government guarantees 2009 2010 2011 2012 2020 GDP -0.35 -0.7 -0.8 -0.82 -0.7 Consumption -0.46 -0.85 -0.94 -0.96 -0.85 Corp. investment -0.5 -1.11 -1.34 -1.36 -0.97 Res. Investment -0.2 -0.53 -0.6 -0.58 -0.37 Real wages 0.14 0.3 0.33 0.29 0.01 Employment -0.37 -0.73 -0.83 -0.83 -0.56 Value of banks -0.81 -0.97 -1.02 -1.02 -0.9 Real interest rate (5y) (bps) -4.07 0.32 2.14 2.33 1.98 Labour income tax (pp) 1.01 1.97 2.05 1.99 1.35 Gov. debt (% of GDP) 3.56 6.83 6.96 6.54 3.01
Note: % deviation from no default baseline As can be seen from these tables, the government guarantees can prevent economic
activity from collapsing in the first two years.
However, these guarantees also have negative effects as higher labour taxes have a
negative impact on employment and corporate investment in the medium term.
6. Conclusions
This paper has assessed the cost and benefits of state aid to the financial system in
an economy which is hit by a severe financial shock and is subject to financial market
imperfections.
Our analysis has shown that state interventions can stabilise the economy.
Multipliers are lower than those for government consumption, but generally larger
than those for transfers to households.
State support to the banking sector has helped to stabilise corporate investment,
which is the component of aggregate demand most severely affected from the
financial shock when there are financial frictions.
This feature also distinguishes state aid from conventional fiscal interventions (like an
increase in government spending or transfers), which primarily target non-investment
demand categories and rather crowd out private capital formation.
While asset purchases and recapitalisations are effective in the case of actual losses,
government guarantees play an important role in stabilising pessimistic financial
markets driven by excessively strong loss expectations.