the i theory of money - woodrow wilson school of public...
TRANSCRIPT
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The I Theory of Money
Markus K. Brunnermeier & Yuliy Sannikov
Princeton University
CSEF-IGIER Symposium Capri, June 24th, 2015
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Motivation
Framework to study monetary and financial stability
Interaction between monetary and macroprudential policy
Connect theory of value and theory of money
Intermediation (credit)β’ βExcessiveβ leverage and liquidity mismatch
Inside money β as store of valueβ’ Demand for money rises with endogenous volatilityβ’ In downturns, intermediaries create less inside money
Endogenous money multiplier = f(capitalization of critical sector)
β’ Value of money goes up β Disinflation spiral a la Fisher (1933)β’ Fire-sales of assets β Liquidity spiral
Flight to safety
Time-varying risk premium and endogenous volatility dynamics
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Some literature
Macro-friction models without moneyβ’ Kiyotaki & Moore, BruSan2014, He & Krishnamurthy, DSS2015
βMoney modelsβ without intermediariesβ’ Money pays no dividend and is a bubble β store of value
With intermediaries/inside moneyβ’ βMoney viewβ (Friedman & Schwartz) vs. βCredit viewβ(Tobin)
New Keynesian Models: BGG, Christian et al., β¦ money in utility function
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Some literature
Macro-friction models without moneyβ’ Kiyotaki & Moore, BruSan2014, He & Krishnamurthy, DSS2015
βMoney modelsβ without intermediariesβ’ Store of value: Money pays no dividend and is a bubble
With intermediaries/inside moneyβ’ βMoney viewβ (Friedman & Schwartz) vs. βCredit viewβ(Tobin)
New Keynesian Models: BGG, Christian et al., β¦ money in utility function
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Some literature
Macro-friction models without moneyβ’ Kiyotaki & Moore, BruSan2014, He & Krishnamurthy, DSS2015
βMoney modelsβ without intermediariesβ’ Store of value: Money pays no dividend and is a bubble
With intermediaries/inside moneyβ’ βMoney viewβ (Friedman & Schwartz) vs. βCredit viewβ(Tobin)
New Keynesian Models: BGG, Christian et al., β¦ money in utility function
Friction OLG
deterministic endowment riskborrowing constraint
Only money Samuelson
With capital Diamond
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Some literature
Macro-friction models without moneyβ’ Kiyotaki & Moore, BruSan2014, He & Krishnamurthy, DSS2015
βMoney modelsβ without intermediariesβ’ Store of value: Money pays no dividend and is a bubble
With intermediaries/inside moneyβ’ βMoney viewβ (Friedman & Schwartz) vs. βCredit viewβ(Tobin)
New Keynesian Models: BGG, Christian et al., β¦ money in utility function
Friction OLG Incomplete Markets + idiosyncratic risk
Risk deterministic endowment riskborrowing constraint
Only money Samuelson Bewley
With capital Diamond Ayagari, Krusell-Smith
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Some literature
Macro-friction models without moneyβ’ Kiyotaki & Moore, BruSan2014, He & Krishnamurthy, DSS2015
βMoney modelsβ without intermediariesβ’ Store of value: Money pays no dividend and is a bubble
With intermediaries/inside moneyβ’ βMoney viewβ (Friedman & Schwartz) vs. βCredit viewβ(Tobin)
New Keynesian Models: BGG, Christian et al., β¦ money in utility function
Friction OLG Incomplete Markets + idiosyncratic risk
Risk deterministic endowment riskborrowing constraint
investment risk
Only money Samuelson Bewley
With capital Diamond Ayagari, Krusell-Smith Basic βI Theoryβ
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Some literature
Macro-friction models without moneyβ’ Kiyotaki & Moore, BruSan2014, He & Krishnamurthy, DSS2015
βMoney modelsβ without intermediariesβ’ Store of value: Money pays no dividend and is a bubble
With intermediaries/inside moneyβ’ βMoney viewβ (Friedman & Schwartz) vs. βCredit viewβ(Tobin)
New Keynesian Models: BGG, Christian et al., β¦ money in utility function
Friction OLG Incomplete Markets + idiosyncratic risk
Risk deterministic endowment riskborrowing constraint
investment risk
Only money Samuelson Bewley
With capital Diamond Ayagari, Krusell-Smith Basic βI Theoryβ
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Some literature
Macro-friction models without moneyβ’ Kiyotaki & Moore, BruSan2014, He & Krishnamurthy, DSS2015
βMoney modelsβ without intermediariesβ’ Store of value: Money pays no dividend and is a bubble
With intermediaries/inside moneyβ’ βMoney viewβ (Friedman & Schwartz) vs. βCredit viewβ(Tobin)
New Keynesian Models: BGG, Christian et al., β¦ money in utility function
Friction OLG Incomplete Markets + idiosyncratic risk
Risk deterministic endowment riskborrowing constraint
investment risk
Only money Samuelson Bewley
With capital Diamond Ayagari, Krusell-Smith Basic βI Theoryβ
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Roadmap
Model absent monetary policyβ’ Toy model: one sector with outside money
β’ Two sector model
β’ Adding intermediary sector and inside money
Model with monetary policy
Model with macro-prudential policy
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One sector basic model
π΄1
Technologies π
Each households can only operate one firmβ’ Physical capital
β’ Output
Demand for money
sector idiosyncratic risk
π¦π‘ = π΄ππ‘
πππ‘ππ‘= (Ξ¦ ππ‘ β πΏ)ππ‘ + π
ππππ‘π + ππ ππ‘
π
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Adding outside money Technologies π
Each households can only operate one firmβ’ Physical capital
β’ Output
Demand for money
πππ‘ππ‘= (Ξ¦ ππ‘ β πΏ)ππ‘ + π
ππππ‘π + ππ ππ‘
π
sector idiosyncratic risk
A LA L
A LA L
π΄1
Money
Net
wo
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Outside Money
π¦π‘ = π΄ππ‘
ππ‘πΎπ‘ value of physical capitalβ’ Postulate constant ππ‘
π΄βπ
πππ‘ + Ξ¦(π β πΏ) ππ‘ + πππππ‘
π + ππ ππ‘π
ππ‘πΎπ‘ value of outside moneyβ’ Postulate value of money changes proportional to πΎπ‘
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Adding outside money Technologies π
Each households can only operate one firmβ’ Physical capital
β’ Output
Demand for money
πππ‘ππ‘= (Ξ¦ ππ‘ β πΏ)ππ‘ + π
ππππ‘π + ππ ππ‘
π
sector idiosyncratic risk
A LA L
A LA L
π΄1
Money
Net
wo
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Outside Money
ππΎπ‘ value of physical capitalβ’ πππ = π΄βπ
πππ‘ + Ξ¦(π β πΏ) ππ‘ + πππππ‘
π + ππ ππ‘π
ππΎπ‘ value of outside moneyβ’ πππ = Ξ¦(π β πΏ)
π
ππ‘ + πππππ‘π
π¦π‘ = π΄ππ‘
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Demand with πΈ 0βπβππ‘ log ππ‘ ππ‘
Technologies π
A LA L
A LA L
Money
Net
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Outside Money
ππΎπ‘ value of physical capitalβ’ πππ = π΄βπ
πππ‘ + Ξ¦(π β πΏ) ππ‘ + πππππ‘
π + ππ ππ‘π
ππΎπ‘ value of outside moneyβ’ πππ = Ξ¦(π β πΏ)
π
ππ‘ + πππππ‘π
Consumption demand:π π + π πΎπ‘ = π΄ β π πΎπ‘
Asset (share) demand π₯π:
πΈ πππ β πππ /ππ‘ = πΆππ£[πππ β πππ,
πππ‘π
ππ‘π
πππ+π₯π πππβπππ
] = π₯π π2
π₯π =πΈ πππβπππ /ππ‘
π2= (π΄βπ)/π π2= ππ+π
Investment rate: (Tobinβs q) Ξ¦β² π = 1/πβ’ For Ξ¦ π = 1
π log(π π + 1) β πβ = πβ1
π
π΄1
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Demand with log-utility Technologies π
A LA L
A LA L
Money
Net
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Outside Money
ππΎπ‘ value of physical capitalβ’ πππ = π΄βπ
πππ‘ + Ξ¦(π β πΏ) ππ‘ + πππππ‘
π + ππ ππ‘π
ππΎπ‘ value of outside moneyβ’ πππ = Ξ¦(π β πΏ)
π
ππ‘ + πππππ‘π
Consumption demand:π π + π πΎπ‘ = π΄ β π πΎπ‘
Asset (share) demand π₯π:
πΈ πππ β πππ /ππ‘ = πΆππ£[πππ β πππ,
πππ‘π
ππ‘π
πππ+π₯π πππβπππ
] = π₯π π2
π₯π =πΈ πππβπππ /ππ‘
π2= (π΄βπ)/π π2= ππ+π
Investment rate: (Tobinβs q) Ξ¦β² π = 1/πβ’ For Ξ¦ π = 1
π log(π π + 1) β πβ = πβ1
π
π΄1
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Demand with log-utility Technologies π
A LA L
A LA L
Money
Net
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Outside Money
ππΎπ‘ value of physical capitalβ’ πππ = π΄βπ
πππ‘ + Ξ¦(π β πΏ) ππ‘ + πππππ‘
π + ππ ππ‘π
ππΎπ‘ value of outside moneyβ’ πππ = Ξ¦(π β πΏ)
π
ππ‘ + πππππ‘π
Consumption demand:π π + π πΎπ‘ = π΄ β π πΎπ‘
Asset (share) demand π₯π:
πΈ πππ β πππ /ππ‘ = πΆππ£[πππ β πππ,
πππ‘π
ππ‘π
πππ+π₯π πππβπππ
] = π₯π π2
π₯π =πΈ πππβπππ /ππ‘
π2= (π΄βπ)/π π2= ππ+π
Investment rate: (Tobinβs q) Ξ¦β² π = 1/πβ’ For Ξ¦ π = 1
π log(π π + 1) β π = πβ1
π
π΄1
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Market clearing Technologies π
A LA L
A LA L
Money
Net
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Outside Money
ππΎπ‘ value of physical capitalβ’ πππ = π΄βπ
πππ‘ + Ξ¦(π β πΏ) ππ‘ + πππππ‘
π + ππ ππ‘π
ππΎπ‘ value of outside moneyβ’ πππ = Ξ¦(π β πΏ)
π
ππ‘ + πππππ‘π
Consumption demand:π π + π πΎπ‘ = π΄ β π πΎπ‘
Asset (share) demand π₯π:
πΈ πππ β πππ /ππ‘ = πΆππ£[πππ β πππ,
πππ‘π
ππ‘π
πππ+π₯π πππβπππ
] = π₯π π2
π₯π =πΈ πππβπππ /ππ‘
π2= (π΄βπ)/π π2= ππ+π
Investment rate: (Tobinβs q) Ξ¦β² π = 1/πβ’ For Ξ¦ π = 1
π log(π π + 1) β π = πβ1
π
π΄1
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Equilibrium
Moneyless equilibrium Money equilibrium
π0 = 0 π = πβ πππ
π0 =π π΄+1π π+1
π = π π΄+1π π π+1
ππ
π
π
0
π0
>
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Welfare analysis
Moneyless equilibrium Money equilibrium
π0 = 0 π = πβ πππ
π0 =π π΄+1π π+1
π = π π΄+1π π π+1
π0 π
welfare0 welfare<
>
>
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Welfare analysis
Moneyless equilibrium Money equilibrium
π0 = 0 π = πβ πππ
π0 =π π΄+1π π+1
π = π π΄+1π π π+1
welfare0 welfare
What ratio nominal to total wealth ππ+π
maximizes welfare?
β’ Force agents to hold less π & more money
β’ Raise π
π+πif and only if π(1 β π π) β€ 2 π
β’ Lowers π β higher E[πππ β πππ] = π΄βππππ‘
β’ Create π-risk to make precautionary money savings more attractive
<
pecuniary externality
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Roadmap
Model absent monetary policyβ’ Toy model: one sector with outside money
β’ Two sector model with outside money
β’ Adding intermediary sector and inside money
Model with monetary policy
Model with macro-prudential policy
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π΄1π΄1
Outline of two sector model
π΄1
π΅1
SwitchSwitch technology
Technologies π Technologies π
Households have to β’ Specialize in one subsector sector specific + idiosyncratic risk
for one period
β’ Demand for money
πππ‘ππ‘= β―ππ‘ + πππππ‘
π + ππ ππ‘π πππ‘
ππ‘= β―ππ‘ + πππππ‘
π + ππ ππ‘π
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Add outside money
Households have to β’ Specialize in one subsector
for one period
β’ Demand for money
Outside Money
A LA L
A
Money
π΅1
LN
et w
ort
h
Technologies π Technologies π
SwitchSwitch technology
A LA L
A LA L
π΄1
Money
Net
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Roadmap
Model absent monetary policyβ’ Toy model: one sector with outside money
β’ Two sector model with outside money
β’ Adding intermediary sector and inside money
Model with monetary policy
Model with macro-prudential policy
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Technologies π
β’ Risk can bepartially sold off to intermediaries
Add intermediaries
Net worth
A L
Outside Money
A LA L
A
Money
π΅1
LN
et w
ort
h
Technologies π
β’ Risk is not contractable(Plagued with moral hazard problems)
A LA L
A LA L
π΄1
Money
Net
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Technologies π
Add intermediaries
Net worth
A L
Outside Money
Intermediaries β’ Can hold outside equity
& diversify within sector πβ’ Monitoring
A LA L
A
Money
π΅1
LN
et w
ort
h
Technologies π
A LA L
A LA L
π΄1
Money
Net
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Technologies π
A L
Ris
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A LR
isky
Cla
im
Add intermediaries
β¦
Net worth
A L
Ris
ky C
laim
Ris
ky C
laim
Ris
ky C
laim
Outside Money
A L
π΅1
Money
Ris
ky C
laim
Insi
de
equ
ity
Intermediaries β’ Can hold outside equity
& diversify within sector πβ’ Monitoring
Technologies π
A LA L
A LA L
π΄1
Money
Net
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A L
Ris
ky C
laim
A LR
isky
Cla
im
Add intermediaries Technologies π
β¦
Net worth
Inside Money(deposits)
A L
Outside Money Pass through
Ris
ky C
laim
Ris
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laim
Ris
ky C
laim
Outside Money
Intermediariesβ’ Can hold outside equity
& diversify within sector πβ’ Monitoringβ’ Create inside moneyβ’ Maturity/liquidity
transformation
A L
π΅1
Money
Ris
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laim
Insi
de
equ
ity
A LA L
A LA L
π΄1
Money
HH
Net
wo
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Technologies π
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Technologies π
A L
Ris
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laim
A L
Shock impairs assets: 1st of 4 steps Technologies π
β¦
Net worth
Inside Money(deposits)
A L
Outside Money Pass through
Ris
ky C
laim
Ris
ky C
laim
Ris
ky C
laim
Losses
A L
π΄1
Money
Ris
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laim
Insi
de
equ
ity
π΅1
A LA L
A LA L
π΄1
Money
HH
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Technologies π
Shrink balance sheet: 2nd of 4 steps
A
Technologies π
Inside Money(deposits)
β¦
Net worth
Inside Money(deposits)
A L
Pass through
Losses
Deleveraging Deleveraging
β¦
Ris
ky C
laim
Ris
ky C
laim
Ris
ky C
laim
Outside Money
Switch
A L
Ris
ky C
laim
A LA L
π΄1
Money
Ris
ky C
laim
Insi
de
equ
ity
π΅1
A LA L
A LA L
π΄1
Money
HH
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Technologies π
Liquidity spiral: asset price drop: 3rd of 4 Technologies π
Switch
A L
Ris
ky C
laim
A LA L
π΄1
Money
Ris
ky C
laim
Insi
de
equ
ity
π΅1
Inside Money(deposits)
Outside Money
β¦
Net worth
Inside Money(deposits)
A L
Pass through
Ris
ky C
laim
Ris
ky C
laim
Ris
ky C
laim
Losses
Deleveraging Deleveraging
A LA L
A LA L
π΄1
Money
HH
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Technologies π Technologies π
Disinflationary spiral: 4th of 4 steps
A LA L
A LA L
π΄1
Money
HH
Net
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A L
Ris
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laim
A LA L
π΄1
Money
Ris
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laim
Insi
de
equ
ity
π΅1
Inside Money(deposits)
Outside Money
β¦
Net worth
Inside Money(deposits)
A L
Pass through
Ris
ky C
laim
Ris
ky C
laim
Ris
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laim
Losses
Deleveraging Deleveraging
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Formal model: capital & output
Model setup in paper is more general: ππ‘ = π΄ ππ‘ πΎπ‘
Technologies π π
Physical capital πΎπ‘- Capital share ππ‘ 1 β ππ‘
Output goods ππ‘π = π΄ππ‘
π ππ‘π = π΄ππ‘
π
Aggregate good (CES)- Consumed or invested- numeraire
ππ‘ =12 ππ‘π(π β1)/π
+12 ππ‘π (π β1)/π
π /(π β1)
Price of goods ππ‘π = 12
ππ‘ππ‘π
1/π
ππ‘π = 12
ππ‘ππ‘π
1/π
Imperfectsubstitutes
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Formal model: risk
When ππ‘ is employed in sector π by agent π
πππ‘ = Ξ¦ ππ‘ β πΏ ππ‘ππ‘ + ππππ‘πππ‘
π + ππππ‘π ππ‘π
β’ Ξ¦ ππ‘ is increasing and concave, e.g. log[ π ππ‘ + 1 /π ]
β’ All ππ are independent of each other
Intermediaries can diversify within sector πβ’ Face no idiosyncratic risk
Households cannot become intermediaries or vice versa
Investment rate (per unit of ππ‘)sectorial idiosyncratic independent Brownian motions(fundamental cash flow risk)
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Asset returns on money
Money: fixed supply in baseline model, total value ππ‘πΎπ‘β’ Return = capital gains (no dividend/interest in baseline model)
β’ If πππ‘/ππ‘ = ππ‘πππ‘ + ππ
ππππ,
β’ ππΎπ‘/πΎπ‘= Ξ¦ ππ‘ β πΏ ππ‘ + 1 β ππ‘ πππππ‘π + ππ‘π
ππππ‘π
(ππ‘π²)ππππ‘
πππ‘π = Ξ¦ ππ‘ β πΏ + ππ‘
π+ πππ ππππ² ππ‘ + ππ
π+ πππ² πππ
ππ‘ =ππ‘
ππ‘+ππ‘fraction of wealth in form of money
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Technologies π
A L
Ris
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laim
A LR
isky
Cla
im
Capital/risk shares Technologies π
β¦
Net worth
Inside Money(deposits)
A L
Outside Money Pass through
A L
ππ‘ππ‘πΎπ‘
Money
Ris
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laim
Insi
de
equ
ity
A LA L
A LA L
Money
HH
Net
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Οπ‘ 1 β Οπ‘
1 β Οπ‘ ππ‘ππ‘πΎπ‘
ππ‘(1 β ππ‘)ππ‘πΎπ‘
Fraction πΌπ‘ of HH
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Technologies π
A L
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A LR
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Cla
im
Capital/risk shares Technologies π
β¦
Net worth
Inside Money(deposits)
A L
Outside Money Pass through
A L
ππ‘ππ‘πΎπ‘
Money
Ris
ky C
laim
Insi
de
equ
ity
A LA L
A LA L
Money
HH
Net
wo
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Οπ‘ 1 β Οπ‘
1 β Οπ‘ ππ‘ππ‘πΎπ‘
ππ‘(1 β ππ‘)ππ‘πΎπ‘
If ππ‘ > π, inside and outside equity
earn same returns (as portfolio of b-technology and money).
If the equity constraint ππ‘ = π binds,
inside equity earns a premium Ξ»
Fraction πΌπ‘ of HH
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Allocation
Equilibrium is a map
Histories of shocks prices ππ‘ , ππ‘, ππ‘, allocationππ, 0 β€ π β€ π‘ πΌπ‘, ππ‘ & portfolio weights (π₯π‘, π₯π‘
π , π₯π‘π)
wealth distribution
ππ‘ =ππ‘
(ππ‘+ππ‘)πΎπ‘β 0,1
intermediariesβ wealth share
β’ All agents maximize utility Choose: portfolio, consumption, technology
β’ All markets clear Consumption, capital, money, outside equity of π
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Numerical example: capital shares
π = 5%,π΄ = .5, ππ = ππ = .4, ππ = .9, ππ = .6, ππ = 1.2, π = .8,
Ξ¦ π =log π π + 1
π , π = 2, π = .001
technology π HH
technology π HH
1 β
intermediaries
ππ
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Numerical example: prices
π
π
Disinflationspiral
Liquidityspiral
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Numerical example: prices
π
π
π = ππ+πDisinflation
spiral
Liquidityspiral
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Numerical example: dynamics of π
amplification
leverage elasticity
Steady state
ππ‘π=π₯π‘(ππ1π β ππ‘
πΎ)
1 β ππ‘(1βππ‘)βππβπβ² ππ/π
fundamental volatility
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Overview
No monetary economicsβ’ Fixed outside money supplyβ’ Amplification/endogenous risk through
Liquidity spiral asset side of intermediariesβ balance sheet Disinflationary spiral liability side
Monetary policyβ’ Aside: Money vs. Credit view (via helicopter drop)β’ Wealth shifts by affecting relative price between
Long-term bond Short-term money
β’ Risk transfers β reduce endogenous aggregate risk
Macroprudential policy
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Adverse shock value of risky claims drops
Monetary policy response: cut short-term interest rateβ’ Value of long-term bonds rises - βstealth recapitalizationβ
Liquidity & Deflationary Spirals are mitigated
β¦
Net worth
Inside Money(deposits)
A L
Outside Money Pass through
ππ‘
Bonds ππ‘πΎπ‘
1 β Οπ‘ ππ‘ππ‘πΎπ‘
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Effects of policy
Effect on the value of money (liquid assets) β helps agents hedge idiosyncratic risks, but distorts investment β’ We saw this in the toy model with one sector
Redistribution of aggregate risk, mitigates risk that an essential sector can become undercapitalized
Affects earnings distribution, rents that different sectors get in equilibrium
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Monetary policy and endogenous risk
Intermediariesβ risk (borrow to scale up)
ππ‘π=
π₯π‘(ππ1π β ππ‘
πΎ)
1 β πβππβπβ² ππ/π+ π(1βπ)βπ
π+ ππ1 β π
ππ‘ππ‘
βπ΅β² π
π΅(π)/π
Example: ππ‘
ππ‘
π΅β² π
π΅ π= πΌπ‘
πβ² π
π(1βπ)
Intuition: with right monetary policy bond price π΅(π) rises as π drops βstealth recapitalizationββ’ Can reduce liquidity and disinflationary spiral
fundamental risk
amplification mitigation
πΌ(π)
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Numerical example with monetary policy
Allocations Prices
Higher intermediariesβcapital share (1 β π)π
ππ Less production of good π
π is more stable
π less disinflation
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ππ‘π=
π₯π‘(ππππ β ππ‘
πΎ)
1 β πβππβπβ² ππ/π+ πβππ +
ππ 1 β π
ππ‘ππ‘
βπ΅β² ππ΅ π /π
Numerical example with monetary policy
Steady state
Less volatile
Recallππ‘ππ‘
π΅β² π
π΅ π= πΌπ‘πβ² π
π(1 β π)
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Numerical example with monetary policy
Welfare: HH and Intermediaries Sum
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Monetary policy β¦ in the limit
full risk sharing of all aggregate risk
ππ‘π=
π₯π‘
1βπβπ
π
βπβ² πππ
+π 1βπ βπ
π+π
π1βπ
ππ‘
ππ‘
βπ΅β² π
π΅(π)/π
(ππππ β ππ‘πΎ)
π is deterministic and converges over time towards 0ββ
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Monetary policy β¦ in the limit
full risk sharing of all aggregate risk
Aggregate risk sharing makes π determinisitic
Like in benchmark toy modelβ’ Excessive π-investment
β’ Too high π(pecuniary externality) Lower capital return
Endogenous risk corrects pecuniary externality
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Overview
No monetary economicsβ’ Fixed outside money supplyβ’ Amplification/endogenous risk through
Liquidity spiral asset side of intermediariesβ balance sheet Disinflationary spiral liability side
Monetary policyβ’ Wealth shifts by affecting relative price between
Long-term bond Short-term money
β’ Risk transfers β reduce endogenous aggregate risk
Macroprudential policyβ’ Directly affect portfolio positions
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MacroPru policy
Regulator can control cannot control
β’ Portfolio choice πs, π₯s β investment decision π π
β consumption decision π
of intermediaries and households
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MacroPru policy
Regulator can control cannot control
β’ Portfolio choice πs, π₯s β investment decision π π
β consumption decision π
of intermediaries and households
β’ De-facto controls π and π within some range
β’ De-factor controls wealth share π Force agents to hold certain assets and generate capital gains
In sum, regulator maximizes sum of agents value functionβ’ Choosing ππ, π, π
distorts
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MacroPru policy: Welfare frontier
Stabilize intermediaries net worth and earnings
Control the value of money to allow HH insure idiosyncratic risk (investment distortions still exists, otherwise can get 1st best
intermediary welfare-20 -15 -10 -5 0 5 10 15 20 25
ho
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elfare
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-5
0
5
10
15
20
25
30
no policy
policy that removes endogenous risk
optimal macroprudential
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Conclusion
Unified macro model to analyzeβ’ Financial stability - Liquidity spiralβ’ Monetary stability - Fisher disinflation spiral
Exogenous risk &β’ Sector specificβ’ idiosyncratic
Endogenous risk β’ Time varying risk premia β flight to safety β’ Capitalization of intermediaries is key state variable
Monetary policy ruleβ’ Risk transfer to undercapitalized critical sectorsβ’ Income/wealth effects are crucial instead of substitution effectβ’ Reduces endogenous risk β better aggregate risk sharing
Self-defeating in equilibrium β excessive idiosyncratic risk taking
Macro-prudential policiesβ’ MacroPru + MoPo to achieve superior welfare optimum