Bubbles, Crashes & the Financial Cycle Sander van der Hoog and - - PowerPoint PPT Presentation

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Bubbles, Crashes & the Financial Cycle Sander van der Hoog and - - PowerPoint PPT Presentation

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Bubbles, Crashes & the Financial Cycle Sander van der Hoog and Herbert Dawid Chair for Economic Theory and Computational Economics Bielefeld University SCE@20 in Oslo, June 2014 www.uni-bielefeld.de Introduction Outline Eurace@Unibi Model

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www.uni-bielefeld.de

Sander van der Hoog and Herbert Dawid Chair for Economic Theory and Computational Economics Bielefeld University SCE@20 in Oslo, June 2014

Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Outline The Business & Financial Cycle Financial Instability Hypothesis Balance sheets

Outline of topics

◮ Agent-based Macroeconomics ◮ Leverage cycle – Geanakoplos ◮ Financial Instability Hypothesis – Minsky ◮ Basel III and the procyclicality of capital adequacy requirements ◮ Macro-prudential banking regulation

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Outline The Business & Financial Cycle Financial Instability Hypothesis Balance sheets

The Business & Financial Cycle

1976-80 US real-estate boom 1980 DIMCA 2011: End of Regulation Q 1989: S&L Crisis 1980: Depository Institutions Deregulation and Monetary Control Act: Deregulation of Savings and Loans institutions 2011: Regulation Q: prohibition of interest-bearing demand deposit accounts Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Outline The Business & Financial Cycle Financial Instability Hypothesis Balance sheets

Financial Instability Hypothesis

◮ Equity/Asset-ratio: Measure for financial robustness ◮ Fragility synchronized with business cycle? (Fragile booms, deleveraging

recovery)

Output and E/A ratio

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Outline The Business & Financial Cycle Financial Instability Hypothesis Balance sheets

Empirical Motivations

Features of macroeconomics with a financial cycle (Borio, 2012):

◮ the financial boom should not just precede the bust but cause it (`

a la Minsky).

◮ the presence of debt and capital stock overhangs (excess stocks,

non-full utilization rates). Findings:

◮ Recessions following a crisis after a fragile boom tend to have much

larger declines in consumption, investment, output, and employment. (Shularick & Taylor, 2012)

◮ Balance sheet recessions: Recessions driven by deleveraging lead to a

prolonged slump. (Koo, 2011)

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Outline The Business & Financial Cycle Financial Instability Hypothesis Balance sheets

Balance sheets

Firm Assets Liabilities Liquidity + revenues – wage bill – taxes – dividends + interest deposits – interest on loans Loans from banks + new loans + new loans – bad debt Inventory + output – sales Capital stock Equity + investment + profits + bad debt Bank Assets Liabilities CB reserves (−0.1%) Deposits – interest deposits +/– withdrawals + interest on loans + new loans – taxes – dividends +/– CB reserves Loans to firms CB debt (+0.15%) + new loans +/– CB reserves – bad debt +/– interest Equity + profits – bad debt

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Activity Role Agent Agent Role Activity

E u r a c e @ U n i b i

B a n k I n v G

  • d

F i r m Household

asset demand savings decision Financial Market

(index bond)

E C B

Monetary policy

G

  • v

Policy maker I n v e s t

  • r

ConsGoodFirm

Consumer C

  • n

s . G

  • d

s M a r k e t

( l

  • c

a l m a l l s )

cgood demand consumption choice P r

  • d

u c e r cgood supply posted prices labor supply reservation wage Employee labor demand wage schedule Labor Market

(search & matching)

Creditor D e b t

  • r

credit supply rank credit risk credit demand rank interest C r e d i t M a r k e t

( c r e d i t r a t i

  • n

i n g )

Employer I n v e s t

  • r

Producer C a p i t a l G

  • d

s M a r k e t igood supply vintage menu posted prices i g

  • d

d e m a n d v i n t a g e c h

  • i

c e s

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Monetary Policy & Banking Regulation Capital Adequacy Requirement Reserve Requirement

Literature: The Credit Channel of Monetary Policy Transmission

  • 1. The broad borrowers’ balance sheet channel:

(Bernanke & Blinder 1988)

◮ Credit demand side ◮ Focusses on external finance premium: probability of default

External finance premium: inversely related to borrower’s net worth.

◮ Changes in the value of assets on the balance sheet of a firm affect the

firm’s ability to borrow.

  • 2. The narrow bank lending channel:

(Bernanke & Gertler 1995)

◮ Supply of bank loans determined by financial health of banks. ◮ Changes in the value of assets on the balance sheet of a bank affects the

bank’s ability to lend.

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Monetary Policy & Banking Regulation Capital Adequacy Requirement Reserve Requirement

Capital Adequacy Requirement

  • 1. Firm’s default probability

PDf

t = max{0.03, 1 − e−νDf

t /Ef t }, ν = 0.1

  • 2. Interest rate offered by bank b to firm i

r bf

t

= r ECB 1 + λB · PDf

t + ǫb t

  • , ǫb

t ∼ U[0, 1]

r ECB = 0.01 λB = 3: penalty rate for high-risk firm, uniform across banks ǫb

t : bank’s ideosyncratic operating costs

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Monetary Policy & Banking Regulation Capital Adequacy Requirement Reserve Requirement

Capital Adequacy Requirement

  • 1. Risk-exposure of credit request (Expected Loss at Default):

xf

t = PDf t · Lf t

(1)

  • 2. Constraint: Capital Adequacy Requirement (CAR)
  • f

xf

t ≡ X b t ≤ αEb t ,

α ≥ 0 (2)

  • 3. Risk-exposure ”budget” of the bank:

V b

t ≡ αEb t − X b t

(3)

  • 4. Loan granted:

ℓf

t =

   Lf

t

if xf

t ≤ V b t

No rationing θ · Lf

t = V b t /PDf t

if 0 ≤ V b

t ≤ xf t

Partial rationing if V b

t ≤ 0

Full rationing (4) Possibility of credit rationing: {θ : V b

t − PDf t · ℓf t = 0} → θLf t = V b t /PDf t

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Monetary Policy & Banking Regulation Capital Adequacy Requirement Reserve Requirement

Reserve Requirement

◮ Constraint: Reserve Requirement

Mb

t ≥ β · Depb t

(5)

◮ Excess liquidity ”budget” of the bank:

W b

t ≡ Mb t − β · Depb t

(6)

◮ Loan granted:

ℓbf

t

=    Lf

t

if W b

t ≥ Lf t

No rationing φ · Lf

t = W b t

if 0 ≤ W b

t ≤ Lf t

Partial rationing if W b

t < 0

Full rationing (7) Possibility of credit rationing: {φ : W b

t − φ · Lf t = 0} → φ = W b t /Lf t ◮ Illiquid banks stop lending to all firms (bank lending channel) ◮ Risky firms cannot get loans (borrower’s balance sheet channel)

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Amplitude of recessions Firm activity Bank activity

Parameter sensitivity analysis

200 400 600 800 1000 2000 3000 4000 5000 Months Eurostat_output alfa_20_gamma 1.0 2.0 4.0 8.0 16.0 32.0

α-sensitivity: Cap. Adq. Req.

◮ Default: α = 32 (3%) ◮ Lower: amplitude of recessions

increases

200 400 600 800 1000 2000 3000 4000 5000 Months Eurostat_output beta_20_gamma_10_alfa 0.01 0.02 0.05 0.10 0.20 0.50

β-sensitivity: Reserve Req.

◮ Default: β = 0.05 (5%) ◮ Higher: amplitude of recessions

decreases

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Amplitude of recessions Firm activity Bank activity

Parameter sensitivity analysis

  • −8000

−6000 −4000 −2000 Parameters batch_full_amplitude_recession 1.0 2.0 4.0 8.0 16.0 32.0 −8000 −6000 −4000 −2000

α-sensitivity: Cap. Adq. Req.

◮ Default: α = 32 (3%) ◮ Lower: amplitude of recessions

increases

  • −7000

−6000 −5000 −4000 −3000 −2000 −1000 Parameters batch_full_amplitude_recession 0.01 0.02 0.05 0.10 0.20 0.50 −7000 −6000 −5000 −4000 −3000 −2000 −1000

β-sensitivity: Reserve Req.

◮ Default: β = 0.05 (5%) ◮ Higher: amplitude of recessions

decreases

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Amplitude of recessions Firm activity Bank activity

Firm activity

Number of illiquid firms

No constraint

100 200 300 400 500 5 10 15 20 Months Firm_insolvency_SL Firm_insolvency_S Firm_insolvency_L Firm_illiquidity_S Firm_illiquidity_L

Capital constraint (α = 2)

100 200 300 400 500 5 10 15 20 Months Firm_insolvency_SL Firm_insolvency_S Firm_insolvency_L Firm_illiquidity_S Firm_illiquidity_L

Liquidity constraint (β = 0.50)

100 200 300 400 500 5 10 15 20 Months Firm_insolvency_SL Firm_insolvency_S Firm_insolvency_L Firm_illiquidity_S Firm_illiquidity_L

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook Amplitude of recessions Firm activity Bank activity

Bank activity

Number of active banks (unconstrained + constrained by equity/liquidity constraint)

No constraint

100 200 300 400 500 5 10 15 20 Months Bank_active_multi Bank_active_none Bank_active_exposure Bank_active_liquidity

Capital constraint (α = 2)

100 200 300 400 500 5 10 15 20 Months Bank_active_multi Bank_active_none Bank_active_exposure Bank_active_liquidity

Liquidity constraint (β = 0.5)

100 200 300 400 500 5 10 15 20 Months Bank_active_multi Bank_active_none Bank_active_exposure Bank_active_liquidity

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook

Summary

Capital Adequacy Requirement (α)

  • 1. More limits on excessive risk-taking
  • 2. Amplitude recessions increases
  • 3. More banks fail
  • 4. More firms go illiquid

◮ constraint does not discriminate ◮ constraint self-reinforcing

  • 5. Steep, sudden deleveraging
  • 6. Concentration in banking sector

Reserve Requirement (β)

  • 1. More limits on liquidity supply
  • 2. Amplitude recessions decreases
  • 3. Banks stay alive
  • 4. Large firms go illiquid

◮ large firms largest credit demand ◮ liq. constraint helps small firms

  • 5. Gradual deleveraging in waves
  • 6. Bank equity can recover

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook

Outlook

◮ Macroprudential regulation

◮ Systemic risk ◮ Bank-firm networks

◮ Empirically-grounded bank behavior

◮ Credit quotas ◮ Credit rationing of SMEs Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Thank you for your attention! Model documentation:

www.wiwi.uni-bielefeld.de/vpl1/research/eurace-unibi.html

Papers:

◮ H Dawid, S Gemkow, P Harting, S van der Hoog & M Neugart (2014):

Agent-Based Macroeconomic Modeling and Policy Analysis: The Eurace@Unibi

  • Model. In: S-H Chen, M Kaboudan (Eds), Handbook on Computational

Economics and Finance. Oxford University Press.

◮ H Dawid, S Gemkow, P Harting, S van der Hoog & M Neugart (2012):

The Eurace@Unibi Model: An Agent-Based Macroeconomic Model for Economic Policy Analysis. Working Paper University Bielefeld.

◮ H Dawid, S Gemkow, P Harting, S van der Hoog & M Neugart (2011):

Eurace@Unibi Model v1.0 User Manual. Working Paper Bielefeld University.

◮ H Dawid & P Harting (2012): Capturing Firm Behavior in Agent-Based Models of

Industry Evolution and Macroeconomic Dynamics, in: G. B¨ unstorf (Ed), Applied Evolutionary Economics, Behavior and Organizations. Edward Elgar, pp. 103-130.

◮ H Dawid & M Neugart (2011): Agent-based Models for Economic Policy Design,

Eastern Economic Journal 37, 44-50.

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Scenario: Capital Adequacy Requirement

Output

100 200 300 400 500 1500 2000 2500 3000 Months Eurostat_output alfa 2.0 8.0

Bank activity

100 200 300 400 500 5 10 15 20 Months Bank_active_multi Bank_active_none Bank_active_exposure Bank_active_liquidity

Firm activity

100 200 300 400 500 5 10 15 20 Months Firm_insolvency_SL Firm_insolvency_S Firm_insolvency_L Firm_illiquidity_S Firm_illiquidity_L 100 200 300 400 500 5000 10000 15000 20000 Months Bank_equity alfa 2.0 8.0

Bank equity

100 200 300 400 500 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 Months F_EARatio alfa 2.0 8.0

Firm fragility

100 200 300 400 500 0.040 0.045 0.050 0.055 0.060 0.065 0.070 Months Firm_mean_interest alfa 2.0 8.0

Mean interest

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Scenario: Minimum Reserve Requirement

Output

100 200 300 400 500 2000 2200 2400 2600 2800 Months Eurostat_output min_cash_reserve_ratio 0.10 0.50

Bank activity

100 200 300 400 500 5 10 15 20 Months Bank_active_multi Bank_active_none Bank_active_exposure Bank_active_liquidity

Firm activity

100 200 300 400 500 5 10 15 20 Months Firm_insolvency_SL Firm_insolvency_S Firm_insolvency_L Firm_illiquidity_S Firm_illiquidity_L 100 200 300 400 500 5000 10000 15000 20000 Months Bank_equity min_cash_reserve_ratio 0.10 0.50

Bank equity

100 200 300 400 500 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Months F_EARatio min_cash_reserve_ratio 0.10 0.50

Firm fragility

100 200 300 400 500 0.045 0.050 0.055 0.060 0.065 0.070 Months Firm_mean_interest min_cash_reserve_ratio 0.10 0.50

Mean interest

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook

Scenarios: Firm Fragility

Firm E/A-ratio

Capital constraint

100 200 300 400 500 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 Months F_EARatio alfa 2.0 8.0

Liquidity constraint

100 200 300 400 500 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Months F_EARatio min_cash_reserve_ratio 0.10 0.50

Liquidity constraint

100 200 300 400 500 0.045 0.050 0.055 0.060 0.065 0.070 Months Firm_mean_interest min_cash_reserve_ratio 0.10 0.50

Sander van der Hoog Bubbles, Crashes & the Financial Cycle

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Introduction Eurace@Unibi Model Simulation Results Summary & Outlook

Literature

◮ Hyman P

. Minsky (1982): The Financial Instability Hypothesis: Capitalistic Processes and the Behavior of the Economy

◮ Hyman P

. Minsky (1986, 2008): Stabilizing an Unstable Economy

◮ Delli Gatti, Desiderio, Gaffeo, Cirillo & Gallegati, 2010: Macroeconomics

from the Bottom-Up

◮ Dosi, Fagiolo, Napoletano & Roventini, 2012: Income distribution, credit

and fiscal policies in an agent-based keynesian model. LEM Papers Series 2012/03,

◮ Ashraf, Gershman & Howitt, 2011: Banks, Market Organization, and

Macroeconomic Performance: An Agent-Based Computational Analysis

◮ Schularick & Taylor, 2012: Credit booms gone bust: Monetary policy,

leverage cycles, and financial crises, American Economic Review 102 (2), 1029-61.

◮ Claessens, Kose & Terrones, 2011: How do business and financial

cycles interact?

Sander van der Hoog Bubbles, Crashes & the Financial Cycle