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Household Balance Sheet Channels of Monetary Policy: A Back of the Envelope Calculation for the Euro Area Jiri Slacalek ECB Oreste Tristani ECB Gianluca Violante Princeton University XXIV Meeting of the Central Bank Researchers Network

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SLIDE 1

Household Balance Sheet Channels of Monetary Policy: A Back of the Envelope Calculation for the Euro Area

Jiri Slacalek

ECB

Oreste Tristani

ECB

Gianluca Violante

Princeton University

XXIV Meeting of the Central Bank Researchers Network

Madrid - 31 October 2019 The views expressed are the authors’ and do not necessarily reflect those of the ECB.

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 2

An Emerging New Macro Framework

  • HA + NK: Aiyagari-Krusell-Smith meets Gali-Gertler-Woodford
  • What is attractive about this approach?
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 3

An Emerging New Macro Framework

  • HA + NK: Aiyagari-Krusell-Smith meets Gali-Gertler-Woodford
  • What is attractive about this approach?

Conceptually, unified framework to study:

◮ Short-run fluctuations and long-run dynamics of distribution ◮ Large MPC + precautionary saving ⇒ AD channel salient ◮ Stabilization, social insurance and redistributive policies

Empirically, unified approach to micro and macro data Technically, now easier and faster to solve these models

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 4

Central Banks are embracing the idea

  • Fraction of speeches at Central Banks and Feds mentioning at

least once the words: heterogeneous, heterogeneity, inequality

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Years

0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.16 0.18

Fraction of Speeches Great Recession

Source: BIS database of central bankers’ speeches

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 5

Transmission mechanism of monetary policy

  • Macroeconomic framework: nominal rigidities (NK)
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 6

Transmission mechanism of monetary policy

  • Macroeconomic framework: nominal rigidities (NK)

RA+NK: intertemporal substitution dominates

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 7

Transmission mechanism of monetary policy

  • Macroeconomic framework: nominal rigidities (NK)

RA+NK: intertemporal substitution dominates HA+NK: no longer true

◮ transmission mechanism is more complex ◮ it mainly works through indirect GE effects on prices ◮ impact differs across the income/wealth distribution

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 8

Transmission mechanism of monetary policy

  • Macroeconomic framework: nominal rigidities (NK)

RA+NK: intertemporal substitution dominates HA+NK: no longer true

◮ transmission mechanism is more complex ◮ it mainly works through indirect GE effects on prices ◮ impact differs across the income/wealth distribution

  • Need micro and macro data to quantify
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 9

Transmission mechanism of monetary policy in HA+NK

  • How can we quantify all these channels at work?
  • Two methodologies in the literature:
  • 1. Rich DSGE models: e.g., KMV, Bayer et al., Hagedorn et al.

Pros: quantitatively plausible + policy counterfactuals Cons: computational complexity + ‘black box’

  • 2. Sufficient statistic approach:Werning, Auclert, Bilbiie, Patterson
  • This paper applies this second approach to Euro Area
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 10

FRAMEWORK

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 11

Approach

  • One-time transitory unexpected shock to policy rate r → C
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 12

Approach

  • One-time transitory unexpected shock to policy rate r → C
  • Household problem w/o uncertainty:

CES utility (IES = 1/γ) Inelastic labor supply / demand-determined hours FOCs + budget constraints + differentiation Closed form expression for each transmission channel

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 13

Approach

  • One-time transitory unexpected shock to policy rate r → C
  • Household problem w/o uncertainty:

CES utility (IES = 1/γ) Inelastic labor supply / demand-determined hours FOCs + budget constraints + differentiation Closed form expression for each transmission channel

  • Separate analysis for non-, poor- and wealthy-hand to mouth hh

Different portfolios, MPC, exposure to aggregate fluctuations

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 14

Approach

  • One-time transitory unexpected shock to policy rate r → C
  • Household problem w/o uncertainty:

CES utility (IES = 1/γ) Inelastic labor supply / demand-determined hours FOCs + budget constraints + differentiation Closed form expression for each transmission channel

  • Separate analysis for non-, poor- and wealthy-hand to mouth hh

Different portfolios, MPC, exposure to aggregate fluctuations

  • Cross-sectional data + VAR to measure key objects
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 15

Direct effects of a change in r

  • Direct effects (DIR): keeping all other prices fixed
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 16

Direct effects of a change in r

  • Direct effects (DIR): keeping all other prices fixed

Intertemporal substitution (IES) Net interest rate exposure (NIE)      dcDIR = dcIES + dcNIE dcIES = − 1 γ (1 − µ)c dr dcNIE = µ (y − c + b) dr

  • y: earnings, c: consumption, b: liquid assets minus liabilities,
  • µ: marginal propensity to consume out of transitory income
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 17

Indirect effects through inflation

  • Fisher effect (NOM)

dcNOM = −µ m dp p

  • m: nominal net worth (e.g., cash + bank deposits - debt)
  • dp/p: inflation induced by the monetary policy shock
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 18

Indirect effects through labor income y

  • Aggregate Demand effects (INC)

dcINC = µ dy = µ εy,Y y Y

  • dY
  • dY : change in aggregate labor income induced by dr
  • εy,Y : elasticity of individual income y to aggregate labor income Y
  • Heterogeneous sensitivity to cycle (age, industry, occupation, etc)
  • Large if sensitivity is positively correlated with MPC and y share
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 19

Indirect effects through capital gains on illiquid assets

  • Capital gains (CAP) on real assets (e.g. housing, stocks)
  • k: units of the asset, q: its price
  • Linear transaction τ cost to deposit/withdraw (assume action)

dcCAP = µ(1 − τ)k dq.

  • dq: capital gain induced by dr
  • µ(1 − τ): effective MPC out of the illiquid capital gain

Summary of transmission to ‘unconstrained’ households dcT OT

n

= dcIES

n

+ dcNIE

n

+ dcNOM

n

+ dcINC

n

+ dcCAP

n

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 20

Poor hand-to-mouth households

  • Small holdings of liquid assets (if positive) or close to the credit

limit (if negative) and no holdings of illiquid assets

  • Consumption is dictated by their budget constraint with unsecured

debt limit b = −b binding c = −rb + y

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 21

Poor hand-to-mouth households

  • Small holdings of liquid assets (if positive) or close to the credit

limit (if negative) and no holdings of illiquid assets

  • Consumption is dictated by their budget constraint with unsecured

debt limit b = −b binding c = −rb + y

  • Total effect of monetary policy shock for poor HtM:

dcT OT

p

= dcNIE

p

+ dcNOM

p

+ dcINC

p

with µ = 1

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 22

Wealthy hand-to-mouth households

  • Small holdings of liquid assets (if positive) or close to the credit

limit (if negative), but positive holdings of illiquid assets

  • On their collateral constraint: ∆ = θqk
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 23

Wealthy hand-to-mouth households

  • Small holdings of liquid assets (if positive) or close to the credit

limit (if negative), but positive holdings of illiquid assets

  • On their collateral constraint: ∆ = θqk
  • Total effect of monetary policy shock at impact:

dcT OT

w

= dcNIE

w

+ dcINC

w

+ dcNOM

w

+ dcCAP

w

with: dcCAP

w

= θ (1 − τ)k dq 1 · θ (1 − τ): effective MPC out of a capital gain

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 24

EMPIRICAL IMPLEMENTATION

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 25

Ingredients of the decomposition

  • 1. Shares of three types of households
  • 2. Their balance sheet composition (b, m, k, ...)
  • 3. Their MPCs (µ)
  • 4. Their earnings’ exposure to the cycle (εy,Y )
  • 5. The aggregate response of prices to the monetary shock
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 26

Shares of hand-to-mouth households

10.3 11.3 12.5 11.2 5.6 16.0 10.2 8.1 10.4 11.8

10 20

EA DE ES FR IT

Source: HFCS wave 2. Countries: DE, ES, FR, IT and Euro area. percentages over total population, by country

Share of hand-to-mouth in the euro area Poor Hand-to-Mouth Wealthy Hand-to-Mouth

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 27

Shares of hand-to-mouth households

10.3 11.3 12.5 11.2 5.6 16.0 10.2 8.1 10.4 11.8

10 20

EA DE ES FR IT

Source: HFCS wave 2. Countries: DE, ES, FR, IT and Euro area. percentages over total population, by country

Share of hand-to-mouth in the euro area Poor Hand-to-Mouth Wealthy Hand-to-Mouth

  • US: Poor HtM: 10%

and Wealthy HtM: 25%

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 28

Shares of hand-to-mouth households by age

15.3 11.1 10.7 14.2 9.2 14.5 8.3 12.5 7.5 9.4 7.0 8.8

5 10 15

16-34 35-44 45-54 55-64 65-74 75+

Source: HFCS wave 2. Countries: Euro Area countries. percentages over total population, by age of the household reference person

Share of hand-to-mouth households in euro area Poor Hand-to-Mouth Wealthy Hand-to-Mouth

Poor HtM: young Wealthy HtM: middle age

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 29

MPCs out of income and wealth

  • Calibrated from existing literature

Marginal Propensity to Consume (annual) Household Type Income Housing Stocks Poor HtM 0.50 −− −− Wealthy HtM 0.50 0.07 0.07 Non HtM 0.05 0.01 0.01

  • Aggregate MPC out of transitory income ≃ 0.20 (low end)
  • Aggregate MPC out of housing/stocks ≃ 0.025
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 30

MPCs out of income and wealth

  • Calibrated from existing literature

Marginal Propensity to Consume (annual) Household Type Income Housing Stocks Poor HtM 0.50 −− −− Wealthy HtM 0.50 0.07 0.07 Non HtM 0.05 0.01 0.01

  • Aggregate MPC out of transitory income ≃ 0.20 (low end)
  • Aggregate MPC out of housing/stocks ≃ 0.025
  • IES = 0.5
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 31

Systematic exposure to aggregate fluctuations

  • From HFCS, estimate Prob(HtM type) as function of observables
  • Impute Prob to each individual in monthly EU Labor Force Survey
  • Estimate, for each group g:

et(g) = α(g) + β(g) · t + ε(g) · Et + νt(g) Germany Spain France Italy Poor HtM 1.7 2.9 1.3 2.1 Wealthy HtM 0.3 1.6 1.6 1.7 Non HtM 1.0 0.7 0.8 0.8

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 32

VAR responses of aggregates to monetary shock

  • High-frequency identification (Gertler-Karadi, Altavilla et al.)
  • Responses to 100BP (60BP averaged over first year)

Germany Spain France Italy Earnings (%) 0.5 1.6 0.7 1.8 Inflation Rate (p.p.) 0.1 0.6 0.3 0.1 House Prices (%) 0.0 5.0 0.3 1.4 Stock Prices (%) 27 21 24 26

  • Spanish macroeconomy much more ‘sensitive’ than German one
  • Huge response of stock prices (common)
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 33

Net interest rate exposure

  • 2
  • 17

25

  • 2
  • 10

40

  • 3
  • 42

2

  • 1
  • 12

24

  • 1
  • 10

18

  • 40
  • 20

20 40 EUR, thousands

EA DE ES FR IT Source: HFCS 2

nd wave. Countries: Euro Area countries.

Poor Hand-to-Mouth Wealthy Hand-to-Mouth Non-Hand-to-Mouth

  • Germany (DE): large liquid savings + FRMs
  • Spain (ES): many homeowners + large ARMs
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 34

Net nominal positions

  • 2
  • 29

19

  • 2
  • 34

29

  • 3
  • 41

5

  • 1
  • 29

15

  • 1
  • 11

17

  • 40
  • 20

20 40

EUR, thousands

EA DE ES FR IT Source: HFCS 2

nd wave. Countries: Euro Area countries.

Poor Hand-to-Mouth Wealthy Hand-to-Mouth Non-Hand-to-Mouth

  • In Italy, most households are outright homeowners
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 35

Stockmarket and housing wealth

7 8 6 8 4 2 4 6 8

EUR, thousands

EA DE ES FR IT Source: HFCS 2 nd wave. Countries: Euro Area countries.

Poor Hand-to-Mouth Wealthy Hand-to-Mouth Non-Hand-to-Mouth

161 198 139 172 180 251 165 193 173 207 50 100 150 200 250

EUR, thousands

EA DE ES FR IT Source: HFCS 2 nd wave. Countries: Euro Area countries.

Poor Hand-to-Mouth Wealthy Hand-to-Mouth Non-Hand-to-Mouth

STOCKS HOUSING

  • Imputation of missing stock-market wealth
  • Stocks are a smaller share of net worth in EA compared to US
  • All illiquid household wealth is in housing
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 36

DECOMPOSITION RESULTS

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 37

Decomposition for the Euro Area

−.1 .4 .9 1.4 1.9 Change in consumption, percent

Poor HtM Wealthy HtM Non−HtM All

Source: HFCS 2

nd wave. Countries: DE, ES, FR and IT.

IES NIE income Fisher housing stocks

Direct Effects Indirect Effects

  • Indirect GE channels account for 2/3 of the total
  • Wealthy HtM benefit the most from easing via indirect channels
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 38

Decomposition: Germany

−1 1 2 Change in consumption, percent

Germany

Poor HtM Wealthy HtM Non−HtM All

IES NIE income Fisher housing stocks

Direct Effects Indirect Effects

  • Traditional transmission mechanism dominated by IES
  • Roughly equal impact across all groups
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 39

Decomposition: Spain

−1 1 2 3 4 5 6 Change in consumption, percent

Spain

Poor HtM Wealthy HtM Non−HtM All

IES NIE income Fisher housing stocks

Direct Effects Indirect Effects

  • Housing wealth effect is dominant
  • HtM households benefit the most from easing
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 40

Decomposition: France

−1 1 2 Change in consumption, percent

France

Poor HtM Wealthy HtM Non−HtM All

IES NIE income Fisher housing stocks

Direct Effects Indirect Effects

  • Similar to Germany
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 41

Decomposition: Italy

−1 1 2 Change in consumption, percent

Italy

Poor HtM Wealthy HtM Non−HtM All

IES NIE income Fisher housing stocks

Direct Effects Indirect Effects

  • Similar to Spain
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 42

VAR responses vs HA model decomposition vs RA

  • Two ‘independent’ estimates of the impact on aggregate C
  • Obtained with different methodologies

Germany Spain France Italy VAR estimate (%) 0.24 1.8 0.03 1.5 HA Decomposition (%) 0.3 1.8 0.4 0.8

  • Repr. Agent - IES (%)

0.2 0.2 0.2 0.2

  • VAR and HA line up, which offers some credibility to the exercise
  • The HANK block amplifies the shock compared to the RA
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 43

TREATMENT OF BUSINESS WEALTH

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 44

Business wealth treated as stocks: EA decomposition

−.1 .4 .9 1.4 1.9 2.4 2.9 Change in consumption, percent

Poor HtM Wealthy HtM Non−HtM Top 10 All

Source: HFCS 2

nd wave. Countries: DE, ES, FR and IT.

IES NIE income Fisher housing stocks

Direct Effects Indirect Effects

  • Clearly an upper bound
  • It doubles overall effects of the monetary shock
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 45

ZOOMING IN ON THE TOP 10%

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 46

Isolating the rich from the rest

  • Separate the top 10% in net worth from the rest of the non HtM
  • Same MPC as Non-HtM
  • Impute to them the missing stock market wealth
  • Recompute their earnings exposure to aggregate cycle

Germany Spain France Italy Poor HtM 1.7 2.9 1.3 2.1 Wealthy HtM 0.3 1.6 1.6 1.7 Non HtM 0.9 1.0 0.7 0.7 Top 10% 1.4 0.4 1.5 1.2

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
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SLIDE 47

Stockmarket and housing wealth

1 45 1 57 1 38 1 46 30 20 40 60

EUR, thousands

EA DE ES FR IT Source: HFCS 2 nd wave. Countries: Euro Area countries.

Poor Hand-to-Mouth Wealthy Hand-to-Mouth Non-Hand-to-Mouth Top 10

161 115 660 139 84 741 180 161 686 165 118 568 173 130 648 200 400 600 800

EUR, thousands

EA DE ES FR IT Source: HFCS 2 nd wave. Countries: Euro Area countries.

Poor Hand-to-Mouth Wealthy Hand-to-Mouth Non-Hand-to-Mouth Top 10

STOCKS HOUSING

  • Stock-market wealth is small even for the richest in the EA
  • The wealth of the richest in the EA is all in housing
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
slide-48
SLIDE 48

Decomposition for the Euro Area

−.1 .4 .9 1.4 1.9 Change in consumption, percent

Poor HtM Wealthy HtM Non−HtM Top 10 All

Source: HFCS 2

nd wave. Countries: DE, ES, FR and IT.

IES NIE income Fisher housing stocks

Direct Effects Indirect Effects

  • Richest lose somewhat from NIE + NOM
  • They gain a lot through asset prices (but small MPC)
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
slide-49
SLIDE 49

Conclusions

  • Household balance sheet channels of monetary policy
  • Simple back of the envelope calculation that offers guidance on:

relative size of various transmission mechanisms heterogeneous impact across types of households heterogeneous impact across countries hit by same shock how total effect changes over time

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
slide-50
SLIDE 50

Conclusions

  • Household balance sheet channels of monetary policy
  • Simple back of the envelope calculation that offers guidance on:

relative size of various transmission mechanisms heterogeneous impact across types of households heterogeneous impact across countries hit by same shock how total effect changes over time

  • Lesson for big DSGE models

Model both the top and bottom of distribution accurately Enrich HANK with credible asset price dynamics

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
slide-51
SLIDE 51

Thanks!

  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”
slide-52
SLIDE 52

Monetary transmission to individual consumption

Direct effects (PE) Indirect effects (GE)

Intertemporal Substitution Income Effects Labor Income Asset Prices/Returns RANK model

  • Woodford
  • Gali
  • Gertler

Capital Gains

Dividends/Profits Standard Income Effects through Interest Rates Income Effects through Mortgage Rates

  • Eichenbaum, Rebelo, Wong
  • Berger, Milbradt, Tourre, Vavra
  • Wong
  • Beraja, Fuster, Hurst, Vavra
  • McKay, Wieland
  • Greenwald
  • Hedlund, Karahan, Mitman,

Ozkan

Valuation Effects from Inflation (Fisher Effects)

Fiscal Policy

  • Auclert
  • Sterk,Tenreyro
  • Doepke,

Schneider

  • Gornemann,

Kuester, Nakajima

  • Alves, Kaplan,

Moll, Violante

  • Kekre, Lenel
  • Werning
  • Kaplan, Moll,

Violante

  • McKay,

Nakamura, Steinsson

  • Auclert, Rognlie,

Straub

  • McKay, Reis
  • Hagedorn,

Manovskii, Mitman

Level

  • Kaplan, Moll,

Violante

  • Luetticke
  • Auclert
  • Auclert, Rognlie,

Straub

  • Werning
  • Farhi, Werning
  • Hagedorn, Luo,

Manovskii, Mitman

  • Bilbiie
  • TANK model

Risk

  • Gornemann,

Kuester, Nakajima

  • Acharya,

Dogra

  • Holm
  • Ravn, Sterk
  • Werning
  • Auclert
  • Kaplan,

Moll, Violante

  • Kaplan, Moll,

Violante

  • Broer, Hansen,

Krusell, Oberg

  • Werning
  • Bilbiie
  • G. Violante, ”Household Balance Sheet Channels of Monetary Policy”