BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Spillovers, Capital Flows and Prudential Regulation in Small Open Economies BANCO CENTRAL DE RESERVA DEL PERÚ Paul Castillo, César Carrera, Marco Ortiz & Hugo Vega Presented by: Hugo Vega RBNZ Workshop “The Interaction of Monetary and Macroprudential Policy” hugo.vega@bcrp.gob.pe The opinions expressed in this paper are not necessarily shared by the institutions with which we are currently affiliated. Hugo Vega October 22nd 2014 1/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Contents Motivation BANCO CENTRAL DE RESERVA DEL PERÚ Literature The Model Workers Tradable Good Producers Non-Tradable Good Producers Results Policy Conclusions Hugo Vega October 22nd 2014 2/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Motivation BANCO CENTRAL DE RESERVA DEL PERÚ Some stylized facts we attempt to replicate: ◮ Strong capital inflows in Latin-American region. ◮ Rapid output growth in both tradable and non-tradable sectors. ◮ Increase in indebtedness, asset prices booms, real appreciation, and current account deficit. ◮ Active policy response using macroprudential instruments. Hugo Vega October 22nd 2014 3/29
Housing8Prices Current8account8balance USG S/. 3.2 USG81857 2000 5000 1.4 S/.84588 1600 4000 -0.6 1200 -1.9 -2.5 3000 -3.6 -4.2 800 -4.9 2006 2007 2008 2009 2010 2011 2012 2013, 2000 400 0 1000 III. 98 III. 99 III. 00 III. 01 III. 02 III. 03 III. 04 III. 05 III. 06 III. 07 III. 08 III. 09 III. 10 III. 11 III. 12 III. 13 USN Constant.domestic.currency Multilateral8RER8Index Output8Growth 120Y00 120Y0 Index.2009.=.100 15Y0 115Y00 115Y0 10Y0 110Y00 110Y0 5Y0 105Y00 105Y0 0Y0 100Y00 100Y0 2006 2007 2008 2009 2010 2011 2012 g5Y0 95Y00 95Y0 Tradable Nongtradable 90Y00 September 2013:.92h56 90Y0 MoM. Change: g0h36 85Y00 YoY.Change:.2h39 85Y0 80Y00 80Y0 Jang03 Julg03 Jang04 Julg04 Jang05 Julg05 Jang06 Julg06 Jang07 Julg07 Jang08 Julg08 Jang09 Julg09 Jang10 Julg10 Jang11 Julg11 Jang12 Julg12 Jang13 Julg13 Figure: Peru - Key Macroeconomic Variables
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Literature ◮ Kiyotaki & Moore (1997): credit limits and asset prices. ◮ Role of financial development in the amplification of capital BANCO CENTRAL DE RESERVA DEL PERÚ flow externalities (Aghion et al. (2004), Aoki et al. (2009)). ◮ Caballero & Krishnamurthy (2001) study the interaction between domestic and foreign lending during periods of sudden stops, using collateral assumptions similar to ours. ◮ Paasche (2001): Two credit constrained SOEs who borrow and export commodities to a third large one. A negative productivity shock in one SOE generates an adverse terms of trade shock on the other, which is amplified. ◮ Sudden stop episodes associated with higher borrowing (Mendoza (2002), Jeanne & Korinek (2010), Bianchi (2011)). Hugo Vega October 22nd 2014 5/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies What we do BANCO CENTRAL DE RESERVA DEL PERÚ ◮ We build a stylized two sector real business cycle model incorporating borrowing constraints that generates the co-movements pointed out in the data, emphasizing spill over effects from the tradable to the non-tradable sector. ◮ We propose a countercyclical LTV rule that manages to reduce output volatility in this economy, generating redistributive welfare effects. Hugo Vega October 22nd 2014 6/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Some intuition BANCO CENTRAL DE RESERVA DEL PERÚ 1. Borrowing constraints generate a link between entrepreneurs’ credit limits and the price of assets used as collateral. 2. This link is responsible for the co-movement between sectors in response to a productivity shock to the tradable sector. 3. When tradable productivity increases, factor demand pushes asset prices up, expanding the borrowing capacity of entrepreneurs in both sectors. 4. This yields output co-movement and increased borrowing in the non-tradable sector. Hugo Vega October 22nd 2014 7/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies The Model BANCO CENTRAL DE RESERVA DEL PERÚ 1. Extension of the model of Aoki et al. (2009) considering a 2 sector SOE in which entrepreneurs require collateral to borrow as in Iacoviello (2005). 2. Real DSGE model without money or price rigidity. 3. Three agents: Workers ( W ) and entrepreneurs/producers of tradable ( T ) and non-tradable ( NT ) goods. Hugo Vega October 22nd 2014 8/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies The Model (II) 4. Besides the markets for tradable and non-tradable goods, BANCO CENTRAL DE RESERVA DEL PERÚ the model incorporates markets for labour, capital, housing and credit. 5. The credit market is segmented by collateral asset and production sector. 6. The tradable sector uses capital ( k ) as collateral to obtain foreign lending while the non-tradable sector uses housing ( h ) as collateral to borrow from domestic agents (the workers). 7. We assume a fixed aggregate supply for both capital and housing assets. Hugo Vega October 22nd 2014 9/29
Wages Labour supply Final goods Non-tradable goods supply (HH) Non-tradable imports (NT) entrepreneurs Intermediate goods imports (NT) Debt service (NT) Credit (NT) Net housing Net capital demand(NT) demand(NT) Net housing T goods NT goods demand (HH) Capital Workers Housing supply (NT) supply (T) market market Net housing Net capital demand(T) demand(T) Tradable goods supply (HH) Final goods Wages Tradable imports (T) entrepreneurs Intermediate goods Labour supply imports (T) Debt Final goods Final goods Credit (T) service (T) imports (HH) exports Foreign economy Figure: The Model
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Workers BANCO CENTRAL DE RESERVA DEL PERÚ ◮ Are the “patient” agents in the domestic economy. ◮ Lend to entrepreneurs producing non-tradable goods ( b NT ) s charging the domestic interest rate ( R s ). ◮ Consume a basket ( C w,s ) of tradable ( c T w,s ) and non-tradable ( c NT w,s ) goods; use housing services ( h W s ) and supply labour ( l s ). Worker Equations Hugo Vega October 22nd 2014 11/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Tradable Good Producers/Entrepreneurs ◮ Consume the same basket of goods ( C t,s ) as workers. BANCO CENTRAL DE RESERVA DEL PERÚ ◮ Combine housing services ( h T s ), capital ( k T s ), labour ( l T s ) and imported inputs ( m T s ) to produce ( y T s +1 ). ◮ Given the lag in production, entrepreneurs need working capital loans ( b T ∗ s ). These are subject to borrowing constraints: � � s b T ∗ ≤ θ T ∗ q k k T R ∗ s E s s s +1 s where q k s is the price of capital, R ∗ s is the foreign interest rate and θ T ∗ is the fraction of capital value accepted as s collateral. Tradable Entrepreneur Equations Hugo Vega October 22nd 2014 12/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Non-Tradable Good Producers/Entrepreneurs ◮ Consume the same basket of goods ( C nt,s ) as workers. BANCO CENTRAL DE RESERVA DEL PERÚ ◮ Use the same inputs ( h NT , k NT , l NT , m NT ) as tradable good s s s s producers to manufacture ( y NT s +1 ). ◮ They are also subject to borrowing constraints in the domestic credit market that only admits housing as collateral. � � R s P W s b NT ≤ θ NT q h h NT E s s s s +1 s ◮ Producers of non-tradable goods sell at relative price p NT s which is expressed in units of tradable goods. Non-Tradable Entrepreneur Equations Hugo Vega October 22nd 2014 13/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies Results: A tradable productivity shock ◮ An increase in productivity in the tradable sector generates BANCO CENTRAL DE RESERVA DEL PERÚ an expansion in the tradable and non-tradable sectors and boosts the price of both assets used as collateral. ◮ The positive wealth effect experienced by tradable entrepreneurs increases demand for non-tradable goods. ◮ This generates a real appreciation which leads to an expansion in the non-tradable sector. Given the increase in housing prices, the borrowing constraint of the non-tradable sector is relaxed. ◮ Non-tradable firms’ demand for housing decreases. Such a decrease is not big enough to outweigh the effect of higher housing prices on their borrowing. Hugo Vega October 22nd 2014 14/29
BANCO CENTRAL DE RESERVA DEL PERÚ Economic Studies ◮ During the adjustment process, collateral assets are exchanged between the non-tradable and the tradable sector. BANCO CENTRAL DE RESERVA DEL PERÚ Non-tradable firms use less housing and the excess is absorbed by tradable firms. The latter liberate capital which is acquired by their non-tradable counterparts. ◮ Workers experience a positive wealth effect because of higher wages. This stimulates savings, reducing the domestic interest rate. As a result, the borrowing constraints of non-tradable firms relax even further and housing becomes less attractive. ◮ Higher demand for imported inputs in both sectors explains the current account deficit that follows the shock. Hugo Vega October 22nd 2014 15/29
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