UK money growth in the long expansion: what can it tell us about the - - PowerPoint PPT Presentation

UK money growth in the long expansion: what can it tell us about the role of money ?

Michael Mcleay Ryland Thomas The Causes and Consequences of the Long UK Expansion Conference 20th September 2013

Background

• Since the financial crisis began a lot of work has been

done on the impact of credit and money on the economy

• Impact of credit supply shocks

– Gilchrist & Zakrajsek (2012), Bleaney, Mizen & Veleanu (2013) – BoE work on UK: Bell & Young (2011), Barnett & Thomas (2013)

• Impact of money supply and demand shocks

– Motivated by analysing QE which works via money supply eg Cobham and Kang (2012), Bridges and Thomas (2012) – Money supply vs demand shocks, Chadha et al (2008)

• What happens if we apply this analysis to the long

expansion period ?

Two underlying questions

• What was the role of the money‐creating sector as a

source of shocks ?

– Monetary shocks versus standard macro shocks eg Chadha et al (2013) – Can we distinguish between different types of shock in the monetary sector; eg Competition, Wholesale Funding costs, Bank risk taking

• What was the role of money in propagating shocks ?

– Credit may have direct allocative effects on the economy – Does the money created by credit matter ? – Does it lead to monetary overhangs and hot potato effects ? – Are these persistent enough to show up in the data so money has incremental information about future activity/inflation ?

Reasons not to bother with money

• What’s the right measure of money ?

– Broad versus narrow ? – Retail versus wholesale ? – Divisia versus simple sum aggregates ? – Financial versus non‐financial sector ?

• The poor experience of monetary targeting in the UK

– Link between money and inflation only strong at long horizons/certain regimes – Short‐term movements in velocity unpredictable – Relationship depends on shocks hitting the economy and policy regime in place (eg Sargent and Surico (2010) – But does not mean there is no information in money

• But many of these issues apply to other variables/concepts

– Output gaps, marginal cost gaps, labour market gaps, natural rate of interest

We don’t have a standard model

• Many textbook models have no explicit role for bank‐

created money

• A lot of work on incorporating banks into macromodels

– no workhorse model that can easily be taken directly to the data – More progress on incorporating credit than money ? – Difficult to embody hot potato effects, difficult to track distribution of money holdings over time – Requires heterogeneous agents, sequential transactions in decentralised markets

• So approach has to be empirical but informed by different

theories

Our eclectic approach

• What features do we implicitly want to capture ?

– Credit may have allocative/supply effects – Post‐Keynesian view of endogenous money by created by credit (and other transactions) so focus on broad money. – Buffer‐stock ideas: money accepted but not necessarily demanded – Individual agent versus aggregate adjustment: hot potato effects

• Use a cointegrated VAR approach

– Allows us to incorporate monetary and other real disequilibria directly (M‐M*) – Can then carry out SVAR or SEM analysis depending on the focus

• Look at aggregate and sectoral models

– Fundamental shock identification easier to do at aggregate level: Part 1 – Propagation role of money easier to discern at sectoral level: Part 2

Money and credit in the long expansion

• Nominal variables look relatively stable in long expansion period
• But various pointers/puzzles point to impending financial crisis

‐20 ‐10 10 20 30 40 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

M4(a) M4 Lending (b) Nominal GDP

percentage change on a year earlier

Fact 1: Credit growth > Money growth

• Credit grew faster than money for most of this period
• Build up of non‐deposit wholesale liabilities, securitisation and overseas funding

Chart 2: Sterling counterparts to broad money

• ver the long expansion

‐0.6 ‐0.4 ‐0.2 0.2 0.4 0.6 0.8 1 1.2 1993‐1997 1998‐2002 2003‐2007

Net lending to the public sector Loan securitisations Net lending to intermediate 'other financial corporations' Net non deposit liabilities Net lending to non‐residents Foreign currency position M4 lending Broad money

£trillions

Inflation, broad money growth and nominal GDP growth 2 4 6 8 10 12 14 1993 1998 2003 2007 Nominal GDP Broad money CPI inflation Percentage change on a year earlier

Fact 2: Money growth > nominal GDP

• All measures of money generally grew faster than nominal GDP over this period
• But there was no large pick up in CPI inflation despite double‐digit money growth

Long expansion

20 40 60 80 100 120 140 160 180 200 1963 1973 1983 1993 2003 2013 Divisia Notes and Coin M4x Velocity of money Index, 1993=100

Fact 3: Corporate money more volatile

• Most of the pick up in broad money growth was due to the corporate

sector

• Household sector money stable
• Implications ?

Chart 5: Contributions to broad money growth by sector

‐4 ‐2 2 4 6 8 10 12 14 1998 2003 2007 Household PNFC Non‐intermediate OFCs Total

4Q growthrate and

The monetary sector as a source of shocks

• Shocks emanating from banking sector v standard

macroeconomic shocks

– How important were they in the lead up to the crisis ? – Typical method is to add some balance sheet measure (eg quantity of credit) and a measure of spreads to standard macro time series to try and identify these separately

• Different types of banking sector shocks

– Can we use money in addition to credit to help us identify these – Use simple Monte‐Klein banking model to motivate this – Competition/cost of providing intermediation services – Wholesale funding costs/availability – Bank risk taking – In principle this also applies to QE and macroprudential policy

The monetary sector as a source of shocks

Loan rates Credit Cost of intermediation ↓ ↑ Wholesale funding costs ↓ ↑ Bank risk taking ↓ ↑

The monetary sector as a source of shocks (Monti‐Klein model)

Deposit rate = Mark-down x [wholesale funding cost - intermediation]

risk free+ risk premium

cost

.

Loan rate = Mark-up x [wholesale funding cost + intermediation + compensation for losses]

risk free+ risk premium

cost expected + unexpected losses

The monetary sector as a source of shocks

Loan rates Credit Deposit rates Money demand (M*) M‐M* Cost of intermediation ↓ ↑ ↑ ↑ Wholesale funding costs ↓ ↑ ↓ ↓ ↑? Bank risk taking ↓ ↑ ↑

Estimating a Cointegrated SVAR

• 10 variables VAR, over long sample period 1964Q1 to 2012Q4

– Allows us to compare long expansion period with earlier periods – But economy subject to structural change over this period

Type of variable Data series Standard macro variables CPI inflation  GDP y Bank Rate is Credit and Money Real Credit (M4Lx(ex)) m4lx‐p Real Broad money (M4x) m4x‐p Loan rate (Corporate bond yield) ib Deposit rate id Asset prices Long‐term govt. bond yield il Real exchange rate e Real equity prices pk

Data choices – credit spreads

• Use corporate bond yield spread to proxy credit spreads:

– Advantages:

• Broad concept, likely to be related to overall credit conditions
• Long time series back to 1960s

– Disadvantages

• not exclusively measure of bank loan rate spreads
• only reflects household rates indirectly through bank funding costs

Long‐run relationships

LR test of restrictions: 2(24) = 42.004 [0.0129]*

• Features

– Can get theoretically appealing long‐run relationships but on the borderline of being rejected – No long‐run credit demand relationship – Credit spread is stationary, but deposit spread is non‐stationary

Description Relationship Money demand relationship m4x ‐ p = 0.5*y + pk + 8*(id ‐ is) + k1 Term structure is = il + k2 Real interest rates is =  + k3 Real equity price to GDP pk = y + k4 Corporate bond spread ib = il + k3

Estimate ‐ 5 cointegrating relationships

• Given 5 long‐run relationships suggests there are 5

permanent shocks driving the stochastic trends in the data and 5 temporary shocks

– King et al (1991), Mellander et al (1992), Robertson and Wickens (1994)

• We use a mix of long‐run and timing restrictions to identify

the shocks

– Sign restrictions difficult to impose in a general way in this framework and can yield implausibly large contemporaneous effects from demand and policy shocks – But mix of LR/SR restrictions chosen appear to yield correct signs

Macroeconomic shocks

• 6 Macro‐shocks split into permanent and temporary shocks

– Nominal growth pinned down by inflation target shock – No long‐run real wage resistance so preference shock has no long‐run effect on

• utput

– Standard timing restrictions based on nominal rigidities

Type of shock Permanent shocks Temporary shocks

Aggregate supply Technology/TFP Cost push/mark up Aggregate demand World demand/preferences Domestic demand/confidence Monetary policy Core inflation/inflation target Deviations from rule

Monetary sector shocks

• Use permanent‐temporary distinction to help identify our banking

sector shocks

• Additional risk premia shock reflecting shocks originating in capital

markets (not in banking sector)

Type of shock Permanent or temporary LR effect on

Cost of intermediation Permanent Cost of intermediation (ib-il) – (id–is) Wholesale funding Permanent Stock of lending relative to money Bank risk taking Temporary Credit spreads are stationary

Additional restrictions

• Wholesale funding cost restricted to have zero long‐run effect on cost of

intermediation

• Bank risk taking shock has delayed effect on macro‐variables but does lead to

initial rise in money and credit

Permanent shocks: Long-run restrictions Temporary shocks: Impact restrictions Permanent shocks: Temporary shocks: = neutral aggregate supply shock = aggregate demand shock = overseas demand / preference shock = monetary policy shock = core/target inflation shock = Bank risk taking shock = cost of intermediation shock = Risk premia shock = wholesale funding shock = Mark up/cost push

Monetary sector shocks

• Signs of the responses to monetary sector shocks are consistent with

the theoretical responses

• 4
• 3
• 2
• 1

1 2 3 4

• 0.4
• 0.3
• 0.2
• 0.1

0.1 0.2 0.3 0.4 4 8 12 16 20 24 28 32 36 40 Deposit rate (LHS) Loan rate (LHS) Money (RHS) Lending (RHS) per cent

• 4
• 3
• 2
• 1

1 2 3 4

• 0.4
• 0.3
• 0.2
• 0.1

0.1 0.2 0.3 0.4 4 8 12 16 20 24 28 32 36 40 Deposit rate (LHS) Cost of intermediation (LHS) Money (RHS) Lending (RHS) per cent

• 4
• 3
• 2
• 1

1 2 3 4

• 0.4
• 0.3
• 0.2
• 0.1

0.1 0.2 0.3 0.4 4 8 12 16 20 24 28 32 36 40 Deposit rate (LHS) Loan rate (LHS) Money (RHS) Lending (RHS) per cent

Impulse responses to a cost of intermediation shock Impulse responses to a wholesale funding shock Impulse responses to a bank risk-taking shock

• 1
• 0.8
• 0.6
• 0.4
• 0.2

0.2 0.4 0.6 0.8 1

• 4
• 3
• 2
• 1

1 2 3 4 4 8 12 16 20 24 28 32 36 40 Equity price (LHS) Inflation (pps) (RHS) Output (RHS) per cent/pps per cent

Monetary sector shocks

• Wholesale funding and Banking Sector shocks both boost GDP and equity prices,

but cost of intermediation has limited impact and leads to a decline in equity prices

• Both cost of intermediation and wholesale funding shocks push down on inflation

suggesting some beneficial cost channel/potential supply effects.

Impulse responses to a cost of intermediation shock Impulse responses to a wholesale funding shock Impulse responses to a bank risk-taking shock

• 1
• 0.8
• 0.6
• 0.4
• 0.2

0.2 0.4 0.6 0.8 1

• 4
• 3
• 2
• 1

1 2 3 4 4 8 12 16 20 24 28 32 36 40 Equity price (LHS) Inflation (pps) (RHS) Output (RHS) per cent/pps per cent

• 1
• 0.8
• 0.6
• 0.4
• 0.2

0.2 0.4 0.6 0.8 1

• 4
• 3
• 2
• 1

1 2 3 4 4 8 12 16 20 24 28 32 36 40 Equity price (LHS) Inflation (pps) (RHS) Output (RHS) per cent/pps per cent

• 25.0
• 20.0
• 15.0
• 10.0
• 5.0

0.0 5.0 10.0 15.0 20.0 25.0 1967Q1 1970Q1 1973Q1 1976Q1 1979Q1 1982Q1 1985Q1 1988Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 2009Q1 2012Q1 Trend+pre-1967 shocks Aggregate Supply Aggregate demand Monetary policy Cost of Intermediation Wholesale funding Bank risk taking Data

Great Inflation Thatcher era Long Expansion Financial crisis

percentage chg on a year ago

Credit growth

• Bank risk taking and wholesale funding important in build up to crisis

• 25.0
• 20.0
• 15.0
• 10.0
• 5.0

0.0 5.0 10.0 15.0 20.0 25.0 1967Q1 1970Q1 1973Q1 1976Q1 1979Q1 1982Q1 1985Q1 1988Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 2009Q1 2012Q1 Trend+pre-1967 shocks Aggregate Supply Aggregate demand Monetary policy Cost of Intermediation Wholesale funding Bank risk taking Data

Great Inflation Thatcher era Long Expansion Financial crisis

percentage chg on a year ago

Real broad money growth

• Wholesale funding relatively less important for broad money growth than bank

risk taking shocks in run up to crisis

• Cost of intermediation shocks more important in the 1980s

Velocity growth

• The two shocks also largely explain declining velocity over the period
• 20.0
• 15.0
• 10.0
• 5.0

0.0 5.0 10.0 15.0 20.0 1967Q1 1970Q1 1973Q1 1976Q1 1979Q1 1982Q1 1985Q1 1988Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 2009Q1 2012Q1 Trend+pre-1967 shocks Aggregate Supply Aggregate demand Monetary policy Cost of Intermediation Wholesale funding Bank risk taking Data

Great Inflation Thatcher era Long Expansion Financial crisis

percentage chg on a year ago

GDP growth

• Monetary shocks push up on GDP growth prior to the crisis, but bank risk taking

shocks only from 2006

• 10.0
• 8.0
• 6.0
• 4.0
• 2.0

0.0 2.0 4.0 6.0 8.0 10.0 1967Q1 1970Q1 1973Q1 1976Q1 1979Q1 1982Q1 1985Q1 1988Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 2009Q1 2012Q1 Trend+pre-1967 shocks Aggregate Supply Aggregate demand Monetary policy Cost of Intermediation Wholesale funding Bank risk taking Data

Great Inflation Thatcher era Long Expansion Financial crisis

percentage chg on a year ago

Inflation

• Wholesale funding shock pushes down on inflation
• Delayed impact of bank risk taking shock
• 10.0
• 5.0

0.0 5.0 10.0 15.0 20.0 25.0 30.0 1967Q1 1970Q1 1973Q1 1976Q1 1979Q1 1982Q1 1985Q1 1988Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 2009Q1 2012Q1 Monetary policy Aggregate Supply Aggregate demand Cost of Intermediation Wholesale funding Bank risk taking Data

Great Inflation Thatcher era Long Expansion Financial crisis

percentage chg on a year ago

Propagation role of money

• Links appear to be clearest at sectoral level

– Money modelled jointly with other sectoral variables – Thomas (1997a,b), Brigden and Mizen (2004), Chrystal and Mizen (2005 a,b)

• Structural econometric models (SEM) rather than SVARs

– Household Money modelled jointly with consumption (and unsecured credit) – PNFCs money modelled jointly with investment (and credit) – NIOFCs money modelled jointly with asset prices and yields – Most direct links between monetary overhangs and economy is in corporate sector (PNFCs and NIOFCs)

ICPFs/NIOFCs

• ICPFs’ money weakly exogenous for asset prices, suggestive of hot potato effects in

financial sector

• Excess money holdings push up asset prices and lower yields on bonds and equities

w = + 0.06692*m(-1) + 0.06692*m(-2) (SE) (0.03003) (-----) + 0.0882*(m-m*)(-1) + 0.0163*rd(-2) + 0.2633 (0.02946) (0.007181) (0.0854) ryield =

• 0.2344*m - 0.0975*rd(-2) - 0.3892*(m-m*)(-1) - 1.1449

(SE) (0.235) (0.0358) (0.1463) (0.424) m - m* = m– w– 0.104*(rd - ryield)

System estimated by FIML over sample: 1988(1) to 2008(3)

PNFCs

• PNFCs’ money appears in business investment equation

when jointly estimated

ibus = - 0.1172*(ibus-ibus*)(-1) + 0.0721*(m-m*)(-1) (SE) (0.0226) (0.025)

• 0.02279*rl + 0.02252*rb

(0.00585) (0.00544) + 0.1169*DD85 + 0.03665*util(-1) - 0.4706 (0.0198) (0.00828) (0.114) Ibus-ibus* = ibus – y + 0.5*rcc + 0.082*(rl-rb) m-m* = m4pnfc – 0.5*ibus – 0.5*y – 0.068*(rd-rb)

System estimated by FIML over sample: 1978(3) to 2008(3)

Corporate money 2003‐2007

• As noted earlier, much of the froth in money growth 2003 to 2007 was in

corporate holdings

• Partial ‘helicopter drop’ experiment, how much could it potentially account for in

terms of equity prices, GDP and investment ?

Build up in corporate money

20 40 60 80 100 120 140 160 180 200 2003 2004 2005 2006 2007 NIOFC money PNFC money £bns

Chart 5: Contributions to broad money growth by sector

‐4 ‐2 2 4 6 8 10 12 14 1998 2003 2007 Household PNFC Non‐intermediate OFCs Total

4Q growthrate and

Corporate money and GDP

• The rise in corporate money could account for up to ¼ of equity price increase

between 2003 and 2007 and sufficient to explain corporate investment

• So, in a partial sense, is sufficient to explain the rise in GDP relative to its historic

trend over this period, when we link the models together

• It suggests some role for money in the propagation of shocks over this period

The impact on equity prices The impact on investment The impact on GDP

2 4 6 8 10 12 14 16 18 2003 2004 2005 2006 2007 NIOFC money PNFC money Data Historic trend per cent

• 10
• 5

5 10 15 20 25 2003 2004 2005 2006 2007 NIOFC money PNFC money Data per cent 10 20 30 40 50 60 70 80 90 100 2003 2004 2005 2006 2007 NIOFC money PNFC money Data per cent

Conclusions

• Money may be a useful variable to help pin down the nature of

shocks emanating from the banking system

• Potentially different banking sector shocks were hitting the

economy in the long expansion than occurred in the 1980s

• Evidence that shocks to the banking system have supply

implications that means high money growth does not always entail high inflation as in long expansion

• Partial evidence that the propagation role of corporate money could

have had significant effects on asset prices and investment