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28 October 2010

Discussion on “The Financial Accelerator under Learning and the Role of Monetary Policy” by Caputo, Medina and Soto. CEPR/ESI 14 th Annual Conference Harun ALP Central Bank of Turkey. 28 October 2010. The Paper.

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28 October 2010

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  1. Discussion on “The Financial Accelerator under Learning and the Role of Monetary Policy” by Caputo, Medina and Soto CEPR/ESI 14th Annual Conference Harun ALPCentral Bank of Turkey 28 October 2010

  2. The Paper • Financial acceleratoron the demand side of credit market is modelled by using BGG (1999) framework. • Borrowat a premium over the risk free rate,which is a function of the leverage of the borrower. • Departure from Rational Expectation assumption. • Adaptive Learning: Agents in economy act like econometricians. • Past data is discounted when agents update their expectations. • Combination of the two elements generates a sizable drop in output and asset prices in response to a negative shock.

  3. The Paper • Consider negative productivity shock under alternative monetary policy rules responding asset prices. • The expectations formation mechanism endogenously generates a significant deviation of asset prices from their fundamental values. • Responding aggressively only to inflationary pressures is still efficient in this environment.

  4. Calibration • Learning itself introduces a lot of inertia. • Milani (2005, 2007): In a New Keynesian model with learning, the estimated degrees of habits and indexations are close to zero. • Parameter values for indexations may be too high. • Estimate the model to see whether financial accelerator and learning are accepted by data.

  5. Instrument Rules • React to the level of asset prices or change in the asset prices. • Some fluctuations in asset prices are efficient in the presence of technology shocks. • React to the deviations of asset price from its fundamental value (flexible price with no financial frictions) • Technology shocks lead to changes in natural rate of interest. • React to the natural rate of interest.

  6. Instrument Rules • Optimized simple instrument rules under an ad-hoc loss function

  7. Optimal Policy • More formal welfare analysis • Consider optimal policy as a benchmark and look at whether simple instrument rules close to optimal. • The central bank tries to stabilize two distortions with one instrument (sticky price and wage vs. financial friction ).

  8. Shocks • Paper considers only technology shocks. • Under a different shock • How learning affects asset price behavior? • Are deviations from RE still large? • How different instrument rules perform? • The size of the shock affect the propagation in a nonlinear way due to the learning. • Consider the policy exercise under different values of shocks. • May affect the coefficients of the instrument rules.

  9. Discussion on “The Financial Shocks and Monetary Reactions in a New Keynesian Model” by de Walque and Pierrard

  10. The Paper • Extend a standard New Keynesian model to incorporate a banking sector including interbank market. • Modelling the supply side of credit market. • No borrowing friction in firm-bank relationship • Key features of the model: • Maturity mismatch. • Risk of default on interbank borrowing. • Collateralized borrowing from central bank. • Consider both conventional and unconventional monetary policy.

  11. Borrowing from the Central Bank • At equilibrium, no borrowing from central bank. • It is difficult to consider collateral requirements in a market which the borrowing does not exist at equilibrium. • Role for money may be needed.

  12. Interbank Market • Interbank loans are increasing following a negative security quality shock.

  13. Maturity Mismatch • 1-period borrowing from interbank and central bank vs. long-term lending to firms. • How the maturity mismatch affects the propagation of shocks? • The fire sale of the long-term assets.

  14. Unconventional Monetary Policy • Looser requirements for the quality of the collateral. • No cost of reducing the quality of collateral. • Why central banks do not use the unconventional policy in normal times? • Some cost needed.

  15. Conventional Monetary Policy • Reacting to a banking variable is beneficial. • Consider aggressive reaction to inflation in policy rule. • Consider rigorous welfare analysis. • In this model, central bank has two instrument. • Look at the optimal policy to see • How unconventional policy behave optimally? • How two instruments interact? • Benefits of using two instrument.

  16. To sum up • Both papers are very interesting and helpful in understanding the current financial crisis. • Both papers introduce a second friction for monetary policy to concern. • Depending on the model structure and the nature of the shock, the trade-off between two frictions may be significant. • Using additional instrument is beneficial.

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