Banque Nationale De Belgique Sa · EURONEXT:BNB
Banque Nationale De Belgique Sa — National Bank of Belgium — Technical Presentation (February 2005)
48 slides from Banque Nationale De Belgique Sa's technical presentation, February 2005
Slide 1: Should Central Bankers Respond to Asset Price Movements: Theory & Evidence
Should Central Bankers Respond to Asset Price Movements: Theory & Evidence Stephen Cecchetti International Business School Brandeis University
Slide 2: Overview
Overview Can central bankers improve economic performance by paying attention to asset prices (in addition to inflation and output)? If so, how should they do it? Using interest rates Alternative “unconventional policies” What have policymakers actually done? February 2005 National Bank of Belgium 2
Slide 3: Main conclusions
Main conclusions Can central bankers improve economic performance by paying attention to asset price (in addition to inflation and output)? Yes, reacting to asset prices can reduce the variability of both inflation and output (about their target levels). February 2005 National Bank of Belgium 3
Slide 4: Main conclusions
Main conclusions Is it possible to identify asset price misalignments (and bubbles)? Bubbles exit and yes they are hard to measure. But central banks have no choice but to forecast asset prices, and measuring misalignments is no harder than estimating the output gap or the equilibrium real interest
Slide 5: Main conclusions
Main conclusions Are there alternative, less conventional, policy responses for addressing perceived asset price misalignments? There is some evidence that changes in margin requirements and other unconventional policy tools will dampen asset price volatility. February 2005 National Bank of Belgium
Slide 6: Main conclusions
Main conclusions What have policymakers done? It appears that they react to measures related to bubbles and financial system stress. February 2005 National Bank of Belgium 6
Slide 7: The Road Map
The Road Map 1. Bubbles a. Arguments for why they exist b. Impact on the Economy 2. Models Examining the Efficacy of Reacting a. Background: What Central Bankers Do b. Conventional/interest rate response c. Non-conventional responses 3. Estimating Reactions February 2005 National Bank of Belgium 7
Slide 8: The US Postal Service will honor the 24 cent value of this stamp
The US Postal Service will honor the 24 cent value of this stamp. Today, collectors value this stamp at approximately $150,000. February 2005 National Bank of Belgium 8
Slide 9: Bubbles
Bubbles Do Bubbles Exist? Easy to argue that prices of collectables reflect deviations from fundamental value Printing errors in stamps are worth more Perfect forgery’s are worth less There should be a presumption in favor of bubbles existing. February 2005 National Bank of Belgium 9
Slide 10: What About Financial Assets?
What About Financial Assets? Argument against bubbles is based on arbitrage. Assume that we know there is a bubble Someone will short the asset Increased desire to sell drives the price down The bubble is eliminated February 2005 National Bank of Belgium 10
Slide 11: When Arbitrage Fails
When Arbitrage Fails Holding short positions can be difficult or impossible. Requires constantly posting additional margin as prices rise Risk of being squeezed How do you short residential housing? Information asymmetries Too many open-ended funds Managers have short horizons Benchmark to average r
Slide 12: February 2005 National Bank of Belgium
February 2005 National Bank of Belgium 12
Slide 13: Bubbles Distort Economic Decisions
Bubbles Distort Economic Decisions Investment: Financing is too cheap, especially in sectors where the bubble is biggest. Consumption: False impression of wealth Housing price increases temporarily alleviate liquidity constraints, making borrowing possible. But with the collapse, there is debt is un
Slide 14: Bubbles Distort Economic Decisions
Bubbles Distort Economic Decisions Fiscal Policy: Increase in revenue leads to tax cuts and expenditure increases Pension Funds: Book high returns, become over funded, so company sponsors can make withdrawals Insurance Companies: High returns make reserves look big February 2005 National Bank of Bel
Slide 15: Bubbles Distort Economic Decisions
Bubbles Distort Economic Decisions Potential GDP: Over investment in high productivity growth sectors makes both real growth and productivity look higher than it actually is. Balance Sheet of Financial Institutions: Deterioration of the quality of assets, placing banks at risk. February 2005 Nationa
Slide 16: Consequences of Bubbles
Consequences of Bubbles Output rises and then falls Depending on the exact mechanism, potential output can rise and fall as well. Financial Intermediaries can be impaired February 2005 National Bank of Belgium 16
Slide 17: Considerations
Considerations Theoretical Models Logical Arguments Evidence of Response February 2005 National Bank of Belgium 17
Slide 18: Theoretical Models
Theoretical Models Bernanke and Gertler Dupor Gruen, Plumb, and Stone February 2005 National Bank of Belgium 18
Slide 19: The Bernanke-Gertler model
The Bernanke-Gertler model Firm finance: 1. Combination of internal funds and external borrowing. 2. Credit market frictions make external finance more costly. 3. External borrowing premium depends on firm’s balance sheet position. February 2005 National Bank of Belgium 19
Slide 20: The Bernanke-Gertler model
The Bernanke-Gertler model Consider an increase in a firm’s share price: Raises net worth of the firm’s owners Improves firm’s creditworthiness Reduces external finance premium Increases borrowing and investment February 2005 National Bank of Belgium 20
Slide 21: The Bernanke-Gertler model
The Bernanke-Gertler model Consequences of Financial Accelerator: Monetary policy, through it’s impact on the real interest rate, can move asset prices affecting borrowing costs. Asset Price Misalignments cause investment boom-bust cycles. February 2005 National Bank of Belgium 21
Slide 22: The Bernanke-Gertler model
The Bernanke-Gertler model Conclusions: Focus on inflation is important Reacting to asset prices can improve performance February 2005 National Bank of Belgium 22
Slide 23: Dupor: Nominal versus Asset Price Stabilization
Dupor: Nominal versus Asset Price Stabilization The model is necessarily complex The intuition is straightforward Two marginal conditions Atemporal Consumption – Leisure: distorted by nominal price rigidity Intertemporal Investment: distorted by asset price bubble Policymaker has one instrument Resu
Slide 24: Gruen, Plumb, and Stone
Gruen, Plumb, and Stone Activist raising interest rates initially to combat the bubbles initial effects. But then lowers interest rates quickly in anticipation of the bubble bursting. As the bubble grows, the potential negative impact of its eventual bursting will increase. Case for tightening in re
Slide 25: Arguments Against Activism
Arguments Against Activism “I believe that if central bankers allow the fluctuations in asset market prices to affect their decisions, it may distract them from concentrating on some combination of output growth and inflation. The focus of the Federal Reserve on the level of equity prices in 1929 cl
Slide 26: Arguments Against Activism
Arguments Against Activism “I believe that if central bankers allow the fluctuations in asset market prices to affect their decisions, it may distract them from concentrating on some combination of output growth and inflation. The focus of the Federal Reserve on the level of equity prices in 1929 cl
Slide 27: 1929 Revisited
1929 Revisited Crash was caused by Fed behavior They sought to bring prices down by keeping banks from lending that would be used to purchase stock. FRB Board members believed Speculation was causing stock prices to rise Result was damaging the real economy February 2005 National Bank of Belgium 27
Slide 28: 1929 Federal Reserve Board statement
1929 “The Federal Reserve Act does not, in the opinion of the Federal Reserve Board, contemplate the use of the resources of the Federal reserve banks for the creation or extension of speculative credit. A member bank is not within its reasonable claims for rediscount facilities at its Federal reser
Slide 29: Fed Confusion and Market Response
Fed Confusion and Market Response FR Board thought the increase in debt used real resources decreasing real investment Following the statement, interest rates on broker loans skyrocketed 26 Mar 1929 the overnight rate rose to 20% and stock prices fell 10% FRBNY President & 1st National City Bank Pre
Slide 30: Current Arguments Against Activism
Current Arguments Against Activism Difficult to identify imbalances Risk that responsive policy is destabilizing Difficult to provide public justification February 2005 National Bank of Belgium 30
Slide 31: Identifying Misalignments
Identifying Misalignments Central bankers have no extra information or expertise: If you’re so smart, why aren’t you rich? Market expectations are unobservable February 2005 National Bank of Belgium 31
Slide 32: Estimating asset price misalignments: Too hard to be practical?
Estimating asset price misalignments: Too hard to be practical? Estimating potential output also requires estimates of trend productivity growth and equity risk premium But forecasts for inflation and real growth require forecasts of Investment Equity Prices! Current Account Exchange Rates! Interest
Slide 33: Risk of Destabilizing the Economy
Risk of Destabilizing the Economy Qualitative knowledge is great Quantitative knowledge is not. Imprecision argues for caution, not paralysis February 2005 National Bank of Belgium 33
Slide 34: Communication
Communication Responding to bubbles stabilize growth and inflation Clarity of goals should make explanation possible. February 2005 National Bank of Belgium 34
Slide 35: Regulation vs. Monetary Policy
Regulation vs. Monetary Policy Why not adjust regulations instead? Possibilities Cyclically sensitive capital requirements Difficult to implement Interest rates can respond to banking system stress Vary Margin requirements Argument against this is that it is ineffective Why not try? February 2005 Na
Slide 36: What Central Banks Do
What Central Banks Do 1997-98 Greenbook: Forecast a 10 to 20 percent drop in the stock market February 2005 National Bank of Belgium 36
Slide 37: Alan Greenspan's Speech at the American Enterprise Institute
Alan Greenspan’s Speech at the American Enterprise Institute "[H]ow do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into moneta
Slide 38: "Irrational Exuberance"
“Irrational Exuberance” Did public silence imply private indifference? Were officials discussing and reacting to asset price movements & banking system conditions? What was the FOMC saying and doing? February 2005 National Bank of Belgium 38
Slide 39: What Was the FOMC Saying?
What Was the FOMC Saying? Figure 1: Keyword Ratio and Equity Risk Premium 4 5 Keyword Ratio 4 Equity Risk 3 Premium 3 2 2 1 1 0 0 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 Time Keyword Ratio (left scale) Equity Risk Premium (right scale) Correlation = -0.42 (s.e.=0.07) February 200
Slide 40: What Was the FOMC Doing?
What Was the FOMC Doing? Examine a forward-looking Taylor Rule rt* r* [ E ( t ,k | t) * ] y [ E ( yt ,q | t )] rt = (L)rt-1 + (1- )+ t Policymakers respond smoothly to a combination of expected deviation of inflation from its target and the output gap. February 2005 National Bank of Belgium 40
Slide 41: Augmented-Taylor Rule
Augmented-Taylor Rule Add Stock market bubble Banking System stress rt* r* [ E ( t ,k | t) * ] y [ E ( yt , q | t )] b b t s s t February 2005 National Bank of Belgium 41
Slide 42: Table 1: Augmented-Taylor Rule for the U.S.
Table 1: Augmented-Taylor Rule for the U.S. (1990 Q1 to 2003 Q1) Inflation Output Equity Banking Sum of Test of Goodness Inflation Gap Gap Market System adjustment Over- of Fit Index Bubble Stress lags, identifying (R 2) y Restrictions Consumer 0.34 0.57 0.23 0.51 0.80 Price Index (0.30) (0.00) (0.0
Slide 43: Chairman Greenspan
Chairman Greenspan: “It seems reasonable to generalize from our recent experience that no low-risk, low-cost, incremental monetary tightening exists that can reliably deflate bubble. But is there some policy that can at least limit the size of the bubble and, hence, its destructive fallout? From the
Slide 44: Reactions
Reactions Immediately harsh. “Given the problems of the intervening years how can he say that the FOMC shouldn’t even have tried?” More Charitable reaction: “They tried and failed. Maybe they should have done more.” February 2005 National Bank of Belgium 44
Slide 45: State of the Debate
State of the Debate Property vs. Equity Price Bubbles Property price collapses are more serious Does the structure of the financial system matter? February 2005 National Bank of Belgium 45
Slide 46: Comparing Equity and Property Bubbles
Comparing Equity and Property Bubbles Equity Property Size Impact Size Impact Boom +104.6 +0.38 +34.4 +0.73 Bust -44.0 -1.77 -32.5 -2.36 Definitions: Equity Booms +40%, Busts -30% Property Booms +15%, Busts -15% Data are from 23 countries February 2005 National Bank of Belgium 46
Slide 47: Financial Structure
Financial Structure Preliminary Results Suggest: During housing booms, GDP growth is higher in economies where financial markets are more important. During housing busts, GDP declines by more in economies where banks are less important. February 2005 National Bank of Belgium 47
Slide 48: The Picture of a Cautious Central Banker
The Picture of a Cautious Central Banker The Suspenders (Then) ECB President Wim Duisenberg, wears both a belt and suspenders. There’s no chance his pants will fall down! The Belt February 2005 National Bank of Belgium 48
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