Krzysztof Makarski

Credit crunch in a small open economy

We construct an open-economy DSGE model with a banking sector to analyze the impact of the recent credit crunch on a small open economy. In our model the banking sector operates under monopolistic competition, collects deposits and grants collateralized loans. Collateral effects amplify monetary policy actions, interest rate stickiness dampens the transmission of interest rates, and financial shocks generate non-negligible real and nominal effects. As an application we estimate the model for Poland–a typical small open economy. According to the results, financial shocks had a substantial, though not overwhelming, impact on the Polish economy during the 2008/09 crisis, lowering GDP by approximately 1.5 percent.

The Anatomy of Standard DSGE Models with Financial Frictions

In this paper we compare two standard extensions to the New Keynesian model featuring financial frictions. The first model, originating from Kiyotaki and Moore (1997), is based on collateral constraints. The second, developed by Carlstrom and Fuerst (1997) and Bernanke et al. (1999), accentuates the role of external finance premia. Our goal is to compare the workings of the two setups. Towards this end, we tweak the models and calibrate them in a way that allows for both qualitative and quantitative comparisons. Next, we make a thorough analysis of the two frameworks using moment matching, impulse response analysis and business cycle accounting. Overall, we find that the business cycle properties of the external finance premium framework are more in line with empirical evidence. In particular, the collateral constraint model fails to generate hump-shaped impulse responses and, for some important variables, shows moments that are inconsistent with the data by a large margin.

Macroprudential Policy and Imbalances in the Euro Area

Since its creation the euro area suffered from imbalances between its core and peripheral members. This paper checks whether macroprudential policy applied to the peripheral countries could contribute to providing more macroeconomic stability in this region. To this end we build a two-economy macrofinancial model and simulate the effects of macroprudential policy (regulating the loan-to-value ratio) when the core and the periphery are exposed to asymmetric shocks. We find that macroprudential policy is able to substantially lower the amplitude of credit and output fluctuations in the periphery. However, for the policy to be effective, it should be decentralized. Very similar conclusions hold when welfare is considered as the optimality criterion.

The Macroeconomic Effects of Losing Autonomous Monetary Policy after the Euro Adoption in Poland

There are many issues associated with the Eurozone accession of Poland. The goal of this paper is to analyse one, but very important aspect, namely - the macroeconomic impact of the loss of autonomous monetary policy. In order to answer this question, we build a two country DSGE model with sticky prices. We begin by evaluating the performance of our model. Next, we investigate how joining the Eurozone will affect the business cycle behaviour of the main macroeconomic variables in Poland. We find that the Euro adoption will have a noticeable impact on the Polish economic fluctuations. In particular, the volatility of domestic output increases and the volatility of inflation decreases. Also, in order to quantify the effect of the Euro adoption, we compute the welfare effect of this monetary policy change. Our findings suggest that the welfare cost is not large.

Credit Crunch in a Small Open Economy

We construct an open-economy DSGE model with a banking sector to analyse the impact of the recent credit crunch on a small open economy. In our model the banking sector operates under monopolistic competition, collects deposits and grants collateralized loans. Collateral effects amplify monetary policy actions, interest rate stickiness dampens the transmission of interest rates, and financial shocks generate non-negligible real and nominal effects. As an application we estimate the model for Poland - a typical small open economy. According to the results, financial shocks had a substantial, though not overwhelming, impact on the Polish economy during the 2008/09 crisis, lowering GDP by approximately 1.5 percent.

A Penalty Function Approach to Occasionally Binding Credit Constraints

Empirical evidence suggests that contractionary monetary and macroprudential policies have stronger effects than expansionary ones. We introduce this feature into a structural DSGE model with financial frictions. The asymmetry results from the assumption of occasionally binding credit constraints which we introduce via a penalty function. Our simulations show that a large loan-to-value ratio (our macroprudential tool) tightening can have a much stronger impact on the economy than a loosening of the same size. In contrast, small policy innovations, whether expansionary or contractionary, have effects of almost equal magnitude. Our approach provides an interesting way of modeling asymmetric effects of financial frictions for policy purposes.

Assessing macro-financial linkages: a model comparison exercise

The recent global financial crisis has increased interest in macroeconomic models that incorporate financial linkages. Here, we compare the simulation properties of five mediumsized general equilibrium models used in Eurosystem central banks which incorporate such linkages. The financial frictions typically considered are the financial accelerator mechanism (convex spread costs related to firms leverage ratios) and collateral constraints (based on asset values). The harmonized shocks we consider illustrate the workings and mechanisms underlying the financial-macro linkages embodied in the models. We also look at historical shock decompositions of real GDP growth across the models since 2005 in order to shed light on the common driving factors underlying the recent financial crisis. In these exercises, the models share qualitatively similar and interpretable features. This gives us confidence that we have some broad understanding of the mechanisms involved. In addition, we also survey the current and developing trends in the literature on financial frictions.

The business cycle implications of the euro adoption in Poland

This article analyses the macroeconomic impact of the loss of autonomous monetary policy after the euro adoption in Poland. Using a two-country Dynamic Stochastic General Equilibrium (DSGE) model with sticky prices and wages, we find that the euro adoption will have a noticeable impact on the magnitude of economic fluctuations. In particular, the volatility of output, interest rate, consumption and employment is expected to increase while the volatility of inflation should decrease. Also, in order to quantify the effect of the euro adoption, we compute the welfare effect of this monetary policy change. Our findings suggest that the welfare cost is not large.

Monetary Policy in a Non-Representative Agent Economy: A Survey

It is well known that central bank policies affect not only macroeconomic aggregates, but also their distribution across economic agents. Similarly, a number of papers demonstrated that heterogeneity of agents may matter for the transmission of monetary policy to macro variables. Despite this, the mainstream monetary economics literature has so far been dominated by dynamic stochastic general equilibrium models with representative agents. This paper aims to tilt this imbalance towards heterogeneous agents setups by surveying the main positive and normative findings of this line of the literature, and suggesting areas in which these models could be implemented. In particular, we review studies that analyse the heterogeneity of (i) households’ income, (ii) households’ preferences, (iii) consumers’ age, (iv) expectations and (v) firms’ productivity and financial position. We highlight the results on issues that, by construction, cannot be investigated in a representative agent framework and discuss important papers modifying the findings from the representative agent literature.

Monetary and macroprudential policy with foreign currency loans

In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents’ welfare. To this end we construct a small open economy model with financial frictions where housing loans can be denominated in domestic or foreign currency. We calibrate the model for Poland - a typical small open economy with a large share of foreign currency loans (FCL) - and use it to conduct a series of simulations. They show that FCLs negatively affect the transmission of monetary policy. In contrast, their impact on the effectiveness of macroprudential policy is much weaker but positive. We also demonstrate that FCLs increase welfare when domestic interest rate shocks prevail and decrease it when risk premium (exchange rate) shocks dominate. Under a realistic calibration of the stochastic environment FCLs are welfare reducing. Finally, we show that regulatory policies that correct the share of FCLs may cause a cyclical slowdown.