Paolo Gelain

Monetary and Macroprudential Policy with Multi-Period Loans

We study the implications of multi-period loans for monetary and macroprudential policy, considering several realistic modifications – variable vs. fixed loan rates, non-negativity constraint on newly granted loans, and possibility for the collateral constraint to become slack – to an otherwise standard DSGE model with housing and financial intermediaries. Our general finding is that multiperiodicity affects the working of both policies, though in substantially different ways. We show that multi-period contracts make the monetary policy less effective, but only under fixed rate mortgages, and do not generate significant asymmetry to its transmission. In contrast, the effects of macroprudential policy do not depend much on the type of interest payments, but exhibit strong asymmetries, with tightening having stronger effects than easening, especially for short and medium maturities.

Output Gap in Presence of Financial Frictions and Monetary Policy Trade-Offs

The recent global financial crisis illustrates that financial frictions are a significant source of volatility in the economy. This paper investigates monetary policy stabilization in an environment where financial frictions are a relevant source of macroeconomic fluctuation. We derive a measure of output gap that accounts for frictions in financial market. Furthermore we illustrate that, in the presence of financial frictions, a benevolent central bank faces a substantial trade-off between nominal and real stabilization; optimal monetary policy significantly reduces fluctuations in price and wage inflations but fails to alleviate the output gap volatility. This suggests a role for macroprudential policies.

Monetary and macroprudential policies in an estimated model with financial intermediation

We estimate the Smets and Wouters (2007) model augmented with the Gertler and Karadi (2011) financial intermediation sector on US data by using real and financial observables. Given the framework of the estimated model, we address the question whether and how standard monetary policy should interact with macroprudential policy in order to safeguard real and financial stability. For this purpose, monetary policy is described by a flexible inflation targeting regime using the interest rate as instrument, while the macroprudential regulator adopts a tax/subsidy on bank capital in a countercyclical manner in order to stabilize nominal credit growth and the output gap. We look at the gains from coordination between the central bank and the macroprudential regulator under alternative assumptions regarding the degree of importance assigned to output gap fluctuations in the macroprudential mandate. The results suggest that there can be considerable gains from coordination if the macroprudential regulator has been assigned a sufficiently high weight on output gap stabilization, i.e. the common objective with monetary policy. If, on the other hand, the main focus of the macroprudential mandate is on credit growth, the macroprudential policy maker can reach better outcomes, while the central bank does worse, in the absence of coordination. Therefore, whether and to which extent monetary policy gains from coordination with the macroprudential regulator depends on the relative weight assigned to output fluctuations in the macroprudential mandate. Our counterfactual analysis further confirms the effectiveness of the countercyclical macroprudential tax/subsidy in containing the amplification effects triggered by a financial shock, and suggests that having a macroprudential regulatory tool at work could have successfully avoided the massive drop in credit such as the one observed at the onset of the Great Recession.

A demand-driven search model with self-fulfilling expectations: the new 'Farmerian' framework under scrutiny

In this paper, we implement Bayesian econometric techniques to analyze a theoretical framework built along the lines of Farmer’s micro-foundation of the General Theory. Specifically, we test the ability of a demand-driven search model with self-fulfilling expectations to match the behaviour of the US economy over the last 30 years. The main findings of our empirical investigation are the following. First, all over the period, our model fits data very well. Second, demand shocks are the most relevant in explaining the variability of concerned variables. In addition, our estimates reveal that a large negative demand shock caused the Great Recession via a sudden drop of confidence. Overall, those results are consistent with the main features of the New `Farmerian’ Economics as well as to latest demand-side explanations of the finance-induced recession.

An Estimated Dynamic Stochastic General Equilibrium Model with Financial Frictions for Estonia

In this paper we estimate an extended version of the previously estimated small open economy dynamic stochastic general equilibrium model for Estonia (Gelain and Kulikov 2009). Here we introduce financial frictions, in the form of the so-called financial accelerator. Our main findings are: (1) financial frictions improve the ability of the model to fit the data; (2) the financial shock is relevant in explaining the variance of the macroeconomic variables; (3) impulse response functions describe the expected amplification of shocks, except for some of them (e.g., the technology shock); and (4) all of the nominal and real rigidities are important for obtaining a better fit of the model, with the exception of real wages.

Structural Factors, Unemployment and Monetary Policy: The Useful Role of the Natural Rate of Interest

We study the role of monetary policy in response to variations in unemployment due to structural factors, modeled as exogenous changes in matching efficiency and in the size of the labor force. We fi?nd that monetary policy should play a role in such a scenario. Both negative shocks to the matching efficiency and negative shocks to the labor force increase infl?ation, thus calling for an increase in the interest rate when policy is conducted following Taylor-type rules. However, the natural rate of interest declines in response to both shocks. The optimal Ramsey policy prescribes small deviations from price stability and lowers the interest rate, thus tracking the natural rate of interest in response to both shocks. Structural factors in the labor market may have contributed to the recent decline in the natural rate of interest in the US.