Stephen Millard

Financial innovation, macroeconomic stability and systemic crises

We present a general equilibrium model of intermediation designed to capture some of the key features of the modern financial system. The model incorporates financial constraints and state-contingent contracts, and captures the spillovers associated with asset fire sales during periods of stress. If a sufficiently severe shock occurs during a credit expansion, these spillovers can potentially generate a systemic financial crisis that may be self-fulfilling. Our model suggests that financial innovation and greater macroeconomic stability may have made financial crises in developed countries less likely than in the past, but potentially more severe.

The Network Topology of CHAPS Sterling

In this paper, we seek to understand the network topology of large-value interbank payment flows in the United Kingdom so as to understand better the risks associated with the system. We first examined the broad network topology of interbank payments in the United Kingdom. We found that, despite the fact that there are far fewer banks in the United Kingdom than in the United States, the structure of UK interbank payments is similar in certain respects to that of the United States, but that the tiered structure of the UK system implies rather different risk characteristics. We then looked at CHAPS and found that payment flows in CHAPS form a well-connected network whose properties change little day to day. This means that liquidity is able to flow efficiently around the network and that the network is quite resilient to shocks. This finding was backed up by examining the effects of a particular incident on the properties of the CHAPS network. In that particular instance, the effective removal of one bank for much of the day had little impact on the ability of other banks to make payments between one another.

Inflation dynamics with labour market matching: assessing alternative specifications

This paper reviews recent approaches to modeling the labour market and assesses their implications for inflation dynamics through both their effect on marginal cost and on price-setting behavior. In a search and matching environment, we consider the following modeling setups: right-to-manage bargaining vs. efficient bargaining, wage stickiness in new and existing matches, interactions at the firm level between price and wage-setting, alternative forms of hiring frictions, search on-the-job and endogenous job separation. We find that most specifications imply too little real rigidity and, so, too volatile inflation. Models with wage stickiness and right-to-manage bargaining or with firm-specific labour emerge as the most promising candidates.

Using estimated models to assess nominal and real rigidities in the United Kingdom

This paper aims to contribute to our understanding of inflation dynamics in the United Kingdom by estimating two dynamic stochastic general equilibrium models and assessing the role of nominal and real rigidities within them. We first obtain an empirical representation of the monetary transmission mechanism in the United Kingdom and then estimate the models by minimising the difference between this representation and its model equivalents. We find that both models can explain the data reasonably well without relying on undue amounts of price and wage stickiness.

The cyclicality of mark-ups and profit margins for the United Kingdom: some new evidence

In this paper, we assess the cyclicality of mark-ups and profit margins within the United Kingdom, at both the aggregate and industry level. We find that the private sector labour share moves countercyclically, suggesting that the aggregate mark-up moves procyclically. This result survives when we consider more sophisticated measures of the mark-up. And this result is also supported by industry-level data. We find that the aggregate market sector profit share moves procyclically and that the cyclical behaviour of profit margins is largely homogenous across industries. Nevertheless, there is some evidence that margins moved against the cycle in the late 1990s, starting to fall in 1997, whereas GDP growth did not peak until 2000. In tandem with these cyclical movements, we also find that the market sector profit share has trended upwards since 1970, in contrast to the aggregate mark-up, which fell over the same period.

The Role of Asset Prices in Transmitting Monetary and Other Shocks

In this paper framework is constructed within which the ability of asset prices to convey information about the underlying shocks hitting the economy can be assessed. An identified VAR is used to establish a set of stylised facts as to how asset prices respond to exogenous monetary policy movements. A theoretical model of the economy is then developed, and used to analyse how asset prices modelled within it respond to different shocks. Consumers in the model consume both market-produced and home-produced goods. There are two types of firms: those producing traded goods sold on competitive world markets and those producing non-traded goods. Non-traded goods producers face costs of adjusting their capital stocks and can only reset their prices once a year in a staggered fashion. It is shown that the model is able to replicate the stylised facts found in the empirical exercise. It is then shown how asset prices respond to shocks to productivity in the traded, non-traded and household production sectors and a shock to the world price of traded goods. With these results, it is possible to assess what information asset prices may give us about the shocks affecting the economy at any particular time.

Business Cycles and the Labour Market: Can Theory Fit the Facts?

The performance of six alternative models in accounting for UK labour market behaviour over the business cycle is examined. Models are assessed in terms of their ability to mimic actual cycle correlations and volatility, their success in replicating persistence, and their success in modelling asymmetries between expansions and downturns. Most are found to be successful in accounting for co-movements of key variables and in explaining asymmetries. But the models underpredict the volatility of employment and unemployment, produce too high a correlation between wages and employment, and do not capture the slow adjustment exhibited in the data.

Understanding the Macroeconomic Effects of Working Capital in the United Kingdom

The most recent recession has been associated with a financial crisis that led to a large widening of spreads and quantitative restrictions on lending. As well as affecting investment, such a credit contraction is likely to have had a large effect on the working capital positions of UK firms and this, in turn, is likely to have affected the United Kingdom’s supply potential, at least temporarily. However, the role of such disruptions in the business cycle is not well understood. In this paper we first document the behaviour of working capital in the United Kingdom. In order to understand the effects of working capital on macroeconomic variables, we then solve and calibrate a DSGE model that introduces an explicit role for the components of working capital (net cash, inventories, and trade credit). We find that this model produces the standard responses of macroeconomic variables to productivity shocks, but we also find that financial intermediation shocks, similar to those experienced in the United Kingdom post-2007, have persistent negative effects on economic activity; these effects are reinforced by reductions in trade credit. Our model also documents a crucial role for monetary policy to offset such shocks.

Tailwinds and headwinds: how does growth in the BRICs affect inflation in the G7?

In this paper, we analyse the impact of a persistent productivity increase in a set of countries – which we think of as the BRIC economies – on inflation in their trading partners, the G7. In particular we want to understand conditions under which this shock can lead to tailwinds or headwinds in the economies of trading partners. We build a three-country DSGE model in which there are two oil-importing countries (home and foreign) and one oil-exporting country. We perform several experiments where we try to disentangle the importance of different factors that can shape inflation dynamics in the home country when the foreign country is hit by a persistent productivity shock. These factors are wage stickiness, the role of the oil sector and its share in both consumption and production, foreign monetary policy and the degree of completeness of financial markets. We find that the tailwinds effect, lowering inflation in the home economy, dominates the headwinds effect as long as there is scope for borrowing and lending across countries and the foreign country’s production is not too oil intensive.

Wage Rigidities in an Estimated DSGE Model of the UK Labour Market

We estimate a New Keynesian model with matching frictions and nominal wage rigidities on UK data. We are able to identify important structural parameters, recover the unobservable shocks that have affected the UK economy since 1971 and study the transmission mechanism. With matching frictions, wage rigidities have limited effect on inflation dynamics, despite improving the empirical performance of the model. The reason is that with matching frictions, marginal costs depend on unit labour costs and on an additional component related to search costs. Wage rigidities affect both components in opposite ways leaving marginal costs and inflation virtually unaffected.