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Paul Hubert. Does Monetary Policy generate Asset Price Bubbles?

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Open seminar
Bank of Estonia
10 February 2017

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Paul Hubert. Does Monetary Policy generate Asset Price Bubbles?

  1. 1. 1 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Does Monetary Policy generate Asset Price Bubbles? Christophe Blot OFCE – Sciences Po Paul Hubert OFCE – Sciences Po Fabien Labondance Université de Franche-Comté & OFCE – Sciences Po Bank of Estonia 10 February2017
  2. 2. 2 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Motivation  Since 2009, huge increases in the size of central bank balance sheets  Worries about the concomitant rise in asset prices  Revival of the debate on the effect of monetary policy on bubbles
  3. 3. 3 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Motivation  However, not all asset price increases are bubbles.  Asset price = Fundamental + Bubble
  4. 4. 4 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Our research question  Does monetary policy generate bubbles?  We do not assess the effect of monetary policy on the fundamental or asset prices in general.  standard wealth and balance sheet channels  Definition: bubbles as deviations from fundamental (or trend)  Booms and busts  Over and undervaluation  …
  5. 5. 5 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Motivation  Why does the bubble component matter?  Risks of inefficient capital allocation  Financial stability risks  Bubble bursts are associated with financial crises and with deeper and longer recessions  If negative correlation with the fundamental, bubble goes against the transmission mechanism of MP
  6. 6. 6 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Related literature  The effect of monetary policy on asset price bubbles remains disputed  Borio and Lowe (2002), Cecchetti et al. (2003), Woodford (2012), Borio and Zabai (2016) and Juselius et al. (2016) are in favor of a “leaning against the wind” approach: expansionary monetary policy inflates asset price bubbles and restrictive policy can deflate them.  This debate echoes the critics raised by Taylor (2009): “too low for too long”. Challenged by Dokko et al. (2009), Kuttner (2012)  An alternative view, the “modified Jackson Hole consensus”, would not use monetary policy to deal with bubbles and financial stability issues and rely on macroprudential tools. See Gerlach (2010), Svensson (2012), Collard et al. (2017).  Gali-Gambetti (2015): Monetary tightening increases asset prices
  7. 7. 7 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Monetary policy in bubble models  No consensus about the impact of monetary policy on bubbles  In rational bubble models à la Blanchard and Watson (1982): -fundamental value equals the sum of expected cash-flows -bubble component is a rational stochastic deviation and grows with the discount factor. Gali (2014): bubbles are linked to monetary policy since the discount factor is related to the real interest rate.  In models accounting for financial frictions, Allen and Gale (2000, 2004) suggest that expansionary monetary policy would feed bubbles through the credit dynamics. See also Gruen et al. (2005) and Christiano et al. (2010).  In models emphasizing informational frictions, coordination failure, overconfidence, or heterogeneous beliefs, no much role for monetary policy as private agents’ behaviour is the key determinant of bubbles. See Abreu and Brunnermeier (2003) and Ofek and Richardson (2003)
  8. 8. 8 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po What we do in this paper 1. We identify bubble components  using a range of bubble models  from which we extract the first component  for stock, bond and housing markets  in the US and in the EA 2. We assess the impact of monetary policy on bubbles  we identify monetary policy shocks to the overall stance of monetary policy using Romer and Romer (2004)  we estimate linear and asymmetric effects (restrictive vs. expansionary shocks)  Results do not suggest a strong and stable causal link between monetary policy and asset price bubbles
  9. 9. 9 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Bubble identification  Main empirical challenge we face to investigate this question  No consensual bubble definition or method to identify them  Brunnermeier (2008):  “Bubbles are typically associated with dramatic asset price increases followed by a collapse.  Bubbles arise if the price exceeds the asset’s fundamental value”.  Fundamental approach: Basile & Joyce (2001), Gali (2014)  Statistical approach: Goodhart & Hofman (2008), Bordo & Jeanne (2002), Alessi & Detken (2011), Bordo & Landon-Lane (2013), Jorda et al. (2015)
  10. 10. 10 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Bubble identification  Agnostic method to identify the bubble component  We consider the various different alternatives  Fundamental approach  Structural  Econometric  Statistical approach  Model averaging using Principal Component Analysis  Focus on the common denominator of all models  Abstract from the idiosyncratic evolution of each model
  11. 11. 11 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Bubble identification  A range of 5 bubble models: 1. Cash-flow model adjusted for risk-premium (OLS) 2. Cash-flow model adjusted for risk-premium (ECM) 3. Data-rich information price model (OLS). Best prediction of the fundamental value from a set of macro and financial variables 4. Data-rich information price model (ECM)  For each of these 4 models, the bubble series is the cumulative sum of the (Christiano-Fitzgerald) filtered residuals, as long as these filtered residuals have the same sign. 5. Statistical approach: boom (resp. bust) period is defined as a deviation from the CF-trend above (resp. below) 1.5 SD Correlation between bubble components
  12. 12. 12 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Bubble identification  We obtain 5 bubble series for each market  stock, bond and housing prices  Bubble indicator: first component of a PCA of the 5 series  Maximizing the common variance among the 5 series  No prior about which bubble model is best  Idiosyncratic evolutions are dropped out  Model averaging with estimated weight (eigenvalues)  PCA estimation details & robustness  Overall bubble indicator: first component of a PCA of the 5*3 series  Sample period  US : January 1986 – August 2016  Euro area : January 1999 – June 2016
  13. 13. 13 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Bubbles in the United States
  14. 14. 14 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Bubbles in the Euro area
  15. 15. 15 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of monetary shocks  Empirical strategy  Local projections à la Jorda (2005) :  yt+h is the PCA bubble measure at the horizon h  𝜖 𝑡 is the monetary shock at time t. 𝑦𝑡+ℎ = 𝛼 + 𝛽ℎ 𝜖𝑡 + 𝜙ℎ,𝑖. 𝑦𝑡−𝑖 + 𝜂𝑡+ℎ 𝐾 𝑖=1
  16. 16. 16 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of monetary shocks  Identification of monetary shocks  Romer and Romer (2004): policy instrument orthogonal to CB (FOMC and ECB/Eurosystem) and private agents’ information (SPF) sets, and macro and financial variables.  Monetary instrument: overall monetary stance with shadow short rate (Wu & Xia, 2016)  Time series  Robustness:  (1) residuals from a forward-looking augmented Taylor rule  (2) high frequency identification based on event-study assumptions – daily change in the Krippner (2015) SSR on the day of policy decisions  (3) standard VAR
  17. 17. 17 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of monetary shocks  Hypotheses tested:  H0: “Leaning against the wind” hypothesis à la Borio or Christiano et al. (2010) Restrictive (expans.) monetary shocks reduce (increase) bubbles  H1: rational bubble models à la Gali (2014) Restrictive (expans.) policies increase (decrease) bubbles
  18. 18. 18 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of (restric.) shocks in the US
  19. 19. 19 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of (restric.) shocks in the EA
  20. 20. 20 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The asymmetric impact of monetary shocks  Non-linear effects: expansionary and restrictive monetary shocks  Local projections à la Jorda (2005) augmented with interaction terms to estimate asymmetric effects  𝜖 𝑡 𝑒𝑥𝑝 , 𝜖 𝑡 𝑟𝑒𝑠 are expansionary and restrictive monetary shocks 𝑦𝑡+ℎ = 𝛼 + 𝛽ℎ 𝑒𝑥𝑝 . 𝜖𝑡 𝑒𝑥𝑝 + 𝛽ℎ 𝑟𝑒𝑠 . 𝜖𝑡 𝑟𝑒𝑠 + 𝜙ℎ,𝑖. 𝑦𝑡−𝑖 + 𝜂𝑡+ℎ 𝐾 𝑖=1
  21. 21. 21 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Restrictive vs. Expansionary policies in the US  Weak evidence in favor of H1 for expansionary shocks  Driven by stock and bond markets
  22. 22. 22 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Restrictive vs. Expansionary policies in the EA  No evidence of non-linear effects
  23. 23. 23 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Insights on policy debates  Has QE created bubbles?  Is restrictive monetary policy able to deflate bubbles in normal times? – The “leaning against the wind” argument  Does expansionary monetary policy inflate bubbles in normal times? – The Taylor (2009) hypothesis
  24. 24. 24 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of unconventional policies Post-2008 sample  United States  No effect  Euro area  Only on the bond market
  25. 25. 25 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of the policy rate Pre-2008 sample / Restrictive policies  United States  No effects  Euro area  Only on the stock market
  26. 26. 26 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po The impact of the policy rate Pre-2008 sample / Expansionary policies  United States  Only on stock market  Rational bubble prediction  Euro area  Only on stock markets  Rational bubble prediction
  27. 27. 27 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Conclusion  We propose a synthetic indicator to identify asset price bubbles  We analyze the impact of monetary shocks on bubbles  US: monetary shocks have a positive effect on stock bubbles only  EA: no effect of monetary policy on bubbles  QE may be fueling a bond price bubble in the EA  The policy rate is not a relevant instrument to reduce bubbles overall (only on EA stock markets)  The policy rate is not responsible for growing bubbles
  28. 28. 28 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Additional slides
  29. 29. 29 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Correlation between bubble components Back r1 r2 r3 r4 r5 r1 r2 r3 r4 r5 r1 1 r1 1 r2 0.00 1 r2 -0.10 1 r3 0.14 0.37 1 r3 0.22 0.06 1 r4 -0.24 0.72 0.36 1 r4 -0.18 0.57 0.25 1 r5 0.49 0.41 0.38 0.20 1 r5 0.27 0.53 0.13 0.22 1 r1 r2 r3 r4 r5 r1 r2 r3 r4 r5 r1 1 r1 1 r2 -0.01 1 r2 0.00 1 r3 0.01 -0.09 1 r3 0.19 -0.02 1 r4 -0.02 0.96 -0.11 1 r4 0.22 0.83 -0.03 1 r5 0.33 0.13 -0.10 0.13 1 r5 0.41 0.25 0.14 0.28 1 r1 r2 r3 r4 r5 r1 r2 r3 r4 r5 r1 1 r1 1 r2 0.22 1 r2 0.59 1 r3 0.05 0.54 1 r3 0.05 -0.01 1 r4 -0.12 0.70 0.57 1 r4 0.16 0.64 -0.02 1 r5 0.16 -0.05 0.21 -0.14 1 r5 -0.32 -0.03 0.09 0.16 1 Housing Housing United States Euro Area Stock Stock Bonds Bonds
  30. 30. 30 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po PCA estimation Back Obs = 365 Obs = 205 Eigenvalue Proportion KMO stat Eigenvalue Proportion KMO stat PCA_Overall 3.50 0.23 0.61 PCA_Overall 3.79 0.25 0.63 PCA_Stock 2.27 0.45 0.60 PCA_Stock 1.96 0.39 0.49 PCA_Bonds 2.02 0.40 0.51 PCA_Bonds 2.07 0.41 0.47 PCA_Housing 2.22 0.44 0.55 PCA_Housing 1.96 0.39 0.46 Variable PCA_Stock PCA_Bonds PCA_Housing Variable PCA_Stock PCA_Bonds PCA_Housing r1 0.13 0.04 0.08 r1 0.04 0.30 0.53 r2 0.57 0.68 0.59 r2 0.61 0.58 0.67 r3 0.46 -0.15 0.54 r3 0.26 0.08 0.00 r4 0.50 0.68 0.59 r4 0.54 0.62 0.51 r5 0.45 0.20 0.01 r5 0.51 0.43 -0.12 Rotation: (unrotated=principal) Principal components/correlation Note: Kaiser-Meyer-Olkin measure of sampling adequacy Principal component scoring coefficients (eigenvectors) United States Euro Area Principal components/correlation Rotation: (unrotated=principal) Principal component scoring coefficients (eigenvectors) Overall Stock Bonds Housing Overall Stock Bonds Housing Overall 1 Overall 1 Stock 0.64 1 Stock -0.07 1 Bonds 0.73 0.29 1 Bonds 0.68 -0.24 1 Housing 0.74 0.18 0.34 1 Housing 0.84 0.08 0.37 1 Bubble: Stock Bonds Housing Bubble: Stock Bonds Housing Fundam. Fundam. Stock -0.11 Stock 0.23 Bonds -0.14 Bonds -0.07 Housing -0.14 Housing -0.01 Bubbles correlation Bubble-Fundamental correlation Bubbles correlation Bubble-Fundamental correlation United States Euro Area
  31. 31. 31 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Robustness Back Housing 0.74 0.18 0.34 1 Housing 0.84 0.08 0.37 1 Bubble: Stock Bonds Housing Bubble: Stock Bonds Housing Fundam. Fundam. Stock -0.11 Stock 0.23 Bonds -0.14 Bonds -0.07 Housing -0.14 Housing -0.01 Baseline: Stock Bonds Housing Baseline: Stock Bonds Housing 0.831 0.754 0.862 0.879 0.845 0.904 Contemp. 12m 36m Contemp. 12m 36m 0.999 0.999 0.998 0.999 0.999 0.984 0.999 0.996 0.970 0.961 0.956 0.934 0.969 0.972 0.999 0.999 0.879 0.914 1986-96 1996-06 2006-16 1999-05 2005-10 2010-16 0.957 0.995 0.996 0.974 0.765 0.881 0.890 0.984 0.972 0.674 0.760 0.974 0.918 0.964 0.991 0.978 0.942 0.848 Stock Bonds Housing Stock Bonds Housing 0.889 0.476 0.883 0.877 0.752 0.890 Stock Bonds Housing Stock Bonds Housing 0.806 0.774 0.575 0.889 0.622 0.834 Bubble-Fundamental correlation Bubble-Fundamental correlation Sensitivity tests PCA_Hous PCA_Bonds PCA_Stock PCA_Hous PCA_Bonds PCA_Stock PCA_Hous PCA_Bonds PCA_Stock PCA_Hous Subsample PCA estimation PCA_cumfil PCA_cumfil Removing r4 PCA_without r4 PCA_without r4 PCA_Bonds PCA_Stock DCF model with GMM Inverting steps CF parameter: min: 15 & max: 144 periods PCA_alt-CF PCA_alt-CF
  32. 32. 32 Does Monetary Policy generate Asset Price Bubbles? Paul Hubert, OFCE – Sciences Po Shadow rate shocks Euro area United States Back

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