Quantitative methods for economic policy: limits

Transcript:Quantitative methods for economic policy: limits:
Quantitative methods for economic policy: limits and new directions Ignazio Visco Banca d’Italia Philadelphia, 25 October 2014 Outline Before the outbreak of the global financial crisis Limits unveiled Real-financial linkages Non-linearities Increased interconnectedness III. Quantitative challenges for macroeconomic policy Taking advantage of large datasets Modeling inflation expectations Identifying structural vs. cyclical developments Macroprudential policy 2 Before the outbreak of the global financial crisis Policymaking tools: from large-scale macroeconometric models to more structural, medium-size “microfounded” DSGE models Policy analysis framework in central banks: New Keynesian (NK) DSGE models Rational expectations (RE), representative agent, real/nominal rigidities Structural interpretation, complement to VAR analysis, positive and normative use Forecasting: large-scale models Flexibility, role of judgment Provide detailed description of the economy (pros and cons) 3 4 Before the outbreak of the global financial crisis Source: Banca d’Italia staff calculations *Obtained using a (non-centered) 10-year moving window Before the outbreak of the global financial crisis 5 Before the outbreak of the global financial crisis Financial resources collected by private sector (percentage of GDP) OTC and exchange-traded derivatives in US (notional value, trillion of USD) Source: Banca d’Italia staff calculations Source: Banca d’Italia staff calculations 6 Before the outbreak of the global financial crisis 7 The outbreak of the global financial crisis Source: Chung, Laforte, Reifschneider, Williams (2012) FRB/US Assessment of the Likelihood of Recent Events: History Versus 2007Q4 Model Projection 8 The outbreak of the global financial crisis Yet, explaining the dynamics of the crisis is crucial. Analytical toolbox for macroeconomic policy must be repaired and updated 9 Limits unveiled Real-financial linkages Non-linearities Increased interconnectedness 10 Limit #1: Real-financial linkages 11 Limit #1: Real-financial linkages No financial sector in pre-crisis, workhorse NK models used for policy analysis: one interest rate enough to track cyclical dynamics and support normative analysis Why? Efficient Markets Hypothesis (EMH) behind the scenes: market clearing and RE guarantee that all information is efficiently used. No need to explicitly model financial sector… …nonetheless, significant work on financial factors in pre-crisis NK models (e.g. financial accelerator) Important (overlooked) contributions in macroeconomic literature: e.g. debt deflation, financial crises 12 Limit #1: Real-financial linkages The crisis has ignited promising research in this area. Medium-scale NK models enriched along several dimensions: inclusion of financial intermediation and liquidity private-sector leverage over the cycle and role of institutions modelling unconventional monetary policy. Which channels? Liquidity, credit, expectations Departures from representative agent framework More attention to country-specific institutional features: