A DSGE model with partial euroization: the case of the Macedonian economy

This paper describes the theoretical structure and estimation results for a DSGE model for the Macedonian economy. Having as benchmark the model of Copaciu et al. (2015), modified to allow for a fixed exchange rate, we are able to match relatively well the volatility observed in the data. Given the monetary policy regime in place, the debt deflation channel is more important relative to the financial accelerator one when compared to the flexible exchange rate case. The lack of balance sheet effects results in no significant differences in terms of net worth evolution across the two types of entrepreneurs when impulse response functions are evaluated. However, the shocks related to the financial sector appear to be especially important for investment, for the domestic interest rate and interest rate spreads, illustrating the relevance of including financial frictions in the model. With the exchange rate not acting as a shock absorber, the external shocks are more relevant for the CPI inflation and the domestic interest rate. The drop in GDP associated with the pandemic mainly reflects the negative innovations to the consumption preference shock and to the permanent technology shock.

Frequency vs. Size of Bank Fines in Local Credit Markets

We examine how banking supervisors affect credit at the local level by charging fines to individual banks. Using a macro approach to capture the direct effect on the fined bank and the indirect effect on the other banks operating in the local credit market, we estimate reputational, reallocation and balance sheet effects on Italian provinces over the period 2005–2016 by a fixed effects model and instrumental variables. Provincial gross bank loans expand after a fine independently of its size. The impact of fine frequency depends on the size of the provincial banking sector, but neither on bank governance/ownership nor crises. No statistically significant evidence supports reputational or balance sheet effects. Instead, our results suggest that it would behoove bank supervisors to favor frequency over size of bank fines. Bank fines seem to work more like a good housekeeping seal of approval, enhancing transparency and effective banking practices.

Don't Put All Your Eggs in Foreign Baskets

I analyze the sluggish response of exports during and after financial crises using firm level data for two countries-episodes: Argentina 2001 and Peru 1998 crises. I find that both incumbent exporting firms do not expand and that there’s no significant entry of new exporting firms. Furthermore, I present evidence that suggests that the export elasticity to the real exchange rate is asymmetric, smaller for depreciations than for appreciations. I build and estimate a DSGE model for a small open economy where exporting entrepreneurs are subject to financial frictions and balance sheet effects in order to try and explain these stylized facts. Although these frictions decrease the response of exports to movements in the exchange rate, I use computational exercises to show that they are not enough to explain the empirical results.

Debt and Financial Sentiment. Early Keynes on Balance Sheet Effects of Asset Price Changes

Summary: The paper explores the link between financial sentiment and private debt, using Keynes’s A Treatise on Money as a conceptual backdrop. In responding to his critics after the publication of his General Theory Keynes famously talked about unexpected, violent changes in conventional asset valuations resulting from doubts with a life of their own boiling over onto the surface. Such doubts he argued influenced the size of what he called the bear position, which in his Treatise on Money he took to be an index of financial sentiment. Minsky also drew from Keynes’s earlier work when he famously argued that optimistic future expectations raise asset prices, creating a margin that enables firms to access finance in the present. However, neither asset price speculation nor shifting financial sentiment over the business cycle received in his work the kind of attention they did in Keynes’s Treatise. The focus of this paper is what Minsky left unexplored on financial sentiment and the balance sheet effects of asset price changes in the Treatise, which sheds light on when private debt can become excessive. The central insight is that financial sentiment begins to diverge when economic performance unexpectedly falls short, raising doubts that current asset prices are excessive. While the economy might be debt-led when financial sentiment is strong it tends to become debt-burdened as sentiment weakens.

Structural Transformation, Deep Downturns, and Government Policy

Most recessions are a result of some shock to the economic system, typically amplified by financial accelerators, and leading to large, persistent balance sheet effects on households and firms. Over time, however, the balance sheets get restored. Even banks recover. But episodically, the ‘shock’ is deeper. It is structural. Among advanced countries, such large economic transformations include the movement from agriculture to manufacturing (completed in the twentieth century), and the more recent movement from manufacturing to the service sector. The associated downturns are longer lasting. The usual tools for restoring growth, particularly monetary policy, are of only limited efficacy. Policies have to be designed to facilitate such transformations: markets on their own typically do not do well. This chapter explains why such transformations are associated with persistently high unemployment, and what kinds of government policies are needed. It looks at the lessons of the Great Depression both for the advanced countries and the developing countries today as they go through their structural transformations.