Paul Hubert. Does Monetary Policy generate Asset Price Bubbles?

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Does Monetary Policy generate Asset Price Bubbles?

Paul Hubert, OFCE – Sciences Po


Christophe Blot OFCE – Sciences Po

Paul Hubert OFCE – Sciences Po

Fabien Labondance Université de Franche-Comté & OFCE – Sciences Po

Bank of Estonia 10 February2017

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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

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Motivation

However, not all asset price increases are bubbles. Asset price = Fundamental + Bubble

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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 …

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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

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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

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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)

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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

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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)

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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

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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

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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

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Bubbles in the United States

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Bubbles in the Euro area

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The impact of monetary shocks

Empirical strategy

Local projections à la Jorda (2005) :

yt+h is the PCA bubble measure at the horizon h

𝜖𝑡 is the monetary shock at time t.

𝑦𝑡+ℎ = 𝛼 + 𝛽ℎ𝜖𝑡 + 𝜙ℎ ,𝑖 .𝑦𝑡−𝑖 + 𝜂𝑡+ℎ

𝐾

𝑖=1

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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

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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

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The impact of (restric.) shocks in the US

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The impact of (restric.) shocks in the EA

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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

𝜖𝑡𝑒𝑥𝑝, 𝜖𝑡𝑟𝑒𝑠 are expansionary and restrictive monetary shocks

𝑦𝑡+ℎ = 𝛼 + 𝛽ℎ𝑒𝑥𝑝

. 𝜖𝑡𝑒𝑥𝑝

+ 𝛽ℎ𝑟𝑒𝑠 . 𝜖𝑡

𝑟𝑒𝑠 + 𝜙ℎ ,𝑖 .𝑦𝑡−𝑖 + 𝜂𝑡+ℎ

𝐾

𝑖=1

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Restrictive vs. Expansionary policies in the US

Weak evidence in favor of H1 for expansionary shocks Driven by stock and bond markets

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Restrictive vs. Expansionary policies in the EA

No evidence of non-linear effects

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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

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The impact of unconventional policies Post-2008 sample

United States No effect

Euro area Only on the bond market

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The impact of the policy rate Pre-2008 sample / Restrictive policies

United States No effects

Euro area Only on the stock market

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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

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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

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Additional slides

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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

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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)


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



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Robustness

Back

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

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

Bubbles correlation


Bubbles 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

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Shadow rate shocks

Euro area

United States

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Paul Hubert. Does Monetary Policy generate Asset Price Bubbles?

Economy & Finance

Transcript of Paul Hubert. Does Monetary Policy generate Asset Price Bubbles?