Reassessing Macroeconomics from aReassessing Macroeconomics from a Monetary Perspective

byPiti Disyatat

B k f Th il dBank of Thailand

November 28, 2013

M i Th iMain Thesis

Failure of mainstream theory comes from underlying conceptual framework that gives no meaningful role for money and finance

“Real” versus “monetary” analysis

Three examples

Money and credit creation

Current  account and capital flows

Potential output

2

3

Wh D W N d M ?Why Do We Need Money?

Frictions in the process of exchange

Double coincidence of wants

• Inter‐ and intra‐temporal dimension

Limited commitment

• Transferability of contracts

Imperfect record‐keeping

“Evil is the root of all money” (Kiyotaki and Moore (2002))

4

C l P di f R l A l iConceptual Paradigm of Real Analysis

Walrasian Auctioneer

Frictionless process of exchange

• No informational and trade frictions

N d f lt• No default

• Exchange occurs only once, after equilibrium price determined

Schumpeter “veil of money”; Money neutrality 

Perfect barter: No role for money

5

C l P di f R l A l iConceptual Paradigm of Real Analysis

Money artificially grafted on

Short‐cuts for role of money

• Money in utility function

M i d ti f ti• Money in production function

• Cash in advance constraint

Introduction of money reduces set of feasible allocations!Introduction of money reduces set of feasible allocations!

Merely a unit of account 

Real models disguised as monetary ones

6

C l P di f R l A l iConceptual Paradigm of Real Analysis

Rational representative agent

No meaningful interaction

• Trade with own budget constraint

N h di di ti f il• No herding or coordination failures

Stable with shocks

A h d t ilib iAnchored to equilibrium

• Negative feedback loops

Focus on flowsFocus on flows

• Little role for stock imbalances and balance sheets

Absence of bubbles, financial imbalances, financial cycles, financial crises

7

Wh I M E i ?Where Is My Engine?

8

Monetary AnalysisMonetary Analysis

Money is not a “veil” 

F i ti i f h h l i tFrictions in process of exchange have real impact

• Boom/bust cycles, coordination failures

Di ilib iDisequilibrium

Dynamic

T di t “f l i ”Trading at “false prices”

• Not continuous market clearing

Importance of stocksImportance of stocks

• Cumulative processes (imbalances)

9

Monetary AnalysisMonetary Analysis

Inherently unstable

Capacity for self‐regulation limited

• Positive feedback loops

Complex dynamical systemComplex dynamical system

• Externality and fallacy of composition

Endogenously generated instabilityEndogenously generated instability 

Finance and real economy inextricably intertwined

10

Real and Financial Cycle IntertwinedReal and Financial Cycle Intertwined

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Example 1

Credit and Money Creation

Money multiplier and the transmission mechanism

Disyatat (2008, 2010); Borio and Disyatat (2010) 

“Real” model of lending

Must acquire resource before lending

• Constraint on lending is deposits or reserves

• Credit and money driven by real factors

“Monetary” model of lending

Loan creates deposits (purchasing power)

• No quantitative constraint on lending except through capital requirementsrequirements

Credit drives real economy

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Financial system elasticity

AWorld of Credit

Example 1

A World of CreditPublic debt and bank credit to private non‐financial sector for 17 advanced countries

13Source:  Jordà, Ò., M. Schularick and A. Taylor (2013)

Current Account and Capital Flows

Example 2

Current  Account and Capital Flows

“Real” intermediation model extended to open economy

Y = C + I + G + NXY = C + I + G + NX

Y – C – G – I = NX

S – I = NX = Current AccountS Cu e t ccou t

“Excess saving” view

• Global imbalances  cause of crisis (King (2010), Bernanke (2009), Krugman (2009))

• Global saving glut (Bernanke 2005))

S f t h t (C b ll t l (2010))• Safe asset shortage (Caballero et al. (2010))

Focus on current account and net capital flows

• Countries with roughly balanced current account exert• Countries with roughly balanced current account exert neutral influence on dynamics of global financial flows

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Global Imbalances

Example 2

Global ImbalancesCurrent account balance as a % of world GDP

2.50%

1.50%

2.00%Oil Exporting Euro Area

EMA United States

Japan China

0.50%

1.00%

‐0.50%

0.00%

‐1.50%

‐1.00%

‐2.00%

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

15

1 2 2 2 2 2 2 2 2 2 2 2 2 2

Source: IMF; Emerging market Asia = China, Taiwan, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand

E S i Vi C i i

Example 2

Excess Saving View: Critique

Focus on current account misplaced

Current account captures only trade‐related flows

Gross flows are much larger 

• All financial transactions generate offsetting gross flows

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Gross Capital Flows

Example 2

p(percent of world GDP)

35

40

Oil exporters

25

30Emerging Europe

Emerging Asia

Advanced economies

15

20

5

10

-5

0

5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2

19

9

19

9

19

9

19

9

19

9

20

0

20

0

20

0

20

0

20

0

20

0

20

0

20

0

20

0

20

0

20

1

20

1

20

1

Source: IMF

Bulk of cross‐border gross flows involve advanced economies

17

g

Unlikely that EM flows determine global financial conditions

US Capital Flows

Example 2

US Capital Flows(As a percentage of US GDP)

20 Gross Outflow

10

15Gross Inflow

Current Account

0

5

10

‐5

0

‐15

‐10

97 97 98 99

00 00 01 02

03 03 04 05

06 06 07 08

09 09 10 11

12 12

Jan‐9

Oct‐9

Jul‐9

Apr‐9

Jan‐0

Oct‐0

Jul‐0

Apr‐0

Jan‐0

Oct‐0

Jul‐0

Apr‐0

Jan‐0

Oct‐0

Jul‐0

Apr‐0

Jan‐0

Oct‐0

Jul‐1

Apr‐1

Jan‐1

Oct‐1

Gross inflows roughly 3 times larger than net before the crisis

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Gross inflows roughly 3 times larger than net before the crisis

Net inflows fell by $20 billion in 2008, gross inflows fell by $1.6 trillion!

US Capital Flows

Example 2

Gross capital inflows by region

(As a percentage of US GDP)

15

10

5

5

0

Japan  OPEC China Canada

‐10

‐5 China Canada United Kingdom Euro area

Most important source was Europe not emerging markets

Oct‐99

Jul‐00

Apr‐01

Jan‐02

Oct‐02

Jul‐03

Apr‐04

Jan‐05

Oct‐05

Jul‐06

Apr‐07

Jan‐08

Oct‐08

Jul‐09

Apr‐10

Jan‐11

Oct‐11

Jul‐12

Most important source was Europe, not emerging markets

Flows from Asia stabilising force during crisis 19

B i C B d B ki

Example 2

Boom in Cross‐Border Banking 

18USD Trillions

14

16

Developed Europe (non-euro)

Euro

10

12Euro

Other Developed

Developing

4

6

8

0

2

4

0

Dec

.95

Sep

.96

Jun

.97

Mar

.98

Dec

.98

Sep

.99

Jun

.00

Mar

.01

Dec

.01

Sep

.02

Jun

.03

Mar

.04

Dec

.04

Sep

.05

Jun

.06

Mar

.07

Dec

.07

Sep

.08

Jun

.09

Mar

.10

Dec

.10

Sep

.11

Jun

.12

Mar

.13

20

External claims (loans and deposits) of BIS reporting country banks on borrowers in country group listed. (Source: BIS Locational Banking Statistics, Table 7A)

E S i Vi C i i

Example 2

Excess Saving View: Critique

Focus on current account misplaced

Reveal little about global financing patterns

• An economy running a balanced current account can t ll b d i l l i t di ti ti itactually be engaged in large‐scale intermediation activity

Crisis was not driven by a disorderly unwinding of global imbalances but dislocation in the global intermediation chaing

F l b l fi i l bili li i ddFor global financial stability, policies to address current account imbalances cannot be the priority

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E i i P i l O

Example 3

Estimating Potential Output

Potential output as sustainable level of activity

Prevailing measures focus on inflation

But unsustainable credit boom may not result in inflation 

• Outward supply shifts often accompany credit cycle

• Appreciation tames price pressure

• Sectoral misallocation• Sectoral misallocation 

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E i i P i l O

Example 3

Estimating Potential Output

Incorporating financial factors

Credit availability determines elasticity of financial system

• Financial cycle and real activity intertwined

i i l il i d d h d i d• Financial tailwinds and headwinds 

Small sate‐space system

S f HP filt• Same frequency as HP filter

∆ 1 ∆ 0 (1) ∆ 1 ∆ 0, (1)

1 1 2, (2)

Finance‐neutral potential output

,

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US O G

Example 3

4Percent

US Output Gap

2

3

4

0

1

2

‐1

0

un‐80

eb‐82

Oct‐83

un‐85

eb‐87

Oct‐88

un‐90

eb‐92

Oct‐93

un‐95

eb‐97

Oct‐98

un‐00

eb‐02

Oct‐03

un‐05

eb‐07

Oct‐08

un‐10

eb‐12

‐3

‐2 Ju Fe O Ju Fe O Ju Fe O Ju Fe O Ju Fe O Ju Fe O Ju Fe

‐5

‐4

Finance Neutral HP Filter

‐624

Th i O G

Example 3

15Percent

Thai Output Gap

10

5

0

93 94

95

96 97

98

99 00 01 03 04

05 06

07

08 09

10

11 12

‐5 Mar‐9

Apr‐9

May‐9

Jun‐9

Jul‐9

Aug‐9

Sep‐9

Oct‐0

Nov‐0

Jan‐0

Feb‐0

Mar‐0

Apr‐0

May‐0

Jun‐0

Jul‐0

Aug‐1

Sep‐1

Oct‐1

‐10

Finance Neutral HP Filter

‐1525

Real time Performance: US

Example 3

As a percentage of potential output Graph 1

IMF OECD

Real‐time Performance: US

0

3

0

3

–6

–3

–6

–3

HP Finance-neutral

–9

01 02 03 04 05 06 07 08 09 10 11

–9

01 02 03 04 05 06 07 08 09 10 11

0

3

0

3

–6

–3

–6

–3

–9

01 02 03 04 05 06 07 08 09 10 11

–9

01 02 03 04 05 06 07 08 09 10 11

Real-time Ex-post 26

Example 3

T l R l US8

Percent Taylor Rules: US

6

7

4

5

2

3

0

1

‐2

‐1 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Policy Rate Taylor‐HP

‐3Taylor‐Finance Neutral Taylor‐Production

27

P li i li i

Example 3

Policy implications

Financial factors contain substantial information about cyclical output

Financial cycle matters for judgment about state of business cycle and its sustainabilitycycle and its sustainability

Short‐cut to factoring in financial factors 

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T k A

Conclusion

Take Aways

Financial cycle matters

Ability to create purchasing power means that finance can drive real economy

li h ld id fi i l l i iPolicy should consider financial system elasticity

Macroeconomics must return to monetary roots

Stock imbalances and balance sheets

Endogenous financial cycle

b• Booms cause busts

Disequilibrium 

Essence of macro is aggregation of interaction between heterogenous agents under imperfect information and markets

29

markets

ReferencesReferencesBernanke, B (2005): “The global saving glut and the U.S. current account deficit,” speech at the Sandridge Lecture,Richmond, March 10.

______ (2009): “Financial reform to address systemic risk,” Speech at the Council on Foreign Relations, Washington,______ ( ) y , p g , g ,D.C, 10 March.

Borio, C. and P. Disyatat (2011): “Global Imbalances and the Financial Crisis: Link or No Link?” BIS Working Papers.No. 346.

(2010) “Unconventional Monetary Policies: An Appraisal ” The Manchester School Vol 78(s1) pp 53 89______ (2010), Unconventional Monetary Policies: An Appraisal, The Manchester School, Vol 78(s1), pp. 53–89.

Borio, C, P Disyatat and M Juselius (2013), “Rethinking Potential Output: Embedding Information from the FinancialCycle”, BIS Working Papers, No. 404.

Caballero R (2010): “The “other” imbalance and the financial crisis,” NBER Working Paper, no. 15636.

Disyatat, P (2008): “Monetary policy implementation: Misconceptions and their consequences,” BIS Working Papers,no 269, December.

______ (2010): “The bank lending channel revisited,” Journal of Money, Credit, and Banking, Vol. 43 (4), pp. 711‐734734.

King, M (2010): Speech delivered to the University of Exeter Business Leaders’ Forum, 19 January.

Kiyotaki N and J Moore (2002), “Evil is the root of all money,” American Economic Review, Vol. 92 (2), pp. 62‐75.

Krugman, P (2009): “Revenge of the glut,” The New York Times, 1 March.g , ( ) g g , ,

Wolf, M (2008): “Global monetary and financial disorder: the role of global imbalances,” speech delivered at the 7thBIS Annual Conference, June 27.

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