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October 16, 2007

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Firms Balance-Sheet Effects: This mechanism is related to the 'credit channel' ... Real Housing Rent Index and Net Transfer of Resources* (Index 1980=100; % of ... – PowerPoint PPT presentation

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Title: October 16, 2007


1
ASSET PRICES INCREASES IN LAC WHAT CAN OR SHOULD
MONETARY POLICY DO?
  • October 16, 2007

2
Outline
  • I . ASSET PRICES AND MONETARY POLICY
  • II. MACROECONOMIC DISTORTIONS AND ASSET PRICES IN
    MEXICO (EARLY 90S)
  • III. MACROECONOMIC STABILITY AND FINANCIAL
    DEEPENING IN MEXICO (2000S)
  • IV. THE RELEVANCE OF ASSET PRICE CHANNELS FOR
    MEXICO
  • V. CONCLUSIONS

3
I. Asset Prices and Monetary Policy
  • The role of asset prices in the transmission
    mechanism of monetary policy
  • Stock Market Effects on Investment Tobin's
    q-theory (Tobin, 1969).
  • Firms Balance-Sheet Effects This mechanism is
    related to the credit channel (Bernanke and
    Gertler 1995).
  • Households Wealth Effects Consumption is
    determined by the lifetime resources of consumers
    (Ando and Modigliani 1963).

4
I. Asset Prices and Monetary Policy
  • How should monetary policy respond to asset price
    movements?
  • Two general monetary policy responses to
    fluctuations in asset prices have been proposed
  • Standard or Conventional Policy (Bernanke and
    Gertler 2001) Changes in asset prices should
    affect monetary policy only to the extent that
    they convey information about the future path of
    inflation and output.
  • Leaning against the bubble or active policy
    (Ceccheti, Genberg, Lypsky y Wadhwani 2000)
    Monetary policy should be used to contain or
    reduce bubbles that push asset prices above the
    value implied by fundamentals, in order to
    alleviate their negative consequences on the
    economy.

5
I. Asset Prices and Monetary Policy
  • Arguments in favor of activism
  • Bubbles in asset prices could have severe adverse
    macroeconomic consequences.
  • The cost of ignoring bubbles can be high. Thus,
    reducing the bubble in advance is a preferred
    policy.
  • The difficulties in identifying bubbles in asset
    prices do not justify ignoring them.

6
I. Asset Prices and Monetary Policy
  • Arguments against activism
  • Identifying a bubble in progress is extremely
    difficult.
  • A leaning against the bubble policy could
    destabilize the economy.
  • It may require a significant policy rate hike,
    which may imply near-term deviations from central
    banks macroeconomic goals (with loss of
    credibility).
  • It may affect considerably other sectors.
  • Not all asset price booms result in burst.
  • Alternative vehicles to avoid bubbles are
    financial regulation or supervision.

7
I. Asset Prices and Monetary Policy
  • Risk-Management Approach of Monetary Policy
  • A risk management approach to monetary policy
    involves describing the uncertainty and assessing
    the costs associated with each of the possible
    policies.
  • This approach evaluates monetary policy under a
    wide range of scenarios, considering not only the
    scenario with the highest probability to occur.
  • It may be worthwhile for Central Banks to take
    out some insurance against the formation of
    bubbles in asset markets and its potentially
    negative effects on the economy.

8
Outline
  • I . ASSET PRICES AND MONETARY POLICY
  • II. MACROECONOMIC DISTORTIONS AND ASSET PRICES IN
    MEXICO (EARLY 90S)
  • III. MACROECONOMIC STABILITY AND FINANCIAL
    DEEPENING IN MEXICO (2000S)
  • IV. THE RELEVANCE OF ASSET PRICE CHANNELS FOR
    MEXICO
  • V. CONCLUSIONS

9
II. Macroeconomic Distortions and Asset Prices in
Mexico (early 90s)
  • Credit Expansions in Mexico

Early 90s 2000s
Rigid exchange rate. Credit expansion based on capital inflows. Weak banking regulation and supervision. High contingent risk. Short maturity of government debt. Foreign currency denominated bonds. Inflation targeting, flexible ER. Credit expansion based in domestic savings. Strong banking regulation and supervision Macroeconomic stability. Issuance of financial contracts at longer term. Local currency denominated bonds.
10
II. Macroeconomic Distortions and Asset Prices in
Mexico (early 90s)
Mexico Real Housing Rent Index and Net Transfer
of Resources (Index 1980100 of GDP)
Current account balance less net interest
payments Source Banco de México and World Bank.
11
II. Macroeconomic Distortions and Asset Prices in
Mexico (early 90s)
Financial Saving and Banks Foreign Liabilities
(Stocks as of GDP)
Source Banco de México.
12
Outline
  • I . ASSET PRICES AND MONETARY POLICY
  • II. MACROECONOMIC DISTORTIONS AND ASSET PRICES IN
    MEXICO (EARLY 90S)
  • III. MACROECONOMIC STABILITY AND FINANCIAL
    DEEPENING IN MEXICO (2000S)
  • IV. THE RELEVANCE OF ASSET PRICE CHANNELS FOR
    MEXICO
  • V. CONCLUSIONS

13
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000s)
Average maturity of Government securities and
inflation (Days Percentage)
Financial savings (M4) and inflation ( Rate
Percentage of GDP)
Source Banco de México
Source Banco de México
14
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000s)
  • The recent rapid growth in housing finance
    through private mortgages appears grounded on
    more solid primary and secondary markets than in
    the past.
  • Mortgage credit is issued at long maturities and
    the most common mortgage instrument used by
    private financial intermediaries is a fixed rate
    loan.
  • Financial sector reforms have facilitated the
    standardization of mortgages issuances and the
    progressive securitization of mortgages
    contracts.
  • The expansion in mortgages credit has been
    preceded by several years of stagnation and is
    not a response to a relaxation in lending
    standards.
  • The current expansion of credit is based in
    domestic financial savings.

15
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000s)
Mortgage Credit ( of GDP)
Source Banco de México
16
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000s)
Households Balance ( of GDP)
Source Banco de México
17
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000s)
Net Financial Position of Households ( of GDP)
Source Banco de México.
18
Outline
  • I . ASSET PRICES AND MONETARY POLICY
  • II. MACROECONOMIC DISTORTIONS AND ASSET PRICES IN
    MEXICO (EARLY 90S)
  • III. MACROECONOMIC STABILITY AND FINANCIAL
    DEEPENING IN MEXICO (2000S)
  • IV. THE RELEVANCE OF ASSET PRICE CHANNELS FOR
    MEXICO
  • V. CONCLUSIONS

19
IV. The Relevance of Asset Price Channels for
Mexico
  • Given the relative size of the stock market, an
    increase in stock prices, whether driven by
    fundamentals or by a bubble, is not expected to
    have a significant impact on consumption
    expenditures.
  • Common stocks are not the most important
    component of households wealth. Nevertheless,
    they have been gaining importance in the last few
    years.
  • Housing is a more important component of
    households wealth than common stocks. However,
    mortgage credit as a fraction of GDP still has a
    small value compared to a decade ago.
  • High transaction costs and the lack of mechanisms
    for withdrawing housing equity, reduce the effect
    of real state price increases on consumption
    expenditures.

20
IV. The Relevance of Asset Price Channels for
Mexico
Capitalization Value of BMV ( of GDP)
Market Capitalization ( of GDP)
Source World Bank.
Source World Bank.
21
Outline
  • I . ASSET PRICES AND MONETARY POLICY
  • II. MACROECONOMIC DISTORTIONS AND ASSET PRICES IN
    MEXICO (EARLY 90S)
  • III. MACROECONOMIC STABILITY AND FINANCIAL
    DEEPENING IN MEXICO (2000S)
  • IV. THE RELEVANCE OF ASSET PRICE CHANNELS FOR
    MEXICO
  • V. CONCLUSIONS

22
Conclusions
  • Macroeconomic stability and a strong financial
    regulation and supervision are factors that help
    to avoid the formation of bubbles in asset
    prices.
  • Nowadays, domestic financial markets have
    strengthened and deepened. Nevertheless, in
    Mexico financial intermediation is still low,
    both compared to international levels and to the
    size of the Mexican economy.
  • However, to the extent that asset markets become
    deeper, the role of asset price channels may
    possibly gain more importance in the transmission
    mechanism of the monetary policy in Mexico.
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