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Discussion:
Financial Crises, Bank Risk Exposure and
Government Financial Policy
by
M. Gertler, N. Kiyotaki and A. Queralto
Franklin Allen
Macro Financial Modeling Meeting
Becker Friedman Institute and MIT Sloan
May 2-3, 2013
Contribution
•  Paper is a state-of-the-art quantitative macro model
with a financial friction that results in lending to
firms by banks being restricted
•  The key feature of the intermediation sector is that
banks’ choice of capital structure is modeled
•  Whole economy is modeled so that the effects of
Fed’s policy of large scale asset purchases on output,
investment, employment and so forth can be
measured
2 •  Modeling of banks is cleverly done to maintain a
representative household structure
•  This allows the 17 equations in 17 endogenous
variables to be solved
•  The system remains tractable and the dynamics can
be solved for various scenarios
•  This allows policy analysis in a general equilibrium
setting
•  The whole analysis is very neatly done
3 Comments
•  As with most of these macro models the cost of the
modeling of the whole economy is that the financial
friction is quite simplistic
•  This raises the question of the trade-off between the
sophistication of the financial stability analysis and
the tractability of the macroeconomic analysis
•  To what extent is a simple financial restriction such as
limited lending by banks what goes wrong in
financial crises?
4 •  The popular discussion in the press seems to put
tremendous weight on this factor:
–  If only banks would lend more then the economy
would recover and we would be back to a normal
world again…
•  But as always with lower bank lending, there is the
question of which direction causality goes, are banks
not lending or are creditworthy firms not borrowing?
•  Very few, if any, convincing studies that establish
causation
5 •  Data such as the Bank of Spain Credit Registry needs
to be made much more widely available so we can
base these kinds of macro models on much better
empirical evidence
•  But restricted lending by banks is only one aspect of
what may happen in financial crises
•  The key issue from the financial stability side is what
is systemic risk and which aspects should we try to
embed in macro models?
6 What are the sources of systemic risk?
1.  Panics – banking crises due to multiple equilibria
2.  Banking crises due to asset price falls
a.  Business cycle
b.  Bursting of real estate bubbles
c.  Bursting of other asset price bubbles
d.  Mispricing due to limits to arbitrage
e.  Mispricing due to “flash crashes”
f.  Sovereign default
g.  Increases in interest rates
7 3. Contagion
(a) Domino style contagion through interlinkages
(b) Similar asset holdings by banks
(c) Fear of the unknown as seems to have happened
after the Lehman bankruptcy
4.  Foreign exchange mismatches in the banking
system
5.  Agency problems in financial intermediaries
8 Focus on two of these here
1.  A fall in the price of bank assets due to the bursting
of a real estate bubble
- This seems to be have been very important in
the recent crisis and is very often a cause of
financial crises
2.  A fall in the price of bank assets due to an increase
in interest rates
- This is arguably one of the major systemic risks
that we currently face
9 Nominal Housing Prices in Various European Countries and the U.S.
500 450 400 House Price Index 350 300 250 200 150 100 50 0 1996 France 1997 1998 Germany 1999 2000 Greece 2001 2002 Ireland 2003 Italy 2004 2005 Portugal 2006 Spain 2007 2008 UK 2009 USA 2010 2011 Sweden Nominal Housing Prices in Different U.S. Cities
400.00 350.00 CA-­‐Los Angeles Case_shiller housign index
300.00 CA-­‐San Diego CA-­‐San Francisco 250.00 CO-­‐Denver DC-­‐Washington 200.00 FL-­‐Miami IL-­‐Chicago 150.00 MA-­‐Boston NV-­‐Las Vegas 100.00 NY-­‐New York Composite-­‐10 50.00 0.00 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 11 A Rise in Interest Rates
• 
Japan provides an interesting example of what may
happen with a rise in interest rates
• 
Bank of Japan plans to increase rate of inflation to
2% a year
• 
What will this do to interest rates and the value of
10 year JGBs held by banks?
• 
What will it do to the long term fiscal position
given Japan’s large gross debt?
12 Suggested Procedure for
Macro Financial Modeling
1.  Establish a rigorous theoretical understanding of
possible sources of systemic risk
2.  Establish the empirical importance of each
3.  Embed the most important ones in a macro model
to consider interactions and effect on
macroeconomic variables of interest
13