Download The e¤ects of asymmetric information in an open economy Iris Claus

Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
The e¤ects of asymmetric information in an
open economy
Business cycle
e¤ects
Iris Claus
Sensitivity
analysis
Summary and
conclusion
CAMA and RBNZ Conference
16-17 December 2010
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Motivation
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
Credit markets can have real economic e¤ects.
Wicksell’s early writings on monetary dynamics
Fisher’s “debt-de‡ation theory of great depressions”
Distressed …nancial and banking systems (e.g. US, UK,
Scandinavia, Latin America, Japan, east Asian countries)
have rekindled interest in credit markets.
CAMA and RBNZ Conference
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Motivation
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
Credit market frictions are caused by asymmetric
information between borrowers and lenders.
Borrowers know more about their investment projects than
lenders do.
Agency costs arise when lenders delegate control over
resources to borrowers, and borrowers (agents) have an
incentive not to perform in the best interest of lenders
(principals).
Agency costs increase …rms’cost of external …nance
relative to internal funds.
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Motivation
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
The literature has focused on closed economies (e.g.
Bernanke and Gertler, 1989, Carlstrom and Fuerst, 1997
and Bernanke, Gertler and Gilchrist, 1999).
Credit market frictions may be more pronounced in small
open economies than in large closed economies.
This paper assesses the e¤ects of asymmetric information
between borrowers and lenders in an open economy with
access to international capital markets.
It builds on Carlstrom and Fuerst’s closed economy model.
CAMA and RBNZ Conference
4 / 27
Credit markets
Motivation
Credit market
frictions
Current theories of the role of credit markets build on the
economics of imperfect information.
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
Information is a public good.
Less than socially optimal quantity of information may be
produced.
Financial intermediaries and markets can reduce the
asymmetric information problem.
But this is costly.
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Ex ante information asymmetry
Motivation
Credit market
frictions
Stylised model
Lenders cannot di¤erentiate between borrowers with
di¤erent credit risks before providing loans.
Long-run
e¤ects
This leads to an adverse selection problem.
Business cycle
e¤ects
Financial intermediaries are more likely to lend to high-risk
borrowers.
Sensitivity
analysis
Summary and
conclusion
Those who are willing to pay higher interest rates will, on
average, be worse risks.
CAMA and RBNZ Conference
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Ex post information asymmetry
Motivation
Credit market
frictions
Stylised model
Only borrowers can costlessly observe actual returns after
project completion.
Long-run
e¤ects
This leads to a moral hazard problem.
Business cycle
e¤ects
Borrowers engage in activities that reduce the likelihood of
a loan being repaid.
Sensitivity
analysis
Summary and
conclusion
This type of asymmetric information is included in the
model.
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Open economies
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
Credit market frictions may be more pronounced in small
open economies.
Small economies tend to have a large number of small
…rms and fewer large businesses.
Small …rms are more a¤ected by asymmetric information
because of economies of scale in acquiring and monitoring
information.
In open economies with access to international capital
markets, domestic savings are not constrained to domestic
(risky) investments.
The cost of borrowing is in‡uenced by movements in the
exchange rate.
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Six agents
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Households
Firms
Financial intermediaries
Business cycle
e¤ects
Entrepreneurs
Sensitivity
analysis
Government
Summary and
conclusion
Monetary authority
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Financial intermediaries
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
Financial intermediaries help overcome an information
asymmetry problem.
They provide external …nancing to entrepreneurs.
Entrepreneurs also use their own net worth.
Instead of lending to risky entrepreneurs …nancial
intermediaries can hold risk-free foreign bonds.
Access to international capital markets increases the
opportunity cost of lending to entrepreneurs, who may
default on their debt.
This increases the rate of return lenders demand for the
use of their funds.
CAMA and RBNZ Conference
10 / 27
Information asymmetry
Motivation
Credit market
frictions
Stylised model
Entrepreneurs’production technology is subject to
idiosyncratic shocks.
Long-run
e¤ects
Only entrepreneurs can costlessly observe the shocks.
Business cycle
e¤ects
The information asymmetry creates a moral hazard
problem.
Sensitivity
analysis
Summary and
conclusion
Entrepreneurs have an incentive to underreport the true
value of their technology shock.
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Debt contract
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Financial intermediaries lend to entrepreneurs via a debt
contract.
The optimal contract is structured so that entrepreneurs
always truthfully report their technology shock.
In the event of default, …nancial intermediaries monitor
entrepreneurs and con…scate all returns from their projects.
Entrepreneurs with larger net worth receive larger loans.
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
The size of loans …nancial intermediaries are willing to
provide is in‡uenced by the opportunity cost of not lending
internationally.
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Households
Motivation
Credit market
frictions
maximise utility
Stylised model
work
Long-run
e¤ects
own …rms
Business cycle
e¤ects
rent capital to …rms
Sensitivity
analysis
Summary and
conclusion
can hold domestic and foreign bonds
must hold demand deposits to purchase consumption and
capital goods
CAMA and RBNZ Conference
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Firms
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
are monopolistic competitors
hire labour and capital from households and entrepreneurs
use commodity inputs, which they import at the beginning
of each period
produce output of consumptions goods
pay dividends to households at the end of each period
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Entrepreneurs
Motivation
Credit market
frictions
produce the capital that …rms use in the production of
consumption goods
Stylised model
Long-run
e¤ects
use their own net worth, which consists of their after-tax
wage earnings and the market value of their capital stock
Business cycle
e¤ects
obtain external …nancing from …nancial intermediaries
Sensitivity
analysis
face idiosyncratic technology shocks
Summary and
conclusion
who are still solvent after the shocks occur repay their
loans and make their consumption decisions
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Government
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
collects taxes on households’and entrepreneurs’wage and
rental incomes
Business cycle
e¤ects
uses this revenue to purchase consumption goods from
…rms
Sensitivity
analysis
has a balanced budget constraint in each period
Summary and
conclusion
CAMA and RBNZ Conference
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Monetary authority
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
has an explicit consumer price in‡ation target
adjusts the nominal rate of interest paid on domestic
bonds
follows a Taylor rule with interest rate smoothing
Summary and
conclusion
CAMA and RBNZ Conference
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Long-run e¤ects of asymmetric information
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
The stylised model is solved for a steady state with and
without agency costs.
The two steady states are compared.
The information asymmetry problem disappears when
entrepreneurs’production process is certain.
Entrepreneurs no longer become bankrupt and default on
their debt.
They can obtain all external …nancing directly from
households.
They no longer need collateral or net worth.
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Agency costs in the open economy
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
capital
investment
output
cost of external …nance
Agency cost
model
26.068
0.538
4.495
3.4 %
No agency
costs
27.151
0.559
4.552
0.0 %
Di¤erence
4.2 %
3.9 %
1.3 %
-3.4 p.p.
Sensitivity
analysis
Summary and
conclusion
The cost of external …nance is higher than in Carlstrom
and Fuerst’s closed economy (3.4 % compared to 2.4 %).
CAMA and RBNZ Conference
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Productivity shock
output
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
1.0
0.8
0.6
0.4
0.2
0.0
interest rate
0.03
0.00
-0.03
-0.06
-0.09
-0.12
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Agency cost model
No agency costs
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
An appreciation of the domestic currency increases the
relative return to foreign assets and reduces (domestic and
foreign) lenders’willingness to provide funds to
entrepreneurs.
This raises further the cost of external …nance.
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Foreign demand shock
Motivation
Credit market
frictions
Stylised model
output
0.04
interest rate
Agency cost model
No agency costs
0.03
0.02
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
0.008
0.006
0.004
0.01
0.002
0.00
0.000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
As in the case of the productivity shock, the presence of
agency costs dampens the e¤ects on output and the
central bank’s response.
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Reduced access to international capital markets
Motivation
Credit market
frictions
Financial intermediaries can only lend to entrepreneurs.
Stylised model
That is, they can no longer hold risk-free foreign bonds.
Long-run
e¤ects
This lowers the cost of external …nance.
Business cycle
e¤ects
The cost of external …nance no longer includes the
opportunity cost of not lending internationally.
Sensitivity
analysis
Summary and
conclusion
The reduction in the cost of external …nance raises steady
state capital, investment, output and consumption.
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Productivity shock
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
output
1.0
interest rate
0.03
0.00
-0.03
-0.06
-0.09
-0.12
0.8
0.6
0.4
0.2
0.0
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16
Agency cost model
No agency costs
Reduced capital mobility
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
A reduction in capital mobility lessens the e¤ects of
agency costs following a supply shock.
The exchange rate no longer a¤ects the cost of external
…nance.
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Foreign demand shock
output
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
0.08
Agency cost model
No agency costs
Reduced capital mobility
0.06
0.04
0.02
0.00
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
interest rate
0.018
0.015
0.012
0.009
0.006
0.003
0.000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
The real exchange rate appreciation no longer raises the
cost of external …nance.
In fact, the cost of external …nancing falls
... as the positive demand shock leads to a reduction in
investment to meet increased foreign demand.
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Summary and conclusion
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
This paper assessed the e¤ects of asymmetric information
between borrowers and lenders in a small open economy
with access to international capital markets.
Only borrowers could costlessly observe actual returns
after project completion.
The ex post information asymmetry led to agency costs
and a moral hazard problem.
Financial intermediaries helped overcome the information
asymmetry.
They lent via a debt contract and monitored borrowers
who defaulted on their debt.
CAMA and RBNZ Conference
25 / 27
Main …ndings
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
Asymmetric information and agency costs have real
economic e¤ects.
They raise the cost of external …nance and lower steady
state investment, capital and output.
The long-run e¤ects are exacerbated in an open economy.
Agency costs impact on the business cycle.
Shocks to the economy a¤ect the cost of external …nance.
In an open economy the cost of external …nance is also
in‡uenced by the exchange rate.
Whether agency costs dampen or magnify business cycle
‡uctuations depends on the degree of capital mobility and
type of shock.
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Implications of …ndings
Motivation
Credit market
frictions
Stylised model
Long-run
e¤ects
Business cycle
e¤ects
Sensitivity
analysis
Summary and
conclusion
The results underline the importance of well-functioning
…nancial systems.
Macroeconomic models that do not account for
asymmetric information in credit markets provide an
incomplete description of the economy.
Credit market interactions are altered in small open
economies compared to large closed economies.
Credit market frictions may change with increases in
international capital mobility due to …nancial liberalization
and globalization.
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