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Summary of Paper Leverage and Recessions Some Comments Discussion of “The Role of Credit, House Prices, Non-Core Liabilities, and Exuberance Measures for Predicting Financial Crises” by A. Anundsen, K. Gerdrup, F. Hansen, and K. Kragh-Sørensen Kevin J. Lansing1 FRB San Francisco October 22, 2014 RBNZ Workshop The Interaction of Monetary and Macroprudential Policy 1 Any opinions expressed here do not necessarily re‡ect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System Summary of Paper Leverage and Recessions Some Comments What variables help to predict …nancial crises? Authors estimate a multivariate logit model of crises probability to give early warning signal up to 3 years ahead. (27 total crisis episodes in panel). Summary of Paper Leverage and Recessions Some Comments What variables help to predict …nancial crises? Authors estimate a multivariate logit model of crises probability to give early warning signal up to 3 years ahead. (27 total crisis episodes in panel). Multivariate extension of Drehmann, Borio, and Tsatsaronis (IJCB 2011). Nevertheless, the Credit/GDP gap alone appears to predict crises just as well in out-of-sample forecasting exercises. Summary of Paper Leverage and Recessions Some Comments What variables help to predict …nancial crises? Authors estimate a multivariate logit model of crises probability to give early warning signal up to 3 years ahead. (27 total crisis episodes in panel). Multivariate extension of Drehmann, Borio, and Tsatsaronis (IJCB 2011). Nevertheless, the Credit/GDP gap alone appears to predict crises just as well in out-of-sample forecasting exercises. Household Credit/GDP gap is a more important predictor of crises (in-sample) than Business Credit/GDP gap. Summary of Paper Leverage and Recessions Some Comments What variables help to predict …nancial crises? Authors estimate a multivariate logit model of crises probability to give early warning signal up to 3 years ahead. (27 total crisis episodes in panel). Multivariate extension of Drehmann, Borio, and Tsatsaronis (IJCB 2011). Nevertheless, the Credit/GDP gap alone appears to predict crises just as well in out-of-sample forecasting exercises. Household Credit/GDP gap is a more important predictor of crises (in-sample) than Business Credit/GDP gap. Inclusion of Global Credit/GDP gap improves in-sample …t of model. “A tree’s risk of catching …re is usually small, except when the forest is ablaze.” –Jorda (IJCB 2011). Summary of Paper Leverage and Recessions Some Comments What variables help to predict …nancial crises? Authors estimate a multivariate logit model of crises probability to give early warning signal up to 3 years ahead. (27 total crisis episodes in panel). Multivariate extension of Drehmann, Borio, and Tsatsaronis (IJCB 2011). Nevertheless, the Credit/GDP gap alone appears to predict crises just as well in out-of-sample forecasting exercises. Household Credit/GDP gap is a more important predictor of crises (in-sample) than Business Credit/GDP gap. Inclusion of Global Credit/GDP gap improves in-sample …t of model. “A tree’s risk of catching …re is usually small, except when the forest is ablaze.” –Jorda (IJCB 2011). Authors construct country-spec…c “exuberance measures” to indicate explosive behavior in: (1) House Price/Income or (2) Credit/GDP. These variables improve in-sample …t of model but not much help in out-of-sample forecasts. Summary of Paper Leverage and Recessions Some Comments Leverage magni…es the severity of recessions Source: IMF World Economic Outlook (2009), Chapter 3. "Over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money." — Irving Fisher (Econometrica, 1933, p. 341) Summary of Paper Leverage and Recessions Some Comments Leverage magni…es the severity of recessions Source: IMF World Economic Outlook (2009), Chapter 3. "Over-investment and over-speculation are often important; but they would have far less serious results were they not conducted with borrowed money." — Irving Fisher (Econometrica, 1933, p. 341) Data from 21 countries, 1970 to 2008 Total number of busts Mean number of busts per country Mean price decline per episode Mean duration of episode Mean decline in GDP per episode1 1. Relative to GDP trend. House Price Stock Price Busts Busts 47 98 2.8 4.7 -18% -37% 10 qtrs 7 qtrs -4.3% -1.3% Summary of Paper Leverage and Recessions Some Comments More household leverage makes recessions worse Sources: M. King (EER 1994) and R. Glick and K.J. Lansing (FRBSF EL 2010). Summary of Paper Leverage and Recessions Some Comments Debt-to-income (DTI) versus Loan-to-value (LTV) ratios DTI was an early warning signal of the dangerous buildup in U.S. household leverage. Summary of Paper Leverage and Recessions Some Comments What about Investment/GDP as a predictor variable? Borio and Lowe (2002): “Periods of strong credit growth, booming asset prices, and high levels of investment almost invariably lead to stresses in the …nancial system.” 110 Real Residential Investment and Real House Price Index (Each series normalized to 100 at the investment peak) Real Business Investment and Real S&P 500 Index (each series normalized to 100 at the investment peak) 140 Real Business Investment 100 120 90 100 Real Residential Investment 80 80 70 60 Real S&P 500 Index 60 50 Real S&P Case-Shiller Price Index 40 20 40 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Summary of Paper Leverage and Recessions Credit/GDP gap alone beats multivariate model What about Household Credit/GDP gap alone? Some Comments Summary of Paper Leverage and Recessions Har vi en boligboble i Norge? Norwegian ratios are well above the last major peak observed in late 1980s. House Price/Income Mortgage Debt/Income Some Comments Summary of Paper Leverage and Recessions Exuberance measures: Norway vs. U.S. Why are Norway’s exuberance measures so low? Why not compute household credit exuberance? Jorda, Schularick, Taylor (2011): No 2008 crisis in Norway. Some Comments