Financial Regulation and Shadow Banking: A Small-Scale DSGE Perspective

September 13, 2017

By Patrick Fève and Olivier Pierrard

In this paper, we revisit the role of regulation in a small-scale dynamic stochastic general equilibrium (DSGE) model with interacting traditional and shadow banks. We estimate the model on US data and we show that shadow banking interferes with macro-prudential policies. More precisely, asymmetric regulation causes a leak towards shadow banking which weakens the expected stabilizing effect. A counterfactual experiment shows that a regulation of the whole banking sector would have reduced investment fluctuations by 10% between 2005 and 2015. Our results therefore suggest to base regulation on the economic functions of financial institutions rather than on their legal forms.

Regulators and banks play a cat and mouse game, and I wonder whether to adopt a rule like “if it looks like a bank, regulate as a bank” would work. But this is a good attempt at tackling the shadow banking sector, which is difficult to track properly both in real life and as a modeler.


Goods and Factor Market Integration: A Quantitative Assessment of the EU Enlargement

September 7, 2017

By Lorenzo Caliendo, Luca David Opromolla, Fernando Parro and Alessandro Sforza

The economic effects from labor market integration are crucially affected by the extent to which countries are open to trade. In this paper we build a multi-country dynamic general equilibrium model with trade in goods and labor mobility across countries to study and quantify the economic effects of trade and labor market integration. In our model trade is costly and features households of different skills and nationalities facing costly forward-looking relocation decisions. We use the EU Labour Force Survey to construct migration flows by skill and nationality across 17 countries for the period 2002-2007. We then exploit the timing variation of the 2004 EU enlargement to estimate the elasticity of migration flows to labor mobility costs, and to identify the change in labor mobility costs associated to the actual change in policy. We apply our model and use these estimates, as well as the observed changes in tariffs, to quantify the effects from the EU enlargement. We find that new member state countries are the largest winners from the EU enlargement, and in particular unskilled labor. We find smaller welfare gains for EU-15 countries. However, in the absence of changes to trade policy, the EU-15 would have been worse off after the enlargement. We study even further the interaction effects between trade and migration policies and the role of different mechanisms in shaping our results. Our results highlight the importance of trade for the quantification of the welfare and migration effects from labor market integration.

Trade in goods and movement of labor are substitutes. Opening trade and labor may thus introduce complex interactions. This paper tries to sort that out in general equilibrium, and it turns out everyone wins, although not necessarily a lot.

Banking Panics and Output Dynamics

September 1, 2017

By Daniel Sanches

This paper develops a dynamic general equilibrium model with an essential role for an illiquid banking system to investigate output dynamics in the event of a banking crisis. In particular, it considers the ex-post efficient policy response to a banking crisis as part of the dynamic equilibrium analysis. It is shown that the trajectory of real output following a panic episode crucially depends on the cost of converting long-term assets into liquid funds. For small values of the liquidation cost, the recession associated with a banking panic is protracted as a result of the premature liquidation of a large fraction of productive banking assets to respond to a panic. For intermediate values, the recession is more severe but short-lived. For relatively large values, the contemporaneous decline in real output in the event of a panic is substantial but followed by a vigorous rebound in real activity above the long-run level.

Hmm, Daniel Sanches is onto something here. Could the high level of financial development be the reason it took so long for the United States to get out of the last banking crisis? Eyeballing the graphs, it looks like the total cost of a banking crisis recession is higher if liquidation is less costly. That seems to be a surprising and counter-intuitive result, as large financial frictions seem to be better. And I wonder whether the steady-state effect of liquidation costs is stronger than the cyclical effect. So many questions…