Liquidity inflation and asset prices in a timevarying

Liquidity, inflation and asset prices in a timevarying framework for the euro-area Paper by C Baumeister, E Durinck and G Peersman Discussion by Kostas Tsatsaronis Bank for International Settlements Towards an integrated macro-finance framework for monetary policy NBB Conference Brussels, 16 October 2008 1

Overview l Main question: Look at the dynamic links between liquidity (money) and other macro variables from a monetary policy perspective. • How do prices and quantities react to money shocks? • Do these reactions differ conditionally on the broader macro context ? l Basic answers: Money does matter… • …for inflation, output growth and real asset prices • …in particular “narrow money” and credit • …especially during a financial boom-bust cycle 2

General comments l An central question in macro and very important for central bankers l Rich implications for inputs to policy decision making l Brings to bear useful techniques: • Time-varying VAR • analysis of responses within different macro context l Provides a lot of food for further thought 3

The workhorse: VAR Endogenous variables: Exogenous variables: GDP growth Period dummies: great moderation post 1985 Inflation Interest Rate Equity volatility index (high-low split) Real asset price growth Liquidity growth Estimation: 1971 -2005 Three lags Choleski identification 4

Comment of Grumpy Old Discussant l Why use the “synthetic” euro area data for such an investigation? l The euro area did not exist but for six out of 35 years in the sample period • Data artificially biased towards an average that may mean little for each individual economy l Focus on financial and monetary variables while ignoring the flexibility of European exchange rates! l Why not look at single countries, or Germany together with its close monetary allies? 5

Further comments on the VAR l Asset price volatility: maybe deviation from trend? l How important is the ordering of the first variables? • Especially the interest rate and asset price growth l Three lags may be an issue • Evidence that some of the mechanisms of interest are long-fused • Especially the “endogenous risk” component 6

Time-varying parameter VAR l An interesting idea to capture more subtle shifts in mechanisms l Results are a little puzzling: • Recently a liquidity shock leads to stronger output and inflation response, despite the higher interest rate • Evidence of a change in the nature of what “liquidity” proxies for? • Maybe worth to look into the M 1 vs M 3 -M 1 split 7

Analysis conditional on “states” l An interesting idea to uncover regularities • similar to split-sample regression but more flexible • akin to quartile regressions in some cases where the states refer to ranges for the LHS variable l The use of estimated residuals as RHS variables could be problematic, but I am not a purist 8

Conditional results l The effect of liquidity shocks on output, inflation and real asset prices is strengthened during asset price booms and busts l The liquidity effects during business cycle upswings are not too pronounced except for property prices l In high inflation regimes liquidity boosts nominal asset prices and real property prices 9

Conditional results (cont’d) Ø Policy should be concerned with the dynamics of asset markets in assessing the response to liquidity shocks Ø Could one interpret the asset price boom periods as supply-driven, and business cycle boom periods as demand driven episodes of increased liquidity and credit? Ø What do we know about the periods that combine characteristics? 10

Bottom line I like the paper because: l It presents different facets of the interactions between money/credit and the macroeconomy l It provides ground for more structured analysis of these channels I think that authors have to look deeper in: l Explaining the patterns they have uncovered l Making sure that the results are not influenced by the “synthetic” nature of the data used 11