Transcript asset prices increases in lac: what can or should monetary policy do?

ASSET PRICES INCREASES IN
LAC: WHAT CAN OR SHOULD
MONETARY POLICY DO?
October 16, 2007
Outline
I . ASSET PRICES AND MONETARY POLICY
II. MACROECONOMIC DISTORTIONS AND ASSET
PRICES IN MEXICO (EARLY 90’S)
III. MACROECONOMIC STABILITY AND FINANCIAL
DEEPENING IN MEXICO (2000’S)
IV. THE RELEVANCE OF ASSET PRICE CHANNELS
FOR MEXICO
V. CONCLUSIONS
2
I. Asset Prices and Monetary Policy
The role of asset prices in the transmission mechanism
of monetary policy:

Stock Market Effects on Investment: Tobin's q-theory
(Tobin, 1969).

Firms Balance-Sheet Effects: This mechanism is
related to the “credit channel” (Bernanke and Gertler
1995).

Households Wealth Effects: Consumption is
determined by the lifetime resources of consumers
(Ando and Modigliani 1963).
3
I. Asset Prices and Monetary Policy
How should monetary policy respond to asset price
movements?
Two general monetary policy responses to fluctuations in
asset prices have been proposed:

Standard or Conventional Policy (Bernanke and Gertler
2001): Changes in asset prices should affect monetary policy
only to the extent that they convey information about the
future path of inflation and output.

“Leaning against the bubble” or active policy (Ceccheti,
Genberg, Lypsky y Wadhwani 2000): Monetary policy should
be used to contain or reduce bubbles that push asset prices
above the value implied by fundamentals, in order to alleviate
their negative consequences on the economy.
4
I. Asset Prices and Monetary Policy
Arguments in favor of activism:

Bubbles in asset prices could
macroeconomic consequences.

The cost of ignoring bubbles can be high. Thus, reducing the
bubble in advance is a preferred policy.

The difficulties in identifying bubbles in asset prices do not justify
ignoring them.
have
severe
adverse
5
I. Asset Prices and Monetary Policy
Arguments against activism:

Identifying a bubble in progress is extremely difficult.

A “leaning against the bubble” policy could destabilize the
economy.
 It may require a significant policy rate hike, which may imply
near-term deviations from central bank’s macroeconomic
goals (with loss of credibility).
 It may affect considerably other sectors.

Not all asset price booms result in burst.

Alternative vehicles to avoid bubbles are financial
regulation or supervision.
6
I. Asset Prices and Monetary Policy
Risk-Management Approach of Monetary Policy

A risk management approach to monetary policy involves
describing the uncertainty and assessing the costs
associated with each of the possible policies.

This approach evaluates monetary policy under a wide
range of scenarios, considering not only the scenario with
the highest probability to occur.

It may be worthwhile for Central Banks to take out some
insurance against the formation of bubbles in asset
markets and its potentially negative effects on the
economy.
7
Outline
I . ASSET PRICES AND MONETARY POLICY
II. MACROECONOMIC DISTORTIONS AND ASSET
PRICES IN MEXICO (EARLY 90’S)
III. MACROECONOMIC STABILITY AND FINANCIAL
DEEPENING IN MEXICO (2000’S)
IV. THE RELEVANCE OF ASSET PRICE CHANNELS
FOR MEXICO
V. CONCLUSIONS
8
II. Macroeconomic Distortions and Asset
Prices in Mexico (early 90’s)
Credit Expansions in Mexico
Early 90s
2000s
•
Rigid exchange rate.
•
Inflation targeting, flexible ER.
•
Credit expansion based on capital
inflows.
•
Credit
expansion
domestic savings.
•
Weak banking
supervision.
•
Strong banking regulation and
supervision
•
High contingent risk.
•
Macroeconomic stability.
regulation
and
 Short maturity of government debt.
 Foreign
bonds.
currency
denominated
based
in
Issuance of financial contracts at
longer term.
Local
bonds.
currency
denominated
9
II. Macroeconomic Distortions and Asset
Prices in Mexico (early 90’s)
Mexico: Real Housing Rent Index and Net
Transfer of Resources*
(Index 1980=100; % of GDP)
140
6
120
4
100
2
80
0
60
-2
Real Rent Housing Index
40
-4
Net Transfer of Resources (right axis)
*Current account balance less net interest payments
Source: Banco de México and World Bank.
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
-6
1980
20
10
II. Macroeconomic Distortions and Asset
Prices in Mexico (early 90’s)
Financial Saving and Banks Foreign Liabilities
(Stocks as of GDP)
80
External financing to commercial banks
Financial savings from non-residents
Financial savings from residents
70
60
Dic 89
Dic 94
50
40
30
20
10
Source: Banco de México.
Dec-05
Dec-03
Dec-01
Dec-99
Dec-97
Dec-95
Dec-93
Dec-91
Dec-89
Dec-87
Dec-85
-
11
Outline
I . ASSET PRICES AND MONETARY POLICY
II. MACROECONOMIC DISTORTIONS AND ASSET
PRICES IN MEXICO (EARLY 90’S)
III. MACROECONOMIC STABILITY AND FINANCIAL
DEEPENING IN MEXICO (2000’S)
IV. THE RELEVANCE OF ASSET PRICE CHANNELS
FOR MEXICO
V. CONCLUSIONS
12
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000’s)
Financial savings (M4) and
inflation
Average maturity of Government
securities and inflation
(% Rate; Percentage of GDP)
(Days; Percentage)
180
55
160
Inflation
140
M2/GDP
(right axis)
2000
70
1800
Average Manurity of Government
Securities
1600
Inflation (right axis)
50
45
120
50
1400
1200
100
40
80
35
40
1000
30
800
600
60
30
40
25
20
20
400
10
200
Source: Banco de México
Source: Banco de México
Jan-06
Jan-04
Jan-02
Jan-00
Jan-98
Jan-96
Jan-94
Jan-92
2006
2002
1998
1994
1990
1986
1982
1978
1974
1970
20
0
Jan-90
0
0
60
13
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000’s)

The recent rapid growth in housing finance through private mortgages
appears grounded on more solid primary and secondary markets than in
the past.

Mortgage credit is issued at long maturities and the most common
mortgage instrument used by private financial intermediaries is a fixed
rate loan.

Financial sector reforms have facilitated the standardization of
mortgages issuances and the progressive securitization of mortgages
contracts.

The expansion in mortgages credit has been preceded by several years
of stagnation and is not a response to a relaxation in lending standards.

The current expansion of credit is based in domestic financial savings.
14
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000’s)
Mortgage Credit
(% of GDP)
14
12
Total
Banks
Sofoles
Infonavit
10
8
6
4
2
Source: Banco de México
Dec-06
Apr-06
Aug-05
Dec-04
Apr-04
Aug-03
Dec-02
Apr-02
Aug-01
Dec-00
Apr-00
Aug-99
Dec-98
Apr-98
Aug-97
Dec-96
Apr-96
Aug-95
Dec-94
0
15
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000’s)
Households Balance
(% of GDP)
Total
Total Real Assets
Housing
Durable goods
Financial Assets
Financial savings
Equities 1/
Financial Liabilities
Consumption
Housing
Memoranda items
Total Net Financial Position
Total Public Pension Funds
Net Financial Position excluding
Equities and Public Pension Funds
Source: Banco de México
2000
146.9
95.7
73.7
22.0
51.2
30.1
21.1
9.7
1.4
8.2
2001
151.8
99.1
76.1
23.1
52.7
33.1
19.5
10.1
1.8
8.3
2002
153.2
101.6
77.7
23.9
51.6
34.7
16.9
10.9
2.3
8.6
2003
158.3
103.2
78.9
24.3
55.1
35.3
19.8
11.1
2.5
8.5
2004
161.2
102.3
78.1
24.1
59.0
34.3
24.7
11.9
3.3
8.6
2005
170.9
103.2
78.7
24.5
67.7
37.4
30.3
13.0
4.3
8.7
2006
182.8
102.9
78.3
24.5
80.0
38.9
41.1
14.4
5.2
9.2
41.5
7.0
42.6
8.8
40.8
9.8
44.0
10.7
47.1
11.0
54.6
12.0
65.6
12.3
13.4
14.3
14.1
13.5
11.4
12.3
12.2
16
III. Macroeconomic Stability and Financial
Deepening in Mexico (2000’s)
Net Financial Position of Households
(% of GDP)
30
25
20
15
10
Total position
5
Position excluding pension funds
Source: Banco de México.
Jun-07
Dec-06
Jun-06
Dec-05
Jun-05
Dec-04
Jun-04
Dec-03
Jun-03
Dec-02
Jun-02
Dec-01
Jun-01
Dec-00
0
17
Outline
I . ASSET PRICES AND MONETARY POLICY
II. MACROECONOMIC DISTORTIONS AND ASSET
PRICES IN MEXICO (EARLY 90’S)
III. MACROECONOMIC STABILITY AND FINANCIAL
DEEPENING IN MEXICO (2000’S)
IV. THE RELEVANCE OF ASSET PRICE CHANNELS
FOR MEXICO
V. CONCLUSIONS
18
IV. The Relevance of Asset Price Channels
for Mexico

Given the relative size of the stock market, an increase in stock prices,
whether driven by fundamentals or by a bubble, is not expected to have
a significant impact on consumption expenditures.

Common stocks are not the most important component of households
wealth. Nevertheless, they have been gaining importance in the last
few years.

Housing is a more important component of households wealth than
common stocks. However, mortgage credit as a fraction of GDP still
has a small value compared to a decade ago.

High transaction costs and the lack of mechanisms for withdrawing
housing equity, reduce the effect of real state price increases on
consumption expenditures.
19
IV. The Relevance of Asset Price Channels
for Mexico
Capitalization Value of BMV
Market Capitalization
(% of GDP)
(% of GDP)
45
41.5
38.2
40
300
250
35
30.8
32.0
31.2
200
30
25.2
25
21.5
20.3
150
19.2
20
100
15.9
15
50
10.1
10
5
Source: World Bank.
2006
2005
2004
2003
2002
2001
2000
1999
1994
1992
1989
0
Venezuela
Argentina
New Zealand
Portugal
Turkey
Colombia
Mexico
Germany
Italy
Philippines
Brazil
Thailand
France
Spain
India
Korea
Israel
Australia
Chile
Canada
United States
United
Singapore
South Africa
0
Source: World Bank.
20
Outline
I . ASSET PRICES AND MONETARY POLICY
II. MACROECONOMIC DISTORTIONS AND ASSET
PRICES IN MEXICO (EARLY 90’S)
III. MACROECONOMIC STABILITY AND FINANCIAL
DEEPENING IN MEXICO (2000’S)
IV. THE RELEVANCE OF ASSET PRICE CHANNELS
FOR MEXICO
V. CONCLUSIONS
21
Conclusions

Macroeconomic stability and a strong financial regulation and
supervision are factors that help to avoid the formation of bubbles
in asset prices.

Nowadays, domestic financial markets have strengthened and
deepened. Nevertheless, in Mexico financial intermediation is still
low, both compared to international levels and to the size of the
Mexican economy.

However, to the extent that asset markets become deeper, the
role of asset price channels may possibly gain more importance
in the transmission mechanism of the monetary policy in Mexico.
22