East Asian Seminar on Economics

June 18-19, 2015
Takatoshi Ito, University of Tokyo, and Andrew K. Rose, University of California, Berkeley, Organizers

Jens Christensen, Jose Lopez, and Glenn Rudebusch, Federal Reserve Bank of San Francisco

A Probability-Based Stress Test of Federal Reserve Assets and Income

To support the economic recovery, the Federal Reserve amassed a large portfolio of long-term bonds. Christensen, Lopez, and Rudebusch assess the Fed's associated interest rate risk - including potential losses to its Treasury and mortgage-backed securities holdings and declines in the Fed's remittances to the Treasury. In assessing this interest rate risk, the researchers use probabilities of alternative interest rate scenarios that are obtained from a dynamic term structure model that respects the zero lower bound on yields. The resulting probability-based stress tests indicate that large portfolio losses or a cessation of remittances to the Treasury are unlikely to occur over the next few years.

Jiseob Kim, Korea Development Institute

How Loan Modifications Influence the Prevalence of Mortgage Defaults

How much can government-driven mortgage modification programs reduce the mortgage default rate? Kim compares an economy without a modification option to one with easy modifications, and evaluates the impact of these loan modifications on the foreclosure rate. Through loan modification, mortgage servicers can mitigate their losses and households can improve their financial positions without having to walk away from their homes. When modifying loan contracts is prohibitively costly, the default rate increases 1.5 percentage points in response to a 2007-style unexpected drop in housing prices of 30%. Kim calibrates the cost of modification after the financial crisis to match the Home Affordable Modification Program (HAMP) modification rate of 0.68%. The author's quantitative exercises show that current government efforts to promote mortgage modifications reduce the mortgage default rate by 0.63 percentage points.

Sumit Agarwal, Jessica Pan, and Wenlan Qian, National University of Singapore

Age of Decision: Pension Savings Withdrawal and Consumption and Debt Response

This paper uses a unique panel of consumer financial transactions to examine how aging consumers respond to the option to cash out retirement savings. To obtain causal identification, Agarwal, Pan, and Qian exploit an administrative regulation in Singapore that allows individuals to cash out a fraction of their pension savings at age 55. The researchers find a large and highly significant increase in bank account balances when an individual turns 55, suggesting that the average consumer in the sample withdraws a large portion of their eligible retirement savings. In line with the predictions from the life-cycle/permanent-income hypothesis, the authors find modest increases (about 9% of the increase in account balance) in cumulative total spending twelve months later. This increase is driven largely by an increase in debit card spending and is concentrated among low-liquidity consumers. Consumers also use the increase in disposable income to pay down their credit card debt. The researchers do not find any evidence that the average consumer responds by excessively increasing present consumption at the expense of future financial security. Nevertheless, consumers leave a sizeable portion of their withdrawn savings in low-interest accruing bank accounts for at least a year after withdrawal. The authors provide some suggestive evidence that consumer demographics, especially those related to financial literacy and sophistication, appear to matter for consumersÂ’ withdrawal decisions.

John D. Burger, Loyola University Maryland; Rajeswari Sengupta, Indira Gandhi Institute of Development Research; Francis E. Warnock, University of Virginia and NBER; and Veronica Cacdac Warnock, University of Virginia

U.S. Investment in Global Bonds: As the Fed Pushes, Some EMEs Pull

Burger, Sengupta, Warnock, and Warnock analyze reallocations within the international bond portfolios of U.S. investors. The most striking empirical observation is a steady increase in U.S. investors' allocations toward emerging market local currency bonds, unabated by the global financial crisis and accelerating in the post-crisis period. Part of the increase in EME allocations is associated with global "push" factors such as low U.S. long-term interest rates and unconventional monetary policy as well as subdued risk aversion/expected volatility. But also evident is investor differentiation among EMEs, with the largest reallocations going to those EMEs with strong macroeconomic fundamentals such as more positive current account balances, less volatile inflation, and stronger economic growth. The researchers also provide a descriptive analysis of global bond markets' structure and returns.

Hao Wang, Tsinghua University; Honglin Wang, Hong Kong Institute for Monetary Research; Lisheng Wang, Chinese University of Hong Kong; and Hao Zhou, Tsinghua University

Shadow Banking: China's Dual-Track Interest Rate Liberalization

Shadow banking in China is mainly conducted by commercial banks to evade regulatory restrictions on deposit rate and loan quantity. It essentially constitutes a dual-track pragmatic approach to gradually liberalize the country's repressed interest rate policy. Wang, Wang, Wang, and Zhou show in equilibrium that shadow banking improves social surplus given high deposit reserve requirement and inefficient bond market. Full interest rate liberalization leads to additional gain in social surplus. The dual-track approach to interest rate liberalization avoids the potential economic turbulence caused by an otherwise single-track one-step approach.

Òscar Jordà, Federal Reserve Bank of San Francisco; Moritz Schularick, University of Bonn; and Alan M. Taylor, University of California, Davis and NBER

Leveraged Bubbles

What risks do asset price bubbles pose for the economy? This paper studies bubbles in housing and equity markets in 17 countries over the past 140 years. History shows that not all bubbles are alike. Some have enormous costs for the economy, while others blow over. Jordà, Schularick, and Taylor demonstrate that what makes some bubbles more dangerous than others is credit. When fueled by credit booms, asset price bubbles increase financial crisis risks; upon collapse they tend to be followed by deeper recessions and slower recoveries. Credit-financed house price bubbles have emerged as a particularly dangerous phenomenon.

Douglas W. Diamond and Anil Kashyap, University of Chicago and NBER

Liquidity Requirements, Liquidity Choice and Financial Stability

Chung-Hua Shen, National Taiwan University; Hao Fang, Hwa Hsia University of Technology; and Yen-Hsien Lee, Chung Yuan Christian University

How Early of the Early Warning Signal in Banking Crisis? The Three Booms, Credit, Housing and Capital, Cases

Many studies or anecdotal episodes claim that fast growth of credit, housing or international capital flow may cause the banking crisis. This study examines this argument by pursuing two unresolved issues. First, individual and joint effects provide an early warning signal (i.e., EWS) for the banking crises. Next, how early the EWS sends the signal. Using 49 sample countries (33 from OECD and 16 from non-OECD countries), a credit boom has more effective early warnings for advanced countries than emerging countries. In contrast, a housing boom has more effective prediction power in emerging countries than advanced countries. Capital boom has the same warning power in these two types of countries. Shen, Fang, and Lee find that the power of the predictability increases as the number of booms adds simultaneously. Hence, the joint occurrence of the three booms has the most effective early warning in terms of leading time and power of predictability. The authors find interesting evidence that this phenomenon does not change in the different boom definitions, but it is more likely to occur in the emerging countries.

Kenichi Ueda and Frederic Lambert, International Monetary Fund

The Effects of Unconventional Monetary Policies on Bank Soundness

Unconventional monetary policy is often assumed to benefit banks. However, Lambert and Ueda find little supporting evidence. Rather, the researchers find some evidence for heightened medium-term risks. In an event study using a novel instrument for monetary policy surprises, they do not detect clear effects of monetary easing on bank stock valuation but find a deterioration of medium-term bank credit risk in the United States, the euro area, and the United Kingdom. However, these risks are essentially the same as conventional monetary easing in pre-crisis years.

Tim Robinson, University of Melbourne

LVR Policy and the Business Cycle

This paper demonstrates how the effectiveness of loan-to-value (LTV) ratio policies can be evaluated based on their implications for the business cycle. In particular, Robinson and Yao assess how key characteristics of the business cycle, such as the duration and amplitude of recessions, change with alternative LTV policies. The researchers study the impacts of these policies in models where housing serves as collateral for either short-term debt, akin to Iacoviello [2005] and Iacoviello and Neri [2010], or long-term mortgages, following Garriga et al. [2013], using the business cycle dating techniques developed by Harding and Pagan [2002]. The researchers find that a permanent tightening of LTV policy decreases the depth and frequency of recessions and that the magnitudes of these effects vary with how mortgage debt is modeled. The impact of countercyclical LTV rules on the business cycle is found to be considerably less.

David Cook, Hong Kong University of Science & Technology

Policy Conflicts and Inflation Targeting: The Role of Credit Markets

A broad set of countries have adopted inflation targeting monetary policy regimes. Choi and Cook show that stabilizing volatility in credit growth often conflicts with price stability goals as unusual credit expansions often occur when inflation is low relative to goals and credit slumps often appear when inflation is overshooting. The researchers find that inflation-targeting central banks target credit conditions in both developed and emerging-market economies. However, emerging-market central banks are more sensitive to inflation conditions, responding to credit growth only when consistent with reaching the price target. The authors also find that macroprudential regulations are also used as a substitute for monetary policy to address financial markets when orthodox monetary policy moves would be inconsistent with the price target.

Andrés Fernández, Inter-American Development Bank; Alessandro Rebucci, Johns Hopkins University; and Martín Uribe, Columbia University and NBER

Are Capital Controls Countercyclical?

A growing theoretical literature advocates the use of countercyclical capital control policy, that is, the tightening of restrictions on net capital inflows during booms and the relaxation thereof during recessions. Fernández, Rebucci, and Uribe examine the behavior of capital controls in 78 countries over the period 1995-2011. The authors find that capital controls are remarkably acyclical. Booms and busts in aggregate activity are associated with virtually no movements in capital controls. These results are robust to controlling for the level of development, external indebtedness, and the exchange-rate regime. They also obtain around the great contraction of 2007.

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