Archive for July 7th, 2009

A feeler on DSGE Models

July 7, 2009

Ever since I realised DSGE Models used by central banks have played quite an important role in this crisis, I have been trying to find some basic literature on the same (though we should never really blame the models for any crisis. Instead we should question the economists who build these models). DSGE Models are also used highly in number of papers and one needs to understand some basics to get some idea (whether we like it or not, DSGE has caught on big time with the economists) 

I pointed to a paper by Camilo Tovar of BIS which tells you basics of DSGE Models. However, it was more from theoretical point of view and still does not tell you how does one go about building a DSGE Model. He points to a number of papers on the subject but it requires quite an effort to search them etc….

I came across a short paper by Kirdan Lees of RBNZ which gives you a feeler about NZ’s DSGE Model called KITT or Kiwi Inflation Targeting Technology. A bit on DSGE:

Modern macroeconomic modellers develop their models from a set of microeconomic assumptions regarding the firms, households and policymakers that populate the economy. These models are DSGE (Dynamic Stochastic General Equilibrium) models and specify very particular assumptions. Relative to earlier DSGE models, the new generation of multi-sector macroeconomic models contains sufficient richness to model the interactions between households and firms in the different sectors of the New Zealand economy for forecasting and policy purposes.  “General equilibrium” models work with the assumption label” refers to the shocks that hit the economy. Unlike static general equilibrium models, “dynamic” general equilibrium models explicitly map the transition across steady-state or long-run equilibria.

The paper tells you a bit about the way RBNZ has organised the key economic actors (households, business etc) doing economic activities (consumption, producing tradeable and non-tradeable goods etc) into a model. Fairly well done.

However, again it does not really have a role for fiscal policy and financial frictions as the criticism goes. But it gives you a feeler on how do we think about building such DSGE models.

Interest Rate Dilemma for Policymakers and Markets

July 7, 2009

Here is my new paper on the same topic. Though, I had looked at the dilemma in this early paper as well. This new one is more focussed on the interest rates dilemma. Let me know of your comments/suggestions.

Riksbank lowers deposit rates to negative!

July 7, 2009

I do follow Riksbank moves pretty closely (apart from some interesting developments at Riksbank, see this, this and this) but missed this news completely.  Riksbank in its monetary policy meeting on 2 July 2009, lowered its main policy rate – Repo rate by 25 bps to 0.25%. It also revised its growth and inflation forecasts lower.

However, in one of the paras was hidden this very important move:

The deposit rate is at the same time cut to -0.25 per cent and the lending rate to 0.75 per cent.

yeah -o.25%. Thanks to Scott Sumner for pointing this in his very wise blog. TNR Blog points this could perhaps be the first tome a central bank targets negative int rates.

Before I discuss this further, here is a look at what each of the rates mean in Sweden:

Repo rate:  The Riksbank’s most important policy rate, which is used to influence short-term market rates. The repo rate is the rate that banks receive or pay when depositing or borrowing funds at the Riksbank for a period of seven days.

Deposit rate:  Overnight rate of interest paid by the Riksbank on money held in accounts with banks.

Lending rate:  Overnight rate of interest paid by banks on money borrowed from the Riksbank.

Hmm. if banks want to submit overnight deposits at Riksbank, they will have to pay riksbank 0.25%. For 7 day deposit they still get 0.25%. This is mainly done to push banks to discourage banks to park excess reserves with the Riksbank.

In its Feb meeting it had lowered deposit rate to 0.25% and in April meeting t0 0%. Further, in April meeting it was said:

Cutting the repo rate to 0.5 per cent means that the interest rate corridor, that is the Riksbank’s deposit and lending facilities, should be modified as the current corridor construction would in this case entail a negative deposit rate. Material was presented proposing a slightly narrower corridor that entails the Riksbank’s lending rate and deposit rate being set at 1.0 per cent and 0.0 per cent respectively with a repo rate of 0.5 per cent

Hmmm. so discussions started in April itself. What seemed bizarre when suggested by Mankiw, Buiter, Krugman and Sumner (see TNR Blog for related links), is indeed taking place.

Riksbank seems to be pioneering another development in central banking. Wow! This should generate tons of research going ahead.  It is no more a case of zero bound for monetary policy at all. If Riksbank is successful,  the question would be how much negative?? It will be interesting to see the Minutes of July Riksbank meeting to be released on 16 July 2009.

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