Transcript Slide 1

The Impact of Financial Crisis and Policy
Response in Croatia
Nikola Bokan, Lovorka Grgurić, Ivo Krznar, Maroje Lang
15th Dubrovnik Economic Conference
June 2009
Outline
1.
2.
3.
4.
5.
Motivation
Model structure
Simulation exercise
Comparison with the actual developments
Conclusion
1 Motivation
Aim :

Understand the impact of the current financial crisis on Croatia
and possible monetary policy response
Method :
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
Unprecedented shocks prevents us to use standard statistics
Testing a newly built model in a challenging situation
2. Model – introductory remarks
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
Small open economy DSGE model
Built with a purpose to analyze different possible shocks
facing Croatian economy



Different from standard IT model due to different
monetary policy regime

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
Contains large number of possible shocks
Calibrated and not estimated
Stable exchange rate, heavy use of regulations (RR)
Monetary policy works through banking sector
Financial eurisation
Interest in financial variables (credit, debt)
Model structure
Monetary policy in the model
2.
Stable exchange rate (random walk)
Reserve requirement as monetary policy instrument
•
Discretionary monetary policy
1.
High regulatory cost
(defined as “immobilized” assets / total liabilities)
3. Simulation exercise

Current financial crisis simulated as an external shock
to Croatian economy
1.
2.
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Increase in price of foreign borrowings (3 pp)
Drop in exports (10 %)
Impulse responses
Foreign interest rate shock

increase in foreign interest rates:
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cost of foreign borrowing increases for both banks and firms
domestic interest rates increase even more due to RR
real sector:
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increase in debt/service & production cost
 decrease in demand (consumption) => decrease in production &
imports

financial sector:
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decrease in credit demand (HH and firms)
 decrease in foreign borrowing
Export demand shock
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decrease in exports lowers domestic production and
household income
real sector:
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decrease in demand (consumption) => decrease in production &
imports
financial sector:
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decrease in credit demand (HH and firms)
decrease in foreign borrowing
Monetary policy response

Limited room for maneuver


Exchange rate depreciation would increase debt service cost
and bad loans due to eurization (not fully modeled)
Monetary authorities can decrease regulatory cost (RR)

Simulation of 10 pp decrease in RR
Reserve requirement reduction
1.
Decrease in regulatory cost
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2.
Decrease in domestic interest rates
Some increase in real economic activity due to lower interest
rate (consumption, production, imports)
Release of previously immobilized assets

Significant decrease in foreign borrowing
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Banks can't lend all released assets domestically
Combined effect of three shocks
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Monetary easing through RR only marginally reduces
negative impact of the crisis on real sector
Net exports improve (imports decrease more than
exports)
Interest rate increases significantly
Credit activity decreases
Significant reduction in foreign borrowing
4. Comparison with the actual developments

Early dana showing initial impact of the crisis are available
Model predicted:
Slowdown in real activity
GDP and Personal Consumption (annual rate of change YoY)
8
6
4
%
2
0
-2
-4
-6
-8
2004:1
2005:1
2006:1
2007:1
GDP
Consumption
2008:1
2009:1(f)
Improvement in trade balance
Merchandise Trade
2,000
1,800
EUR million
1,600
1,400
1,200
1,000
800
600
400
2005:1
2006:1
2007:1
2008:1
Exports (trend)
Imports (trend)
2009:1
Decrease in credit activity
Monetary Aggregates
(trend, annual rate of change YoY, constant exchange rate)
28
24
20
%
16
12
8
4
0
2005:1
2006:1
2007:1
2008:1
Credits to private sector (trend)
Broad money (trend)
2009:1
However:
Domestic interest rates increased moderately
Interest rates on loans to private sector
11.0
10.0
%
9.0
8.0
7.0
6.0
5.0
2004:1
2005:1
2006:1
2007:1
2008:1
Households (long term fx indexed)
Enterprises (short term kuna loans)
2009:1
Reasons for moderate increase in domestic
interest rates
1.
Impact of shock might be exaggerated in simulation
1.
2.
2.
3.
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Decreased faster than assumed by the model
Foreign borrowing by banks/firms actually cheaper/postponed
Reduction in RR contributed to less interest rate
increase
Popular pressures against interest rates increase and
already high bank profits
evidence of credit-rationing instead
Yield to maturity of government bonds (in percentage points)
9
8
7
%
6
5
4
3
2
1
2004:1
2005:1
2006:1
HR
CEE1 (PL,SI,SK)
2007:1
2008:1
2009:1
DE
CEE2 (HU,RO)
Foreign borrowing continued
(although somewhat slower than before)
Foreign Debt
28,000
EUR million
24,000
20,000
16,000
12,000
8,000
4,000
2004:1
2005:1
2006:1
2007:1
Commercial banks
Enterprises
2008:1
2009:1
Reason why foreign borrowing slowed only
marginally
GOVERNMENT BORROWING
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Banks lent to the government as fiscal revenues dropped
5. Conclusion
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The results to a large extent match the actual data
showing the early impact of the crisis

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model is a useful policy analysis tool
With stable exchange rate regime, decreasing the
regulatory burden can only marginally reduce the
negative impact of the current crisis on real economy