The Academy of Economic Studies Bucharest The Faculty of Finance, Insurance, Banking and Stock Exchange DOFIN - Doctoral School of Finance and Banking MSc Student Dragomir Ioana Supervisor Professor Mois ă Alt ă r Monetary policy through the “credit-cost channel”. A VECM APROACH FOR ROMANIA

Topics n Introduction n Literature review n The model n Data description n Methodology n Estimation results n Conclusions

Introduction n The aim of this paper is to contribute to the analysis of the effects of interest-rate based monetary policy by means of a model that blends the credit and cost channels of monetary policy into a single, integrated "credit-cost channel" (CCC). n The purposes of the model is to demonstrate that firms reliance on bank loans (“credit channel”) could make aggregate supply sensitive to bank interest rates (“cost channel”), which are driven by the policy rate, controlled by the central bank and by a credit risk premium charged by banks on firms.

Literature review Monetary policy impulses have persistent real effects in the economy: n aggregate demand  credit channel Getler and Gilchrist(1993);Bernake and Getler (1995);Trautwein (2000); n aggregate supply  cost channel Barth and Ramey (2001);Christiano and Eichenbaum (1997,2005); Chowdhury(2006); Ravenna and Walsh(2003,2006); n aggregate demand and supply  credit-cost channel Greenwald and Stiglitz (1988,1993); Fiorentini and Tamborini (2002); Passamani and Tamborini (2005,2006);

The model n The economy: 3 markets: Labor, Credit and Output 3 classes of agents: firms, households and banks and a central bank; n The economy operates sequentially t, t+1,..., production takes 1 period; n Firms -(t): plan production for sale at t+1; -(t): face uncertainty about revenue from output sales; -(t): hire workers in the labor market; -(t): borrow the wage bill in the credit market. n Households - (t): sell labor and receive their income- is saved for consumption in t+1; -(t): consumption is brought out of saving carried over from t-1; n Banks -offer deposits services to households at zero interest and standard debt contracts to firms; -insure against credit risk by borrowing reserves from the central bank at the policy rate;

The model Firms - output of firm j; - labour force used by firm j; - total output in the economy; - market clearing price level; - price forecast for firm j; - forecast error for firm j, i.i.d. random variable, with unit expected value and zero correlation across firms

The loans demanded by a firm at time t: against which the firm is committed to paying in t+1:,if solvency state is declared,if default state is declared - the gross nominal interest rate charged by banks; - the nominal wage The firm expected one-period profit: The model Firms

The first order condition for maximazing profit: The model Firms - curent real wage - expected real interest rate - expected inflation rate The labour demand function: The output supply:

At period t, each household h choses the sequence: in order to maximize their utility: Constraints: The model Households - amount of consumption goods at t+1 for h - price forecast for household h - price of goods at t - deposit due at t The labour supply function

- loans oferred equals - deposits collected by bank b; The model Banks The expected net profit of a bank: - borrowed reserves from central bank; - gross official interest rate; - default probability: - gross bank interest rate; - credit risk premium;

The Model Macroeconomic equilibrium Labour market Credit market Output market

If changes in have negative effects on The Model Shocks from credit variables

output - the industrial production index; inflation rate - the consumer price index; real wage rate - the total economy gross wage index / CPI; monetary policy variable - the 3M interbank rate ROBOR; credit risk premium - the average bank lending rate for the private sector; the foreign variable - the interbank rate 3M EURIBOR; Data description Monthly series covering the period 2000M M03: All variables, excluding interest rates are log–transformed. All variables are seasonal-adjusted. The base year of indices-2005.The gestation time of output s =12

The transmission mechanism Response to an increase in the bank interest rate: The Labour Market The output-market

Data description

Data description Results of the unit root tests I(1)

Methodology VAR(p) ESTIMATION

VAR ESTIMATION Lag Length Selection Stability condition check p=1 the VAR satisfies the stability condition test

- elements: adjustment coefficients of variables towards their long-run relationships Methodology Structural cointegration method Johansen&Juselius Objective: The identification of the long-run structural relationships Re specification of the model: - matrices of coefficients; - error correction mechanism; - columns: r cointegration vectors long-run relationships

VECM ESTIMATION Johansen Cointegration Test Stability condition check VECM: with 5 variables vector y’ t = [w t, k t, q t+12 ,  t,  t+12 ], 1 exogenous variable z’ t =[k* t ], 3 cointegrating relations and 0 lag. the VEC satisfies the stability condition test

Estimation results The unrestricted model The coefficients of the inter-bank rate in all of the 3 cointegration equations is positive and significant, underlying the negative correlation between the policy rate and the key variables of the economy.

The unrestricted model the short dynamics of : w t,  t+1, Q t+1 are not explosive. adjusts significantly and rapidly in the direction of all three long-term relations; hardly adjusts to any long-term equilibrium relation; adjusts slowly and significantly in the direction of the 3th coEq.

The unrestricted model The impulse response functions

The cointegration graph Production, wages and inflation small deviations from the long term level.

Estimation results The unrestricted model

Estimation results The restricted model

Conclusions Empirical results show that, by way of the CCC transmission mechanism the inter-bank rate is a co- determinant with negative sign of the long-run stochastic equilibrium paths of the real wage rate, output and inflation. The results for the premium risk variable reject the same hypothesis, due to the lack of a better measure of risk.