1. “Fiscal Multipliers and Financial Crises” By Miguel Faria-e-Castro
Discussion of
“Fiscal Multipliers and Financial Crises”
By Miguel Faria-e-Castro
Jonathan A. Parker
Capital Market and the Economy
NBER Summer Institute
July 19, 2017
Especially in financial crises, credit policy is an important part of stabilization policy. D. Lucas 2016 BPEA notes that recent crisis response included 1.6 trillion in loan and guarantees to households, for about the same expenditure cost as all transfers to households, $350bn. There is lots of research on measuring tax and spending multipliers. This paper studies the financial policy multiplier with a focus on the household sector (not investment), and the interaction between the traditional stabilization policies, T, t, and G, and the financial policies, here equity injections and loan guarantees.

2. Outline: Teach the paper, make a few comments on the method and results
The ingredients
Households
Firms
Financial markets and banks
Government
Calibration and solution
Results and comments

4. Textbook NK Firms Standard No capital
Continuum of varieties of intermediate goods produce non-housing consumption
TFP shocks
Menu costs of price adjustment
No role for financial sector for firms other than through product demand and labor supply

5. Default when bank goes bankrupt Perpetual youth defaultable debt
One period debt
Default when bank goes bankrupt
Perpetual youth defaultable debt
No prepayment
Leverage constraint
Leverage constraint
Interest rate risk due to maturity mismatch
Bank-specific default
Possible bankruptcy
(Scale invariant, no persistence)

6. Financial crisis is an increase in the spread of the borrower house value shocks (2-state Markov process)
Default = F(House value shock)
Leverage constraint
Default = F(Bank portfolio return shock)

7. Collateral channel
Equity injections (and other policies)
Financial sector increases lending
Raises demand for housing
Raises house prices
Relaxes leverage constraint and reduces bank losses
This second, is an additional channel for amplification

8. Government Monetary policy rule: Fiscal policy:
Taxes, Transfers, and Spending
Financial: Credit guarantees and equity injections
old purchases financial inc transfers new
debt policy tax debt
Non-crisis state: fix G None fix τ exog T(B) to
stabilize debt
Crisis state: Set to match size of policy observed in Great Recession
Each policy crisis vs. non-crisis is independent two–state Markov process

9. 2. Calibration and solution
What about state and local taxes and spending?
John Taylor and others argue that the S&L cutbacks offset Federal expansionary policy (and ERRA was partly designed with this in mind)

10. Other parameters
Very, very nicely calibrated . . .

11. Solution A small number of state variables
No high-dimensional distributions to keep track of
But a highly non-linear model
Solve using global methods
Collocation and linear interpolation
Given model solution, use times-series of observable quantities to solve for time-series of crisis states (idiosyncratic house price variance and policies) and productivity shocks (time varying) for US economy
Is this unique?
Vary policy shock series to perform counterfactuals

12. 3. Results and comments
Fiscal policy reduced by 1/3 the decline in C

13. Results and comments
Dropping one policy: transfers most effective

14. Results and comments
Equity injections benefitted savers and borrowers similarly
Multiplier highly time-varying

15. Comment: Two implications of non-linear state dependence
Time-varying impulse response functions
For a given policy, its efficacy varies over time
Non-linear response to the size of a policy
Larger policies have different impulse responses than smaller polices
The multiplier depends on when and how big the policy
Both largely ignored in existing literature (see Parker 2013 JEL)
This paper a nice big step forward (see also McKay and Reis EMA)
Implies extra care needed in calibration: set parameters to match features for periods in the model matched to periods for the source estimates
(Both done and interpreted correctly in the paper)

16. Comment: The paper is not studying crisis rules – all crisis policy is i.i.d. shocks and not response to economy
All series crisis vs. non-crisis are i.i.d. & uncorrelated
Just a coincidence that crisis policy happened after crisis started
On the one hand: Maybe somewhat reasonable: what policy responses were expected conditional on crisis? All? Some? None? But still a higher probability
Also might be reasonable given how expectations persistently wrong about interest rates and growth for past decade
But on the other: inconsistent with careful ratex DSGE elsewhere in the modelling

17. Conclusion Important and understudied question Suggestions:
In a financial crisis, likely efficacy of fiscal and monetary policy affected by financial frictions
Normal policy has been studied a lot
Comparably little attention to DSGE studies of efficacy of equity injections and guarantees
And little study of interactions, which look to be critical
This paper: a really nice step forward
Suggestions:
Make policy crisis-non-crisis correlated
Study policy rules
Consider monetary policy rule that is different in crisis; similarly consider ZLB