1. HOUSEHOLD LEVERAGE AND SOVEREIGN RISK Comments Juan F. Jimeno (Research Division) CONFERENCE: “Debt and Credit, Growth and Crises” Madrid 18-19 June 2012

2. RESEARCH DIVISION THE PAPER (I) Main objective Explanation of cross-country GDP and employment growth in the Eurozone (EZ) during the crisis Using the US experience as a starting point (Mian and Sufi, 2010, Midrigan and Philippon, 2010) In the EZ: A two-stage story of the crisis (Two stages ?):Two stages ? 2007-2010: Deleveraging in the private sector 2010-?: Fiscal consolidation and sovereign crisis Cross-country differences in household leverage and financing costs to Governments, respectively, can explain cross-country differences in GDP, consumption, and employment growth in 2007-2009 and 2010-2011. 2

3. RESEARCH DIVISION THE PAPER (II) Method Calibration of DSGE model with credit frictions (still preliminary) “Islands” with representative consumers Cash-in-advance-constraint with two sources of “money” Two sectors (tradables, non-tradables) with sector-specific labor Sticky wages Intertemporal substitution modeled as adjustment costs to asset holdings Government and private lenders are perfect substitutes. No monetary policy (M=1). Fiscal transfers providing money. Extension (and simplification) of Midrigan and Philippon (2010) to account for fiscal policy Two exogenous shocks: collateral constraint to private credit financing costs of Governments 3

4. RESEARCH DIVISION MAIN QUESTION Do the model’s assumptions fit well with the European experience to be explained? Empirical evidence on the credit-consumption channel The different nature of the crisis across EZ countries Asymmetries and imbalances in the EZ Credit boom, deleveraging and sovereign risk premia 4

5. RESEARCH DIVISION 5 COMMENT #1: RELATIONSHIP BETWEEN CREDIT AND CONSUMPTION IN EUROPE Alberola, Molina and del Rio (2012)

6. RESEARCH DIVISION COMMENT #1: RELATIONSHIP BETWEEN CREDIT AND CONSUMPTION IN EUROPE 6  The role of housing as a source of liquidity UK : Increases in housing prices led to more borrowing Bridges, Disney and Gathergood (2009). DK: Introduction of home equity loans led to increases in consumption. Leth-Petersen (2010) Less evidence for other economies, as equity withdrawal less intense SP: Bover (2005): Estimation of wealth effects. Not very large. Marques and Nieto (2003): Mortgage refinancing did not increase as a result of higher house prices. (Update: only in 2005 increase in mortgage debt > increase in housing investment) 2. But even without home equity withdrawals, mortgage credit conditions may affect household consumption (SP: Masier and Villanueva, 2011). Longer mortgage maturity partly allows to diminish the mortgage payment and increase consumption by recent home owners Specially important if expect income to be higher later in life 3. On the downside: Are households/firms credit-constrained? Disentangling demand-supply of credit SP: Hernando and Villanueva (2012): “relatively small magnitude of credit supply factors”

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9. LEVERAGE AS DRIVING CONSUMPTION: EVIDENCE FOR SPAIN Spanish Survey of Household Finances, (EFF 2002, 2005, 2008) A panel that allows tracking the consumption, labor supply, wealth and debt of households The evolution of household expenditure in vehicles between 2002 and 2008 by the leverage ratio in 2002 Some evidence of higher cyclicality of the expenditure in durables among indebted households 9

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11. RESEARCH DIVISION MAIN QUESTION Do the model’s assumptions fit well with the European experience to be explained? Empirical evidence on the credit-consumption channel SOME EMPIRICAL SUPPORT. LIKELY TO BE RELEVANT. BUT PROBABLY LESS STRONG THAN IN THE US The different nature of the crisis across EZ countries Asymmetries and imbalances in the EZ Credit boom, deleveraging and sovereign risk premia 11

12. RESEARCH DIVISION 12 Employment growth (%) vs. GDP growth (2007q2-2010q2) GDPGDP COMMENT #2. SAME SHOCK? SAME (LABOR MARKET) TRANSMISSION MECHANISMS?

13. RESEARCH DIVISION 13 Employment growth (%) vs. GDP growth (20010q2-2011q4) GDPGDP COMMENT #2. SAME SHOCK? SAME (LABOR MARKET) TRANSMISSION MECHANISMS?

14. RESEARCH DIVISION MAIN QUESTION Do the model’s assumptions fit well with the European experience to be explained? Empirical evidence on the credit-consumption channel The different nature of the crisis across EZ countries DIFFERENT SHOCKS. DIFFERENT LABOR MARKET RESPONSES DIFFICULT TO EXPLAIN WITH SAME DEGREE OF LABOR MARKET RIGIDITIES ACROSS COUNTRIES Asymmetries and imbalances in the EZ Credit boom, deleveraging and sovereign risk premia 14

15. RESEARCH DIVISION COMMENT #3. ASYMMETRIES AND IMBALANCES 15 Lower productivity growth in the periphery during 1999-2007… … and higher wage pressure, led to Alberola, Molina and del Rio (2012)

16. RESEARCH DIVISION COMMENT #3. ASYMMETRIES AND IMBALANCES 16 …and together with lax fiscal policies to Alberola, Molina and del Rio (2012)

17. RESEARCH DIVISION COMMENT #3. ASYMMETRIES AND IMBALANCES 17 but could have a more restrictive fiscal policy avoided the increase in external debt? Gavilán, Jimeno, Hernandez de Cos, and Rojas (2010) Assume government consumption would have stayed constant, in per capita terms, at its 19981s level for 10 years (Scenario #1) or 20 years (Scenario #2). Beyond 2008 in Scenario #1, 2018 in Scenario #2, government consumption represents again a 17:3% of GDP in each period.

18. RESEARCH DIVISION MAIN QUESTION Do the model’s assumptions fit well with the European experience to be explained? Empirical evidence on the credit-consumption channel The different nature of the crisis across EZ countries Asymmetries and imbalances in the EZ COMPETITIVENESS, EXTERNAL IMBALANCES ARE KEY TO UNDERSTAND EZ CRISIS Credit boom, deleveraging and sovereign risk premia 18

19. RESEARCH DIVISION COMMENT #4. SOURCES OF SHOCKS Endogenous leverage The role of banks (and shadow banking) at generating credit cycles Nuño and Thomas (2012) Martinez-Miera and Suarez (2012) Factors behind the financing cost of EZ Governments ? Only fiscal variables? Contagion effects? Interactions public-private sectors? Other variables? 19

20. RESEARCH DIVISION FINANCING COST OF GOVERNMENTS 20 Spain: 10y bond yield July 7th: 4.71 % July 11th: Spain wins FIFA World Cup August 27th: 3.98 % October 14 th : 3.92%

21. RESEARCH DIVISION THANKS FOR YOUR ATTENTION ¡¡¡

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