Periodic Reporting for period 1 - NAUTILUS (NEW MODELS FOR MACROPRUDENTIAL POLICY AND FORECASTING: THE EURO CRISIS)
Berichtszeitraum: 2015-07-01 bis 2016-12-31
In the aftermath of the global financial crisis, the Euro area countries were severely damaged and the sustainability of the public finances still remains fragile. Subsequently, an interest both among academics and policy makers has been triggered in finding new predictive tools to assess financial risks and to devise coordinated strategies. Recently, the role of uncertainty in the transmission and amplification of shocks has been emphasized.
Can the recent Great Recession be understood as a transitory period in the long-run business cycle? Moreover, can stimulus packages, austerity programmes, quantitative easing on the part of ECB eventually slow down or even cancel out the perspective of a viable recovery and growth, as Hayek predicted in the 1930s?’His view has been criticized in favor of a “lack of aggregate demand” analysis advocated by Keynes as well as by modern economists, among others by Krugman. If recessions are efficient adjustment mechanisms, then they should not be socially painful as economic agents are rationally make decisions. However, public belief among commentators, politicians or many economists poses a considerable doubt on this view.
Before the crises, monetary policy may have been an important factor in stabilizing economic activity within a currency union. Nevertheless, the crisis has exposed a fallacy in this paradigm; a severe economic downturn may be constrained by the zero lower bound and the heterogeneity of fiscal multipliers in a currency union. Hence, the optimal level of monetary policies and government spending in response to a deep recession should vary among member states based on the strength of policy cooperation inside the Union. In the US and the UK, central banks have adopted forward guidance and quantitative easing in managing long term inflation expectations which in turn impact real interest rates. The ECB has adopted similar, yet not identical ideas. Financial distress affects the ability of agents to learn about economic fundamentals. The presence of financial frictions endogenously determines market efficiency and monetary policy and thereby governs uncertainty among agents.
The NAUTILUS project via novel econometric modeling challenged the mechanism that explains persistence during financial crises. In states of financial distress, real business activity does not reflect actual business conditions, leaving market agents uncertain about the state of the economy. Further investigation of the role of macro-financial spillovers and frictions for the business cycle in the Eurozone area was conducted.
In NAUTILUS we probed into optimal regulation in financial markets in the EU and analyzed the Banking Union. We re-examined the established models utilized so far to describe the ongoing crisis. Furthermore, our research was motivated by the creation of the European Stability Mechanism (ESM) as a “crisis management” mechanism, as opposed to simple debt refinancing.
The research outcomes of NAUTILUS included i) the development of novel time-varying parameter adaptive econometric VAR models to account for inherent nonlinearities of the Euro area economy, ii) the extension of benchmark calibrated dynamic stochastic general equilibrium (DSGE) models with financial intermediation, frictions and asymmetric information including moral hazard, iii) the introduction of Hybrid DSGE models in order to deal with the trade-off between theoretical coherence and empirical fit, iv) the combination of rich structural models, novel solution algorithms, powerful simulation and estimation of DSGE models, v) the investigation of contagion, and spillover effects among the US, EU and Asian markets, vi) the detection of co-movement, long-run relationships and short-run dynamics of EU business cycles vis-à-vis international economies and vii) a robust comparative predictability analysis versus benchmark statistical tools for key macro-financial variables in the Eurozone.
Can the recent Great Recession be understood as a transitory period in the long-run business cycle? Moreover, can stimulus packages, austerity programmes, quantitative easing on the part of ECB eventually slow down or even cancel out the perspective of a viable recovery and growth, as Hayek predicted in the 1930s?’His view has been criticized in favor of a “lack of aggregate demand” analysis advocated by Keynes as well as by modern economists, among others by Krugman. If recessions are efficient adjustment mechanisms, then they should not be socially painful as economic agents are rationally make decisions. However, public belief among commentators, politicians or many economists poses a considerable doubt on this view.
Before the crises, monetary policy may have been an important factor in stabilizing economic activity within a currency union. Nevertheless, the crisis has exposed a fallacy in this paradigm; a severe economic downturn may be constrained by the zero lower bound and the heterogeneity of fiscal multipliers in a currency union. Hence, the optimal level of monetary policies and government spending in response to a deep recession should vary among member states based on the strength of policy cooperation inside the Union. In the US and the UK, central banks have adopted forward guidance and quantitative easing in managing long term inflation expectations which in turn impact real interest rates. The ECB has adopted similar, yet not identical ideas. Financial distress affects the ability of agents to learn about economic fundamentals. The presence of financial frictions endogenously determines market efficiency and monetary policy and thereby governs uncertainty among agents.
The NAUTILUS project via novel econometric modeling challenged the mechanism that explains persistence during financial crises. In states of financial distress, real business activity does not reflect actual business conditions, leaving market agents uncertain about the state of the economy. Further investigation of the role of macro-financial spillovers and frictions for the business cycle in the Eurozone area was conducted.
In NAUTILUS we probed into optimal regulation in financial markets in the EU and analyzed the Banking Union. We re-examined the established models utilized so far to describe the ongoing crisis. Furthermore, our research was motivated by the creation of the European Stability Mechanism (ESM) as a “crisis management” mechanism, as opposed to simple debt refinancing.
The research outcomes of NAUTILUS included i) the development of novel time-varying parameter adaptive econometric VAR models to account for inherent nonlinearities of the Euro area economy, ii) the extension of benchmark calibrated dynamic stochastic general equilibrium (DSGE) models with financial intermediation, frictions and asymmetric information including moral hazard, iii) the introduction of Hybrid DSGE models in order to deal with the trade-off between theoretical coherence and empirical fit, iv) the combination of rich structural models, novel solution algorithms, powerful simulation and estimation of DSGE models, v) the investigation of contagion, and spillover effects among the US, EU and Asian markets, vi) the detection of co-movement, long-run relationships and short-run dynamics of EU business cycles vis-à-vis international economies and vii) a robust comparative predictability analysis versus benchmark statistical tools for key macro-financial variables in the Eurozone.
The NAUTILIS project was decomposed into three Work Packages which have been further analysed into Tasks and Sub-Tasks. Each WP was analyzed in terms of the main results achieved analytically and the outcomes beyond the state of the art. They included information under which WP and Task the Advancements were being implemented and the achievements “interlinked” with the specific objectives. All Work Packages, Tasks and Sub-Tasks were committed to promotional activities, conference participation / organization and information dissemination through the production and distribution of project deliverables, which include Publications, Working Papers, Scientific Conferences, Presentations, Workshops, Academic Visits, Schools etc. The Fellow has reinforced the execution of partnerships in the form of lasting collaborations and knowledge sharing based on his interaction with institutions and scholars from the EU.
The NAUTILUS project via novel econometric modeling beyond the state of the art incorporated the high uncertainty feeding back into real economy from financial markets creating a self-confirming cycle. Evidently, this feedback loop had important implications on the economic growth of member states in response to various shocks. An excessive leverage cycle leads to inefficient allocation of capital and skills across members of a currency union and has adverse amplification effects during business cycles. Commonly, there is high leverage in normal times (as during the great moderation period), whilst too little leverage in crisis periods (Great recession). The NAUTILUS project was motivated by the creation of the ESM as a “crisis management” mechanism, as opposed to simple debt refinancing. Hence, the results can be useful in the direction of inaugurating a more permanent mechanism of crisis management within the Euro area beyond the ESM. The issue of revision and modernization of institutional regulations was examined.
The socio-economic impact and the wider scientific and societal implications of NAUTILUS could be summarized in i) the created breakthrough of state-of-the-art which increased the awareness of the academic community on novel formal methods of analysis in macroprudential policy, monetary and fiscal consolidation, and forecasting, ii) the integration of datasets of economic indicators and macro-econometric models that would be of interest to international organizations, iii) the comparative evaluation of different models and tools in order to identify best way practices for policy design and iv) the development of crisis measurement tools incorporating different forms of shock-absorption mechanisms as outlined in the Van Rompuy Report (2012).
Overall, NAUTILUS aimed at increasing the awareness of the general public and policy makers on the existence and usefulness of formal methods of macroprudential analysis in the economic sciences, through the diffusion of project results. Hopefully, the proposed modeling can be valuable in providing new insights for policy making, regulation and crisis management in the Euro area.
The socio-economic impact and the wider scientific and societal implications of NAUTILUS could be summarized in i) the created breakthrough of state-of-the-art which increased the awareness of the academic community on novel formal methods of analysis in macroprudential policy, monetary and fiscal consolidation, and forecasting, ii) the integration of datasets of economic indicators and macro-econometric models that would be of interest to international organizations, iii) the comparative evaluation of different models and tools in order to identify best way practices for policy design and iv) the development of crisis measurement tools incorporating different forms of shock-absorption mechanisms as outlined in the Van Rompuy Report (2012).
Overall, NAUTILUS aimed at increasing the awareness of the general public and policy makers on the existence and usefulness of formal methods of macroprudential analysis in the economic sciences, through the diffusion of project results. Hopefully, the proposed modeling can be valuable in providing new insights for policy making, regulation and crisis management in the Euro area.