A Semi-Structural Model for Credit Cycle and Policy Analysis – An Application for Luxembourg

ASemi-StructuralModelforCreditCycleandPolicyAnalysis AnApplicationforLuxembourg CarlosdeResende,AlexandraSolovyeva,andMoezSouissiWP/24/140 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2024 JUL ©2024InternationalMonetaryFundWP/24/140 IMFWorkingPaper EuropeanDepartment ASemi-StructuralModelforCreditCycleandPolicyAnalysis–AnApplicationforLuxembourgPreparedbyCarlosdeResende,AlexandraSolovyeva,andMoezSouissi* AuthorizedfordistributionbyBernardinAkitobbyJuly2024 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Thepaperexploresthenexusbetweenthefinancialandbusinesscyclesinasemi-structuralNewKeynesianmodelwithafinancialaccelerator,anactivebankingsector,andanendogenousmacroprudentialpolicyreactionfunction.WeparametrizethemodelforLuxembourgthroughamixofcalibrationandBayesianestimationtechniques.Themodelfeaturesdynamicpropertiesthatalignwiththeoreticalpriorsandempiricalevidenceanddisplayssensibledata-matchingandforecastingcapabilities,especiallyforcreditindicators.Wefindthatthecreditgap,whichremainedpositiveduringCOVID-19amidcontinuedfavorablefinancialconditionsandpolicysupport,hadbeenclosingbymid-2022.Model-basedforecastsusingdataupto2022Q2andconditionalontheOctober2022WEOprojectionsfortheEuroareasuggestthatLuxembourg'sbusinessandcreditcycleswoulddeteriorateuntillate2024.Basedontheseinsightsaboutthecurrentandprojectedpositionsinthecreditcycle,themodelcanguidepolicymakersonhowtoadjustthemacroprudentialpolicystance.Policysimulationssuggestthattheweightsgiventomeasuresofcredit-to-GDPandassetpricegapsinthemacroprudentialpolicyruleshouldbewell-calibratedtoavoidunwarrantedvolatilityinthepolicyresponse. RECOMMENDEDCITATION:deResende,C.Solovyeva,A.,andSouissi,M.(2024).ASemi-StructuralModelforCreditCycleandPolicyAnalysis–AnApplicationforLuxembourg.IMFWorkingPaper24/140. JELClassificationNumbers: E42,G21,G28,E37,O52 Keywords: Macroprudentialpolicy;creditcycle;banks;forecastingandsimulation;Luxembourg Author’sE-MailAddress: cderesende@imf.org,asolovyeva@imf.org,msouissi@imf.org WORKINGPAPERS ASemi-StructuralModelforCreditCycleandPolicyAnalysis AnApplicationforLuxembourg PreparedbyCarlosdeResende,AlexandraSolovyeva,andMoezSouissi1 1“TheauthorsgreatlyappreciatetheusefulcommentsandsuggestionsreceivedfromVincenzoGuzzo,TarakJardak,EmilStavrev,andBernardinAkitobyduringtheIMFWorkingPaperreviewprocess.Also,thepaperbenefitsfromdiscussionswithparticipantsinSeminarsfromICD(February2024)andLuxembourg’sauthorities(March2021). Contents I.Introduction4 II.MacroprudentialPolicyandInstitutionalSetupinLuxembourg7 III.StylizedFacts:RecentMacroeconomicDevelopmentsinLuxembourg8 IV.TheModel9 A.OutputandInflation10 B.CreditMarketandBankingSector11 C.MacroprudentialPolicyRule14 V.Data,Calibration,BayesianEstimation,andModelValidation15 A.Data15 B.CalibrationandBayesianEstimation15 C.ModelValidation17 MomentComparison:Datavs.Model17 PseudoOut-of-SampleForecasts19 Modelvs.SimpleTimeSeriesForecastingMethods20 VI.ModelProperties22 MinimumCapitalRequirementShock22 A.ImpactoftheMainStructuralShocksintheModel24 DemandandSupplyShocks24 CreditDemandandSupplyShocks27 B.InterpretationofHistoricalDataUsingtheModel29 IndicatorsoftheFinancialCycle31 VII.Out-of-SampleForecasts33 A.AssumptionsfortheEuroArea33 B.Results34 VIII.Conclusion36 AnnexI.MainFeaturesoftheEuroAreaModel37 AnnexII.DataandSources38 AnnexIII.CalibrationandEstimation39 References42 FIGURES 1.RecentDevelopmentsintheCreditMarket9 2.PriorDistributionsandPosteriorModesforSelectedCoefficients17 3.ConfidenceIntervalsforSimulatedandActualMoments18 4.ActualDatavs.PseudoOut-of-SampleForecasts(2016Q1-2020Q4)20 5.ImpulseResponsestoaMinimumCapitalRequirementShock23 6.ImpulseResponseswithMacroprudentialRuleBasedontheCreditGap26 7.ImpulseResponseswithaMacroprudentialRuleBasedontheCredit-to-GDPGap27 8.ImpulseResponsestoaCreditDemandShock28 9.ImpulseResponsestoaCreditSupplyShock29 10.DecompositionoftheKeyIndicatorsoftheBusinessCycle30 11.DecompositionoftheKeyIndicatorsoftheCreditCycle32 12.MacroeconomicProjectionsfortheEuroAreaUndertheBaselineScenario33 13.BaselineForecastsfortheRealBusinessandFinancialCycles(2023–2027)35 14.VolatilityofthePolicyResponse36 TABLES 1.Datavs.Model-GeneratedMoments18 2.RMSEsoftheModelRelativetoSimpleBenchmarks21 I.Introduction The2007GlobalFinancialCrisishighlightedtheneedtocomprehendthecomplexrelationshipbetweenbusinessandcreditcycledynamics.Alargebodyoftheliteratureemergedfrompriorresearchonmacro-financialinterlinkages,suchasBernanke,Gertler,andGilchrist(1999;henceforthBGG)andKiyotakiandMoore(1997;henceforthK&M).Thisbodyofresearch,includingstudiesbyCalstromandFuerst(1997),Marcucc