A Flow-of-Funds Perspective on the Financial Crisis Palgrave Studies in Economics and Banking Series Editor: Professor Richard Werner This series focuses on the economic implications of banking, bridging the usual divide between economics and banking/finance Titles in the series facilitate a deeper understanding of the interaction between banking and the economy, enabling readers to better understand the role and importance of banking in economic activity, and promote a better integration of banking and finance into policy models at theoretical and empirical levels Titles include: A Flow-of-Funds Perspective on the Financial Crisis, Volume I: Money, Credit and Sectoral Balance Sheets Bernhard Winkler, Ad van Riet and Peter Bull (editors) A Flow-of-Funds Perspective on the Financial Crisis, Volume II: Macroeconomic Imbalances and Risks to Financial Stability Bernhard Winkler, Ad van Riet and Peter Bull (editors) Palgrave Studies in Economics and Banking Series Standing Order ISBN: 978–1137–33135–9 (outside North America only) You can receive future titles in this series as they are published by placing a standing order Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England A Flow-of-Funds Perspective on the Financial Crisis Volume I: Money, Credit and Sectoral Balance Sheets Edited by Bernhard Winkler Senior Advisor, European Central Bank, Frankfurt am Main, Germany Ad van Riet Senior Advisor, European Central Bank, Frankfurt am Main, Germany Peter Bull Director General Statistics (retired), European Central Bank, Frankfurt am Main, Germany Editorial matter, selection and introduction © Bernhard Winkler, Ad van Riet and Peter Bull on behalf of the European Central Bank 2014 Foreword and remaining chapters © Respective authors or their affiliations 2014 Softcover reprint of the hardcover 1st edition 2014 978-1-137-35297-2 All rights reserved No reproduction, copy or transmission of this publication may be made without written permission No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6–10 Kirby Street, London EC1N 8TS Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages The authors have asserted thier rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988 First published 2014 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010 Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries ISBN 978-1-349-46944-4 DOI 10.1057/9781137352989 ISBN 978-1-137-35298-9 (eBook) This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin A catalogue record for this book is available from the British Library A catalog record for this book is available from the Library of Congress Contents List of Figures vii List of Tables x Foreword by Peter Praet xii Notes on Editors xv Notes on Contributors xvi Introduction and Overview Bernhard Winkler, Ad van Riet and Peter Bull Part I Money, Credit and Liquidity in the Flow of Funds The Quantity Theory of Money Revisited Carmelo Salleo The Quantity Theory of Credit and Some of Its Policy Implications Richard A Werner Euro Area Money Demand and International Portfolio Allocation: A Contribution to Assessing Risks to Price Stability Roberto A De Santis, Carlo A Favero and Barbara Roffia 13 22 46 Global Liquidity and Credit Booms Claudio Borio, Robert N McCauley and Patrick McGuire Dual Liquidity Crises under the Gold Standard and in a Monetary Union: A Financial Accounts Perspective Ulrich Bindseil and Adalbert Winkler 125 Determinants and Consequences of Credit Tightening: An Analysis of the United States and the Euro Area Riccardo De Bonis, Luigi Infante and Francesco Patern`o 146 v 94 vi Contents Part II Sectoral Analysis of the Flow of Funds Financial Intermediary Balance Sheet Management Tobias Adrian and Hyun Song Shin Bank Leverage and the Credit Cycle in the Euro Area: A Bayesian Semi-Parametric Approach Celestino Gir´on and Silvia Mongelluzzo 10 11 12 13 Households’ Financial Portfolio Choices: A Comparison between France and Germany (1978–2009) Sanvi Avouyi-Dovi, Vladimir Borgy, Christian Pfister, Michael Scharnagl and Franck S´edillot Household Balance Sheets and Debt: An International Country Study Jacob Isaksen, Paul Lassenius Kramp, Louise Funch Sørensen and Søren Vester Sørensen Analysing Recent Developments in the Financing of Euro Area Non-Financial Corporations Laurent Maurin Monetary Policy and the Flow of Funds in the Euro Area Riccardo Bonci Index 177 203 236 257 271 296 318 Figures 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 5.1 5.2 5.3 5.4 5.5 5B.1 5A.1 6.1 6.2 6.3 7.1 7.2 Standard fiscal policy funded via bond issuance Bank-funded fiscal policy Annual HICP inflation and M3 growth in the euro area Euro area annual M3 velocity growth and net flows in portfolio investment between non-monetary financial institutions Calza et al money demand for the euro area: its structural instability and four-step ahead out-of-sample (from 2000 Q1) projections of real money growth The DFR money demand model for the euro area Projections of real money growth based on the DFR money demand for the euro area Expected real M3 growth: short, medium and long term Excess liquidity measures and HICP inflation The disequilibria in money demand and asset prices before and after the euro area sovereign debt crisis Out-of-sample projections of real money growth and real GDP growth over the euro area sovereign debt crisis Overall HICP inflation and HICP inflation excluding food and energy Global credit in dollars, euros and yen Credit to the non-financial private sector in selected European countries Credit to the non-financial private sector in selected advanced countries Credit to the non-financial private sector: Asia in the 1990s Credit to the non-financial private sector in selected emerging economies Credit to the non-financial private sector The challenges of international credit A simple system of financial accounts in which households consider banknotes the safe asset The gold standard: a financial accounts presentation Monetary union: a financial accounts presentation United States: impact of a per cent decline of CAR on GDP Euro area: impact of a per cent decline of CAR on GDP vii 38 38 47 47 52 58 64 66 67 80 83 84 102 104 108 110 112 116 121 128 131 137 169 169 viii List of Figures 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 8.10 8.11 8.12 8.13 9.1 9.2 9.3 9.4 9.5 9.6 9.7 10.1 10.2 10.3 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 12.1 12.2 12.3 12.4 Balance sheet financing by debt and equity Asset growth and leverage growth Relationship between asset growth and leverage growth for US household sector Relationship between asset growth and leverage growth for US non-financial corporate sector Increased leverage through expansion in balance sheet size Regions of increasing and decreasing equity Set of points with constant equity growth Leverage growth and asset growth of US investment banks Leverage growth and asset growth for US commercial banks Northern Rock’s liabilities (1998–2007) Stylised financial system Short intermediation chain Long intermediation chain Leverage-ratio across countries for 1999Q1–2012Q1 Assets growth rate across countries for 1999Q1–2012Q1 Dynamic correlation between notional assets growth rate and logarithm of leverage Posterior distributions: parametric Gaussian mixing distribution Posterior distributions: Dirichlet Process Posterior distributions for β2 : Enriched Dirichlet Process Posterior distributions for β0 and β1 : Enriched Dirichlet Process Germany: portfolio structure (1978–2009) France: portfolio structure (1978–2009) Households’ portfolio structure in France and in Germany in 2009 Household net wealth, gross debt and pension wealth Household wealth and gross debt Household gross debt External debt and net financial assets at sector level (2010) Estimated net savings ratios for the household sector Financial development, pension wealth and gross debt Arrears with home loans or rent (2009) Household gross debt and consumption volatility Financial liabilities of euro area NFCs Investment and external financing of euro area NFCs Original maturity MFI loans to euro area NFCs Movements in MFI loans to NFCs per maturity 179 180 181 182 183 184 184 185 186 191 194 195 196 208 208 209 218 218 219 220 239 240 243 260 261 262 263 264 265 267 269 273 274 275 276 List of Figures ix 12.5 12.6 12.7 12.8 12A.1 Financial liabilities of euro area NFCs Financing costs of NFC Estimated shocks Shock decomposition of some series in the VAR Response of endogenous variables to a shock to bank lending spread 12A.2 Response of endogenous variables to a shock to bank loans 12A.3 Response of endogenous variables to a shock to investment 13.1 VAR model variables 13.2 The impact of a contractionary monetary policy shock 13.3 The effect of a contractionary monetary policy shock on other macro variables 13.4 Net funds raised by each sector 13.5 Impact of a contractionary monetary policy shock on firm assets and liabilities 13.6 Impact of a contractionary monetary policy shock on net funds raised 13.7 Impact of a contractionary monetary policy shock on household assets and liabilities 13.8 Impact of a contractionary monetary policy shock on total loans 13.9 Impact of a contractionary monetary policy shock on non-bank loans 277 278 283 285 291 292 293 298 299 301 302 303 305 307 312 313 312 Riccardo Bonci Loans to private sector Loans to households 40000 20000 30000 10000 20000 5000 10000 0 -5000 -10000 -10000 -20000 -20000 -15000 -40000 12 16 Short-term loans to private sector 20000 10000 Loans to non-financial corporations 15000 12 -30000 16 Short-term loans to households 10000 5000 -500 -5000 -1000 -10000 -1500 12 16 15000 0 12 1000 -20000 1500 500 -10000 Short-term loans to non-finan corp 20000 16 -15000 Long-term loans to private sector 12 16 Long-term loans to households 20000 8000 10000 4000 0 -10000 -4000 -20000 -8000 12 16 Long-term loans to non-finan corp 15000 10000 12 5000 -5000 -10000 -15000 16 Consumer credit to households 2000 12 16 12 16 Loans for house purchases 10000 1500 5000 1000 500 0 -500 -5000 -1000 -1500 -10000 12 16 12 16 Figure 13.8 Impact of a contractionary monetary policy shock on total loans (deviation from the baseline; e millions of 1995) Note: See note to Figure 13.3 Focusing on loans granted by non-bank agents, it arises that the policy tightening is associated with a credit expansion occurring in the very first quarters While the overall impact on such non-bank loans is significant only for households, the response of the long-term component turns out to be relevant both for households and for firms (Figure 13.9) The response of long-term non-bank loans to firms is of particular interest, because they account for almost half of the total in the case of the business sector After the 24 basis points interest rate tightening, long-term loans to firms increase at impact by about e3 billion, Monetary Policy and the Flow of Funds in Euro Area 313 Other loans to private sector Other loans to households 15000 3000 10000 2000 5000 1000 0 Other loans to non-financial corp 8000 4000 -4000 -5000 -1000 -10000 -2000 10000 1000 4000 5000 500 2000 0 -5000 -500 -2000 -10000 -1000 -4000 -15000 -1500 5000 2000 0 -5000 -2000 -4000 -8000 12 16 12 16 12 16 Other short-term loans to private sector Other short-term loans to households Other short-term loans to non-fin corp 15000 1500 6000 -6000 12 16 12 16 12 16 Other long-term loans to private sector Other long-term loans to households Other long-term loans to non-fin corp 10000 4000 8000 -10000 4000 -4000 12 16 -8000 12 16 12 16 Figure 13.9 Impact of a contractionary monetary policy shock on non-bank loans (deviation from the baseline; e millions of 1995) Note: See note to Figure 13.3 corresponding to some 12 per cent of the average of the quarterly flow (Table 13.1), supporting the view that firms try to substitute at least a fraction of bank loans with alternative sources of funds, including inter-company loans, after the change in the short-term rate Also, the response of long-term loans granted to households by sectors other than banks is considerable compared with the average of the series (some 16 per cent of the average flow at the peak; Table 13.1) This result might hint at some households, especially those whose loan application has been (or would probably be, given their weak financial situation) rejected by banks, attempting to borrow more funds from other financial institutions, possibly also being ready to pay a higher cost The increase of non-bank loans to the private sector in the aftermath of a tightening, although it might be considered as counterintuitive at first glance, is not new in the empirical literature on the impact of monetary policy (for example, Christiano et al., 1996; Bernanke and Gertler, 314 Riccardo Bonci 1995; den Haan et al., 2007); also, for the euro area, Giannone et al (2009) detected a positive and persistent response of (total) business loans after a monetary contraction A number of possible explanations have been put forward in the literature for the observed positive effect of an adverse monetary policy shock on lending Some might also apply to our case, in which only non-bank loans increase after the tightening First, when conditions on the trade credit market deteriorate, as is normally the case in an economic downturn, firms might need more time for cashing their sales, thus increasing their working capital financing needs On the other hand, to face rising unemployment and the cutback of financial wealth associated with the slowdown of asset prices (Figure 13.6), households might be willing to maintain a minimum level of consumption, also increasing their demand for loans Moreover, agents might react to the tightening by drawing from pre-committed credit lines that are locked at the lower pre-shock rate, especially when the response of lending rates to the tightening is delayed These factors could help account for the increase in loan demand in the aftermath of the policy shock As regards the supply side, Bernanke and Gertler (1995) argued that a credit expansion can still be consistent with a reduction in the supply of loans (as the bank lending channel would predict), provided that firms’ demand for loans is actually higher that the observed equilibrium in that it is only partially met by financial institutions A similar argument could be applied to the household sector 13.5 Conclusion This chapter has investigated the transmission of monetary policy in the euro area via its impact on the borrowing and lending decisions of the economic sectors An estimated VAR model is used to identify monetary policy shocks in the euro area and is then augmented to include the flow-of-funds variables A number of interesting results arise as to the transmission of monetary policy through the flow of funds lent and borrowed among the sectors as a result of their real imbalances Firms cut their issuance of liabilities and their acquisition of financial assets, with a negligible overall effect on net funds borrowed from the rest of the economy Consistently with standard monetary business cycle models, firms face the slowdown of profits and the higher cost of credit which follows the policy tightening by drawing on their liquidity, Monetary Policy and the Flow of Funds in Euro Area 315 and have more recourse to inter-company loans as a (partial) substitute for bank loans We don’t find evidence of strong financial frictions in the euro area which would prevent firms from adjusting their level of nominal expenditures after the policy shock, as is the case in the US economy according to Christiano et al (1996) Besides firms’ ability to adjust their nominal expenditures and reduce their financing needs, which affects credit demand, the observed drop in business loans after the policy shock might, of course, be related to a deterioration in the supply of loans (up to a credit crunch) In this respect, the different response found for the US economy by Christiano et al (1996), that is, an increase of firms’ net borrowing after the shock, could be due to the larger average firm size, assuming that large corporations are less subject to the worsening of business conditions and thus might manage to smooth the impact of reduced sales via larger debt issuance (instead of cutting on investment) more than small firms Households react to the policy tightening by reducing the issuance of new financial liabilities rather quickly, resulting in an acceleration of (net) funds lent to other sectors Together with the observed reduction of private consumption, this result could suggest that households try to increase precautionary savings in the context of the weak economic juncture, observing the fall of output and the rise of unemployment Reverting from the short-term response, households start borrowing more funds (in net terms) from the rest of the economy two years after the shock, when the recovery of consumption also starts materialising Besides financing their increasing levels of consumption (with disposable income still weak due to relatively high unemployment), the rise of new liabilities issued is used by households, together with part of their liquid assets, to accumulate more shares, whose price has fallen significantly in the meantime Consistently with the lower credit demand associated with the slowdown in economic activity and with the bank lending channel of monetary policy, the interest rate tightening is associated with a significant fall in total loans to the private sector, especially short-term; the result is confirmed when only bank loans are taken into account, while the impact on non-bank loans is of the opposite sign, especially for the household sectors The heterogeneity of the sectors’ responses hints at the relevance of the analysis based on the flow-of-funds data for the conduct of monetary policy and calls for similar exercises to be developed also for other countries, taking advantage of the growing availability, improved timeliness and better quality of the flow-of-funds statistics worldwide 316 Riccardo Bonci Acknowledgement I am thankful to B Fischer, M Lenza, A Musso, M Tujula, B Winkler, T Westermann and participants at two seminars at the European Cenmtral Bank for very helpful suggestions and discussions All the remaining errors are mine References Almeida, H., Campiello, M and M.S Weisbach (2004) ‘The Cash Flow Sensitivity of Cash’, Journal of Finance, 59 (4), 1777–804 Bernanke, B.S and A.S Blinder (1992) ‘The Federal Funds Rate and the Channels of Monetary Transmission’, American Economic Review, 82 (4), 901–21 Bernanke, B.S and A.S Blinder (1988) ‘Credit, Money and Aggregate Demand’, American Economic Review, 78 (2), 435–9 Bernanke, B.S and M Gertler (1995) ‘Inside the Black Box: The Credit Channel of Monetary Policy Transmission’, Journal of Economic Perspectives, (4), 27–48 Bonci, R and F Columba (2008) ‘Monetary Policy Effects: New Evidence from the Italian Flow of Funds’, Applied Economics, 40 (21), 2803–18 Christiano, L., Eichenbaum, M and C Evans (1996) ‘The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds’, Review of Economics and Statistics, 78 (1), 16–34 den Haan, W., Sumner, S and G Yamashiro (2007) ‘Bank Loan Portfolios and the Monetary Transmission Mechanism’, Journal of Monetary Economics, 54 (3), 904–24 Ehrmann, M (2000) ‘Firm Size and Monetary Policy Transmission Evidence from German Business Survey Data’, ECB Working Paper, No 21 Eichenbaum, M (1992) ‘Comment on Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy’, European Economic Review, 36 (5), 1001–11 Fuerst, T (1994) ‘The Availability Doctrine’, Journal of Monetary Economics, 34 (3), 429–43 Gameiro, I.M and J Sousa (2010) ‘Monetary Policy Effects: Evidence from the Portuguese Flow of Funds’, Banco de Portugal Working Paper, No 14 Gertler, M and S Gilchrist (1993) ‘The Role of Credit Market Imperfections in the Monetary Transmission Mechanism: Arguments and Evidence’, Scandinavian Journal of Economics, 95 (1), 43–64 Gertler, M and S Gilchrist (1994) ‘Monetary Policy, Business Cycles and the Behavior of Small Manufacturing Firms’, Quarterly Journal of Economics, 109 (2), 309–40 Giannone, D., Lenza, M and L Reichlin (2009) Money, credit, monetary policy and the business cycle in the euro area, paper presented at the conference ‘Monetary Policy Transmission Mechanism in the Euro Area in its First Ten Years’, Frankfurt am Main, 28–29 September, mimeo Han, S and J Qiu (2007) ‘Corporate Precautionary Cash Holdings’, Journal of Corporate Finance, 13 (1), 43–57 Monetary Policy and the Flow of Funds in Euro Area 317 Monticelli, C and O Tristani (1999) ‘What Does the Single Monetary Policy Do? A SVAR Benchmark for the European Central Bank’, ECB Working Paper, No P`al, R and A Ferrando (2010) ‘Financing Constraints and Firm Cash Policy in the Euro Area’, European Journal of Finance, 16 (2), 153–71 Peersman, G and F Smets (2003) ‘The Monetary Transmission Mechanism in the Euro Area: Evidence from VAR Analysis’ in I Angeloni, A Kashyap and B Mojon (eds), Monetary Policy Transmission in the Euro Area (Cambridge, UK: Cambridge University Press) Sims, C (1992) ‘Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy’, European Economic Review, 36 (5), 975–1000 Index accounting identities, 27–8, 31 active leverage, 207 Adrian, Tobias, 5–6, 177 adverse selection, 188 aggregate demand, 154, 166, 170 Almost Ideal Demand System (AIDS), 237, 243 Asia, credit booms in, 107, 110–11 asset-backed commercial paper (ABCP), 197, 200 asset-backed securities (ABSs), 195, 196–7, 200 assets asset bubbles, 17, 33, 41–2 growth, 179–88, 194–5 household, prices, 33, 40, 49, 53–4, 60, 122, 204, 205, 206 Austria, 204, 207 Avouyi-Dovi, Sanvi, 6, 236 balance sheet management, 5–6, 177–99 background on, 178–80 equity stickiness and, 187–9, 198 financial system risk and, 192–3 introduction to, 177–8 leverage and, 180–1 systemic risk and, 194–6 balance sheets capacity, 189–91 household, 7, 258–69 Baltic States, 104, 107 bank capital, 5, 33, 146–9, 151, 152–3, 155–7, 166–7, 170–1, 189–90 bank credit, 3–4, 24, 27, 29, 31–2, 35–6, 39, 41–3, 149–50 see also bank loans; credit Bank for International Settlements (BIS), 4, 94 bank holding companies (BHCs), 186, 200 banking crises causes of, 42 prevention of, 40–2, 43 bank loans, 8, 24, 147, 149–50, 271–8, 282, 312, 315 Bank of Japan, 2, 119, 121 bankruptcy, 179, 197, 203 banks balance sheet growth of, capitalisation of, 33, 147–9, 170, 189 capital losses of, 5, 146, 170 capital requirements for, 201 commercial, 6, 186–7, 195–8, 206 credit creation by, 17, 24, 31, 34–6, 42 cross-border lending by, 4, 94, 95, 118–21 deleveraging, 271 domestic, 192–3 European, 147, 149, 189, 206 government bail-outs of, 40 interconnectedness of, 194–6 investment, 6, 185, 187, 189, 198, 203–4, 206 lending standards, 5, 149–50, 152–61, 170, 280 lending survey data, 151–2 leverage-ratio, 6, 203–33 money creation by, 28, 34 regulations on, 31–2, 146, 201 reserves, 147, 151 role of, 20–1 shadow, 15, 196–7 stress tests, 189 US, 147, 148–9, 189, 206 Basel III, 119–20, 201 Bayesian model, 212–21 behavioural information, 27 Belgium, 204, 207 Benati, L., 50 Bernanke, B.S., 146, 147, 150, 296 318 Index 319 Bewley transform, 246 Bindseil, Ulrich, 5, 125 Bonci, Riccardo, 7–8, 296 bond issuance, 37 bonds, 277–9 bond yields, 84–5, 281 boom-bust cycles, 4, 40–2, 194–5 Borgy, Vladimir, 6, 236 Borio, Claudio, 4, 94 Brazil, 103, 107, 117 broad money demand, 49–50 Bull, Peter, business cycle, 16, 146, 280, 302 business models, 18, 24, 178 Cambodia, 99 capital, 23 accumulation, bank, 5, 33, 146–9, 152–3, 155–7, 166–7, 170–1, 189–90 losses, 146, 170 requirements, 146, 201 Capital Asset Pricing Model (CAPM), 40 capital buffers, 6, 119–20 capital gains, 32–3 capital structure, 179 cash, 280 central banks, 2, 4, 34 credit guidance regime, 40–2 dual liquidity crises and, 126–42 euro area, 136–7 European Central Bank, 2, 25, 26, 48, 51, 139, 151 Federal Reserve, 2, 25, 150, 201 financial system and, 20–1 as lenders of last resort, 5, 141 monetary policy, 99 quantitative easing by, 39, 40 reaction to financial crisis by, 168, 170 regulation by, 31 CGL money demand model, 51–3, 90n12 China, 35, 95, 117 credit booms in, 107 foreign currency credit to, 95, 102 Christiano, L., 296, 297, 300, 304, 306, 311 classical economics, 22, 23–4 collateral constraints, 129, 130, 135, 138, 141 collateralised debt obligations (CDOs), 197, 201 collateralised mortgage obligations (CMOs), 195 commercial banks, 6, 186–7, 195–8, 206 competition, 18 consumer loans, 5, 154, 158–66, 310, 312–15 Consumer Price Index (CPI), 247 consumption, 5, 7, 155, 158, 161–8, 170, 268, 269 consumptive credit, 33 corporate debt, 180 corporate savings, 258 country-specific credit aggregates, 115–17 Covered Bond Purchase Programme, 48 credit, 42 bank, 24, 27, 29, 31–2, 35–6, 39, 41–3, 149–50 booms, 4, 33, 35, 94–5, 98, 103–20, 190–1, 193–5 consumer, 5, 154, 158–66 consumptive, 33 country-specific credit aggregates, 115–17 creation, 17, 24, 31–7 cross-border (external), 4, 94, 95, 103–21 currency-specific credit aggregates, 114–15 demand for, 31, 43n4, 147, 150–1, 166 financial, 32–3 foreign currency, 94, 95, 99–103, 118–21, 123n11 global, 99–103 growth, 311–14 impact of contractionary monetary policy on, 312–14 lending standards and, 5, 149–50, 152–61, 170, 276 320 Index credit – continued leverage and, 206–31 to non-financial sector, 105–6, 108–13 quantity theory of, 3–4, 22–45 spending and, 158, 161–6, 167, 168, 170 statistics on, 151–2 supply restrictions, 276, 279 tightening of, 146–74, 190–1, 302–3 trade, 31, 43n3, 304, 314 US dollar, 94, 99–102 credit card debt, 18 credit cycle, 6, 203–33 credit guidance regime, 40–2 credit standards, 5, 149–50, 152–61, 170, 276 cross-border credit, 4, 94, 95, 103–21 cross-border liquidity, 136–8 cross-border portfolio flows, 88 crowding out, 37 currency appreciation, 118 currency deposits, 242 currency-specific credit aggregates, 114–15 currency union, 125 cyclicality coefficient, 207, 219, 227 Dawes Plan, 135 De Bonis, Riccardo, 5, 146 debt corporate, 180 credit card, 18 cyclical fluctuations and, 268–9 government, 126 gross, 257–69 household, 7, 18, 258–69 increase in, 205 international, 119 leverage and, 205–6 public, 262–3, 296 debt financing, 178–9, 190–1 debt securities, 243, 252, 253, 271, 273, 277, 279 deleveraging process, 206, 271, 278, 296 Denmark, 257–69 deregulation, 18 De Santis, Roberto A., 4, 46 DFR money demand model, 54–64 Dirichlet Process, 204, 214–18, 222–27 disposable income, 261 dividend yields, 88 domestic banks, 192–3 domestic bonds, 115 domestic credit booms, 103–18 dotcom bubble, 283–4 dual liquidity crises, 125–45 within closed system of financial accounts, 126–30 euro area, 125, 136–40 German crisis of 1931, 130–6, 142 under gold standard, 130–6, 141, 142 under monetary union, 136–40, 141–2 Duesenberry, J., 26, 27 Dynamic Stochastic General Equilibrium (DSGE), 26 ease of financing, 96 East Asian Miracle, 35–6 economic activity, money and, 14 economic development, 35–6 economy, 22–3 real, 22–4, 28–30, 32, 125, 146, 271 shocks to, 268, 284–6 emerging economies credit booms in, 112–13 foreign currency credit in, 122n11 employment, 43 enhanced debt management, 37–9 Enriched Dirichlet Process, 214, 219–20, 222, 224–6 entrepreneurial income, 281, 282 entrepreneurs, 24 equity financing, 179 growth, 183–4, 185–6 prices, 205 shares, 243 stickiness of, 198 euro, 4, 94, 101, 102, 142n1, 149 euro area bank finance in, 277 bank leverage in, 203–30 Index 321 budget deficit, 311 consumer credit in, 158 credit tightening in, 155–7, 162–3, 167–9 dual liquidity crisis in, 125, 136–40 flow of funds, 300–11 inflation forecast, 78–9, 85 interest rates, 87 machinery investment in, 165 monetary policy, 296–315 money demand, 46–93 non-financial corporations, 271–93 residential investment, 167 sovereign debt crisis, 37–9, 48–9, 77–84, 146 European banks, 146–7, 149, 189, 206 European Central Bank (ECB), 2, 25, 26, 48, 51, 139, 151 European System of Accounts (ESA), 237–8 Eurosystem, 149–50 Eurosystem Bank Lending Survey, 276, 280 excess leverage, 203, 205, 206 excess liquidity, 65–79, 85–6 excess sensitivity framework, 155 exchange rates, 88, 89n10, 118 exports, 118 external credit, 103–18 Favero, Carlo A., 4, 46 Federal Deposit Insurance Corporation (FDIC), 155, 186 Federal Reserve, 2, 25, 140, 200 see also US Federal Reserve FED model, 53–4, 57, 89n6 financial accounts, closed system of, 126–30 Financial Almost Ideal Demand System (FAIDS), 7, 237, 243–6, 253 financial credit, 32–3 financial crisis, see global financial crisis financial cycle, 184–5, 190–1 financial flows, 1–2 financial innovation, 49, 205 financial instability, 20–1 financial intermediaries, 5–6, 18, 20 balance sheet management, 177–99 interconnectedness of, 194–6 risk management, 190 financial liberalisation, financial portfolio structure econometric results, 247–53 household, 237–53, 296 introduction to, 236–7 monetary policy and, 296 theoretical model, 243–6 financial sector, 23, 28 interaction with real economy, 146 losses in, 267–8 role of, 17–19 as wealth destroying, 20 financial shocks, 280 financial system, 22 financial system risk, 192–3 financial transactions, 18, 23 see also transactions financing debt, 190–1 decisions, 177–96 ease of, 96 market-based, 275 of non-financial corporations, 271–93 sources, Finland, 204, 207 firms asset growth in, 179–80 impact of contractionary monetary policy on, 303–6 investment by, 154, 162–3, 165, 166, 170 leverage growth in, 179–80 liabilities and profits, 151 non-financial, 271–95 fiscal policy, 36–7, 38, 42 Fisher, Irving, 13 fixed-rate full-allotment policy, 139 flexible exchange rates, 136–8 flow effect, 27 flow-of-funds analysis, 1–8, 19, 25–6, 296–315 accounting identities and, 27–8 global liquidity and, 98–9 parsimonious, 29–32 322 Index flow-of-funds analysis – continued quantity theory of credit and, 28–32 sectoral analysis, 5–8 flow-of-funds statistics, 17–18, 98, 121 foreign currency credit, 94, 95, 99–103, 118–21, 122n11 France, 134, 150, 151, 204, 207, 261 household portfolio structure, 6–7, 237–47, 250–4 French Stock Market Index, 251 funding liquidity, 95–6 German Bond Index, 247 German Stock Exchange Index, 247 Germany, 36, 204, 207, 261 banking structure in, 41–2 dual liquidity crisis of 1931, 130–6, 142 household portfolio structure, 6–7, 237–53 Gibbs Sample algorithm, 227–30 Giron, ´ Celestino, 6, 203 global credit, 99–103 global financial crisis, 1–2, 40, 189, 271, 296 aftermath of, 301 central banks and, credit tightening and, 146–7, 168–71 excess leverage and, 203, 205 external credit and, 104 foreign currency credit and, 102 reforms following, 201 globalisation, 4, 16 global liquidity, 4, 94–124 credit booms and, 103–18 flow of funds and, 98–9 in international currencies, 99–103 measurement problems in, 120–1 policy implications, 118–20 gold coverage ratio (GCR), 130, 133–4 gold standard, 5, 28, 125 constraints, 130–5 dual liquidity crisis/crises under, 130–6, 141, 142 goods price indices, 87 government debt, 126 government expenditures, crowding out by, 37 government securities, 97 government-sponsored enterprise, 201 Great Depression, 146 Great Moderation, 16, 205, 206 Greece, 35, 37, 42, 48, 204, 207 Greenspan, Alan, 89n7 Greiber, C., 88n3 gross debt, 258–69 gross domestic product (GDP), 23, 33, 87, 280 nominal, 35–6, 39, 87 real, 87 Harmonised Index of Consumer Prices (HICP), 46, 47, 67, 68–77, 81, 87 hedge funds, 197 Hong Kong, 102, 103 household balance sheet(s), 181, 258–69 debt, 7, 18, 258–69 disposable income, 170, 260 financial liabilities, 151 financial portfolio choices, 6–7, 237–53, 296 impact of contractionary monetary policy on, 306–10 savings, 8, 241–2, 257–9, 263–4 wealth, 49, 257–69 house prices, 268, 300 housing saving schemes, 241 housing wealth, 259, 269n2 Hungary, 107 hyperinflation, 143n3 Iceland, 42 income disposable, 170, 260 entrepreneurial, 281, 282 national, 32, 146 India, 103 Indonesia, 103, 107 Infante, Luigi, 5, 146 inflation, 4, 7, 20, 33, 40, 46, 47, 48, 50, 67, 81 excess liquidity and, 68–77 monetary growth and, 89n5 Index 323 information asymmetry, 277, 279–80, 306 insurance, 241–2, 247, 251, 252 interconnectedness, 194–6 interest rates, 7, 8, 34–5, 89n10, 148, 161, 205, 281, 296, 298, 311 euro area, 87 US, 87–8 international bonds, 115 international currencies, 99–103, 118–21 international debt, 119 international liquidity, see global liquidity international portfolio allocation, 46–93 intra-sector transactions, 18–20 investment banks, 6, 185, 187–8, 189, 198, 203–4, 206 Ireland, 35, 42, 104, 117 Isaksen, Jacob, 7, 257 Italy, 149–50, 204, 207, 261 Japan, 35, 36, 39, 107, 119, 121 Johansen test, 55, 56 Keynesian economics, 28, 29 Knapp, G.F., 24 Korea, 35, 103, 107 Kramp, Paul Lassenius, 7, 257 Latin America, 103 Lehman Brothers, 68, 147, 150, 185, 203, 204, 216, 220, 221–4 lender of last resort, 5, 141 lending standards, 5, 149–50, 152–61, 170, 276 leverage, 280 active, 207 balance sheet size and, 180–1 excess, 203 growth, 179–87 leverage-ratio, 203–33 Bayesian model, 212–21 data analysis, 207–8 introduction to, 205–7 overview of, 203–5 statistical framework and background, 209–17 liabilities-to-assets ratio, see leverage-ratio liberalisation, 18 life insurance, 238–40, 251 liquidity crisis, cross-border, 136–8 domestic context, 95–6 excess, 65–79, 85–6 funding, 95–6 global, 94–124 international context, 96 market, 95–6 measures, 4, 46, 65–77, 78–9, 96–7 overview of, 95–7 shocks, 136–8 liquidity preference motive, 16 loan origination, 196 loan warehousing, 196 Long-Term Refinancing Operations (LTROs), 39 M2, 89n4 M3 growth, 46–50, 54, 66, 85–6, 88n1, 90n16 machinery investment, 152–4, 158, 161, 162, 165, 166, 170 macroeconomics, 23–5 Malaysia, 103 market-based finance, 275 market liquidity, 95–6 Maurin, Laurent, 7, 271 McCauley, Robert, 4, 94 McGuire, Patrick, 4, 94 Merton, R.C., 180, 185 Miles, David, 24 Modigliani-Miller theorem, 148, 177–9, 185–6, 278 monetary aggregates, 86 monetary analysis, monetary economics, 24 monetary financial institutions (MFIs), 271 monetary financing prohibitions, 135–6, 139–42 monetary growth, inflation and, 89n5 324 Index monetary liquidity, see liquidity monetary policy, 7–8, 19, 50, 96, 99, 148, 296–315 contractionary, 300–15 flow of funds and, 300–11 impact on credit, 311–15 monetary quantity equation, 30, 31, 42 monetary quantity theory, 36–7 see also quantity theory of money monetary system, 22 monetary union, 5, 125, 136–42 money, 23, 24 creation of, 28, 34 defined, 14–15, 28, 34 economic activity and, 14 measurement of, 34 national income and, 146 prices and, 48, 49, 122 quantity theory of, 3, 13–21 as store of value, 16 transactions and, 13–14 trend dynamics of, 65–77 velocity of, 15, 50, 53–4, 84–6 money demand, 4, 15–16, 18, 19, 46–93 broad (M3), 49–50 DFR model, 54–64 disequilibria in, 79–81 euro area, 51–64 instability of traditional models, 51–3 stability of, 46 money market funds (MMFs), 207 money supply, 28, 42 Mongelluzzo, Silvia, 6, 203 moral hazard, 279 mortgage-backed securities (MBSs), 195 mortgages, 18, 154, 158, 161, 172n8, 267 mutual funds, 241 NAIRU, national income, 32, 146 national income accounting, 23, 25–6, 29, 43n2 neo-classical economics, 22, 28 Netherlands, 204, 207, 259, 262 net present value (NPV), 178, 179, 187–8 new classical economics, 22, 23–4, 28 New Keynesianism, 50 nominal GDP, 35–6, 39, 87 non-bank loans, 8, 121, 311, 311–12 non-financial corporations (NFCs) cash hoarding by, 279 financial liabilities of, 273, 277 financing costs of, 278 financing of, 271–93 internal financing by, 278–9 investment, 272, 274, 280 Northern Rock, 191 Norway, 262 Office for Financial Research, 19 Paterno, ` Francesco, 5, 146 pensions, 7, 242–3, 248, 260–2, 266–7 perfect information, 23–4, 31 Pfister, Christian, 6, 236 Philippines, 102, 103 portfolio allocation household, 6–7, 236–53, 296 international, 46–93 problem, portfolio motives, 16–17 Portugal, 37, 42, 204, 207 positive sum games, 32 Praet, Peter, xii–xiv price-earnings ratio, 60, 84–5, 88 prices see also asset prices money and, 48, 49, 122 price stability, 68–9 procyclicality, 221–21 productivity shocks, 280 public debt, 261–2, 296 quantitative easing, 39, 40 quantity crowding out, 37 quantity theory of credit, 3–4, 22–45 flow-of-funds analysis and, 28–32 quantity theory of money, 3, 13–21 quasi-money, 16 Index 325 real bills doctrine, 135 real economy, 22–4, 28–30, 32, 125, 146, 271 real GDP, 22, 87 recessions, 43n4 regulations, banking, 31–2, 146, 201 regulatory arbitrage, 120–1 Reichsbank, 130, 133–5 repurchase agreements (repo), 189, 190, 201 residential investment, 152–4, 161, 163, 166, 167, 170 risk, 97 aversion, 16–17 financial system, 192–3 management, 18, 190 systemic, 194–6 Roffia, Barbara, 4, 46 Salleo, Carmelo, 3, 13 savings corporate, 259 household, 8, 241–2, 257–8, 262–3 increase in, 16–17 savings glut hypothesis, 16 Scharnagl, Michael, 6, 236 Schumpeter, J.A., 24, 31, 32 Securities Markets Programme (SMP), 48 S´edillot, Franck, 6, 236 seemingly unrelated regression (SUR), 246 Senior Loan Officer Opinion Survey, 150, 151 Setzer, R., 88n3 shadow banking system, 15, 196–7 Shin, Hyun Song, 5–6, 177 short-side principle, 31 signal-to-noise ratio, 50 Sørensen, Louise Funch, 7, 257 Sørensen, Søren Vester, 7, 257 sovereign debt crisis, 37–9, 48–9, 77–84, 146 Spain, 35, 37, 42, 107, 204, 207 Special Drawing Rights (SDR), 96 Stein, J., 20 stock prices, 300 structural vector autoregressive (SVAR) framework, 272 systemic risk, 194–6 Taiwan, 35 TARGET2 balances, 136, 139, 140, 141 Thailand, 102, 103, 107, 117 Tobin’s-Q theory, 273 trade credit, 31, 43n3, 304, 314 transactions data on, 19 financial, 23 increase in financial, 18 intra-sector, 18–19, 20 money and, 13–14 in real economy, 29–30, 32 United Kingdom, 42, 50, 107, 114 United Nations System of National Accounts (NSA), 25 United States, 49–50 bank finance in, 277 banks, 147, 148–9, 189 bank stress tests in, 189 bond yields, 84–5 commercial banks, 186–7, 206 consumer credit in, 158, 161–2 credit booms in, 107 credit tightening in, 147, 155–7, 167, 169 interest rates, 87–8, 89n10 investment banks, 185, 206 machinery investment in, 166 non-bank loans, 121 price-earnings ratio, 60, 84–5 residential investment in, 163, 166 US dollar, 4, 94, 99–102 US dollar/euro exchange rate, 88, 89n10 US Federal Reserve, 2, 25, 150, 200 value at risk (VaR), 190, 201 van Riet, Ad, vector autoregression (VAR) models, 147, 152, 280, 282, 297–300, 304 326 Index vector error correction model (VECM), 280 velocity decline, 30–1, 34, 42 velocity of money, 15, 50, 53–4, 84–6 wealth, household, 49, 257–69 Werner, Richard A., 3, 22 Winkler, Adalbert, 5, 125 Winkler, Bernhard, yen, 101 zero-sum games, 20, 23, 32 ... macrofinancial analysis Financial flows and sectoral balance sheets are the ‘bread and butter’ of flow -of- funds analysis They lie at the heart of the financial crisis, while debt, default and financial... volumes The first volume on ? ?Money, credit and sectoral balance sheets? ?? focuses on the role of flow -of- funds analysis in complementing traditional monetary analysis centred on bank balance sheets and. .. corresponding balance sheets The financial crisis has driven home the importance of financial flows and balance sheets for an understanding of real–financial linkages and it has spurred a renewed academic