Financial Crises in DSGE Models: A Prototype Model

Abstract

This paper presents the theoretical structure of MAPMOD, a new IMF model designed to study vulnerabilities associated with excessive credit expansions, and to support macroprudential policy analysis. In MAPMOD, bank loans create purchasing power that facilitates adjustments in the real economy. But excessively large and risky loans can impair balance sheets and sow the seeds of a financial crisis. Banks respond to losses through higher spreads and rapid credit cutbacks, with adverse effects for the real economy. These features allow the model to capture the basic facts of financial cycles. A companion paper studies the simulation properties of MAPMOD.

A Welfare Analysis of Macroprudential Policy Rules in the Euro Area

“…It determines the interest rate on loans contracted by entrepreneurs. Assuming that it is able to modify its loan interest rate with a probability 1 − θ L i , it chooses R L * i,t (b) to maximize its expected sum of profits: i.e., banks recover (1 − µ B )(1 − η i,t+1 )((1 + R L i,t b))L s i,t+1 (b): we borrow this shortcut from Benes et al (2014), which is a tractable and easier way to introduce the loss-given-default µ B than in the initial framework of Bernanke et al (1999) where investors have a technology to size the collateral in case of default. 21 This tax is necessary to solve the model in steady state.…”

Financial Crises in DSGE Models: Selected Applications of MAPMOD

“…In particular, the quantitative properties of the model when subjected to large shocks will contain enormous uncertainty around them. As we argue in the companion paper (Benes, Kumhof, and Laxton, 2014), a great amount of such uncertainty, uncertainty or ambiguity in the true Knightian sense, will always remain unresolved (and unresolvable) no matter what empirical methods are used. This does not, by any means, underplay the role of models in macroprudential policy.…”

“…by ≥ E = 0.5 in the terminology of the companion paper (Benes, Kumhof, and Laxton, 2014), with the first scenario corresponding to ≥ E = 1.…”

“…This paper, together with a companion paper (Benes, Kumhof, and Laxton, 2014), presents MAPMOD, a new model that has been developed at the IMF to support macrofinancial and macroprudential policy analysis. While the technical companion paper discusses the theoretical structure of MAPMOD, this paper presents its simulation properties.…”

Stock-Flow Consistent Modeling of Default Events Sequence in a Closed Economy

“…Thus, the dynamic stochastic general equilibrium (DSGE) model developed by Benes et al (2014) makes a connection between defaults on loans and macroeconomic variables. Their model allows simulating productivity growth, changes in the riskiness of bank borrowers, deviations of asset prices, shocks to bank equity, etc.…”