Financial Crises in DSGE Models: Selected Applications of MAPMOD

Abstract

This paper, together with a technical companion paper, presents 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 both the pre-crisis and crisis phases of financial cycles.

An Overview of Macroprudential Policy Tools

“…5 In particular, most Dynamic Stochastic General Equilibrium (DSGE) models suggest that monetary policy not to change markedly when macroprudential policies are also used, even when different types of shocks are considered. A big caveat is that most models employ limited representations of financial systems and related financial frictions, and often use assumptions that imply linear relationships, making both policies operate mostly similar (see Laxton, 2014a and2014b, for DSGE-models with non-linearities).…”

Macroeconomic Management When Policy Space is Constrained: A Comprehensive, Consistent and Coordinated Approach to Economic Policy

“…For a discussion of an analytical framework that deals with vicious interactions between bank balance sheets, asset prices, and the real economy, seeLaxton (2014a, 2014b).©International Monetary Fund. Not for Redistribution…”

What Do We Know About the Effects of Macroprudential Policy?

“…A fourth line of research, pursued at the IMF, includes financial intermediaries’ balance sheets into DSGE models to yield highly non‐linear feedback effects between bank balance sheets, borrower balance sheets and the real economy during financial crises (Beneš et al . ,b). Parameters in these models are calibrated to match basic stylized facts of financial cycles.…”