Liquidity, inflation and asset prices in a time-varying framework for the euro-area

1. Liquidity, inflation and asset prices in a time-varying framework for the euro-area Paper by C Baumeister, E Durinck and G Peersman Discussion by Kostas Tsatsaronis Bank for International Settlements 1

2. Overview • Main question: Look at the dynamic links between liquidity (money) and other macro variables from a monetary policy perspective. • How do prices and quantities react to money shocks? • Do these reactions differ conditionally on the broader macro context ? • Basic answers: Money does matter… • …for inflation, output growth and real asset prices • …in particular “narrow money” and credit • …especially during a financial boom-bust cycle

3. General comments • An central question in macro and very important for central bankers • Rich implications for inputs to policy decision making • Brings to bear useful techniques: • Time-varying VAR • analysis of responses within different macro context • Provides a lot of food for further thought

4. The workhorse: VAR Endogenous variables: GDP growth Inflation Interest Rate Real asset price growth Liquidity growth Exogenous variables: Period dummies: great moderation post 1985 Equity volatility index(high-low split) Estimation: 1971-2005 Three lags Choleski identification

5. Comment of Grumpy Old Discussant • Why use the “synthetic” euro area data for such an investigation? • The euro area did not exist but for six out of 35 years in the sample period • Data artificially biased towards an average that may mean little for each individual economy • Focus on financial and monetary variables while ignoring the flexibility of European exchange rates! • Why not look at single countries, or Germany together with its close monetary allies?

6. Further comments on the VAR • Asset price volatility: maybe deviation from trend? • How important is the ordering of the first variables? • Especially the interest rate and asset price growth • Three lags may be an issue • Evidence that some of the mechanisms of interest are long-fused • Especially the “endogenous risk” component

7. Time-varying parameter VAR • An interesting idea to capture more subtle shifts in mechanisms • Results are a little puzzling: • Recently a liquidity shock leads to stronger output and inflation response, despite the higher interest rate • Evidence of a change in the nature of what “liquidity” proxies for? • Maybe worth to look into the M1 vs M3-M1 split

8. Analysis conditional on “states” • An interesting idea to uncover regularities • similar to split-sample regression but more flexible • akin to quartile regressions in some cases where the states refer to ranges for the LHS variable • The use of estimated residuals as RHS variables could be problematic, but I am not a purist

9. Conditional results • The effect of liquidity shocks on output, inflation and real asset prices is strengthened during asset price booms and busts • The liquidity effects during business cycle upswings are not too pronounced except for property prices • In high inflation regimes liquidity boosts nominal asset prices and real property prices

10. Conditional results (cont’d) • Policy should be concerned with the dynamics of asset markets in assessing the response to liquidity shocks • Could one interpret the asset price boom periods as supply-driven, and business cycle boom periods as demand driven episodes of increased liquidity and credit? • What do we know about the periods that combine characteristics?

11. Bottom line I like the paper because: • It presents different facets of the interactions between money/credit and the macroeconomy • It provides ground for more structured analysis of these channels I think that authors have to look deeper in: • Explaining the patterns they have uncovered • Making sure that the results are not influenced by the “synthetic” nature of the data used