Introduction Methodology Results Concluding remarks Impulse Responses Robustness Kiss Me Deadly: From Finnish Great Depression to Great Recession Adam Gulan Markus Haavio Juha Kilponen Bank of Finland 1 April 10 2015 1 The views expressed are those of the authors and do not necessarily reflect the views of the Bank of Finland
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Adam Gulan, Markus Haavio, Juha Kilponen. Kiss Me Deadly: From Finnish Great Depression to Great Recession
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Collapse of Finnish-Soviet trade in 1991:and ToT reversalreinforced by labor market frictions“From Russia with Love”, Gorodnichenko et al., AER 2012(see also Tarkka, 1994)
Financial:
Finnish Great Depression was preceded by financialliberalization, asset price boom, credit boomasset price collapsesevere banking crisis and credit crunche.g. Vihriala, 1997, Honkapohja and Koskela, 1999
Collapse of Finnish-Soviet trade in 1991and ToT reversalreinforced by labor market frictions“From Russia with Love”, Gorodnichenko et al., AER 2012 (see also Tarkka, 1994)
Financial:
Finnish Great Depression was preceded by financialliberalization, asset price boom, credit boomasset price collapsesevere banking crisis and credit crunche.g. Vihriala, 1997, Honkapohja and Koskela, 1999
Estimate a partially identified SVAR(1) model of 9 variables
External block:- World trade (real total global imports)- Finnish ToT (price of exports over price of imports)- financial market stress indicator CISS (Hollo et al. 2012)New Keynesian block:- real GDP- inflation (GDP deflator)- interest rate spread (lending rate - 3m MM rate)Financial block:- asset prices (first PCA of stock and house prices)- new loan volumes (to nonfinancial private sector)- loan losses (total real losses of banks)
Estimate a partially identified SVAR(1) model of 9 variables
External block:- World trade (real total global imports)- Finnish ToT (price of exports over price of imports)- financial market stress indicator CISS (Hollo et al. 2012)New Keynesian block:- real GDP- inflation (GDP deflator)- interest rate spread (lending rate - 3m MM rate)Financial block:- asset prices (first PCA of stock and house prices)- new loan volumes (to nonfinancial private sector)- loan losses (total real losses of banks)
Estimate a partially identified SVAR(1) model of 9 variables
External block:- World trade (real total global imports)- Finnish ToT (price of exports over price of imports)- financial market stress indicator CISS (Hollo et al. 2012)New Keynesian block:- real GDP- inflation (GDP deflator)- interest rate spread (lending rate - 3m MM rate)Financial block:- asset prices (first PCA of stock and house prices)- new loan volumes (to nonfinancial private sector)- loan losses (total real losses of banks)
Estimate a partially identified SVAR(1) model of 9 variables
External block:- World trade (real total global imports)- Finnish ToT (price of exports over price of imports)- financial market stress indicator CISS (Hollo et al. 2012)New Keynesian block:- real GDP- inflation (GDP deflator)- interest rate spread (lending rate - 3m MM rate)Financial block:- asset prices (first PCA of stock and house prices)- new loan volumes (to nonfinancial private sector)- loan losses (total real losses of banks)
Structural shocks: linked to residuals through someidentification matrix W
ut = W εt , Σ = WW ′
Start with Cholesky decomposition on Σ
Σ = BB ′
where B is a lower triangular matrix
Draw some orthonormal matrix Q (such that QQ ′ = I )
Σ = BB ′ = BQQ ′B ′
so that W = BQ and ut = BQεt .
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks
et = B−1ut
where BB ′ = Σ and B is obtained by a the Choleskydecomposition
3 Draw an orthonormal rotation matrix Q, and produce analternative set of structural shocks
εt = Q ′et
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks
et = B−1ut
where BB′ = Σ and B is obtained by the Cholesky decomposition
3 Draw an orthonormal rotation matrix Q, and produce analternative set of structural shocks
εt = Q ′et
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks
et = B−1ut
where BB ′ = Σ and B is obtained by a the Choleskydecomposition
3 Draw an orthonormal rotation matrix Q, and produce analternative set of structural shocks
εt = Q ′et
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks et3 lternative set of structural shocks εt4 Let
W = BQ
The impulse responses to the structural shocks εt are given by
Φ0 = W (on impact, or period 0)
Φ1 = AW (period 1)...
Φj = AjW (period j)
5 If the impulse responses satisfy the sign restricitons, keep therotation matrix Q and the stuctural shocks εt . Otherwisediscard Q and the stuctural shocks εt .
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks et3 lternative set of structural shocks εt4 Let
W = BQ
The impulse responses to the structural shocks εt are given by
Φ0 = W (on impact, or period 0)
Φ1 = AW (period 1)...
Φj = AjW (period j)
5 If the impulse responses satisfy the sign restricitons, keep therotation matrix Q and the stuctural shocks εt . Otherwisediscard Q and the stuctural shocks εt .
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks et3 lternative set of structural shocks εt4 Let
W = BQ
The impulse responses to the structural shocks εt are given by
Φ0 = W (on impact, or period 0)
Φ1 = AW (period 1)...
Φj = AjW (period j)
5 If the impulse responses satisfy the sign restricitons, keep therotation matrix Q and the stuctural shocks εt . Otherwisediscard Q and the stuctural shocks εt .
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks et3 lternative set of structural shocks εt4 Let
W = BQ
The impulse responses to the structural shocks εt are given by
Φ0 = W (on impact, or period 0)
Φ1 = AW (period 1)...
Φj = AjW (period j)
5 If the impulse responses satisfy the sign restricitons, keep therotation matrix Q and the stuctural shocks εt . Otherwisediscard Q and the stuctural shocks εt .
The procedure step by step
1 Reduced form residuals ut2 Cholesky-based structural shocks et3 lternative set of structural shocks εt4 Let
W = BQ
The impulse responses to the structural shocks εt are given by
Φ0 = W (on impact, or period 0)
Φ1 = AW (period 1)...
Φj = AjW (period j)
5 If the impulse responses satisfy the sign restricitons, keep therotation matrix Q and the stuctural shocks εt . Otherwisediscard Q and the stuctural shocks εt .
The procedure step by step
We repeat the procedure N times
In our case, N = 8× 1010 (or 80 billion)
... and we get a certain number K of structural models (or Qmatrices) that satisfy all the sign restrictions (and theFry-Pagan filter)
In our case, K = 2700
Model selection
Which of the K structural models do we choose, when we tryto interprete Finnish business cycles, and economic crises?
We base model selection on the historical shock decomposition
Θt = ∑j
ΦjEt−j
where Et−j is matrix with εt−j on the diagonal (and zeroselsewhere)
The cumulative contribution of current and past structuralshocks to model variables
To avoid contaminating identified shocks with unidentified ones,disregard all draws of Q for which unidentified shocks give rise tosame impulse response patterns as the identified ones.Then, all unidentifed shocks remain orthogonal to identified ones. + − ?
“From Russia with Love” can explain at most half of FinnishGreat Depression.
Financial crisis started the depression and prolonged it Great recession was very different. Imported recession.No financial crisis in Finland. Initial financial conditions much more robust.
Large overall role of financial shocks, esp. related to loansupply and banking