Output Composition of the Monetary Policy Transmission Mechanism: Is Australia Different?

Output Composition of the Monetary PolicyTransmission Mechanism: Is Australia Different?

Tuan PhanAustralian National University

November 2013

Outline

I Motivation

I Literature

I Methodology

I DataI Results

I Output compositionI Housing and non-housing investmentI Durable and non-durable consumption

I Conclusion

Motivation

I Concensus: i ↑−→ Y ↓ (output, aggregate demand)

I Two main channels:- Investment channel: i ↑−→ I ↓−→ Y ↓- Consumption channel: i ↑−→ C ↓−→ Y ↓

I Deeper look: Which channel is more important(dominant)?

I Consumption smoothing and Investment volatility: investmentchannel might be more sensitive to interest rate changes.

I Answers can be informative for the theory on the channels ofthe monetary policy transmission mechanism, and alsopotentially help central bankers/policy makers in monitoringthe economy.

Literature

I Angeloni, I, Kashyap, A, Mojon, B and Terlizzese, D 2003,‘The Output Composition Puzzle: A Difference in theMonetary Transmission Mechanism in the Euro Area andU.S.’, Journal of Money, Credit and Banking, 35(6):- European countries (1970 - 2000): I>C- US (1965 - 2001): C>I “Output Composition Puzzle”

I Fujiwara, I 2004, ‘Output composition of the monetary policytransmission mechanism in Japan’, The B.E. Journal ofMacroeconomics, 0(1): I>C (1980 - 2003)

I Reasons: most possible: structure of housing markets (iaffects C and I in housing markets)

I If so, we can guess: for Australia: C>I, or at least closer toUS rather than Japan or Euro area.

The VAR models

I Christiano, Eichenbaum and Evans (2001): 10 variables(consumption, investment, other GDP components, CPI, realwages, labour productivity, policy rate, the profit-to-GDPratio, money and share price index)

I Erceg and Levin (2002): 6 variables (consumption,investment, other GDP components, CPI, commodity prices,and policy rate)

I Generalized Erceg and Levin (2002): add 2 variables (bondyields and money)

I Peersman and Smets (2003): 7 endogenous variables(consumption, investment, other GDP components,commodity prices, money, policy rate, and the real effectiveexchange rate), 3 exogenous variables (the US federal fundsrate, the US GDP, and the US price index) for Australia andthe Euro area; oil prices for the US

Data

I Australia, the Euro area, the US

I Quarterly data for the period 1982Q3–2007Q4

I Log form

I 1 or 2 lag structure

I Exogenous variables for all VARs for Australia

Output composition (Consumption and Investmentchannels)

Results are based on 2 indicators:

I Impulse Responses: Proportional effect

I Contribution: Size effect

Impulse Responses for AustraliaConsumption Investment Other GDP CPI Policy rate

Impulse Responses for Euro areaConsumption Investment Other GDP CPI Policy rate

Impulse Responses for the USConsumption Investment Other GDP CPI Policy rate

Proportional effect

I Investment reacts stronger at peak, but comes back faster

I Consumption stays significant for longer period

I Investment responds relatively strongest in Australia, then US,then Euro area

Calculation of Size contribution

1. Step 1

IC × weightC

C × weightC + I × weightI +G× weightG= C1

II × weightI

C × weightC + I × weightI +G× weightG= I1

2. Step 2

IC1

C1 + I1= C2

II1

C1 + I1= I2

So C2 + I2 = 1. Normally C2, I2 ∈ (0, 1).If C2 > 0.5⇒ C > I.If C2 < 0.5⇒ I > C.

Shares of GDP components

Country/Region Consumption Investment Other GDP components

Australia 0.54 0.17 0.29Euro area 0.57 0.21 0.22

US 0.65 0.16 0.19

Consumption contributionAustralia Euro area US

Size contribution results

I Consumption channel is much weaker in Australia (Investmentchannel is much stronger).

I In the Euro area and the US: not clear whether investment orconsumption channel is dominant.

So what are the main reasons of the differences between Australiaand the two comparators?

I Might be the housing investment (themore-interest-rate-sensitive component of investment)?

I To check: decompose investment into housing andnon-housing investment

I Use the same VARs, the same techniques (proportional andsize effect)

Housing and non-housing investment: impulse responsesAustralia Euro area US

Housing Non-housing Housing Non-housing Housing Non-housing

Shares of housing and non-housing investment

Country Housing Non-housing

/Region In GDP (In investment) In GDP (In investment)

Australia 0.06 (35%) 0.11 (65%)

Euro area 0.075 (36%) 0.135 (64%)

US 0.05 (31%) 0.11 (69%)

Housing contributionAustralia Euro area US

Housing contribution results

I Housing contribution is higher in Australia and the US.

I Housing contribution is much lower in the Euro area.

I Therefore, the difference in housing investment responsesrelatively to non-housing investment is likely the key reasonbehind the difference between Australia and the Euro area.

I Remain: between Australia and the US?

I Next: decompose consumption into durable consumption(more sensitive to interest rate changes) and non-durableconsumption (for Australia and the US).

I Use the same VARs, the same techniques (proportional andsize effect).

Durable and non-durable consumption: impulse responsesAustralia US

Durable Non-durable Durable Non-durable

Shares of durable and non-durable consumption

Country Durable consumption Non-durable consumption

/Region In GDP (In consumption) In GDP (In consumption)

Australia 0.04 (7.5%) 0.54 (92.5%)

US 0.055 (8.5%) 0.595 (91.5%)

Durable consumption contributionAustralia US

Durable and non-durable contribution results

I Durable contribution is around 0.3–0.4 in both Australia andthe US (though the band is much narrower in the US).

I Therefore, the difference in the shares of consumption andinvestment in total GDP is the main reason behind the outputcompostion difference between Australia and the US.

Country/Region Consumption Investment Other GDP components

Australia 0.54 0.17 0.29US 0.65 0.16 0.19

Conclusion

I Investment channel is stronger compared to consumptionchannel in Australia.

I In the Euro area and the US, the two channels are basicallynot different when shares are taken into account.

The reasons behind:

I Between Australia and the Euro area: the housing investmentresponses.

I Between Australia and the US: the shares in the total GDP.

Thank you!