9.5 Interest-Rate Risk #Notebook

 9.5 Interest-Rate Risk #Notebook

A Bank's profits highly rely on the difference between what it pays for its liabilities and earns on its assets. 

If interest rates increase +, the difference will decline -

*Because the value of its rate-sensitive liabilities exceeds that of its rate-sensitive assets.

For example, suppose a bank b pays 3% for your deposits and then receives 7% on the mortgages it lent. The difference is 4%, the amounts can be huge if they have billions of assets and liabilities on hand. The bank will be paying $100 billion * .03 = $3 billion to earn $7 billion.

If interest rates increase +1% on each side of the balance sheet, The bank will be paying $4 billion to earn $8 billion. 

Formally, this type of calculation, called basic gap analysis, is

 

Cρ = (Ar−Lr) × △i

Cρ = changes in profitability

Ar = risk-sensitive assets

Lr = risk-sensitive liabilities

i = change in interest rates

Duration, also known as Macaulay’s Duration, measures the average length of a security’s stream of payments. 

△%P = −△%i × d = △%MktV = −△%i × Dyr

Δ%P = % change in market value

Δi = change in interest (not decimalized, i.e., represent 5% as 5, not .05. Also note the negative sign)

d = duration (years)

So, let's get some practice...

Exp I. 

If interest rates increase 2% and the average duration of a bank’s $100 million of assets is 3 years, the value of those assets will fall approximately.....

△%MktV = −△%i × Dyr = −2 × 3 = −6%, or $6 million.

Then, at the same time..

If the value of that bank’s liabilities is $95 million, and the duration is also 3 years, the value of the liabilities will also fall, 95 × .06 = $5.7 million, effectively reducing the bank’s equity (6 − 5.7= ) $.3 million. 

If the duration of the bank’s liabilities is only 1 year, then its liabilities will fall −2 × 1 = −2% or 95 × .02 = $1.9 million, and the bank will suffer an even larger loss (6 − 1.9 =) of $4.1 million. If, on the other hand, the duration of the bank’s liabilities is 10 years, its liabilities will decrease −2 × 10 = −20% or $19 million and the bank will profit from the interest rate rise.

Apparently, we get the key point....

A basic interest rate risk reduction strategy when interest rates are expected to fall is to keep the duration of liabilities short and the duration of assets long. 

That way, the bank continues to earn the old, higher rate on its assets but benefits from the new lower rates on its deposits, CDs, and other liabilities. 

Quite the opposite, when interest rates increase +, banks would like to keep the duration of assets short and the duration of liabilities long.

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license. 

10.5 Banking Industry Profitability and Structure #Notebook

Banking Industry Profitability and Structure

When interest rates rose enough to cause disintermediation, to cause funds to flow out of banks to higher-yielding investments, banks are likely to compete with each other for funds and deposits. 

Securitization has hurt banks by giving rise to numerous small lenders that basically sell every loan they originate.

In 1933, at the nadir of the Great Depression, commercial and investment banking activities, strictly separated by legislation, Glass-Steagall. 

The banking crisis of the 1980s has caused some reforms, including greatly easing restrictions on branch banking and investment activities.

Due to the deregulation, banks began to merge in large numbers (consolidation), and participating in nonbanking financial activities, like insurance (conglomeration).

Due to the demise of Glass-Steagall, conglomerate banks can now more easily tap economies of scope, consolidation and conglomeration have left the nation with fewer but larger and more profitable banks to supply numerous products or services. 

Consolidation has allowed banks to diversify their risks geographically and to tap economies of scale, due to the high initial costs of employing the latest and greatest computer and telecommunications technologies.

Complex banking organizations or large, complex financial institutions point to the costs of the new regime. These institutions are too big, complex, and politically potent to regulate effectively.

However, they are also taking on higher levels of risk. A combination of consolidation, conglomeration, and concentration helped to trigger a systemic financial crisis acute enough to negatively affect the national and world economies.

Those big banks control the vast bulk of the industry’s assets and rapidly gaining market share. Nevertheless, U.S. banking is still far less concentrated than the banking sectors of most other countries. 

In Canada, the commercial bank Herfindahl index hovers around 1,600, and in Colombia and Chile, the biggest five banks make more than 60% of all loans. The Herfindahl index is calculated by summing the squares of the market shares of each bank.

However, bank entry is fairly easy, so new banks will form to compete with them, the Herfindahl index may be ultimately back in line. Consultants like Dan Hudson of NuBank.com help new banks to form and begin operations.

The U.S. banking industry is increasingly international in scope. Foreign banks can enter the U.S. market relatively easily. Foreign banks can buy U.S. banks or simply establish branches in the United States. 

The internationalization of banking means that U.S. banks can operate in other countries, and also a way to diversify assets. 

In continental Europe, like Germany and Switzerland, so-called universal banks that offer commercial and investment banking services and insurance prevail. 

Great Britain and its commonwealth members, full-blown financial conglomerates are less common for now, but most banks engage in both commercial and investment banking activities. 

Increasingly, the world’s financial system is becoming one, make it more efficient, but also raises fears of financial catastrophe.

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

How has technology changed the banking industry?

How has technology changed the banking industry?

Before microprocessors been massively used, it was extremely hard to process tons of works that banks regularly do. Microprocessors help to do everything from controlling elevators to searching the Web. Microprocessors combine with the internet and powerful computers, help financial institutions to do better management, efficient investment, risk management, and provide much more convenience products to their clients. 

Nowadays, FinTech such as mobile banking, investing, borrowing services, and cryptocurrency aiming to make financial services more accessible to the general public. Financial technology companies consist of both startups and established financial institutions and technology companies trying to replace or enhance the usage of financial services provided by existing financial companies. Robinhood app is a great example, which provides much more affordable investment services. 

FinTech also dramatically change the way we pay for everyday life. From physical credit cards to Apple Pay, LINE Pay, and Google Pay, our smartphone is now can do more than we can imagine. An American financial service company PayPal Holdings, Inc. operating a worldwide online payment system that supports online international money transfers and serves. In 2015, PayPal launched its peer-to-peer payment platform "PayPal.Me", a service that allows users to send a custom link to request funds via text, email, or other messaging platforms. In short, those financial innovations change how we move, exchange, and store our money. 

In the future, big data mining, cloud computer, and AI would change our world even more dramatically. Cloud computing services like Amazon AWS and Snowflake work smoothly with retail companies and banks to find better opportunities to improve their profits. AI technology is also a huge milestone in human history. Powerful computers can even keep learning by themselves and processing much more complex data to help financial institutions reduce their chores. It also means a lot of traditional jobs will disappear. However, new jobs such as engineers, programmers, and analyzers will increase abundantly.

Furthermore, quantum computers will soon change the world even bigger. Quantum computers will be able to solve incredibly complex, substantially faster than classical computers. IBM Quantum provides cloud-based software for companies to access their quantum computers and experience platform.

Reference

Fisher, C. (2009, April 02). IBM: What is Quantum Computing? Retrieved September 27, 2020, from https://www.ibm.com/quantum-computing/learn/what-is-quantum-computing/

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

10.4 Banking on Technology #Notebook

10.4 Banking on Technology #Notebook

The advent of cheap electronic computing and digital telecommunications after World War II did eventually significant innovation.

After World War II, Diners Club applied the idea to restaurants, essentially telling restaurateurs that it would pay their customers’ bills. (Diners Club later collected from the customers.) However, it's very costly and did not successfully spread.

In the late 1960s, when improvements in computer technology and telecommunications made it possible for machines to conduct the transactions at both the point of sale and card issuer sides of the transaction. Since then, several major credit card networks have arisen, and thousands of institutions, including many nonbanks, now issue credit cards.

Visa and MasterCard have created private payment systems that benefit the economy. Retailers win because they are assured of getting paid, only have to pay a small fixed fee, and a few percentage points for each transaction because people like to pay by credit card. Carrying a credit card is also much easier and safer than carrying around cash. 

Retailers like debit cards better than checks, because a debit card can’t bounce, or be returned for insufficient funds. Automatic teller machine (ATM) allow customers to withdraw cash. 

Technological improvements made possible the rise of securitization, the process of transforming illiquid financial assets like mortgages, automobile loans, and accounts receivable into marketable securities. Securitization allows bankers to specialize in originating loans rather than in holding assets.

Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

10.3 Loophole Mining and Lobbying #Notebook

 10.3 Loophole Mining and Lobbying #Notebook

Financiers responded by developing money market mutual funds (MMMFs), which offered checking account, like liquidity while paying interest at market rates, and by investing in short-term, high-grade assets like Treasury Bills and AAA-rated corporate commercial paper. 

Nonbank banks

Since the law defined banks as institutions that “accept deposits and make loans,” banks surmised they could establish de facto branches that did one function or the other, but not both. This loophole mining is less economically efficient than establishing real branches.

Sweep accounts, checking accounts that were invested each night in overnight loans, allowed banks to do the end around on reserve requirements, legal minimums of cash and Federal Reserve deposits. 

Bank holding companies (BHCs), and banking-related service companies, offered bankers another way to use loophole mining because regulation of BHCs was more liberal. BHCs could circumvent restrictive branching regulations and earn extra profits by providing investment advice, data processing, and credit card services. J.P. Morgan Chase, Bank of America, and Citigroup are all BHCs.

Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

10.2 Innovations Galore #Notebook

 10.2 Innovations Galore #Notebook

The competition drives bankers to adopt new technologies and search for ways to reduce the negative effects of volatility. 

Bankers responded to the increased interest rate risk by inducing others to assume it with financial derivatives, like options, futures, and swaps. 

In the 1970s, bankers began to make adjustable-rate mortgage loans. Traditionally, mortgages had been fixed rates. That way, bankers transfer the risks to borrowers. Although, when rates decrease, the borrower pays less to the bank, the interest rate risk still falls on borrowers.

To induce borrowers to take on that risk, banks must offer them a more attractive (lower) interest rate than on fixed-rate mortgages. 

However, fixed-rate mortgages remain popular, because many people don’t like the risk of possibly paying higher rates in the future. 

If mortgages contain no prepayment penalty, borrowers can take advantage of lower interest rates by refinancing, getting a new loan at the current, lower rate and using the proceeds to pay off the higher-rate loan. 

In the 1970s and 1980s, life insurance companies sought regulatory approval for several innovations, including adjustable-rate policy loans and variable annuities. Because policy loans are loans that whole life insurance policyholders can take out against the cash value of their policies. 

Most policies stipulated a 5% or 6% fixed rate and annuities were also traditionally fixed, therefore, life insurance companies, or banks, were adversely affected by event like the Great Inflation. 

If policyholders borrowed the cash values of their life insurance policies at 6%, then re-lent the money at the going market rate, which was often in the double digits. By making the policy loans variable would limit such arbitrage. 

Fixed annuities were a difficult sell during the Great Inflation because annuitants saw the purchasing power of their annual payments decrease dramatically. 

Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

10.1 Early Financial Innovations #Notebook

 10.1 Early Financial Innovations #Notebook

Innovation is driven by changes in the financial environment, specifically in macroeconomic volatility, technology, competition, and regulation. 

During the Civil War, Congress passed a law authorizing the establishment of national banks but referred only to the fact that the national government chartered and regulated them. Under the national banking acts could not branch across state lines. Although banking was essentially a local retail business, you were free to do your banking elsewhere if you didn’t like the local bank. However, most people were reluctant to do that, so the local bank got their business. 

Unexpectedly, near-monopoly in banking led to innovation in the financial markets. Instead of depositing money in the local bank, investors looked for higher returns by lending directly to entrepreneurs, and entrepreneurs sought cheaper funds by selling bonds directly into the market. 

As a result, the United States developed the world’s most efficient, and most innovative financial markets, gave birth to large, liquid markets for short-dated business IOUs and junk bonds (aka BIG, or below investment grade, bonds). Nevertheless, markets suffer from higher levels of asymmetric information, free-rider problems, and frauds.

Innovation in life insurance has been more rapid than banks. Data-processing innovations, like the use of punch-card-tabulating machines, automated mechanical mailing address machines, and mainframe computers, occurred in life insurers earlier.

Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

9.6 Off the Balance Sheet #Notebook

 9.6 Off the Balance Sheet #Notebook

Banks charge customers all sorts of fees, and not just the little ones. They charge fees for loan guarantees, backup lines of credit, foreign exchange transactions and, also sell some of their loans to investors. 

Suppose A bank might discount the $100,000 note of Citi Corp. for 1 year at 8%. 

From the present value formula that on the day it is made...

The loan is worth PV = FV/(1 + i) = 100,000/1.08 = $92,592.59. 

Then, the bank might sell it for 100,000/1.0785 = $92,721.37 and pocket the difference. 

Banks often sell loans with a guarantee or stipulation that they will buy them back if the borrower defaults, but it very costly. Although loans and fees can help keep up bank revenues and profits, they must carefully manage the credit risks.

Banks and intermediaries also take off balance-sheet positions in derivatives markets or even futures.

Suppose bankers sell futures contracts on U.S. Treasuries. If interest rates increase, the price of bonds will decrease. The bank can then effectively buy bonds in the open market at less than the contract price, make good on the contract, and pocket the difference.

Bankers can also hedge their bank’s interest rate risk by engaging in interest rate swaps, like agree to pay a fixed 6% on a $100 million notational principle (or $6 million) every year for 10 years in exchange for a promise to pay to back LIBOR plus+ 3%. 

Banks and intermediaries sometimes speculate in derivatives and the foreign exchange markets to make money. However, with the potential for high returns comes high levels of risk. 

Internal controls to prevent risking too much of the capital, called value at risk and stress testing.

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

9.4 Credit Risk #Notebook

 9.4 Credit Risk #Notebook

Financial intermediaries use the application only as a starting point. Typically do two things:

I. Make the application a binding part of the financial contract.

II. Verify the information with disinterested third parties. Financial intermediaries can also buy credit reports from professional report providers like Equifax, Experian, and Trans Union.

Insurance companies regularly share information with each other so that risky applicants can’t take advantage of them easily.

To improve the screening acumen, many financial intermediaries specialize by making loans to only one or a few types of borrowers, by insuring automobiles in a handful of states.

Specialization also helps to keep monitoring costs to a minimum. To reduce moral hazard, intermediaries have to pay attention to what borrowers and people who are insured do and know what sort of restrictive covenants (aka loan covenants) to build into their contracts. 

Loan covenants include the types of information to be provided in reports, inspections, limitations on account withdrawals. Insurance companies also build covenants into their contracts and investigate claims that seem fishy to reduce moral hazard.

However, specialization has its costs. Issuing too many policies, or making too many loans will lead to overspecialize and hurting their asset management.

Forging long-term relationships with customers can help financial intermediaries to manage their credit risks such as lending with better assurance.

One way that lenders create long-term relationships with businesses is by providing loan commitments, promises to lend $x at y interest for z years, arrangements called lines of credit.

Bankers also often insist on collateral, assets pledged by the borrower for repayment of a loan, the collateral is called compensating or compensatory balances. 

Credit rationing is another tool to combat asymmetric information.

However, in 2007–2008, banks and other lenders are not perfect screeners, under competitive pressure, they lend to borrowers they should not have. 

External political or societal pressures induce bankers to make loans they normally wouldn’t. Such excesses are always reversed eventually because the lenders suffer from high levels of non-performing loans.

In the crisis of 2007, why didn’t the government immediately intervene by guaranteeing the subprime mortgages?

Directly bailing out the subprime lenders by guaranteeing mortgage payments would cause moral hazard to skyrocket, because the borrowers might be more likely to default by rationalizing that the crime is a victimless one and the lenders would learn that they can make crazy loans to anyone because Uncle Sam(=The US government) will prevent their fall.

Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

9.3 Bank Management Principles #Notebook

 9.3 Bank Management Principles #Notebook

Bankers must manage their assets and liabilities to ensure three conditions:

1. Liquidity management. Has enough reserves to pay for outflows.

2. Asset management, earns profits by own a portfolio of remunerative assets. Liability management, to obtain its funds cheaply.

3. Capital adequacy management, sufficient net worth, or equity capital for regulatory.

To earn profits and manage liquidity and capital, banks face two major risks: 

1.Credit risk, the risk of borrowers defaulting on the loans and securities it owns.

2. Interest rate risk, the risk that interest rate changes will decrease the returns on its assets. 

The financial panic of 2008 reminded bankers that they also can face liability and capital adequacy risks if financial markets become less liquid or seize up completely.

＊In a bank's T-account, only equity capital can be negative.

An example of T-account...

Reference

Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation.  Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.

Monetary Policy and the Housing Bubble

Review on: http://www.federalreserve.gov/pubs/feds/2009/200949/200949pap.pdf 

This is a working paper entitled “Monetary Policy and the Housing Bubble” from Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board.

The Role of US Monetary Policy and The Housing Market Bubble During The Early 2000’s

When the author tries to demonstrate what role did the setting of monetary policy plays in housing market developments in this period in the beginning. The author stated that "researchers are increasingly suggesting that loose monetary policy was a primary cause of the bubble in house prices and activity.", which means the author is likely to persuade readers to believe that the monetary policy is truly an issue and follow up some examples from authority sayings. It's something like to persuade you to take a certain medicine with a doctor's suggestion. 

However, the author also mentioned that the relationship between interest rates and housing activity simply is not strong enough to explain the rise in residential investment or house prices. So, more evidence is needed to support the idea. Because during the 2001 recession, the impetus from monetary policy to housing markets was only a small factor, and several countries, such as Germany, Switzerland, and Japan, experienced little to no increase in house prices in the same lower fund rate period.

The author does not believe that the accommodative monetary policies of the period played a large role, although it is possible that the shifts in housing finance. Nonetheless, real estate is not like other industries in that it takes a lot of time to buy and sell homes and other properties which means that transactions can take a long time to complete. 

Low Rates Accompanied An Increase in Demand for Housing

Although adjustments to the federal funds rate sufficient to have a sizable impact on house prices, it would probably have had large and undesirable effects on unemployment and inflation. The law of supply and demand dictates the equilibrium price of a property. A lower supply, housing inventory, or increase in housing demand may drive the prices up.

When interest rates are low, people are more willing to take on more debt since they can afford relatively more debt and enjoy it. This situation can spread pretty fast. As more buyers enter the market, the demand for housing increases soar. Combine with a limited supply of housing inventory, the prices may rise even more. Meanwhile, new home construction adding to the existing inventory increase the supply of housing. However, land property is a finite resource, so the amount of new developments is generally limited. That means the supply of houses is generally lower during the higher demand periods. Ideas in your brain can change quickly, but the houses do not build and disappear just like that.

Loose versus Tight Monetary Policy

Monetary policy influences the amount of money available to consumers and businesses, particularly within the credit market. The Federal Reserve analyzes the health of the economy to adjust the monetary policy. Monetary policy actions include reserve requirements, discount rates, and treasury bonds. 

Tight monetary policy seeks to slow economic growth to reduce inflation such as increase reserve requirements, the banks' deposits. Those actions will result in reduced money supply and restrictions on credit availability for businesses and consumers, it would affect the ability of businesses to expand their business and hire additional workers, cause the unemployment rate to remain high. 

Loose monetary policy, in contrast, seeks to stimulate production and employment through an increase in the availability of money and credit in the marketplace. With the implementation of loose monetary policy, small businesses would benefit from expanded credit opportunities, leading to increased investment, production, and then the GDP will growth.

Taylor Rule

Taylor rule is an econometric model that describes the relationship between Federal Reserve operating targets and the rates of inflation and gross domestic product growth.(Chappelow, 2020). In economics, Taylor's rule is essentially a forecasting model used to determine what interest rates should be in order to shift the economy toward stable prices and full employment. Taylor's rule makes the recommendation that the Federal Reserve should raise interest rates when inflation is high or when employment exceeds full employment levels. Conversely, when inflation and employment levels are low, the Taylor rule implies that interest rates should be decreased.(Chappelow, 2020)

In this article, the author mentioned the rule to explain why the Fed was acting like that. However, the federal funds rate was below levels suggested during the recession period. Taylor rule uses a particular measure of the output gap, even though several measures are available such as PCI instead of CPI. 

Policy Assessment and Outcomes

If policymakers implement initiatives without ever assessing the results of those initiatives, then the next questions will be, is the program producing the desired results? Does the program generate a positive, and effective impact? A successful evaluation requires analysis of both a program's process and its outcomes. We should know how the program is administered, and ultimately in accordance with its intended design. To evaluate the possible outcome, we should generally focus on a program's effectiveness, to figure out whether the program achieved its intended goal.

For example, to lower the unemployment rate, the Fed announced a lower fund rate policy and make a promise of the lower rate will be a very long term until it achieves its desired result. Then we should monitor the business owners and the public to know how they react to such a loose policy. The data can help us to understand how the real world is moving right now. However, before we think the effectiveness of the policy by the monitors, we should also think about it possible delay and expectations.

Rise of Cheap and Available Credit Stimulated Housing Demand

A house may take 1-2 years to build, but the demand can be immediately and hot. Despite people do not have enough money on hands, the rise of cheap and readily available credit still stimulated housing demand and increased investor demand for mortgage-backed securities.

Real estate is a tangible asset and physical property on the land which is unmovable. Like other assets, they can be traded and also subject to supply and demand. This means that the prices of homes, just like those of stocks, bonds, and other goods, highly depend on the law of supply and demand. More demand, means more people going to bid the prices, and tend to rise. On the opposite, the prices tend to fall as more people want to sell them.

Evaluate Monetary Policy by How Effective It Is in Attaining Goals

Generally, the main goals of monetary policy are to promote maximum employment and stable prices. Thus, people would live in a more ideal world. To do this, the Fed must implement effective monetary policy to maintain stable prices, thereby supporting conditions for long-term economic growth and maximum employment.

Basically, the Federal Reserve has three main instruments of monetary policy are open market operations, discount rate, and reserve requirements. The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans. As we talked before, the Fed will implement a lower discount rate to stimulate economic growth. However, this step does not totally a win-win option. Just like the housing market, the interest rate was one of the reasons for the housing bubble. 

So, how does one best estimate the effects of monetary policy on house prices and other economic variables of interest? One of the approaches is to use economic theory to describe the relationship between variables, in this case, the interest rates, and house prices. However, the potential shortcoming is only a reasonably accurate description that occurs in the real world. I think we should look to a more evidence-based approach.

Evidence that Monetary Policy Played A Role by The Timing of Housing Boom

Since the financial crisis, regulators have favored stable sources of funding such as insured deposits. Between 2003 and 2006, the Federal Reserve raised rates by around 4 to 4.25%. This tightening induced a large contraction in deposits, leading banks to substantially reduce their portfolio mortgage lending. It is possible that much more aggressive tightening would have contracted lending enough to slow down the boom. However, this may not be an effective or even realistic course as drastically higher rates would damage other parts of the economy.

Economic Simulation Models

As we know that economists build some simplified descriptions to enhance their understanding of how things work since the economy is like a complex machine. However, no economic model can be a perfect description of reality. But the very process of constructing, testing, and revising models forces economists and policymakers to tighten their views about how an economy works.

For example, all existing models fail to predict the global financial crisis that began in 2008. Although all researches will add new behavioral equations to current economic models, It will also entail modifying existing equations to link them.

Other Research, The Repeat-Sales Method

The repeat-sales method is a method of calculating changes in the sales price of the same piece of real estate within a specific period. Housing market analysts use this relatively simple approach to estimate shifts in home prices over periods stretching from months to years. Housing price indexes are tasked with the important and tricky job of assessing real estate trends. The majority of them seek to achieve this by tracking valuations in a specific region over a certain period. But, some of the calculations these indexes use can result in an inaccurate picture of housing price trends.

Reference

Chappelow, J. (2020, August 28). Taylor's Rule. https://www.investopedia.com/terms/t/taylorsrule.asp.

Hall, M. (2020, September 2). The Effect of Supply and Demand on the Housing Market. https://www.investopedia.com/ask/answers/040215/how-does-law-supply-and-demand-affect-housing-market.asp.

Liberto, D. (2020, January 29). Repeat-Sales Method Definition. https://www.investopedia.com/terms/r/repeatsales-method.asp.

Long, N. (2016, October 26). How to Distinguish Between Tight & Loose Monetary Policy. https://smallbusiness.chron.com/distinguish-between-tight-loose-monetary-policy-3872.html.

Monetary Policy Basics. https://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy.

Ouliaris, S. (2020). Finance & Development. https://www.imf.org/external/pubs/ft/fandd/basics/models.htm.

Policy Statement 6: Measuring Outcomes and Evaluating Impact. https://nationalreentryresourcecenter.org/policy-statement-6-measuring-outcomes-and-evaluating-impact/.

Savov, A., & Schnabl, P. (2019, February). How Monetary Policy Shaped the Housing Boom. http://pages.stern.nyu.edu/~asavov/alexisavov/Alexi_Savov_files/MonetaryPolicyHousingBoom.pdf.

Williams, J. C. Measuring the effects of monetary policy on house prices and the economy. https://www.bis.org/publ/bppdf/bispap88_keynote.pdf.