nep-cba New Economics Papers
on Central Banking
Issue of 2011‒02‒12
twenty-one papers chosen by
Alexander Mihailov
University of Reading

  1. Ambiguity and the Bayesian Paradigm By Itzhak Gilboa; Massimo Marinacci
  2. Running for the Exit: International Banks and Crisis Transmission By Ralph de Haas; Neeltje van Horen
  3. Running for the exit: international banks and crisis transmission By Ralph De Haas; Neeltje Van Horen
  4. Regulating Asset Price Risk By Philippe Bacchetta, Cédric Tille, Eric van Wincoop
  5. A Comparison of Forecasting Procedures for Macroeconomic Series: the Contribution of Structural Break Models By Luc Bauwens; Gary Koop; Dimitris Korobilis; Jeroen V.K. Rombouts
  6. Systemic risk contributions By Xin Huang; Hao Zhou; Haibin Zhu
  7. Macroprudential policy - a literature review By Gabriele Galati; Richhild Moessner
  8. Trichet Bonds To Resolve the European Sovereign Debt Problem By Nicholas Economides; Roy C. Smith
  9. Stigma in financial markets: evidence from liquidity auctions and discount window borrowing during the crisis By Olivier Armantier; Eric Ghysels; Asani Sarkar; Jeffrey Shrader
  10. Purchasing Power Parity and the Taylor Rule By Hyeongwoo Kim; Masao Ogaki
  11. International Transmission of Business Cycles By Siedschlag, Iulia
  12. Monetary policy and its impact on stock market liquidity: Evidence from the euro zone By Octavio Fernández-Amador; Martin Gächter; Martin Larch; Georg Peter
  13. The Impact of the Global Business Cycle on Small Open Economies: A FAVAR Approach for Canada By Garima Vasishtha; Philipp Maier
  14. The Dynamic Effects of U.S. Monetary Policy on State Unemployment By Dimitris Korobilis; Michelle Gilmartin
  15. Modelling Monetary and Fiscal Policy in the US: A Cointegration Approach By J. James Reade
  16. Imprecision of Central Bank Announcements and Credibility By Daniel Laskar
  17. Uncertainty and Central Banl Transparency: A Non-Bayesian Approach By Daniel Laskar
  18. Financial volatility and optimal instrument choice: A revisit to Poole’s analysis By Dai, Meixing
  19. Central-Bank Government Relationship in the Context of Emerging Economic Environment By P. B. Jauasundera
  20. Monetary policy transmission in an emerging market setting. By Bhattacharya, Rudrani; Patnaik, Ila; Shah, Ajay
  21. How to measure inflation in India? By Patnaik, Ila; Shah, Ajay; Veronese, Giovanni

  1. By: Itzhak Gilboa; Massimo Marinacci
    Abstract: This is a survey of some of the recent decision-theoretic literature involving beliefs that cannot be quantified by a Bayesian prior. We discuss historical, philosophical, and axiomatic foundations of the Bayesian model, as well as of several alternative models recently proposed. The definition and comparison of ambiguity aversion and the updating of non-Bayesian beliefs are briefly discussed. Finally, several applications are mentioned to illustrate the way that ambiguity (or “Knightian uncertainty”) can change the way we think about economic problems.
    Date: 2011
  2. By: Ralph de Haas; Neeltje van Horen
    Abstract: The global financial crisis has reignited the debate about the risks of financial globalization, in particular the international transmission of financial shocks. We use data on individual loans by the largest international banks to their various countries of operation to examine whether banks’ access to borrower information affected the transmission of the financial shock across borders. The simultaneous use of country and bank fixed effects allows us to disentangle credit supply and demand and to control for general bank characteristics. We find that during the crisis banks continued to lend more to countries that are geographically close, where they are integrated into a network of domestic co-lenders, and where they had gained experience by building relationships with (repeat) borrowers.
    Keywords: Crisis transmission; sudden stop; cross-border lending; syndicated loans
    JEL: F36 F42 F52 G15 G21 G28
    Date: 2011–02
  3. By: Ralph De Haas (EBRD); Neeltje Van Horen (De Nederlandsche Bank)
    Abstract: The global financial crisis has reignited the debate about the risks of financial globalisation, in particular the international transmission of financial shocks. We use data on individual loans by the largest international banks to their various countries of operations to examine whether banks’ access to borrower information affected the transmission of the financial shock across borders. The simultaneous use of country and bank-fixed effects allows us to disentangle credit supply and demand and to control for general bank characteristics. We find that during the crisis banks continued to lend more to countries that are geographically close, where they are integrated into a network of domestic co-lenders, and where they had gained experience by building relationships with (repeat) borrowers.
    JEL: O1 P2 P5
    Date: 2011–02
  4. By: Philippe Bacchetta, Cédric Tille, Eric van Wincoop (IHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: There has been a long debate about whether speculators are stabilizing or not. We consider a model where speculators have a stabilizing role in normal times, but may also provoke large risk panics. The very feature that makes arbitrageurs liquidity providers in normal times, namely their tolerance of risk, enables a large increase in asset price risk during a financial panic. We show that a policy that discourages balance sheet risk reduces the magnitude of financial panics, as well as asset price risk in both normal and panic states.
    Keywords: Asset Pricing, Risk Management, Leverage.
    JEL: E44 G11 G18
    Date: 2011–01
  5. By: Luc Bauwens; Gary Koop; Dimitris Korobilis; Jeroen V.K. Rombouts
    Abstract: This paper compares the forecasting performance of different models which have been proposed for forecasting in the presence of structural breaks. These models differ in their treatment of the break process, the parameters defining the model which applies in each regime and the out-of-sample probability of a break occurring. In an extensive empirical evaluation involving many important macroeconomic time series, we demonstrate the presence of structural breaks and their importance for forecasting in the vast majority of cases. However, we find no single forecasting model consistently works best in the presence of structural breaks. In many cases, the formal modeling of the break process is important in achieving good forecast performance. However, there are also many cases where simple, rolling OLS forecasts perform well.
    Keywords: Forecasting, change-points, Markov switching, Bayesian inference
    JEL: C11 C22 C53
    Date: 2011
  6. By: Xin Huang; Hao Zhou; Haibin Zhu
    Abstract: We adopt a systemic risk indicator measured by the price of insurance against systemic financial distress and assess individual banks' marginal contributions to the systemic risk. The methodology is applied using publicly available data to the 19 bank holding companies covered by the U.S. Supervisory Capital Assessment Program (SCAP), with the systemic risk indicator peaking around $1.1 trillion in March 2009. Our systemic risk contribution measure shows interesting similarity to and divergence from the SCAP expected loss measure. In general, we find that a bank's contribution to the systemic risk is roughly linear in its default probability but highly nonlinear with respect to institution size and asset correlation.
    Date: 2011
  7. By: Gabriele Galati; Richhild Moessner
    Abstract: The recent financial crisis has highlighted the need to go beyond a purely micro approach to financial regulation and supervision. In recent months, the number of policy speeches, research papers and conferences that discuss a macro perspective on financial regulation has grown considerably. The policy debate is focusing in particular on macroprudential tools and their usage, their relationship with monetary policy, their implementation and their effectiveness. Macroprudential policy has recently also attracted considerable attention among researchers. This paper provides an overview of research on this topic. We also identify important future research questions that emerge from both the literature and the current policy debate.
    Keywords: macroprudential policy
    Date: 2011–02
  8. By: Nicholas Economides (Stern School of Business, NYU); Roy C. Smith (Stern School of Business, NYU)
    Abstract: We propose the creation of “Trichet Bonds” as a comprehensive solution to the current sovereign debt crisis in the EU area. “Trichet Bonds,” to be named after the ECB president Jean-Claude Trichet, will be similar to “Brady Bonds” that resolved the Latin American debt crisis in the late 1980s and were named after the then Treasury Secretary Nicholas Brady. Like the Brady Bonds, Trichet Bonds will be new long-duration bonds issued by countries in the EU area that will be collateralized by zero-coupon bonds of the same duration issued by the ECB. The zero-coupon bonds will be sold by the ECB to the countries issuing Trichet Bonds, which will be offered in exchange for outstanding sovereign debt of the countries. The exchange is offered at market value, so current debt holders will experience a “haircut” from par value, and thus the exchange does not involve a “bailout.” However, present holders of sovereign debt will be exchanging low quality bonds with limited liquidity, for higher quality bonds with greater liquidity. Debt holders not accepting the exchange will be at risk of a forced restructuring at a later date at terms less favorable. The effect of the exchange offer, if a threshold of approximately 70% approve it, is to replace old debt with a lesser amount of new debt with longer maturities. The creation of Trichet bonds will result in various advantages both in comparison to the present unstable situation and other proposed solutions. First, the long duration of Trichet bonds will eliminate the immediate crisis caused by short term expiration of significant amounts of debt which is looming over Greece, Ireland, Portugal, Spain and possibly other EU countries. Second, the guarantee of the principal with the zero-coupon ECD bond collateral increases the quality of the Trichet Bonds compared to existing sovereign debt. Third, the market for the new Trichet Bonds will be liquid and likely to trade at appreciating prices as refinancing (roll-over) risk is reduced and time is allowed for economic reforms by the issuing countries (a condition of the ECB) to take effect. In addition, the exchange of existing sovereign debt for Trichet bonds will force many European banks holding the sovereign debt to take the write-offs required, thus making their own balance sheets more transparent. Many European banks are thought to have large holdings of sovereign debt from the “peripheral” countries that have not been marked-to-market, and thus represent sizeable potential losses for the banks when the sovereign debt is ultimately restructured, as we believe it must be over the next few years. Most of the sovereign bank debt likely to be exchanged, however, is held by larger German, French and Swiss banks with the capability (if not necessarily the desire) to take the write-offs required. The overhang of such future losses affects the entire European banking system at a time when it too is being restructured. The ECB, and the European central banks need to identify those banks that are impaired by excessive sovereign holdings and assist them in recapitalization – the sooner the better – but they should also push the larger, stronger banks to accept the exchange offers in the interest of bank transparency and restructuring as well as in resolving the sovereign debt problem. Clearly the two problems – sovereign debt and bank restructuring – are connected. The issuance of Trichet Bonds, will help to resolve both problems by recognizing market realities and offering an easier way out than through a forced, cram-down restructuring once the ailing sovereigns exhaust their ability to repay the existing debt. There are significant advantages to Trichet bonds over other discussed solutions to the sovereign debt problem. One such proposed solution is the issuance of “Euro Bonds” guaranteed by the Eurozone countries or the EU itself for the purpose of redeeming sovereign bonds by market purchases, or by lending the proceeds to the countries involved for them to acquire their debt. Apart from the considerable political obstacles to such a program, the undertaking actually makes it less likely that existing self-interested debt-holders will sell in the market. The implication of the program is that either through market interventions that push prices up, or by the assumption that the program will continue to enable the debt to be retired at par on maturity, debt-holders won’t sell unless the price is pushed high enough to constitute a bailout. The ECB’s current efforts to support the prices of distressed sovereign bonds is currently having this effect, which transfers some, if not all of the cost of resolving the problem to European taxpayers, where increasingly it is resented. The alternative approach, that has only been discussed by market participants, is for a Russian or Argentine solution in which the debt-holders are made a take-it-or-leave-it offer to exchange outstanding debt for new, generally illiquid bonds at an arbitrary price that discourages future investment by the market. Such an approach is understood by the sovereign debt market to constitute a de facto default. Such a default would likely have serious adverse consequences for the Euro and the EU, and may be less likely that a bailout of some kind. The great advantage of Trichet Bonds is that they avoid both bailouts and defaults.
    Keywords: Trichet bonds, sovereign debt, euro, debt restructuring, Greece, Ireland, Portugal, Spain, Italy, Brady bonds
    JEL: G10 G20 G28
    Date: 2011–01
  9. By: Olivier Armantier; Eric Ghysels; Asani Sarkar; Jeffrey Shrader
    Abstract: We provide empirical evidence for the existence, magnitude, and economic impact of stigma associated with banks borrowing from the Federal Reserve’s discount window facility. We find that, during the height of the financial crisis, banks were willing to pay an average premium of at least 37 basis points (and 150 basis points after Lehman’s bankruptcy) to borrow from the Term Auction Facility rather than from the discount window. The incidence of stigma varied according to bank characteristics and market conditions. Finally, we find that discount window stigma is economically relevant since it increased banks’ borrowing costs during the crisis. Our results have important implications for the provision of liquidity by central banks.
    Keywords: Discount window ; Financial crises ; Monetary policy ; Bank liquidity ; Banks and banking - Costs ; Auctions
    Date: 2011
  10. By: Hyeongwoo Kim; Masao Ogaki
    Abstract: In the Kehoe and Midrigan (2007) model, the persistence parameter of the real exchange rate is closely related to the measure of price stickiness in the Calvo-pricing model. When we employ this view, Rogoff's (1996) 3 to 5 year consensus half-life implies that firms update their prices every 18 to 30 quarters on average. This is at odds with most estimates from U.S. aggregate data when single equation methods are applied to the New Keynesian Phillips Curve (NKPC), or when system methods are applied to Dynamic Stochastic General Equilibrium (DSGE) models that include the NKPC. It is well known, however, that there is a large degree of uncertainty around the consensus half-life of the real exchange rate. To obtain a more efficient estimator, this paper develops a system method that combines the Taylor rule and a standard exchange rate model to estimate half-lives. We use a median unbiased estimator for the system method with nonparametric bootstrap confidence intervals, and compare the results with those from the single equation method typically used in the literature. Applying the method to the real exchange rates of 18 developed countries against the U.S. dollar, we find that most of the half-life estimates from the single equation method fall in the range of 3 to 5 years with wide confidence intervals that extend to positive infinity. In contrast, the system method yields median-unbiased estimates that are typically shorter than one year with much sharper 95% confidence intervals, most of which range from 3 quarters to 5 years. These median unbiased estimates and the lower bound of the confidence intervals for the half-lives of real exchange rates are consistent with most estimates of price stickiness using aggregate U.S. data for the NKPC and DSGE models.
    Keywords: Purchasing Power Parity, Calvo Pricing, Taylor Rule, Half-Life of PPP Deviations, Median Unbiased Estimator, Grid-t Confidence Interval
    JEL: C32 E52 F31
    Date: 2011–02
  11. By: Siedschlag, Iulia
    Date: 2010–10
  12. By: Octavio Fernández-Amador; Martin Gächter; Martin Larch; Georg Peter
    Abstract: The recent financial crisis has been characterized by unprecedented monetary policy interventions of central banks with the intention to stabilize financial markets and the real economy. This paper sheds light on the actual impact of monetary policy on stock liquidity and thereby addresses its role as a determinant of commonality in liquidity. To capture effects both at the micro and macro level of stock markets, we apply panel estimations and vector autoregressive models. Our results suggest that an expansionary monetary policy of the European Central Bank leads to an increase of stock market liquidity in the German, French and Italian markets. These findings are robust for seven proxies of liquidity and two measures of monetary policy.
    Keywords: Stock liquidity, monetary policy, euro zone
    JEL: E44 E51 E52 G12
    Date: 2011–02
  13. By: Garima Vasishtha; Philipp Maier
    Abstract: Building on the growing evidence on the importance of large data sets for empirical macroeconomic modeling, we use a factor-augmented VAR (FAVAR) model with more than 260 series for 20 OECD countries to analyze how global developments affect the Canadian economy. We focus on several sources of shocks, including commodity prices, foreign economic activity, and foreign interest rates. We evaluate the impact of each shock on key Canadian macroeconomic variables to provide a comprehensive picture of the effect of international shocks on the Canadian economy. Our findings indicate that Canada is primarily exposed to shocks to foreign activity and to commodity prices. In contrast, the impact of shocks to global interest rates or global inflation is substantially lower. Our findings also expose the different channels through which higher commodity prices impact the Canadian economy: Canada benefits from higher commodity prices through a positive terms of trade shock, but at the same time, higher commodity prices tend to lower global economic activity, hurting demand for Canadian exports.
    Keywords: International topics; Econometric and statistical methods; Business fluctuations and cycles
    JEL: C32 F41
    Date: 2011
  14. By: Dimitris Korobilis (Université Catholique de Louvain); Michelle Gilmartin (University of Strathclyde)
    Abstract: This paper studies the transmission of monetary shocks to state unemployment rates, within a novel structural factor-augmented VAR framework with a timevarying propagation mechanism. We find evidence of large heterogeneity over time in the responses of state unemployment rates to monetary policy shocks, which do not necessarily comply with the response of the national unemployment rate. We also find evidence of heterogeneity over the spatial dimension, although geographical proximity seems to play an important role in the transmission of monetary shocks.
    Keywords: regional unemployment, structural VAR, factor model, monetary policy
    JEL: R15 C11 E52
    Date: 2011–02
  15. By: J. James Reade
    Abstract: As governments and economists worldwide reflect on the unprecedented peacetime build-ups of government deficits and debts since 2008 and the Great Recession, the importance of fiscal and monetary policy interactions and their sustainability is key. This involves both thorough theoretical and careful econometric analysis. This paper provides the latter. We use multivariate cointegration methods to investigate monetary and fiscal interactions using the example of the United States since the early 1980s. Using survey data for inflation expectations, we find that monetary policymaking is heavily forward looking, and passive in the sense that it responds to policy rule. Fiscal policy is found to be active in that it does not respond to the fiscal policy rule discovered in the data. Entering into debates on the efficacy of fiscal policy, we find that in the long-term fiscal deficits are very harmful to growth, but in the short run fiscal stimuli can be effective in restoring the economy to equilibrium. The interactions between the two policy spheres appear somewhat limted in that neither policy tool enters the policy rule of the other policy sphere, but the more passive monetary policy does movwe in reaction to fiscal policy movements - the two policy spheres are complementary in that both respond in the same direction to revive and restrain the economy in downturns and boom times respectively.
    Keywords: Monetary policy, fiscal policy, policy interactions, cointegrated VAR method
    JEL: E52 E62 C01
    Date: 2011–01
  16. By: Daniel Laskar (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: We consider a model where the central bank faces a credibility problem in its announcements, but also cares about its credibility and, therefore, wants to make truthful announcements. We show that, although the central bank would be able to perfectly transmit its information to the private sector through precise announcements, the central bank may nonetheless prefer to make imprecise announcements. This choice of the central bank would be suboptimal from the point of view of society. However, if the central bank gives enough weight to making truthful announcements, this suboptimality disappears, because the central bank would then prefer precise announcements to imprecise announcements.
    Keywords: central bank transparency; central bank announcements; imprecise announcements; credibility
    Date: 2010–11–29
  17. By: Daniel Laskar (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: We underline that some results obtained in the literature on central bank transparency may be quite different when we take a non-Bayesian approach to uncertainty, where "ambiguity" is taken into account. We consider some specific argument of the literature (obtained under a Bayesian approach), which implies that political uncertainty can be beneficial and central bank transparency harmful. We show that when ambiguity is large enough, these results do not hold anymore: political uncertainty is always harmful and central bank transparency always beneficial. Furthermore, as soon as we depart from the Bayesian case, Knightian uncertainty is always harmful. JEL Classification: E58; E52 Keywords: central bank transparency; political uncertainty; Knightian uncertainty; ambiguity; non-Bayesian approach
    Keywords: central bank transparency; political uncertainty; Knightian uncertainty; ambiguity; non-Bayesian approach
    Date: 2010–09–27
  18. By: Dai, Meixing
    Abstract: In this paper, using an IS-LM model with reserve market, we examine weather the operating procedure actually adopted by many central banks in the world, i.e. targeting directly short run interest rates and hence indirectly market interest rates, is more efficient in stabilizing output than a monetary base operating procedure if shocks affecting the interest rate policy are taken into account. Our results suggest that for an interest rate policy to be more efficient than a monetary aggregate oriented policy, central banks should directly target market interest rates which are narrowly linked to the aggregate spending.
    Keywords: Poole’s analysis; optimal instrument choice; financial volatility; monetary policy operating procedures.
    JEL: E58 E51 E52 E44
    Date: 2010–02–18
  19. By: P. B. Jauasundera
    Abstract: The relationship between the Central Bank and the Government is based not on a mere legal framework, but also on multifaceted political economic considerations. Although in many respects the Central Bank is independent, it has become an integral part of the Government, particularly in managing macroeconomic challenges. The recent financial crisis in most advanced countries has put the Central Banks and Governments on to one mission and to work in close collaboration. [60th Anniversary Oration of the Bank of Sri Lanka]
    Keywords: central bank, financial crisis, central bank-government relationship, South Asia, Sri Lanka
    Date: 2011
  20. By: Bhattacharya, Rudrani (National Institute of Public Finance and Policy); Patnaik, Ila (National Institute of Public Finance and Policy); Shah, Ajay (National Institute of Public Finance and Policy)
    Abstract: Some emerging economies have a relatively ineffective monetary policy transmis- sion owing to weaknesses in the domestic financial system and the presence of a large and segmented informal sector. At the same time, small open economies can have a substantial monetary policy transmission through the exchange rate channel. In order to understand this setting, we explore a unified treatment of monetary policy transmission and exchange-rate pass-through. The results for an emerging market, India, suggest that the most effective mechanism through which monetary policy impacts inflation runs through the exchange rate.
    Keywords: Monetary policy transmission ; Exchange rate pass-through ; Exchange rate regime ; Financial development ; India
    JEL: E31 E52
    Date: 2011–01
  21. By: Patnaik, Ila (National Institute of Public Finance and Policy); Shah, Ajay (National Institute of Public Finance and Policy); Veronese, Giovanni (Bank of Italy)
    Abstract: What is the best inflation measure in India? What inflation measure is most relevant for monetary policy making in India? Questions of timeliness, weights in the price index, accuracy of food price measurement, and inclusion of services prices are relevant to the choice of measure. We show that under present conditions of measurement, the Consumer Price Index for Industrial Workers (CPI-IW) is preferable to either the Wholesale Price Index or the GDP deflator.
    Keywords: Monetary policy ; Inflation measure ; Statistical system
    JEL: E52 E58
    Date: 2011–02

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