nep-cba New Economics Papers
on Central Banking
Issue of 2011‒11‒14
38 papers chosen by
Alexander Mihailov
University of Reading

  1. Optimal Monetary Policy with Informational Frictions By George-Marios Angeletos; Jennifer La'O
  2. Supply-Side Policies and the Zero Lower Bound By Fernández-Villaverde, Jesús; Guerron-Quintana, Pablo A.; Rubio-Ramírez, Juan Francisco
  3. Loose monetary policy and excessive credit and liquidity risk-taking by banks. By Ongena, S.; Peydro, J.L.
  4. The simple analytics of money and credit in a quasi-linear environment By David Andolfatto
  5. Bank risk during the financial crisis: do business models matter? By Yener Altunbas; Simone Manganelli; David Marques-Ibanez
  6. Redistribution and the Multiplier By Monacelli, Tommaso; Perotti, Roberto
  7. Persistent Liquidity Effects and Long Run Money Demand By Fernando E. Alvarez; Francesco Lippi
  8. Interest rate expectations and uncertainty during ECB governing council days: evidence from intraday implied densities of 3-month Euribor By Olivier Vergote; Josep Maria Puigvert Gutiérrez
  9. An estimated small open economy model with frictional unemployment By Julien Albertini; Günes Kamber; Michael Kirker
  10. Macroprudential Regulation and the Monetary Transmission Mechanism By Pierre-Richard Agénor; Luiz A. Pereira da Silva
  11. A New-Keynesian Model of the Yield Curve with Learning Dynamics: A Bayesian Evaluation By Dewachter, Hans; Iania, Leonardo; Lyrio, Marco
  12. Nowcasting GDP in real-time: A density combination approach By Knut Are Aastveit; Karsten R. Gerdrup; Anne Sofie Jore; Leif Anders Thorsrud
  13. Fiscal Sustainability, Default Risk and Euro Area Sovereign Bond Spreads Markets By Borgy, V.; Laubach, T.; Mésonnier, J-S.; Renne, J-P.
  14. The Duration of Bank Retail Interest Rates By Ben R. Craig; Valeriya Dinger
  15. Sovereign spreads in the Euro area: Which prospects for a Eurobond? By Favero, Carlo A.; Missale, Alessandro
  16. SAFE: An early warning system for systemic banking risk By Mikhail V. Oet; Ryan Eiben; Timothy Bianco; Dieter Gramlich; Stephen J. Ong; Jing Wang
  17. The redistributive effects of monetary policy By Olivier Ledoit
  18. The Lucas Orchard By Ian Martin
  19. Inflation and asset prices By Tatom, John
  20. Monetary policy in disarray By Tatom, John
  21. Factor Proportions and International Business Cycles By Keyu Jin; Nan Li
  22. The Effects of Quantitative Easing on Interest Rates: Channels and Implications for Policy By Arvind Krishnamurthy; Annette Vissing-Jorgensen
  23. How do banks’ funding costs affect interest margins? By Arvid Raknerud; Bjørn Helge Vatne; Ketil Rakkestad
  24. Real time analysis of euro area fiscal policies: adjustment to the crisis By Paloviita, Maritta; Kinnunen, Helvi
  25. Business Cycle and Bank Capital Regulation: Basel II Procyclicality By Guangling (Dave) Liu; Nkhahle Seeiso
  26. Cross border banking supervision : incentive conflicts in supervisory information sharing between home and host supervisors By D'Hulster, Katia
  27. Trilemma and Financial Stability Configurations in Asia By Aizenman, Joshua
  28. Les « hélicoptères » des banques centrales By Dai, Meixing
  29. Risk Sharing through Capital Gains By Balli, Faruk; Kalemli-Ozcan, Sebnem; Sørensen, Bent E
  30. Early Warning Indicators of Economic Crises: Evidence from a Panel of 40 Developed Countries By Jan Babecky; Tomas Havranek; Jakub Mateju; Marek Rusnak; Katerina Smidkova; Borek Vasicek
  31. Evaluating density forecasts: model combination strategies versus the RBNZ By Chris McDonald; Leif Anders Thorsrud
  32. Forecasting GDP growth in times of crisis: private sector forecasts versus statistical models By Jasper de Winter
  33. The role of labour markets in fiscal policy transmission By Obstbaum, Meri
  34. Housing and Banking in a Small Open Economy DSGE Model By Viktors Ajevskis; Kristine Vitola
  35. China's dominance hypothesis and the emergence of a tri-polar global currency system By Marcel Fratzscher; Arnaud Mehl
  36. Cycles inside cycles: Spanish regional aggregation By Ana Gomez Loscos; M. Dolores Gadea; Antonio Montañes
  37. Motivations and strategies for a real revaluation of the Yuan. By Meixing Dai
  38. Exchange Rate Pass-Through to Prices: Evidence from Mexico By Carlos Capistrán; Raúl Ibarra-Ramírez; Manuel Ramos Francia

  1. By: George-Marios Angeletos; Jennifer La'O
    Abstract: We study optimal monetary policy in an environment in which firms’ pricing and production decisions are subject to informational frictions. Our framework accommodates multiple formalizations of these frictions, including dispersed private information, sticky information, and certain forms of inattention. An appropriate notion of constrained efficiency is analyzed alongside the Ramsey policy problem. Similarly to the New-Keynesian paradigm, efficiency obtains with a subsidy that removes the monopoly distortion and a monetary policy that replicates flexible-price allocations. Nevertheless, “divine coincidence” breaks down and full price stability is no more optimal. Rather, the optimal policy is to “lean against the wind”, that is, to target a negative correlation between the price level and real economic activity.
    JEL: D61 D83 E32 E52
    Date: 2011–11
  2. By: Fernández-Villaverde, Jesús; Guerron-Quintana, Pablo A.; Rubio-Ramírez, Juan Francisco
    Abstract: This paper examines how supply-side policies may play a role in fighting a low aggregate demand that traps an economy at the zero lower bound (ZLB) of nominal interest rates. Future increases in productivity or reductions in mark-ups triggered by supply-side policies generate a wealth effect that pulls current consumption and output up. Since the economy is at the ZLB, increases in the interest rates do not undo this wealth effect, as we will have in the case outside the ZLB. We illustrate this mechanism with a simple two-period New Keynesian model. We discuss possible objections to this set of policies and the relation of supply-side policies with more conventional monetary and fiscal policies.
    Keywords: New Keynesian models; supply-side policies; zero lower bound
    JEL: E30 E50 E60
    Date: 2011–11
  3. By: Ongena, S. (Universiteit van Tilburg); Peydro, J.L.
    Date: 2011
  4. By: David Andolfatto
    Abstract: Lagos and Wright (2005) demonstrate how the essential properties of a money-search model are preserved in an environment that is rendered highly tractable with the use of quasi-linear preferences. In this paper, I show that this same innovation can be applied to closely related environments used elsewhere in the literature that study insurance and credit markets under limited commitment and private information. The analysis demonstrates clearly how insurance, credit, and money are interrelated in terms of their basic functions. The analysis also leads to a heretofore neglected result pertaining to the Friedman rule. In particular, I find that the same frictions that render money essential may at the same time operate to render the Friedman rule infeasible. Thus, even if the Friedman rule is a desirable policy, an incentive-induced lower bound on the rate of deflation may nevertheless entail a strictly postive rate of inflation.
    Keywords: Money ; Credit
    Date: 2011
  5. By: Yener Altunbas (Centre for Banking and Finance, University of Wales, Bangor, Gwynedd, LL57 2DG, UK.); Simone Manganelli (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.); David Marques-Ibanez (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: We exploit the 2007-2009 financial crisis to analyze how risk relates to bank business models. Institutions with higher risk exposure had less capital, larger size, greater reliance on short-term market funding, and aggressive credit growth. Business models related to significantly reduced bank risk were characterized by a strong deposit base and greater income diversification. The effect of business models is non-linear: it has a different impact on riskier banks. Finally, it is difficult to establish in real time whether greater stock market capitalization involves real value creation or the accumulation of latent risk. JEL Classification: G21, G15, E58, G32.
    Keywords: Bank risk, business models, bank regulation, financial crisis, Basle III.
    Date: 2011–11
  6. By: Monacelli, Tommaso; Perotti, Roberto
    Abstract: Does it matter, for the size of the government spending multiplier, which category of agents bears the brunt of the necessary adjustment in taxes? In an economy with heterogeneous agents and imperfect financial markets, the answer depends on whether or not New Keynesian features, such are price rigidity, are present. If prices are flexible, the tax-financing rule is either neutral or leads to a larger multiplier when taxes are levied on the borrowing constrained agents. If prices are sticky, the multiplier is larger when taxes are levied on the unconstrained agents. We discuss the conditions under which these results hold. Furthermore, we study the real effects of fiscal expansions via pure, revenue-neutral, tax redistributions.
    JEL: E62
    Date: 2011–11
  7. By: Fernando E. Alvarez; Francesco Lippi
    Abstract: We present a monetary model in the presence of segmented asset markets that implies a persistent fall in interest rates after a once and for all increase in liquidity. The gradual propagation mechanism produced by our model is novel in the literature. We provide an analytical characterization of this mechanism, showing that the magnitude of the liquidity effect on impact, and its persistence, depend on the ratio of two parameters: the long-run interest rate elasticity of money demand and the intertemporal substitution elasticity. At the same time, the model has completely classical long-run predictions, featuring quantity theoretic and Fisherian properties. The model simultaneously explains the short-run “instability” of money demand estimates as-well-as the stability of long-run interest-elastic money demand.
    JEL: E31 E4 E41 E43 E5
    Date: 2011–11
  8. By: Olivier Vergote (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.); Josep Maria Puigvert Gutiérrez (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: This paper analyses changes in short-term interest rate expectations and uncertainty during ECB Governing Council days. For this purpose, it first extends the estimation of risk-neutral probability density functions up to tick frequency. In particular, the non-parametric estimator of these densities, which is based on fitting implied volatility curves, is applied to estimate intraday expectations of threemonth EURIBOR three months ahead. The estimator proves to be robust to market microstructure noise and able to capture meaningful changes in expectations. Estimates of the noise impact on the statistical moments of the densities further enhance the interpretation. In addition, the paper assesses the impact of the ECB communication during Governing Council days. The results show that the whole density may react to the communication and that such repositioning of market participants’ expectations will contain information beyond that of changes in the consensus view already observed in forward rates. The results also point out the relevance of the press conference in providing extra information and triggering an adjustment process for interest rate expectations. JEL Classification: C14, E43, E52, E58, E61.
    Keywords: Risk-neutral probability density functions, option-implied densities, interest rate expecta-tions, central bank communication, intraday analysis, announcement effects, tick data.
    Date: 2011–10
  9. By: Julien Albertini; Günes Kamber; Michael Kirker (Reserve Bank of New Zealand)
    Abstract: This paper investigates labour market dynamics in New Zealand by estimating a structural small open economy model enriched with standard search and matching frictions in the labour market. We show that the model its the business cycle features of key macroeconomic variables reasonably well and provides an appealing monetary transmission mechanism. We then extend our analysis to understand the driving forces behind labour market variables. Our findings suggest that the bulk of variation in labour market variables is solely explained by disturbances pertaining to the labour market.
    JEL: E32 J6
    Date: 2011–08
  10. By: Pierre-Richard Agénor; Luiz A. Pereira da Silva
    Abstract: This paper presents a simple dynamic macroeconomic model of a bank-dominated financial system that captures some of the key credit market imperfections commonly found in middle-income countries. The model is used to analyze the interactions between monetary and macroprudential policies, involving, in the latter case, changes in reserve requirements and the imposition of an upper limit on banks’ leverage ratio. Policy implications are also discussed, in the context of the post-crisis debate on the use of macroprudential tools. The analysis shows that understanding how these tools operate is essential because they may alter, possibly in substantial ways, the monetary transmission mechanism.
    Date: 2011–11
  11. By: Dewachter, Hans; Iania, Leonardo; Lyrio, Marco
    Date: 2011–10
  12. By: Knut Are Aastveit (Norges Bank (Central Bank of Norway)); Karsten R. Gerdrup (Norges Bank (Central Bank of Norway)); Anne Sofie Jore (Norges Bank (Central Bank of Norway)); Leif Anders Thorsrud (BI Norwegian Business School and Norges Bank (Central Bank of Norway))
    Abstract: In this paper we use U.S. real-time vintage data and produce combined density nowcasts for quarterly GDP growth from a system of three commonly used model classes. The density nowcasts are combined in two steps. First, a wide selection of individual models within each model class are combined separately. Then, the nowcasts from the three model classes are combined into a single predictive density. We update the density nowcast for every new data release throughout the quarter, and highlight the importance of new information for the evaluation period 1990Q2-2010Q3. Our results show that the logarithmic score of the predictive densities for U.S. GDP increase almost monotonically as new information arrives during the quarter. While the best performing model class is changing during the quarter, the density nowcasts from our combination framework is always performing well both in terms of logarithmic scores and calibration tests. The density combination approach is superior to a simple model selection strategy and also performs better in terms of point forecast evaluation than standard point forecast combinations.
    Keywords: Density combination, Forecast densities, Forecast evaluation, Monetary policy, Nowcasting; Real-time data
    JEL: C32 C52 E37 E52
    Date: 2011–09–28
  13. By: Borgy, V.; Laubach, T.; Mésonnier, J-S.; Renne, J-P.
    Abstract: This paper develops an arbitrage-free affine term structure model of potentially defaultable sovereign bonds to model a cross-section of eight euro area government bond yield curves since January 1999. The existence of a common monetary policy under European Monetary Union determines the short end of the yield curves, whereas decentralized debt policies drive expected default probabilities and thereby spreads towards Germany, assumed to be free of default risk. The pricing factors are three observable area-wide macroeconomic variables and measures of national fiscal sustainability, which we proxy by expected changes in debt/GDP ratios of the respective countries. Our model explains spreads both before and during the crisis to an impressive extent. The deterioration in public finances was the major driver of the widening in spreads since 2008 through both heightened compensations for default risk and increases in risk premia. We also present perceived probabilities of sovereign default at any maturity and assess their elasticity to shifts in expected changes in debt/GDP ratios.
    Keywords: Government debt, affine term structure models, default risk, yield spreads, fiscal projections.
    JEL: C32 E6 G12 H6
    Date: 2011
  14. By: Ben R. Craig; Valeriya Dinger (Universitaet Osnabrueck)
    Abstract: We use bank retail interest rates as price examples in a study of the determinants of price durations. The extraordinary richness of the data allows us to address some major open issues from the price rigidity literature, such as the functional form of the hazard of changing a price, the effect of firm and market characteristics on the duration of prices, and asymmetry in the speed of adjustments to positive and negative cost shocks. We find that the probability of a bank changing its retail rate initially (that is, in roughly the first six months of a spell) increases with time. The most important determinants of the duration of retail interest rates are the cumulated change in the money market interest rates and the policy rate since the last retail rate change. Among bank and market characteristics, the size of the bank, its market share in a given local market, and its geographical scope significantly modify retail rate durations. Retail rates adjust asymmetrically to positive and negative wholesale interest rate changes; the asymmetry of the adjustment is reinforced in part by the bank’s market share. This suggests that monopolistic distortions play a vital role in explaining asymmetric price adjustments.
    Keywords: price stickiness, interest rate pass-through, duration analysis, hazard rate
    Date: 2011–11–07
  15. By: Favero, Carlo A.; Missale, Alessandro
    Abstract: In this paper, we provide new evidence on the determinants of sovereign yield spreads and contagion effects in the euro area in order to evaluate the rationale for a common Eurobond jointly guaranteed by euro-area Member States. We find that default risk is the main driver of yield spreads, suggesting small gains from greater liquidity. Fiscal fundamentals matter in the pricing of default risk but only as they interact with other countries’ yield spreads; i.e. with the global risk that the market perceives. More important, the impact of this global risk variable is not constant over time, a clear sign of contagion driven by shifts in market sentiment. This evidence points to a discontinuity in the disciplinary role of financial markets. If markets can stay irrational longer than a country can stay solvent, then the role of yield spreads on national bonds as a fiscal discipline device is considerably weakened, and issuing Eurobonds can be economically justified.
    Keywords: contagion; Eurobonds; sovereign debt crisis
    Date: 2011–11
  16. By: Mikhail V. Oet; Ryan Eiben; Timothy Bianco; Dieter Gramlich; Stephen J. Ong; Jing Wang
    Abstract: This paper builds on existing microprudential and macroprudential early warning systems (EWSs) to develop a new, hybrid class of models for systemic risk, incorporating the structural characteristics of the fi nancial system and a feedback amplification mechanism. The models explain fi nancial stress using both public and proprietary supervisory data from systemically important institutions, regressing institutional imbalances using an optimal lag method. The Systemic Assessment of Financial Environment (SAFE) EWS monitors microprudential information from the largest bank holding companies to anticipate the buildup of macroeconomic stresses in the financial markets. To mitigate inherent uncertainty, SAFE develops a set of medium-term forecasting specifi cations that gives policymakers enough time to take ex-ante policy action and a set of short-term forecasting specifications for verification and adjustment of supervisory actions. This paper highlights the application of these models to stress testing, scenario analysis, and policy.
    Keywords: Systemic risk ; Liquidity (Economics)
    Date: 2011
  17. By: Olivier Ledoit
    Abstract: We introduce a model of the economy as a social network. Two agents are linked to the extent that they transact with each other. This generates well-defined topological notions of location, neighborhood and closeness. We investigate the implications of our model for monetary economics. When a central bank increases the money supply, it must inject the money somewhere in the economy. We demonstrate that the agent closest to the location where money is injected is better off, and the one furthest is worse off. This redistribution channel is independent from the ones previously noted in the literature. Symmetrically, any decrease in the money supply redistributes purchasing power in the other direction. We also outline the testable implications of our model.
    Keywords: Money, redistribution, policy, central bank, social network, topology
    JEL: E40 E50
    Date: 2011–10
  18. By: Ian Martin
    Abstract: This paper investigates the behavior of asset prices in an endowment economy in which a representative agent with power utility consumes the dividends of multiple assets. The assets are Lucas trees; a collection of Lucas trees is a Lucas orchard. The model generates return correlations that vary endogenously, spiking at times of disaster. Since disasters spread across assets, the model generates large risk premia even for assets with stable fundamentals. Very small assets may comove endogenously and hence earn positive risk premia even if their fundamentals are independent of the rest of the economy. I provide conditions under which the variation in a small asset’s price-dividend ratio can be attributed almost entirely to variation in its risk premium.
    JEL: G12
    Date: 2011–11
  19. By: Tatom, John
    Abstract: Changes in the general level of prices and inflation have profound effects on asset prices. There are several reasons for these effects and the influence differs depending on the source of the inflation and whether it is expected or not. To understand these effects it is important to clarify what is meant by inflation, the pure theory of the sources of inflation, how inflation affects goods and services prices and how it affects the assets that are used to finance production, both equity prices and fixed income assets. This article reviews the theory of inflation, its sources and effects on asset prices, especially equity, bond and real asset prices. The simplest and broadest economic model suggests that money is a veil and that changes in its value (the price level and its rate of depreciation (inflation) have no real effect s on the economy, especially asset prices and real rates of return on assets. There are a variety of reasons to expect that inflation is not “neutral,” however. This article focuses on several factors that give rise to real adverse effects of inflation on asset prices, including supply shocks that reduce wealth and raise prices, and tax effects of inflation that arise from a lack of full indexation of the tax system. Inflation has had large effects on asset prices in the United States, especially during the Great Inflation from 1965 to 1984. The evidence here supports these sources of real effects of inflation.
    Keywords: Inflation; asset prices; supply shocks; real rate of interest; real rate of return on equity
    JEL: E31 E44 G0
    Date: 2011–11
  20. By: Tatom, John
    Abstract: Monetary policy has become difficult to characterize or follow since 2007. A debate as to whether interest rate targets or monetary aggregate targets are better indicators of policy and prospective outcomes has given way to a new credit policy built on inflating the Federal Reserve (Fed) balance sheet to provide private sector credit. This policy grew out of the Great Depression and has led the Fed to ignore monetary growth and render a federal funds rate target impotent by pushing it to zero. To implement the more than doubling of the Fed’s assets, the Fed took up commercial banking policies. Three examples are: selling Treasury assets to fund private assets, paying subsidies to banks for holding reserves and attracting a new class of Treasury debt sterilized in Fed deposits. These actions insulated monetary aggregates and the effective monetary base from the explosion in the Fed’s balance sheet. The new credit policy severed the tight link that had existed for over 70 years between Fed credit and its effective monetary base. Fortunately, it also insulated the economy from a more than doubling of the general price level. But these actions have turned the balance sheet of the Fed into a collection of illiquid and risky private assets. A similar portfolio of government securities that has the longest duration in history and therefore the greatest interest rate risk limits the Fed’s ability to reduce its assets or the excess reserve position of banks, exceeding $1.5 trillion and costing the taxpayer over $3.3 billion, from 2009 to mid-2011. The subsidy and excess reserve levels of the first half of 2011 will cost $2.3 billion per year going forward. Finally, the paper rebuts claims by Fed officials that the Fed has successfully followed the framework of monetary policy developed by Milton Friedman. The paper concludes with recommendations for Congressional restrictions on the Fed and Treasury to ensure that the Fed focus on responsible monetary policy and not its failed credit policy.
    Keywords: monetary policy; credit policy; central banking; Milton Friedman; business cycles
    JEL: E5 E3
    Date: 2011–08–27
  21. By: Keyu Jin; Nan Li
    Abstract: Positive investment comovements across OECD economies as observed in the data are difficult to replicate in open-economy real business cycle models, but also vary substantially in degree for individual country-pairs. This paper shows that a two-country stochastic growth model that distinguishes sectors by factor intensity (capital-intensive vs. labor-intensive) gives rise to an endogenous channel of the international transmission of shocks that first, can substantially ameliorate the "quantity anomalies" that mark large open-economy models, and second, generate a cross-sectional prediction that is strongly supported by the data: investment correlations tend to be stronger for country-pairs that exhibit greater disparity in the factor-intensity of trade. In addition, three new pieces of evidence support the central mechanism: (1) the production composition of capital versus labor-intensive sectors changes over the business cycle; (2) the prices of capital-intensive goods and labor-intensive goods are respectively, procyclical and countercyclical; (3) a positive productivity shock in the U.S. tilts the composition of production towards capital-intensive sectors in other countries.
    Keywords: International business cycles, international comovement, composition effects
    JEL: F41
    Date: 2011–11
  22. By: Arvind Krishnamurthy; Annette Vissing-Jorgensen
    Abstract: We evaluate the effect of the Federal Reserve’s purchase of long-term Treasuries and other long-term bonds ("QE1" in 2008-2009 and "QE2" in 2010-2011) on interest rates. Using an event-study methodology we reach two main conclusions. First, it is inappropriate to focus only on Treasury rates as a policy target because QE works through several channels that affect particular assets differently. We find evidence for a signaling channel, a unique demand for long-term safe assets, and an inflation channel for both QE1 and QE2, and an MBS pre-payment channel and a corporate bond default risk channel for QE1. Second, effects on particular assets depend critically on which assets are purchased. The event-study suggests that (a) mortgage-backed securities purchases in QE1 were crucial for lowering mortgage-backed security yields as well as corporate credit risk and thus corporate yields for QE1, and (b) Treasuries-only purchases in QE2 had a disproportionate effect on Treasuries and Agencies relative to mortgage-backed securities and corporates, with yields on the latter falling primarily through the market’s anticipation of lower future federal funds rates.
    JEL: E4 E5 G14 G18
    Date: 2011–10
  23. By: Arvid Raknerud (Statistisk sentralbyrå (Statistics Norway)); Bjørn Helge Vatne (Norges Bank (Central Bank of Norway)); Ketil Rakkestad (Norges Bank (Central Bank of Norway))
    Abstract: We use a dynamic factor model and a detailed panel data set with quarterly accounts data on all Norwegian banks to study the effects of banks’ funding costs on their retail rates. Banks’ funds are categorized into two groups: customer deposits and long-term wholesale funding (market funding from private and institutional investors including other banks). The cost of market funding is represented in the model by the three-month Norwegian Inter Bank Offered Rate (NIBOR) and the spread of unsecured senior bonds issued by Norwegian banks. Our estimates show clear evidence of incomplete pass-through: a unit increase in NIBOR leads to an approximately 0.8 increase in bank rates. On the other hand, the difference between banks’ loan and deposit rates is independent of NIBOR. Our findings are consistent with the view that banks face a downward-sloping demand curve for loans and an upward-sloping supply curve for customer deposits.
    Keywords: Interest rates, NIBOR, Pass-through, Funding costs, Bank panel data, Dynamic factor model
    JEL: E43 E27 C33
    Date: 2011–07–06
  24. By: Paloviita, Maritta (Bank of Finland Research); Kinnunen, Helvi (Bank of Finland)
    Abstract: Using real time data from the OECD and fiscal policy reaction functions, this study explores euro area fiscal policies since the late 1990s. Both discretionary plans for the budget year and policy changes during budget implementation stages are investigated. The main focus is on the fiscal adjustment to the recent financial and economic crisis. The results suggest that during the time of monetary union (EMU) euro area planned fiscal policies have been long-term oriented and counter-cyclical. In the implementation stages new policy decisions have been made in response to unexpected economics developments. We provide evidence that the crisis had a clear impact on discretionary policies. Due to the resultant increase in uncertainty, the crisis spotlighted the impact of cyclical developments on fiscal planning. In the implementation stages, huge forecast errors in connection with planned policy were observed. As a consequence, new decisions were made in order to alleviate the negative impacts of the crisis on euro area economies.
    Keywords: fiscal policy; real time data; planning stage; implementation stage; cyclical sensitivity; economic crisis
    JEL: E32 E62
    Date: 2011–10–14
  25. By: Guangling (Dave) Liu (Department of Economics, University of Stellenbosch); Nkhahle Seeiso (Department of Economics, University of Stellenbosch)
    Abstract: This paper studies the impact of bank capital regulation on business cycle fluctuations. In particular, we study the procyclical nature of Basel II claimed in the literature. To do so, we adopt the Bernanke et al. (1999) ``financial accelerator" model (BGG), to which we augment a banking sector. We first study the impact of a negative shock to entrepreneurs' net worth and a positive monetary policy shock on business cycle fluctuations. We then look at the impact of a negative net worth shock on business cycle fluctuations when the minimum capital requirement increases from 8 percent to 12 percent. Our comparison studies between the augmented BGG model with Basel I bank regulation and the one with Basel II bank regulation suggest that, in the presence of credit market frictions and bank capital regulation, the liquidity premium effect further amplifies the financial accelerator effect through the external finance premium channel, which, in turn, contributes to the amplification of Basel II procyclicality. Moreover, under Basel II bank regulation, in response to a negative net worth shock, the liquidity premium and the external finance premium rise much more if the minimum bank capital requirement increases, which, in turn, amplify the response of real variables. Finally, small adjustments in monetary policy can result in stronger response in the real economy, in the presence of Basel II bank regulation in particular, which is undesirable.
    Keywords: Business cycle fluctuations, financial accelerator, bank capital requirement, monetary policy
    JEL: E32 E44 G28 E50
    Date: 2011
  26. By: D'Hulster, Katia
    Abstract: The global financial crisis has uncovered a number of weaknesses in the supervision and regulation of cross border banks. One such weakness was the lack of effective cooperation among banking supervisors. Since then, international bodies, such as the G-20, the Financial Stability Board and the Basel Committee have actively promoted the use of supervisory colleges. The objective of this paper is to explore the obstacles to effective cross border supervisory information sharing. More specifically, a schematic presentation illustrating the misalignments in incentives for information sharing between home and host supervisors under the current supervisory task-sharing anchored in the Basel Concordat is developed. This paper finds that in the absence of an ex ante agreed upon resolution and burden-sharing mechanism and deteriorating health of the bank, incentive conflicts escalate and supervisory cooperation breaks down. The promotion of good practices for cooperation in supervisory colleges is thus not sufficient to address the existing incentive conflicts. What is needed is a rigorous analysis and review of the supervisory task-sharing framework, so that the right incentives are secured during all stages of the supervisory process. For this purpose, it is essential that policy makers integrate and harmonize the current debates on crisis management, resolution policy and good supervisory practices for cross border banking supervision.
    Keywords: Banks&Banking Reform,Emerging Markets,Labor Policies,Financial Intermediation,Debt Markets
    Date: 2011–11–01
  27. By: Aizenman, Joshua (Asian Development Bank Institute)
    Abstract: This paper takes stock of recent research dealing with the degree to which the trilemma choices of Asian countries facilitated a smoother adjustment during the global crisis of 2008–2009, and the way the region has been coping with the adjustment to the postcrisis challenges. We point out that emerging Asia has converged to a middle ground of the trilemma configuration: limited financial integration, a degree of monetary independence, and controlled exchange rate buffered by sizable international reserves.
    Keywords: trilemma choices; financial stability; global crisis 2008–2009
    JEL: F31 F32 F33 F36
    Date: 2011–11–02
  28. By: Dai, Meixing
    Abstract: The effects of quantitative easing policy, which looks like a “helicopter dropping” of money, are quite complex. Implemented following a major crisis induced by the deflation of bubbles on asset prices, this policy creates redistributive effects in favour of financial and banking institutions without effectively stimulating the growth due to its character of restricted currency distribution. Banking and sovereign debt crises in the euro area implies that the European Central Bank must reform the way it “drops” the money to effectively reduce the financing costs of financially constrained agents, including the governments of the member States of EMU.
    Keywords: Quantitative easing; liquidity trap; monetary policy reform; sovereign debt and banking crisis; deflation
    JEL: E58 E52 E44
    Date: 2011–06–09
  29. By: Balli, Faruk; Kalemli-Ozcan, Sebnem; Sørensen, Bent E
    Abstract: We estimate channels of international risk sharing between European Monetary Union (EMU), European Union, and other OECD countries 1992-2007. We focus on risk sharing through savings, factor income flows, and capital gains. Risk sharing through factor income and capital gains was close to zero before 1999 but has increased since then. Risk sharing from capital gains, at about 6 percent, is higher than risk sharing from factor income flows for European Union countries and OECD countries. Risk sharing from factor income flows is higher for Euro zone countries, at 14 percent, reflecting increased international asset and liability holdings in the Euro area.
    Keywords: capital markets; income insurance; international financial integration
    JEL: F21 F36
    Date: 2011–11
  30. By: Jan Babecky; Tomas Havranek; Jakub Mateju; Marek Rusnak; Katerina Smidkova; Borek Vasicek
    Abstract: Using a panel of 40 EU and OECD countries for the period 1970–2010 we construct an early warning system. The system consists of a discrete and a continuous model. In the discrete model, we collect an extensive database of various types of economic crises called CDEC 40-40 and examine potential leading indicators. In the continuous model, we construct an index of real crisis incidence as the response variable. We determine the optimal lead employing panel vector autoregression for each potential indicator, and then select useful indicators employing Bayesian model averaging. We re-estimate the resulting specification by system GMM and, to allow for country heterogeneity, additionally evaluate the random coefficients estimator and divide countries into clusters. Our results suggest that global variables are among the most useful early warning indicators. In addition, housing prices emerge consistently as an important source of risk. Finally, we simulate the past effectiveness of several policy instruments and conclude that some central bank tools (for example, reserves) could be useful in mitigating crisis incidence.
    Keywords: Bayesian model averaging, dynamic panel, early warning indicators, macroprudential policies, panel VAR.
    JEL: C25 C33 E44 E58
    Date: 2011–10
  31. By: Chris McDonald; Leif Anders Thorsrud (Reserve Bank of New Zealand)
    Abstract: Forecasting the future path of the economy is essential for good monetary policy decisions. The recent financial crisis has highlighted the importance of tail events, and that assessing the central projection is not enough. The whole range of outcomes should be forecasted, evaluated and accounted for when making monetary policy decisions. As such, we construct density fore- casts using the historical performance of the Reserve Bank of New Zealand's (RBNZ) published point forecasts. We compare these implied RBNZ den- sities to similarly constructed densities from a suite of empirical models. In particular, we compare the implied RBNZ densities to combinations of density forecasts from the models. Our results reveal that the combined den- sities are comparable in performance and sometimes better than the implied RBNZ densities across many dierent horizons and variables. We also find that the combination strategies typically perform better than relying on the best model in real-time, that is the selection strategy.
    JEL: C52 C53 E52
    Date: 2011–08
  32. By: Jasper de Winter
    Abstract: This paper examines the accuracy of short run forecasts of Dutch GDP growth by several linear statistical models and private sector analysts. We focus on the financial crisis of 2008-2009 and the dot-com recession of 2001-2002. The dynamic factor model turns out to be the best model. Its forecast accuracy during the crisis deteriorates much less than that of the other linear models and hardly at all when backcasting and nowcasting. Moreover, the dynamic factor model beats the private sector forecasters at nowcasting. This finding suggests that adding judgement to a mechanical model may not improve short-term forecasting performance.
    Keywords: Nowcasting; Professional Forecasters; Factor Model; Forecasting
    JEL: E52 C53 C33
    Date: 2011–11
  33. By: Obstbaum, Meri (Aalto University School of Economics and Ministry of Finance)
    Abstract: This paper shows how frictions in the labour market shape the responses of the economy to government spending shocks. The open economy New Keynesian DSGE model is extended by labour market frictions of the Mortensen-Pissarides type and a detailed description of fiscal policy. The nature of offsetting fiscal measures is found to be critical for the effects of fiscal stimulus, due to the different effects of different tax instruments on the labour market. Specifically, shifting the debt-stabilizing burden towards distortionary labour taxes has detrimental effects on the labour market outcome and on overall economic performance in a flexible wage regime. The results show that wage rigidity increases the effectiveness of fiscal policy in the short term but leads to a worse longer term result including unemployment exceeding steady state levels. The analysis suggests that a closer look at the functioning of labour markets may help to identify fiscal policy transmission channels not captured by the standard New Keynesian model.
    Keywords: search frictions; wage bargaining; wage and price rigidity; fiscal rules; debt stabilization
    JEL: E62 J41
    Date: 2011–08–05
  34. By: Viktors Ajevskis; Kristine Vitola
    Abstract: The severe repercussions of the latest financial crisis highlighted the crucial role of the financial sector in the propagation of economic and financial shocks. In this paper we analyse the role of financial market frictions in business cycle fluctuations and in the transmission of monetary policy in a small open economy pursuing fixed exchange rate strategy. To this end, we develop and estimate a DSGE model for Latvia with financially constrained households and firms, embedding monopolistically competitive banking sector facing capital constraints. This general equilibrium framework is useful to study the potential of macro-prudential tools and their interaction with other macroeconomic and monetary policy instruments. Our findings suggest that the banking sector mutes the response of bank retail rates to an increase in the foreign policy rate and thus attenuates the drop in real aggregates. A permanent bank capital contraction subdues output, consumption, investment, domestic lending and foreign borrowing in the long run. Under a temporary shock to bank capital, asset prices and housing investment are first to recover, for loans it takes several years, while output, consumption and capital investment rebound at a slower pace. In the long run, a tighter capital requirement leads to higher output, capital investment and domestic lending while reducing household deposits and foreign liabilities of banks.
    Keywords: DSGE, DSGE models, Bayesian estimation, banks, financial frictions, macro-financial linkages, small open economy
    JEL: C11 E32 E43 E44 F41 R21
    Date: 2011–11–03
  35. By: Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.); Arnaud Mehl (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: This paper assesses whether the international monetary system is already tripolar and centred around the US dollar, the euro and the Chinese renminbi (RMB). It focuses on what we call China’s “dominance hypothesis”, i.e. whether the renminbi is already the dominant currency in Asia, exerting a large influence on exchange rate and monetary policies in the region, a direct reference to the old “German dominance hypothesis” which ascribed to the German mark a dominant role in Europe in the 1980s-1990s. Using a global factor model of exchange rates and a complementary event study, we find evidence that the RMB has become a key driver of currency movements in emerging Asia since the mid-2000s, and even more so since the global financial crisis. These results are consistent with China’s dominance hypothesis and with the view that the international monetary system is already tri-polar. However, we also find that China’s currency movements are to some extent affected by those in the rest of Asia. JEL Classification: F30, F31, F33, N20.
    Keywords: International monetary system, exchange rates, tri-polarity, China, renminbi, US dollar, euro, German dominance hypothesis.
    Date: 2011–10
  36. By: Ana Gomez Loscos; M. Dolores Gadea; Antonio Montañes
    Abstract: This paper sets out a comprehensive framework to identify regional business cycles within Spain and analyses their stylised features and the degree of synchronization present among them and the Spanish economy. We show that the regional cycles are quite heterogeneous although they display some degree of synchronization that can be partially explained using macroeconomic variables. We also propose a dynamic factor model to cluster the regional comovements and Önd out if the country cycle is simply the aggregation of the regional ones. We Önd that the Spanish business cycle is not shared by the seventeen regions, but is the sum of the di§erent regional behaviours. The implications derived from our results are useful both for policy makers and analysts.
    Date: 2011–09
  37. By: Meixing Dai
    Abstract: Most Western economists and policymakers agree that the Yuan is significantly undervalued and push for its quick nominal revaluation. This paper defends that many domestic and foreign factors could be responsible for the Yuan’s undervaluation, and the People’s bank of China (PBC) cannot optimally invest growing foreign exchange reserves. It provides a theoretical framework to discuss the optimal strategy associating a gradual nominal revaluation of the Yuan with higher inflation, and structural and macroeconomic policies to bring the real exchange rate to its equilibrium level. This strategy allows absorbing external imbalances while laying down the foundation for China’s long-term growth.
    Keywords: Real revaluation; Yuan; Renminbi (RMB); foreign exchange reserves; external imbalance; macroeconomic adjustment measures.
    JEL: E2 E5 E6 F3
    Date: 2011
  38. By: Carlos Capistrán; Raúl Ibarra-Ramírez; Manuel Ramos Francia
    Abstract: This paper analyzes the pass-through of exchange rate to different price indexes in Mexico. The analysis is based on a vector autoregressive model (VAR) using monthly data from January 1997 to December 2010. The pass-through effects are calculated by means of accumulated impulse response functions to a recursively identified exchange rate shock. The results show that the exchange rate pass-through to import prices is complete, but it declines along the distribution chain in such a way that the impact on consumer prices is below 20 percent. Moreover, we find that the exchange rate pass-through seems to have decreased substantially from 2001 onwards, which coincides with the adoption of an inflation targeting regime by Banco de Mexico.
    Keywords: Exchange rate pass-through, import price, consumer price, distribution chain, inflation.
    JEL: E31 F31 F41
    Date: 2011–11

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