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on Central Banking |
| By: | Gersbach, Hans; Hahn, Volker |
| Abstract: | We introduce a new type of incentive contract for central bankers: inflation forecast contracts, which make central bankers’ remunerations contingent on the precision of their inflation forecasts. We show that such contracts enable central bankers to influence inflation expectations more effectively, thus facilitating more successful stabilization of current inflation. Inflation forecast contracts improve the accuracy of inflation forecasts, but have adverse consequences for output. On balance, paying central bankers according to their forecasting performance improves welfare. Optimal inflation forecast contracts stipulate high rewards for accurate forecasts. |
| Keywords: | central banks; incentive contracts; inflation forecast targeting; inflation targeting; intermediate targets; transparency |
| JEL: | E58 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8933&r=cba |
| By: | Michael Woodford |
| Abstract: | A number of commentators have argued that the desirability of inflation targeting as a framework for monetary policy analysis should be reconsidered in light of the global financial crisis, on the ground that it requires neglect of the implications of monetary policy for financial stability. This paper argues that monetary policy may indeed affect the severity of risks to financial stability, but that it is possible to generalize an inflation targeting framework to take account of financial stability concerns alongside traditional stabilization objectives. The resulting framework can still be viewed as a form of flexible inflation targeting; in particular, the paper proposes a target criterion that would still imply an invariant long-run price level, despite fluctuations over time in risks to financial stability or even the occurrence of occasional financial crises. |
| JEL: | E52 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17967&r=cba |
| By: | Robert G. King (Boston University, Department of Economics); Mark W. Watson (Department of Economics and Woodrow Wilson School, Princeton University) |
| Abstract: | We study two decompositions of inflation, , motivated by a New Keynesian Pricing Equation. The first uses four components: lagged , expected future , real unit labor cost ( ), and a residual. The second uses two components: fundamental inflation (discounted expected future ) and a residual. We find large low-frequency differences between actual and fundamental inflation. From 1999-2011 fundamental inflation fell by more than 15 percentage points, while actual inflation changed little. We discuss this discrepancy in terms of the data (a large drop in labor's share of income) and through the lens of a canonical structural model (Smets-Wouters (2007)). |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2012-005&r=cba |
| By: | Paul Alagidede (Department of Economics and Economic History, Rhodes University); Theodore Panagiotidis (Department of Economics, University of Macedonia) |
| Abstract: | The relationship between stock returns and inflation is examined for the G7 countries and some positive coefficients in the distribution for Italy and the UK were revealed. A positive one-for-one relationship is found once a GARCH filter is employed in all cases except Canada.. |
| Keywords: | Stock Returns, Inflation, Hedging, quantile regression. |
| JEL: | G10 G15 C32 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:mcd:mcddps:2012_04&r=cba |
| By: | Günes Kamber; Christoph Thoenissen (Reserve Bank of New Zealand) |
| Abstract: | The ability of financial frictions to amplify the output response of monetary policy, as in the financial accelerator model of Bernanke et al (1999), is analysed for a wider class of policy rules where the policy interest rate responds to both inflation and the output gap. When policy makers respond to the output gap as well as inflation, the standard financial accelerator model reacts less to an interest rate shock than does a comparable model without an operational financial accelerator mechanism. In recessions, when firm-specific volatility rises, financial acceleration due to financial frictions is further reduced, even under pure inflation targeting. |
| JEL: | E32 E52 |
| Date: | 2012–02 |
| URL: | http://d.repec.org/n?u=RePEc:nzb:nzbdps:2012/01&r=cba |
| By: | Thorvald Grung Moe |
| Abstract: | Henry Simons's 1936 article "Rules versus Authorities in Monetary Policy" is a classical reference in the literature on central bank independence and rule-based policy. A closer reading of the article reveals a more nuanced policy prescription, with significant emphasis on the need to control short-term borrowing; bank credit is seen as highly unstable, and price level controls, in Simons's view, are not be possible without limiting banks' ability to create money by extending loans. These elements of Simons's theory of money form the basis for Hyman P. Minsky's financial instability hypothesis. This should not come as a surprise, as Simons was Minsky's teacher at the University of Chicago in the late 1930s. I review the similarities between their theories of financial instability and the relevance of their work for the current discussion of macroprudential tools and the conduct of monetary policy. According to Minsky and Simons, control of finance is a prerequisite for successful monetary policy and economic stabilization. |
| Keywords: | Monetary Policy; Financial Stability; Narrow Banking; Financial Regulation |
| JEL: | B22 E42 E52 G28 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_713&r=cba |
| By: | Goodhart, Ch. A. E.; Kashyap, A. K.; Tsomocos, D. P.; Vardoulakis, A. P. |
| Abstract: | This paper explores how different types of financial regulation could combat many of the phenomena that were observed in the financial crisis of 2007 to 2009. The primary contribution is the introduction of a model that includes both a banking system and a “shadow banking system” that each help households finance their expenditures. Households sometimes choose to default on their loans, and when they do this triggers forced selling by the shadow banks. Because the forced selling comes when net worth of potential buyers is low, the ensuing price dynamics can be described as a fire sale. The proposed framework can assess five different policy options that officials have advocated for combating defaults, credit crunches and fire sales, namely: limits on loan to value ratios, capital requirements for banks, liquidity coverage ratios for banks, dynamic loan loss provisioning for banks, and margin requirements on repurchase agreements used by shadow banks. The paper aims to develop some general intuition about the interactions between the tools and to determine whether they act as complements and substitutes. |
| Keywords: | Price setting, changeover, euro, inflation. |
| JEL: | G28 L51 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:372&r=cba |
| By: | Glocker, Ch.; Towbin P. |
| Abstract: | Monetary authorities in emerging markets are often reluctant to raise interest rates when dealing with credit booms driven by capital inflows, as they fear that an increase attracts even more capital and appreciates the currency. A number of countries therefore use reserve requirements as an additional policy instrument. The present study provides evidence on their macroeconomic effects. We estimate a vector autoregressive (VAR) model for the Brazilian economy and identify interest rate and reserve requirement shocks. For both instruments a discretionary tightening leads to a decline in domestic credit. We find, however, very different effects for other macroeconomic aggregates. In contrast to interest rate policy, a positive reserve requirement shock leads to an exchange rate depreciation and an improvement in the current account, but also to an increase in prices. The results suggest that reserve requirement policy can complement interest rate policy in pursuing a financial stability objective, but cannot be its substitute with regards to a price stability objective. |
| Keywords: | Reserve Requirements, Capital flows, Monetary Policy, Business Cycle. |
| JEL: | E58 E52 F32 F41 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:374&r=cba |
| By: | Frank Packer; Haibin Zhu |
| Abstract: | In the wake of the Asian financial crisis, many regimes in Asia adopted stricter provisioning requirements, as well as discretionary measures, with the objective of increasing provisioning in good times in response to rising levels of risk. Based on a final sample of 240 banks in 12 Asian economies, the evidence is that countercyclical loan loss provisioning has dominated throughout emerging Asia, most strikingly so in the case of India. Thus, loan loss provisioning did not simply become more conservative at all points in time subsequent to the Asian financial crisis, but actively leaned in a fashion that ameliorated swings in earnings and the macroeconomy. |
| Keywords: | Loan loss provisioning, financial system procyclicality, international accounting standards, earnings smoothing, macroprudential policy |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:375&r=cba |
| By: | Thorvald Grung Moe |
| Abstract: | Global liquidity provision is highly procyclical. The recent financial crisis has resulted in a flight to safety, with severe strains in key funding markets leading central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot's advice to "lend freely at high rates against good collateral" has been stretched to the limit in order to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask, How elastic should the supply of central bank currency be? Even when the central bank has the ability to create abundant official liquidity, there should be some limits to its support for the financial sector. Traditionally, the misuse of the fiat money privilege has been limited by self-imposed rules that central bank loans must be fully backed by gold or collateralized in some other way. But since the onset of the crisis, we have seen how this constraint has been relaxed to accommodate the demand for market support. My suggestion is that there has to be some upper limit, and that we should work hard to find guidelines and policies that can limit the need for central bank liquidity support in future crises. In this paper, I review the recent expansion of central bank liquidity support during the crisis, before discussing the collateral polices related to central banks' lender-of-last-resort and market-maker-of-last-resort policies and their rationale. I then examine the relationship between the central bank and the treasury, and the potential threat to central bank independence if they venture into too much risky balance sheet expansion. A discussion about the exceptional growth of the shadow banking system follows. I introduce the concept of "liquidity illusion" to describe the fragility upon which much of the sector is based, and note that market growth has been based largely on a "fair-weather" view that central banks will support the market on rainy days. I argue that we need a better theoretical framework to understand the growth in the shadow banking system and the role of central banks in providing liquidity in a crisis. Recently, the concept of "endogenous finance" has been used to explain the strong procyclical tendencies of the global financial system. I show that this concept was central to Hyman P. Minsky's theory of financial instability, and suggest that his insights should be integrated into the ongoing search for a better theoretical framework for understanding the growth of the shadow banking system and how we can limit official liquidity support for this system. I end the paper with a summary and a discussion of some of the policy issues. I note that the Basel III "package" will hopefully reduce the need for central bank liquidity support in the future, but suggest that further structural reforms of the financial sector are needed to ease the tension between freewheeling private credit expansion and the limited ability or willingness of central banks to provide unlimited official liquidity support in a future crisis. |
| Keywords: | Financial Regulation; Financial Stability; Monetary Policy; Central Bank Policy |
| JEL: | E44 E52 E58 G28 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_712&r=cba |
| By: | Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis |
| Abstract: | Motivated by the Chinese experience, we analyze a semi-open economy where the central bank has access to international capital markets, but the private sector has not. This enables the central bank to choose an interest rate different from the international rate. We examine the optimal policy of the central bank by modelling it as a Ramsey planner who can choose the level of domestic public debt and of international reserves. The central bank can improve savings opportunities of credit-constrained consumers modelled as in Woodford (1990). We find that in a steady state it is optimal for the central bank to replicate the open economy, i.e., to issue debt financed by the accumulation of reserves so that the domestic interest rate equals the foreign rate. When the economy is in transition, however, a rapidly growing economy has a higher welfare without capital mobility and the optimal interest rate differs from the international rate. We argue that the domestic interest rate should be temporarily above the international rate. We also find that capital controls can still help reach the first best when the planner has more fiscal instruments. |
| Keywords: | reserve accumulation; capital controls; Ramsey planner; credit constraints |
| JEL: | E58 F36 F41 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:lau:crdeep:11.08&r=cba |
| By: | Carlo A. Favero |
| Abstract: | Unstability in the comovement among bond spreads in the euro area is an important feature for dynamic econometric modelling and forecasting. This paper proposes a non-linear GVAR approach to spreads in the euro area where the changing interdepence among these variables is modelled by making each country spread function of a global variable determined by fiscal fundamentals with a time-varying composition. The model naturally accommodates the possibility of multiple equilibria in the relation between default premia and local fiscal fundamentals. The estimation reveals a significant non-linear relation between spreads and fiscal fundamentals that generates time-varying impulse response of local spreads to shocks in other euro area countries spreads. The GVAR framework is then applied to the analysis of the dynamic effects of fiscal stabilization packages on the cost of government borrowing and to the evaluation of the importance of potential contagion effects determining a significant increase in cross-market linkages after a shock to a group of countries. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:igi:igierp:431&r=cba |
| By: | Frédérique Bec (CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique, THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise); Songlin Zeng (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise) |
| Abstract: | Since the late nineties, both theoretical and empirical analysis devoted to the real exchange rate suggest that their dynamics might be well approximated by nonlinear models. This paper examines this possibility for post-1970 monthly ASEAN-5 data, extending the existing research in two directions. First, we use recently developed unit root tests which allow for more flexible nonlinear stationary models under the alternative than the commonly used Self-Exciting Threshold or Exponantial Smooth Transition AutoRegressions. Second, while different nonlinear models survive the mis-specification tests, a Monte Carlo experiment from generalized impulse response functions is used to compare their relative relevance. Our results i) support the nonlinear mean-reverting hypothesis, and hence the Purchasing Power Parity, in most of the ASEAN-5 countries and ii) point to the Multiple Regime-Logistic Smooth Transition and the Exponantial Smooth Transition AutoRegression models as the most likely data generating processes of these real exchange rates. |
| Keywords: | Purchasing Power Parity; Nonlinear ThresholdModels; Southeast Asian Real Exchange Rates |
| Date: | 2012–02–07 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00685812&r=cba |
| By: | Jacky Mallett |
| Abstract: | This paper presents a description of the mechanical operations of banking as used in modern banking systems regulated under the Basel Accords, in order to provide support for a verifiable and complete description of the banking system suitable for computer simulation. Feedback is requested on the contents of this document, both with respect to the operations described here, and any known national, regional or local variations in their structure and practice. |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1204.1583&r=cba |
| By: | Jianjun Miao (Department of Economics, Boston University, CEMA, Central University of Finance and Economics, and AFR, Zhejiang University); PENGFEI WANG (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.) |
| Abstract: | This paper develops a macroeconomic model with a banking sector in which banks face endogenous borrowing constraints. There is no uncertainty about economic fundamentals. Banking bubbles can emerge through a positive feedback loop mechanism. Changes in household confidence can cause the collapse of bubbles, resulting in a financial crisis. Credit policy can mitigate economic downturns but also incur an efficiency loss. Bank capital requirements can prevent the formation of banking bubbles by limiting leverage. But a too restrictive requirement leads to less lending and hence less production. |
| Keywords: | Banking Bubble, Multiple Equilibria, Financial Crisis, Self-ful?lling Prophecy, Credit Policy, Capital Requirements, Borrowing Constraints |
| JEL: | E2 E44 G01 G20 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2012-010&r=cba |
| By: | Massimiliano Caporin (Univerista' di Padova); Loriana Pelizzon (Univerista' Ca' Foscari Venezia and MIT Sloan); Francesco Ravazzolo (Norges Bank (Central Bank of Norway) and BI Norwegian Business School); Roberto Rigobon (MIT Sloan and NBER) |
| Abstract: | This paper analyzes the sovereign risk contagion using CDS spreads for the major euro area countries. Using several econometric approaches (non linear regression, quantile regression and Bayesian quantile with heteroskedasticity) we show that propagation of shocks in Europe's CDS's has been remarkably constant even though in a signi cant part of the sample periphery countries have been extremely a ected by their sovereign debt and scal situations. Thus, the integration among the di erent countries is stable, and the risk spillover among countries is not a ected by the size of the shock. |
| Keywords: | Sovereign Risk, Contagion |
| JEL: | E58 F34 F36 G12 G15 |
| Date: | 2012–04–10 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2012_05&r=cba |
| By: | Erik S. Reinert |
| Abstract: | This paper provides a historical and theoretical overview of the mechanisms leading up to financial crises and financial bubbles. It suggests that the potentially explosive growth of the financial sector at the expense of the real economy fed by compound interest has . since before Ancient Mesopotamia under the rule of Hammurabi . represented a real threat for such crises. A more modern and additional factor that builds up crises is Joseph Schumpeterÿs observation of the clustering of innovations. Carlota Perez has more recently developed Schumpeterÿs vision into a theory of techno-economic paradigms which . about midway in their trajectory . produce the build-up to financial crises. The theories of Schumpeterian economist Hyman Minsky, describing the mechanisms producing the collapse of financial bubbles complete the overview. The paper ends with recommendations to bring the West out of the present crisis by .once again . putting the real economy rather than the financial economy in the driverÿs seat of capitalism. |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:tth:wpaper:39&r=cba |
| By: | Peter C. B. Phillips (Yale University, University of Auckland, University of Southampton & Singapore Management University); Shu-Ping Shi (Research School of Economics, The Australian National University); Jun Yu (Sim Kee Boon Institute for Financial Economics, School of Economics and Lee Kong Chian School of Business) |
| Abstract: | Identifying and dating explosive bubbles when there is periodically collapsing behavior over time has been a major concern in the economics literature and is of great importance for practitioners. The complexity of the nonlinear structure inherent in multiple bubble phenomena within the same sample period makes econometric analysis particularly difficult. The present paper develops new recursive procedures for practical implementation and surveillance strategies that may be employed by central banks and fiscal regulators. We show how the testing procedure and dating algorithm of Phillips, Wu and Yu (2011, PWY) are affected by multiple bubbles and may fail to be consistent. The present paper proposes a generalized version of the sup ADF test of PWY to address this difficulty, derives its asymptotic distribution, introduces a new date-stamping strategy for the origination and termination of multiple bubbles, and proves consistency of this dating procedure. Simulations show that the test significantly improves discriminatory power and leads to distinct power gains when multiple bubbles occur. Empirical applications are conducted to S&P 500 stock market data over a long historical period from January 1871 to December 2010. The new approach identifies many key historical episodes of exuberance and collapse over this period, whereas the strategy of PWY and the CUSUM procedure locate far fewer episodes in the same sample range. |
| Keywords: | Date-stamping strategy; Generalized sup ADF test; Multiple bubbles, Rational bubble; Periodically collapsing bubbles; Sup ADF test |
| JEL: | C15 C22 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:siu:wpaper:13-2012&r=cba |
| By: | Jurgen von Hagen (University of Bonn, Indiana University and CEPR); Haiping Zhang (School of Economics, Singapore Management University) |
| Abstract: | Recent literature has proposed two alternative types of financial frictions, i.e., limited commitment and incomplete markets, to explain the patterns of international capital flows between developed and developing countries observed in the past two decades. This paper integrates both types of frictions into a two-country overlapping-generations framework to facilitate a direct comparison of their effects. In our model, limited commitment distorts the investment made by agents with different productivity, which creates a wedge between the interest rates on equity capital vs. credit capital; while incomplete markets distort the investment among projects with different riskiness, which creates a wedge between the risk-free rate and the mean rate of return to risky capital. We show that the two approaches are observationally equivalent with respect to their implications for international capital flows, production efficiency, and aggregate output. |
| Keywords: | E44, F41 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:siu:wpaper:10-2012&r=cba |