nep-cba New Economics Papers
on Central Banking
Issue of 2012‒09‒09
fifteen papers chosen by
Maria Semenova
Higher School of Economics

  1. A DSGE model for a SOE with systematic interest and foreign exchange policy in which policymakers exploit the risk premium for stabilization purposes By Escudé, Guillermo J.
  2. Central Banking for Financial Stability: Some Lessons from the Recent Instability in the United States and Euro Area By Wall, Larry D.
  3. Central Banking for Financial Stability in Asia By Kawai, Masahiro; Morgan, Peter J.
  4. Systemic Risk and the European Banking Sector By Nicola Borri; Marianna Caccavaio; Giorgio Di Giorgio; Alberto Maria Sorrentino
  5. What Central Bankers Need to Know about Forecasting Oil Prices By Baumeister, Christiane; Kilian, Lutz
  6. Three Essays on Robustness and Asymmetries in Central Bank Forecasting By Taro Ikeda
  7. Heterogeneous distribution of money supply across the euro area By Jitka Pomenkova; Svatopluk Kapounek
  8. Imperfect Credibility and Robust Monetary Policy By Richard Dennis
  9. Bank Leverage Shocks and the Macroeconomy: a New Look in a Data-Rich Environment By Jean-Stéphane Mésonnier; Dalibor Stevanovic
  10. An Early-warning and Dynamic Forecasting Framework of Default Probabilities for the Macroprudential Policy Indicators Arsenal By Xisong Jin; Francisco Nadal De Simone
  11. Capital Adequacy and the Bank Lending Channel: Macroeconomic Implications By Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
  12. Algorithm for identifying systemically important banks in payment systems By Soramäki, Kimmo; Cook, Samantha
  13. Money Velocity with Interest Rate Stochastic Volatility and Exact Aggregation By William Barnett; Haiyang Xu
  14. Finding communities in credit networks By Bargigli, Leonardo; Gallegati, Mauro
  15. Self-Control, Financial Literacy and Co-Holding Puzzle By John Gathergood; Joerg Weber

  1. By: Escudé, Guillermo J.
    Abstract: This paper builds a DSGE model for a small open economy (SOE) in which the central bank systematically intervenes both the domestic currency bond and the FX markets using two policy rules: a Taylor-type rule and a second rule in which the operational target is the rate of nominal currency depreciation. For this, the instruments used by the central bank (bonds and international reserves) must be included in the model, as well as the institutional arrangements that determine the total amount of resources the central bank can use. The corner regimes in which only one of the policy rules is used are particular cases of the model. The model is calibrated and implemented in Dynare for 1) simple policy rules, 2) optimal simple policy rules, and 3) optimal policy under commitment. Numerical losses are obtained for ad-hoc loss functions for different sets of central bank preferences (styles). The results show that the losses are systematically lower when both policy rules are used simultaneously, and much lower for the usual preferences (in which only inflation and/or output stabilization matter). It is shown that this result is basically due to the central bank's enhanced ability, when it uses the two policy rules, to influence capital flows through the effects of its actions on the endogenous risk premium in the (risk-adjusted) interest parity equation. --
    Keywords: DSGE models,small open economy,exchange rate policy,optimal policy
    JEL: D58 F41 O24
    Date: 2012
  2. By: Wall, Larry D. (Asian Development Bank Institute)
    Abstract: Central banks have had an important role in maintaining financial stability through their lender of last resort role. As lender of last resort, the central bank is given enormous power which is normally tempered by a variety of limits. In the most recent crises in both the United States and euro area, the Federal Reserve and European Central Bank (ECB) have come under enormous pressure to take lender of last resort actions that exceed these normal bounds. This paper reviews the experience of these two central banks and draws some implications for future policy.
    Keywords: central banking; financial stability; united states; euro area; federal reserve; european central bank
    JEL: E50 E58 G28
    Date: 2012–09–04
  3. By: Kawai, Masahiro (Asian Development Bank Institute); Morgan, Peter J. (Asian Development Bank Institute)
    Abstract: A key lesson of the 2007–2009 global financial crisis was the importance of containing systemic financial risk and the need for a “macroprudential” approach to surveillance and regulation that can identify system-wide risks and take appropriate actions to maintain financial stability. By virtue of their overview of the economy and the financial system and their responsibility for payments and settlement systems, there is a broad consensus that central banks should play a key role in monitoring and regulating financial stability. Emerging economies face additional challenges because of their underdeveloped financial systems and vulnerability to volatile international capital flows, especially “sudden stops” or reversals of capital inflows. This paper reviews the recent literature on this topic and identifies relevant lessons for central banks, especially those in Asia’s emerging economies.
    Keywords: central banking; central banks; financial stability; asia; surveillance and regulation; global financial crisis
    JEL: E52 F31 G28
    Date: 2012–08–31
  4. By: Nicola Borri (LUISS Guido Carli University, Department of Economics and Finance and CASMEF); Marianna Caccavaio (LUISS Guido Carli University, Department of Economics and Finance and CASMEF); Giorgio Di Giorgio (LUISS Guido Carli University, Department of Economics and Finance and CASMEF); Alberto Maria Sorrentino (University of Rome Tor Vergata and CASMEF)
    Abstract: Systemic risk is the risk of a collapse of the entire financial system, typically triggered by the default of one, or more, large and interconnected financial institutions. In this paper we estimate the systemic risk contribution of each financial institution in a large sample of European banks. We follow a recent methodology first proposed by Adrian and Brunnermeier (2011) based on the CoVaR and find that size is a predictor of a bank contribution to systemic risk, but it is not the only one. Leverage is important as well. Also, banks that have their headquarters in countries with a more concentrated banking system tend to contribute more to European wide systemic risk, even after controlling for their size. Therefore, any financial regulation designed only to curb banksÕ size would not completely eliminate systemic risk. On average, balance sheet variables are very weak predictors of banksÕ contribution to systemic risk, if compared to market based variables. Accounting rules provide enough degrees of freedom to make balance sheet less informative than market prices. As a result, measures of risk based on higher frequency market prices are more likely to anticipate systemic risk.
    Keywords: Systemic Risk, SIFIs, European Banking System, CoVaR.
    JEL: G01 G18 G21 G32
    Date: 2012
  5. By: Baumeister, Christiane; Kilian, Lutz
    Abstract: Recent research has shown that recursive real-time VAR forecasts of the real price of oil tend to be more accurate than forecasts based on oil futures prices of the type commonly employed by central banks worldwide. Such monthly forecasts, however, differ in several important dimensions from the forecasts central banks require when making policy decisions. First, central banks are interested in forecasts of the quarterly real price of oil rather than forecasts of the monthly real price of oil. Second, many central banks are interested in forecasting the real price of Brent crude oil rather than any of the U.S. benchmarks. Third, central banks outside the United States are interested in forecasting the real price of oil measured in domestic consumption units rather than U.S. consumption units. Addressing each of these three concerns involves modeling choices that affect the relative accuracy of alternative forecasting methods. In addition, we investigate the costs and benefits of allowing for time variation in VAR model parameters and of constructing forecast combinations. We conclude that quarterly forecasts of the real price of oil from suitably designed VAR models estimated on monthly data generate the most accurate forecasts among a wide range of methods including forecasts based on oil futures prices, nochange forecasts and forecasts based on models estimated on quarterly data.
    Keywords: Central banks; Forecasting methods; Oil futures prices; Out-of-sample forecast; Quarterly horizon; Real price of oil; Real-time data; VAR
    JEL: C53 E32 Q43
    Date: 2012–09
  6. By: Taro Ikeda (Kurume University, Faculty of Economics)
    Abstract: This paper introduces asymmetric central bank forecasting into the standard New Keynesian model within the context of robust control theory. Asymmetric forecasting expresses policymakersf reservations about economic forecasts, and the degree of their reservations is reflected as an asymmetric preference whose existence warrants laying aside the assumption that policymakersf base decisions primarily on rational expectations. This study concludes that monetary policy becomes more aggressive because of policymakersf reservations about forecasts stemming from asymmetry, and preference for policies robust enough to overcome unanticipated situations. In addition, adopted policies will likely amplify economic fluctuations and significantly reduce social welfare.
    Keywords: robust control, asymmetric forecasting, bounded rationality
    JEL: E50 E52 E58
    Date: 2012–08
  7. By: Jitka Pomenkova (Department of National Economy, Faculty of Economics, VÅ B-Technical University of Ostrava); Svatopluk Kapounek (Department of Finance, Faculty of Business and Economics, Mendel university in Brno)
    Abstract: The recent economic crisis is regarded as symmetric shock which negatively affects all Eurozone member countries. Even if the whole euro area is in recession the probability of asymmetric shock arises on the monetary side of the economy. The issue is that money supply is unevenly distributed across the euro area. Different credit money creation increases inflationary pressures not only in long run but also in short-term, especially in house prices. The combination of credit money creation and increases in asset prices contributes to financial instability. The empirical part of the paper is based on the analysis in time-frequency domain. The authors apply wavelet analysis to identify increasing differences of co-movements in money supply between the selected old Eurozone member states and peripheral countries. The authors use the contribution of different member countries to the monetary aggregate M3 as the proxy of money supply distribution across the euro area.
    Keywords: wavelet analysis, financial stability, asset prices, monetary aggregates
    JEL: E51 F36
    Date: 2012–09
  8. By: Richard Dennis
    Abstract: This paper studies the behavior of a central bank that seeks to conduct policy optimally while having imperfect credibility and harboring doubts about its model. Taking the Smets-Wouters model as the central bank.s approximating model, the paper's main findings are as follows. First, a central bank's credibility can have large consequences for how policy responds to shocks. Second, central banks that have low credibility can benefit from a desire for robustness because this desire motivates the central bank to follow through on policy announcements that would otherwise not be time-consistent. Third, even relatively small departures from perfect credibility can produce important declines in policy performance. Finally, as a technical contribution, the paper develops a numerical procedure to solve the decision-problem facing an imperfectly credible policymaker that seeks robustness
    JEL: E58 E61 C63
    Date: 2012–08
  9. By: Jean-Stéphane Mésonnier; Dalibor Stevanovic
    Abstract: The recent crisis has revealed the potentially dramatic consequences of allowing the build-up of an overstretched leverage of the financial system, and prompted proposals by bank supervisors to significantly tighten bank capital requirements as part of the new Basel 3 regulations. Although these proposals have been fiercely debated ever since, the empirical question of the macroeconomic consequences of shocks to banks’ leverage, be they policy induced or not, remains still largely unsettled. In this paper, we aim to overcome some longstanding identification issues hampering such assessments and propose a new approach based on a data-rich environment at both the micro (bank) level and the macro level, using a combination of bank panel regressions and macroeconomic factor models. We first identify bank leverage shocks at the micro level and aggregate them to an economy-wide measure. We then compute impulse responses of a large array of macroeconomic indicators to our aggregate bank leverage shock, using the new methodology developed by Ng and Stevanovic (2012). We find significant and robust evidence of a contractionary impact of an unexpected shock reducing the leverage of large banks. <P>
    Keywords: bank capital ratios, macroeconomic fluctuations, panel, dynamic factor models,
    JEL: C23 C38 E32 E51 G21 G32
    Date: 2012–09–01
  10. By: Xisong Jin; Francisco Nadal De Simone
    Abstract: The estimation of banks? marginal probabilities of default using structural credit risk models can be enriched incorporating macro-financial variables readily available to economic agents. By combining Delianedis and Geske?s model with a Generalized Dynamic Factor Model into a dynamic t-copula as a mechanism for obtaining banks? dependence, this paper develops a framework that generates an early warning indicator and robust out-of-sample forecasts of banks? probabilities of default. The database comprises both a set of Luxembourg banks and the European banking groups to which they belong. The main results of this study are, first, that the common component of the forward probability of banks? defaulting on their long-term debt, conditional on not defaulting on their short-term debt, contains a significant early warning feature of interest for an operational macroprudential framework driven by economic activity, credit and interbank activity. Second, incorporating the common and the idiosyncratic components of macro-financial variables improves the analytical features and the out-of-sample forecasting performance of the framework proposed.
    Keywords: financial stability, macroprudential policy, credit risk, early warning indicators, default probability, Generalized Dynamic Factor Model, dynamic copulas, GARCH
    JEL: C30 E44 G1
    Date: 2012–07
  11. By: Shaw, Ming-fu; Chang, Juin-jen; Chen, Hung-Ju
    Abstract: This paper develops an analytically tractable dynamic general-equilibrium model with a banking system to examine the macroeconomic implications of capital adequacy requirements. In contrast to the hypothesis of a credit crunch, we find that increasing the strength of bank capital requirements does not necessarily reduce the equilibrium quantity of loans, provided that banks have the option to respond to the capital requirements by accumulating more equity instead of cutting back on lending. Accordingly, we show that there is an inverted-U-shaped relationship between CAR and capital accumulation (and consumption). Furthermore, the optimal capital adequacy ratio for social-welfare maximization is lower than that for capital-accumulation maximization. In accordance with general empirical findings, the capital- accumulation maximizing capital adequacy ratio is procyclical with respect to economic conditions. We also find that monetary policy affects the real macroeconomic activities via the so-called bank lending channel, but the effectiveness of monetary policy is weakened by bank capital requirements.
    Keywords: Banking capital regulation; bank lending channel; the loan-deposit rate
    JEL: E5 O4
    Date: 2012–09–05
  12. By: Soramäki, Kimmo; Cook, Samantha
    Abstract: The ability to accurately estimate the extent to which the failure of a bank disrupts the financial system is very valuable for regulators of the financial system. One important part of the financial system is the interbank payment system. This paper develops a robust measure, SinkRank, that accurately predicts the magnitude of disruption caused by the failure of a bank in a payment system and identifies banks most affected by the failure. SinkRank is based on absorbing Markov chains, which are well-suited to model liquidity dynamics in payment systems. Because actual bank failures are rare and the data is not generally publicly available, the authors test the metric by simulating payment networks and inducing failures in them. The authors use two metrics to evaluate the magnitude of the disruption: the duration of delays in the system (Congestion) aggregated over all banks and the average reduction in available funds of the other banks due to the failing bank (Liquidity dislocation). The authors test SinkRank on Barabasi-Albert types of scale-free networks modeled on the Fedwire system and find that the failing bank's SinkRank is highly correlated with the resulting disruption in the system overall; moreover, the SinkRank technology can identify which individual banks would be most disrupted by a given failure. --
    Keywords: Systemic risk,interbank payment system,liquidity,Markov chains,simulation
    JEL: C63 E58 G28
    Date: 2012
  13. By: William Barnett (Department of Economics, The University of Kansas); Haiyang Xu (Washington University in St.Louis)
    Abstract: The determinants of money velocity are theoretically explored under various assumptions of interest rate uncertainty in a monetary general equilibrium model. Money is introduced by putting monetary services in the utility function. Monetary assets pay interest. When interest rates are uncertain, it is found that the degree of risk aversion in consumers' preferences and the risk in the return rates of the benchmark asset affect both the intercept and slope of the money velocity function, while the risk in return rates of monetary assets only affects the intercept of the money velocity function. The traditional money velocity function would become unstable if covariances change over time between interest rates and consumption growth rate or between interest rates and real money growth rate. We simulate the model developed in this paper and find that the coefficients of the money velocity function are volatile. The Swamy and Tinsley (1980) random coefficient model is then estimated with money velocity data to compare the results with those from model simulation. It is found that the estimated stochastic slope coefficient of the velocity function behaves in a manner that is approximately consistent with the simulation results.
    Date: 2012–09
  14. By: Bargigli, Leonardo; Gallegati, Mauro
    Abstract: In this paper the authors focus on credit connections as a potential source of systemic risk. In particular, they seek to answer the following question: how do we find densely connected subsets of nodes within a credit network? The question is relevant for policy, since these subsets are likely to channel any shock affecting the network. As it turns out, a reliable answer can be obtained with the aid of complex network theory. In particular, the authors show how it is possible to take advantage of the community detection network literature. The proposed answer entails two subsequent steps. Firstly, the authors need to verify the hypothesis that the network under study truly has communities. Secondly, they need to devise a reliable algorithm to find those communities. In order to be sure that a given algorithm works, they need to test it over a sample of random benchmark networks with known communities. To overcome the limitation of existing benchmarks, the authors introduce a new model and test alternative algorithms, obtaining very good results with an adapted spectral decomposition method. To illustrate this method they provide a community description of the Japanese bank-firm credit network, getting evidence of a strengthening of communities over time and finding support for the well-known Japanese main bank system. Thus, the authors find comfort both from simulations and from real data on the possibility to apply community detection methods to credit markets. They believe that this method can fruitfully complement the study of contagious defaults, since the likelihood of intracommunity default contagion is expected to be high. --
    Keywords: Credit networks,communities,contagion,systemic risk
    JEL: C49 C63 D85 E51 G21
    Date: 2012
  15. By: John Gathergood (School of Economics, University of Nottingham); Joerg Weber (School of Economics, University of Nottingham)
    Abstract: We use UK household survey data incorporating measures of financial literacy and behavioural characteristics to analyse the puzzling co-existence of high cost revolving consumer credit alongside low yield liquid savings in household balance sheets, which we term the ‘co-holding puzzle’. Approximately 20% of households in our sample co-hold, on average, £6,500 of revolving consumer credit alongside £8,000 of liquid savings. Co-holders are typically more financially literate, with above average income and education. However, we show co-holding is also associated with impulsive spending behaviour on the part of the household. Our results lend empirical support to theoretical models in which sophisticated households co-hold as a means of managing a self-control problem.
    Keywords: consumer credit, self-control, financial literacy
    Date: 2012–02

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