nep-cba New Economics Papers
on Central Banking
Issue of 2012‒09‒22
fourteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Some Reflections on the Recent Financial Crisis By Gary B. Gorton
  2. Uncertainty and Disagreement in Forecasting Inflation: Evidence from the Laboratory (Revised version of CentER DP 2011-053) By Pfajfar, D.; Zakelj, B.
  3. Required Reserves as a Credit Policy Tool By Yasin Mimir; Enes Sunel; Temel Taskin
  4. Factor Model Forecasts of Exchange Rates By Charles Engel; Nelson C. Mark; Kenneth D. West
  5. The fiscal implications of a banking union By Jean Pisani-Ferry; Guntram B. Wolff
  6. The Manipulation of Basel Risk-Weights. Evidence from 2007-10 By Mike Mariathasan; Ouarda Merrouche
  7. An Anatomy of Credit Booms and their Demise By Enrique G. Mendoza; Marco E. Terrones
  8. Bubbles, Financial Crises, and Systemic Risk By Markus K. Brunnermeier; Martin Oehmke
  9. The impact of the LCR on the interbank money market By Bonner, Clemens; Eijffinger, Sylvester C W
  10. Sovereign default Risk in the Euro-Periphery and the Euro-Candidate Countries By Gabrisch, Hubert; Pusch, Toralf; Orlowski, Lucjan T
  11. Credit Ratings and Debt Crises. By Bussière, M.; Ristiniemi, A.
  12. Liquidity risk and interest rate risk on banks: are they related? By Baldan, Cinzia; Zen, Francesco; Rebonato, Tobia
  13. How Do Regulators Influence Mortgage Risk: Evidence from an Emerging Market By John Y. Campbell; Tarun Ramadorai; Benjamin Ranish
  14. The Euro Crisis: Some Reflexions on Institutional Reform. By Tirole, Jean

  1. By: Gary B. Gorton
    Abstract: Economic growth involves metamorphosis of the financial system. Forms of banks and bank money change. These changes, if not addressed, leave the banking system vulnerable to crisis. There is no greater challenge in economics than to understand and prevent financial crises. The financial crisis of 2007-2008 provides the opportunity to reassess our understanding of crises. All financial crises are at root bank runs, because bank debt—of all forms—is vulnerable to sudden exit by bank debt holders. The current crisis raises issues for crisis theory. And, empirically, studying crises is challenging because of small samples and incomplete data.
    JEL: E02 E3 E30 E32 E44 G01 G1 G2 G21
    Date: 2012–09
  2. By: Pfajfar, D.; Zakelj, B. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: This paper compares the behavior of subjects' uncertainty in different monetary policy environments when forecasting inflation in the laboratory. We find that inflation targeting produces lower uncertainty and higher accuracy of interval forecasts than inflation forecast targeting. We also establish several stylized facts about the behavior of individual uncertainty, aggregate distribution of forecasts, and disagreement between individuals. We find that the average confidence interval is the measure that performs best in forecasting inflation uncertainty. Subjects correctly perceive the underlying inflation uncertainty in only 60% of cases and tend to report asymmetric confidence intervals, perceiving higher uncertainty with respect to inflation increases.
    Keywords: Laboratory Experiments;Confidence Bounds;New Keynesian Model;Inflation Expectations.
    JEL: C91 C92 E37 D80
    Date: 2012
  3. By: Yasin Mimir; Enes Sunel; Temel Taskin
    Abstract: This paper conducts a quantitative investigation of the role of reserve requirements as a macroprudential policy tool. We build a monetary DSGE model with a banking sector in which (i) an agency problem between households and banks leads to endogenous capital constraints for banks in obtaining funds from households, (ii) banks are subject to time-varying reserve requirements that countercyclically respond to expected credit growth, (iii) households face cash-in-advance constraints, requiring them to hold real balances, and (iv) standard productivity and money growth shocks are two sources of aggregate uncertainty. We calibrate the model to the Turkish economy which is representative of using reserve requirements as a macroprudential policy tool recently. We also consider the impact of financial shocks that affect the net worth of financial intermediaries. We find that (i) the time-varying required reserve ratio rule countervails the negative effects of the financial accelerator mechanism triggered by adverse macroeconomic and financial shocks, (ii) in response to TFP and money growth shocks, countercyclical reserves policy reduces the volatilities of key real macroeconomic and financial variables compared to fixed reserves policy over the business cycle, and (iii) a time-varying reserve requirement policy is welfare superior to a fixed reserve requirement policy. The credit policy is most effective when the economy is hit by a financial shock. Time-varying required reserves policy reduces the intertemporal distortions created by the credit spreads at expense of generating higher inflation volatility, indicating an interesting trade-off between price stability and financial stability.
    Keywords: Banking sector, time-varying reserve requirements, macroeconomic and financial shocks
    JEL: E44 E51 G21 G28
    Date: 2012
  4. By: Charles Engel; Nelson C. Mark; Kenneth D. West
    Abstract: We construct factors from a cross section of exchange rates and use the idiosyncratic deviations from the factors to forecast. In a stylized data generating process, we show that such forecasts can be effective even if there is essentially no serial correlation in the univariate exchange rate processes. We apply the technique to a panel of bilateral U.S. dollar rates against 17 OECD countries. We forecast using factors, and using factors combined with any of fundamentals suggested by Taylor rule, monetary and purchasing power parity (PPP) models. For long horizon (8 and 12 quarter) forecasts, we tend to improve on the forecast of a “no change” benchmark in the late (1999-2007) but not early (1987-1998) parts of our sample.
    JEL: C53 C58 F37 G17
    Date: 2012–09
  5. By: Jean Pisani-Ferry; Guntram B. Wolff
    Abstract: Systemic banking crises are a threat to all countries whatever their development level. They can entail major fiscal costs that can undermine the sustainability of public finances. More than anywhere else, however, a number of euro-area countries have been affected by a lethal negative feedback loop between banking and sovereign risk, followed by disintegration of the financial system, real economic fragmentation and the exposure of the European Central Bank. Recognising the systemic dimension of the problem, the Euro-Area Summit of June 2012 called for the creation of a banking union with common supervision and the possibility for the European Stability Mechanism to recapitalise banks directly. The findings of this paper were presented at the Informal ECOFIN in Nicosia on 14 September 2012.
    Date: 2012–09
  6. By: Mike Mariathasan; Ouarda Merrouche
    Abstract: In this paper, we analyse a novel panel data set to compare the relevance of alternative measures of capitalisation for bank failure during the 2007-10 crisis, and to search for evidence of manipulated Basel risk-weights. Compared with the unweighted leverage ratio, we find the risk-weighted asset ratio to be a superior predictor of bank failure when banks operate under the Basel II regime, provided that the risk of a crisis is low. When the risk of a crisis is high, the unweighted leverage ratio is the more reliable predictor. However, when banks do not operate under Basel II rules, both ratios perform comparably, independent of the risk of a crisis. Furthermore, we find a strong decline in the risk-weighted asset ratio leading up to the crisis. Several empirical findings indicate that this decline is driven by the strategic use of internal risk models under the Basel II advanced approaches. Evidence of manipulation is stronger in less competitive banking systems, in banks with low initial levels of Tier 1 capital and in banks that adopted Basel II rules early. We find tangible common equity and Tier 1 ratios to be better predictors of bank distress than broader measures of capital, and identify market-based measures of capitalisation as poor indicators. We find no relationship between the probability of a bank being selected into a public recapitalisation plan and regulatory measures of capital.
    Keywords: Banks, Basel risk-weights, Capital, Regulation
    JEL: G20 G21 G28
    Date: 2012
  7. By: Enrique G. Mendoza; Marco E. Terrones
    Abstract: What are the stylized facts that characterize the dynamics of credit booms and the associated fluctuations in macro-economic aggregates? This paper answers this question by applying a method proposed in our earlier work for measuring and identifying credit booms to data for 61 emerging and industrial countries over the 1960-2010 period. We identify 70 credit boom events, half of them in each group of countries. Event analysis shows a systematic relationship between credit booms and a boom-bust cycle in production and absorption, asset prices, real exchange rates, capital inflows, and external deficits. Credit booms are synchronized internationally and show three striking similarities in industrial and emerging economies: (1) credit booms are similar in duration and magnitude, normalized by the cyclical variability of credit; (2) banking crises, currency crises or Sudden Stops often follow credit booms, and they do so at similar frequencies in industrial and emerging economies; and (3) credit booms often follow surges in capital inflows, TFP gains, and financial reforms, and are far more common with managed than flexible exchange rates.
    JEL: E32 E44 E51 G21
    Date: 2012–09
  8. By: Markus K. Brunnermeier; Martin Oehmke
    Abstract: This chapter surveys the literature on bubbles, financial crises, and systemic risk. The first part of the chapter provides a brief historical account of bubbles and financial crisis. The second part of the chapter gives a structured overview of the literature on financial bubbles. The third part of the chapter discusses the literatures on financial crises and systemic risk, with particular emphasis on amplification and propagation mechanisms during financial crises, and the measurement of systemic risk. Finally, we point toward some questions for future research.
    JEL: G00 G01 G20
    Date: 2012–09
  9. By: Bonner, Clemens; Eijffinger, Sylvester C W
    Abstract: This paper analyses the impact of the Basel 3 Liquidity Coverage Ratio (LCR) on the unsecured interbank money market and therefore on the implementation of monetary policy. Combining two unique datasets, we show that banks which are just above/below their short-term regulatory liquidity requirement charge higher interest rates for unsecured interbank loans. The effect is larger for longer maturities and increases after the failure of Lehman Brothers. During a crisis, being close to the minimum liquidity requirement induces a negative impact on lending volumes. Given the high importance of a well-functioning interbank money market, our results suggest that the current design of the LCR is likely to dampen the effectiveness of monetary policy.
    Keywords: Basel 3; Interbank Market; Interest Rate
    JEL: E42 E43 G21
    Date: 2012–09
  10. By: Gabrisch, Hubert; Pusch, Toralf; Orlowski, Lucjan T
    Abstract: This study examines the key drivers of sovereign default risk in five euro area periphery countries and three euro-candidates that are currently pursuing independent monetary policies. We argue that the recent proliferation of sovereign risk premiums stems from both domestic and international sources. We focus on contagion effects of external financial crisis on sovereign risk premiums in these countries, arguing that the countries with weak fundamentals and fragile financial institutions are particularly vulnerable to such effects. The domestic fiscal vulnerabilities include: economic recession, less efficient government spending and a rising public debt. External ‘push’ factors entail increasing liquidity- and counter-party risks in international banking, as well as risk-hedging appetites of international investors embedded in local currency depreciation against the US Dollar. We develop a model capturing the internal and external determinants of sovereign risk premiums and test for the examined country groups. The results lead us to caution against premature fiscal consolidation in the aftermath of the global economic crisis, since such policy might actually worsen sovereign default risk. The model works well for the euro-periphery countries; it is less robust for the euro-candidates that upon a future euro adoption will have to pursue real economy growth oriented policies in order to mitigate a potential increase in sovereign default risk.
    Keywords: sovereign default risk; euro area; euro-candidate countries; public debt; liquidity risk; counter-party risk
    JEL: E43 E63 G13
    Date: 2012–09–12
  11. By: Bussière, M.; Ristiniemi, A.
    Abstract: This paper analyses the role of credit rating agencies in sovereign debt crises. Using a panel of 53 emerging and developing countries with annual data going back to 1977, the paper shows that credit ratings are not very good predictors of debt distress events once tested against a simple benchmark model with standard macroeconomic variables. Next, the paper turns to higher frequency data for a subset of countries to analyze the link between credit ratings and bond spreads. The results indicate that bond spreads react strongly to credit ratings, especially to downgrades in the non-investment grade category. The results are robust to a variety of additional tests.
    Keywords: Credit rating agencies, debt crises, fiscal policy, emerging market economies, developing countries, panel estimation.
    JEL: E60 C33 C35
    Date: 2012
  12. By: Baldan, Cinzia; Zen, Francesco; Rebonato, Tobia
    Abstract: The present study aims at ascertaining whether a relationship exists between the liquidity risk and the interest rate risk of credit institutions. By analysing the balance sheet of a small Italian bank during the years 2009 and 2010, we outlined its liquidity profile, the variables that influenced its dynamics and their effects on the bank’s global management, with particular attention to the interest margin and the interest rate risk in the banking book. We would like to fill a gap identified in the literature, shedding light on how a set of decisions designed mainly to reduce the liquidity risk and comply with the new parameters established by the Basel III Framework enables a more effective management of the regulatory capital and helps the bank to achieve a solid balance between profitability and solvency. Our main findings demonstrate that the bank succeeded in modifying its liquidity profile in order to comply with the incoming constraints imposed by the Basel III framework; the actions taken to reduce the liquidity risk also lowered its interest margin, but also enabled the bank to reduce the amount of capital absorbed by the interest rate risk, giving rise to a globally positive effect.
    Keywords: Asset and Liability Management; Basel III Framework; Integration of Liquidity Risk and Interest Rate Risk; Risk Management
    JEL: G2
    Date: 2012
  13. By: John Y. Campbell; Tarun Ramadorai; Benjamin Ranish
    Abstract: To understand the effects of regulation on mortgage risk, it is instructive to track the history of regulatory changes in a country rather than to rely entirely on cross-country evidence that can be contaminated by unobserved heterogeneity. However, in developed countries with fairly stable systems of financial regulation, it is difficult to track these effects. We employ loan-level data on over a million loans disbursed in India over the 1995 to 2010 period to understand how fast-changing regulation impacted mortgage lending and risk. We find evidence that regulation has important effects on mortgage rates and delinquencies in both the time-series and the cross-section.
    JEL: G21
    Date: 2012–09
  14. By: Tirole, Jean
    Abstract: The debate on the Euro crisis understandably has had a strong short term focus. Avoiding short‐term disaster has been tantamount and the long term sustainability issue sometimes neglected; yet, the institutional failure of the Eurozone forces us to reconsider current arrangements in order to restore credibility and sustainability. The article discusses various paths for the reform of the overall governance, from fiscal management to banking regulation, through the recent proposals to mutualize and repackage part of the Sovereign debts into a supranational one or to introduce joint‐and‐several liability.
    JEL: E62 F34 H63
    Date: 2012

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