nep-cba New Economics Papers
on Central Banking
Issue of 2012‒09‒30
twenty papers chosen by
Maria Semenova
Higher School of Economics

  1. The Elusive Promise of Independent Central Banking By Marvin Goodfriend
  2. Deriving the Taylor Principle when the Central Bank Supplies Money By Davies, Ceri; Gillman, Max; Kejak, Michal
  3. The Macroeconomic Effects of Interest on Reserves By Peter N. Ireland
  4. A Macroeconomic Model of Endogenous Systemic Risk Taking By Martinez-Miera, David; Suarez, Javier
  5. Capital Account Policies and the Real Exchange Rate By Olivier Jeanne
  6. Knightian uncertainty and interbank lending By Matthew Pritsker
  7. The interest rate - exchange rate nexus: exchange rate regimes and policy equilibria By Christoph Himmels; Tatiana Kirsanova
  8. The use of the Eurosystem's monetary policy instruments and operational framework since 2009 By Fabian Eser; Marta; Stefano Iacobelli; Marc Rubens
  9. Federal Reserve liquidity provision during the financial crisis of 2007-2009 By Michael J. Fleming
  10. Shadow banking in the Euro area: an overview By Klára Bakk-Simon; Stefano Borgioli; Celestino Giron; Hannah Sabine Hempell; Angela Maddaloni; Fabio Recine; Simonetta Rosati
  11. Explaining EU Citizens' Trust in the ECB in Normal and Crisis Times By Ehrmann, Michael; Soudan, Michel; Stracca, Livio
  12. Do Social Networks Prevent Bank Runs? By Hubert Janos Kiss; Ismael Rodriguez-Lara; Alfonso Rosa-Garcia
  13. How Do Regulators Influence Mortgage Risk? Evidence from an Emerging Market By Campbell, John Y; Ramadorai, Tarun; Ranish, Benjamin
  14. Financial Literacy, Financial Education and Economic Outcomes By Justine S. Hastings; Brigitte C. Madrian; William L. Skimmyhorn
  15. Design and Evaluation of Empirical Models for Stock Price Prediction By De Fortuny E.J.; De Smedt T.; Martens D.; Daelemans W.
  16. Financial Crisis and Domino Effect By Pedro Bação; João Maia Domingues; António Portugal Duarte
  17. Financial liberalisation, Banking Crises and Economic Growth in African Countries By Enowbi Batuo, Michael; Mlambo, Kupukile
  18. Anatomy of Cashless Banking in Nigeria: What Matters? By Atanda, Akinwande A.; Alimi, Olorunfemi Y.
  19. The Role of Risk and Information for International Capital Flows: New Evidence from the SDDS By Yuko Hashimoto; Konstantin M. Wacker
  20. Revisiting the theory of optimum currency areas: Is the CFA franc zone sustainable? By Cécile Couharde; Issiaka Coulibaly; David Guerreiro; Valérie Mignon

  1. By: Marvin Goodfriend (Professor of Economics, Tepper School of Business, Carnegie Mellon University (E-mail:
    Abstract: Independent central banking is reviewed as it emerged first under the gold standard and later with an inconvertible paper money. Monetary and credit policy are compared and contrasted as practiced by the 19th century Bank of England and the Federal Reserve. The lesson is that wide operational and financial independence given to monetary and credit policy in the public interest subjects the central bank to incentives detrimental for macroeconomic and financial stability. An independent central bank needs the double discipline of a priority for price stability and bounds on expansive credit initiatives to secure its promise for stabilization policy.
    Keywords: Bank of England, central bank independence, credit turmoil of 2007-8, Federal Reserve, Great Inflation, lender of last resort, monetary policy
    JEL: E3 E4 E5 E6
    Date: 2012–09
  2. By: Davies, Ceri; Gillman, Max (Cardiff Business School); Kejak, Michal
    Abstract: The paper presents a human-capital-based endogenous growth, cash-in-advance economy with endogenous velocity where exchange credit is produced in a decentralized banking sector, and money is supplied stochastically by the central bank. From this it derives an exact functional form for a general equilibrium “Taylor rule”. The inflation coefficient is always greater than one when the velocity of money exceeds one; velocity growth enters the equilibrium condition as a separate variable. The paper then successfully estimates the magnitude of the coefficient on inflation from 1000 samples of Monte Carlo simulated data. This shows that it would be spurious to conclude that the central bank has a reaction function with a strong response to inflation in a ‘Taylor principle’ sense, since it is only meeting fiscal needs through the inflation tax. The paper also estimates several deliberately misspecified models to show how an inflation coefficient of less than one can result from model misspecification. An inflation coefficient greater than one holds theoretically along the balanced growth path equilibrium, making it a sharply robust principle based on the economy’s underlying structural parameters.
    Keywords: Taylor rule; velocity; forward-looking; misspecification bias
    JEL: E13 E31 E43 E52
    Date: 2012–08
  3. By: Peter N. Ireland
    Abstract: This paper uses a New Keynesian model with banks and deposits to study the macroeconomic effects of policies that pay interest on reserves. While their effects on output and inflation are small, these policies require major adjustments in the way that the monetary authority manages the supply of reserves, as liquidity effects vanish in the short run. In the long run, however, the additional degree of freedom the monetary authority acquires by paying interest on reserves is best described as affecting the real quantity of reserves: policy actions that change prices must still change the nominal quantity of reserves proportionally.
    JEL: E31 E32 E51 E52 E58
    Date: 2012–09
  4. By: Martinez-Miera, David; Suarez, Javier
    Abstract: We analyze banks' systemic risk taking in a simple dynamic general equilibrium model. Banks collect funds from savers and make loans to firms. Banks are owned by risk-neutral bankers who provide the equity needed to comply with capital requirements. Bankers decide their (unobservable) exposure to systemic shocks by trading off risk-shifting gains with the value of preserving their capital after a systemic shock. Capital requirements reduce credit and output in
    Keywords: Capital requirements; Credit cycles; Financial crises; Macroprudential policies; Risk shifting; Systemic risk
    JEL: E44 G21 G28
    Date: 2012–09
  5. By: Olivier Jeanne
    Abstract: This paper presents a simple model of how a small open economy can undervalue its real exchange rate using its capital account policies. The paper presents several properties of such policies, and proposes a rule of thumb to assess their welfare cost. The model is applied to an analysis of Chinese capital account policies.
    JEL: F31 F32 F36
    Date: 2012–09
  6. By: Matthew Pritsker
    Abstract: The bursting of the housing price bubble during 2007 and 2008 was accompanied by high interbank spreads, and a partial breakdown of interbank lending. This paper theoretically models how Knightian uncertainty over banks risk exposures may have contributed to the breakdown. The paper shows: 1) the two-tier structure of the U.S. Fed Funds market makes it robust to uncertainty, but the market may nevertheless collapse — and private incentives to restart it may be insufficient. 2) In some circumstances government bank audits and information releases about exposures that resemble a stress test can restart markets and improve welfare by internalizing an externality associated with economy-wide uncertainty reduction. 3) Collapses due to uncertainty are less likely ex-ante and less costly to fix ex-post when there is better publicly available information on core banks aggregate risk exposures. Based on 2) and 3), ex-ante and ex-post “transparency initiatives” are proposed. Their success depends on the financial architecture of bank interlinkages.
    Keywords: Risk ; Banks and banking ; Interbank market ; Federal funds market (United States)
    Date: 2012
  7. By: Christoph Himmels; Tatiana Kirsanova
    Date: 2012
  8. By: Fabian Eser (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Marta (Banco de España, C/Alcalá, 48, 28014 Madrid, Spain.); Stefano Iacobelli (Banca d’Italia, Via Nazionale, 91, 00184 Roma, Italy.); Marc Rubens (National Bank of Belgium, Boulevard de Berlaimont 14, 1000 Brussels, Belgium.)
    Abstract: This paper provides a comprehensive overview of the use of the Eurosystem’s monetary policy instruments and the operational framework from the first quarter of 2009 until the second quarter 2012. The paper discusses in detail, from a liquidity management perspective, the standard and non-standard monetary policy measures taken over this period. The paper reviews the evolution of the Eurosystem balance sheet, participation in tender operations, the outright purchase programmes, patterns of reserve fulfilment, recourse to standing facilities as well as the steering of money market interest rates. JEL Classification: D02, E43, E58, E65
    Keywords: Monetary policy implementation, central bank operational framework, central bank liquidity management, non-standard monetary policy measures
    Date: 2012–08
  9. By: Michael J. Fleming
    Abstract: This paper examines the Federal Reserve's unprecedented liquidity provision during the financial crisis of 2007-2009. It first reviews how the Fed provides liquidity in normal times. It then explains how the Fed's new and expanded liquidity facilities were intended to enable the central bank to fulfill its traditional lender-of-last-resort role during the crisis while mitigating stigma, broadening the set of institutions with access to liquidity, and increasing the flexibility with which institutions could tap such liquidity. The paper then assesses the growing empirical literature on the effectiveness of the facilities and provides insights as to where further research is warranted.
    Keywords: Financial crises ; Bank liquidity ; Troubled Asset Relief Program ; Liquidity (Economics) ; Lenders of last resort
    Date: 2012
  10. By: Klára Bakk-Simon (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Stefano Borgioli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Celestino Giron (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Hannah Sabine Hempell (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Angela Maddaloni (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Fabio Recine (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Simonetta Rosati (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: Shadow banking, as one of the main sources of financial stability concerns, is the subject of much international debate. In broad terms, shadow banking refers to activities related to credit intermediation and liquidity and maturity transformation that take place outside the regulated banking system. This paper presents a first investigation of the size and the structure of shadow banking within the euro area, using the statistical data sources available to the ECB/Eurosystem. Although overall shadow banking activity in the euro area is smaller than in the United States, it is significant, at least in some euro area countries. This is also broadly true for some of the components of shadow banking, particularly securitisation activity, money market funds and the repo markets. This paper also addresses the interconnection between the regulated and the non-bank-regulated segments of the financial sector. Over the recent past, this interconnection has increased, likely resulting in a higher risk of contagion across sectors and countries. Euro area banks now rely more on funding from the financial sector than in the past, in particular from other financial intermediaries (OFIs), which cover shadow banking entities, including securitisation vehicles. This source of funding is mainly shortterm and therefore more susceptible to runs and to the drying-up of liquidity. This finding confirms that macro-prudential authorities and supervisors should carefully monitor the growing interlinkages between the regulated banking sector and the shadow banking system. However, an in-depth assessment of the activities of shadow banking and of the interconnection with the regulated banking system would require further improvements in the availability of data and other sources of information. JEL Classification: G01, G15, G21, G28
    Keywords: Shadow banking, bank regulation, repo markets, securitisation
    Date: 2012–04
  11. By: Ehrmann, Michael (European Central Bank, Frankfurt/Main, Germany); Soudan, Michel (European Central Bank, Frankfurt/Main, Germany); Stracca, Livio (European Central Bank, Frankfurt/Main, Germany)
    Abstract: We study the determinants of trust in the ECB as measured by the European Commission’s Eurobarometer survey in particular during the global financial crisis and the European sovereign debt crisis. We find that the fall in trust in the ECB in crisis times can be rather well explained based on the pre-crisis determinants, and show that the fall in trust reflected the macroeconomic deterioration, a more generalised fall in the trust in European institutions in the wake of the crisis as well as the severity of the banking sector’s problems, to which the ECB was associated in the public opinion.
    Keywords: Trust, Eurobarometer, Global financial crisis, Public opinion, European Central Bank
    JEL: E58 G21 Z13
    Date: 2012–08
  12. By: Hubert Janos Kiss (Eötvös Loránd University, Department of Economics); Ismael Rodriguez-Lara (ERI-CES); Alfonso Rosa-Garcia (Universidad de Murcia, Dpt. Analisis Economico)
    Abstract: We report experimental evidence on the effect of observability of actions on bank runs. We model depositors' decision-making in a sequential framework, with three depositors located at the nodes of a network. Depositors observe the other depositors' actions only if connected by the network. A sufficient condition to prevent bank runs is that the second depositor to act is able to observe the first one's action (no matter what is observed). Experimentally, we find that observability of actions affects the likelihood of bank runs, but depositors' choice is highly influenced by the particular action that is being observed. This finding suggests a new source for the ocurrence of bank runs. Observability of actions can provoke runs that cannot be explained neither by coordination nor by fundamental problems, the two main culprits identified by the literature.
    Keywords: bank runs, social networks, coordination failures, experimental evidence
    JEL: C70 C91 D80 D85 G21
    Date: 2012–06
  13. By: Campbell, John Y; Ramadorai, Tarun; Ranish, Benjamin
    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.
    Keywords: delinquencies; emerging markets; India; mortgage finance; regulation
    JEL: G21 G28 R21 R31
    Date: 2012–09
  14. By: Justine S. Hastings; Brigitte C. Madrian; William L. Skimmyhorn
    Abstract: In this article we review the literature on financial literacy, financial education, and consumer financial outcomes. We consider how financial literacy is measured in the current literature, and examine how well the existing literature addresses whether financial education improves financial literacy or personal financial outcomes. We discuss the extent to which a competitive market provides incentives for firms to educate consumers or offer products that facilitate informed choice. We review the literature on alternative policies to improve financial outcomes, and compare the evidence to evidence on the efficacy and cost of financial education. Finally, we discuss directions for future research.
    JEL: C93 D14 D18 D91 G11 G28
    Date: 2012–09
  15. By: De Fortuny E.J.; De Smedt T.; Martens D.; Daelemans W.
    Abstract: The efficiënt market hypothesis and related theories claim that it is impossible to predict future stock prices. Even so, empirical research has countered this claim by achieving better than random prediction performance. Using a model built from a combination of text mining and time series prediction, we provide further evidence to counter the efficient market hypothesis. We discuss the difficulties in evaluating such models by investigating the drawbacks of the common choices of evaluation metrics used in these empirical studies. We continue by suggesting alternative techniques to validate stock prediction models, circumventing these shortcomings. Finally, a trading system is built for the Euronext Brussels stock exchange market. In our framework, we applied a novel sentiment mining technique in the design of the model and show the usefulness of state-of-the-art explanation-based techniques to validate the resulting models.
    Date: 2012–09
  16. By: Pedro Bação (Faculty of Economics, University of Coimbra and GEMF, Portugal); João Maia Domingues (Faculty of Economics, University of Coimbra, Portugal); António Portugal Duarte (Faculty of Economics, University of Coimbra and GEMF, Portugal)
    Abstract: This paper analyses the spread of the sovereign debt crisis in the Eurozone. To this end we employ three approaches. The first approach employs univariate autoregressive models. These allow the identification of shocks to government bond yields in Portugal, Italy, Ireland, Greece, Spain and Germany. The timing of the shocks is then analysed in search for evidence of a domino effect. The second approach applies the same identification procedure to VAR models estimated for each country. Finally, the third approach computes Granger causality tests between government bond yields in those countries. The results from the first two approaches do not appear to favor the contagion hypothesis. Nevertheless, the third approach, when bivariate VAR models are used, suggests that there may be interdependence between Greece, Ireland and Portugal, which might have justified European intervention to stop the crisis from spreading.
    Keywords: contagion; financial crisis; Granger causality; identification of shocks; sovereign debt crisis
    JEL: F36 E21 F32
    Date: 2012–08
  17. By: Enowbi Batuo, Michael; Mlambo, Kupukile
    Abstract: While financial liberalisation is considered to be good for economic growth in that it promotes the development of the financial sector, banking crises on the other hand tend to be inimical for economic growth. Moreover, banking crises tend to be preceded by financial liberalisation, as noted in a number of studies. This is because financial liberalisation tends to induce greater risk-taking behaviour by agents, thus leading to banking crises. In this paper we study the effect of financial liberalisation and banking crises on the economic performance of African countries during the period covering 1985 to 2010. Using a treatment effect, two step methods and a panel probit method, our results show that banking crises have a negative impact on economic growth meanwhile financial liberalisation tends to reduce the likelihood of banking crises in African countries.
    Keywords: O16; O47;G23; O55
    JEL: O16 N17 O4
    Date: 2012–06
  18. By: Atanda, Akinwande A.; Alimi, Olorunfemi Y.
    Abstract: This study discussed in details the structure, importance, challenges and consequences of the newly adopted cashless policy programme in the Nigerian banking sector. The cashless policy is mainly instituted to enhance the effectiveness of flow of financial resources among economic agents in the economy at least cost possible as well as ensuring prompt cash transfers within the system. The Central of Bank of Nigeria (CBN) cashless initiative is geared towards eliminating the continuous use of physical cash in most daily transactions at the business unit of the economy, as well as regulating, controlling, and securing the financial system. A critical analysis at the policy as contained in this report as identified major constraints that can hinder the effectiveness of the cashless banking without prompt attention by the concerned authority.
    Keywords: Cashless Banking; Cashless Economy; Financial System; Electronic payment; Nigeria
    JEL: E0 E02 E42 E58
    Date: 2012–08
  19. By: Yuko Hashimoto (International Monetary Fund); Konstantin M. Wacker (Georg-August-University Göttingen)
    Abstract: In this paper, we investigate whether better information about the macroeconomic environment of an economy has a positive impact on its capital inflows, namely portfolio and foreign direct investment (FDI). The purpose of our study is to explicitly quantify information asymmetries by compliance with the IMF's Special Data Dissemination Standard (SDDS). For FDI, we find statistically signicant and robust support for this hypothesis: SDDS subscription increased inflows by an economically relevant magnitude of about 60 percent. We also find evidence of aversion against political and macroeconomic risk as determinants of portfolio and FDI flows and use a non-parametric test for spatial correlation in the residuals of capital flows.
    Keywords: determinants of capital flows; information; panel data; risk; SDDS; IMF; FDI; portfolio investment; spatial econometrics
    JEL: C33 F21 G14
    Date: 2012–09–12
  20. By: Cécile Couharde; Issiaka Coulibaly; David Guerreiro; Valérie Mignon
    Abstract: This paper aims at explaining why the CFA countries have successfully maintained a currency union for several decades, despite failing to meet many of optimum currency area criteria. We suggest that the CFA zone, while not optimal, has been at least sustainable. We test this sustainability hypothesis by relying on the Behavioral Equilibrium Exchange Rate (BEER) approach. In particular, we assess and compare the convergence process of real exchange rates towards equilibrium for the CFA zone countries and a sample of other sub-Saharan African (SSA) countries. Our findings evidence that internal and external balances have been fostered and adjustments facilitated in the CFA zone as a whole—compared to other SSA countries—as well as in each of its member countries.
    Keywords: Equilibrium exchange rates, CFA zone, Optimum Currency Areas, currency union sustainability
    JEL: F31 F33 C23
    Date: 2012

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