nep-cba New Economics Papers
on Central Banking
Issue of 2012‒10‒06
eighteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Monetary policy in a DSGE model with “Chinese Characteristics” By Chun Chang; Zheng Liu; Mark M. Spiegel
  2. A DSGE model for a SOE with Systematic Interest and Foreign Exchange policies in which policymakers exploit the risk premium for stabilization purposes By Escudé, Guillermo J.
  3. Monetary Policy, Asset Prices, and Liquidity in Over-the-Counter Markets By Athanasios Geromichalos; Lucas Herrenbrueck
  4. News and Financial Intermediation in Aggregate and Sectoral Fluctuations By Görtz, Christoph; Tsoukalas, John D.
  5. Mussa redux and conditional PPP By Paul R. Bergin; Reuven Glick; Jyh-Lin Wu
  6. Non-Core Bank Liabilities and Financial Vulnerability By Joon-Ho Hahm; Hyun Song Shin; Kwanho Shin
  7. Dirty floating and monetary independence in Central and Eastern Europe - The role of structural breaks By Thomas Windberger; Jesus Crespo Cuaresma; Janette Walde
  8. Banking, Debt, and Currency Crises: Early Warning Indicators for Developed Countries By Jan Babecký; Tomáš Havránek; Jakub Mateju; Marek Rusnák; Katerina Šmídková; Borek Vašícek
  9. The Effects of Reconstruction Finance Corporation Assistance on Michigan’s Banks’ Survival in the 1930s By Charles W. Calomiris; Joseph R. Mason; Marc Weidenmier; Katherine Bobroff
  10. Capital Controls and Exchange Rate Expectations in Emerging Markets By Gustavo Abarca; Claudia Ramírez; José Gonzalo Rangel
  11. New Measures of the Trilemma Hypothesis : Implications for Asia By Hiro Ito; Masahiro Kawai
  12. Time-varying Betas of the Banking Sector By Tomáš Adam; Sona Benecká; Ivo Jánský
  13. Too-connected versus too-big-to-fail: banks’ network centrality and overnight interest rates. By Gabrieli, S.
  14. The impact of the sovereign debt crisis on the activity of Italian banks By Ugo Albertazzi; Tiziano Ropele; Gabriele Sene; Federico M. Signoretti
  15. Financial Intermediation and the Role of Price Discrimination in a Two-Tier Market By Stefan Reitz; Markus A. Schmidt; Mark P. Taylor
  16. Benchmarking financial systems around the world By Cihak, Martin; Demirguc-Kunt, Asli; Feyen, Erik; Levine, Ross
  17. Have Changes in the Financial Structure Affected Bank Profitability? Evidence for Austria By Fabio Rumler; Walter Waschiczek
  18. Banking and Trading By Boot, Arnoud W A; Ratnovski, Lev

  1. By: Chun Chang; Zheng Liu; Mark M. Spiegel
    Abstract: We examine optimal monetary policy under prevailing Chinese policy – including capital controls and nominal exchange rate targets – in a DSGE model calibrated to Chinese and global data. Under the closed capital account, domestic citizens are prohibited from holding foreign assets. Foreign currency revenues are sold to the central bank, which then sterilizes these purchases by issuing domestic debt. Uncovered interest parity conditions do not hold, so sterilization results in transfers between the private sector and the government. Given a negative shock to relative foreign interest rates, similar to that which occurred during the global financial crisis, sterilization costs increase and optimal policy calls for a reduction in sterilization activity, resulting in an easing of monetary policy and an increase in Chinese inflation. We then compare these dynamics to three alternative liberalizations: A partial opening of the capital account, removing the exchange rate peg, or doing both simultaneously. The regime with liberalized capital accounts and floating exchange rate yields the lowest losses to the central bank under the foreign interest rate shock. However, intermediate reforms do less well. In particular, letting the exchange rate float without opening the capital account results in higher losses following the interest rate shock than the benchmark case of no liberalization.
    Keywords: Monetary policy ; Foreign exchange ; China
    Date: 2012
  2. By: Escudé, Guillermo J.
    Abstract: This paper builds a DSGE model for a 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 di¤erent 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’ 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: E58 F41 O24
    Date: 2012–09
  3. By: Athanasios Geromichalos; Lucas Herrenbrueck (Department of Economics, University of California Davis)
    Abstract: We revisit a traditional topic in monetary economics: the relationship between asset prices and monetary policy. We study a model in which money helps facilitate trade in decentralized markets, as in Lagos andWright (2005), and real assets are traded in an over-the-counter (OTC) market, as in Duffie, Gˆarleanu, and Pedersen (2005). Agents wish to hold liquid portfolios, but liquidity comes at a cost: inflation. The OTC market serves as a secondary asset market, in which agents can rebalance their positions depending on their liquidity needs. Hence, a contribution of our paper is to provide a micro-founded explanation of the assumption that different investors have different valuations for the same asset, which is the key for generating gains from trade in the Duffie et al framework. In equilibrium, assets can be priced higher than their fundamental value because they help agents avoid the inflation tax.
    Keywords: monetary-search models, liquidity, asset prices, over-the-counter markets
    JEL: E31 E50 E52 G12
    Date: 2012–09–25
  4. By: Görtz, Christoph; Tsoukalas, John D.
    Abstract: We estimate a two-sector DSGE model with financial intermediaries—a-la Gertler and Karadi (2011) and Gertler and Kiyotaki (2010)—and quantify the importance of news shocks in accounting for aggregate and sectoral fluctuations. Our results indicate a significant role of financial market news as a predictive force behind fluctuations. Specifically, news about the value of assets held by financial intermediaries, reflected one to two years in advance in corporate bond markets, generate countercyclical corporate bond spreads, affect the supply of credit, and are estimated to be a significant source of aggregate fluctuations, accounting for approximately 31% of output, 22% of investment and 31% of hours worked variation in cyclical frequencies. Importantly, asset value news shocks generate both aggregate and sectoral co-movement with a standard preference specification. Financial intermediation is key for the importance and propagation of asset value news shocks.
    Keywords: news; financial intermediation; business cycles; DSGE; Bayesian estimation
    JEL: E2 E3
    Date: 2012–09
  5. By: Paul R. Bergin; Reuven Glick; Jyh-Lin Wu
    Abstract: Long half-lives of real exchange rates are often used as evidence against monetary sticky price models. In this study we show how exchange rate regimes alter the long-run dynamics and half-life of the real exchange rate, and we recast the classic defense of such models by Mussa (1986) from an argument based on short-run volatility to one based on long-run dynamics. The first key result is that the extremely persistent real exchange rate found commonly in post Bretton Woods data does not apply to the preceding fixed exchange rate period in our sample, where the half-live was roughly half as large. This result suggests a reinterpretation of Mussa’s original finding, indicating that up to two thirds of the rise in variance of the real exchange rate in the recent floating rate period is actually due to the rise in persistence of the response to shocks, rather than due to a rise in the variance of shocks themselves. This result also suggests a way to resolve the “PPP puzzle,” reconciling real exchange rate persistence with volatility. The second key result explains the rise in persistence over time by identifying underlying shocks using a panel VECM model. Shocks to the nominal exchange rate induce more persistent real exchange rate responses compared to price shocks, and these shocks became more prevalent under a flexible exchange rate regime.
    Keywords: Foreign exchange rates ; Monetary policy
    Date: 2012
  6. By: Joon-Ho Hahm; Hyun Song Shin; Kwanho Shin
    Abstract: A lending boom is reflected in the composition of bank liabilities when traditional retail deposits (core liabilities) cannot keep pace with asset growth and banks turn to other funding sources (non-core liabilities) to finance their lending. We formulate a model of credit supply as the flip side of a credit risk model where a large stock of non-core liabilities serves as an indicator of the erosion of risk premiums and hence of vulnerability to a crisis. We find supporting empirical evidence in a panel probit study of emerging and developing economies.
    JEL: F32 F33 F34
    Date: 2012–09
  7. By: Thomas Windberger; Jesus Crespo Cuaresma; Janette Walde
    Abstract: Obtaining reliable estimates of the volatility of interest rates and exchange rates is a necessary condition to evaluate issues related to monetary independence and fear of floating. In this paper we use methods which explicitly account for structural breaks in the volatility dynamics in order to assess monetary independence in the Czech Republic, Hungary and Poland. Our results indicate that the explicit modelling of structural breaks in volatility estimates can lead to striking differences concerning the evidence of monetary independence in Central and Eastern Europe. The results based on volatility estimates which account for regime change tend to indicate that the Czech Republic, Hungary and Poland have had a significant degree of monetary independence in the last decade.
    Keywords: Fear of floating, monetary independence, structural break, change-point model
    JEL: F31 C22 C11
    Date: 2012–09
  8. By: Jan Babecký (Czech National Bank); Tomáš Havránek (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Jakub Mateju (CERGE-EI); Marek Rusnák (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Katerina Šmídková (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Borek Vašícek (Czech National Bank)
    Abstract: We construct and explore a new quarterly dataset covering crisis episodes in 40 developed countries over 1970–2010. First, we examine stylized facts of banking, debt, and currency crises. Using panel vector autoregression, we confirm that currency and debt crises are typically preceded by banking crises, but not vice versa. Banking crises are also the most costly in terms of the overall output loss, and output takes about six years to recover. Second, we try to identify early warning indicators of crises specific to developed economies, accounting for model uncertainty by means of Bayesian model averaging. Our results suggest that onsets of banking and currency crises tend to be preceded by booms in economic activity. In particular, we find that growth of domestic private credit, increasing FDI inflows, rising money market rates as well as increasing world GDP and inflation were common leading indicators of banking crises. Currency crisis onsets were typically preceded by rising money market rates, but also by worsening government balances and falling central bank reserves. Early warning indicators of debt crises are difficult to uncover due to the low occurrence of such episodes in our dataset. Finally, employing a signaling approach we show that using a composite early warning index significantly increases the usefulness of the model when compared to using the best single indicator (domestic private credit).
    Keywords: Early warning indicators, Bayesian model averaging, macro-prudential policies
    JEL: C33 E44 E58 F47 G01
    Date: 2012–07
  9. By: Charles W. Calomiris; Joseph R. Mason; Marc Weidenmier; Katherine Bobroff
    Abstract: This paper examines the effects of the Reconstruction Finance Corporation’s (RFC) loan and preferred stock programs on bank failure rates in Michigan during the period 1932-1934, which includes the important Michigan banking crisis of early 1933 and its aftermath. Using a new database on Michigan banks, we employ probit and survival duration analysis to examine the effectiveness of the RFC’s loan program (the policy tool employed before March 1933) and the RFC’s preferred stock purchases (the policy tool employed after March 1933) on bank failure rates. Our estimates treat the receipt of RFC assistance as an endogenous variable. We are able to identify apparently valid and powerful instruments (predictors of RFC assistance that are not directly related to failure risk) for analyzing the effects of RFC assistance on bank survival. We find that the loan program had no statistically significant effect on the failure rates of banks during the crisis; point estimates are sometimes positive, sometimes negative, and never estimated precisely. This finding is consistent with the view that the effectiveness of debt assistance was undermined by some combination of increasing the indebtedness of financial institutions and subordinating bank depositors. We find that RFC’s purchases of preferred stock – which did not increase indebtedness or subordinate depositors – increased the chances that a bank would survive the financial crisis. We also perform a parallel analysis of the effects of RFC preferred stock assistance on the loan supply of surviving banks. We find that RFC assistance not only contributed to loan supply by reducing failure risk; conditional on bank survival, RFC assistance is associated with significantly higher lending by recipient banks from 1931 to 1935.
    JEL: G01 G18 G21 G28 N12 N22
    Date: 2012–09
  10. By: Gustavo Abarca; Claudia Ramírez; José Gonzalo Rangel
    Abstract: This article examines changes in the exchange rate expectations associated with capital controls and banking regulations in a group of emerging countries that implemented these measures to control the adverse effects of sudden capital flows on their currencies. The evidence suggests that for most countries the effects of this type of policies are limited. Moreover, in some cases they appear to have an opposite effect from the one intended. In particular, for some currencies our results suggest there were changes in the extremes of their exchange rate distributions, which make their tails heavier and signal that the market allocates a greater probability to extreme movements. In the same way, evidence is found that this type of measures increases the levels of currency risk premium.
    Keywords: Capital controls, banking regulation, exchange rate expectations, emerging economies, generalized extreme value.
    JEL: C14 E44 E58 F31 G15
    Date: 2012–09
  11. By: Hiro Ito (Asian Development Bank Institute (ADBI)); Masahiro Kawai
    Abstract: We develop a new set of indexes of exchange rate stability, monetary policy independence, and financial market openness as the metrics for the trilemma hypothesis. In our exploration, we take a different and more nuanced approach than the previous indexes developed by Aizenman, Chinn, and Ito (2008). We show that the new indexes add up to the value two, supporting the trilemma hypothesis. We locate our sample economies’ policy mixes in the famous trilemma triangle—a useful and intuitive way to illustrate the state and evolution of policy mixes. We also examine if the persistent deviation of the sum of the three indexes from the value two indicates an unsustainable policy mix and therefore needs to be corrected by economic disruptions such as economic and financial crises. We obtain several findings. First, such a persistent deviation can occur particularly in emerging economies that later experience an inflation (or potentially a general or a currency) crisis, and dissipates in the postcrisis period. Second, there is no evidence for this type of association between deviations from the trilemma constraint and general, banking, or debt crises. Third, Thailand experienced such a deviation from the trilemma constraint in the period leading to the baht crisis of 1997, but not other East and Southeast Asian economies. This last result suggests that the main cause for the Thai baht crisis was an unsustainable policy mix in the precrisis period, while other affected economies experienced crises mainly due to contagion from Thailand.
    Keywords: exchange rate stability, monetary policy independence, financial market openness, the trilemma hypothesis, emerging economies, Southeast Asian, Thailand
    JEL: F15 F F31 F36 F41 O24
    Date: 2012–09
  12. By: Tomáš Adam (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Sona Benecká (Czech National Bank); Ivo Jánský (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: This paper analyses the evolution of systematic risk of banking industries in eight advanced countries using weekly data from 1990 to 2012. The estimation of time-varying betas is done by means of a Bayesian state space model with stochastic volatility, whose results are contrasted with those of the standard M-GARCH and rolling-regression models. We show that both country specific and global events affect the perceived systematic risk, while the impact of the latter differs largely across countries. Finally, our results do not support the previous findings that systematic risk of the banking sector was underestimated before the last financial crisis.
    Keywords: CAPM, Time-varying Beta, Multivariate GARCH, Bayesian State Space Models, Stochastic Volatility
    JEL: C11 G12 G21
    Date: 2012–07
  13. By: Gabrieli, S.
    Abstract: What influences banks’ borrowing costs in the unsecured money market? The objective of this paper is to test whether measures of centrality, quantifying network effects due to interactions among banks in the market, can help explain heterogeneous patterns in the interest rates paid to borrow unsecured funds once bank size and other bank and market factors that affect the overnight segment are controlled for. Preliminary evidence shows that large banks borrow on average at better rates compared to smaller institutions, both before and after the start of the financial crisis. Nonetheless, controlling for size, centrality measures can capture part of the cross-sectional variation in overnight rates. More specifically: (1) Before the start of the crisis all the banks, independently of their size, profit from different forms of interconnectedness, but the economic size of the effect is small. Bank reputation and perceived credit riskiness are the most relevant factors to reduce average daily interest rates. Foreign banks borrow at a discount over Italian ones. (2) After August 2007 the impact of banks’ interconnectedness becomes larger but changes sign: the “reward” stemming from a higher centrality becomes a “punishment”, which possibly reflects market discipline. Bank reputation becomes even more important. (3) After Lehman’s bankruptcy the effect of centrality on the spread maintains the same sign as after August 2007, but the magnitude increases remarkably. Foreign banks borrow at a relevant premium over Italian ones; reputation becomes outstandingly more important than in normal times.
    Keywords: Network centrality; Interbank market; Financial crisis; Money market integration; Macro-prudential analysis.
    JEL: C23 D85 G01 G21 G28
    Date: 2012
  14. By: Ugo Albertazzi (Banca d'Italia); Tiziano Ropele (Banca d'Italia); Gabriele Sene (Banca d'Italia); Federico M. Signoretti (Banca d'Italia)
    Abstract: We assess the effects of the sovereign debt crisis on Italian banksÂ’ activity using aggregate data on funding and loan rates, lending quantities and income statements for the period 1991-2011. We augment standard reduced-form equations for the variables of interest with the spread on 10-year sovereign bonds as an additional explanatory variable. We find that, even when controlling for the standard economic variables that influence bank activity, a rise in the spread is followed by an increase in the cost of wholesale and of certain forms of retail funding for banks and in the cost of credit to firms and households; the impact tends to be larger during periods of financial turmoil. An increase in the spread also has a direct negative effect on lending growth, beyond that implied by the rise in lending rates. Finally, we document a negative impact of the spread on banksÂ’ profitability, stronger for larger intermediaries.
    Keywords: sovereign spread, bank loan rates, bank lending
    JEL: E44 E51 G21
    Date: 2012–09
  15. By: Stefan Reitz; Markus A. Schmidt; Mark P. Taylor
    Abstract: Though unambiguously outperforming all other financial markets in terms of liquidity, foreign exchange trading is still performed in opaque and decentralized markets. In particular, the two-tier market structure consisting of a customer segment and an interdealer segment to which only market makers have access gives rise to the possibility of price discrimination. We provide a theoretical foreign exchange pricing model that accounts for market power considerations and analyze a database of the trades of a German market maker and his cross section of end-user customers. We find that the market maker generally exerts low bargaining power vis-á-vis his customers. The dealer earns lower average spreads on trades with financial customers than commercial customers, even though the former are perceived to convey exchange-rate-relevant information. From this perspective, it appears that market makers provide interdealer market liquidity to end-user customers with cross-sectionally differing spreads
    Keywords: Foreign Exchange, Market Mictrostructure, Pricing Behavior
    JEL: F31 F41
    Date: 2012–09
  16. By: Cihak, Martin; Demirguc-Kunt, Asli; Feyen, Erik; Levine, Ross
    Abstract: This paper introduces the Global Financial Development Database, an extensive dataset of financial system characteristics for 205 economies from 1960 to 2010. The database includes measures of (a) size of financial institutions and markets (financial depth), (b) degree to which individuals can and do use financial services (access), (c) efficiency of financial intermediaries and markets in intermediating resources and facilitating financial transactions (efficiency), and (d) stability of financial institutions and markets (stability). The authors document cross-country differences and time series trends.
    Keywords: Debt Markets,Emerging Markets,Access to Finance,Banks&Banking Reform,Economic Theory&Research
    Date: 2012–08–01
  17. By: Fabio Rumler; Walter Waschiczek
    Abstract: We examine the impact of changes in the financial structure of the Austrian banking sector over the past 15 years, such as disintermediation, internationalization and privatization, on the profitability of banks. Several proxies based on bank balance sheet data at the micro level as well as macroeconomic variables are used to capture these changes. The case of Austria is particularly interesting because country-specific developments, such as the opening-up of the banking sector due to EU accession, coincided with the global deregulation of banking activities. Our estimation results, which are based on dynamic panel regression methods, indicate that disintermediation (a lower percentage of loans over total assets) and higher market concentration in the banking sector had a positive effect on bank profitability, while, surprisingly, changes in the ownership structure (privatization and increased foreign ownership) as well as more foreign lending by Austrian banks did not have a clear-cut or significant impact on bank profits. JEL classification: G21, E44, D40, G32, C33
    Keywords: Bank Profitability, Banking Market Structure, Dynamic Panel Estimation
    Date: 2012–09–26
  18. By: Boot, Arnoud W A; Ratnovski, Lev
    Abstract: We study the effects of a bank’s engagement in trading. Traditional banking is relationship-based: not scalable, long-term oriented, with high implicit capital, and low risk (thanks to the law of large numbers). Trading is transactions-based: scalable, short-term, capital constrained, and with the ability to generate risk from concentrated positions. When a bank engages in trading, it can use its ‘spare’ capital to profitably expand the scale of trading. However there are two inefficiencies. A bank may allocate too much capital to trading ex-post, compromising the incentives to build relationships ex-ante. And a bank may use trading for risk-shifting. Financial development augments the scalability of trading, which initially benefits conglomeration, but beyond some point inefficiencies dominate. The deepening of financial markets in recent decades leads trading in banks to become increasingly risky, so that problems in managing and regulating trading in banks will persist for the foreseeable future. The analysis has implications for capital regulation, subsidiarization, and scope and scale restrictions in banking.
    Keywords: banking; capital regulation; scale restrictions; trading
    JEL: G21 G24 G28 G32
    Date: 2012–09

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