nep-cba New Economics Papers
on Central Banking
Issue of 2012‒11‒11
fifteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Dual liquidity crises under alternative monetary frameworks: a financial accounts perspective By Ulrich Bindseil; Adalbert Winkler
  2. Central bank communication on fiscal policy By Julien Allard; Marco Catenaro; Jean-Pierre Vidal; Guido Wolswijk
  3. Banking, debt and currency crises: early warning indicators for developed countries By Jan Babecký; Tomáš Havránek; Jakub Matějů; Marek Rusnák; Kateřina Šmídková; Bořek Vašíček
  4. Debt-Deflation versus the Liquidity Trap : The Dilemma of Nonconventional Monetary Policy. By Gaël Giraud; Antonin Pottier
  5. Persistent Habits, optimal Monetary Policy Inertia and Interest Rate Smoothing By Corrado, L.; Holly, S.; Raissi, M.
  6. Bailouts, Contagion, and Bank Risk-Taking By LEV RATNOVSKI; Giovanni Dell'Ariccia
  7. Monetary Policy in Transition – Essays on Monetary Policy Transmission Mechanism in China By Koivu, Tuuli
  8. Has the Basel Accord Improved Risk Management During the Global Financial Crisis? By Michael McAleer; Juan-Angel Jimenez-Martin; Teodosio Perez-Amaral
  9. The Dodd-Frank Act and Basel III: Intentions, Unintended Consequences, and Lessons for Emerging Markets By Acharya, Viral V.
  10. Bank Competition and Stability: Cross-country Heterogeneity (Revised version of CentER DP 2011-080) By Beck, T.H.L.; De Jonghe, O.G.; Schepens, G.
  11. Banking across borders By Friederike Niepmann
  12. Business cycles and financial crises: the roles of credit supply and demand shocks By James M Nason; Ellis Tallman
  13. Early warning indicators for the German banking system: A macroprudential analysis By Jahn, Nadya; Kick, Thomas
  14. Information Acquisition in Rumor Based Bank Runs By Zhiguo He; Asaf Manela
  15. Financial Intermediation, International Risk Sharing, and Reserve Currencies By Matteo Maggiori

  1. By: Ulrich Bindseil (European Central Bank); Adalbert Winkler (Frankfurt School of Finance & Management)
    Abstract: This paper contributes to the literature on liquidity crises and central banks acting as lenders of last resort by capturing the mechanics of dual liquidity crises, i.e. funding crises which encompass both the private and the public sector, within a closed system of financial accounts. We analyze how the elasticity of liquidity provision by a central bank depends on the international monetary regime in which the relevant country operates and on specific central bank policies like collateral policies, monetary financing prohibitions and quantitative borrowing limits imposed on banks. Thus, it provides a firm basis for a comparative analysis of the ability of central banks to absorb shocks. Our main results are as follows: (1) A central bank that operates under a paper standard with a flexible exchange rate and without a monetary financing prohibition and other limits of borrowings placed on the banking sector is most flexible in containing a dual liquidity crisis. (2) Within any international monetary system characterized by some sort of a fixed exchange rate, including the gold standard, the availability of inter-central bank credit determines the elasticity of a crisis country’s central bank in providing liquidity to banks and financial markets. (3) A central bank of a euro area type monetary union has a similar capacity in managing dual liquidity crises as a country central bank operating under a paper standard with a flexible exchange rate as long as the integrity of the monetary union is beyond any doubt. JEL Classification: E50, E58
    Keywords: Liquidity crisis, bank run, sovereign debt crisis, central bank co-operation, gold standard
    Date: 2012–10
  2. By: Julien Allard; Marco Catenaro (European Central Bank); Jean-Pierre Vidal (European Central Bank); Guido Wolswijk (European Central Bank)
    Abstract: While the established literature on central bank communication has traditionally dealt with communication of monetary policy messages to financial markets and the wider public, central bank communication on fiscal policy has so far received little attention. This paper empirically reviews the intensity of central banks’ fiscal communication by five central banks (the US Federal Reserve, the ECB, the Bank of Japan, the Bank of England and the Swedish Riksbank) over the period 1999-2011. To that end, it develops a fiscal indicator measuring the fiscal-related communication in minutes or introductory statements. Our findings indicate that the ECB communicates intensively on fiscal policies in both positive as well as normative terms. Other central banks more typically refer to fiscal policy when describing foreign developments relevant to domestic macroeconomic developments, when using fiscal policy as input to forecasts, or when referring to the use of government debt instruments in monetary policy operations. The empirical analysis also indicates that the financial crisis has overall increased the intensity of central bank communication on fiscal policy. It identifies the evolution of the government deficit ratio as a driver of the intensity of fiscal communication by central banks in the euro area, the US and Japan, and for Sweden since the start of the crisis. In England the fiscal share in central bank communication is related to developments in government debt as of the start of the crisis. JEL Classification: E58, E61, E63
    Keywords: Central bank communication, fiscal policy, quantification of verbal information
    Date: 2012–09
  3. By: Jan Babecký (Czech National Bank); Tomáš Havránek (Czech National Bank; Charles University, Institute of Economic Studies); Jakub Matějů (Czech National Bank; Center for Economic Research and Graduate Education - Economics Institue (CERGE-EI)); Marek Rusnák (Czech National Bank; Charles University, Institute of Economic Studies); Kateřina Šmídková (Czech National Bank; Charles University, Institute of Economic Studies); Bořek Vašíček (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. Banking turmoil was most frequent in developed economies. 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 crisis 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 increases the usefulness of the model when compared to using the best single indicator (domestic private credit). JEL Classification: C33, E44, E58, F47, G01
    Keywords: Early warning indicators, Bayesian model averaging, macro-prudential policies
    Date: 2012–10
  4. By: Gaël Giraud (Centre d'Economie de la Sorbonne - Paris School of Economics); Antonin Pottier (CIRED)
    Abstract: This paper examines quantity-targeting monetary policy in a two-period economy with fiat money, endogenously incomplete markets of financial securities, durable goods and production. Short positions in financial assets and long-term loans are backed by collateral, the value of which depends on monetary policy. The decision to default is endogenous and depends on the relative value of the collateral to the loan. We show that Collateral Monetary Equilibria exist and prove there is also a refinement of the Quantity Theory of Money that turns out to be compatible with the long-run non-neutrality of money. Moreover, only three scenarios are compatible with the equilibrium condition : 1) either the economy enters a liquidity trap in the first period ; 2) or a credible ex-pansionary monetary policy accompanies the orderly functioning of markets at the cost of running an inflationary risk ; 3) else the money injected by the Central Bank increases the leverage of indebted investors, fueling a financial bubble whose bursting leads to debt-deflation in the next period with a non-zero probability. This dilemma of monetary policy highlights the default channel affecting trades and production, and provides a rigorous foundation to Fisher’s debt deflation theory as being distinct from Keynes’ liquidity trap.
    Keywords: Central Bank, liquidity trap, collateral, default, deflation, quantitative easing, debt-deflation.
    JEL: D50 E40 E44 E50 E52 E58 G38 H50
    Date: 2012–10
  5. By: Corrado, L.; Holly, S.; Raissi, M.
    Abstract: Dynamic stochastic general equilibrium models featuring imperfect competition and nominal rigidities have become central for the analysis of the monetary transmission mechanism and for understanding the conduct of monetary policy. However, it is agreed that the benchmark model fails to generate the persistence of output and inflation that is observed in the data. Moreover, it cannot provide a theoretically well-grounded justification for the interest rate smoothing behaviour of monetary authorities. This paper attempts to overcome these deficiencies by embedding a multiplicative habit specification in a New Keynesian model. We show that this particular form of habit formation can explain why monetary authorities smooth interest rates.
    Keywords: Multiplicative habits, interest rate inertia, optimal monetary policy.
    JEL: D12 E52 E43
    Date: 2012–10–29
  6. By: LEV RATNOVSKI (International Monetary Fund); Giovanni Dell'Ariccia (IMF)
    Abstract: We revisit the link between bailouts and bank risk taking. The expectation of government support to failing banks (bailout) creates moral hazard and encourages risk-taking. However, when a bank's success depends on both its idiosyncratic risk and the overall stability of the banking system, a government's commitment to shield banks from contagion may increase their incentives to invest prudently. We explore these issues in a simple model of financial intermediation where a bank's survival depends on another bank's success. We show that the positive effect from systemic insurance dominates the classical moral hazard effect when the risk of contagion is high.
    Date: 2012
  7. By: Koivu, Tuuli (Bank of Finland Research)
    Abstract: China’s economic development has been exceptionally robust since the end of the 1970s, and the country has already emerged as the second biggest economy in the world. In this study, we seek to illuminate the role of the monetary policy in this successful economic performance and as a part of the extensive economic reforms of the last two decades. The five empirical essays seek to discover which monetary policy tools are the most used and most effective for guiding China’s economic development. In addition, we explore which monetary policy transmission channels are functioning and to what extent monetary policy impacts inflation and real economic developments in China. The results indicate that the conduct of monetary policy in China differs substantially from what is typical for an advanced market economy, where an independent central bank often aims to hit an inflation target by simply controlling the target interest rate. First, China’s monetary policy toolkit is highly diverse. Besides a collection of administrated interest rates, it contains quantitative policy tools and direct guidelines. Second, China’s central bank is not independent in its decision-making. For these reasons, it is exceptionally challenging to measure the monetary policy stance or to distinguish monetary policy from other macroeconomic policies in China’s case. This has been taken into account in this study by using a variety of monetary-policy indicators. Our results suggest that China’s monetary-policy implementation and its transmission to the real economy still rely heavily on quantitative policy tools and direct guidelines; interest rates play a much smaller role, in terms of both usage and effectiveness. Overall, our findings suggest that the direct link between monetary policy and real economic performance is weak in China. On the other hand, this study clearly shows that monetary policy has played a key role in price developments, which tells us that monetary policy has been an important factor in China’s economic success.
    Keywords: China; monetary policy; economic growth; inflation; exchange rates
    JEL: E50 P30
    Date: 2012–10–26
  8. By: Michael McAleer (Econometric Institute Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute The Netherlands and Institute of Economic Research Kyoto University and Department of Quantitative Economics Complutense University of Madrid); Juan-Angel Jimenez-Martin (Department of Quantitative Economics Complutense University of Madrid); Teodosio Perez-Amaral (Department of Quantitative Economics Complutense University of Madrid)
    Abstract: The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. In this paper we define risk management in terms of choosing from a variety of risk models, and discuss the selection of optimal risk models. A new approach to model selection for predicting VaR is proposed, consisting of combining alternative risk models, and we compare conservative and aggressive strategies for choosing between VaR models. We then examine how different risk management strategies performed during the 2008- 09 global financial crisis. These issues are illustrated using Standard and Poor’s 500 Composite Index.
    Keywords: Value-at-Risk (VaR), daily capital charges, violation penalties, optimizing strategy, risk forecasts, aggressive or conservative risk management strategies, Basel Accord, global financial crisis.
    JEL: G32 G11 G17 C53 C22
    Date: 2012–11
  9. By: Acharya, Viral V. (Asian Development Bank Institute)
    Abstract: This paper is an attempt to explain the changes to finance sector reforms under the Dodd-Frank Act in the United States and Basel III requirements globally; their unintended consequences; and lessons for currently fast-growing emerging markets concerning finance sector reforms, government involvement in the finance sector, possible macroprudential safeguards against spillover risks from the global economy, and, finally, management of government debt and fiscal conditions.
    Keywords: dodd-frank act; united states; basel iii requirements; macroprudential regulation; finance sector
    JEL: G20 G21 G28
    Date: 2012–10–28
  10. By: Beck, T.H.L.; De Jonghe, O.G.; Schepens, G. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: This paper documents large cross-country variation in the relationship between bank competition and bank stability and explores market, regulatory and institutional features that can explain this variation. We show that an increase in competition will have a larger impact on banks’ fragility in countries with stricter activity restrictions, lower systemic fragility, better developed stock exchanges, more generous deposit insurance and more effective systems of credit information sharing. The effects are economically large and thus have important repercussions for the current regulatory reform debate.
    Keywords: Competition;Stability;Banking;Herding;Deposit Insurance;Information Sharing;Risk Shifting.
    JEL: G21 G28 L51
    Date: 2012
  11. By: Friederike Niepmann
    Abstract: This paper develops and tests a theoretical model that allows for the endogenous decision of banks to engage in international and global banking. International banking, where banks raise capital in the home market and lend it abroad, is driven by differences in factor endowments across countries. In contrast, global banking, where banks intermediate capital locally in the foreign market, arises from differences in country-level bank efficiency. Together, these two driving forces determine the foreign assets and liabilities of a banking sector. The model provides a rationale for the observed rise in global banking relative to international banking. Its key predictions regarding the cross-country pattern of foreign bank asset and liability holdings are strongly supported by the data.
    Keywords: Banks and banking, International ; Globalization ; Banks and banking, Foreign ; Loans, Foreign ; Capital movements
    Date: 2012
  12. By: James M Nason; Ellis Tallman
    Abstract: This paper explores the hypothesis that the sources of economic and financial crises differ from noncrisis business cycle fluctuations. We employ Markov-switching Bayesian vector autoregressions (MS-BVARs) to gather evidence about the hypothesis on a long annual U.S. sample running from 1890 to 2010. The sample covers several episodes useful for understanding U.S. economic and financial history, which generate variation in the data that aids in identifying credit supply and demand shocks. We identify these shocks within MS-BVARs by tying credit supply and demand movements to inside money and its intertemporal price. The model space is limited to stochastic volatility (SV) in the errors of the MS-BVARs. Of the 15 MS-BVARs estimated, the data favor a MS-BVAR in which economic and financial crises and noncrisis business cycle regimes recur throughout the long annual sample. The best-fitting MS-BVAR also isolates SV regimes in which shocks to inside money dominate aggregate fluctuations.
    Keywords: Business cycles ; Forecasting ; Financial markets ; Economic history
    Date: 2012
  13. By: Jahn, Nadya; Kick, Thomas
    Abstract: Over the past two decades, Germany experienced several periods of banking system instability rather than full-blown banking system crises. In this paper we introduce a continuous and forward-looking stability indicator for the banking system based on information on all financial institutions in Germany between 1995 and 2010. Explaining this measure by means of panel regression techniques, we identify significant macroprudential early warning indicators (such as asset price indicators, leading indicators for the business cycle and monetary indicators) and spillover effects. Whereas international spillovers play a significant role across all banking sectors, regional spillovers and the credit-to-GDP ratio are more important for cooperative banks and less relevant for commercial banks. --
    Keywords: Early Warning Indicators,Banking System Stability,Regional Spillover Effects,Panel Regression Techniques
    JEL: C23 E44 G01 G21
    Date: 2012
  14. By: Zhiguo He; Asaf Manela
    Abstract: We study information acquisition and withdrawal decisions when a liquidity event triggers a spreading rumor and exposes a solvent bank to a run. Uncertainty about the bank's liquidity and potential failure motivates agents who hear the rumor to acquire additional signals. Depositors with unfavorable signals may wait and thus gradually run on the bank, leading to an endogenous aggregate withdrawal speed. A bank run equilibrium exists when agents aggressively acquire information. We study threshold parameters (e.g. liquidity reserve and deposit insurance) that eliminate runs. Public provision of solvency information can eliminate runs by indirectly crowding-out individual depositors' effort to acquire liquidity information. However, providing too much information that slightly differentiates competing solvent-but-illiquid banks can result in inefficient runs
    JEL: E61 G01 G21
    Date: 2012–11
  15. By: Matteo Maggiori (UC Berkeley)
    Abstract: I provide a framework for understanding the global financial architecture as an equilibrium outcome of the risk sharing between countries with different levels of financial development. The country that has the most developed financial sector takes on a larger proportion of global fundamental and financial risk because its financial intermediaries are better able to deal with funding problems following negative shocks. This asymmetric risk sharing has real consequences. In good times, and in the long run, the more financially developed country consumes more, relative to other countries, and runs a trade deficit financed by the higher financial income that it earns as compensation for taking greater risk. During global crises, it suffers heavier capital losses than other countries, exacerbating its fall in consumption. This country's currency emerges as the world's reserve currency because it appreciates during crises and so provides a good hedge. The model is able to rationalize these facts, which characterize the role of the US as the key country in the global financial architecture.
    Date: 2012

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