nep-cba New Economics Papers
on Central Banking
Issue of 2012‒11‒17
thirteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Liquidity Traps and the Price (In)Determinacy of Monetary Rules By Eagle, David M
  2. Debt-Deflation versus the Liquidity Trap : the Dilemma of Nonconventional Monetary Policy By Gaël Giraud; Antonin Pottier
  3. On the new central bank strategy toward monetary and financial instabilities management in finances: Econophysical analysis of nonlinear dynamical financial systems By Dimitri O. Ledenyov; Viktor O. Ledenyov
  4. Monetary targeting and financial system characteristics: An empirical analysis By Samarina, Anna
  5. Modeling credit contagion via the updating of fragile beliefs By Luca Benzoni; Pierre Collin-Dufresne; Robert S. Goldstein; Jean Helwege
  6. Ranking Systemically Important Financial Institutions By Mardi Dungey; Matteo Luciani; David Veredas
  7. Systemic Risks in Global Banking: What Available Data can tell us and What More Data are Needed? By Eugenio Cerutti; Stijn Claessens; Patrick McGuire
  8. International Taxation and Cross-Border Banking By Harry Huizinga; Johannes Voget; Wolf Wagner
  9. The Federal Reserve’s response to the financial crisis: what it did and what it should have done By Daniel L. Thornton
  10. Fitting and Forecasting Sovereign Defaults Using Multiple Risk Signals By Roberto Savona; Marika Vezzoli
  11. Fitting U.S. Trend Inflation: A Rolling-Window Approach. By Efrem Castelnuovo
  12. Regional Financial Arrangements and the International Monetary Fund By Eichengreen, Barry
  13. Financial Safety Nets in Asia: Genesis, Evolution, Adequacy, and Way Forward By Hill, Hal; Menon, Jayant

  1. By: Eagle, David M
    Abstract: This paper proposes a new methodology for assessing price indeterminacy to supplant the discredited nonexplosive criterion. Using this methodology, we find that nominal GDP targeting and price-level targeting do determine prices when the central bank follows a sufficiently strong feedback rule for setting the nominal interest rate. However, inflation targeting leads to price indeterminacy, a result consistent with the principles of calculus. This price indeterminacy of inflation targeting could manifest itself in a liquidity trap or zero bound for nominal interest rates rendering central banks impotent. Nominal GDP targeting could overcome this liquidity-trap effect.
    Keywords: inflation targeting; price-level targeting; nominal GDP inflation targeting; price-level targeting; nominal income targeting; price determinacy; liquidity trap
    JEL: E31 E58 E52
    Date: 2012–11–02
  2. By: Gaël Giraud (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Antonin Pottier (CIRED - Centre International de Recherche sur l'Environnement et le Développement - CIRAD : UMR56 - CNRS : UMR8568 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - AgroParisTech)
    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.
    Date: 2012–10
  3. By: Dimitri O. Ledenyov; Viktor O. Ledenyov
    Abstract: We describe the innovations in finances, introduced over the recent decades, and analyze most of the business and regulatory challenges, faced by the financial industry, because of the present disruptive changes in the global capital markets. We use the integrative thinking approach to formulate the new central bank strategy and propose that the new strategy has to be focused on the constant management of the monetary and financial instabilities, using the knowledge base in the field of econophysics. We propose the new theoretical model of economics, which is called the Nonlinear Dynamic Stochastic General Equilibrium (NDSGE), which takes to the account the nonlinearities, appearing during the interaction between the business cycles. We show that the central banks, which will apply the knowledge gained from the econophysical analysis to understand the complex processes in the national financial systems in the time of high volatility in global capital markets, will be able to govern the national financial systems successfully.
    Date: 2012–11
  4. By: Samarina, Anna (Groningen University)
    Abstract: This paper investigates how reforms and characteristics of the financial system affect the likelihood of countries to abandon their strategy of monetary targeting. Apart from financial system characteristics, we include macroeconomic, fiscal, and institutional factors potentially associated with countries? choices to give up monetary targeting. Panel logit models are estimated on a sample of 35 monetary targeting countries over the period 1975-2009. The findings suggest that financial liberalization, deregulation, and development as well as dollarization significantly increase the likelihood to abandon monetary targeting. Additionally, more developed countries with lower inflation and larger fiscal deficits are more likely to quit this monetary strategy. However, the financial determinants of abandoning monetary targeting differ between advanced and emerging and developing countries.
    Date: 2012
  5. By: Luca Benzoni; Pierre Collin-Dufresne; Robert S. Goldstein; Jean Helwege
    Abstract: We propose a tractable equilibrium model for pricing defaultable bonds that are subject to contagion risk. Contagion arises because agents with ‘fragile beliefs’ are uncertain about both the underlying state of the economy and the posterior probabilities associated with these states. As such, agents adopt a robust decision rule for updating that leads them to over-weight the posterior probabilities of ‘bad’ states. We estimate the model using panel data on sovereign Euro-zone CDS spreads during the recent crisis, and find that it captures levels and dynamics of spreads better than traditional affine models with the same number of observable and latent state variables.
    Keywords: Bonds - Prices ; Europe - Economic conditions ; Eurozone
    Date: 2012
  6. By: Mardi Dungey (School of Economics and Finance, University of Tasmania; CFAP University of Cambridge, CAMA ANU); Matteo Luciani (ECARES, Solvay Brussels School of Economics and Management, Université libre de Bruxelles; F.R.S.-FNRS); David Veredas (ECARES, Solvay Brussels School of Economics and Management, and Duisenberg school of finance)
    Abstract: We propose a simple network–based methodology for ranking systemically important financial institutions. We view the risks of firms –including both the financial sector and the real economy– as a network with nodes representing the volatility shocks. The metric for the connections of the nodes is the correlation between these shocks. Daily dynamic centrality measures allow us to rank firms in terms of risk connectedness and firm characteristics. We present a general systemic risk index for the financial sector. Results from applying this approach to all firms in the S&P500 for 2003–2011 are twofold. First, Bank of America, JP Morgan and Wells Fargo are consistently in the top 10 throughout the sample. Citigroup and Lehman Brothers also were consistently in the top 10 up to late 2008. At the end of the sample, insurance firms emerge as systemic. Second, the systemic risk in the financial sector built–up from early 2005, peaked in September 2008, and greatly reduced after the introduction of TARP and the rescue of AIG. Anxiety about European debt markets saw the systemic risk begin to rise again from April 2010. We further decompose these results to find that the systemic risk of insurance and deposit– taking institutions differs importantly, the latter experienced a decline from late 2007, in line with the burst of the housing price bubble, while the former continued to climb up to the rescue of AIG.
    Keywords: Systemic risk; ranking; financial institutions; Lehman
    JEL: G01 G10 G18 G20 G28 G32 G38
    Date: 2012–10–26
  7. By: Eugenio Cerutti; Stijn Claessens; Patrick McGuire
    Abstract: The recent financial crisis has shown how interconnected the financial world has become. Shocks in one location or asset class can have a sizable impact on the stability of institutions and markets around the world. But systemic risk analysis is severely hampered by the lack of consistent data that capture the international dimensions of finance. While currently available data can be used more effectively, supervisors and other agencies need more and better data to construct even rudimentary measures of risks in the international financial system. Similarly, market participants need better information on aggregate positions and linkages to appropriately monitor and price risks. Ongoing initiatives that will help in closing data gaps include the G20 Data Gaps Initiative, which recommends the collection of consistent bank-level data for joint analyses and enhancements to existing sets of aggregate statistics, and the enhancement to the BIS international banking statistics.
    JEL: F21 F34 G15 G18 Y1
    Date: 2012–11
  8. By: Harry Huizinga; Johannes Voget; Wolf Wagner
    Abstract: This paper examines empirically how international taxation affects the volume and pricing of cross-border banking activities for a sample of banks in 38 countries over the 1998-2008 period. International double taxation of foreign-source bank income is found to reduce banking-sector FDI. Furthermore, such taxation is almost fully passed on into higher interest margins charged abroad. These results imply that international double taxation distorts the activities of international banks, and that the incidence of international double taxation of banks is on bank customers in the foreign subsidiary country. Our analysis informs the debate about additional taxation of the financial sector that has emerged in the wake of the recent financial crisis.
    JEL: F23 G21 H25
    Date: 2012–10
  9. By: Daniel L. Thornton
    Abstract: This paper analyzes the Federal Reserve’s major policy actions in response to the financial crisis. The analysis is divided into the pre-Lehman and post-Lehman monetary policies. Specifically, I describe the pre- and post-Lehman monetary policy actions that I believe were appropriate and those that were not. I then describe the monetary policy actions the Fed should have taken and why those actions would have fostered better financial market and economic outcomes. Had these actions been taken, the Fed’s balance sheet would have returned to normal and the FOMC’s target for the federal funds rate would be a level consistent with a positive real rate and an inflation target of 2 percent.
    Keywords: Federal Reserve banks ; Monetary policy ; Financial crises
    Date: 2012
  10. By: Roberto Savona (Department of Business Studies, University Of Brescia); Marika Vezzoli (Department of Quantitative Methods, University Of Brescia)
    Abstract: In this paper we face the fitting versus forecasting paradox with the objective of realizing an optimal Early Warning System to better describe and predict past and future sovereign defaults. We do this by proposing a new Regression Tree-based model that signals a potential crisis whenever preselected indicators exceed specific thresholds. Using data on 66 emerging markets over the period 1975-2002, our model provides an accurate description of past data, although not the best description relative to existing competing models (Logit, Stepwise logit, Noise-to-Signal Ratio and Regression Trees), and produces the best forecasts accomodating to different risk aversion targets. By modulating in- and out-of sample model accuracy, our methodology leads to unambiguous empirical results, since we find that illiquidity (short-term debt to reserves ratio), insolvency (reserve growth) and contagion risks act as the main determinants/predictors of past/future debt crises.
    Keywords: Data mining; Evaluating forecasts; Model selection; Panel data; Probability forecasting.
    JEL: C14 C23 G01 H63
    Date: 2012
  11. By: Efrem Castelnuovo (University of Padova)
    Abstract: The role of trend inflation shocks for the U.S. macroeconomic dynamics is investigated by estimating two DSGE models of the business cycle. Policymakers are assumed to be concerned with a time-varying inflation target, which is modeled as a persistent and stochastic process. The identification of trend inflation shocks (as opposed to a number of alternative innovations) is achieved by exploiting the measure of trend inflation recently proposed by Arouba and Schorfheide (2011, American Economic Journal: Macroeconomics). Our main findings point to a substantial contribution of trend inflation shocks for the volatility of inflation and the policy rate. Such contribution is found to be time-dependent and highest during the mid-1970s to mid-1980s.
    Keywords: trend inflation shocks, new-keynesian DSGE models, rolling-window approach great moderation.
    JEL: E31 E32 E52
    Date: 2012–10
  12. By: Eichengreen, Barry (Asian Development Bank Institute)
    Abstract: The rise of regional monetary arrangements poses a challenge for the International Monetary Fund (IMF)'s global surveillance efforts. This paper reviews how the IMF has responded to earlier regional initiatives, from the European Payments Union of the 1950s and the Gold Pool of the 1960s to the CFA franc zone and the European Monetary System. The penultimate section draws out the implications for monetary regionalism in East Asia.
    Keywords: international monetary fund; regional monetary arrangements; global surveillance; european monetary system
    JEL: F30 F53 F55
    Date: 2012–11–06
  13. By: Hill, Hal (Asian Development Bank Institute); Menon, Jayant (Asian Development Bank Institute)
    Abstract: Financial safety nets in Asia have come a long way since the Asian Financial Crisis (AFC) of 1997–98. Not wanting to rely solely on the International Monetary Fund (IMF) again, the Chiang Mai Initiative (CMI) was created in 2000. When the CMI also proved inadequate following the Global Financial Crisis (GFC), it was first multilateralized (CMIM), and then doubled in size to $240 billion, while the IMF de-linked portion was increased to 30%. A surveillance unit, the Association for Southeast Asian Nations (ASEAN)+3 Macroeconomic Research Office (AMRO), was set-up in 2011. The authors assess whether these developments are sufficient to make the CMIM workable.
    Keywords: financial safety nets; chiang mai initiative; asean+3; asia; asian monetary fund; imf
    JEL: F32 F33 F34
    Date: 2012–11–12

This nep-cba issue is ©2012 by Maria Semenova. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.