nep-cba New Economics Papers
on Central Banking
Issue of 2012‒12‒15
eighteen papers chosen by
Maria Semenova
Higher School of Economics

  1. The Regulator's Trade-off: Bank Supervision vs. Minimum Capital By Florian Buck; Eva Schliephake
  2. Macroprudential policy: its effects and relationship to monetary policy By Hyunduk Suh
  3. The past, present and future of central banking By David Cobham
  4. Can European Bank Bailouts work? By Dirk Schoenmaker; Arjen Siegmann
  5. Efficient Bailouts? By Javier Bianchi
  6. The Tragedy of the Commons and Inflation Bias in the Euro Area By Dinger, Valeriya; Steinkamp, Sven; Westermann, Frank
  7. European States and Financial Systems: A Biased Relationship By Nathalie Rey
  8. The lender of last resort: lessons from the Fed’s first 100 years By Mark A. Carlson; David C. Wheelock
  9. From Bretton Woods to inflation targeting: financial change and monetary policy evolution in Europe By David Cobham
  10. The Panic of 1907 By Ellis W. Tallman
  11. Is Inflation Targeting Still On Target? By Luis Felipe Céspedes; Roberto Chang; Andrés Velasco
  12. Non-bank financial institutions: assessment of their impact on the stability of the financial system By Patrice Muller; Graham Bishop; Shaan Devnani; Mark Lewis; Rohit Ladher
  13. Optimal Fiscal Policy and the Banking Sector By Matthew Schurin
  14. External Imbalances and Financial Crises By Alan M. Taylor
  15. Equity Investment Regulation and Bank Risk: Evidence from Japanese Commercial Banks By Konishi, Masaru
  16. Financial crisis and quantitative easing: can broad money tell us anything? By David Cobham; Yue Kang
  17. Bank Ownership and Credit Cycle: the lower sensitivity of public bank lending to the business cycle. By Duprey, T.
  18. Central banks and house prices in the run-up to the crisis By David Cobham

  1. By: Florian Buck; Eva Schliephake
    Abstract: We develop a simple model of banking regulation with two policy instruments: minimum capital requirements and supervision of domestic banks. The regulator faces a trade-off: high capital requirements cause a drop in the banks’ profitability, while strict supervision reduces the scope of intermediation and is costly for taxpayers. We show that the expected costs of a banking crisis are minimised with a mix of both instruments. Once we allow for cross-border banking, the optimal policy is not feasible. If domestic supervisory effort is not observable, our model predicts a race to the bottom in banking regulation. Therefore, countries are better off by harmonising regulation on an international standard.
    Keywords: bank regulation, regulatory competition, supervision and capital requirements
    JEL: F36 G18 K23 L51
    Date: 2012
  2. By: Hyunduk Suh
    Abstract: This paper examines the interactions of macroprudential policy and monetary policy in a New Keynesian DSGE model with financial frictions. Macroprudential policy can stabilize credit cycles. However, a macroprudential instrument that aims to stabilize a specific segment of the credit market can cause regulatory arbitrage, that is, a reallocation of credit to a less regulated part of the market. Within this model, welfare-maximizing monetary policy aims to stabilize only inflation and macroprudential policy only stabilizes credit. Two aspects of the model account for this dichotomy. First, credit stabilization is welfare improving because lower volatility is compensated by higher mean equilibrium credit and capital. Second, monetary policy is sub-optimal for credit stabilization. The reason is that it operates on the decisions of borrowers and savers, while macroprudential policy operates only on the decisions of borrowers.
    Keywords: Ratio analysis
    Date: 2012
  3. By: David Cobham
    Abstract: The financial crisis, on the one hand, and the recourse to ‘unconventional’ monetary policy, on the other, have given a sharp jolt to perceptions of the role and status of central banks. In this paper we start with a brief ‘contrarian’ history of central banks since the second world war, which presents the Great Moderation and the restricted focus on inflation targeting as a temporary aberration from the norm. We then discuss how recent developments in fiscal and monetary policy have affected the role and status of central banks, notably their relationships with governments, before considering the environment central banks will face in the near and middle future and how they will have to change to address it.
    Date: 2012
  4. By: Dirk Schoenmaker (Duisenberg School of Finance, VU University Amsterdam); Arjen Siegmann (VU University Amsterdam)
    Abstract: Cross‐border banking needs cross‐border recapitalisation mechanisms. Each mechanism, however, suffers from the financial trilemma, which is that cross‐border banking, national financial autonomy and financial stability are incompatible. In this paper, we study the efficiency of different burdensharing agreements for the recapitalisation of the 30 largest banks in Europe. We consider bank bailouts for these banks in a simulation framework with stochastic country‐specific bailout benefits. Among the burden sharing rules, we find that the majority and qualified‐majority voting rules come close to the efficiency of a bailout mechanism with a supranational authority. Even a unanimous voting rule works better than home‐country bailouts, which are very inefficient.
    Keywords: Financial Stability; Public Good; International Monetary Arrangements; International
    JEL: F33 G28 H41
    Date: 2012–10–24
  5. By: Javier Bianchi
    Abstract: This paper develops a non-linear DSGE model to assess the interaction between ex-post interventions in credit markets and the build-up of risk ex ante. During a systemic crisis, bailouts relax balance sheet constraints and mitigate the severity of the recession. Ex ante, the anticipation of such bailouts leads to an increase in risk-taking, making the economy more vulnerable to a financial crisis. The optimal policy requires, in general, a mix of ex-post intervention and ex-ante prudential policy. We also analyze the effects of bailouts on financial stability and welfare in the absence of ex-ante prudential policy. Our results show that the moral hazard effects of bailouts are significantly mitigated by making bailouts contingent on the occurrence of a systemic financial crisis.
    JEL: E2 E20 E3 E32 E44 E6 F40
    Date: 2012–12
  6. By: Dinger, Valeriya (Universitaet Osnabrueck); Steinkamp, Sven (Universitaet Osnabrueck); Westermann, Frank (Universitaet Osnabrueck)
    Abstract: Central bank credit has expanded dramatically in some of the euro area member countries since the beginning of the financial crisis. This paper makes two contributions to understand this stylized fact. First, we discuss a simple model of monetary policy that includes (i) a credit channel and (ii) a common pool problem in a monetary union. We illustrate that the interaction of the two elements leads to an inflation bias that is independent of the standard time-inconsistency bias. Secondly, we present empirical evidence that is consistent with the view that national central banks in the euro area have indeed followed an independent monetary policy. We show that after 2007, central bank credit has been highly correlated with unemployment, but not with inflation in the respective countries.
    Keywords: Tragedy of the Commons, Inflation Bias, Credit Channel, TARGET2, Euro Area
    JEL: E52 E58 H41
    Date: 2012–11–30
  7. By: Nathalie Rey (CEPN - Centre d'Economie de l'Université Paris Nord - Université Paris XIII - Paris Nord - CNRS : UMR7234)
    Abstract: Public intervention in the banking sector takes three main forms: prudential regulation, especially with the Basel II ratio for adequacy of a bank's own funds for their exposure to risk ; insuring deposits, the goal of which is to ensure a minimum level of protection for depositors and savers in order to avoid a run on banks ; and control and supervision of banks by public authorities, which ensures that the rules are applied properly. Intervention by central banks, through their monetary policy and as lenders of last resort, constitutes the fourth means of regulating the banking system, and the main form of intervention in financial markets. Central banks intervene in order to ensure the stability of financial systems. The financial crisis has shown that traditional modes of public intervention in the financial system are ineffective and insufficient. Before analyzing the principles and limits of these forms of public intervention, we examine cases of exceptional intervention and support to banks by public powers during the crisis. Then, in conclusion, we compare these forms of public intervention with the current state of financial systems.
    Keywords: Financial systems; Financial crisis; States; Public intervention; Prudential regulation
    Date: 2012–10–02
  8. By: Mark A. Carlson; David C. Wheelock
    Abstract: We review the responses of the Federal Reserve to financial crises over the past 100 years. The authors of the Federal Reserve Act in 1913 created an institution that they hoped would prevent banking panics from occurring. When this original framework did not prevent the banking panics of the 1930s, Congress amended the Act and gave the Federal Reserve considerably greater powers to respond to financial crises. Over the subsequent decades, the Federal Reserve responded more aggressively when it perceived that there were threats to financial stability and ultimately to economic activity. We review some notable episodes and show how they anticipated in several respects the Federal Reserve’s responses to the financial crisis in 2007-2009. We also discuss some of the lessons that can be learned from these responses and some of the challenges that face a lender of last resort.
    Keywords: Federal Reserve banks ; Banks and banking, Central ; Discount window
    Date: 2012
  9. By: David Cobham
    Abstract: Different ‘monetary architectures’ are distinguished, as a background to a discussion of the change in developed country monetary policy frameworks from fixed exchange rates under the Bretton Woods international monetary system to, ultimately, formal or informal inflation targeting. The introduction and experience of monetary targets in the 1970s is considered, followed by an analysis of the changes in countries’ monetary architectures, with particular reference to money and bond markets and to France and Italy, in the 1980s. Exchange rate targeting in Europe in the 1980s and 1990s is examined, followed by the changes in central bank independence in the 1990s. This leads to a discussion of the introduction of inflation targeting, and the issues raised for inflation targeting by the financial crisis of the late 2000s.
    Date: 2012
  10. By: Ellis W. Tallman
    Abstract: This paper summarizes the academic literature on the Panic of 1907 in the United States. Despite over 100 years of separation, research by financial economic historians continues to uncover important data and underexploited connections between institutions to improve present day understanding of a watershed economic event—one that preceded the successful movement to establish a central bank in the United States in 1913.
    Keywords: Financial crises ; Financial markets ; Bank liquidity
    Date: 2012
  11. By: Luis Felipe Céspedes; Roberto Chang; Andrés Velasco
    Abstract: This paper reviews the recent experience of a half-dozen Latin American inflation-targeting (IT) nations. We document repeated and large deviations from the standard IT framework: exchange market interventions have been lasting and widespread; the real exchange rate has often become a target of policy, though this target is seldom made explicit; a range of other non-conventional policy tools, especially changes in reserve requirements but occasionally also taxes or restrictions on international capital movements, also came into common use. As in developed nations, during the 2008-2009 crisis issues of liquidity provision took center stage. We also attempt a first evaluation of the emerging modified framework of monetary policy. In general terms, the new approach seems to have been effective, at the very least since the region weathered the crisis reasonably well. But also, and perhaps more importantly, many questions remain about the desirability of non-conventional monetary policies in Latin America.
    JEL: E52 E58 F41
    Date: 2012–11
  12. By: Patrice Muller; Graham Bishop; Shaan Devnani; Mark Lewis; Rohit Ladher
    Abstract: The study paper examines how non-bank financial institutions (in particular money market funds, private equity firms, hedge funds, pension funds and insurance undertakings, central counterparties, and UCITS and ETFs) have performed over the last decade and during the financial crisis. The report addresses the risks run by each of this type of institutions (credit, counterparty, liquidity, redemption, and fire sales risk), and highlights also the risks arising from a number of activities frequently undertaken by these institutions, in particular securitisation (a.o. agency risk), securities lending (a.o. counterparty risk) and repos (a.o. liquidity risk). The report finally provides a selected overview of approaches for the measurement of financial instability and financial distress.
    JEL: G23
    Date: 2012–11
  13. By: Matthew Schurin (University of Connecticut)
    Abstract: What should the government’s fiscal policy be when banks hold significant amounts of public debt and the government can default on its debt obligations? This question is addressed using a dynamic general equilibrium model where banks face constraints on their leverage ratios and adjust lending to satisfy regulatory requirements. In response to adverse real shocks, the government subsidizes banks and accelerates bond repayments to sustain private sector lending. When government consumption exogenously increases, however, the government optimally taxes banks and partially defaults on its debt. Debt issuance is procyclical to ensure equilibrium in the deposit market. With an opening of the economy, the government uses less aggressive tax and default policies. JEL Classification: E32, E62, F41, H21, H63 Key words: Business Fluctuations, Debt, Fiscal Policy, Government Bonds, Ramsey Equilibrium, Optimal Taxation
    Date: 2012–11
  14. By: Alan M. Taylor
    Abstract: In broad perspective, there have been essentially two competing views of the global financial crisis, albeit there are some complementarities among them. One view looks across the border: it mainly blames external imbalances, the large-scale mix of unprecedented pattern current account deficits and surpluses which entailed massive and growing net and gross international financial flows in the last decade. The alternative view looks within the border: it finds more fault in the domestic arena of the afflicted countries, attributing the problems to financial systems where risks originated in excessive credit booms in local banks. This paper uses the lens of macroeconomic and financial history to confront these dueling hypotheses with evidence. Of the two, the credit boom explanation stands out as the most plausible predictor of financial crises since the dawn of modern finance capitalism in the late nineteenth century. Historically, we find that global imbalances are not as important as a factor in financial crises as is often perceived, and they have much less correlation with subsequent episodes of financial distress compared to direct indicators like credit drawn from the financial system itself.
    JEL: E3 E4 E5 F3 F4 N1
    Date: 2012–12
  15. By: Konishi, Masaru
    Abstract: Using data from Japanese banks, this paper empirically investigates the relation between equity investment and bank risk during the period of banking crisis. Empirical evidence suggests that bank risk is positively associated with the ratio of shareholding to equity capital, suggesting that limiting shareholding can reduce commercial banks’ exposure to market risk. However, regulators should not expect that restricting banks from shareholding automatically leads to less bank failures in a financial system. This is because unhealthy banks voluntarily refrain from holding a large amount of firms’ shares relative to their equity capital, and bank risk is less sensitive to shareholding at unhealthy banks than at healthy banks.
    Keywords: Bank risk, Bank shareholding, Separation of banking and commerce
    JEL: G21 G28 G30
    Date: 2012–10
  16. By: David Cobham; Yue Kang
    Abstract: When Bank of England (and the Federal Reserve Board) introduced their quantitative easing (QE) operations they emphasised the effects on money and credit, but much of their empirical research on the effects of QE focuses on long-term interest rates. We use a flow of funds matrix with an independent central bank to show the implications of QE and other monetary developments, and argue that the financial crisis, the fiscal expansion and QE are likely to have constituted major exogenous shocks to money and credit in the UK which could not be digested immediately by the usual adjustment mechanisms. We present regressions of a reduced form model which considers the growth of nominal spending as determined by the growth of nominal money and other variables. These results suggest that money was not important during the Great Moderation but has had a much larger role in the period of the crisis and QE. We then use these estimates to illustrate the effects of the financial crisis and QE. We conclude that it would be useful to incorporate money and/or credit in wider macroeconometric models of the UK economy.
    Date: 2012
  17. By: Duprey, T.
    Abstract: Overall lending cyclicality increased in the years 2000s, but public bank lending remains significantly less cyclical than their private counterparts. This stylized fact is showed to hold empirically on a dataset of 140 countries over 1989-2009 covering 464 public banks and 72 privatizations while accounting for the unbalanced feature of the panel. Using a dataset on banking crisis and records about bank privatizations, I can control for nationalizations during crisis as well as the evolution of ownership status overtime. Nevertheless the cyclical properties remain heterogeneous depending (i) on the area considered --still procyclical in OECD countries, acyclical in Europe, while countercyclical for developing countries, or on (ii) the phase of the business cycle itself --with lower reactions to economic fluctuations in periods of recession, even in Europe, where credit expansion by public banks is then acyclical. As a robustness check, I indeed observe that newly privatized banks engage in more procyclical lending. In addition, most liability item, like short/long term liabilities or customer deposits, pattern the same reduced cyclicality, especially during economic downturns. Last, I do not find evidences that this cyclical pattern is encompassed by forced loans to the government nor institutional features.
    Keywords: lending cycle, procyclicality, public banking, privatizations.
    JEL: G21 G28 G32 H44
    Date: 2012
  18. By: David Cobham
    Abstract: The financial crisis and the role played within it by fluctuations in house prices has reopened the debate about whether monetary policy should respond to asset prices. This paper investigates how the central banks of the euro area, the UK and the US considered, understood and responded to the trends in house prices in the six or seven years preceding the crisis, and how they have analysed those developments since the crisis. It suggests that these central banks, particularly the Anglo-Saxon ones, might have been able to take some useful action if they had devoted more intellectual resources to analysing the possible misalignments of house prices and been willing to act on them.
    Date: 2012

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