nep-cba New Economics Papers
on Central Banking
Issue of 2013‒01‒19
thirteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Leverage, investment, and optimal monetary policy By Filippo Occhino; Andrea Pescatori
  2. Has the Basel Accord Improved Risk Management During the Global Financial Crisis? By Michael McAleer; Juan-Ángel Jiménez-Martín; Teodosio Pérez-Amaral
  3. Runs on Interest Rate Pegs By Christopher Phelan; Marco Bassetto
  4. The Impact of the LCR on the Interbank Money Market By Clemens Bonner; Sylvester Eijffinger
  5. Dealing with Exchange Rate Issues: Reserves or Capital Controls? By Raquel Almeida Ramos
  6. Sovereign Default, Domestic Banks, and Financial Institutions By Nicola Gennaioli; Alberto Martin; Stefano Rossi
  7. Monetary Transmission Mechanism and Time Variation in the Euro Area By Kemal Bagzibagli
  8. Inflation and Economic Growth By Robert J. Barro
  9. Financial Flows and Exchange Rates: Challenges Faced by Developing Countries By Raquel Almeida Ramos
  10. Financial stress index: a lens for supervising the financial system By Timothy Bianco; Dieter Gramlich; Mikhail V. Oet; Stephen J. Ong
  11. Eurozone: The Untold Economics By John Hatgioannides; Marika Karanassou; Hector Sala
  12. Financial Flows Can Create Exchange Rate Issues By Raquel Almeida Ramos
  13. Currency intervention and the global portfolio balance effect: Japanese lessons By Gerlach, Petra; McCauley, Robert N.; Ueda, Kazuo

  1. By: Filippo Occhino; Andrea Pescatori
    Abstract: We study optimal monetary policy in an economy where firms’ debt overhangs lead to under-investment and under-production. The magnitude of this debt-induced distortion varies over the business cycle, rising significantly during recessions. When debt is contracted in nominal terms, this distortion gives rise to a balance sheet channel for monetary policy. In the presence of real and financial shocks, the monetary authority faces a trade-off between inflation and output gap stabilization. The optimal monetary policy rule prescribes that the anticipated component of inflation should be set equal to a target level, while the unanticipated component should rise in response to adverse shocks, smoothing the debt overhang distortion and the output gap.
    Keywords: Business cycles ; Monetary policy
    Date: 2012
  2. By: Michael McAleer (Erasmus University Rotterdam); Juan-Ángel Jiménez-Martín (Complutense University of Madrid); Teodosio Pérez-Amaral (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: 2013–01–08
  3. By: Christopher Phelan (University of Minnesota); Marco Bassetto (Federal Reserve Bank of Chicago)
    Abstract: Until the last couple of years, most central banks around the world conducted monetary policy by setting targets for short-term interest rates. Manoeuvering interest rates as a way to achieve low and stable inflation is now regarded as a success story. Yet this was not always the case. As mentioned by Sargent (1983), the German Reichsbank also discounted treasury and commercial bills at fixed nominal interest rates in 1923; but, rather than contributing to stabilizing the value of the mark, the policy added fuel to the hyperinflation by transferring money to the government and to the lucky holders of the discounted commercial bills. In our paper, we study the extent to which setting a short-term interest rate can be used as a way of implementing a unique equilibrium in a monetary economy. We start our analysis in a simple environment where both the central bank and Treasury trade with all agents in the economy in every period. An explicit model of the interaction among the agents in the economy allows us to clearly specify the policies of the central bank and the fiscal authority as a mapping from histories to actions. We then analyze the consequences of an interest-rate rule, where the central bank sets a price at which private agents are free to trade currency for one-period debt. When the central bank faces a limit to its ability to print money, or when private agents are limited in the amount of bonds that can be pledged to the central bank in exchange for money, an interest-rate peg leads to multiple deterministic equilibria, one with low inflation and another one with high inflation and high money growth. The second equilibrium involves a run on the central bank's interest rate target, and the shadow interest rate in the private market is different from the central bank target. We then extend the analysis to environments where agents have infrequent access to financial markets, in which an interest rate run might evolve more gradually.
    Date: 2012
  4. By: Clemens Bonner; Sylvester Eijffinger
    Abstract: This paper analyzes the impact of a liquidity requirement similar to the Basel 3 Liquidity Coverage Ratio (LCR) on the unsecured interbank money market and therefore on the implementation of monetary policy. Combining two unique datasets of Dutch banks from 2005 to 2011, we show that banks which are just above/below their short-term regulatory liquidity requirement pay and charge higher interest rates for unsecured interbank loans. The effect is larger for maturities longer than the liquidity requirement’s 30 day horizon. Being close to the minimum liquidity requirement induces banks to increase borrowing volumes in general while it only decreases lending volumes for maturities longer than 30 days. These results also hold when controlling for an institution’s riskiness, the solvency of its counterparts, relationship-lending and period-specific effects.
    Keywords: Monetary Policy; Liquidity; Interbank Market; Basel 3
    JEL: G18 G21 E42
    Date: 2012–12
  5. By: Raquel Almeida Ramos (IPC-IG)
    Abstract: Developing countries? positions regarding the capital account have changed significantly in the last decade. After a period of wide liberalisation, country authorities have now been constantly increasing their policy toolkit with new instruments to intervene in the capital account and limit the consequences of excessively volatile capital flows. This change is a response to the increasing size and volatility of capital flows, which is associated with the process of financialisation that has been taking place in recent decades, where financial actors and motives have assumed more important roles. The increasing magnitude and volatility of finance-related flows are clearly shown in Figure 1, which presents the net financial flows excluding Foreign Direct Investment (FDI) received by developing and emerging countries since 1990. (?)
    Keywords: Dealing with Exchange Rate Issues: Reserves or Capital Controls?
    Date: 2012–11
  6. By: Nicola Gennaioli; Alberto Martin; Stefano Rossi
    Abstract: We present a model of sovereign debt in which, contrary to conventional wisdom, government defaults are costly because they destroy the balance sheets of domestic banks. In our model, better financial institutions allow banks to be more leveraged, thereby making them more vulnerable to sovereign defaults. Our predictions: government defaults should lead to declines in private credit, and these declines should be larger in countries where financial institutions are more developed and banks hold more government bonds. In these same countries, government defaults should be less likely. Using a large panel of countries, we find evidence consistent with these predictions. JEL classification: F34, F36, G15, H63. Keywords: Sovereign Risk, Capital Flows, Institutions, Financial Liberalization, Sudden Stops
    Date: 2012
  7. By: Kemal Bagzibagli
    Abstract: This paper examines the monetary transmission mechanism in the euro area for the period of single monetary policy using factor-augmented vector autoregressive (FAVAR) techniques. The contributions of the paper are fourfold. First, a novel dataset consisting of 120 disaggregated macroeconomic time series spanning the period 1999: M1 through 2011: M12 is gathered for the euro area as an aggregate. Second, Bayesian joint estimation technique of FAVARs is applied to the European data. Third, time variation in the transmission mechanism and the impact of the global financial crisis is investigated in the FAVAR context using a rolling windows technique. Fourth, we tried to contribute to the question of whether more data are always better for factor analysis as well as the estimation of structural FAVAR models. We find that there are considerable gains from the implementation of the Bayesian technique such as smoother impulse response functions and statistical significance of the estimates. According to our rolling estimations, consumer prices and monetary aggregates display the most time variant responses to the monetary policy shocks. The pre-screening technique considered, elimination of almost half of the dataset seems to do no worse, and in some cases, better in a structural context.
    Keywords: Monetary Policy Shocks, FAVAR, Bayesian Methods, Rolling Windows, Euro Area
    JEL: C11 C32 C33 E5
    Date: 2012–11
  8. By: Robert J. Barro (Department of Economics Littauer Center 120 Harvard University; NBER)
    Abstract: Data for around 100 countries from 1960 to 1990 are used to assess the effects of inflation on economic performance. If a number of country characteristics are held constant, then regression results indicate that the impact effects from an increase in average inflation by 10 percentage points per year are a reduction of the growth rate of real per capita GDP by 0.2-0.3 percentage points per year and a decrease in the ratio of investment to GDP by 0.4-0.6 percentage points. Since the statistical procedures use plausible instruments for inflation, there is some reason to believe that these relations reflect causal influences from inflation to growth and investment. However, statistically significant results emerge only when high-inflation experiences are included in the sample. Although the adverse influence of inflation on growth looks small, the long-term effects on standards of living are substantial. For example, a shift in monetary policy that raises the long-term average inflation rate by 10 percentage points per year is estimated to lower the level of real GDP after 30 years by 4-7%, more than enough to justify a strong interest in price stability.
    Date: 2012
  9. By: Raquel Almeida Ramos (IPC-IG)
    Abstract: With the global financial crisis, emerging developing countries have been experiencing marked cycles of capital flows: significant inflows until the collapse of Lehman Brothers; a sudden outflow in the sequence; a rebound of inflows some months after; and, more recently, more short-lived periods of risk aversion and outflows due to the problems concerning the Euro. This period has been of singular intensity, with cycles changing much more rapidly than previously. The different intensity has major implications for understanding the process, especially regarding the relative importance of push and pull factors and the formulation of policy options. (?)
    Keywords: Financial Flows and Exchange Rates: Challenges Faced by Developing Countries
    Date: 2012–11
  10. By: Timothy Bianco; Dieter Gramlich; Mikhail V. Oet; Stephen J. Ong
    Abstract: This paper develops a new financial stress measure (Cleveland Financial Stress Index, CFSI) that considers the supervisory objective of identifying risks to the stability of the financial system. The index provides a continuous signal of financial stress and broad coverage of the areas that could indicate it. The construction methodology uses daily public market data collected from different sectors of financial markets. A unique feature of the index is that it employs a dynamic weighting method that captures the changing relative importance of the different sectors of the financial system. This study shows how the index can be applied to monitoring and analyzing financial system conditions.
    Keywords: Financial markets ; Time-series analysis ; Interest rates ; Business cycles ; Econometric models
    Date: 2012
  11. By: John Hatgioannides (City University); Marika Karanassou (Queen Mary, University of London and IZA); Hector Sala (Universitat Autònoma de Barcelona and IZA)
    Abstract: This paper dwells on the Eurozone woes and addresses the origins of the transition from a fictitious boom to a painful bust by unravelling (i) the supply-side structural imbalances that formed the core-periphery economic divide, and (ii) the necessity of the periphery’s sovereign debt to finance imports from the export-led core. Within our macroeconomic setup, we challenge the cliché that countries of the core have funded the sovereign debts of the periphery and demonstrate that the commonly held view that the periphery countries have lived beyond their means (due to wages growing beyond what is justified by productivity gains) is in stark contrast to the trajectories followed by the wage shares. We argue against the tyrannical neoliberal policies of austerianism and we propose the rebooting of central and private banking. We present a fresh vision for the future of the Eurozone that will halt the tearing of the social fabric of its member states.
    Keywords: Eurozone crisis, Structural imbalances, Sovereign debt, Austerity, Neoliberal policies, Banking/credit system
    JEL: E50 E62 E65 G01
    Date: 2013–01
  12. By: Raquel Almeida Ramos (IPC-IG)
    Abstract: Developing countries have been receiving increasing amounts of finance-related flows, which are also becoming more volatile ?two features that increase the importance of such flows in determining exchange rates. This process is part of broader changes in the relationship between the ?financial? and the ?real? sectors, characterised by the increasing importance of financial assets and motives. These changes have been referred to as financialisation. (?)
    Keywords: Financial Flows Can Create Exchange Rate Issues
    Date: 2012–11
  13. By: Gerlach, Petra; McCauley, Robert N.; Ueda, Kazuo
    Abstract: This paper shows that the Japanese foreign exchange interventions in 2003/04 seem to have lowered long-term interest rates in a wide range of countries, including Japan. It seems that this decline was triggered by the investment of the intervention proceeds in US bonds and that a global portfolio balance effect spread the resulting decline in US yields to other bond markets, thus easing global monetary conditions.
    Keywords: exchange/investment/US
    Date: 2012–10

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