nep-cba New Economics Papers
on Central Banking
Issue of 2013‒03‒09
twenty-two papers chosen by
Maria Semenova
Higher School of Economics

  1. ECB projections as a tool for understanding policy decisions By Paul Hubert
  2. Central Bank Forecasts of Policy Interest Rates: An Evaluation of the First Years By Beechey, Meredith; Österholm, Pär
  3. On the use of sterilisation bonds in emerging Asia By Mehrotra, Aaron
  4. The influence and policy signaling role of FOMC forecasts By Paul Hubert
  5. Understanding Financial Crises: Causes, Consequences, and Policy Responses By Stijn Claessens; M. Ayhan Kose; Luc Laeven; Fabián Valencia
  6. Tailoring Bank Capital Regulation for Tail Risk By Nataliya Klimenko
  7. Benign neglect of the long-term interest rate By Philip Turner
  8. On measuring the nonlinear effect of interest rates on inflation and output By Hyeong Ho Moon; Tae-Hwan Kim; Seongho Nah
  9. Financial services regulation in the wake of the crisis: The Capital Requirements Directive IV and the Capital Requirements Regulation By Casselmann, Farina
  10. Sudden stops in emerging markets: How to minimize their impact on GDP? By José Osler Alzate Mahecha
  11. The Impact of Monetary Policy Surprises on Australian Financial Futures Markets By Xinsheng Lu; Ying Zhou; Mingting Kou
  12. How Likely is Contagion in Financial Networks? By H Peyton Young; Paul Glasserman
  13. Rethinking potential output: Embedding information about the financial cycle By Claudio Borio; Frank Piti Disyatat; Mikael Juselius
  14. Does “Skin in the Game” Reduce Risk Taking? Leverage, Liability and the Long-Run Consequences of New Deal Financial Reforms By Mitchener, Kris James; Richardson, Gary
  15. Financial Crises: Explanations, Types and Implications By Stijn Claessens; M. Ayhan Kose
  16. Policy Responses to the Global Financial Crisis: What Did Emerging Economies Do Differently? By Ceballos, Francisco; Didier, Tatiana; Hevia, Constantino; Schmukler, Sergio
  17. Equilibrium Credit: The Reference Point for Macroprudential Supervisors By Buncic, Daniel; Martin Melecky
  18. Nonlinear Mechanism of the Exchange Rate Pass-Through: Does Business Cycle Matter? By Nidhaleddine Ben Cheikh
  19. The Current Eurozone – an impediment to critical French reform By Brigitte Granville
  20. Economic Stability and Choice of Exchange Rate Regimes By Kaji, Sahoko
  21. Labour's Record on Financial Regulation By Arupratan Daripa; Sandeep Kapur; Stephen Wright
  22. Granger Causality from Exchange Rates to Fundamentals: What Does the Bootstrap Test Show Us? By Hsiu-Hsin Ko; Masao Ogaki

  1. By: Paul Hubert (Ofce sciences-po)
    Abstract: The European Central Bank publishes inflation projections quarterly. This paper aims at establishing whether they influence private forecasts and whether they may be considered as an enhanced means of implementing policy decisions by facilitating private agents’ information processing. We provide original evidence that ECB inflation projections do influence private inflation expectations. We also find that ECB projections give information about future ECB rate movements, and that the ECB rate has different effects if complemented or not with the publication of ECB projections. We conclude that ECB projections enable private agents to correctly interpret and predict policy decisions
    Keywords: Monetary policy, ECB, Private forecasts,Influence, structural Var
    JEL: E52 E58
    Date: 2013–02
  2. By: Beechey, Meredith (Sveriges Riksbank); Österholm, Pär (National Institute of Economic Research)
    Abstract: In recent years the central banks of Norway and Sweden have published their endogenous policy interest-rate forecasts. In this paper, we evaluate those forecasts alongside policy-rate expectations inferred from market pricing. We find that for both economies there are only small differences in relative forecasting precision between the central bank and market-implied measures. However, both types of forecast fail tests for unbiasedness and efficiency at longer horizons.
    Keywords: Monetary policy; Market expectations; Norges Bank; Sveriges Riksbank
    JEL: E52
    Date: 2013–01–22
  3. By: Mehrotra, Aaron (BOFIT)
    Abstract: We document recent developments in the use of sterilisation bonds by six central banks in emerging Asia, and discuss the implications for monetary policy and the financial sector. An important development in the sterilisation of foreign exchange interventions in past years has been the frequent use of central banks’ own paper. There has been an attempt to lengthen the maturity structure of sterilisation bills, and maturities have risen, especially in 2010–11. The choice of sterilisation instrument is likely to depend partly on their relative costs. In particular, as the yield on central bank securities has fallen relative to the rate of remuneration of required reserves, some central banks in Asia have increasingly used central bank securities for sterilisation.
    Keywords: sterilisation bond; central bank bonds and bills; foreign exchange reserves; emerging Asia;
    JEL: E43 E50 E52 E58
    Date: 2013–01–15
  4. By: Paul Hubert (Ofce sciences-po)
    Abstract: Policymakers at the Federal Open Market Committee (FOMC) publish forecasts since 1979. We examine the effects of publishing FOMC inflation forecasts in two steps using a structural VAR model. We assess whether they influence private inflation expectations and the underlying mechanism at work: do they convey policy signals for forward guidance or help interpreting current policy decisions? We provide original evidence that FOMC inflation forecasts are able to influence private ones. We also find that FOMC forecasts give information about future Fed rate movements and affect private expectations in a different way than Fed rate shocks. This body of evidence supports the use of central bank forecasts to affect inflation expectations especially while conventional policy instruments are at the zero lower bound
    Keywords: Monetary policy, Forecasts, FOMC, influence, Policy signals, structural Var
    JEL: E52 E58
    Date: 2013–02
  5. By: Stijn Claessens; M. Ayhan Kose; Luc Laeven; Fabián Valencia
    Abstract: The global financial crisis of 2007-09 has led to an intensive research program analyzing a wide range of issues related to financial crises. This paper presents a summary of a forthcoming book, Financial Crises: Causes, Consequences, and Policy Responses, that includes 19 contributions examining these issues and distilling policy lessons. The book covers a wide range of crises, including banking, balance-of-payments, and sovereign debt crises. It reviews the typical patterns prior to crises, considers lessons on their antecedents, and analyzes their evolution and aftermath. It also provides valuable policy lessons on how to prevent, contain and manage financial crises.
    Keywords: Global financial crisis, sudden stops, debt crises, banking crises, currency crises, defaults, restructuring, welfare cost, asset price busts, credit busts, prediction of crises
    JEL: E32 F44 G01 E5 E6 H12
    Date: 2013–02
  6. By: Nataliya Klimenko (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS)
    Abstract: The experience of the 2007-09 financial crisis has showed that the bank capital regulation in place was inadequate to deal with "manufacturing" tail risk in the financial sector. This paper proposes an incentive-based design of bank capital regulation aimed at efficiently dealing with tail risk engendered by bank top managers. It has two specific features: (i) first, it incorporates information on the optimal incentive contract between bank shareholders and bank managers, thereby dealing with the internal agency problem; (ii) second, it relies on the mechanism of mandatory recapitalization to ensure this contract is adopted by bank shareholders.
    Keywords: Capital requirements, tail risk, recapitalization, incentive compensation, moral hazard.
    JEL: G21 G28 G32 G35
    Date: 2013–02
  7. By: Philip Turner
    Abstract: Large-scale central bank purchases of government bonds have made the long-term interest rate key in the monetary policy debate. How central banks react to bond market movements has varied greatly from one episode to another. Driving the term premium in long-term rates negative may stimulate aggregate demand. And a negative term premium encourages borrowers to lengthen the maturity of their debts. Such a reduction in maturity risks makes the financial system more resilient to shocks, and in particular can help emerging economies finance their heavy infrastructure and housing investment needs more safely. But an extended period of very low long rates and high public debt creates financial stability risks. Interest rate risk in the banking system has grown, and some institutional investors face significant exposures. Central banks in the advanced economies now hold a high proportion of bonds issued by their governments, most of which have so far failed to arrest the rise in the ratio of government debt to GDP. Implementing an effective exit strategy will be difficult. Current policy frameworks should be reconsidered, with a view to clarifying the importance of the long-term interest rate for monetary policy, for financial stability and for government debt management.
    Keywords: Central banks, bond market crisis, exit strategy, sovereign debt management
    Date: 2013–02
  8. By: Hyeong Ho Moon (Department of Economics, University of California at San Diego, USA); Tae-Hwan Kim (School of Economics, Yonsei University, South Korea); Seongho Nah (Bank of Korea, South Korea)
    Abstract: While economists are interested in the reaction of the interest rate to changes in the inflation rate, central bankers are usually more interested in the reverse causal relationship, i.e., the response of inflation (and output) to a change in the official interest rate as administrated by the central bank. Whether the reverse causal relationship is linear or nonlinear is an empirical issue. We investigated the reverse causal relationship by employing the LSTVAR model proposed by Weise (1999). We found strong evidence in favor of nonlinearity. As a consequence of the nonlinearity, we discovered various types of asymmetric effects of the interest rate on inflation and output. An asymmetric effect of monetary shocks of different sizes was uncovered, which implies that when the unexpected change in the official rate is doubled (i.e. from 0.25% to 0.5%), its effect on inflation and output is likely to be more than doubled. However, this finding is upheld only when the economy is in recession. The opposite result, in which the effect is smaller, is supported when the economy is expanding. Regarding the other asymmetric effect of monetary shocks with different signs, we found that central banks can expect that increasing the official rate by some certain amount (e.g. 0.25%) is likely to have much larger effect on inflation and output than decreasing the rate by the same amount (e.g. -0.25%) regardless of the state of the economy.
    Keywords: Nonlinear VAR, impulse response function, asymmetric monetary effect
    JEL: E43 E58
    Date: 2012–02–13
  9. By: Casselmann, Farina
    Abstract: This paper analyzes the Capital Requirements Directive IV and the Capital Requirements Regulation, a new legislative package proposed by the European Commission in July 2011 which aims to strengthen the regulation of the banking sector and amend the European Union's rules on capital requirements for banks and investment firms. It is argued that the CRD IV package makes a great contribution towards creating a sounder and safer financial system, however, several aspects are insufficiently addressed and/or not comprehensive enough to produce the anticipated results. It is found that the main fallacies of the CRD IV proposal lay in increased risk-taking, procyclicality, deficient implementation, overreliance on credit rating agencies, and risk weightings. Moreover, the proposal does not touch upon the issues of the shadow banking system, diversification, the problem of 'too-big-to-fail' or the 'Volcker Rule'. It is, hence, concluded that the CRD IV proposal is not ambitious enough to address essential issues of systemic risk, regulatory arbitrage, or the fragility of the financial system. --
    JEL: E25 E44 F4
    Date: 2013
  10. By: José Osler Alzate Mahecha
    Abstract: Since the beginning of the 1990s, capital flows to emerging markets soared to historically high levels. However, many countries suffered sudden stops in these capital flows. These sudden stops affected simultaneously several countries with different economic characteristics. Taking into account the sudden stop episodes that occurred after 1990, this work attempts to analyze in an empirical manner which characteristics and policies helped reduce the cost of the different crises on GDP. The countries with a lower level of external debt had a less costly crisis. Additionally, a countercyclical fiscal policy and the sale of international reserves to counter the domestic currency’s depreciation also helped reduce the cost of the sudden stops on output. On the other hand, the level of exports and the changes in the central bank’s interest rate did not have statistically significant effects.
    Date: 2013–01–27
  11. By: Xinsheng Lu (Department of Economics and Finance, Tongji University, China); Ying Zhou (Department of Economics, Auckland University of Technology); Mingting Kou (Business School, Datong University, China)
    Abstract: This paper investigates the impact of unanticipated Australian monetary policy changes on AUD/USD exchange rate futures, 3-year and 10-year Australian Treasury bond futures, during the period from January 1997 to April 2010. Our study contributes to the literature by using both 30-day and 90-day bank accepted bill (BAB) rates to disentangle anticipated from surprise cash rate target changes in the Australian money market, and by concurrently modelling the effects of monetary surprises and other key macroeconomic announcements in Australia. The empirical results suggest that the 30-day BAB rate is served as the best proxy for the expected monetary policy actions. Further, the effect of Australian monetary surprises on volatility of all futures instruments is significant and complete when other key macroeconomic announcements are considered simultaneously.
    Keywords: monetary policy surprises, financial futures, asset return volatility
    JEL: C22 E44 G12 G14
    Date: 2013–01
  12. By: H Peyton Young; Paul Glasserman
    Abstract: Interconnections among financial institutions create potential channels for contagion and amplification of shocks to the financial system.  We propose precise definitions of these concepts and analyze their magnitude.  Contagion occurs when a shock to the assets of a single firm causes other firms to default through the network of obligations; amplification occurs when losses among defaulting nodes keep escalating due to their indebtedness to one another.  Contagion is weak if the probability of default through contagion is no greater than the probability of default through independent direct shocks to the defaulting nodes.  We derive a general formula which shows that, for a wide variety of shock distributions, contagion is weak unless the triggering node is large and/or highly leveraged compared to the nodes it topples through contagion.  We also estimate how much the interconnections between nodes increase total losses beyond the level that would be incurred without interconnections.  A distinguishing feature of our approach is that the results do not depend on the specific topology: they hold for any financial network with a given distribution of bank sizes and leverage levels.  We apply the framework to European Banking Authority data and show that both the probability of contagion and the expected increase in losses are small under a wide variety of shock distributions.  Our conclusion is that the direct transmission of shocks through payment obligations does not have a major effect on defaults and losses; other mechanisms such as loss of confidence and declines in credit quality are more llikely sources of contagion.
    Keywords: Systemic risk, contagion, financial network
    JEL: D85 G21
    Date: 2013–02–05
  13. By: Claudio Borio; Frank Piti Disyatat; Mikael Juselius
    Abstract: This paper argues that incorporating information about the financial cycle is important to improve measures of potential output and output gaps. Conceptually, identifying potential output with non-inflationary output is too restrictive. Potential output is seen as sustainable; yet experience indicates that output may be on an unsustainable path even if inflation is low and stable whenever financial imbalances are building up. More generally, as long as potential output is identified with the non-cyclical component of output fluctuations and financial factors play a key role in explaining the cyclical part, ignoring these factors leaves out valuable information. Within a simple and transparent framework, we show that including information about the financial cycle can yield measures of potential output and output gaps that are not only estimated more precisely, but also much more robust in real time. In the context of policy applications, such "finance-neutral" output gaps are shown to yield more reliable estimates of cyclically adjusted budget balances and to serve as complementary guides for monetary policy.
    Keywords: Potential output, output gap, financial cycle, monetary policy, fiscal policy
    Date: 2013–02
  14. By: Mitchener, Kris James (University of Warwick); Richardson, Gary (University of California, Irvine)
    Abstract: We examine how the Banking Acts of the 1933 and 1935 and related New Deal legislation influenced risk taking in the financial sector of the U.S. economy. Our analysis focuses on contingent liability of bank owners for losses incurred by their firms and how the elimination of this liability influenced leverage and lending by commercial banks. Using a new panel data set that compares balance sheets of state and national banks, we find contingent liability reduced risk taking, particularly when coupled with rules requiring banks to join the Federal Deposit Insurance Corporation. Leverage ratios are higher in states with limited liability for bank owners. Banks in states with contingent liability converted each dollar of capital into fewer loans, and thus could sustain larger loan losses (as a fraction of their portfolio) than banks in limited liability states. The New Deal replaced a regime of contingent liability with stricter balance sheet regulation and increased capital requirements, shifting the onus of risk management from banks to state and federal regulators. By separating investment banks from commercial banks, the Glass-Steagall Act left investment banks to manage their own leverage, a feature of financial regulation that, in part, depended on their partnership structure.
    Date: 2013
  15. By: Stijn Claessens; M. Ayhan Kose
    Abstract: This paper reviews the literature on financial crises focusing on three specific aspects. First, what are the main factors explaining financial crises? Since many theories on the sources of financial crises highlight the importance of sharp fluctuations in asset and credit markets, the paper briefly reviews theoretical and empirical studies on developments in these markets around financial crises. Second, what are the major types of financial crises? The paper focuses on the main theoretical and empirical explanations of four types of financial crises?currency crises, sudden stops, debt crises, and banking crises?and presents a survey of the literature that attempts to identify these episodes. Third, what are the real and financial sector implications of crises? The paper briefly reviews the short- and medium-run implications of crises for the real economy and financial sector. It concludes with a summary of the main lessons from the literature and future research directions.
    Keywords: Sudden stops, debt crises, banking crises, currency crises, defaults, policy implications, financial restructuring, asset booms, credit booms, crises prediction
    JEL: E32 F44 G01 E5 E6 H12
    Date: 2013–02
  16. By: Ceballos, Francisco (World Bank); Didier, Tatiana (World Bank); Hevia, Constantino (World Bank); Schmukler, Sergio (World Bank)
    Abstract: In contrast to the past, many emerging countries faced the global financial crisis of 2008-2009 with more solid financial positions and the required credibility and capacity to conduct countercyclical policies. This allowed them to better cope with the global downturn and thus behave more similarly to developed countries. This paper documents the policy responses and discusses other factors that allowed emerging countries to partially absorb the negative external shock. In particular, it characterizes (i) monetary and exchange rate policies, (ii) fiscal policy, and (iii) external and domestic financial positions.
    Keywords: financial crisis, policy cyclicality, fiscal policy, monetary policy
    JEL: E50 F30 G01 G15
    Date: 2013–01
  17. By: Buncic, Daniel; Martin Melecky
    Abstract: Equilibrium credit is an important concept as it helps identify excessive credit provision. This paper proposes a two-stage approach to determine equilibrium credit. The two stages allow us to study changes in the demand for credit due to varying levels of economic, financial and institutional development of a country. Using a panel of high- and middle-income countries over the period 1980-2010, we provide empirical evidence that the credit-to-GDP ratio is inappropriate to measure equilibrium credit. The reason for this is that such an approach ignores heterogeneity in the parameters that determine equilibrium credit across countries due to different stages of economic development. The main drivers of this heterogeneity are financial depth, access to financial services, use of capital markets, efficiency and funding of domestic banks, central bank independence, the degree of supervisory integration, and experience of a financial crisis. Also, countries in Europe and Central Asia show a slower adjustment of credit to its long-run equilibrium compared to other regions of the world.
    Keywords: Equilibrium Credit, Macroprudential Supervision, Demand for Credit, Time-Series Panel Data, High- and Middle Income Countries
    JEL: G28 E58 G21
    Date: 2013–01
  18. By: Nidhaleddine Ben Cheikh (University of Rennes 1 - CREM UMR CNRS 6211, France)
    Abstract: This paper examines the presence of nonlinear mechanism in the exchange rate pass-through (ERPT) to CPI inflation for 12 euro area (EA) countries. Using logistic smooth transition models, we explore the existence of nonlinearity with respect to economic activity along the business cycle. Our results provide a strong evidence of nonlinearity in 6 out of 12 EA countries with significant differences in the degree of ERPT between the periods of expansion and recession. However, we find no clear direction in this regime-dependence of pass-through to business cycle. In some countries, ERPT is higher during expansions than in recessions; however, in other countries, this result is reversed. These cross-country differences in the nonlinear mechanism of pass-through would have important implications for the design of monetary policy and the control of inflation in the EA context.
    Keywords: Exchange Rate Pass-Through, Inflation, Smooth Transition Regression
    JEL: C22 E31 F31
    Date: 2013–01
  19. By: Brigitte Granville
    Abstract: France currently needs deep structural reforms to boost competitiveness; but such reforms seem impossible while France remains in the straitjacket of the rules-bound transfer union that is the current Eurozone. High outstanding sovereign debt coupled with almost zero economic growth pose a real challenge to the French economy saved only by the relatively low government bond yield but this is subject to market swings. An unacceptably large proportion of the French workforce is trapped in long-term unemployment with the most affected part of the population being the young and older workers suffering from long term unemployment because of the adverse incentives brought about by a social safety net financed by taxing labour.
    Keywords: Euro, transfers, internal devalution, current account, public debt, inflation.
    JEL: J45 H11 J23
    Date: 2013–03
  20. By: Kaji, Sahoko (Asian Development Bank Institute)
    Abstract: This paper emphasizes the importance of Europe’s structural problems and governance as the cause of the current euro area crisis. The euro may have led to bubbles, but member economies were not free of trouble before the euro. Many members were losing competitiveness and in need of removing structural rigidities. If anything, the euro was expected to encourage structural reform, by taking away the easy choice of monetary and fiscal expansion. We first discuss the relationship between the single currency and economic stability in Europe. We confirm the asymmetries that remained after the introduction of the euro and then discuss the governance overhaul taking place in Europe today. This overhaul was something that should have been done before introducing the euro, and its advancement may be the silver lining of this crisis. Finally, we touch upon the implications for Asia and Japan, from the point of view of the choice of exchange rate regime as a method to advance necessary reforms.
    Keywords: single currency; europe; euro area crisis; economic stability; exchange rate regimes
    JEL: F33 F41
    Date: 2013–02–20
  21. By: Arupratan Daripa (Department of Economics, Mathematics & Statistics, Birkbeck); Sandeep Kapur (Department of Economics, Mathematics & Statistics, Birkbeck); Stephen Wright (Department of Economics, Mathematics & Statistics, Birkbeck)
    Abstract: In 1997 the new Labour government launched major initiatives in the area of financial regulation, setting up the Financial Services Authority as a comprehensive regulatory body, supported by the legislative framework of the Financial Services and Markets Act 2000. We evaluate the Labour government’s record on financial regulation in terms of its achievements and failures, especially in dealing with the global financial crisis that started in 2007. While we identify some clear flaws in regulatory design and enforcement, our evaluation highlights some inherent difficulties of financial regulation.
    Keywords: Financial Regulation, New Labour, Financial Crisis
    JEL: G01 G2
    Date: 2013–02
  22. By: Hsiu-Hsin Ko (National University of Kaohsiung); Masao Ogaki
    Abstract: We use a residual-based bootstrap method to re-examine the finding of the Granger causality relationship from exchange rates to fundamentals in Engel and West (Exchange rate and fundamentals, Journal of Political Economy 2005, 113 (3), 485–517), in which the evidence for the relation is taken as evidence for the present-value model for exchange rates. The test results are against the previous findings. The Monte Carlo experiment results suggest that the causality test implemented in the previous study tends to spuriously reject null hypotheses. Thus, the existing evidence for the present value model for exchange rates is not robust.
    Keywords: Bootstrap, Granger causality, exchange rates, fundamentals
    JEL: F30 F31 C32
    Date: 2013–02

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