nep-cba New Economics Papers
on Central Banking
Issue of 2013‒08‒16
nineteen papers chosen by
Maria Semenova
Higher School of Economics

  1. The systemic risk of European banks during the financial and sovereign debt crises By Lamont Black; Ricardo Correa; Xin Huang; Hao Zhou
  2. Bank size and macroeconomic shock transmission: Are there economic volatility gains from shrinking large, too big to fail banks? By Uluc Aysun
  3. Monetary Policy Regimes and Inflation in the New-Keynesian Model By Bartholomew Moore
  4. Markov Switching and the Taylor Principle By Christian Murray; Nikolsko-Rzhevskyy Alex; Papell David
  5. Monetary policy expectations at the zero lower bound By Michael D. Bauer; Glenn D. Rudebusch
  6. Chinese monetary expansion and the U.S. economy By Vespignani, Joaquin L.; Ratti, Ronald A
  7. ECB monetary policy in the recession: a New Keynesian (old monetarist) critique By Robert L. Hetzel
  8. Sudden stops, time inconsistency, and the duration of sovereign debt By Juan Carlos Hatchondo; Leonardo Martinez
  9. Capital Controls and Recovery from the Financial Crisis of the 1930s By Mitchener, Kris James; Wandschneider, Kirsten
  10. Systemic Risk Measures By Solange Maria Guerra; Benjamin Miranda Tabak; Rodrigo Andrés de Souza Penaloza; Rodrigo César de Castro Miranda
  11. Loan Pricing Following a Macro Prudential Within-Sector Capital Measure By Bruno Martins; Ricardo Schechtman
  12. Optimal Dynamic Portfolio with Mean-CVaR Criterion By Jing Li; Mingxin Xu
  13. Financial Openness, Market Structure and Private Credit: An Empirical Investigation By Ronald Fischer; Patricio Valenzuela
  14. (When) does money growth help to predict Euro-area inflation at low frequencies? By Schreiber, Sven
  15. Searching for Irving Fisher By Mitchener, Kris James; Weidenmier, Marc D
  16. Solving second and third-order approximations to DSGE models: A recursive Sylvester equation solution By Andrew Binning
  17. The determinants of the deviations from the interest rate parity condition By Uluc Aysun; Sanglim Lee
  18. Are Credit Shocks Supply or Demand Shocks? By Bijapur, Mohan
  19. Too big to fail in Banking: What does it mean? By George Kaufman

  1. By: Lamont Black; Ricardo Correa; Xin Huang; Hao Zhou
    Abstract: We propose a hypothetical distress insurance premium (DIP) as a measure of the European banking systemic risk, which integrates the characteristics of bank size, default probability, and interconnectedness. Based on this measure, the systemic risk of European banks reached its height in late 2011 around € 500 billion. We find that the sovereign default spread is the factor driving this heightened risk in the banking sector during the European debt crisis. The methodology can also be used to identify the individual contributions of over 50 major European banks to the systemic risk measure. This approach captures the large contribution of a number of systemically important European banks, but Italian and Spanish banks as a group have notably increased their systemic importance. We also find that bank-specific fundamentals predict the one-year-ahead systemic risk contribution of our sample of banks in an economically meaningful way.
    Date: 2013
  2. By: Uluc Aysun (University of Central Florida, Orlando, FL)
    Abstract: This paper investigates the transmission of macroeconomic shocks to production in a model that includes a large and a small bank. The two banks are differentiated by parameters that govern their sensitivities to their own and their borrowers’ balance sheets and simulations show that the large (small) bank responds more to demand/financial (supply) shocks. Bank-level evidence generally supports the model’s assumptions but indicates that the large banks’ sensitivities and the sensitivity to borrower balance sheets are more important. Incorporating U.S. macroeconomic shocks into the empirical model illustrates a stronger transmission through large bank lending. Shrinking banks can, therefore, decrease volatility.
    Keywords: bank size, economic fluctuations, call report data, too big to fail, DSGE model
    JEL: E44 E32 G21 E02
    Date: 2013–08
  3. By: Bartholomew Moore (Fordham University)
    Abstract: This paper shows that plausible modifications to the Taylor rule for monetary policy can help explain several empirical anomalies to the behavior of inflation in the new--Keynesian general equilibrium model. The key anomalies considered are (1) the persistence of inflation, both in reduced form and after conditioning on inflation's driving processes, (2) the positive correlation between the output gap and the change in the inflation rate, and (3) the apparent bias in survey measures of expected inflation. The Taylor rule in this model includes the now standard assumption that the central bank smoothes changes to its target interest rate. It also includes Markov switching of a persistent inflation target between a low target rate and a high target rate. The model is calibrated to match Benati's (2008) result that, historically, changes in monetary policy lead to a statistically significant change in the persistence of inflation. Matching Benati's result requires a reduction in an exogenous, hence structural, source of persistence. However, inflation in the model inherits additional, non-structural, persistence from the process that governs the inflation target. As a result, the model is able to replicate measures of inflation persistence, even after conditioning on inflation's driving processes. Agents with rational expectations and knowledge of the current inflation target will be aware of the possibility of a future target switch, causing their expectations to appear biased in small samples. Finally, with sticky nominal prices a discrete drop to the low-inflation target requires a loss of output while previously-set prices adjust.
    Keywords: Monetary Policy, Markov Switching, Inflation Persistence, Expectations
    JEL: E52 E31 D84
    Date: 2013
  4. By: Christian Murray (University of Houston); Nikolsko-Rzhevskyy Alex (Lehigh University); Papell David (University of Houston)
    Abstract: Early research on the Taylor rule typically divided the data exogenously into pre-Volcker and Volcker-Greenspan subsamples.  We contribute to the recent trend of endogenizing changes in monetary policy by estimating a real-time forward-looking Taylor rule with endogenous Markov switching coefficients and variance. The response of the interest rate to inflation is regime dependent, with the pre and post-Volcker samples containing monetary regimes where the Fed did and did not follow the Taylor principle. While the Fed consistently adhered to the Taylor principle before 1973 and after 1984, it followed the Taylor principle from 1975-1979 and did not follow the Taylor principle from 1980-1984.  We also find that the Fed only responded to real economic activity during the states in which the Taylor principle held.  Our results are consistent with the idea that exogenously dividing postwar monetary policy into pre-Volcker and post-Volcker samples misleading. The greatest qualitative difference between our results and recent research employing time varying parameters is that we find that the Fed did not adhere to the Taylor Principle during most of Paul Volcker’s tenure, a finding which accords with the historical record of monetary policy.
    Keywords: Markov Switching, Taylor Principle, Taylor Rule
    JEL: E52 C24
    Date: 2013–08–05
  5. By: Michael D. Bauer; Glenn D. Rudebusch
    Abstract: Obtaining monetary policy expectations from the yield curve is difficult near the zero lower bound (ZLB). Standard dynamic term structure models, which ignore the ZLB, can be misleading. Shadow-rate models are better suited for this purpose, because they account for the distributional asymmetry in projected short rates induced by the ZLB. Besides providing better interest rate fit and forecasts, our shadow-rate models deliver estimates of the future monetary policy liftoff from the ZLB that are closer to survey expectations. We also document significant improvements for inference about monetary policy expectations when macroeconomic factors are included in the term structure model.
    Keywords: Monetary policy ; Macroeconomics - Econometric models
    Date: 2013
  6. By: Vespignani, Joaquin L.; Ratti, Ronald A
    Abstract: This paper examines the influence of monetary shocks in China on the U.S. economy over ‎‎1996-2012. The influence on the U.S. is through the sheer scale of China’s growth through ‎effects in demand for imports, particularly that of commodities. China’s growth influences ‎world commodity/oil prices and this is reflected in significantly higher inflation in the U.S. ‎China’s monetary expansion is also associated with significant decreases in the trade ‎weighted value of the U.S. dollar that is due to the operation of a pegged currency. China ‎manages the exchange rate and has extensive capital controls in place. In terms of the ‎Mundell–Fleming model, with imperfect capital mobility, sterilization actions under a ‎managed exchange rate permit China to pursue an independent monetary policy with ‎consequences for the U.S.‎
    Keywords: International monetary transmission, U.S. Macroeconomics, China’s monetary policy
    JEL: E42 E5 E50 E52 E58
    Date: 2013–08–04
  7. By: Robert L. Hetzel
    Abstract: Use of the New Keynesian model to identify shocks points to contractionary monetary policy as the cause of the Great Recession in the Eurozone.
    Keywords: Monetary policy ; Recessions ; Keynesian economics
    Date: 2013
  8. By: Juan Carlos Hatchondo; Leonardo Martinez
    Abstract: We study the sovereign debt duration chosen by the government in the context of a standard model of sovereign default. The government balances increasing the duration of its debt to mitigate rollover risk and lowering duration to mitigate the debt dilution problem. We present two main results. First, when the government decides the debt duration on a sequential basis, sudden stop risk increases the average duration by 1 year. Second, we illustrate the time inconsistency problem in the choice of sovereign debt duration: Governments would like to commit to a duration that is 1.7 years shorter than the one they choose when decisions are made sequentially.
    Keywords: Debt
    Date: 2013
  9. By: Mitchener, Kris James (University of Warwick); Wandschneider, Kirsten (Occidental College)
    Abstract: We examine the first widespread use of capital controls in response to a global or regional financial crisis. In particular, we analyze whether capital controls mitigated capital flight in the 1930s and assess their causal effects on macroeconomic recovery from the Great Depression. We find evidence that they stemmed gold outflows in the year following their imposition; however, time-shifted, difference-indifferences (DD) estimates of industrial production, prices, and exports suggest that exchange controls did not accelerate macroeconomic recovery relative to countries that went off gold and floated. Countries imposing capital controls also appear to perform similar to the gold bloc countries once the latter group of countries finally abandoned gold. Time series regressions further demonstrate that countries imposing capital controls refrained from fully utilizing their newly acquired monetary policy autonomy. Even so, capital controls remained in place as instruments for manipulating trade flows and for preserving foreign exchange for the repayment of external debt.
    Keywords: capital controls, financial crises, Great Depression, interwar gold standard
    Date: 2013
  10. By: Solange Maria Guerra; Benjamin Miranda Tabak; Rodrigo Andrés de Souza Penaloza; Rodrigo César de Castro Miranda
    Abstract: In this paper we present systemic risk measures based on contingent claims approach, banking sector multivariate density and cluster analysis. These indicators aim to capture credit risk stress and its potential to become systemic. The proposed measures capture not only individual bank vulnerability, but also the stress dependency structure between them. Furthermore, these measures can be quite useful for identifying systematically important banks. The empirical results show that these indicators capture with considerable fidelity the moments of increasing systemic risk in the Brazilian banking sector in recent years.
    Date: 2013–08
  11. By: Bruno Martins; Ricardo Schechtman
    Abstract: This paper investigates the consequences on loan spreads of a within-sector macro prudential capital measure in Brazil. Due to concerns related to a possibly too fast and unbalanced expansion of the auto-loan sector, regulatory capital was raised for auto-loans with specific long maturities and high LTVs. Our results show that Brazilian banks, after the regulatory measure, increased spreads charged on the same borrower for similar auto loans whose regulatory risk weights have increased. In comparison to the set of untargeted loans, the increase was at least of 13%. On the other hand, evidence on increase of spreads also for loans whose risk weights have not been altered is not robust. Finally, this paper shows that the later withdrawal of the regulatory capital measure was associated, similarly, to lower spreads charged on auto loans whose risk weights have decreased. Nevertheless, when measured relatively, this reduction in spreads was smaller than the original increase.
    Date: 2013–08
  12. By: Jing Li; Mingxin Xu
    Abstract: Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR) are popular risk measures from academic, industrial and regulatory perspectives. The problem of minimizing CVaR is theoretically known to be of Neyman-Pearson type binary solution. We add a constraint on expected return to investigate the Mean-CVaR portfolio selection problem in a dynamic setting: the investor is faced with a Markowitz type of risk reward problem at final horizon where variance as a measure of risk is replaced by CVaR. Based on the complete market assumption, we give an analytical solution in general. The novelty of our solution is that it is no longer Neyman-Pearson type where the final optimal portfolio takes only two values. Instead, in the case where the portfolio value is required to be bounded from above, the optimal solution takes three values; while in the case where there is no upper bound, the optimal investment portfolio does not exist, though a three-level portfolio still provides a sub-optimal solution.
    Date: 2013–08
  13. By: Ronald Fischer; Patricio Valenzuela
    Abstract: This paper empirically examines whether the effect of financial openness on private credit depends on the market structure of the banking sector prior liberalization. We find that financial openness has a positive effect on private credit in countries characterized by a highly competitive banking sector. However, this effect vanishes and even becomes negative in countries where the market structure is one of imperfect competition. These findings are consistent with the predictions of recent theoretical models.
    Date: 2013
  14. By: Schreiber, Sven
    Abstract: Short answer: It helps a lot when other important variables are excluded from the information set. Longer answer: We revisit claims in the literature that money growth is Granger-causal for inflation at low frequencies. Applying frequency-specific tests in a comprehensive system setup for euro-area data we consider various theoretical predictors of inflation. A general-to-specific testing strategy reveals a recursive structure where only the unemployment rate and long-term interest rates are directly Granger-causal for low-frequency inflation movements, and all variables affect money growth. We therefore interpret opposite results from bivariate inflation/money growth systems as spurious due to omittedvariable biases. We also analyze the resulting four-dimensional system in a cointegration framework and find structural changes in the long-run adjustment behavior, which do not affect the main conclusions, however. --
    Keywords: money growth,granger causality,quantity theory,unemployment
    JEL: E31 E40
    Date: 2013
  15. By: Mitchener, Kris James (University of Warwick); Weidenmier, Marc D (Claremont McKenna College)
    Abstract: There is a long-standing debate as to whether the Fisher effect operated during the classical gold standard period. We break new ground on this question by developing a market-based measure of inflation expectations during the gold standard. We derive a measure of silver-gold inflation expectations using the interest-rate differential between Austrian silver and gold perpetuity bonds. Our use of the silver-gold interest rate differential is motivated by the fact that both gold and silver served as numeraires in the pre-WWI period, so that a change in the price of either precious metal would impact the prices of all goods and services. The empirical evidence suggests that silver-gold inflation expectations exhibited significant persistence at the weekly, monthly, and annual frequencies. Further, we find that there is a one-to-one relationship between silver-gold inflation expectations and the interest rate on Austrian perpetuity bonds that were denominated in paper currency. The analysis suggests the operation of a Fisher effect during the classical gold standard period.
    Keywords: Fisher effect, inflation expectations, gold standard
    Date: 2013
  16. By: Andrew Binning (Norges Bank (Central Bank of Norway))
    Abstract: In this paper I derive the matrix chain rules for solving a second and a third-order approximation to a DSGE model that allow the use of a recursive Sylvester equation solution method. In particular I use the solution algorithms of Kamenik (2005) and Martin & Van Loan (2006) to solve the generalised Sylvester equations. Because I use matrix algebra instead of tensor notation to find the system of equations, I am able to provide standalone Matlab routines that make it feasible to solve a medium scale DSGE model in a competitive time. I also provide Fortran code and Matlab/Fortran mex files for my method.
    Keywords: Solving dynamic models, Second-order approximation, Third-order appeoximation, Second-order matrix chain rule, Third-order matrix chain rule, Generalised Sylvester equations
    Date: 2013–08–05
  17. By: Uluc Aysun (University of Central Florida, Orlando, FL); Sanglim Lee (Korea Energy Economics Institute, 132 Naesonsunhwan-ro, Uiwang-si, Gyeonggi-do, Korea)
    Abstract: This paper shows that the deviation from the uncovered interest parity (UIP) condition is equally large in advanced and emergingmarket economies. Using monthly data, and a GARCH-M model we find that a large share of these deviations in both country groups are explained by time varying risk premium. To more clearly identify risk premium shocks, we then estimate a two country, New Keynesian, DSGE model using a Bayesian methodology and quarterly data. The results suggest that at the quarterly frequency, the large deviations from the UIP condition and the high explanatory power of risk premium is only observed for emerging market economies.
    Keywords: Uncovered Interest Rate Parity, Forward Premium Puzzle, Time Varying Risk Premium
    JEL: E32 E44 F31 F33 F44
    Date: 2013–08
  18. By: Bijapur, Mohan
    Abstract: This paper provides new insights into the relationship between the supply of credit and the macroeconomy. We present evidence that credit shocks constitute shocks to aggregate supply in that they have a permanent effect on output and cause inflation to rise in the short term. Our results also suggest that the effects on aggregate supply have grown stronger in recent decades.
    Keywords: Financial crisis; Potential output; Inflation; Credit crunch.
    JEL: E31 E32
    Date: 2013–07–21
  19. By: George Kaufman
    Abstract: Interest in TBTF resolutions of insolvent large complex firms has intensified in recent years, particularly in banking. TBTF resolutions protect some in-the-money counterparties of the targeted insolvent firm from losses that would be suffered if the usual bankruptcy resolution regimes used in resolving other firms in the industry were applied. Although special TBTF resolution regimes may reduce the collateral spill-over costs of the failure, the combined direct and indirect costs from such “bailouts” may be large and financed in part or total by taxpayers. Thus, TBTF has become a major public policy issue that has not been resolved in part because of disagreements about definitions and thereby the estimates of the benefits and costs. This paper explores these differences and develops a framework for standardizing the definitions and evaluating the desirability of TBTF resolutions more accurately.
    Date: 2013

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