nep-cba New Economics Papers
on Central Banking
Issue of 2013‒11‒16
39 papers chosen by
Maria Semenova
Higher School of Economics

  1. Basel III: Some costs will outweigh the benefits By Paul H. Kupiec
  2. Optimal State-dependent Monetary Policy Rules By Christian Baker; Richard W. Evans
  3. Towards Deeper Financial Integration in Europe: What the Banking Union Can Contribute By Claudia M. Buch; T. Körner; B. Weigert
  4. Sudden stop of capital flows and the consequences for the banking sector and the real economy By Neagu, Florian; Mihai, Irina
  5. Predicting distress in European banks By Betz, Frank; Oprica, Silviu; Peltonen, Tuomas A.; Sarlin, Peter
  6. Setting countercyclical capital buffers based on early warning models: would it work? By Behn, Markus; Detken, Carsten; Peltonen, Tuomas A.; Schudel, Willem
  7. Central Banking after the Crisis: Brave New World or Back to the Future?. By Emmanuel Carré; Jézabel Couppey-Soubeyran; Dominique Plihon; Marc Pourroy
  8. Macroprudential policy instruments and economic imbalances in the euro area By Brzoza-Brzezina, Michał; Kolasa, Marcin; Makarski, Krzysztof
  9. On the use of monetary and macroprudential policies for financial stability in emerging markets By F. Gulcin Ozkan; D. Filiz Unsal
  10. Explaining the Strength and the Efficiency of Monetary Policy Transmission: A Panel of Impulse Responses from a Time-Varying Parameter Model By Jakub Mateju
  11. Links between the trust in the ECB and its interest rate policy By Maciej Albinowski; Piotr Ciżkowicz; Andrzej Rzońca
  12. Central bank refinancing, interbank markets and the hypothesis of liquidity hoarding: evidence from a euro-area banking system By Affinito, Massimiliano
  13. Non-Standard Monetary Policy Measures – Magic Wand or Tiger by the Tail? By Ansgar Belke
  14. Determinacy and Indeterminacy in Monetary Policy Rules with Money By John Keating; Andrew Lee Smith
  15. Global effects of unorthodox monetary policies By Desmond Lachman
  16. Surprising Similarities: Recent Monetary Regimes of Small Economies By Andrew K. Rose
  17. Interbank contagion and resolution procedures: inspecting the mechanism By Edoardo Gaffeo; Massimo Molinari
  18. Does Monetary Policy Respond to Commodity Price Shocks? By Ano Sujithan, Kuhanathan; Koliai, Lyes; Avouyi-Dovi, Sanvi
  19. Sovereign debt crises in Latin America: A market pressure approach By Kuper, Gerard; Jacobs, Jan; Boonman, Tjeerd
  20. Monetary policy, bank capital and credit supply: a role for discouraged and informally rejected firms By Popov, Alexander
  21. Inflation-Targeting and Foreign Exchange Interventions in Emerging Economies. By Marc Pourroy
  22. The early warnings of balance-of-payments problems: Kaminsky and Reinhart revisited By Lang, Michael
  23. Bank Overleverage and Macroeconomic Fragility By Ryo Kato; Takayuki Tsuruga
  24. Are Consumer Expectations Theory-Consistent? The Role of Macroeconomic Determinants and Central Bank Communication By Michael J. Lamla; Lena Dräger; Damjan Pfajfar
  25. Goodbye Inflation Targeting, Hello Fear of Floating? Latin America after the Global Financial Crisis* By Reinhart, Carmen
  26. House Prices, Heterogeneous Banks and Unconventional Monetary Policy Options By Andrew Lee Smith
  27. Monetary Union, Banks and Financial Integration By Breton, Régis; Rojas Breu, Mariana; Bignon, Vincent
  28. An Excursion-Theoretic Approach to Regulator's Bank Reorganization Problem By Masahiko Egami; Tadao Oryu
  29. The German Public and its Trust in the ECB: The Role of Knowledge and Information Search By Bernd Hayo; Edith Neuenkirch
  30. Systemic Risk, Sovereign Yields and Bank Exposures in the Euro Crisis By Niccolò Battistini; Marco Pagano; Saverio Simonelli
  31. Conditional Eurobonds and the Eurozone Sovereign Debt Crisis By John Muellbauer
  32. Financial exposure and the international transmission of financial shocks By Kamber, Gunes;; Thoenissen, Christoph
  33. Banking in Africa By Beck, Thorsten; Cull, Robert
  34. Sovereign Wealth and Risk Management. A New Framework for Optimal Asset Allocation of Sovereign Wealth By Bodie, Zvi; Brière, Marie
  35. How to Measure Financial (In)Stability in Emerging Europe? By Petr Jakubik; Tomas Slacik
  36. The sovereign debt crisis: the impact on the intermediation model of Italian banks By Stefano Cosma; Elisabetta Gualandri
  37. A Systematic approach to identify systemically important firms By Natasha Agarwal et al
  38. Does it take two to tango? Improving cooperation between the IMF and the World Bank: theory and empirical evidence By Silvia Marchesi; Laura Sabani
  39. On the relationship between exchange rates and external imbalances: East and Southeast Asia By Juan Carlos Cuestas; Paulo José Regis

  1. By: Paul H. Kupiec (American Enterprise Institute)
    Abstract: The new Basel III regulations will require significantly higher minimum capital levels for banks and bank holding companies. Although many applaud higher capital levels for large institutions, it is unclear that there are good economic reasons to apply these rules to small banks.
    Keywords: financial services outlook,capital requirements,Basel III,Basel Committee on Banking Supervision
    JEL: A G
    Date: 2013–11
  2. By: Christian Baker (Department of Economics, Brigham Young University); Richard W. Evans (Department of Economics, Brigham Young University)
    Abstract: This paper defines a monetary equilibrium and computes an optimal nonlinear, full-information, state-dependent monetary policy rule to which the monetary authority commits at the beginning of time. This type of optimal monetary policy represents a combination of the flexibility of discretion with the time consistency of commitment. The economic environment is a closed-economy general equilibrium model of incomplete markets with monopolistic competition, producer price stickiness, and a transaction cost motive for holding money. We prove existence and uniqueness of the competitive equilibrium given a monetary policy rule and prove existence of the optimal rule. We show that the optimal state-dependent monetary policy rule satisfies the standard results of the discretionary policy literature in that it keeps inflation and nominal interest rates low (Friedman rule) and reduces inefficient variance in prices. Lastly, we compare the optimal monetary policy rule to a limited-information Taylor rule. We find that the Taylor rule, based on observable macroeconomic variables, is able to closely approximate the economic outcomes of the model under the optimal full-information rule.
    Keywords: Optimal monetary policy, Money supply rules, Time consistency, Nonlinear solution methods
    JEL: E52 E42 E31 C68
    Date: 2013–10
  3. By: Claudia M. Buch; T. Körner; B. Weigert
    Abstract: The agreement to establish a Single Supervisory Mechanism in Europe is a major step towards a Banking Union, consisting of centralized powers for the supervision of banks, the restructuring and resolution of distressed banks, and a common deposit insurance system. In this paper, we argue that the Banking Union is a necessary complement to the common currency and the Internal Market for capital. However, due care needs to be taken that steps towards a Banking Union are taken in the right sequence and that liability and control remain at the same level throughout. The following elements are important. First, establishing a Single Supervisory Mechanism under the roof of the ECB and within the framework of the current EU treaties does not ensure a sufficient degree of independence of supervision and monetary policy. Second, a European institution for the restructuring and resolution of banks should be established and equipped with sufficient powers. Third, a fiscal backstop for bank restructuring is needed. The ESM can play a role but additional fiscal burden sharing agreements are needed. Direct recapitalization of banks through the ESM should not be possible until legacy assets on banks’ balance sheets have been cleaned up. Fourth, introducing European-wide deposit insurance in the current situation would entail the mutualisation of legacy assets, thus contributing to moral hazard.
    Keywords: banking union, Europe, single supervisory mechanism, risk sharing
    JEL: E02 E42 G18
    Date: 2013–10
  4. By: Neagu, Florian; Mihai, Irina
    Abstract: The paper develops a macro-prudential liquidity stress-testing tool in order to capture the possible consequences of a capital outflow (including a run of deposits). The tool includes a feedback from the banking sector to the real economy, incorporates a link between liquidity risk and solvency risk, and is tailored for emerging market features. The stress-testing tool aims to: (i) test the capacity of the banking sector to withstand the sudden stop of capital flows, and to gauge the consequences of the liquidity stress to the solvency ratio; (ii) quantify the liquidity deficit that a central bank should accommodate; (iii) assess the impact on credit supply when the sudden stop occurs; and (iv) support the implementation of an orderly disintermediation process. The macro-prudential tool is applied on the Romanian banking sector. JEL Classification: G21, F32
    Keywords: banks, emerging markets, macro-prudential tool, stress-testing, systemic liquidity
    Date: 2013–09
  5. By: Betz, Frank; Oprica, Silviu; Peltonen, Tuomas A.; Sarlin, Peter
    Abstract: The paper develops an early-warning model for predicting vulnerabilities leading to distress in European banks using both bank and country-level data. As outright bank failures have been rare in Europe, the paper introduces a novel dataset that complements bankruptcies and defaults with state interventions and mergers in distress. The signals of the early warning model are calibrated not only according to the policy-maker’s preferences between type I and II errors, but also to take into account the potential systemic relevance of each individual financial institution. The key findings of the paper are that complementing bank specific vulnerabilities with indicators for macro-financial imbalances and banking sector vulnerabilities improves model performance and yields useful out-of-sample predictions of bank distress during the current financial crisis. JEL Classification: E44, E58, F01, F37, G01
    Keywords: bank distress, early-warning model, prudential policy, signal evaluation
    Date: 2013–10
  6. By: Behn, Markus; Detken, Carsten; Peltonen, Tuomas A.; Schudel, Willem
    Abstract: This paper assesses the usefulness of private credit variables and other macrofinancial and banking sector indicators for the setting of Basel III / CRD IV countercyclical capital buffers (CCBs) in a multivariate early warning model framework, using data for 23 EU Members States from 1982 Q2 to 2012 Q3. We find that in addition to credit variables, other domestic and global financial factors such as equity and house prices as well as banking sector variables help to predict vulnerable states of the economy in EU Member States. We therefore suggest that policy makers take a broad approach in their analytical models supporting CCB policy measures. JEL Classification: G01, G21, G28
    Keywords: banking crises, Basel III, countercyclical capital buffer, CRD IV, early warning model, financial regulation
    Date: 2013–11
  7. By: Emmanuel Carré (Centre d'Economie de Paris Nord); Jézabel Couppey-Soubeyran (Centre d'Economie de la Sorbonne); Dominique Plihon (Centre d'Economie de Paris Nord); Marc Pourroy (Centre d'Economie de la Sorbonne)
    Abstract: This paper provides a snapshot of the current state of central banking doctrine in the aftermath of the crisis, using data from a questionnaire produced in 2011 and sent to central bankers (from 13 countries plus the euro zone) and economists (31) for a report by the French Council of Economic Analysis to the Prime Minister. The results of our analysis of the replies to the questionnaire are twofold. First, we show that the financial crisis has led to some amendments of pre-crisis central banking. We highlight that respondents to the questionnaire agree on the general principle of a ‘broader’ view of central banking extended to financial stability. Nevertheless, central bankers and economists diverge or give inconsistent answers about the details of implementation of this ‘broader’ view. Therefore, the devil is once again in the details. We point out that because of central bankers' conservatism, a return to the status quo cannot be excluded.
    Keywords: Central banking, financial crisis, financial stability, macroprudential, financial supervision architecture.
    JEL: E44 E52 G01 G18
    Date: 2013–10
  8. By: Brzoza-Brzezina, Michał; Kolasa, Marcin; Makarski, Krzysztof
    Abstract: Since its creation the euro area suffered from imbalances between its core and peripheral members. This paper checks whether macroprudential policy tools - applied in a countercyclical fashion as known from the DSGE literature to the peripheral countries - could contribute to providing more macroeconomic stability in this region. To this end we build a two-economy macrofinancial DSGE model and simulate the effects of macroprudential tools under the assumption of asymmetric shocks hitting the core and the periphery. We find that a countercyclical application of macroprudential tools is able to partly make up for the loss of independent monetary policy in the periphery. Moreover, LTV policy seems more efficient than regulating capital adequacy ratios. However, for the policies to be effective, they must be set individually for each region. Area-wide policy is almost ineffective in this respect. JEL Classification: E32, E44, E58
    Keywords: DSGE with banking sector, euro-area imbalances, Macroprudential policy
    Date: 2013–09
  9. By: F. Gulcin Ozkan; D. Filiz Unsal
    Abstract: This paper explores optimal monetary and macroprudential policy rules in an open-economy with significant exposure to external borrowing in the face of a sudden reversal of capital inflows. We consider optimal Taylor-type interest rate rules, where the policy rate is set as a function of inflation, output, and credit growth; and a macroprudential instrument is set as a function of credit growth. We have two key results. First, we find that, in the presence of macroprudential measures, there are no significant welfare gains from monetary policy also reacting to credit growth above and beyond its response to inflation. Thus, from a welfare point of view it is better to delegate ’lean against the wind’ squarely to macroprudential policy. Second, the source of borrowing (domestic versus foreign) plays a crucial role in the choice of policy instrument in responding to credit market developments. When the source of borrowing is external, monetary policy responses required to stabilize financial markets would be unduly large. In contrast, macroprudential instrument can directly influence the cost of credit and ease the fiancial markets. Therefore, emerging economies where foreign borrowing is typically sizeable are likely to find macroprudential measures particularly effective in promoting financial stability.
    Keywords: Financial instability; monetary policy; macroprudential measures; emerging markets; and financial crises
    JEL: E5 F3 F4
    Date: 2013–11
  10. By: Jakub Mateju (CERGE-EI, Prague and Czech National Bank)
    Abstract: This paper analyzes both the cross-sectional and time variation in aggregate monetary policy transmission from nominal short term interest rates to price level. Using Bayesian TVP-VARs where the structural interest rate shocks are identi_ed by sign restrictions, we show that monetary policy transmission became stronger over the last decades. This applies both to developed and emerging economies. Monetary policy sacrifice ratios (the output costs of disination induced by monetary policy tightening) gradually decreased from their peak in the 1980's. Exploring the cross-country and time variation in panel regressions, we show that when a country adopted ination targeting regime, monetary transmission became stronger (by about 0.8 p.p. of price level response to 1 p.p. shock to the policy rate) and sacrifice ratios decreased. In periods of banking crises, the transmission from monetary policy interest rate shocks to prices is weaker (by about 1 p.p. of price level response to a 1 p.p. shock to the policy rate) and the related costs in output are higher. Further, countries with higher domestic credit to GDP have stronger transmission while countries with higher foreign debt seem to be less inuenced by domestic monetary policy.
    Keywords: monetary policy transmission, TVP-VAR, sign-restrictions
    JEL: E52 C54
    Date: 2013–11
  11. By: Maciej Albinowski (Warsaw School of Economics); Piotr Ciżkowicz (Warsaw School of Economics); Andrzej Rzońca (Warsaw School of Economics and Monetary Policy Council in Narodowy)
    Abstract: We contribute to the new, albeit fast-growing empirical literature on the determinants of trust in central banks. Like in most other studies we use panel data models based on the Eurobarometer survey on trust in the European Central Bank. Firstly, we confirm the main conclusion from previous studies that the trust in the ECB has suffered from the crisis’ outburst. Moreover, households perceive the ECB’s responsibility for the occurrence of the crisis to go beyond the responsibility of other institutions. This finding casts some doubt on the central bank’s ability to manage expectations in a country having been hit by a severe negative demand shock, while this ability is precondition of the central banks’ power to boost aggregate demand when its interest rates are at the zero lower bound. Secondly (and most importantly), in addition to previous studies, we examine the links between the trust in the ECB and its policy. Our main result is that when households have pessimistic expectations, aggressive cuts in interest rates have an adverse effect on their trust in central bank. This result is in accordance with the ‘lack-of-confidence shock’ hypothesis developed by Schmitt-Grohé and Uribe (2012) and go against the ‘fundamental shock’ hypothesis which would imply positive effects of aggressive cuts for trust in the ECB. These findings are robust to changes in the estimation method, the definition of the lack of confidence shock, control variables and countries under consideration. We also show that it cannot be easily rejected as spurious.
    Keywords: trust in central banks, zero lower bound, lack-of-confidence shock, Eurobarometer, panel data
    JEL: C23 E58 H12
    Date: 2013
  12. By: Affinito, Massimiliano
    Abstract: This paper tests the hypothesis of liquidity hoarding in the Italian banking system during the 2007-2011 global financial crisis. According to this hypothesis, in periods of crisis, interbank markets stop working and central banks’ interventions are ineffective because banks hoard the liquidity injected rather than channelling it on to other banks and the real economy. The test uses monthly data at banking-group level for all intermediaries operating in Italy between January 1999 and August 2011. This is the first paper to use micro data to analyse the relationship between single banks’ positions vis-à-vis the central bank and the interbank market. The results show that the Italian interbank market functioned well even during the crisis, and, contrary to widespread conjecture, the liquidity injected by the Eurosystem was intermediated among banks and towards the real economy. This finding is robust to the use of several estimation methods and data on the different segments of the money market. JEL Classification: G21, E52, C30
    Keywords: central bank refinancing, financial crisis, Interbank Market, liquidity
    Date: 2013–11
  13. By: Ansgar Belke
    Abstract: This paper briefly assesses the effectiveness of the different non-standard monetary policy tools in the Euro Area. Its main focus is on the Outright Monetary Transactions (OMT) Programme which is praised by some as the ECB’s “magic wand”. Moreover, it discloses further possible unintended consequences of these measures in the current context of weak economic activity and subdued growth going forward. For this purpose, it investigates specific risks for price stability and asset price developments in the first main part of the paper. It is not a too remote issue that the Fed does have a “tiger by the tail”, as Hayek (2009) expressed it, i.e. that the bank will finally have to accept either a recession or inflation and that there is no choice in between. Furthermore, it checks on whether the OMT programme really does not impose costs onto the taxpayer. Finally, it comes up with some policy implications from differences in money and credit growth in different individual countries of the Euro Area. The second main part of the paper assesses which other tools the ECB could use in order to stimulate the economy in the Euro Area. It does so by delivering details on whether and how the effectiveness of the ECB’s policies can be improved through more transparency and “forward guidance”.
    Keywords: Central bank transparency; euro area; forward guidance; non-standard monetary policies; outright monetary transactions, quantitative easing; segmentation of credit markets
    JEL: E52 E58 F32
    Date: 2013–10
  14. By: John Keating (Department of Economics, The University of Kansas); Andrew Lee Smith (Department of Economics, The University of Kansas)
    Abstract: Does Friedman’s k-percent rule guarantee a unique equilibrium outcome? We show analytically the answer to this question is sensitive to the method of aggregation. Focusing on broad measures of money, we show that fixing the growth rate of the true monetary aggregate will generate a unique rational expectations equilibrium. Since the true monetary aggregate is parametric, we show this determinacy result extends to the non-parametric Divisia monetary aggregate growth rule. Interestingly, Friedman’s proposal to fix the growth rate of the broad simple-sum monetary aggregate is shown to result in indeterminacy stemming from this aggregate’s inaccuracy in tracking the true monetary aggregate. Determinacy regions of interest rate rules reacting to the growth rate of monetary aggregates are also discussed and a novel Taylor principle is shown to hold for such rules when the monetary aggregate is accurately measured. All of these results are presented in the framework of the canonical New-Keynesian model.
    Keywords: Friedman’s k-percent Rule, Determinacy, Monetary Aggregates, Taylor Rules
    JEL: C43 E31 E40 E44 E51 E52 E58 E60
    Date: 2013–10
  15. By: Desmond Lachman (American Enterprise Institute)
    Abstract: In the aftermath of the Great Recession, major central banks have scrambled to support economic recovery and to avoid deflation through highly accommodative and unorthodox monetary policy stances. Although relatively successful in the short term, these policies have given rise to incipient asset- and credit-market bubbles and to spillover effects on the emerging-market economies.
    Keywords: Monetary policy,Global economic outlook,central banks,AEI Economic Perspectives
    JEL: A E
    Date: 2013–11
  16. By: Andrew K. Rose
    Abstract: In contrast to earlier recessions, the monetary regimes of many small economies have not changed in the aftermath of the global financial crisis. This is due in part to the fact that many small economies continue to use hard exchange rate fixes, a reasonably durable regime. However, most of the new stability is due to countries that float with an inflation target. Though a few have left to join the Eurozone, no country has yet abandoned an inflation targeting regime under duress. Inflation targeting now represents a serious alternative to a hard exchange rate fix for small economies seeking monetary stability. Are there important differences between the economic outcomes of the two stable regimes? I examine a panel of annual data from more than 170 countries from 2007 through 2012 and find that the macroeconomic and financial consequences of regime-choice are surprisingly small. Consistent with the literature, business cycles, capital flows, and other phenomena for hard fixers have been similar to those for inflation targeters during the Global Financial Crisis and its aftermath.
    JEL: E58 F33
    Date: 2013–11
  17. By: Edoardo Gaffeo; Massimo Molinari
    Abstract: This paper develops a network model of a stylized banking system in which banks are connected to one another through interbank claims, which allows us to study the diffusion of default avalanches triggered by an exogenous shock under a number of different assumptions on the degree of interconnectedness, level of capitalization, liquidity buffers, the size of the interbank market and fire-sales. We expand upon the existing literature by embedding two alternative resolution mechanisms. First, liquidations triggered by either illiquidity or insolvency-related distress implying asset sales and compensation of creditors. Second, a bail-in mechanism avoiding bank closure by forcing a recapitalization provided by bank creditors. Our model speaks to how contagion dynamics unravel via illiquidity-driven defaults in the first case and higher-order losses in the latter one. Within this framework, we show how counter-party liquidity risk externality can be resolved and put forward a macro-criterion to assess the adequacy of the liquidity ratio introduced with Basel III.
    Keywords: Systemic Risk, Banking Network, Resolution Procedures
    JEL: D85 G28 G33
    Date: 2013
  18. By: Ano Sujithan, Kuhanathan; Koliai, Lyes; Avouyi-Dovi, Sanvi
    Abstract: Commodity prices, especially oil prices, peaked in the aftermath of the financial crisis of 2007 and they have remained highly volatile. All things being equal, the increase in commodity prices may induce a similar tendency of inflation and hence become a monetary policy issue. However, the impact of the changes of commodity prices on inflation is not clear. In this paper, by using Markov-switching models we show that there is an implicit impact of commodity markets on short-term interest rates for a set of heterogeneous countries (the U.S., the Euro area, Brazil, India, Russia and South Africa) over the period from January 1999 to August 2012. Besides, the VAR models reveal that short-term interest rates respond to commodity volatility shocks whatever the country. Moreover, the linkage between commodity markets and monetary policy instruments is stronger since the recent financial crisis.
    Keywords: Markov - switching; Commodity prices; VAR models; Monetary Policy;
    JEL: E43 E52 E58
    Date: 2013–06
  19. By: Kuper, Gerard; Jacobs, Jan; Boonman, Tjeerd (Groningen University)
    Abstract: We construct a continuous sovereign debt crisis index for four large Latin American countries for the period 1870-2012. Our sovereign debt crisis index is similar to the Exchange Market Pressure Index for currency crises, and the Money Market Pressure Index for banking crises. To obtain the optimal set of indicators and the optimal value of the threshold for dating crises we apply the Receiver Operating Characteristic (ROC) curve. We calculate our sovereign debt crisis index as a weighted average of three indicators, the debt to GDP ratio, the external interest rate spread and the exports to imports ratio. The continuous index allows a more advanced analysis of sovereign debt crises. We include two applications. In the first application we investigate the relationship between sovereign debt crises and the business cycle in Latin America. Our second application constructs a similar index for five European countries.
    Date: 2013
  20. By: Popov, Alexander
    Abstract: This paper conducts the first empirical study of the bank balance sheet channel using data on discouraged and informally rejected firms in addition to information on the formal loan granting process. I take advantage of a unique survey data on the credit experience of firms in 8 economies that use the euro or are pegged to it over 2004-2007, and analyze the effect of monetary policy and the business cycle on bank lending and risk-taking. Identification rests on exploiting 1) the exogeneity of monetary policy to local business cycles, and 2) firm-level and bank-level data to separate the supply of credit from changes in the level and composition of credit demand. Consistent with previous studies, I find that lax monetary conditions increase bank credit in general and bank credit to ex-ante risky firms in particular, especially for banks with lower capital ratios. Importantly, I find that the results are considerably stronger when data on informal credit constraints are incorporated. JEL Classification: E32, E51, E52, F34, G21
    Keywords: bank capital, bank lending channel, business cycle, cross-border lending, monetary policy
    Date: 2013–09
  21. By: Marc Pourroy (Centre d'Economie de la Sorbonne)
    Abstract: Are emerging economies implementing inflation targeting (IT) with a perfectly flexible exchange-rate arrangement, as developed economies do, or have these countries developed their own IT framework? This paper offers a new method for assessing exchange-rate policies that combines the use of “indicator countries”, providing an empirical definition of exchange-rate flexibility or rigidity, and clustering through Gaussian mixture estimates in order to identify countries' de facto regimes. By applying this method to 19 inflation-targeting emerging economies, I find that the probability of those countries having a perfectly flexible arrangement as developed economies do is 52%, while the probability of having a managed float system, obtained through foreign exchange market intervention, is 28%, and that of having a rigid exchange-rate system (similar to those of pegged currencies) is 20%. The results also provide evidence of two different monetary regimes under inflation targeting: flexible IT when the monetary authorities handle only one tool, the interest rate, prevailing in ten economies, and hybrid IT when the monetary authorities add foreign exchange interventions to their toolbox, prevailing in the remaining nine economies.
    Keywords: Inflation-targeting, foreign exchange interventions, Gaussian mixture model.
    JEL: E31 E40 E58 F31
    Date: 2013–10
  22. By: Lang, Michael
    Abstract: This paper builds upon the model of Kaminsky and Reinhart (1999) and extends it to triplecrises. It applies a new visualisation approach combining elements of an event study analysis and a fan chart technique. This approach illustrates the deviation of fundamentals in the runup to balance-of-payments problems. The results suggest that both systemic banking crises and deteriorating government finances are highly significant leading indicators. Taking these indicators into account helps build a new early warning system for currency crises. The results are highly significant and robust. The out-of-sample forecasts demonstrate the strong predictive power of the model. --
    Keywords: currency crisis,financial sector vulnerability,early warning system
    JEL: F30 F31 F34 F41 G01
    Date: 2013
  23. By: Ryo Kato; Takayuki Tsuruga
    Abstract: This paper develops a dynamic general equilibrium model that explicitly includes a banking sector engaged in a maturity mismatch. We demonstrate that rational competitive banks take on excessive risks systemically, resulting in overleverage and ine¢ ciently high crisis probabilities. The model accounts for the banks seemingly over-optimistic outlook about their own solvency and the asset prices, compared to the social optimum. The result calls for policy intervention to reduce the high crisis probabilities. To this end, the government can commit to bailing out banks through public supply of liquidity or a low-interest rate policy. As opposed to the intention of the government, however, expectations of a bailout could incentivize banks to be even more overleveraged, leaving the economy exposed to higher crisis probabilities.
    Keywords: Financial crisis, Liquidity shortage, Maturity mismatch, Credit externalities, Financial regulation
    JEL: E3 G01 G21
  24. By: Michael J. Lamla (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Lena Dräger (University of Hamburg, Germany); Damjan Pfajfar (University of Tilburg, Netherlands)
    Abstract: Using the microdata of the Michigan Survey of Consumers, we evaluate whether U.S. consumers form macroeconomic expectations consistent with different economic concepts. We check whether their expectations are in line with the Phillips Curve, the Taylor Rule and the Income Fisher Equation. We observe that 50% of the surveyed population have expectations consistent with the Income Fisher equation and the Taylor Rule, while 25% are in line with the Phillips Curve. However, only 6% of consumers form theory-consistent expectations with respect to all three concepts. For the Taylor Rule and the Phillips curve we observe a strong cyclical pattern. For all three concepts we find significant differences across demographic groups. Evaluating determinants of consistency, we provide evidence that the likelihood of having theory-consistent expectations with respect to the Phillips curve and the Taylor rule falls during recessions and with inflation higher than 2%. Moreover, consistency with respect to all three concepts is affected by changes in the communication policy of the Fed, where the strongest positive effect on consistency comes from the introduction of the official inflation target. Finally, we show that consumers with theory-consistent expectations have lower absolute inflation forecast errors and are closer to professionals' inflation forecasts.
    Keywords: Macroeconomic expectations, microdata, macroeconomic literacy, central bank communication, consumer forecast accuracy
    JEL: C25 D84 E31
    Date: 2013–11
  25. By: Reinhart, Carmen
    Abstract: This paper focuses on some of the macroeconomic risks that lie ahead for Latin America. The discussion is informed by my work on crises and capital flows and their macroeconomic consequences. The trends and initial conditions that allowed the region to weather the global economic storm of 2008-2009 are discussed, as is the subsequent reversal of some of those benign trends. I review the historical patterns connecting large capital inflow surges, or “capital flow bonanzas,” with the likelihood of a variety of crises—banking, currency, external default and inflation. For Latin America, in particular, large capital flow bonanzas have seldom ended well. The implications for inflation of importing (via less than fully flexible exchange rates) the expansionary policy of the “North” are discussed.
    Keywords: capital inflows, appreciation, currency crises, banking crises, inflation, debt
    JEL: E3 E31 F3 F30 G01 N16 N26
    Date: 2013–04
  26. By: Andrew Lee Smith (Department of Economics, The University of Kansas)
    Abstract: Bank regulators acknowledge that large U.S. commercial banks allocate considerably more resources to originating and trading off-balance sheet assets than their smaller counter parts. In this paper: (i) I show the asset concentration in these large banks moves closely with home prices due to the collateralized nature of off-balance sheet assets. (ii) I then develop a general equilibrium capable of capturing this asset redistribution between heterogeneous banks. When home prices fall, endogenously tightening leverage constraints force the big productive banks to unload real-estate secured debt to small unproductive banks. The redistribution to less productive banks sets off an asset price spiral in the model - amplifying typical downturns into deep recessions. The model has predictions for the joint behavior of finance premiums, output, home prices and the share of assets held by large banks. (iii) I use a VAR to confirm the model's predictions for these variables are consistent with the data. (iv) Finally, I use this empirically verified model to examine the effectiveness of unconventional monetary policyin mitigating a recession generated by a drop in housing demand. Despite the fact that both equity injections into "Too Big to Fail" banks and asset purchases by the Fed such as "QE 1/2/3" mitigate the crisis, the nuances of the policies are important. A prolonged asset purchase program is preferable to a short-term equity injection.
    Keywords: Financial Crises, Financial Frictions, Housing, Unconventional Monetary Policy
    JEL: E32 E44 G01 G21
    Date: 2013–11
  27. By: Breton, Régis; Rojas Breu, Mariana; Bignon, Vincent
    Abstract: This paper analyzes a two-country model of money and banks to examine the conditions under which the creation of a monetary union between two countries is optimal. Is is shown that if agents resort to banks to adjust their monetary holdings through borrowing and if nobody can force them to repay their debts, it may be optimal for both countries to set up two different currencies, along with strictly positive conversion costs. A necessary condition for this is that credit market integration is limited. This arises even though both countries are perfectly identical.
    Keywords: Monetary union; credit; default; limited commitment;
    JEL: E42 G21
    Date: 2013–06
  28. By: Masahiko Egami; Tadao Oryu
    Abstract: The importance of the global financial system cannot be exaggerated. When a large financial institution becomes problematic and is bailed out, that bank is often claimed as "too big to fail". On the other hand, to prevent bank's failure, regulatory authorities adopt the Prompt Corrective Action (PCA) against a bank that violates certain criteria, often measured by its leverage ratio. In this article, we provide a framework where one can analyze the cost and effect of PCA's. We model a large bank with deteriorating asset and regulatory actions attempting to prevent a failure. The model uses the excursion theory of Levy processes and finds an optimal leverage ratio that triggers a PCA. A nice feature includes it incorporates the fact that social cost associated with PCA's are be greatly affected by the size of banks subject to PCA's, so that one can see the cost of rescuing a bank "too big to fail".
    Date: 2013–11
  29. By: Bernd Hayo (University of Marburg); Edith Neuenkirch (University of Marburg)
    Abstract: In this paper, we analyse the effects of objective and subjective knowledge about mone-tary policy, as well as the information search patterns, of German citizens on trust in the ECB. We rely on a unique representative public opinion survey of German households conducted in 2011. We find that subjective and factual knowledge, as well as the desire to be informed, about the ECB foster citizens’ trust. Specific knowledge about the ECB is more influential than general monetary policy knowledge. Objective knowledge is more important than subjective knowledge. However, an increasing intensity of media usage, especially newspaper reading, has a significantly negative influence on trust. We con-clude that the only viable way for the ECB to generate more trust in itself is to spread monetary policy knowledge.
    Keywords: ECB, Economic knowledge, German public attitudes, Institutional trust
    JEL: D83 E52 E58
    Date: 2013
  30. By: Niccolò Battistini (Rutgers University); Marco Pagano (Università di Napoli Federico II, CSEF, EIEF and CEPR.); Saverio Simonelli (Università di Napoli "Federico II" and CSEF)
    Abstract: Since 2008, euro-area sovereign yields have diverged sharply, and so have the corresponding CDS premia. At the same time, banks’ sovereign debt portfolios featured an increasing home bias. We investigate the relationship between these two facts, and its rationale. First, we inquire to what extent the dynamics of sovereign yield differentials relative to the swap rate and CDS premia reflect changes in perceived sovereign solvency risk or rather different responses to systemic risk due to the possible collapse of the euro. We do so by decomposing yield differentials and CDS spreads in a country-specific and a common risk component via a dynamic factor model. We then investigate how the home bias of banks’ sovereign portfolios responds to yield differentials and to their two components, by estimating a vector error-correction model on 2008-12 monthly data. We find that in most countries of the euro area, and especially in its periphery, banks’ sovereign exposures respond positively to increases in yields. When bank exposures are related to the country-risk and common-risk components of yields, it turns out that (i) in the periphery, banks increase their domestic exposure in response to increases in country risk, while in core countries they do not; (ii) in most euro area banks respond to an increase in the common risk factor by raising their domestic exposures. Finding (i) hints at distorted incentives in periphery banks’ response to changes in their own sovereign’s risk. Finding (ii) indicates that, when systemic risk increases, all banks tend to increase the home bias of their portfolios, making the euro-area sovereign market more segmented.
    Keywords: sovereign yield differentials, dynamic latent factor model, home bias, vector error-correction model
    JEL: C32 C51 C58 G11 G15
    Date: 2013–10–28
  31. By: John Muellbauer
    Abstract: This paper proposes that all new euro area sovereign borrowing be in the form of jointly guaranteed Eurobonds.� To avoid classic moral hazard problems and to insure the guarantors against default, each country would pay a risk premium conditional on economic fundamentals to a joint debt management agency.� This suggests that these bonds be called 'Euro-insurance-bonds'.� While the sovereign debt markets have taken increasing account of the economic fundamentals, the signal to noise ratio has been weakened by huge market volatility, so undercutting incentives for appropriate reforms and obscuring economic realities for voters.� This paper uses an econometric model to show that competitiveness, public and private debt to GDP, and the fall-out from housing market crises are the most relevant economic fundamentals.� Formula-based risk spreads based on these fundamentals would provide clear incentives for governments to be more oriented towards economic reforms to promote long-run growth than mere fiscal contraction.� Putting more weight on incentives that come from risk spreads, than on fiscal centralisation and the associated heavy bureaucratic procedures, would promote the principle of subsidiarity to which member states subscribe.� The paper compares Euro-insurance-bonds incorporating these risk spreads with other policy proprosals.
    Keywords: Sovereign spreads, eurobonds, eurozone sovereign debt crisis, subsidiarity
    JEL: E43 E44 G01 G10 G12
    Date: 2013–10–29
  32. By: Kamber, Gunes;; Thoenissen, Christoph (Reserve Bank of New Zealand)
    Abstract: This paper analyzes the transmission mechanism of banking sector shocks in an international real business cycle model with heterogeneous bank sizes. We examine to what extent the financial exposure of the banking sector affects the transmission of foreign banking sector shocks. In our model, the more exposed domestic banks are to the foreign economy via lending to foreign firms, the greater are the spillovers from foreign financial shocks to the home economy. The model highlights the role of openness to trade and the dynamics of the terms of trade in the international transmission mechanism of banking sector shocks Spillovers from foreign banking sector shocks are greater the more open the home economy is to trade and the less the terms of trade respond to foreign shocks.
    JEL: E32 J6
    Date: 2013–01
  33. By: Beck, Thorsten; Cull, Robert
    Abstract: This paper takes stock of the current state of banking systems across Sub-Saharan Africa and discusses recent developments including innovations that might help Africa leapfrog more traditional banking models. Using an array of different data, the paper documents that African banking systems are shallow but stable. African banks are well capitalized and over-liquid, but lend less to the private sector than banks in non-African developing countries. African enterprises and households are less likely to use financial services than their peers in other developing countries. The paper also describes a number of financial innovations across the continent that can help overcome different barriers to financial inclusion and have helped to expand the bankable and the banked population.
    Keywords: Access to Finance,Banks&Banking Reform,Debt Markets,Emerging Markets,Bankruptcy and Resolution of Financial Distress
    Date: 2013–10–01
  34. By: Bodie, Zvi; Brière, Marie
    Abstract: This paper sets out a new analytical framework for optimal asset allocation of sovereign wealth, based on the theory of contingent claim ana lysis (CCA) applied to the sovereign’s economic balance sheet. A country solves an asset-l iability management (ALM) problem between its sources of income and its expenditures. We derive analytically the optimal asset allocation of sovereign wealth, taking explic it account of all sources of risks affecting the sovereign’s balance sheet. The optima l composition of sovereign wealth should involve a performance-seeking portfolio and three hedging demand terms for the variability of the fiscal surplus, and external and domestic debt. Our results provide guidance for sovereign wealth management, particula rly with respect to sovereign wealth funds and foreign exchange reserves. A real-life ap plication of our model in the case of Chile shows that at least 60% of the Chilean asset allocation should be dedicated to emerging bonds, developed and emerging equities. Ch ile’s current sovereign investment is under-diversified.
    Keywords: Central Bank Reserves; Sovereign Wealth Funds; Asset-Liability Management; Contingent Claim Analysis; Balance Sheet;
    JEL: H63 H50 H11 G18 G11
    Date: 2013–05
  35. By: Petr Jakubik (European Insurance and Occupational Pensions Authority (EIOPA), Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Tomas Slacik (Oesterreichische Nationalbank, Foreign Research Division)
    Abstract: The importance of assessing financial stability in emerging Europe has increased rapidly since the recent financial crisis. Against this background, in the present paper we contribute to the existing literature in a twofold way: First, by using a broad range of indicators from money, bond, equity and foreign exchange markets, we develop a comprehensive financial instability index (FII) that gauges the level of financial market stress in some key Central, Eastern and Southeastern European (CESEE) countries. In a second step, we perform a panel estimation to investigate which macroprudential indicators that cover both internal and external imbalances explain the evolution of our FII over the past more than 15 years. Our analysis suggests that both the levels and changes of some indicators (such as credit growth and the level of private sector indebtedness) play an important role for financial stability. Moreover, we find that the impact of some key indicators on financial (in)stability is nonlinear and varies over time depending on market sentiment.
    Keywords: Financial stability, crisis, macroprudential framework, emerging Europe, external and internal imbalances
    JEL: G28 G32 G33 G38
    Date: 2013–09
  36. By: Stefano Cosma; Elisabetta Gualandri
    Abstract: The aim of the contribute is to analyze the impact of the financial crisis, in particular since the start of the sovereign debt phase, on Italian banks and their intermediation model. Italian banks’ specific business model explains why they suffered less than those of other countries during the first phase of the crisis, requiring one of the lowest levels of public facilities in the EC as compared to GDP. Most of these same characteristics have changed from positive to negative factors since the sovereign debt crisis, which hit Italy hard, affecting first banks’ liquidity and secondly the cost and volumes of funding and loans. Italian banks are now facing the effects of the double-dip recession, which has significantly weakened businesses and households, their key customer segments, and their borrowing and saving capability, with an increasing rate of non-performing loans. This situation is impairing the sustainability of the “traditional” intermediation model and means that banks must introduce strategies for significantly modifying the banking business model they adopt.
    Keywords: Italian banks, sovereign debt crisis, economic recession, intermediation model, credit crunch
    JEL: G01 G15 G18 G21 G28 L50
    Date: 2013–10
  37. By: Natasha Agarwal et al (Indira Gandhi Institute of Development Research)
    Abstract: This paper uses the average of the percentile ranking of three measures of systemic risk - Granger Causality, Marginal Expected Shortfall, and Conditional Value at Risk - to calculate a single systemic risk index (SRI) for a lrm. The SRI is used to identify systemically important lrms (SIFs) among the 50 largest lrms in a quarter. This has the advantage of identifying SIFs on a regular basis using readily available data. The paper uses this approach to identify SIFs by SRI each quarter from 2000 to 2012, and lnds that the cumulative risk of the SIFs tracks the changes in systemic risk in India during the 2008 crisis. The paper also lnds merit in monitoring non-lnancial lrms by their SRI, particularly when bank loan portfolios have concentrated exposures in these firms.
    Keywords: Systemic Risk Measures, Systemically Important Firms
    JEL: G12 G29 C13 G31
    Date: 2013–10
  38. By: Silvia Marchesi; Laura Sabani
    Abstract: This paper analyzes the impact of different governance structures on the degree of Bank-Fund cooperation, focusing on the quality of their information transmission. It compares the performance of a decentralized governance with that of a centralized one. A centralized structure better addresses the necessity of coordinating policy actions, but greater consistency in policy actions will be achieved at the expenses of a less satisfactory adaptation to "local conditions." It is shown that when the need for coordination is relevant, a centralized governance allows to achieve a greater level of overall payoffs. In the real world the governance structure of the two institutions is certainly decentralized. A testable implication of the model would then be to see whether Bank-Fund's coordination is really important for their impact on recipient countries. The empirical evidence shows that a Bank-Fund simultaneous intervention is beneficial to growth and that such beneficial effect is increasing with the willingness to coordinate of the two organizations. This evidence would then be in favor of a (more) centralized governance.
    Keywords: IMF and WB conditionality, coordination, communication
    JEL: D83 F33 N2
    Date: 2013
  39. By: Juan Carlos Cuestas (University of Sheffield); Paulo José Regis (Xi'an Jiaotong-Liverpool University)
    Abstract: The role the real exchange rate plays in determining current account balances has gathered momentum as East and Southeast Asian countries have seen increasingly positive current account balances. This paper analyses the evolution of current accounts in the region. A cointegrating relationship between the real effective exchange rate and the ratio of the current account balance of the GDP is tested, based on both linear and nonlinear models. The half-life of current account imbalances is relatively short, implying high capital mobility. Results poin to the existence of a long-run relationship, and in most cases the causality runs from the exchange rate to the current account.
    Keywords: emerging markets, current account, half-life, East and Southeast Asia
    JEL: C22 E32 F15
    Date: 2013–10

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