nep-cba New Economics Papers
on Central Banking
Issue of 2014‒05‒24
twenty-two papers chosen by
Maria Semenova
Higher School of Economics

  1. Inflation Targeting and Quantitative Tightening: Effects of Reserve Requirements in Peru By Adrián Armas; Paul Castillo; Marco Vega
  2. Is it really more dispersed? Measuring and comparing the stress from the common monetary policy in the euro area By Quint, Dominic
  3. Has the Financial Crisis Permanently Changed the Practice of Monetary Policy? Has It Changed the Theory of Monetary Policy? By Benjamin M. Friedman
  4. Inflation Targeting in Colombia, 2002-2012 By Miguel Urrutia; Marc Hofstetter; Franz Hamann
  5. A Comparison of Optimal Policy Rules for Pre and Post Inflation Targeting Eras : Empirical Evidence from Bank of Canada By Neslihan Kaya
  6. Has U.S. monetary policy tracked the efficient interest rate? By Curdia, Vasco; Ferrero, Andrea; Ng, Ging Cee; Tambalotti, Andrea
  7. Stale Forward Guidance By Gunda-Alexandra Detmers; Dieter Nautz; ;
  8. Coordination and Crisis in Monetary Unions By Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
  9. A Model of Monetary Policy and Risk Premia By Itamar Drechsler; Alexi Savov; Philipp Schnabl
  10. Choice of Monetary Policy Instrument under Targeting Regimes in a Simple Stochastic Macro Model By Haider Ali; Eatzaz Ahmad
  11. House prices, credit and the effect of monetary policy in Norway: Evidence from Structural VAR Models By Ørjan Robstad
  12. Impact of Monetary Policy on Financial Markets Efficiency and Speculative Bubbles: A Non-linear Entropy-based Approach By Alonso-Rivera, Angélica; Cruz-Aké, Salvador; Venegas-Martínez, Francisco
  13. Interest Rates and Money in the Measurement of Monetary Policy By Michael T. Belongia; Peter N. Ireland
  14. Output Composition of the Monetary Policy Transmission Mechanism: Is Australia Different? By Tuan Phan
  15. Macroprudential Consolidation Policy in Interbank Networks By Edoardo Gaffeo; Massimo Molinari
  17. Dealer financial conditions and lender-of-last resort facilities By Acharya, Viral V.; Fleming, Michael J.; Hrung, Warren B.; Sarkar, Asani
  18. Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops By Emmanuel Farhi; Jean Tirole
  19. Purchase of SME-related ABS by the Bank of Japan: Monetary Policy and SME Financing in Japan By Hideaki Hirata; Tokiko Shimizu
  20. China’s Monetary Policy and Commodity Prices By Shawkat Hammoudeh; Duc Khuong Nguyen; Ricardo M. Sousa
  21. Financial liberalization, disaggregated capital flows and banking crisis: Evidence from developing countries By BOUKEF JLASSI, NABILA; HAMDI, HELMI
  22. An Empirical Analysis of the Relationship between US and Colombian Long-Term Sovereign Bond Yields? By Alexander Guarín; José Fernando Moreno; Hernando Vargas

  1. By: Adrián Armas; Paul Castillo; Marco Vega
    Abstract: This paper provides an overview of the reserve requirement measures undertaken by the Central Bank of Peru. It provides a rationale for the use of these instruments as well as empirical evidence of their effectiveness. In general, the results show that tightening reserve requirements has the desired effects on interest rates and credit levels at both banks and smaller financial institutions (cajas municipales).
    Keywords: Monetary Policy, Interest rates, Exchange rates, Fiscal Policy, Policy evaluation, Inflation targeting, Financial system, Foreign currency liabilities, Reserve requirements, Nonconventional monetary policy, Foreign currency, Domestic currency, IDB-WP-499
    Date: 2014–04
  2. By: Quint, Dominic
    Abstract: The ECB's one size monetary policy is unlikely to fit all euro area members at all times, which raises the question of how much monetary policy stress this causes at the national level. I measure monetary policy stress as the difference between actual ECB interest rates and Taylor-rule implied optimal rates at the member state level. Optimal rates explicitly take into account the natural rate of interest to capture changes in trend growth. I find that monetary policy stress within the euro area has been steadily decreasing prior to the recent financial crisis. Current stress levels are not only lower today than in the late 1990s, they are also in line with what is commonly observed among U.S. states or pre-euro German Länder. --
    Keywords: euro area,currency union,European Central Bank,ECB,Taylor rule,real natural rate,common monetary policy,monetary policy stress,inflation
    JEL: C22 E53 E58
    Date: 2014
  3. By: Benjamin M. Friedman
    Abstract: I argue in this paper that one of the two forms of hitherto unconventional monetary policy that many central banks have implemented in response to the 2007 financial crisis – large-scale asset purchases, or to put the matter more generically, use of the central bank’s balance sheet as a distinct tool of monetary policy – is likely to become part of the standard toolkit of monetary policymaking in normal times as well. As intended, these purchases have lowered long-term interest rates relative to short-term rates, and lowered interest rates on more-risky compared to less-risky obligations. Moreover, their introduction fills a conceptual vacuum that has long stood at the heart of monetary policy analysis and implementation. By contrast, forward guidance on the future trajectory of monetary policy has been less successful. Public statements by central banks about their actions and intentions will no doubt continue, but transparency for the sake of transparency is not the same as the deliberate attempt to shape market expectations for purposes of achieving specific monetary policy objectives. Finally, there is a conceptual component to all this as well. In contrast to the last century or more of monetary theory, which has focused on central banks’ liabilities, the basis for the effectiveness of central bank asset purchases turns on the role of the asset side of the central bank’s balance sheet. The implications for monetary theory are profound.
    JEL: E52 E58
    Date: 2014–05
  4. By: Miguel Urrutia; Marc Hofstetter; Franz Hamann
    Abstract: After decades using monetary aggregates as the main instrument of monetary policy and having different varieties of crawling peg exchange rate regimes, Colombia adopted a full-fledged inflation-targeting (IT) regime in 1999, with inflation as the nominal anchor, a floating exchange rate, and the short-term interest rate as the main instrument. This paper examines the experience of the Colombian Central Bank over the last decade, a period of consolidation and innovation of its IT strategy. The paper studies the increasing number of instruments used by the CB, including systematic foreign exchange interventions, announcements, and, sporadically, macro-prudential policies, capital controls, and changes in reserve requirements, among others. The study also examines some political economy dimensions that help explain the behavior of the CB during this period. To guide the discussion, a small-scale open-economy policy model is estimated.
    Keywords: Monetary Policy, Interest rates, Capital flows, Investment, Inflation targeting, IDB-WP-487
    Date: 2014–02
  5. By: Neslihan Kaya
    Abstract: In this paper, we derive policy rules of Bank of Canada for different preferences over the goal variables in their loss functions. The optimal rules are derived for the pre and post inflation-targeting eras. According to the results, the monetary policy rule of the Bank of Canada for the pre inflation-targeting era is best described with a loss function that attaches equal weight to inflation, interest rate smoothing incentive and the output gap in the loss function. In the post-inflation targeting era the optimal interest rate attaches the highest weight to inflation rate in the loss function; followed by the interest rate smoothing incentive and then the output gap. The inclusion of the exchange rate as another goal variable in the loss function does not significantly alter the results in approximating the actual policy rate of Bank of Canada. Next, simulations of demand (positive) and supply (negative) shocks are carried out for the post-IT period for two cases where the monetary policy rule is mimicked by (i) an ad-hoc Taylor rule and (ii) the derived optimal rule. The results indicate that the ad-hoc Taylor rule brings down inflation rates more quickly compared to the derived optimal rule, but only at the cost of higher contraction in output and more volatile interest rates.
    Keywords: Inflation targeting, optimal monetary policy rule, linear-quadratic regulator problem.
    JEL: E52 E58 C63
    Date: 2014
  6. By: Curdia, Vasco (Federal Reserve Bank of San Francisco); Ferrero, Andrea (University of Oxford); Ng, Ging Cee (University of Chicago); Tambalotti, Andrea (Federal Reserve Bank of New York)
    Abstract: Interest rate decisions by central banks are universally discussed in terms of Taylor rules, which describe policy rates as responding to inflation and some measure of the output gap. We show that an alternative specification of the monetary policy reaction function, in which the interest rate tracks the evolution of a Wicksellian efficient rate of return as the primary indicator of real activity, fits the U.S. data better than otherwise identical Taylor rules. This surprising result holds for a wide variety of specifications of the other ingredients of the policy rule and of approaches to the measurement of the output gap. Moreover, it is robust across two different models of private agents’ behavior.
    Keywords: U.S. monetary policy; Interest rate rules; DSGE models; Bayesian model comparison
    JEL: C11 E43 E58
    Date: 2014–05
  7. By: Gunda-Alexandra Detmers; Dieter Nautz; ;
    Abstract: An increasing number of central banks manage market expectations via interest rate projections. Typically, those projections are updated only quarterly and thus, may become stale when new information enters the market. We use data from New Zealand to investigate the time-varying and state-dependent effects of interest rate projections on market expectations and interest rate uncertainty. Confirming the stabilizing effect of fresh central bank announcements, we show that interest rate uncertainty rises between two projection releases. Moreover, rate uncertainty and the importance of macroeconomic news increase if expectations deviate from the rate projected by the central bank. Counterfactual analysis suggests that the efficiency of projections would improve if the central bank updated its projection whenever it becomes stale.
    Keywords: Central bank interest rate projections, central bank communication, quantitative forward guidance, interest rate uncertainty
    JEL: E52 E58
    Date: 2014–05
  8. By: Mark Aguiar; Manuel Amador; Emmanuel Farhi; Gita Gopinath
    Abstract: We characterize fiscal and monetary policy in a monetary union with the potential for rollover crises in sovereign debt markets. Member-country fiscal authorities lack commitment to repay their debt and choose fiscal policy independently. A common monetary authority chooses inflation for the union, also without commitment.� We first describe the existence of a fiscal externality that arises in the presence of limited commitment and leads countries to over borrow; this externality rationalizes the imposition of debt ceilings in a monetary union. We then investigate the impact of the composition of debt in a monetary union, that is the fraction of high-debt versus low-debt members, on the occurrence of self-fulfilling debt crises. We demonstrate that a high-debt country may be less vulnerable to crises and have higher welfare when it belongs to a union with an intermediate mix of high- and low-debt members, than one where all other members are low-debt. This contrasts with the conventional wisdom that all countries should prefer a union with low-debt members, as such a union can credibly deliver low inflation. These findings shed new light on the criteria for an optimal currency area in the presence of rollover crises.
    Date: 2014–01
  9. By: Itamar Drechsler; Alexi Savov; Philipp Schnabl
    Abstract: We present a dynamic heterogeneous-agent asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk tolerant agents (banks) borrow from risk averse agents (depositors) and invest in risky assets subject to a reserve requirement. By varying the nominal interest rate, the central bank affects the spread banks pay for external funding (i.e., leverage), a link that we show has strong empirical support. Lower nominal rates result in increased leverage, lower risk premia and overall cost of capital, and higher volatility. The effects of policy shocks are amplified via bank balance sheet effects. We use the model to implement dynamic interventions such as a ``Greenspan put'' and forward guidance, and analyze their impact on asset prices and volatility.
    JEL: E52 E58 G12 G21
    Date: 2014–05
  10. By: Haider Ali (Pakistan Institute of Development Economics, Islamabad); Eatzaz Ahmad (Quaid-i-Azam University, Islamabad)
    Abstract: This paper analyzes the relative performance of inflation and price-level targeting regimes in an AS-IS-LM framework under alternative policy instruments used by the central bank. Being general in its nature, the results are further used to derive equilibrium values of the important macroeconomic variables under the two targeting regimes for two limiting cases; when LM schedule becomes vertical (Quantity Theory of Money) and when it becomes horizontal (Endogenous Money Hypothesis). Contrary to Svensson’s findings, our results imply a ‘free lunch’ in case of inflation targeting rather than pricelevel targeting. Calibration results for Pakistan also support these theoretical findings and point towards inadequacy of using interest rate, rather than money supply, as a policy instrument both under the inflation and price level targeting regimes.
    Keywords: Monetary Policy; Inflation Targeting; Endogenous Money Hypothesis; Calibration
    JEL: E52 E31 E12 C63
    Date: 2014
  11. By: Ørjan Robstad (Norges Bank)
    Abstract: This paper investigates the responses of house prices and household credit to monetary policy shocks in Norway, using Bayesian structural VAR models. I find that the effect of a monetary policy shock on house prices is large, while the effect on household credit is muted. This is consistent with a relatively small refinancing rate of the mortgage stock each quarter. Using monetary policy to guard against - financial instability by mitigating property-price movements may prove effective, but trying to mitigate household credit may prove costly in terms of GDP and inflation variation.
    Keywords: House Prices, Credit, Monetary Policy, Structural VAR
    JEL: E32 E37 E44 E52
    Date: 2014–05–15
  12. By: Alonso-Rivera, Angélica; Cruz-Aké, Salvador; Venegas-Martínez, Francisco
    Abstract: This paper examines, through the concept of mutual information based on entropy, the impact of monetary policy on the loss of efficiency in the financial markets and speculative bubbles. The proposed information measure is useful to quantify the efficiency with which financial markets respond to the implementation of monetary policy. The findings show that an increase in both money supply and credit growth, as well as a declining of interest rates, generate strong inefficiencies during the initial periods of formation of a bubble. Moreover, empirical evidence suggests that when a loose monetary policy generates inefficiencies, its instruments are not effective to realign the performance of financial markets.
    Keywords: Monetary policy, speculative bubbles, market efficiency, non-linear models, entropy.
    JEL: E58
    Date: 2014–05–21
  13. By: Michael T. Belongia; Peter N. Ireland
    Abstract: Over the last twenty-five years, a set of influential studies has placed interest rates at the heart of analyses that interpret and evaluate monetary policies. In light of this work, the Federal Reserve’s recent policy of “quantitative easing,” with its goal of affecting the supply of liquid assets, appears to be a radical break from standard practice. Alternatively, one could posit that the monetary aggregates, when measured properly, never lost their ability to explain aggregate fluctuations and, for this reason, represent an important omission from standard models and policy discussions. In this context, the new policy initiatives can be characterized simply as conventional attempts to increase money growth. This view is supported by evidence that superlative (Divisia) measures of money often help in forecasting movements in key macroeconomic variables. Moreover, the statistical fit of a structural vector autoregression deteriorates significantly if such measures of money are excluded when identifying monetary policy shocks. These results cast doubt on the adequacy of conventional models that focus on interest rates alone. They also highlight that all monetary disturbances have an important “quantitative” component, which is captured by movements in a properly measured monetary aggregate.
    JEL: E51 E52 E58
    Date: 2014–05
  14. By: Tuan Phan
    Abstract: This paper compares the output composition of the monetary policy transmission mechanism in Australia to those for the Euro area and the United States. Four Vector Autoregressive (VAR) models are used to estimate the contributions of private consumption and investment to output reactions resulting from nominal interest rate shocks for the period 1982Q3–2007Q4. The results suggest that the investment channel plays a more important role than the consumption channel in Australia, while the contributions of the two channels are indistinguishable in the Euro area and the U.S. The difference between Australia and the Euro area comes from differences in housing investment responses, whereas Australia is different to the U.S. mainly because it has a lower share of household consumption in total demand.
    Keywords: output composition, monetary policy transmission mechanism, interest rate, housing investment, durable consumption
    JEL: E52 E2
    Date: 2014–05
  15. By: Edoardo Gaffeo; Massimo Molinari
    Abstract: Can consolidation policy be made consistent with macro-prudential supervision? In this study, we seek to provide new insights on this key-question using a network approach. We study how the resilience of a banking network evolves as we shock an initially homogenous competitive market with a sequence of M&A activities that significantly alter the topology of the network. We study how different M&A treatments impact on the structural vulnerabilities that can propagate through the system and we show that the severity of contagion and default dynamics depends on the chosen treatment. The desirability of alternative competitive settings (such as hub-centered market or a more concentrated and yet symmetric market) are assessed against an homogenous benchmark case and we show that the choice depends crucially on the size of the interbank market and the level of bank capitalization. The existence of a large highly connected hub is beneficial in a capitalized network with a well-developed interbank market but it can significantly weaken the system resilience in a poorly capitalized market. Antitrust and competition authorities shall adopt a state-contingent approach to M&A activities according to the market conditions in which banks operate.
    Keywords: Consolidation Policy, Macroprudential Regulation, Interbank Networks
    Date: 2014
  16. By: Andrew Cornford
    Abstract: In the post-crisis agenda of reform of financial regulation, macroprudential regulation has been assigned a central role. Some of the measures of this agenda involve restrictions on cross-border financial flows and discriminatory restrictions targeting particular financial institutions and activities. Others target corporate form and the relations between the constituent parts of banking groups. Many of the measures implemented or proposed as part of the reform agenda may be inconsistent with the WTO General Agreement on Trade in Services (GATS) and with other bilateral and regional agreements on trade and investment in banking services. As a result both sets of rules may eventually require revision.
    Date: 2014
  17. By: Acharya, Viral V. (Federal Reserve Bank of New York); Fleming, Michael J. (Federal Reserve Bank of New York); Hrung, Warren B. (Federal Reserve Bank of New York); Sarkar, Asani (Federal Reserve Bank of New York)
    Abstract: We examine the financial conditions of dealers that participated in two of the Federal Reserve’s lender-of-last-resort (LOLR) facilities--the Term Securities Lending Facility (TSLF) and the Primary Dealer Credit Facility (PDCF)--that provided liquidity against a range of assets during 2008-09. Dealers with lower equity returns and greater leverage prior to borrowing from the facilities were more likely to participate in the programs, borrow more, and--in the case of the TSLF--at higher bidding rates. Dealers with less liquid collateral on their balance sheets before the facilities were introduced also tended to borrow more. There also appear to be some interaction effects between financial performance and balance sheet liquidity in explaining dealer behavior. The results suggest that both financial performance and balance sheet liquidity play a role in LOLR utilization.
    Keywords: lender of last resort; central banking; crises; illiquidity; insolvency; stigma
    JEL: D44 E58 G01 G28
    Date: 2014–05–01
  18. By: Emmanuel Farhi; Jean Tirole
    Abstract: The recent unravelling of the Eurozone’s financial integration raised concerns about feedback loops between sovereign and banking insolvency, and provided an impetus for the European banking union. This paper provides a “double-decker bailout†theory of the feedback loop that allows for both domestic bailouts of the banking system by the domestic government and sovereign debt forgiveness by international creditors. Our theory has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.
    Date: 2014–01
  19. By: Hideaki Hirata; Tokiko Shimizu
    Abstract: The malfunction of the monetary transmission mechanism in Japan has been cited as one of the main reasons why the quantitative easing of monetary policy undertaken by the Bank of Japan (BOJ) has been insufficient in achieving the objective of an early escape from deflation and the economic slump. The BOJ has quantitatively eased monetary policy, promising to provide as much money as the market needs, and as a result, short term interest rates have fallen to very low levels. However, the growth rate of bank lending particularly to small and medium-sized enterprises (SMEs), has been drawing a secular downtrend for years (Chart 1), thus leading to considerable debate over the effectiveness of the monetary policy. The factors underlying the malfunction of the monetary transmission channel lurk both in the financial and non- financial sectors. Of all the underlying factors, there is broad consensus that the "health" of the Japanese financial sector should be considered as the problem of most concern. The financial sector has played a central role in providing external finance to the non- financial sectors through financial intermediation, accumulating credit risks within the financial sector itself. Associated with the non-performing loan problem, the excess accumulation of credit risks in the banking sector lowers the financial intermediation ability. Thus, it impairs the smooth propagation of monetary policy through the credit channel. On the side of non- financial enterprises, SMEs as a driving force in the Japanese economy, in particular, have been struggling with their fundraising. Limited availability of reliable information on SMEs, in other words, the asymmetric information problem of SMEs is pivotal as is often mentioned. Furthermore, it is important to bear in mind that the shortage of collateral is an obstacle to credit availability for SMEs. SMEs with lower credit status seek alternative sources of funding that strengthen the effects of monetary easing. The BOJ announced its intention to purchase asset backed securities (ABS) whose underlying assets are closely related to SME economic activities. One important motivation for this policy arises from the idea that utilizing modern financial tools, i.e., securitization, can be a possible way to solve the overconcentration or excess accumulation of credit risks in the banking sector, albeit it would be a rare move for central banks to buy private debt. The outright purchase is expected to restore the monetary transmission mechanism by helping diversify credit risks in the financial sector among other economic agents including the BOJ. The other motivation of the new policy is to increase fundraising options for SMEs. For example, the BOJ will purchase ABS backed by accounts receivable. The use of accounts receivable as collateral is not a popular fundraising method for SMEs in Japan. SMEs can take advantage of the BOJ's policy to utilize quality assets which have not been effectively used as collateral in the past. SME external financial sources can be multi-tracked, thereby reducing their heavy reliance upon traditional financial intermediation. Thus, through the implementation of "traditional" monetary policy tools to purchase "untraditional" financial assets, the policy is expected to strengthen the monetary transmission mechanism. The spirit of this policy is to effectively improve SME access to financing through accelerating the development of ABS markets, without causing distortions in the ABS markets. The scheme is carefully designed to avoid any moral hazards and to contribute to the removal of obstacles to SME financing through enhancing financial disintermediation.
  20. By: Shawkat Hammoudeh; Duc Khuong Nguyen; Ricardo M. Sousa
    Abstract: This paper examines the effects of the monetary policy of China on commodity prices. Using a Bayesian Structural VAR, we identify shocks to the interest rate as a price rule and to the monetary aggregate (M2) as a quantity rule, and then evaluate their impacts on commodity prices. Those prices include the aggre- gate commodity price index and all its major constituents. Our results suggest that a positive interest rate (contractionary) shock has a negative and persistent effect on commodity prices. Additionally, the bever- ages and metals are the commodities whose prices fall by most in response to changes in the Chinese monetary policy. In what concerns the positive shock to the growth rate of the monetary aggregate, we find that although it does not have a significant impact on the commodity price aggregate, such result “hides” important heterogeneity across different types of commodity prices. Finally, we show that while adjusting the growth rate of the monetary aggregate and changing the interest rates appear to be macroe- conomic stabilizing tools of similar power, the price instrument seems more effective in explaining the dynamics of commodity prices than the quantity one.
    Keywords: monetary policy, commodity prices, Bayesian Structural VAR, China
    JEL: E37 E52
    Date: 2014–05–19
    Abstract: The aim of this paper is to examine whether or not financial liberalization has triggered banking crises in developing countries. We focus in particular on the role of capital inflows as their volatilities threat economic stability. In the empirical model, based on Panel Logit estimation, we use the two common financial liberalization indicators (de facto and dejure) for a panel of 58 developing countries for the period from 1984 to 2007. Unlike the previous studies, this paper reveals that both indicators of financial liberalization did not trigger banking crises in our sample.
    Keywords: Banking Crises, Financial Liberalization, Capital Flows, Developing Countries
    JEL: F32 F33 F34 F36 F41 G01 G11 G15 G18
    Date: 2013
  22. By: Alexander Guarín; José Fernando Moreno; Hernando Vargas
    Abstract: We study the relationship between US and Colombian sovereign debt interest rates. We also evaluate the response of the Colombian long-term bond yield and other asset prices to shocks to the US long-term Treasury rate. Two empirical exercises are performed. First, we use a moving window linear regression to examine the link between sovereign bond yields. Second, we estimate a VARX – MGARCH model to compute the short-term response of local asset prices to foreign financial shocks. Our exercises consider daily data between 2004 and 2013. The analysis is performed on three sample periods (i.e. before, during and after the global financial crisis). Our findings show that the link between sovereign bond yields has changed over time. Moreover, the short-run responses of local asset prices to foreign financial shocks have been qualitatively different in the three periods. The especial role of US Treasuries as a “safe haven asset” during highly volatile time spans seems to be at the root of these changes.
    Keywords: Long-term bond yields, global financial crisis, emerging markets, moving window linear regression, VARX – MGARCH model.
    JEL: C30 E43 E58 F42 G15
    Date: 2014–05–19

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