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on Central Banking |
| By: | Reinhart, Carmen M.; Rogoff, Kenneth |
| Abstract: | Even after one of the most severe multi-year crises on record in the advanced economies, the received wisdom in policy circles clings to the notion that high-income countries are completely different from their emerging market counterparts. The current phase of the official policy approach is predicated on the assumption that debt sustainability can be achieved through a mix of austerity, forbearance and growth. The claim is that advanced countries do not need to resort to the standard toolkit of emerging markets, including debt restructurings and conversions, higher inflation, capital controls and other forms of financial repression. As we document, this claim is at odds with the historical track record of most advanced economies, where debt restructuring or conversions, financial repression, and a tolerance for higher inflation, or a combination of these were an integral part of the resolution of significant past debt overhangs. |
| JEL: | E44 E6 F3 F34 G1 H6 N10 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9750&r=cba |
| By: | Acharya, Viral V; Engle III, Robert F; Pierret, Diane |
| Abstract: | Macroprudential stress tests have been employed by regulators in the United States and Europe to assess and address the solvency condition of financial firms in adverse macroeconomic scenarios. We provide a test of these stress tests by comparing their risk assessments and outcomes to those from a simple methodology that relies on publicly available market data and forecasts the capital shortfall of financial firms in severe market-wide downturns. We find that: (i) The losses projected on financial firm balance-sheets compare well between actual stress tests and the market-data based assessments, and both relate well to actual realized losses in case of future stress to the economy; (ii) In striking contrast, the required capitalization of financial firms in stress tests is found to be inadequate ex post compared to that implied by market data; (iii) This discrepancy arises due to the reliance on regulatory risk weights in determining required levels of capital once stress-test losses are taken into account. In particular, the continued reliance on regulatory risk weights in stress tests appears to have left financial sectors under-capitalized, especially during the European sovereign debt crisis, and likely also provided perverse incentives to build up exposures to low risk-weight assets. |
| Keywords: | macroprudential regulation; risk-weighted assets; stress test; systemic risk |
| JEL: | G01 G11 G21 G28 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9800&r=cba |
| By: | Bianchi, Francesco; Melosi, Leonardo |
| Abstract: | We develop a theoretical framework to quantitatively assess the general equilibrium effects and welfare implications of central bank reputation and transparency. Monetary policy alternates between periods of active inflation stabilization and periods during which the emphasis on inflation stabilization is reduced. When the central bank engages in only short deviations from active monetary policy, inflation expectations remain anchored and the model captures the monetary approach described as constrained discretion. However, if the central bank deviates for a prolonged period of time, agents become pessimistic about future monetary policy and uncertainty gradually rises. Reputation determines the speed with which agents' pessimism accelerates once the central bank starts deviating. When the model is fitted to U.S. data, the Federal Reserve is found to benefit from strong reputation and large flexibility in responding to inflationary shocks. Increasing transparency would improve welfare by anchoring agents' expectations. |
| Keywords: | Bayesian learning; inflation expectations; Markov-switching models; reputation; uncertainty |
| JEL: | C11 D83 E52 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9955&r=cba |
| By: | Woodford, Michael |
| Abstract: | This paper assesses the value of central-bank communication about likely future policy, with particular reference to the regular publication of projections for the future path of the policy rate, as with the Riksbank's publication of the repo rate path. It first discusses why publication of a projected interest-rate path represents a natural and desirable evolution of inflation-forecast targeting procedures, and the conditions under which the assumptions about future policy underlying such projections will be intertemporally consistent. It then discusses evidence on the extent to which central-bank statements influence private-sector interest-rate expectations. Particular attention is given to the potential use of forward guidance as an additional tool of policy when an executive lower bound for the policy rate is reached, and alternative approaches to forward guidance in this context are compared, including the recent adoption of quantitative "thresholds" for unemployment and inflation expectations by the U.S. Federal Reserve. The potential role of a nominal GDP level target within an inflation-targeting regime is also considered. |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9722&r=cba |
| By: | Thorvald Grung-Moe |
| Abstract: | Central banks responded with exceptional liquidity support during the financial crisis to prevent a systemic meltdown. They broadened their tool kit and extended liquidity support to nonbanks and key financial markets. Many want central banks to embrace this expanded role as "market maker of last resort" going forward. This would provide a liquidity backstop for systemically important markets and the shadow banking system that is deeply integrated with these markets. But how much liquidity support can central banks provide to the shadow banking system without risking their balance sheets? I discuss the expanding role of the shadow banking sector and the key drivers behind its growing importance. There are close parallels between the growth of shadow banking before the recent financial crisis and earlier financial crises, with rapid growth in near monies as a common feature. This ebb and flow of shadow-banking-type liabilities are indeed an ingrained part of our advanced financial system. We need to reflect and consider whether official sector liquidity should be mobilized to stem a future breakdown in private shadow banking markets. Central banks should be especially concerned about providing liquidity support to financial markets without any form of structural reform. It would indeed be ironic if central banks were to declare victory in the fight against too-big-to-fail institutions, just to end up bankrolling too-big-to-fail financial markets. |
| Keywords: | Financial Regulation; Financial Stability; Monetary Policy; Central Bank Policy |
| JEL: | E44 E52 E58 G28 |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_802&r=cba |
| By: | Reichlin, Lucrezia |
| Abstract: | The paper is a narrative on monetary policy and the banking sector during the two recent euro area recessions. It shows that while in the two episodes of recession and financial stress the ECB acted aggressively providing liquidity to banks, the second recession, unlike the first, has been characterized by an abnormal decline of loans with respect to both real economic activity and the monetary aggregates. It conjectures that this fact is explained by the postponement of the adjustment in the banking sector. It shows that euro area banks, over the 2008-2012 period, did not change neither the capital to asset ratio nor the size of their balance sheet relative to GDP keeping them at the pre-crisis level. The paper also describes other aspects of banks’ balance sheet adjustment during the two crises pointing to a progressive dismantling of financial integration involving the inter-bank market since the first crisis and the market for government bonds since the second. |
| Keywords: | banks; monetary policy; recession |
| JEL: | E5 |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9647&r=cba |
| By: | Shigeto Kitano (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kenya Takaku (Faculty of Business, Aichi Shukutoku University) |
| Abstract: | We apply a Ramsey-type analysis to a standard sticky price, small open economy model, examining the welfare implications of optimal capital controls under fixed exchange rates and optimal monetary policy under flexible exchange rates. We show that capital controls can significantly reduce the gap between the welfare levels under fixed and flexible exchange rates. |
| Keywords: | Optimal capital controls, Optimal monetary policy, Ramsey policy, Exchange rate regimes, Small open economy, Sticky prices, Welfare comparison, Incomplete markets |
| JEL: | E5 F4 |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:kob:dpaper:dp2014-25&r=cba |
| By: | Ippolito, Filippo; Ozdagli, Ali; Perez Orive, Ander |
| Abstract: | We combine existing balance sheet and stock market data with two new datasets to study whether, how much, and why bank lending to firms matters for the transmission of monetary policy. The first new dataset enables us to quantify the bank dependence of firms precisely, as the ratio of bank debt to total assets. We show that a two standard deviation increase in the bank dependence of a firm makes its stock price about 25% more responsive to monetary policy shocks. We explore the channels through which this effect occurs, and find that the stock prices of bank-dependent firms that borrow from financially weaker banks display a stronger sensitivity to monetary policy shocks. This finding is consistent with the bank lending channel, a theory according to which the strength of bank balance sheets matters for monetary policy transmission. We construct a new database of hedging activities and show that the stock prices of bank-dependent firms that hedge against interest rate risk display a lower sensitivity to monetary policy shocks. This finding is consistent with an interest rate pass-through channel that operates via the direct transmission of policy rates to lending rates associated with the widespread use of floating-rates in bank loans and credit line agreements. |
| Keywords: | bank financial health; bank lending channel; firm financial constraints; floating interest rates; monetary policy transmission |
| JEL: | E52 G21 G32 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9696&r=cba |
| By: | Bacchetta, Philippe; Benhima, Kenza; Kalantzis, Yannick |
| Abstract: | In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modelling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention. |
| Keywords: | China; Exchange rate policy; International reserves |
| JEL: | E58 F31 F41 |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9666&r=cba |
| By: | Jeanne, Olivier |
| Abstract: | This paper analyzes the case for the international coordination of macroprudential policies in the context of a simple theoretical framework. Both domestic macroprudential policies and prudential capital controls have international spillovers through their impact on capital flows. The uncoordinated use of macroprudential policies may lead to a "capital war" that depresses global interest rates. International coordination of macroprudential policies is not warranted, however, unless there is unemployment in some countries. There is scope for Pareto-improving international policy coordination when one part of the world is in a liquidity trap while the rest of the world accumulates reserves for prudential reasons. |
| Keywords: | Capital Controls; Capital Flows; International Policy Coordination; International Reserves; Liquidity Trap; Macroprudential Policy |
| JEL: | F36 F41 F42 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9875&r=cba |
| By: | Rose, Andrew K |
| 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. |
| Keywords: | crisis; data; empirical; exchange rate; financial; float; hard fix; inflation; panel; recession; target |
| JEL: | E58 F33 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9684&r=cba |
| By: | Gertler, Mark; Karadi, Peter |
| Abstract: | We provide evidence on the nature of the monetary policy transmission mechanism. To identify policy shocks in a setting with both economic and financial variables, we combine traditional monetary vector autoregression (VAR) analysis with high frequency identification (HFI) of monetary policy shocks. We first show that the shocks identified using HFI surprises as external instruments produce responses in output and inflation consistent with those obtained in the standard monetary VAR analysis. We also find, however, that monetary policy responses typically produce “modest” movements in short rates that lead to “large” movements in credit costs and economic activity. The large movements in credit costs are mainly due to the reaction of both term premia and credit spreads that are typically absent from the baseline model of monetary transmission. Finally, we show that forward guidance is important to the overall strength of policy transmission. |
| Keywords: | Credit Spread; External Instrument; Forward Guidance; High-Frequency Identification; Monetary Policy Transmission; Structural VAR; Term Premium |
| JEL: | E43 E44 E52 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9824&r=cba |
| By: | Benigno, Gianluca; Chen, Huigang; Otrok, Christopher; Rebucci, Alessandro; Young, Eric R |
| Abstract: | In response to the global financial crisis a new policy paradigm emerged in which capital controls and other quantitative restrictions on credit flows have become part of the standard crisis prevention policy toolkit. A new strand of theoretical literature studies the use of capital controls in a context in which pecuniary externality justifies policy interventions. Within the same theoretical framework adopted in this literature, we show that the optimal design of crisis prevention (ex-ante) policies depends on the effectivness of crisis management (ex-post) policies. This interaction between ex-ante and ex-post policies gives rise to a new rationale for the use of capital controls. Specifically, we show that when ex-post policies are effective in containing crises, there is no need to intervene ex-ante with capital controls. On the other hand, if crises management policies entail efficiency costs and hence lose effectiveness, then the optimal policy mix consists of both ex-ante and ex-post interventions so that crises prevention policies become desirable. In our model, the optimal policy mix combines capital controls in tranquil times with real exchange rate support to limit its depreciation during crises times and yields welfare gains of more than 1% in consumption equivalence terms. |
| Keywords: | Capital Controls; Financial Crises; Financial Frictions; Macro-prudential policies; Pecuniary Externality; Real Exchange Rate |
| JEL: | E52 F37 F41 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9936&r=cba |
| By: | Benigno, Pierpaolo; Nisticò, Salvatore |
| Abstract: | This paper studies monetary policy in models where multiple assets have different liquidity properties: safe and "pseudo-safe" assets coexist. A shock worsening the liquidity properties of the pseudo-safe assets raises interest-rate spreads and can cause a deep recession cum deflation. Expanding the central bank's balance sheet fills the shortage of safe assets and counteracts the recession. Lowering the interest rate on reserves insulates market interest rates from the liquidity shock and improves risk sharing between borrowers and savers. |
| Keywords: | liquidity crisis; unconventional policies; zero lower bound |
| JEL: | E30 E40 E50 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9767&r=cba |
| By: | Cacciatore, Matteo; Fiori, Giuseppe; Ghironi, Fabio |
| Abstract: | The wave of crises that began in 2008 reheated the debate on market deregulation as a tool to improve economic performance. This paper addresses the consequences of increased flexibility in goods and labor markets for the conduct of monetary policy in a monetary union. We model a two-country monetary union with endogenous product creation, labor market frictions, and price and wage rigidities. Regulation affects producer entry costs, employment protection, and unemployment benefits. We first characterize optimal monetary policy when regulation is high in both countries and show that the Ramsey allocation requires significant departures from price stability both in the long run and over the business cycle. Welfare gains from the Ramsey-optimal policy are sizable. Second, we show that the adjustment to market reform requires expansionary policy to reduce transition costs. Third, deregulation reduces static and dynamic inefficiencies, making price stability more desirable. International synchronization of reforms can eliminate policy tradeoffs generated by asymmetric deregulation. |
| Keywords: | Market deregulation; Monetary union; Optimal monetary policy |
| JEL: | E24 E32 E52 F41 J64 L51 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9742&r=cba |
| By: | Lippi, Francesco; Ragni, Stefania; Trachter, Nicholas |
| Abstract: | We study the optimal anticipated monetary policy in a flexible-price economy featuring heterogenous agents and incomplete markets, which give rise to a business cycle. In this setting money policy has distributional effects that depend on the state of the cycle. We parsimoniously characterize the dynamics of the economy and study the optimal regulation of the money supply as a function of the state. The optimal policy prescribes monetary expansions in recessions, when insurance is most needed by cash- poor unproductive agents. To minimize the inflationary effect of these expansions the policy prescribes monetary contractions in good times. Although the optimal money growth rate varies greatly through the business cycle, this policy “echoes” Friedman’s principle in the sense that the expected real return of money approaches the rate of time preference. |
| Keywords: | distributional effects; heterogenous agents; incomplete markets; liquidity; precautionary savings |
| JEL: | E50 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9795&r=cba |
| By: | Edda Claus; Iris Claus; Leo Krippner |
| Abstract: | This paper quantifies the impact of monetary policy shocks on asset markets in the United States and gauges the usefulness of a shadow short rate as a measure of conventional and unconventional monetary policy shocks. Monetary policy surprises are found to have had a larger impact on asset markets since short term interest rates reached the zero lower bound. Our results indicate that much of the increased reaction is due to changes in the transmission of shocks and only partly due to larger monetary policy surprises. |
| Keywords: | Monetary policy shocks, zero lower bound, shadow short rate, asset prices, latent factor model. |
| JEL: | E43 E52 E65 |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:een:camaaa:2014-42&r=cba |
| By: | Hatcher, Michael; Minford, Patrick |
| Abstract: | We survey recent literature comparing inflation targeting (IT) and price-level targeting (PT) as macroeconomic stabilization policies. Our focus is on New Keynesian models and areas which have seen significant developments since Ambler’s (2009) survey: the zero lower bound on nominal interest rates; financial frictions; and optimal monetary policy. Ambler’s main conclusion that PT improves the inflation-output volatility trade-off in New Keynesian models is reasonably robust to these extensions, several of which are attempts to address issues raised by the recent financial crisis. The beneficial effects of PT therefore appear to hang on the joint assumption that agents are rational and the economy New Keynesian. Accordingly, we discuss recent experimental and survey evidence on whether expectations are rational, as well as the applied macro literature on the empirical performance of New Keynesian models. In addition, we discuss a more recent strand of applied literature that has formally tested New Keynesian models with rational expectations. Overall the evidence is not conclusive, but we note that New Keynesian models are able to match a number of dynamic features in the data and that behavioral models of the macroeconomy are outperformed by those with rational expectations in formal statistical tests. Accordingly, we argue that policymakers should continue to pay attention to PT. |
| Keywords: | inflation targeting; price level targeting; Rational Expectations |
| JEL: | E31 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9820&r=cba |
| By: | Svensson, Lars E O |
| Abstract: | My lessons from six years of practical policy-making include (1) being clear about and not deviating from the mandate of flexible inflation targeting (price stability and the highest sustainable employment), including keeping average inflation over a longer period on target; (2) not adding household debt as a new (intermediate) target variable, in addition to inflation and unemployment – not “leaning against the wind,” which is counterproductive, but leaving any problems with household debt to financial policy; (3) using a two-step algorithm to implement “forecast targeting”; (4) using four-panel graphs to evaluate monetary policy ex ante (in real time) and ex post (after the fact); (5) taking a credible inflation target and a resulting downward-sloping Phillips curve into account by keeping average inflation over a longer period on target; and (6) not confusing monetary and financial policy but using monetary policy to achieve the monetary-policy objectives and financial policy to maintain financial stability, with each policy taking into account the conduct of the other. |
| Keywords: | financial stabiilty; household debt; inflation targeting; Monetary policy |
| JEL: | E42 E43 E44 E47 E52 E58 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9756&r=cba |
| By: | Bachmann, Rüdiger; Born, Benjamin; Elstner, Steffen; Grimme, Christian |
| Abstract: | Does time-varying business volatility affect the price setting of firms and thus the transmission of monetary policy into the real economy? To address this question, we estimate from the firm-level micro data of the German IFO Business Climate Survey the impact of idiosyncratic volatility on the price setting behavior of firms. In a second step, we use a calibrated New Keynesian business cycle model to gauge the effects of time-varying volatility on the transmission of monetary policy to output. Heightened business volatility increases the probability of a price change, though the effect is small: the tripling of volatility during the recession of 08/09 caused the average quarterly likelihood of a price change to increase from 31.6% to 32.3%. Second, the effects of this increase in volatility on monetary policy are also small; the initial effect of a 25 basis point monetary policy shock to output declines from 0.347% to 0.341%. |
| Keywords: | monetary; New Keynesian model; price setting; survey data; time-varying volatility |
| JEL: | E30 E31 E32 E50 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9702&r=cba |
| By: | Muhammad, Omer; de Haan, Jakob; Scholtens, Bert |
| Abstract: | We investigate the transmission mechanism of policy-induced changes in the discount rate and required reserves in Pakistan. Our results suggest that the pass through to the lending rate is complete for the discount rate but incomplete for required reserves. However, only shocks to required reserves have an effect on the deposit rate and the exchange rate in the long run. The observation that the discount rate is not a very effective monetary policy tool is attributed to excess liquidity present in the interbank market of Pakistan. Finally, our findings suggest a structural shift in the interbank money market in Pakistan. |
| Keywords: | Monetary transmission mechanism, Pakistan, excess liquidity, VAR |
| JEL: | E51 E52 E58 E61 |
| Date: | 2014–05–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:56161&r=cba |
| By: | Baldursson, Fridrik Mar; Portes, Richard |
| Abstract: | We examine Iceland’s capital controls, which were imposed in October 2008 in order to prevent massive capital flight and a complete collapse of the exchange rate. The controls have not been lifted yet, primarily because of the risk of outflows of domestic holdings of the failed cross-border Icelandic banks. A substantial restructuring of domestic holdings of foreign creditors of the old banks is required before capital controls can be lifted. We argue that even if the controls are damaging, the gains from lifting them are likely to be much lower than the costs associated with a potential currency crisis following a premature liberalisation of capital outflows. The case of Iceland illustrates the difficulty of resolving large cross-border banks situated in a small currency area. |
| Keywords: | capital controls; cross-border banking; Icelandic banks; resolution of failed banks |
| JEL: | E58 F31 G21 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9706&r=cba |
| By: | Sudipto Karmakar |
| Abstract: | This paper develops a dynamic stochastic general equilibrium model to examine the impact of macroprudential regulation on bank’s financial decisions and the implications for the real sector. I explicitly incorporate costs and benefits of capital requirements. I model an occasionally binding capital constraint and approximate it using an asymmetric non linear penalty function. This friction means that the banks refrain from valuable lending. At the same time, countercyclical buffers provide structural stability to the financial system. I show that higher capital requirements can dampen the business cycle fluctuations. I also show that stronger regulation can induce banks to hold buffers and hence mitigate an economic downturn as well. Increasing the capital requirements do not seem to have an adverse effect on the welfare. Lastly, I also show that switching to a countercyclical capital requirement regime can help reduce fluctuations and raise welfare. |
| JEL: | G01 G21 G28 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:ptu:wpaper:w201317&r=cba |
| By: | Tressel, Thierry; Verdier, Thierry |
| Abstract: | We consider a moral hazard economy with the potential for collusion between bankers and borrowers to study how incentives for risk taking are affected by the quality of supervision. We show that low interest rates or a low return on investment may generate excessive risk taking. Because of a pecuniary externality, the market equilibrium is not optimal and there is a need for prudential regulation. We show that the optimal capital ratio depends on the state of the macro-financial cycle, and that,in presence of production externalities, the capital ratio should be complemented by a constraint on asset allocation. We study the political economy of supervision. We show that the political process tends to exacerbate excessive risk taking and credit cycles by weakening the quality of banking supervision when instead it should be strengthened. |
| Keywords: | banking regulation; political economy; regulatory forbearance |
| JEL: | D8 E44 G2 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9871&r=cba |
| By: | Corsetti, Giancarlo; Kuester, Keith; Meier, André; Müller, Gernot |
| Abstract: | Sovereign risk premia in several euro area countries have risen markedly since 2008, driving up credit spreads in the private sector as well. We propose a New Keynesian model of a two-region monetary union that accounts for this "sovereign risk channel." The model is calibrated to the euro area as of mid-2012. We show that a combination of sovereign risk in one region and strongly procyclical fiscal policy at the aggregate level exacerbates the risk of belief-driven deflationary downturns. The model provides an argument in favor of coordinated, asymmetric fiscal stances as a way to prevent self-fulfilling debt crises. |
| Keywords: | euro area; monetary union; pooling of sovereign risk; risk premium; sovereign risk channel; zero lower bound |
| JEL: | E62 F41 F42 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9723&r=cba |
| By: | Gabaix, Xavier; Maggiori, Matteo |
| Abstract: | We provide a theory of the determination of exchange rates based on capital flows in imperfect financial markets. Capital flows drive exchange rates by altering the balance sheets of financiers that bear the risks resulting from international imbalances in the demand for financial assets. Such alterations to their balance sheets cause financiers to change their required compensation for holding currency risk, thus impacting both the level and volatility of exchange rates. Our theory of exchange rate determination in imperfect financial markets not only rationalizes the empirical disconnect between exchange rates and traditional macroeconomic fundamentals, but also has real consequences for output and risk sharing. Exchange rates are sensitive to imbalances in financial markets and seldom perform the shock absorption role that is central to traditional theoretical macroeconomic analysis. We derive conditions under which heterodox government financial policies, such as currency interventions and taxation of capital flows, can be welfare improving. Our framework is flexible; it accommodates a number of important modeling features within an imperfect financial market model, such as non-tradables, production, money, sticky prices or wages, various forms of international pricing-to-market, and unemployment. |
| Keywords: | Capital Flows; Exchange Rate Disconnect; Foreign Exchange Intervention; Limits of Arbitrage |
| JEL: | E42 E44 F31 F32 F41 F42 G11 G15 G20 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9842&r=cba |
| By: | Nakov, Anton; Thomas, Carlos |
| Abstract: | This paper studies optimal monetary policy from the timeless perspective in a general model of state-dependent pricing. Firms are modeled as monopolistic competitors subject to idiosyncratic menu cost shocks. We find that, under certain conditions, a policy of zero inflation is optimal both in the long run and in response to aggregate shocks. Key to this finding is an "envelope" property: at zero inflation, a marginal increase in the rate of inflation has no effect on firms' profits and hence on their probability of repricing. We offer an analytic solution that does not require local approximation or e¢ ciency of the steady state. Under more general conditions, we show numerically that the optimal commitment policy remains very close to strict inflation targeting. |
| Keywords: | monetary policy; monopolistic competition; state-dependent pricing |
| JEL: | E31 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9846&r=cba |
| By: | Bianchi, Francesco; Ilut, Cosmin |
| Abstract: | We reinterpret post World War II US economic history using an estimated microfounded model that allows for changes in the monetary/fiscal policy mix. We find that the fiscal authority was the leading authority in the '60s and the '70s. The appointment of Volcker marked a change in the conduct of monetary policy, but inflation dropped only when fiscal policy accommodated this change two years later. In fact, a disinflationary attempt of the monetary authority leads to more inflation if not supported by the fiscal authority. If the monetary authority had always been the leading authority or if agents had been confident about the switch, the Great Inflation would not have occurred and debt would have been higher. This is because the rise in trend inflation and the decline in debt of the '70s were caused by a series of fiscal shocks that are inflationary only when monetary policy accommodates fiscal policy. The reversal in the debt-to-GDP ratio dynamics, the sudden drop in inflation, and the fall in output of the early '80s are explained by the switch in the policy mix itself. If such a switch had not occurred, inflation would have been high for another fifteen years. Regime changes account for the stickiness of inflation expectations during the '60s and the '70s and for the break in the persistence and volatility of inflation. |
| Keywords: | Bayesian estimation; DSGE; Fiscal policy; general equilbrium.; Great Inflation; Markov-switching |
| JEL: | E31 E52 E58 E62 |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9645&r=cba |
| By: | Forbes, Kristin; Fratzscher, Marcel; Straub, Roland |
| Abstract: | Are capital controls and macroprudential measures successful in achieving their objectives? Assessing their effectiveness is complicated by selection bias and endogeneity; countries which change their capital-flow management measures (CFMs) often share specific characteristics and are responding to changes in variables that the CFMs are intended to influence. This paper addresses these challenges by using a propensity-score matching methodology. We also create a new database with detailed information on weekly changes in controls on capital inflows, capital outflows, and macroprudential measures from 2009 to 2011 for 60 countries. Results show that macroprudential measures can significantly reduce some measures of financial fragility. Most CFMs do not significantly affect other key targets, however, such as exchange rates, capital flows, interest-rate differentials, inflation, equity indices, and different volatilities. One exception is that removing controls on capital outflows may reduce real exchange rate appreciation. Therefore, certain CFMs can be effective in accomplishing specific goals—but most popular measures are not “good for” accomplishing their stated aims. |
| Keywords: | capital controls; capital flows; emerging markets; macroprudential measures; propensity-score matching; selection bias |
| JEL: | F3 F4 F5 G0 G1 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9798&r=cba |
| By: | Asongu Simplice (Yaoundé/Cameroun) |
| Abstract: | Economic theory traditionally suggests that monetary policy can influence the business cycle, but not the long-run potential output. Despite well documented theoretical and empirical consensus on money neutrality in the literature, the role of money as an informational variable for monetary policy decision has remained opened to debate with empirical works providing mixed outcomes. This paper addresses two substantial challenges to this debate: the neglect of developing countries in the literature and the use of new financial dynamic fundamentals that broadly reflect monetary policy. The empirics are based on annual data from 34 African countries for the period 1980 to 2010. Using a battery of tests for integration and long-run equilibrium properties, results offer overall support for the traditional economic theory. |
| Keywords: | Monetary policy; Credit; Empirics; Africa |
| JEL: | E51 E52 E58 E59 O55 |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:agd:wpaper:13/032&r=cba |
| By: | Hyejin Cho (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne) |
| Abstract: | The motivation of this article is to induce the bank capital management solution for banks and regulation bodies on commercial bank. The goal of the paper is intended to mitigate the risk of banking area and also provide the right incentive for banks to support the real economy. |
| Keywords: | Demand Deposit; Risks of on-the-balancesheet and off-the-balancesheet; Portfolio composition; minimum equity capital regulation |
| Date: | 2014–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:hal-00958499&r=cba |
| By: | Roberto Chang |
| Date: | 2013–12–09 |
| URL: | http://d.repec.org/n?u=RePEc:col:000470:011508&r=cba |
| By: | Jordà, Òscar; Schularick, Moritz; Taylor, Alan M. |
| Abstract: | Two separate narratives have emerged in the wake of the Global Financial Crisis. One speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies. However, the two may interact in important and understudied ways. This paper studies the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies financial stability risks have come from private sector credit booms and not from the expansion of public debt. However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sec- tor deleveraging after crises, leading to more prolonged periods of economic depression. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now. |
| Keywords: | booms; business cycles; financial crises; leverage; local projections; recessions |
| JEL: | C14 C52 E51 F32 F42 N10 N20 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9678&r=cba |
| By: | Sandra Gomes |
| Abstract: | The global financial crisis that started in mid-2007 brought back to the monetary policy debate the issue of the zero lower bound on nominal interest rates and the policy options available when this is a binding constraint. Given the significative macroeconomic impact of the crisis it has also brought to the forefront of the discussion ways to revive economic growth. This paper looks at structural reforms as a policy option of economic stimulus for an economy where the zero lower bound binds. We focus in the euro area economy. Our main results show that structural reforms may have positive short run effects that reduce the size of a recession and if coordinated they can drive the euro area out of the zero lower bound. We also show that the short to medium run impact of structural reforms is also crucially dependent on the design of such reforms, namely if the reforms are implemented gradually or not and if the reforms are announced (or perceived) as temporary or permanent. Finally, we show that the zero lower bound does not change significantly the impact of the reforms if the reform is permanent but it does have an important effect if the reform is transitory. |
| JEL: | E52 F42 F47 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ptu:wpaper:w201408&r=cba |
| By: | Miles, David K; Schanz, Jochen |
| Abstract: | This paper explores the impacts on an economy of a central bank changing the size and composition of its balance sheet. One of the ways in which such asset purchases could influence prices and demand is via portfolio balance effects. We develop and calibrate a simple OLG model in which risk-averse households hold money and bonds to insure against risk. Central bank asset purchases have the potential to affect households' choices by changing the composition and return of their asset portfolios. We find that the effect is weak, and that its size depends on how fiscal policy is conducted. That is not to say that the big expansion of central bank balance sheets in recent years has been ineffective. Our finding is rather that the portfolio balance channel evaluated in an environment of normally functioning (though nonetheless incomplete) asset markets is weak. That is not inconsistent with the evidence that large-scale asset purchases by central banks since 2008 have had significant effects, because those purchases were made when financial markets were, to varying extents, dysfunctional. Nonetheless our results are relevant to those purchases because they may be unwound in an environment where financial markets are no longer dysfunctional. |
| Keywords: | Quantitative Easing; Unconventional Monetary Policy |
| JEL: | E51 E52 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9812&r=cba |
| By: | Angeloni, Ignazio; Faia, Ester; Winkler, Roland |
| Abstract: | We study alternative scenarios for exiting the post-crisis fiscal and monetary accommodation using a macromodel where banks choose their capital structure and are subject to runs. Under a Taylor rule, the post-crisis interest rate hits the zero lower bound (ZLB) and remains there for several years. In that condition, pre-announced and fast fiscal consolidations dominate - based on output and inflation performance and bank stability - alternative strategies incorporating various degrees of gradualism and surprise. We also examine an alternative monetary strategy in which the interest rate does not reach the ZLB; the benefits from fiscal consolidation persist, but are more nuanced. -- |
| Keywords: | exit strategies,debt consolidation,fiscal policy,fiscal multipliers,monetary policy,bank runs |
| JEL: | G01 E63 H12 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:50&r=cba |
| By: | Diana Bonfim; Carla Soares |
| Abstract: | It is well established that when monetary policy is accommodative, banks tend to grant more credit. However, only recently attention was given to the quality of credit granted and, naturally, the risk assumed during those periods. This article makes an empirical contribution to the analysis of the so-called risk-taking channel of monetary policy. We use bank loan level data and different methodologies to test whether banks assume more credit risk when monetary policy interest rates are lower. Our results provide evidence in favor of this channel through different angles. We show that banks, most notably smaller banks, grant more loans to non-financial corporations with recent defaults or without credit history when policy interest rates are lower. We also find that loans granted when interest rates are low are more likely to default in the hiking phase of the interest rate cycle. However, the level of policy interest rates at the moment of loan concession does not seem to be relevant for the ex-post probability of default of the overall loan portfolio. |
| JEL: | E44 E5 G21 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:ptu:wpaper:w201402&r=cba |
| By: | Kazuki Onji (Graduate School of Economics, Osaka University); Takeshi Osada (Faculty of Service Management, Bunri University of Hospitality); David Vera (Department of Economics, California State University) |
| Abstract: | Divergent interests of bank managers and financial regulators potentially compromise the efficacy of bank rescue operations. This paper analyses an agency problem encountered in a capital injection program implemented in Japan. We hypothesize that the operationfs requirement to downsize lead banks to overstate the extent of downsizing by reassigning older workers to bank subsidiaries. We implement a difference-in-difference analysis using a panel of Japanese banks from 1990 through 2010. We also employ propensity score matching to control for the sample selection. The result shows that recipients of public capital exhibited workforce rejuvenation relative to non-recipient banks. Among injected banks, average worker age falls by approximately one year, which is equivalent to about seventy less 65-years-old workers. On stand-alone basis, the number of employees in injected banks decreases as a response to injection, but on consolidated basis, which accounts for subsidiary employment, the number of employees at banking does not fall. Our finding suggests that the Japanese practice of life-time employment survived, albeit in a limited form, among restructuring banks. |
| Keywords: | Recapitalization program, lifetime employment, Japanese banks |
| JEL: | C23 G21 G28 |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:1422&r=cba |
| By: | Kinda Hachem; Jing Cynthia Wu |
| Abstract: | We investigate the effectiveness of central bank communication when firms have heterogeneous inflation expectations that are updated through social dynamics. The bank's credibility evolves with these dynamics and determines how well its announcements anchor expectations. We find that trying to eliminate high inflation by abruptly introducing low inflation targets generates short-term overshooting. Gradual targets, in contrast, achieve a smoother disinflation. We present empirical evidence to support these predictions. Gradualism is not equally effective in other situations though: our model predicts aggressive announcements are more powerful when combating deflation. |
| JEL: | E17 E3 E58 |
| Date: | 2014–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20161&r=cba |
| By: | Delatte, Anne-Laure; Fouquau, Julien; Holz, Carsten |
| Abstract: | Fundamental changes in institutions during the transition from a centrally planned to a market economy present a formidable challenge to monetary policy decision makers. For the case of China, we examine the institutional changes in the monetary system during the process of transition and develop money demand functions that reflect these institutional changes. We consider seasonal unit roots and estimate long run, equilibrium money demand functions, explicitly taking into consideration the changes in the institutional characteristics of China's financial system. Using a newly compiled dataset that covers an unprecedented long time period of 1984-2010 at the quarterly frequency, we are able to draw conclusions on the transitions in households', firms', and aggregate money demand, on the role of the credit plan and interest rates, on the mechanisms of macroeconomic control during economic transition, and on theoretical questions in the development and money literature. |
| Keywords: | Chinese economy; cointegration; complementary hyopthesis; money demand; seasonal unit root |
| JEL: | C51 E41 O11 P24 P52 |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9721&r=cba |