nep-cba New Economics Papers
on Central Banking
Issue of 2014‒07‒28
twenty-two papers chosen by
Maria Semenova
Higher School of Economics

  1. The Effectiveness of Unconventional Monetary Policies By G. PEERSMAN
  2. Reputation and Liquidity Traps By Taisuke Nakata
  3. Asset markets and monetary policy shocks at the zero lower bound By Edda Claus; Iris Claus; Leo Krippner
  4. Macroeconomic Regimes By L. BAELE; G. BEKAERT; S. CHO; K. INGHELBRECHT; A. MORENO
  5. The Impact of Monetary Policy and Exchange Rate Shocks in Poland: Evidence from a Time-Varying VAR By Arratibel, Olga; Michaelis, Henrike
  6. Do competitive disadvantages really arise from „over complying“?: proposed Basel III Leverage and Supplementary Leverage Ratios re-visited By Ojo, Marianne
  7. Monetary and Fiscal Policy with Sovereign Default By Joost Röttger
  8. Changes in the Response of Fiscal Policy to Monetary Policy in the EMU By Sanchit Arora; Claire Reicher
  9. Are there Differences in the Effectiveness of Quantitative Easing in Japan over Time? By Michaelis, Henrike; Watzka, Sebastian
  10. Bailouts and Financial Fragility By Todd Keister
  11. FLOATING A “LIFEBOAT”: THE BANQUE DE FRANCE AND THE CRISIS OF 1889 By Eugene White; Pierre-Cyrille Hautcoeur; Angelo Riva
  12. Inflation Targeting and Public Deficit in Emerging Countries: A Time Varying Treatment Effect Approach By Kadria, Mohamed; Ben Aissa, Mohamed Safouane
  13. A Model of the Twin Ds: Optimal Default and Devaluation By Seunghoon Na; Stephanie Schmitt-Grohé; Martin Uribe; Vivian Z. Yue
  14. Examining real interest parity: which component reverts quickest and in which regime? By Kavita Sirichand; Andrew Vivian
  15. Is the Eurozone on the Mend? Latin American Examples to Analyze the Euro Question By Eduardo A. Cavallo; Eduardo Fernández Arias; Andrew Powell
  16. Deposit Insurance Database By Asli Demirgüç-Kunt; Edward Kane; Luc Laeven
  17. Measuring the Performance of Banks: Theory, Practice, Evidence, and Some Policy Implications By Joseph P. Hughes; Loretta J. Mester
  18. The Nominal Interest Rate Yield Response to Net Government Borrowing: GLM Estimates, 1972-2012 By Cebula, Richard
  19. How Much Do Official Price Indexes Tell Us About Inflation? By Tsutomu Watanabe; David Weinstein; Jessie Handbury
  20. Audits as Signals By Kotowski, Maciej Henryk; Weisbach, David A.; Zeckhauser, Richard Jay
  21. Inflation,Inflation Variability, and Output Performance. Venezuela 1951-2002 By Olivo, Victor
  22. Financial Stability and Financial Inclusion By Morgan, Peter; Pontines, Victor

  1. By: G. PEERSMAN (-)
    Abstract: Monetary authorities throughout the world have been responding to the global financial crisis by cutting interest rates to historically low levels and by embarking on a series of unconventional monetary policies, including operations that change the size and composition of their balance sheets and actions that try to guide longer-term interest rate expectations. In this white paper, I review the most important unconventional monetary policies adopted by the Federal Reserve and the European Central Bank, how the transmission mechanism of such policies to the real economy differs from that of conventional interest rate changes, and the relevant macroeconomic consequences. I highlight the uncertain long-term effects of unconventional policies and concerns about potential undesired consequences of these policies.
    Date: 2014–02
  2. By: Taisuke Nakata (Federal Reserve Board)
    Abstract: This paper studies credible policies in a New Keynesian economy in which the nominal interest rate is subject to the ZLB constraint and contractionary shocks hit the economy occasionally. The Ramsey policy involves keeping the policy rate low even after the shock disappears, but the central bank would be tempted to raise the rate to close consumption and inflation gaps if it could re-optimize. I find that the Ramsey policy is credible if the contractionary shock occurs sufficiently frequently. In the best credible plan, if the central bank reneges on the promise of low policy rates, it will lose reputation and the private sector will not believe such promises in future recessions. When the shock hits the economy sufficiently frequently, the incentive to maintain reputation outweighs the short-run incentive to close consumption and inflation gaps, and keeps the central bank on the originally announced path of low nominal interest rates.
    Date: 2014
  3. By: Edda Claus; Iris Claus; Leo Krippner (Reserve Bank of New Zealand)
    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.
    JEL: E43 E52 E65
    Date: 2014–07
    Abstract: We estimate a New-Keynesian macro model accommodating regime-switching behavior in monetary policy and in macro shocks. Key to our estimation strategy is the use of survey-based expectations for inflation and output. Output and inflation shocks shift to the low volatility regime around 1985 and 1990, respectively. However, we also identify multiple shifts between accommodating and active monetary policy regimes, which play an as important role as shock volatility in driving the volatility of the macro variables. We provide new estimates of the onset and demise of the Great Moderation and quantify the relative role played by macro-shocks and monetary policy. The estimated rational expectations model exhibits indeterminacy in the mean-square stability sense, mainly because monetary policy is excessively passive.
    Keywords: Markov-Switching (MS) DSGE models, Survey Expectations, Great Moderation, Monetary Policy, Determinacy in MS DSGE models
    JEL: E31 E32 E52 E58 C42 C53
    Date: 2013–12
  5. By: Arratibel, Olga; Michaelis, Henrike
    Abstract: This paper follows the Bayesian time-varying VAR approach with stochastic volatility developed by Primiceri (2005), to analyse whether the reaction of output and prices to interest rate and exchange rate shocks has changed across time (1996-2012) in the Polish economy. The empirical findings show that: (1) output appears more responsive to an interest rate shock at the beginning of our sample. Since 2000, absorbing this shock has become less costly in terms of output, notwithstanding some reversal since the beginning of the global financial crisis. The exchange rate shock also has a time-varying effect on output. From 1996 to 2000, output seems to decline, whereas for periods between 2000 and 2008 it has a positive significant effect. (2) Consumer prices appear more responsive to an interest rate shock during the first half of our sample, when Poland experienced high inflation. The impact of an exchange rate shock on prices seems to slightly decrease across time.
    Keywords: Bayesian time-varying parameter VAR; monetary policy transmission; exchange rate passthrough
    JEL: C30 E44 E52 F41
    Date: 2013–12
  6. By: Ojo, Marianne
    Abstract: The Basel III Leverage Ratio, as originally agreed upon in December 2010, has recently undergone revisions and updates – both in relation to those proposed by the Basel Committee on Banking Supervision – as well as proposals introduced in the United States. Whilst recent proposals have been introduced by the Basel Committee to improve, particularly, the denominator component of the Leverage Ratio, new requirements have been introduced in the U.S to upgrade and increase these ratios, and it is those updates which relate to the Basel III Supplementary Leverage Ratio that have primarily generated a lot of interests. This is attributed not only to concerns that many subsidiaries of US Bank Holding Companies (BHCs) will find it cumbersome to meet such requirements, but also to potential or possible increases in regulatory capital arbitrage: a phenomenon which plagued the era of the original 1988 Basel Capital Accord and which also partially provided impetus for the introduction of Basel II. This paper is aimed at providing an analysis of the most recent updates which have taken place in respect of the Basel III Leverage Ratio and the Basel III Supplementary Leverage Ratio – both in respect of recent amendments introduced by the Basel Committee and revisions introduced in the United States. Amongst these notable developments, the Final or rather nearly finalised Standard issued by the Basel Committee in January 2014, as well as the 2014 U.S Enhanced Supplementary Leverage Ratios are worth mentioning. Sometimes the competitive disadvantages resulting from over compliance or stringent measures may generate costs which are actually minimal when compared to those costs which could potential arise in a scenario where economic disruptions and crises do occur where such „over compliance“ measures are not implemented. So when do measures become over-compliant? What may be regarded as over-compliance for a particular jurisdiction may not necessarily be the case for another. Conversely what may be required for minimal compliance purposes in certain jurisdictions may prove inadequate for certain major economies.
    Keywords: credit risk; global systemically important banks (G-SIBs); leverage ratios; harmonisation; accounting rules; capital arbitrage; disclosure; stress testing techniques; U.S Basel III Final Rule
    JEL: E3 E32 G2 G28 K2
    Date: 2014–07–21
  7. By: Joost Röttger
    Abstract: How does the option to default on debt payments affect the conduct of public policy? To answer this question, this paper studies optimal monetary and fiscal policy without commitment in a model with nominal debt and endogenous sovereign default. When the government can default on its debt, public policy changes in the short and the long run relative to a setting without default option. The risk of default increases the volatility of interest rates, impeding the government's ability to smooth tax distortions across states. It also limits public debt accumulation and reduces the government's incentive to implement high inflation in the long run. The welfare costs associated with the short-run effects of sovereign default are found to be outweighed by the welfare gains due to lower average debt and inflation.
    Keywords: Monetary and Fiscal Policy, Lack of Commitment, Sovereign Default, Domestic Debt, Markov-Perfect Equilibrium
    JEL: E31 E63 H63
    Date: 2014–06–02
  8. By: Sanchit Arora; Claire Reicher
    Abstract: We study the evolution of the response of scal policy to monetary policy shocks in the EMU in the light of two important events: the signing of the Maastricht treaty in 1992 and the introduction of the EMU in 1999. Based on impulse responses from a panel VAR, we nd that scal and monetary policy acted neutrally toward each other before the Maastricht Treaty; scal and monetary policy acted as substitutes immediately after the Maastricht Treaty; and scal and monetary policy acted as complements after the introduction of the EMU. These results holds for a set of 11 non-EMU countries as well, which indicates that the evolution of the scal response to monetary shocks within the EMU has broadly mirrored global developments. One example of such a global development is the global shift toward lower interest rates and tighter scal policy during the 1990s
    Keywords: monetary policy, scal policy, panel VAR, Maastricht Treaty, EMU
    JEL: E52 E62 E65
    Date: 2014–06
  9. By: Michaelis, Henrike; Watzka, Sebastian
    Abstract: Using a time-varying parameter vector autoregression (TVP-VAR) with a new sign restriction framework, we study the changing effectiveness of the Bank of Japan's Quantitative Easing policies over time. We analyse the Zero-Interest Rate Policy from 1999 to 2000, the Quantitative Easing Policy from 2001 to 2006, and most recently the ‘Abenomics' monetary policy easing strategy. Our results indicate that there are important differences concerning the effects of Quantitative Easing over time. We find a stronger and longer lasting positive influence of QE shocks on real GDP and CPI especially since 2013. This might reflect the influence of the ‘Abenomics' program.
    Keywords: Bayesian time-varying parameter VAR; monetary policy; quantitative easing; zero lower bound
    JEL: C30 E44 E52 F41
    Date: 2014–06
  10. By: Todd Keister (Rutgers University)
    Abstract: Should policy makers be prevented from bailing out investors in the event of a crisis? I study this question in a model of financial intermediation with limited commitment. When a crisis occurs, the policy maker will respond by using public resources to augment the private consumption of those investors facing losses. The anticipation of such a “bailout” distorts ex ante incentives, leading intermediaries to choose arrangements with excessive illiquidity and thereby increasing financial fragility. Prohibiting bailouts is not necessarily desirable, however: while it induces intermediaries to become more liquid, it may nevertheless lower welfare and leave the economy more susceptible to a crisis. A policy of taxing short-term liabilities, in contrast, can both improve the allocation of resources and promote financial stability.
    Keywords: bank runs, bailouts, moral hazard, financial regulation
    JEL: G28
    Date: 2014–01–29
  11. By: Eugene White (Rutgers University and NBER); Pierre-Cyrille Hautcoeur (Paris School of Economics and EHESS); Angelo Riva (European Business School)
    Abstract: When faced with a run on a “systemically important” but insolvent bank in 1889, the Banque de France pre-emptively organized a lifeboat to ensure that depositors were protected and an orderly liquidation could proceed. To protect the Banque from losses on its lifeboat loan, a guarantee syndicate was formed, penalizing those who had participated in the copper speculation that had caused the crisis bringing the bank down. Creation of the syndicate and other actions were consistent with mitigating the moral hazard from such an intervention. This episode contrasts the advice given by Bagehot to the Bank of England to counter a panic by lending freely at a high rate on good collateral, allowing insolvent institutions to fail.
    Keywords: crisis
    JEL: E58
    Date: 2014–05–25
  12. By: Kadria, Mohamed; Ben Aissa, Mohamed Safouane
    Abstract: Several studies including Minea,Tapsoba and Villieu(2012) and Lucotte (2012) claim that in emerging countries, the adoption of inflation targeting(IT) monetary policy and its discipline character allow intensifying their efforts to collect tax revenue and/or expenditure rationalization, and allows the reduction of their budget deficits (Kadria and Ben Aissa, 2014). But, the lag in the effect of monetary policy contains vital information for the policy evaluation (Fang and Miller, 2011). Hence, our contribution to the previous literature is then to evaluate the time varying treatment effect of the IT's adoption by emerging countries on their budgetary discipline in terms of reducing or mastering the public deficit. To do this, we used the propensity score matching approach in order to take account of this "lag effect" or from this effect throughout time. Our empirical analysis, conducted on a sample of 41 economies (20 IT and 21 non-IT economies) for the period from 1990 to 2010, shows that the lag in effect of IT on public deficit performance proves to be shorter and gradual for emerging countries that have adopted this monetary policy framework and our conclusions corroborate the literature disciplining effect of IT on fiscal policy.
    Keywords: Time lag, inflation targeting, public deficit, time varying treatment effect evaluation, propensity score matching, emerging countries.
    JEL: C5 E5 E6 H6
    Date: 2014–05
  13. By: Seunghoon Na; Stephanie Schmitt-Grohé; Martin Uribe; Vivian Z. Yue
    Abstract: This paper characterizes jointly optimal default and exchange-rate policy. The theoretical environment is a small open economy with downward nominal wage rigidity as in Schmitt-Grohé and Uribe (2013) and limited enforcement of international debt contracts as in Eaton and Gersovitz (1981). It is shown that under optimal policy default is accompanied by large devaluations. At the same time, under fixed exchange rates, optimal default takes place in the context of large involuntary unemployment. Fixed- exchange-rate economies are found to be able to support less external debt than economies with optimally floating rates. In addition, the following three analytical results are presented: (1) Real economies with limited enforcement of international debt contracts in the tradition of Eaton and Gersovitz (1981) can be decentralized using capital controls. (2) Real economies in the tradition of Eaton and Gersovitz can be interpreted as the centralized version of models with downward nominal wage rigidity, optimal capital controls, and a full-employment exchange-rate policy. And (3) Full-employment is optimal in an economy with downward nominal wage rigidity, limited enforcement of debt contracts, and optimal capital controls.
    JEL: E52 F31 F34 F41
    Date: 2014–07
  14. By: Kavita Sirichand (School of Business and Economics, Loughborough University); Andrew Vivian (School of Business and Economics, Loughborough University Mark E.Wohar; Department of Economics, University of Nebraska-Omaha, Omaha, Nebraska, USA.)
    Abstract: This article re-examines real interest parity (RIP), focusing upon which component of real interest parity drives convergence to parity. We find that it is the reversion of inflation rather than nominal interest rates which is the primary source of convergence to RIP. Nominal interest rate differential are found to be persistent during both periods. Furthermore, we additionally find that mean reversion in the inflation differentials is faster during the Gold Standard period.
    Keywords: comovement, real interest rate parity, inflation differential, nominal interest
    JEL: G10 G15 G30
    Date: 2014–07
  15. By: Eduardo A. Cavallo; Eduardo Fernández Arias; Andrew Powell
    Abstract: Several European countries face challenges reminiscent of those faced by the emerging economies of Latin America. The economic booms in some peripheral Euro-zone countries financed by large capital inflows; the credit and asset price booms and then the busts including Sudden Stops in capital flows; the strong interaction between sovereign debt and domestic banking systems; the role of foreign banks and contagion; and all in the context of a fixed exchange rate, are familiar plotlines for Latin American audiences. For those Euro-zone countries that built up large Euro-denominated external liabilities, Latin America's experience is particularly relevant and worrisome. Still, Europe may be in a better position to navigate a path out of the crisis given cooperative mechanisms that were absent in Latin America, particularly the availability of massive liquidity support. Nonetheless, while such support buys time, it does not guarantee success. This paper argues that reflecting on Latin America's experience provides useful lessons for Europe to improve the chances for a successful resolution.
    Keywords: Financial Crises & Economic Stabilization, Financial Policy, Public debt, Latin America, Financial crisis, Euro, Debt overhang, Banking crisis, Sudden Stops, Real devaluations, Currency union, Fiscal devaluation
    Date: 2014–07
  16. By: Asli Demirgüç-Kunt; Edward Kane; Luc Laeven
    Abstract: This paper provides a comprehensive, global database of deposit insurance arrangements as of 2013. We extend our earlier dataset by including recent adopters of deposit insurance and information on the use of government guarantees on banks’ assets and liabilities, including during the recent global financial crisis. We also create a Safety Net Index capturing the generosity of the deposit insurance scheme and government guarantees on banks’ balance sheets. The data show that deposit insurance has become more widespread and more extensive in coverage since the global financial crisis, which also triggered a temporary increase in the government protection of non-deposit liabilities and bank assets. In most cases, these guarantees have since been formally removed but coverage of deposit insurance remains above pre-crisis levels, raising concerns about implicit coverage and moral hazard going forward.
    Date: 2014–07–03
  17. By: Joseph P. Hughes (Rutgers University); Loretta J. Mester (Federal Reserve Bank of Philadelphia)
    Abstract: The unique capital structure of commercial banking – funding production with demandable debt that participates in the economy’s payments system – affects various aspects of banking. It shapes banks’ comparative advantage in providing financial products and services to informationally opaque customers, their ability to diversify credit and liquidity risk, and how they are regulated, including the need to obtain a charter to operate and explicit and implicit federal guarantees of bank liabilities to reduce the probability of bank runs. These aspects of banking affect a bank’s choice of risk vs. expected return, which, in turn, affects bank performance. Banks have an incentive to reduce risk to protect the valuable charter from episodes of financial distress and they also have an incentive to increase risk to exploit the cost-of-funds subsidy of mispriced deposit insurance. These are contrasting incentives tied to bank size. Measuring the performance of banks and its relationship to size requires untangling cost and profit from decisions about risk versus expected-return because both cost and profit are functions of endogenous risk-taking. This chapter gives an overview of two general empirical approaches to measuring bank performance and discusses some of the applications of these approaches found in the literature. One application explains how better diversification available at a larger scale of operations generates scale economies that are obscured by higher levels of risk-taking. Studies of banking cost that ignore endogenous risk-taking find little evidence of scale economies at the largest banks while those that control for this risk-taking find large scale economies at the largest banks – evidence with important implications for regulation.
    Keywords: efficiency
    JEL: G1
    Date: 2013–08–01
  18. By: Cebula, Richard
    Abstract: This study provides current empirical evidence on the impact of net U.S. government borrowing (budget deficits) on the nominal interest rate yield on ten-year Treasury notes. The model includes an ex ante real short-term real interest rate yield, an ex ante real long-term interest rate yield, the monetary base as a percent of GDP, expected future inflation, the percentage growth rate of real GDP, net financial capital inflows, and other variables. This study uses annual data for the period 1972-2012. GLM (Generalized Linear Model) estimates imply, among other things, that the federal budget deficit, expressed as a percent of GDP, exercised a positive and statistically significant impact on the nominal interest rate yield on ten-year Treasury notes over the study period.
    Keywords: nominal interest rate yield; budget deficits; GLM estimates
    JEL: E43 E52 E62 H62
    Date: 2014–07–18
  19. By: Tsutomu Watanabe (Hitotsubashi University); David Weinstein (Columbia University); Jessie Handbury (University of Pennsylvania)
    Abstract: Official price indexes, such as the CPI, are imperfect indicators of inflation calculated using ad hoc price formulae different from the theoretically well-founded inflation indexes favored by economists. This paper provides the first estimate of how accurately the CPI informs us about “true†inflation. We use the largest price and quantity dataset ever employed in economics to build a Törnqvist inflation index for Japan between 1989 and 2010. Our comparison of this true inflation index with the CPI indicates that the CPI bias is not constant but depends on the level of inflation. We show the informativeness of the CPI rises with inflation. When measured inflation is low (less than 2.4% per year) the CPI is a poor predictor of true inflation even over 12-month periods. Outside this range, the CPI is a much better measure of inflation. We find that the U.S. PCE Deflator methodology is superior to the Japanese CPI methodology but still exhibits substantial measurement error and biases rendering it a problematic predictor of inflation in low inflation regimes as well.
    Date: 2014
  20. By: Kotowski, Maciej Henryk; Weisbach, David A.; Zeckhauser, Richard Jay
    Abstract: A broad array of law enforcement strategies, from income tax to bank regulation, involve self-reporting by regulated agents and auditing of some fraction of the reports by the regulating bureau. Standard models of self-reporting strategies assume that although bureaus only have estimates of the of an agent’s type, agents know the ability of bureaus to detect their misreports. We relax this assumption, and posit that agents only have an estimate of the auditing capabilities of bureaus. Enriching the model to allow two-sided private information changes the behavior of bureaus. A bureau that is weak at auditing, may wish to mimic a bureau that is strong. Strong bureaus may be able to signal their capabilities, but at a cost. We explore the pooling, separating, and semi-separating equilibria that result, and the policy implications. Important possible outcomes are that a cap on penalties increases compliance, audit hit rates are not informative of the quality of bureau behavior, and by mimicking strong bureaus even weak bureaus can induce compliance.
    Date: 2014
  21. By: Olivo, Victor
    Abstract: This paper explores the relationship between the level of inflation, inflation variability, and output performance in the Venezuelan economy for the period 1951-2002. The paper examines the mechanism through which higher inflation translates into lower non-oil real GDP growth. We find empirical evidence that supports Friedman's (1977) contention that higher inflation produces more inflation volatility /uncertainty that leads to relative price variability that in turn, is harmful for the proper functioning of the market as the best system for allocating resources.
    Keywords: Inflation, inflation variability,inflation uncertainty, output growth, trend inflation, trend money growth, relative prices
    JEL: E59
    Date: 2014–04–09
  22. By: Morgan, Peter (Asian Development Bank Institute); Pontines, Victor (Asian Development Bank Institute)
    Abstract: Developing economies are seeking to promote financial inclusion, i.e., greater access to financial services for low-income households and firms, as part of their overall strategies for economic and financial development. This raises the question of whether financial stability and financial inclusion are, broadly speaking, substitutes or complements. In other words, does the move toward greater financial inclusion tend to increase or decrease financial stability? A number of studies have suggested both positive and negative ways in which financial inclusion could affect financial stability, but very few empirical studies have been made of their relationship. This partly reflects the scarcity and relative newness of data on financial inclusion. This study contributes to the literature on this subject by estimating the effects of various measures of financial inclusion (together with some control variables) on some measures of financial stability, including bank non-performing loans and bank Z scores. We find some evidence that an increased share of lending to small and medium sized enterprises (SMEs) aids financial stability, mainly by reducing non-performing loans (NPLs) and the probability of default by financial institutions. This suggests that policy measures to increase financial inclusion, at least by SMEs, would have the side-benefit of contributing to financial stability as well.
    Keywords: financial stability; financial inclusion; SMEs; bank z-scores; non-performing loans
    JEL: G21 G28 O16
    Date: 2014–07–09

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