nep-cba New Economics Papers
on Central Banking
Issue of 2014‒08‒02
seventeen papers chosen by
Maria Semenova
Higher School of Economics

  1. Property Bubbles and the Driving Forces in the PIGS Countries By Klotz, Philipp; Lin, Tsoyu Calvin; Hsu, Shih-Hsun
  2. The Problems of Real Estate Financing in the Post-Crisis Period in Slovakia By IvaniÄ?ka, Koloman; Spirkova, Daniela
  3. How Can One Tell When the Housing Market Is Out of Equilibrium? By Hill, Robert
  4. The role of liquidity shocks in the housing market By de La Paz, Paloma Taltavull; White, Michael
  5. Innovative financing instruments for real estate development in Western Europe By Vlachostergiou, Vassiliki; Hutchison, Norman
  6. A banking union for Europe: making a virtue out of necessity By Maria Abascal; Tatiana Alonso; Santiago Fernandez de Lis; Wojciech Golecki
  7. Banking crises and sovereign defaults in emerging markets: exploring the links By Irina Balteanu; Aitor Erce
  8. The European Monetary Union and Imbalances: Is it an Anticipation Story ? By D. Siena
  9. Identification of financial factors in economic fluctuations By Francesco Furlanetto; Francesco Ravazzolo; Samad Sarferaz
  10. On modeling banking risk By Efthymios G. Tsionas
  11. Macroeconomic and credit forecasts in a small economy during crisis: A large Bayesian VAR approach By Dimitris P. Louzis
  12. The Macroeconomics of Shadow Banking By Alan Moreira; Alexi Savov
  13. Sintonía fina de la política monetaria mexicana entre objetivos e instrumentos durante la crisis 2007-2009 By Galán-Figueroa, Javier; Venegas-Martínez, Francisco
  14. The Excess Demand Theory of Money By Kehrwald, Bernie
  15. Lessons from the European Financial Crisis By Marco Pagano
  16. Predicting bank insolvency in the Middle East and North Africa By Calice, Pietro
  17. Inflation and indivisible investment in developing economies By Eden, Maya; Nguyen, Ha

  1. By: Klotz, Philipp; Lin, Tsoyu Calvin; Hsu, Shih-Hsun
    Abstract: The PIGS countries stand in the spotlight of the current financial crisis in Europe. The boom and bust of the real estate sector was one of the major sources putting these countries into an economic downturn. This paper determines the extent to which these countries experienced property bubbles and sheds light on the role of monetary policy in the formation of bubbles. We draw from Stiglitz’s (1990) theory on asset bubbles and apply the direct capitalization approach through weighted average cost of capital (WACC) to identify real estate bubbles in the period from 1999 to 2012. In the next step we apply VAR and VECM models to investigate short- and long-run dynamics between the monetary policy of the ECB and property bubbles in the PIGS countries. Our findings indicate that Spain and Ireland experienced the largest positive bubble formation, followed by Portugal with a small bubble. In contrast to that, Greece experienced a strong negative bubble. While we find only a very weak short-run relationship between monetary policy and bubble formation in Portugal, we find both, evidence for a long- and short run relationship in the case of Ireland, Greece and Spain. The varying extent of the bubble formation and the differing impact of the monetary policy on the bubble across the PIGS countries can be mainly attributed to characteristics in the domestic financial-, fiscal- and macroprudential-system. This paper provides strong evidence that countries with very low interest rates and low to moderate tax rate as well as high loan-to-value ratios have the potential to experience large property bubbles. Central bank’s policies are crucial to trigger the boom and burst of property bubbles by manipulating the interest rate and availability of lending for house purchase. As this research only covers aggregate data for entire countries, diverging developments within each country are not captured. Future research could contribute to the literature by focusing on property market developments in specific cities or regions.
    Date: 2013
  2. By: IvaniÄ?ka, Koloman; Spirkova, Daniela
    Abstract: The objective of the paper is to study the changes in the real estate financing in the post crisis period in Slovakia. Slovak transition to market economy enabled to create the booming real estate markets in the 21st century. The FDI inflows and the integration processes, inclusion to Euro zone, were the important catalysts of such progress. Yet the global financial crisis substantially decelerated existing development and revealed the vulnerabilities of the economic growth model, the institutions, public finance and banking systems. The changing macroeconomic fundamentals negatively influenced the real estate vacancies, returns, and investments. The global financial crisis had revealed the serious problems of financial markets, such as the inadequate oversight, and banking regulations. Three new important regulations: Alternative Investment Fund Manager Directive, Basel III, Solvency II aim to prevent the risky behavior of banks. Based on them, many banks have implemented very restrictive criteria for the provision of the real estate credits. At the same time banks had to resolve the problems of distressed loans. This is the opportunity for the debt companies, private equity groups, the sovereign wealth funds, the insurance companies, mezzanine lenders and other investors with flexible capital to step into the market and to take the larger role in financing the real estate developments. This tendency is well observed in the developed countries with stabilized real estate markets, good returns or low risk return, while they are less obvious in CEE (Central and Eastern Europe) region. The consequence of restrictions on the provisions of banking property credits opens the new business opportunities in real estate sector for insurance companies, debt funds, off shore funds, mezzanine funds, private equity funds, etc. The serious problem is still the high public debt, and its negative impact on Eurozone. Many investors had fled from the European periphery into the EU core also because the competitiveness issues of European periphery, including the CEE countries, are not resolved. Recovery of real estate markets in Slovakia is under the way, yet the attainment of the pre-crisis real estate boom is not very probable. Much will depend on economic growth, important institutional reforms, especially in banking, economics, and in European Union as well.
    Date: 2013
  3. By: Hill, Robert
    Abstract: Purpose - One way of detecting departures from equilibrium is by comparing house prices and rents. Here I assess the viability of this approach.Design/methodology - Error-correction models (ECMs) based on price and rent indexes can be used to forecast movements in house prices. The short-term forecasting ability of ECMs is limited though due to the long persistence of departures from equilibrium. ECMs also suffer from the limitation that they do not tell us whether the price-rent ratio is above or below its equilibrium level at any given point in time. To answer this question it is necessary to make cross-section comparisons of prices, rents and user cost (i.e., the cost incurred by owning a house).Findings - A meaningful cross-section comparison requires that prices and rents are quality adjusted. This may require the use of hedonic methods. The equilibrium price-rent ratio (which is derived from the user cost) is difficult to compute since it depends on the expected capital gain. Also, both the actual and equilibrium price-rent ratios differ depending on which segment of the housing market is considered. Originality/value - The housing market, which is prone to booms and busts, can very significantly affect the rest of the economy. Hence it is important that central banks and governments can detect when the housing market is out of equilibrium. I show here how difficult it is to detect such departures.
    Date: 2013
  4. By: de La Paz, Paloma Taltavull; White, Michael
    Abstract: In a previous paper (Taltavull and White, 2012) we analysed the role of money supply, migration and mortgage finance in house price evolution. Using a VECM framework we examined these variables together with income, inflation, and interest rates for both Spain and the UK. The results indicated an important role for income, mortgages and migration in UK house price movements, more so than in Spain. Financial deregulation, and increasing monetary integration have been the background against which flows of liquidity have increased. Increasing interbank flows have also linked markets in different countries providing increased liquidity that can impact the mortgage market. Traditionally, monetary policy used interest rate changes to affect GDP. However this policy tool impacts asymmetrically in Eurozone economies and is generally constrained by the highly internationally interconnected money market. In this paper we build upon our previous work and focus on the role that changes in liquidity have played in the evolution of house prices. In doing this we identify the main channels of transmission affecting the housing market. In addition we also consider how the housing market, being impacted by increased liquidity can also feedback to aggregate money supply. The models tested examine Spain and the UK and identify short run and permanent effects in the relationship between liquidity and house prices.
    Date: 2014
  5. By: Vlachostergiou, Vassiliki; Hutchison, Norman
    Abstract: The scale of the real estate development investment challenge allied with capital budget constraints has meant that the prospect of implementing innovative finance instruments has gained considerable momentum in recent years, at a time when Western European government policy has shifted towards supporting the decentralisation of power to local authorities. For instance in the UK, the introduction of the Community Infrastructure Levy (CIL) has provided local authorities with revenue generating streams to fund infrastructure provision, contributing to the economic viability of real estate development. At a macro-level, the broader economic aspects of the ‘crisis’ of finance in the EU post 2007-08, have taken urban development and regeneration trajectories in different directions. Furthermore, the effects of this ‘crisis’ at a regional EU level have seen different national export structures and dependence on other sources of foreign-currency earnings.In this research, exploration of financial instruments for real estate development is taken from a pan-European perspective. Views are targeted to Western European nations of the United Kingdom, Germany, France, The Netherlands and Spain. The broader pan-European context has been researched institutionally, such as through the JESSICA (Joint European Support for Sustainable Investment in City Areas) initiative of the European Commission, developed in co-operation with the European Investment Bank (EIB) and the Council of Europe Development Bank (CEB). The clear aim and output from the project has been to generate a contemporary conceptual model of financial instruments, used in real estate for urban development and regeneration in Western Europe, that have developed post 2007-08 Global Financial Crisis (GFC). The research has been sponsored by the RICS (Royal Institution of Chartered Surveyors) Research Trust.
    Date: 2014
  6. By: Maria Abascal; Tatiana Alonso; Santiago Fernandez de Lis; Wojciech Golecki
    Abstract: Banking union is the most ambitious European project undertaken since the introduction of the single currency. It was launched in the summer of 2012, in order to send the markets a strong signal of unity against a looming financial fragmentation problem that was putting the euro on the ropes. The main goal of banking union is to resume progress towards the single market for financial services and, more broadly, to preserve the single market by restoring the proper functioning of monetary policy in the eurozone through restoring confidence in the European banking sector. This will be achieved through new harmonised banking rules and stronger systems for both banking supervision and resolution, that will be managed at the European level. The EU leaders and co-legislators have been working against the clock to put in place a credible and effective set-up in record time, amid intense negotiations (with final deals often closed at the last minute) and very significant concessions by all parties involved (most of which would have been simply unthinkable just a few years ago). Despite the fact that the final set-up does not provide for the optimal banking union, we still hold to its extraordinary political value and see its huge potential. By putting Europe back on the right integration path, banking union will restore the momentum towards a genuine economic and monetary union. Nevertheless, in order to put an end to the sovereign/banking loop, further progress in integration is needed including key fiscal, economic and political elements.
    Keywords: European Single Market, European Monetary Union, Banking Union, Banking resolution, Banking supervision, Single rulebook, Financial fragmentation
    JEL: G21 G28 H12 F36
    Date: 2014–07
  7. By: Irina Balteanu (Banco de España); Aitor Erce (Banco de España)
    Abstract: This paper provides a set of stylised facts on the mechanisms through which banking and sovereign distress feed into each other, using a large sample of emerging economies over three decades. We first define “twin crises” as events where banking crises and sovereign defaults combine, and further distinguish between those banking crises that end in sovereign debt crises, and vice-versa. We then assess what differentiates “single” episodes from “twin” ones. Using an event analysis methodology, we study the behaviour around crises of variables describing the balance sheet interconnection between the banking and public sectors, the characteristics of the banking sector, the state of public finances and the macroeconomic context. We find that there are systematic differences between “single” and “twin” crises across all these dimensions. Additionally, we find that “twin” crises are heterogeneous events: taking into account the proper time sequence of crises within “twin” episodes is important for understanding their drivers, transmission channels and economic consequences. Our results shed light on the mechanisms surrounding feedback loops of sovereign and banking stress
    Keywords: banking crises, sovereign defaults, feedback loops, balance sheets
    JEL: E44 F34 G01 H63
    Date: 2014–07
  8. By: D. Siena
    Abstract: This paper investigates the sources of current account imbalances accumulated within the European Monetary Union before the Great Recession. First, it documents that starting in 1996, before the actual introduction of the euro, countries in the euro area periphery experienced increasing current account deficits, appreciating real exchange rates and output growing faster than trends. Then, it develops and estimates a small open economy DSGE model which encompasses a variety of possible unanticipated and anticipated shocks. The main finding is that anticipated reductions in international borrowing costs can explain the observed evidence while productivity increases (anticipated or not) cannot: falling borrowing costs implies appreciation while increasing productivity implies depreciation. Quantitatively, anticipated shocks account for one third of output, half of real exchange rate and two third of current account fluctuations. In particular, anticipated fluctuations in international borrowing costs explain respectively 30 and 40 percent of current account and real exchange rate movements.
    Keywords: Current Account, Business cycles, Anticipated Shocks.
    JEL: E32 F32 F41
    Date: 2014
  9. By: Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Francesco Ravazzolo (Norges Bank (Central Bank of Norway) and BI Norwegian Business School); Samad Sarferaz (ETH Zürich)
    Abstract: We estimate demand, supply, monetary, investment and financial shocks in a VAR identified with a minimum set of sign restrictions on US data. We find that financial shocks are major drivers of fluctuations in output, stock prices and investment but have a limited effect on inflation. In a second step we disentangle shocks originating in the housing sector, shocks originating in credit markets and uncertainty shocks. In the extended set-up financial shocks are even more important and a leading role is played by housing shocks that have large and persistent effects on output.
    Keywords: VAR, Sign restrictions, Financial shocks, External finance premium, Housing, Uncertainty
    JEL: C11 C32 E32
    Date: 2014–07–18
  10. By: Efthymios G. Tsionas (Athens University of Economics and Business)
    Abstract: The paper develops new indices of financial stability based on an explicit model of expected utility maximization by financial institutions subject to the classical technology restrictions of neoclassical production theory. The model can be estimated using standard econometric techniques, like GMM for dynamic panel data and latent factor analysis for the estimation of covariance matrices. An explicit functional form for the utility function is not needed and we show how measures of risk aversion and prudence (downside risk aversion) can be derived and estimated from the model. The model is estimated using data for Eurozone countries and we focus particularly on (i) the use of the modeling approach as an “early warning mechanism”, (ii) the bank- and country-specific estimates of risk aversion and prudence (downside risk aversion), and (iii) the derivation of a generalized measure of risk that relies on loan-price uncertainty.
    Keywords: Financial Stability; Banking; Expected Utility Maximization; Sub-prime crisis; Financial Crisis; Eurozone; PIIGS.
    JEL: G20 G21 C51 C54 D21 D22
    Date: 2014–05
  11. By: Dimitris P. Louzis (Bank of Greece)
    Abstract: We examine the ability of large-scale vector autoregressions (VARs) to produce accurate macroeconomic (output and inflation) and credit (loans and lending rates) forecasts in Greece, during the latest sovereign debt crisis. We implement recently proposed Bayesian shrinkage techniques and we evaluate the information content of forty two (42) monthly macroeconomic and financial variables in a large Bayesian VAR context, using a five year out-of-sample forecasting period from 2008 to 2013. The empirical results reveal that, overall, large-scale Bayesian VARs, enhanced with key financial variables and coupled with the appropriate level of shrinkage, outperform their small- and medium-scale counterparts with respect to both macroeconomic and credit variables. The forecasting superiority of large Bayesian VARs is particularily clear at long-term forecasting horizons. Finally, empirical evidence suggests that large Bayesian VARs can significantly improve the directional forecasting accuracy of small VARs with respect to loans and lending rates variables.
    Keywords: Forecasting; Bayesian VARs; Crisis; Financial variables
    Date: 2014–06
  12. By: Alan Moreira; Alexi Savov
    Abstract: We build a macroeconomic model that centers on liquidity transformation in the financial sector. Intermediaries maximize liquidity creation by issuing securities that are money-like in normal times but become illiquid in a crash when collateral is scarce. We call this process shadow banking. A rise in uncertainty raises demand for crash-proof liquidity, forcing intermediaries to delever and substitute toward safe, collateral- intensive liabilities. Shadow banking shrinks, causing the liquidity supply to contract, discount rates and collateral premia spike, prices and investment fall. The model produces slow recoveries, collateral runs, and flight to quality and it provides a framework for analyzing unconventional monetary policy and regulatory reform proposals.
    JEL: E44 E52 G01 G21 G23
    Date: 2014–07
  13. By: Galán-Figueroa, Javier; Venegas-Martínez, Francisco
    Abstract: This paper carries out an exploration of how the Mexican Bank Central conducted its monetary policy during the crisis 2007-2009 based on the analytical framework of the neoclassical macroeconomics. It is shown that in that period it was followed a countercyclical policy to reduce the crisis adverse effect on economic activity. To accomplish the above, Central Bank used a fine-tuning strategy between objectives and instruments. We estimate a Structural Vector Autoregressions model (SVAR), which allows us to show empirical evidence that Mexican monetary authority reacted in the short term with a countercyclical policy to stimulate economic activity through of a monetary expansion accompanied by a slow reaction of the general price level; while in the long term the dynamics of the general price level increased the interest rate due to an augment in agents’ inflation expectations, thereby the economic activity was negatively affected.
    Keywords: Política monetaria, reglas de política y blancos de inflación.
    JEL: E52
    Date: 2014–07–24
  14. By: Kehrwald, Bernie
    Abstract: This paper introduces a new monetary theory. A simple model is described in which a central bank sets the interest rate in a way that the excess demand for credits equals the preferred amount of money. It is compatible with the Keynesian liquidity preference theory and the neoclassical loanable funds theory and can be used to explain a series of phenomena. It is very suitable for introductory textbooks.
    Keywords: money, interest rate, credit, central bank, savings, investments
    JEL: E40 E50 E51
    Date: 2014–07–27
  15. By: Marco Pagano (Università di Napoli Federico II CSEF, EEIF, CEPR and ECGI)
    Abstract: This paper distils three lessons for bank regulation from the experience of the 2009-12 euro-area financial crisis. First, it highlights the key role that sovereign debt exposures of banks have played in the feedback loop between bank and fiscal distress, and inquires how the regulation of banks’ sovereign exposures in the euro area should be changed to mitigate this feedback loop in the future. Second, it explores the relationship between the forbearance of non-performing loans by European banks and the tendency of EU regulators to rescue rather than resolving distressed banks, and asks to what extent the new regulatory framework of the euro-area “banking union” can be expected to mitigate excessive forbearance and facilitate resolution of insolvent banks. Finally, the paper highlights that capital requirements based on the ratio of Tier-1 capital to banks’ risk-weighted assets were massively gamed by large banks, which engaged in various forms of regulatory arbitrage to minimize their capital charges while expanding leverage. This argues in favor of relying on a set of simpler and more robust indicators to determine banks’ capital shortfall, such as book and market leverage ratios. JEL Classification: G01, G21, G28, G33.
    Keywords: bank regulation, euro, financial crisis, sovereign exposures, forbearance, bank resolution, bank capital requirements.
    Date: 2014–07–24
  16. By: Calice, Pietro
    Abstract: This paper uses a panel of annual observations for 198 banks in 19 Middle East and North Africa countries over 2001-12 to develop an early warning system for forecasting bank insolvency based on a multivariate logistic regression framework. The results show that the traditional CAMEL indicators are significant predictors of bank insolvency in the region. The predictive power of the model, both in-sample and out-of-sample, is reasonably good, as measured by the receiver operating characteristic curve. The findings of the paper suggest that banking supervision in the Middle East and North Africa could be strengthened by introducing a fundamentals-based, off-site monitoring system to assess the soundness of financial institutions.
    Keywords: Banks&Banking Reform,Bankruptcy and Resolution of Financial Distress,Access to Finance,Financial Crisis Management&Restructuring,Debt Markets
    Date: 2014–07–01
  17. By: Eden, Maya; Nguyen, Ha
    Abstract: In countries with limited access to finance, firms accumulate retained earnings to finance indivisible investment projects. McKinnon (1973) illustrates that when cash is used as a primary store of value, inflation may discourage investment as it increases the cost of accumulating retained earnings. This paper formalizes this argument in a dynamic framework and provides a simple calibration of the model that suggests sizable effects of inflation on investment. The mechanism is particularly relevant for small firms, as firms with lower cash flows must accumulate retained earnings for longer periods of time to meet the price of indivisible investment goods. Consistent with the model, empirical evidence suggests that inflation disproportionately reduces investment in small firms.
    Keywords: Investment and Investment Climate,Debt Markets,Economic Theory&Research,Access to Finance,Non Bank Financial Institutions
    Date: 2014–07–01

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