nep-cba New Economics Papers
on Central Banking
Issue of 2014‒11‒01
twenty papers chosen by
Maria Semenova
Higher School of Economics

  1. A Comparative Analysis of Macroprudential Policies By Yaprak Tavman
  2. Optimal Macroprudential Policy By Junichi Fujimoto; Ko Munakata; Koji Nakamura; Yuki Teranishi
  3. So far apart and yet so close: Should the ECB care about inflation differentials? By Zsolt Darvas; Guntram B. Wolff
  4. Decaying expectations: what inflation forecasts tell us about the anchoring of inflation expectations By Aaron Mehrotra; James Yetman
  5. Sovereign Defaults, Bank Runs, and Contagion By Stephan Luck; Paul Schempp
  6. Does Inflation Targeting Outperform Alternative Policies during Global Downturns? By Renée A. Fry-McKibbin; Chen Wang
  7. Toward a New Understanding of Monetary Policy By Friedman, Benjamin Morton
  8. Developing an underlying inflation gauge for China By Marlene Amstad; Ye Huan; Guonan Ma
  9. The Price of Stability. The balance sheet policy of the Banque de France and the Gold Standard (1880-1914). By G. Bazot; M. D. Bordo; E. Monnet
  10. UNITED STATES MONETARY POLICY IN THE POST-BRETTON WOODS ERA Did it cause the Crash of 2008? By Yanis Varoufakis
  11. The Bank of France and the Open-Market instrument: an impossible wedding? By Nicolas Barbaroux
  12. QE and the bank lending channel in the United Kingdom By Butt, Nick; Churm, Rohan; McMahon, Michael; Morotz, Arpad; Schanz, Jochen
  13. Financial Crisis, Unconventional Monetary Policy and International Spillovers By Qianying Chen; Andrew Filardo; Dong He; Feng Zhu
  14. Central Bank Currency Swaps and the International Monetary System By Christophe Destais
  15. The optimal supply of liquidity and the regulations of money substitutes: a Baumol-Tobin approach By Benjamin Eden
  16. The Monetary Approach to Exchange Rate Determination: A geometric analysis Creation Date: 1981 By K.W. Clements
  17. Can interest rate spreads stabilize the euro area? By Michał Brzoza-Brzezina; Jacek Kotłowski; Kamil Wierus
  18. Inflation Risk Premia, Yield Volatility and Macro Factors By Andrea Berardi
  19. On Central Bank Interventions in the Mexican Peso/Dollar Foreign Exchange Market By Santiago García-Verdú; Miguel Zerecero
  20. Does it take two to tango? Improving cooperation between the IMF and the World Bank: theory and empirical evidence By Silvia Marchesi; Laura Sabani

  1. By: Yaprak Tavman
    Abstract: The global financial crisis has clearly shown that macroeconomic stability is not sufficient to guarantee the stability of the financial system. Hence, the recent policy debate has focused on the effectiveness of macroprudential tools and their interaction with monetary policy. This paper aims to contribute to the macroprudential policy literature by presenting a formal comparative analysis of three macroprudential tools: (i) reserve requirements, (ii) capital requirements and (iii) a regulation premium. Utilizing a New Keynesian general equilibrium model with Önancial frictions, we find that capital requirements are the most effective macroprudential tool in mitigating the negative effects of the financial accelerator mechanism. Deriving welfare-maximizing monetary and macroprudential policy rules, we also conclude that irrespective of the type of the shock affecting the economy, use of capital requirements generates the highest welfare gains.
    Keywords: financial crises, monetary policy, macroprudential tools, financial system regulation
    JEL: E44 E58 G21 G28
    Date: 2014–06
  2. By: Junichi Fujimoto (National Graduate Institute for Policy Studies); Ko Munakata (Bank of Japan); Koji Nakamura (Bank of Japan); Yuki Teranishi (Keio University and CAMA, ANU)
    Abstract: This paper introduces financial market frictions into a standard New Keynesian model through search and matching in the credit market. Under such financial mar- ket frictions, a second-order approximation of social welfare includes a term involv- ing credit, in addition to terms for inflation and consumption. As a consequence, the optimal monetary and macroprudential policies must contribute to both finan- cial and price stability. This result holds for various approximated welfares that can change corresponding to macroprudential policy variables. The key features of opti- mal policies are as follows. The optimal monetary policy requires keeping the credit market countercyclical against the real economy. Commitment in monetary and macro- prudential policy, rather than approximated welfare, justifies history dependence and pre-emptiveness. Appropriate combinations of macroprudential and monetary policy achieve perfect financial and price stability.
    Keywords: optimal macroprudential policy; optimal monetary policy; financial market friction
    JEL: E44 E52 E61
    Date: 2014–09
  3. By: Zsolt Darvas; Guntram B. Wolff
    Abstract: Inflation rates can differ across regions of monetary unions. We show that in the euro area, the US, Canada, Japan and Australia, inflation rates have been substantially and persistently different in different regions. Differences were particularly substantial in the euro area. Inflation differences can reflect normal adjustment processes such as price convergence or the Balassa-Samuelson effect, or can reflect the different cyclical position of regions. But they can also be the result of economic distortions resulting from segmented markets or unsustainable demand and credit developments fueled by low real interest rates. In normal times, the European Central Bank cannot influence such developments with its single interest rate instrument. However, unconventional policy measures can have different effects on different countries depending on the chosen instrument, and should be used to reduce fragmentation and ensure the proper transmission of monetary policy. The new macro prudential policy tools are unlikely to be practical in addressing inflation divergences. It is crucial to keep the average inflation rate close to two percent so that inflation differentials are possible without deflation in some parts of the euro area, which in turn might endanger area-wide financial stability and price stability.
    Date: 2014–09
  4. By: Aaron Mehrotra; James Yetman
    Abstract: Well anchored inflation expectations are considered to be a reflection of credible monetary policy. In the past, anchoring has been assessed using either long-run inflation surveys or break-even inflation rates on financial assets with long maturities. But neither of these is ideal. Here we propose an alternative measure of inflation anchoring that makes full use of readily available, multiple-horizon, fixedevent forecasts. We show that a model where forecasts are assumed to diverge away from a long-run anchor towards actual inflation as the forecast horizon shortens fits the data well. It also provides simple estimates of the degree to which inflation expectations are anchored. Based on our estimation results we argue that inflation expectations have become more tightly anchored over time in both inflation targeting economies and in those following other regimes. However, inflation targeting regimes have seen a greater change along three dimensions: the level of the anchor has fallen further; the tightness of anchoring has increased more; and the relationship between the anchor and actual inflation outcomes has weakened to a greater degree.
    Keywords: Inflation expectations, decay function, inflation targeting
    Date: 2014–09
  5. By: Stephan Luck (Max Planck Institute for Research on Collective Goods, Bonn); Paul Schempp (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: We provide a model that unifies the notion of self-fulfilling banking crises and sovereign debt crises. In this model, a bank run can be contagious by triggering a sovereign default, and vice versa. A deposit insurance scheme can eliminate the adverse equilibrium only if the government can repay its debt and credibly insure deposits irrespective of the performance of the financial sector. Moreover, we analyze how banking crises and sovereign defaults can be contagious across countries. We give conditions under which the implementation of a banking union is effective and costless. Finally, we discuss the current proposals for a banking union in the euro area and argue that it should be extended by a supranational Deposit Guarantee Scheme.
    Keywords: bank run, financial crisis, sovereign default, vicious cycle, financial contagion, banking union, deposit insurance
    JEL: G21 G28 H81 H63
    Date: 2014–09
  6. By: Renée A. Fry-McKibbin; Chen Wang
    Abstract: This article examines the performance of inflation targeters during the 2007-2012 downturn compared to those without this policy. Propensity score matching methods are used to compare the policy regimes, where during a downturn the more successful policy results in higher inflation and output growth, lower unemployment, and a better fiscal position. The analysis is conducted separately for developed and emerging countries. Inflation targeting tends to insulate developed countries, but is much less conclusive for the emerging countries during downturns. These results are opposite to those found for normal economic periods which are inconclusive for developed countries, but beneficial for emerging countries. Most concerning for emerging countries is that inflation targeters experience lower GDP growth in downturns. Both developed and emerging countries need to evaluate their choice of monetary regime by taking into account the tradeoff between low and stable inflation during normal periods with growth during downturns.
    Keywords: Inflation, Inflation targeting, Financial crisis, Propensity score matching
    JEL: E31 E52 E58
    Date: 2014–10
  7. By: Friedman, Benjamin Morton
    Date: 2013
  8. By: Marlene Amstad; Ye Huan; Guonan Ma
    Abstract: This paper develops a new underlying inflation gauge (UIG) for China which differentiates between trend and noise, is available daily and uses a broad set of variables that potentially influence inflation. Its construction follows the works at other major central banks, adopts the methodology of a dynamic factor model that extracts the lower frequency components as developed by Forni et al (2000) and draws on the experience of the Peopleâ??s Bank of China in modelling inflation.
    Date: 2014–10
  9. By: G. Bazot; M. D. Bordo; E. Monnet
    Abstract: Under the classical gold standard (1880-1914), the Bank of France maintained a stable discount rate while the Bank of England changed its rate very frequently. Why did the policies of these central banks, the two pillars of the gold standard, differ so much? How did the Bank of France manage to keep a stable rate and continuously violate the “rules of the game”? This paper tackles these questions and shows that the domestic asset portfolio of the Bank of France played a crucial role in smoothing international shocks and in maintaining the stability of the discount rate. This policy provides a striking example of a central bank that uses its balance sheet to block the interest rate channel and protect the domestic economy from international constraints (Mundell’s trilemma).
    Keywords: gold standard, Bank of France, discount rate, central banking, money market.
    JEL: D41 E30 B41
    Date: 2014
  10. By: Yanis Varoufakis (Department of Economics, National and Kapodistrian University of Athens, and Lyndon B. Johnson School of Public Affairs, University of Texas at Austin.)
    Abstract: The Crash of 2008 is often blamed on the Fed’s overly ‘loose’ monetary policy after 2001 (see Taylor, 2009, 2010). In short, the argument goes, American monetary policy was too ‘loose’ for four years between 2002 and 2006; and too ‘tight’ once the Fed realised that it was presiding over an unsustainable boom. This paper argues that the causes of 2008 and its aftermath (i.e. the stuttering ‘recovery’ once financial markets were successfully stabilised) run much deeper than ‘suboptimal’ monetary policy by the Fed. It argues that, by the end of the 1970s, the Bretton Woods system had been replaced with a ‘brave new’ global surplus recycling mechanism in which Wall Street and the rest of the West’s large private banks featured prominently. These developments engendered a new form of ‘private money’ over which the Federal Reserve had decreasing control. Thus, if the Fed did indeed lose control over the effective money supply it lost it not because of any ‘deviation’ from Taylor-rule-based central banking but, rather, because of a major shift in the global role of finance. To understand why the Fed lost much of its influence over the aggregate money supply we first need to understand how this new form of private money had become an indispensible aspect of the aforementioned recycling mechanism. Wall Street’s generation of private money was, in fact, functional to the recycling of global surpluses upon which the ‘Great Moderation’ was founded. This put the Fed in an impossible dilemma: Should it re-assert its control over the effective money supply at the expense of ending the illusion of the Great Moderation? Or should it stick to Taylor-rule like central banking? This paper argues that the Fed opted for the latter. The paper is structured as follows. Sections 1 and 2 offer a non-technical analysis of the arguments outlined above. Section 3 turns to the post-2008 period and asks; Given that the official sector stabilised financial markets, why has recovery proved so tepid? The answer Section 3 provides is an extension of the analysis in Sections 1&2 regarding the true causes of the Fed’s loss of control over the effective money supply well before the Crash of 2008. Along the same lines, it presents a particular critique of the Fed’s Quantitative Easing policy. Section 4 concludes. In addition to its four main sections, the paper offers three analytical appendices. Appendix 1 presents empirical evidence of the Fed’s loss of control over the effective money supply. Appendix 2 supports these observations with a fully dynamic game theoretical analysis of the Fed’s conundrum during the 1980-2008 period. Lastly, Appendix 3 focuses on the unrealistic assumptions under which Quantitative Easing might spearhead recovery
    Keywords: Federal Reserve, Central Bank Games, Financial Crisis, Taylor Rule, Monetary Policy, Quantitative Easing
    JEL: C72 E42 E44 E51 E52 E58 F02 F33
  11. By: Nicolas Barbaroux (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon St Etienne,Université Jean Monnet, Saint-Etienne, F-42000, France)
    Abstract: In the aftermath of the sovereign debt criss, open-market interventions prevailed within the central bank’s policy answers known under the label unconventional monetary policy measures. During interwar period, France was an isolated case, among the leading countries, by everlastingly rejecting open-market operations in its monetary policy toolset. The present study analyzes the French monetary policy history by explaining why Bank of France had been so old-fashioned in monetary policymaking for too long time. Moreover, the article provides an explanation of the latter point by raising five major arguments of explanation : (1) the irrelevancy of the French interwar monetary reforms which enabled the Bank of France to conduct open-market operations per se; (2) the French conservatism throughout the insiders’ view from the Bank of France leaders (not only governors and deputy governors, but also the General Council’s members at the head of the French central bank); (3) the legacy of a metallist vision, embodied by Charles Rist, within the French economists of that time (4) the negative public opinion regarding open-market operations which were seen as being an inflationist public debt financing instrument and lastly (5) the unfair competition that occurred between the discounting operations and the open-market operations in the Bank of France’s balance sheet.
    Keywords: Open-market, Monetary policy, Central banking
    JEL: N B22
    Date: 2014
  12. By: Butt, Nick (Bank of England); Churm, Rohan (Bank of England); McMahon, Michael (University of Warwick); Morotz, Arpad (Bank of England); Schanz, Jochen (Bank for International Settlements)
    Abstract: We test whether quantitative easing (QE) provided a boost to bank lending in the United Kingdom, in addition to the effects on asset prices, demand and inflation focused on in most other studies. Using a data set available to researchers at the Bank, we use two alternative approaches to identify the effects of variation in deposits on individual banks' balance sheets and test whether this variation in deposits boosted lending. We find no evidence to suggest that QE operated via a traditional bank lending channel (BLC) in the spirit of the model due to Kashyap and Stein. We show in a simple BLC framework that if QE gives rise to deposits that are likely to be short-lived in a given bank (‘flighty’ deposits), then the traditional BLC is diminished. Our analysis suggests that QE operating through a portfolio rebalancing channel gave rise to such flighty deposits and that this is a potential reason that we find no evidence of a BLC. Our evidence is consistent with other studies which suggest that QE boosted aggregate demand and inflation via portfolio rebalancing channels.
    Keywords: Monetary policy; bank lending channel; quantitative easing
    JEL: E51 E52 G20
    Date: 2014–09–19
  13. By: Qianying Chen (International Monetary Fund); Andrew Filardo (Bank for International Settlements); Dong He (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research); Feng Zhu (Bank for International Settlements)
    Abstract: This paper studies the effects of unconventional monetary policies in the major advanced economies. We first examine the cross-border financial market impact of central bank announcements of asset purchase programmes based on event studies. We find marked effects, as expansionary balance sheet policies influence the prices of a broad range of emerging market assets, raising equity prices, lowering government and corporate bond yields and compressing CDS spreads. We then study the economic impact of US quantitative easing on both emerging and advanced economies, based on an estimated global vector error-correcting macroeconomic (VECM) model, which takes into account trade and financial linkages. We focus on the effects of reductions in US term and corporate spreads, and in US market volatility. The estimated effects are sizeable and differ across economies. First, US QE measures which help to lower market volatility and reduce corporate spreads appear to have had far greater impact than lowering term spreads, as Blinder (2012) suggested. Second, such measures have prevented a prolonged recession and severe deflation in the advanced economies. Third, the impact on emerging economies has varied but is generally stronger than in the US and other advanced economies. US QE measures contributed to overheating in Brazil, China and other emerging economies in 2010 and 2011, but supported recovery in 2009 and 2012. The sign and size of QE effects differ across economies, implying that their costs and benefits are unevenly distributed.
    Keywords: Announcement Effects, Emerging Economies, Financial Markets, Global VECM, International Spillovers, Quantitative Easing, Unconventional Monetary Policy
    JEL: E43 E44 E52 E65 F42 F47
    Date: 2014–09
  14. By: Christophe Destais
    Abstract: Central bank currency swaps (CBCS) allow central banks to provide foreign currency liquidity to the commercial banks in their jurisdictions. Since the end of 2007, these swaps have emerged as a de facto key feature of the international monetary system (IMS), with the US Federal Reserve (FED) having extensive recourse to them during the financial crisis, and their exploitation by the People’s Bank of China (PBOC) to help internationalizing the renminbi. This trend was further confirmed in the second half of 2013 with (i) the signing of two swaps agreements between the PBOC and the Bank of England (BOE) and the European Central Bank (ECB), and (ii) the little remarked decision by six major western central banks including the US FED, announced on October 31st 2013, to make permanent previously temporary swap lines. Currency swaps combined with the unlimited and exclusive power of central banks to create money can match the volatility of international capital flows. They have proved very effective and extremely helpful during the recent financial crisis. However, so far, central bank swaps have not been associated with conditionality, and are more precarious than alternative institutional arrangements, such as the International Monetary Fund (IMF) or regional financial agreements (RFA). Large scale use of CBCS can render central banks subject to significant counterparty risk. The huge powers that are bestowed upon central banks as a result of CBCS have triggered questions about the possibility of institutionalizing, and therefore limiting, this new tool. This might be a step too far, since most countries link sovereignty and money creation, and would never agree to have their hands tied. However, in our view, an internationally agreed set of principles would enable a fairer and perhaps more efficient exploitation of this instrument. These principles should include a commitment to transparency. They should encourage long-lasting agreements in order to foster stability, as well as the inclusion of provisions that require commercial banks to soundly manage their foreign liquidity risk. They should also encourage international currency issuers not to unfairly exclude potential CBCS beneficiaries.
    Keywords: Central Banks;International Monetary System;Foreign Currency Liquidity Risk;Financial Instability;International Monetary Fund;US dollar;Renminbi
    JEL: F33 F42 G01 G15
    Date: 2014–09
  15. By: Benjamin Eden (Vanderbilt University)
    Abstract: I use the Baumol-Tobin approach to examine the following propositions: (a) The optimal supply of liquidity requires a government loan program in addition to paying interest on reserves held by banks, (b) The adoption of the optimal policy will crowd out private credit arrangement and will thus shrink the financial sector and (c) regulations aimed at eliminating money substitutes may be redundant if the optimal policy is adopted but otherwise may improve welfare.
    JEL: E0 E5
    Date: 2014–01–10
  16. By: K.W. Clements
  17. By: Michał Brzoza-Brzezina (Narodowy Bank Polski and Warsaw School of Economics); Jacek Kotłowski (Narodowy Bank Polski; Warsaw School of Economics); Kamil Wierus (Narodowy Bank Polski)
    Abstract: Since the creation of the euro area significant interest rate spreads have arisen between euro area countries, both for public and private debt. We check whether these spreads could be made to work towards the goal of providing more stability to the euro area. In particular we focus on reducing the imbalances that arose between the core and peripheral members of the euro area in the first decade of its existence. The idea is that stable positive spreads in peripheral countries could have decreased domestic demand, preventing the boom-bust cycles that plagued these economies. They could also prevent such developments in the future. We find that spreads on real interest rates of 0.6 to 5.5 percentage points would have been necessary to stabilize external positions of the four peripheral euro area member countries.
    Keywords: Euro area, imbalances, current account, panel estimation
    JEL: E32 E43 E52
    Date: 2014
  18. By: Andrea Berardi (Department of Economics (University of Verona))
    Abstract: This paper presents and estimates an innovative term structure model where inflation expectations and inflation risk premia are strictly interconnected with both the timevarying volatility of interest rates and investors’ expectations of future GDP growth. The estimation of the model is based on U.S. data over the 1999 to 2012 sample period. Distinct from previous studies, the empirical work explicitly considers data on both the implied volatility of Treasury bonds and survey forecasts of GDP growth, as well as data on nominal Treasury yields, TIPS yields and survey forecasts of CPI inflation. The estimated inflation risk premia, which are relatively low and less volatile with respect to earlier empirical evidence, are negatively related to the volatility of interest rates and have a strongly positive link with the stochastic conditional mean of GDP growth.
    Keywords: Keywords: Term Structure and Macroeconomy, Inflation Risk Premia, TIPS, Yield Volatility
    JEL: G12 E43 E44 C58
    Date: 2013–12
  19. By: Santiago García-Verdú; Miguel Zerecero
    Abstract: In recent years the Bank of Mexico has made a series of rules-based interventions in the peso/dollar foreign exchange market. We assess the effectiveness of two specific interventions. These were the "Dollar auctions with minimum price", active between October 2008 and April 2010, and the "Dollar auctions without minimum price", implemented from March to September, 2009. Broadly speaking, the aims of these two interventions were, respectively, to provide liquidity and to promote orderly conditions in the foreign exchange market. For our analysis, we follow the framework implemented by Dominguez (2003) and Dominguez (2006), an event study microstructure approach. We use the bid-ask spreads as a measure of liquidity and, also, of orderly conditions. In general, our results show no indication of an effect in the bid-ask spread for the first intervention, and are fairly conclusive regarding a significant reduction in it for the second intervention, yet, it is important to consider the limitations of our estimation methodology.
    Keywords: foreign exchange rate, central bank interventions, microstructure.
    JEL: E5 F31
    Date: 2014–08
  20. By: Silvia Marchesi; Laura Sabani
    Abstract: In this paper we present a theoretical model which, focusing on the quality of information transmission between the IMF and the WB, analyzes the sources of the expected loss in the overall performance of the two institutions relative to the first best outcome, which is characterized by centralized decision and perfect information. In particular, given the Bank-Fund strong complementarities, we show that strategic communication is indeed the primary source of loss for the two institutions. A testable implication of the model is to relate Bank-Fund's performance to their willingness (or ability) to communicate. We find evidence that a Bank-Fund simultaneous loan is beneficial to growth and, consistently with the theory, such beneficial effect is reduced by factors preventing full communication, such as the degree of Bank-Fund competition and the salience of their private information.
    Keywords: IMF and WB conditionality, coordination, communication
    JEL: D83 F33 N2
    Date: 2014–10

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