nep-cba New Economics Papers
on Central Banking
Issue of 2014‒11‒17
twenty-six papers chosen by
Maria Semenova
Higher School of Economics

  1. Inflation Targeting As a Monetary Policy Rule: Experience and Prospects By Manai Daboussi, Olfa
  2. 'Financial Regulation, Credit and Liquidity Policy and the Business Cycle' By George J. Bratsiotis; William J. Tayler; Roy Zilberman
  3. Exchange Rate Flexibility under the Zero Lower Bound By Cook, David; Devereux, Michael B.
  4. Drifting Inflation Targets and Monetary Stagflation By Knotek, Edward S.; Khan, Shujaat
  5. Bubbles and Central Banks: Historical Perspectives By Markus K. Brunnermeier; Isabel Schnabel
  6. Is South Africa's inflation target too persistent for monetary policy conduct? By Faul, Joseph; Khumalo, Bridgette; Pashe, Mpho; Khuzwayo, Miranda; Banda, Kamogelo; Jali, Senzo; Myeni, Bathandekile; Pule, Retlaodirela; Mosito, Boitshoko; Jack, Lona-u-Thando; Phiri, Andrew
  7. Lessons learned for monetary policy from the recent crisis By Michael D. Bordo
  8. Monetary and Fiscal Policy in Times of Crises: A New Keynesian Perspective in Continuous Time By Bernd Hayo; Britta Niehof
  9. Monetary Policy, the Composition of GDP, and Crisis Duration in Europe By Nicolas Cachanosky; Andreas Hoffmann
  10. Central Banks: Powerful, Political and Unaccountable? By Buiter, Willem
  11. The Return of the Original Phillips curve? An Assessment of Lars E. O. Svensson's Critique of the Riksbank's Inflation Targeting, 1997-2012 By Andersson, Fredrik N. G.; Jonung, Lars
  12. The effects of ratings-contingent regulation on international bank lending behavior: Evidence from the Basel 2 accord By Hasan, Iftekhar; Kim, Suk-Joong; Wu , Eliza
  13. Cocos, Contagion and Systemic Risk By Stephanie Chan; Sweder van Wijnbergen
  14. What do we know about the effects of macroprudential policy? By Gabriele Galati; Richhild Moessner
  15. Optimal monetary policy in the presence of human capital depreciation during unemployment By Laureys, Lien
  16. In Lands of Foreign Currency Credit, Bank Lending Channels Run Through? The Effects of Monetary Policy at Home and Abroad on the Currency Denomination of the Supply of Credit By Steven Ongena; Ibolya Schindele; Dzsamila Vonnak
  17. Bank Capital Requirements and Mandatory Deferral of Compensation By Feess, Eberhard; Wohlschlegel, Ansgar
  18. Capital Adequacy and Liquidity in Banking Dynamics: Theory and Regulatory Implications By Cao, Jin; Chollete, Loran
  19. Extreme Events and the Origin of Central Bank Priors By Chollete, Loran; Schmeidler, David
  20. Governing by Panic: The Politics of the Eurozone Crisis By David M. Woodruff
  21. International Financial Integration and Crisis Contagion By Devereux, Michael B.; Yu, Changhua
  22. Banking Systemic Risk, Foreign Funding, Exchange Rate Exposure and Carry Trade: is there a relation? By Bruno Freitas Boynard de Vasconcelos; Benjamin Miranda Tabak
  23. Currency Manipulation By Weithing Zhang; Thomas Mertens; Tarek Hassan
  24. Macro Stress-Testing Credit Risk in Romanian Banking System By Ruja, Catalin
  25. Bank Industry Structure and Public Debt By Varelas, Erotokritos
  26. Regional inflation, spatial location and the Balassa-Samuelson effect By Nagayasu, Jun

  1. By: Manai Daboussi, Olfa
    Abstract: This paper examines the inflation targeting experience in developing countries. Based on panel data of 53 developing countries, of which 20 those have adopted inflation targeting policy by the end of 2007, the purpose is to show the effects of inflation targeting on macroeconomic performance in these economies. We use the Great Moderation approach of Pétursson (2005) to analyze the relationship between inflation targeting and macroeconomic performance over the period 1980-2012. A key lesson from this experience is that this monetary policy realizes macroeconomic performance and contributes to the reduction of inflation, especially in developing countries with hyperinflation.
    Keywords: Monetary policy, inflation targeting, macroeconomic performance, developing economies.
    JEL: E52 E58
    Date: 2014–09–14
  2. By: George J. Bratsiotis; William J. Tayler; Roy Zilberman
    Abstract: The global fi?nancial crisis in 2007 prompted policy makers to introduce a combination of bank regulation and macroprudential policies, including non-conventional monetary policies, such as interest on reserves and changes in required reserves. This paper examines how the combination of such policies can help stabilize the effects of real and ?financial shocks in economies where ?financial frictions are important. Although there is an extensive literature on ?financial regulation and macro-prudiential policy, and more recently some literature on the effects of interest on reserves, these policies are usually examined independently. The results point to the importance of coordination between ?financial regulation and monetary policy in minimizing welfare losses following such shocks. Interest on reserves is shown to be more effective in reducing welfare losses than changes in required reserves and to play a signi?cant role in making stabilization policy more effective. The results also suggest an easing of bank capital requirements during recessions, when output and loans are falling and the risk of default is high.
    Date: 2014
  3. By: Cook, David (Hong Kong University of Science and Technology); Devereux, Michael B. (University of British Columbia)
    Abstract: An independent currency and a flexible exchange rate generally helps a country in adjusting to macroeconomic shocks. But recently in many countries, interest rates have been pushed down close to the lower bound, limiting the ability of policy-makers to accommodate shocks, even in countries with flexible exchange rates. This paper argues that if the zero bound constraint is binding and policy lacks an effective ‘forward guidance’ mechanism, a flexible exchange rate system may be inferior to a single currency area. With monetary policy constrained by the zero bound, under flexible exchange rates, the exchange rate exacerbates the impact of shocks. Remarkably, this may hold true even if only a subset of countries are constrained by the zero bound, and other countries freely adjust their interest rates under an optimal targeting rule. In a zero lower bound environment, in order for a regime of multiple currencies to dominate a single currency, it is necessary to have effective forward guidance in monetary policy.
    JEL: E2 E5 E6
    Date: 2014–09–01
  4. By: Knotek, Edward S. (Federal Reserve Bank of Cleveland); Khan, Shujaat (Johns Hopkins University)
    Abstract: This paper revisits the phenomenon of stagflation. Using a standard New Keynesian dynamic, stochastic general equilibrium model, we show that stagflation from monetary policy alone is a very common occurrence when the economy is subject to both deviations from the policy rule and a drifting inflation target. Once the inflation target is fixed, the incidence of stagflation in the baseline model is essentially eliminated. In contrast with several other recent papers that have focused on the connection between monetary policy and stagflation, we show that while high uncertainty about monetary policy actions can be conducive to the occurrence of stagflation, imperfect information more generally is not a requisite channel to generate stagflation.
    Keywords: stagflation; inflation; time-varying inflation target; onetary policy; rules; imperfect nformation
    JEL: E31 E52
    Date: 2014–11–03
  5. By: Markus K. Brunnermeier (Princeton University); Isabel Schnabel
    Abstract: This paper reviews some of the most prominent asset price bubbles from the past 400 years and documents how central banks (or other institutions) reacted to those bubbles. The historical evidence suggests that the emergence of bubbles is often preceded or accompanied by an expansionary monetary policy, lending booms, capital inflows, and financial innovation or deregulation. We find that the severity of the economic crisis following the bursting of a bubble is less linked to the type of asset than to the financing of the bubble – crises are most severe when they are accompanied by a lending boom, high leverage of market players, and when financial institutions themselves are participating in the buying frenzy. Past experience also suggests that a purely passive “cleaning up the mess” stance towards inflating bubbles in many cases is costly. At the same time, while interest - rate leaning policies and macroprudential tools can and sometimes have helped to deflate bubbles and mitigate the associated economic crises, the correct implementation of such proactive policy approaches remains fraught with difficulties.
    Date: 2014–10–31
  6. By: Faul, Joseph; Khumalo, Bridgette; Pashe, Mpho; Khuzwayo, Miranda; Banda, Kamogelo; Jali, Senzo; Myeni, Bathandekile; Pule, Retlaodirela; Mosito, Boitshoko; Jack, Lona-u-Thando; Phiri, Andrew
    Abstract: Can the South African Reserve Bank’s (SARB) substantially control inflation within their set target of 3-6 percent? We sought to investigate this phenomenon by examining multiple threshold effects in the persistence levels of quarterly aggregated inflation data collected between 2003 and 2014. To this end, we employ the three-regime threshold autoregressive (TAR) model of Hansen (2000). We favour this approach over other conventional linear econometric models as it permits us to test for varying persistency within the autoregressive (AR) components of the inflation process. Our empirical explorations reveal that the SARB’s set target does indeed lie within a range in which inflation is found to be most persistent. Overall and more importantly, our results suggest that the SARB should either consider revising their set inflation target by redefining the inflation target range to accommodate higher inflation rates or the Reserve Bank should consider abandoning the inflation targeting regime altogether.
    Keywords: Inflation persistence; TAR Models; Monetary Policy; South African Reserve Bank (SARB); Inflation Targeting; Developing Economy.
    JEL: C22 E30 E31 E52 E58
    Date: 2014–09–01
  7. By: Michael D. Bordo
    Date: 2014–07
  8. By: Bernd Hayo (University of Marburg); Britta Niehof (University of Marburg)
    Abstract: To analyse the interdependence between monetary and fiscal policy during a financial crisis, we develop an open-economy DSGE model with monetary and fiscal policy as well as financial markets in a continuous-time framework based on stochastic differential equations. Monetary policy is modelled using both a standard and a modified Taylor rule and fiscal policy is modelled as either expansionary or austere. In addition, we differentiate between open economies and monetary union members. We find evidence that the modified Taylor rule notably reduces the likelihood that the financial market crisis affects the real economy. But if we assume that households are averse with respect to outstanding government debt, we find that a combination of expansionary monetary policy and austere fiscal policy provides better stabilisation of both domestic and foreign economies in terms of both output and inflation. In the case of a monetary union, we find that stabilisation of output in the country where the financial shock originates is no longer as easy and, in terms of prices, there is now deflation in the country where the crisis originated and a positive inflation rate in the other country.
    Keywords: New Keynesian Models, Financial Crisis, Dynamic Stochastic General Equilibrium Models, Continuous Time Model, Fiscal Policy, Monetary Policy
    JEL: C63 E44 E47 E52 E62 F41
    Date: 2014
  9. By: Nicolas Cachanosky; Andreas Hoffmann
    Abstract: This paper analyzes the effects of changes in interest rates on the composition of production in ten European countries during the boom period of the 2000s. We find that output elasticity differs across industries and across countries for similar industries. The paper suggests that in the run-up to the 2008 crisis, the ECB’s low interest rate policy affected the allocation of resources across industries. This may explain the sluggish overall recovery from the crisis in Europe.
    Keywords: Monetary Policy; Interest Rate Sensitivity; Crisis Duration; GDP Composition
    JEL: E32 E52 E58
    Date: 2014–10
  10. By: Buiter, Willem
    Abstract: Central banks’ economic and political importance has grown in advanced economies since the start of the Great Financial Crisis in 2007. An unwillingness or inability of governments to use countercyclical fiscal policy has made monetary policy the only stabilization tool in town. However, much of the enhanced significance of central banks is due to their lender †of †last †resort and market †maker †of †last †resort roles, providing liquidity to financially distressed and illiquid financial institutions and sovereigns. Supervisory and regulatory functions – often deeply political, have been heaped on central banks. Central bankers also increasingly throw their weight around in the public discussion of and even the design and implementation of fiscal policy and structural reforms †areas which are way beyond their mandates and competence. In this lecture I argue that the preservation of the central bank’s legitimacy requires that a clear line be drawn between the central bank’s provision of liquidity and the Treasury’s solvency support for systemically important financial institutions. All activities of the central bank that expose it to material credit risk should be guaranteed by the Treasury. In addition, central banks must become more accountable by increasing the transparency of their lender †of †last †resort and market maker †of †last resort activities. Central banks ought not to engage in quasi †fiscal activities. Finally, central banks should stick to their knitting and central bankers should not become participants in public debates and deeply political arguments about matters beyond their mandate and competence, including fiscal policy and structural reform.
    Keywords: seigniorage, quasi-fiscal, independence, legitimacy, accountability, monetary policy, regulation, supervision.
    JEL: E02 E42 E5 E52 E58 E6 E62 E63 G18 G28 H63
    Date: 2014
  11. By: Andersson, Fredrik N. G. (Department of Economics, Lund University); Jonung, Lars (Department of Economics, Lund University)
    Abstract: We examine Lars E O Svensson's prominent critique of the monetary policy of the Sveriges Riksbank (the Swedish central bank) from 1995-2012. Our main objection concerns Svensson's conclusion that the original pre-Friedman/Phelps version of the Phillips curve based on constant inflation expectations has returned for Sweden. Based on estimates of this model, Svensson claims that that the Riksbank's policy has contributed to an average of 38 000 more unemployed a year between 1997-2011. This result is based on Svensson's unrealistic as well as unnecessary assumption of constant inflation expectations anchored at the Riksbank's inflation target of 2 per cent. Data show, however, that the public's inflation expectations have varied between 0 and 4 per cent, thus they have not been anchored. The negative employment effect found by Svensson vanishes once actual data on inflation expectations are included in the estimates of the Phillips curve. The long run non-vertical Phillips curve is transformed into a vertical one, in line with the Friedman/Phelps theory. We have additional objections to Svensson's reasoning. First, we show that the Riksbank has on average met its inflation target between 1995 and 2012. Second, we suggest that the original Phillips curve is too simple a model to draw any firm policy conclusions about unemployment and monetary policy in a small open economy such as Sweden. Third, we do not want to overburden Swedish monetary policy by making the Riksbank responsible for three objectives. It has already two objectives: price stability and financial stability. Criticising the Riksbank for employment losses, as Svensson does, gives priority to a third objective, high employment. Finally, Svensson adopts a short-term perspective by focusing on the period 1995-2011. When we compare the Riksbank's inflation targeting regime with previous monetary policy regimes over the past 100 years, inflation targeting in the past fifteen years is clearly one of the most successful.
    Keywords: Sweden; inflation targeting; Phillips curve; inflation expectations; Swedish Riksbank; unemployment
    JEL: C51 D84 E24 E31 E42 E50 E58 N14
    Date: 2014–08–29
  12. By: Hasan, Iftekhar (Fordham University and Bank of Finland); Kim, Suk-Joong (University of Sydney); Wu , Eliza (University of Technology Sydney)
    Abstract: We investigate the effects of credit ratings-contingent financial regulation on foreign bank lending behavior. We examine the sensitivity of international bank flows to debtor countries’ sovereign credit rating changes before and after the implementation of the Basel 2 risk-based capital regulatory rules. We study the quarterly bilateral flows from G-10 creditor banking systems to 77 recipient countries over the period Q4:1999 to Q2:2013. We find direct evidence that sovereign credit re-ratings that lead to changes in risk-weights for capital adequacy requirements have become more significant since the implementation of Basel 2 rules for assessing banks’ credit risk under the standardized approach. This evidence is consistent with global banks acting via their international lending decisions to minimize required capital charges associated with the use of ratings-contingent regulation. We find evidence that banking regulation induced foreign lending has also heightened the perceived sovereign risk levels of recipient countries, especially those with investment grade status.
    Keywords: cross-border banking; sovereign credit ratings; Basel 2; rating-contingent financial regulation
    JEL: E44 F34 G21 H63
    Date: 2014–09–21
  13. By: Stephanie Chan (University of Amsterdam); Sweder van Wijnbergen (University of Amsterdam, the Netherlands)
    Abstract: CoCo’s (contingent convertible capital) are designed to convert from debt to equity when banks need it most. Using a Diamond-Dybvig model cast in a global games framework, we show that while the CoCo conversion of the issuing bank may bring the bank back into compliance with capital requirements, it will nevertheless raise the probability of the bank being run, because conversion is a negative signal to depositors about asset quality. Moreover, conversion imposes a negative externality on other banks in the system in the likely case of correlated asset returns, so bank runs elsewhere in the banking system become more probable too and systemic risk will actually go up after conversion. CoCo’s thus lead to a direct conflict between micro- and macroprudential objectives. We also highlight that ex ante incentives to raise capital to stave off conversion depend critically on CoCo design. In many currently popular CoCo designs, wealth transfers after conversion actually flow from debt holders to equity holders, destroying the latter’s incentives to provide additional capital in times of stress. Finally the link between CoCo conversion and systemic risk highlights the tradeoffs that a regulator faces in deciding to convert CoCo’s, providing a possible explanation of regulatory forbearance.
    Keywords: Contingent Convertible Capital, Contagion, Systemic Risk, Bank Runs, Global Games
    JEL: G01 G21 G32
    Date: 2014–08–21
  14. By: Gabriele Galati; Richhild Moessner
    Abstract: The literature on the effectiveness of macroprudential policy tools is still in its infancy and has so far provided only limited guidance for policy decisions. In recent years, however, increasing efforts have been made to fill this gap. Progress has been made in embedding macroprudential policy in theoretical models. There is increasing empirical work on the effect of some macroprudential tools on a range of target variables, such as quantities and prices of credit, asset prices, and on the amplitude of the financial cycle and financial stability. In this paper we review recent progress in theoretical and empirical research on the effectiveness of macroprudential instruments.
    Keywords: Macroprudential policy; financial regulation
    JEL: E58 G28
    Date: 2014–09
  15. By: Laureys, Lien (Bank of England)
    Abstract: When workers are exposed to human capital depreciation during periods of unemployment, hiring affects the unemployment pool’s composition in terms of skills, and hence the economy’s production potential. Introducing human capital depreciation during unemployment into an otherwise standard New Keynesian model with search frictions in the labour market leads to the finding that the flexible-price allocation is no longer constrained-efficient even when the standard Hosios condition holds. This is because it generates a composition externality in job creation: firms ignore how their hiring decisions affect the extent to which the unemployed workers’ skills erode, and hence the output that can be produced by new matches. Consequently, it might be desirable from a social point of view for monetary policy to deviate from strict inflation targeting. But quantitative analysis shows that although optimal price inflation is no longer zero, strict inflation targeting stays close to the optimal policy.
    Keywords: skill erosion; monetary policy; unemployment
    JEL: E24 E52 J64
    Date: 2014–10–24
  16. By: Steven Ongena (University of Zurich, Swiss Finance Institute and CEPR); Ibolya Schindele (BI Norwegian Business School and Central Bank of Hungary); Dzsamila Vonnak (Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences)
    Abstract: We analyze the differential impact of domestic and foreign monetary policy on the local supply of bank credit in domestic and foreign currencies. We analyze a novel, supervisory dataset from Hungary that records all bank lending to firms including its currency denomination. Accounting for time-varying firm-specific heterogeneity in loan demand, we find that a lower domestic interest rate expands the supply of credit in the domestic but not in the foreign currency. A lower foreign interest rate on the other hand expands lending by lowly versus highly capitalized banks relatively more in the foreign than in the domestic currency.
    Keywords: bank balance-sheet channel, monetary policy, foreign currency lending
    JEL: E51 F3 G21
    Date: 2014–10
  17. By: Feess, Eberhard; Wohlschlegel, Ansgar
    Abstract: Tighter capital requirements and mandatory deferral of compensation are among the most prominently advocated regulatory measures to reduce excessive risk-taking in the banking industry. We analyze the interplay of the two instruments in an economy with two heterogenous banks that can fund uncorrelated projects with fully diversifiable risk or correlated projects with systemic risk. If both project types are in abundant supply, we find that full mandatory deferral of compensation is beneficial as it allows for weaker capital requirements, and hence for a larger banking sector, without increasing the incentives for risk-shifting. With competition for uncorrelated projects, however, deferred compensation may misallocate correlated projects to the bank which is inferior in managing risks. Our findings challenge the current tendency to impose stricter regulations on more sophisticated institutes.
    Keywords: Bank capital requirements; deferred bonuses; risk-shifting; financial crisis; executive compensation
    JEL: D62 G21 G28 J33
    Date: 2014–07–23
  18. By: Cao, Jin (Norges Bank); Chollete, Loran (UiS)
    Abstract: We present a framework for modelling optimum capital adequacy in a dynamic banking context. We combine the (static) capital adequacy framework of Repullo (2013) with a dynamic banking model similar to that of Corbae and D`Erasmo (2014), with the extra feature that the probability of systemic risk is endogenous. Unlike previous work, we examine frameworks to ameliorate bankruptcy using both capital adequacy and liquidity requirements. Since equity is costly, the social cost of regulation may be reduced if a regulatory capital requirement can be accompanied by other tools such as a liquidity buffer.
    Keywords: Keywords: Bankruptcy; Capital Adequacy; Endogenous Systemic Risk; Liquidity Requirement; Regulation Costs
    JEL: E50 G21 G28
    Date: 2014–09–16
  19. By: Chollete, Loran (UiS); Schmeidler, David (Tel Aviv University)
    Abstract: Where do central bank priors come from and how do policymakers evaluate a model before empirical probabilities are available? To address these questions, we analyze two central banks that choose priors about a rare disaster with the help of expert policy teams. Policymakers are misspecification averse when assessing subjective evidence, and therefore hedge in their selection of priors. This hedging results in priors that accommodate a modicum of belief disagreement.
    Keywords: Belief Disagreement; Central Bank; Misspecification Aversion; Rare Disaster; Subjective Evidence
    JEL: A10
    Date: 2014–08–30
  20. By: David M. Woodruff
    Abstract: The Eurozone’s reaction to the economic crisis beginning in late 2008 involved both efforts to mitigate the arbitrarily destructive effects of markets and vigorous pursuit of policies aimed at austerity and deflation. To explain this paradoxical outcome, this paper builds on Karl Polanyi’s account of how politics reached a similar deadlock in the 1930s. Polanyi argued that democratic impulses pushed for the protective response to malfunctioning markets. However, under the gold standard the prospect of currency panic afforded great political influence to bankers, who used it to push for austerity, deflationary policies, and the political marginalization of labor. Only with the achievement of this last would bankers and their political allies countenance surrendering the gold standard. The paper reconstructs Polanyi’s theory of “governing by panic” and uses it to explain the course of the Eurozone policy over three key episodes in the course of 2010-2012. The prospect of panic on sovereign debt markets served as a political weapon capable of limiting a protective response, wielded in this case by the European Central Bank (ECB). Committed to the neoliberal “Brussels-Frankfurt consensus,” the ECB used the threat of staying idle during panic episodes to push policies and institutional changes promoting austerity and deflation. Germany’s Ordoliberalism, and its weight in European affairs, contributed to the credibility of this threat. While in September 2012 the ECB did accept a lender-of-last-resort role for sovereign debt, it did so only after successfully promoting institutional changes that severely complicated any deviation from its preferred policies.
    Keywords: Euro, European Central Bank (ECB), austerity, lender of last resort, Ordoliberalism, gold standard
    Date: 2014–10
  21. By: Devereux, Michael B. (Unniversity of British Columbia); Yu, Changhua (University of International Business and Economics)
    Abstract: International financial integration helps to diversify risk but also may increase the transmission of crises across countries. We provide a quantitative analysis of this trade-off in a two-country general equilibrium model with endogenous portfolio choice and collateral constraints. Collateral constraints bind occasionally, depending upon the state of the economy and levels of inherited debt. The analysis allows for different degrees of financial integration, moving from financial autarky to bond market integration and equity market integration. Financial integration leads to a significant increase in global leverage, doubles the probability of balance sheet crises for any one country, and dramatically increases the degree of ‘contagion’ across countries. Outside of crises, the impact of financial integration on macro aggregates is relatively small. But the impact of a crisis with integrated international financial markets is much less severe than that under financial market autarky. Thus, a tradeoff emerges between the probability of crises and the severity of crises. Financial integration can raise or lower welfare, depending on the scale of macroeconomic risk. In particular, in a low risk environment, the increased leverage resulting from financial integration can reduce welfare of investors.
    JEL: D52 F36 F44 G11 G15
    Date: 2014–09–01
  22. By: Bruno Freitas Boynard de Vasconcelos; Benjamin Miranda Tabak
    Abstract: We study what is the systemic impact of banks' foreign funding and what are the determinants of this flow of international money. With that, we intend to establish a relation between banks' foreign funding, carry trade, exchange rate exposure and banking system risk which is novel in the literature. We used an unique data for Brazilian banks exchange rate transactions combined with other micro and macro data. Our results indicate that banks improve its credit portfolio, free from regulatory investment, in periods when banks get foreign funding. Those results and future analysis and extensions of this work may better quantify this effect and serve as a basis for policy makers in terms of analysis of macroprudential policies
    Date: 2014–10
  23. By: Weithing Zhang (University of Chicago); Thomas Mertens (New York University); Tarek Hassan (The University of Chicago)
    Abstract: Many central banks manage the stochastic behavior of their currencies' exchange rates by imposing pegs relative to a target currency. We study the effects of such currency manipulation in a multi-country model of exchange rate determination with endogenous capital accumulation. We find that the imposition of an exchange rate peg relative to a given target currency increases the volatility of consumption in the target country and decreases the volatility of the target currency's exchange rate relative to all other currencies in the world. In addition, currency pegs affect the formation of capital across sectors and countries. For example, an economically smaller country (such as Saudi Arabia) pegging its currency to an economically large country (such at the U.S.) decreases capital accumulation in the larger country and increases its real and nominal interest rate
    Date: 2014
  24. By: Ruja, Catalin
    Abstract: This report presents an application of a macro stress testing procedure on credit risk in the Romanian banking system. Macro stress testing, i.e. assessing the vulnerability of financial systems to exceptional but plausible macroeconomic scenarios, maintains a central role in macro-prudential and crisis management frameworks of central banks and international institutions around the globe. Credit risk remains the dominant risk challenging financial stability in the Romanian financial system, and thus this report analyses the potential impact of macroeconomic shocks scenarios on default rates in the corporate and household loan portfolios in the domestic banking system. A well-established reduced form model is proposed and tested as the core component of the modelling approach. The resulting models generally confirm the influence of macroeconomic factors on credit risk as documented in previous research including applications for Romania, but convey also specific and novel findings, such as inclusion of leading variables and construction activity level for corporate credit risk. Using the estimated model, a stress testing simulation procedure is undertaken. The simulation shows that under adverse shock scenarios, corporate default rates can increase substantially more than the expected evolution under the baseline scenario, especially in case of GDP shock, construction activity shock or interest rate shocks. Under the assumptions of these adverse scenarios, given also the large share of corporate loans in the banks’ balance sheet, the default rates evolution could have a substantial impact on banks’ loan losses. The households sector stress testing simulation show that this sector is more resilient to macroeconomic adverse evolutions, with stressed default rates higher than expected values under baseline scenario, but with substantially lower deviations. The proposed macro-perspective model and its findings can be incorporated by private banks in their micro-level portfolio risk management tools. Additionally, supplementing the authorities’ stress tests with independent approaches can enhance credibility of such financial stability assessment.
    Keywords: Stress Testing, Macro Stress Testing, Credit Risk, Banking Crisis, Monte Carlo simulation, Romania
    JEL: C01 C12 C13 C15 C32 C52 C53 C87 E58 G01 G21
    Date: 2014–07–23
  25. By: Varelas, Erotokritos
    Abstract: Based on a traditional approach to the behavior of a bank which lends both private and public sector, and utilizing a typical expression for public debt accumulation, this paper concludes that the optimality of the number and size of banks depends heavily on the course of the public debt, ceteris paribus. If the intergenerational dimension of the public debt is assumed away, fiscal consolidation presupposes a limited number of banks under normal only profit, a sort of quasi-competitive banking. In the presence of intergenerational considerations, fiscal consideration requires a few efficient banks experiencing perhaps positive profit, which is consistent with the notion of workable competition. Consequently, the pre-consolidation size distribution of banks is immaterial policy-wise.
    Keywords: Optimum number of banks, Public debt accumulation, Perfect vs. workable competition, Commercial bank seigniorage
    JEL: E50 G20 L10
    Date: 2014
  26. By: Nagayasu, Jun
    Abstract: We empirically analyze regional inflation using data from Japan where there is no regulation to impede the free movement of labor, capitals, goods and services across regions. In particular, our analysis will focus on the geographical location of regions and the productivity effect as explanation for the dynamics of regional inflation. Technically, given that home inflation is often affected by that of neighbors, spatial models have been employed in order to explicitly capture this spillover effect. Similarly, the productivity spillover is modelled in the specification. Then we find that both spatial location and productivity are important determinants of regional inflation. Furthermore inflation persistence is reported to play an important role in explaining regional data.
    Keywords: Regional inflation, Balassa-Samuelson effect, transaction costs, spatial econometric models
    JEL: E3 F3 R1
    Date: 2014–09–01

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