nep-cba New Economics Papers
on Central Banking
Issue of 2014‒11‒28
seventeen papers chosen by
Maria Semenova
Higher School of Economics

  1. Inflation, deflation, and uncertainty: What drives euro area option-implied inflation expectations and are they still anchored in the sovereign debt crisis? By Scharnagl, Michael; Stapf, Jelena
  2. U.S. monetary policy and its global implications By Dudley, William
  3. Optimal monetary policy, asset purchases, and credit market frictions By Schabert, Andreas
  4. Counter-Cyclical Capital Buffers and Interest-Rate Policy as Complements – The Experience of South Africa By Roy Havemann
  5. Good Governance of Monetary Policy in Canada: Lessons from the C.D. Howe Institute’s Shadow Council By Pierre Siklos; Matthias Neuenkirch
  6. Are rules and boundaries sufficient to limit harmful central bank discretion? Lessons from Europe By Orphanides, Athanasios
  7. Monetary Policy and Debt Fragility By Antoine Camous; Russell Cooper
  8. Bringing Financial Stability into Monetary Policy By Eric Leeper; James Nason
  9. Robustness, validity, and significance of the ECB's asset quality review and stress test exercise By Steffen, Sascha
  10. Effectiveness of the Easing of Monetary Policy in the Japanese Economy, Incorporating Energy Prices By Naoyuki Yoshino; Farhad Taghizadeh-Hesary
  11. War of the Words: How Elites' Communication Changes the Economy By Baerg, Nicole Rae
  12. The low interest rate environment: Causes, effects and a way out By Matthes, Jürgen
  13. Do federal reserve bank presidents have a regional bias? By Jung, Alexander; Latsos, Sophia
  14. Stability or upheaval? The currency composition of international reserves in the long run By Eichengreen, Barry; Chiţu, Livia; Mehl, Arnaud
  15. Sovereign Debt Composition in Advanced Economies: A Historical Perspective By S. M. Ali Abbas; Laura Blattner; Mark De Broeck; Asmaa El-Ganainy; Malin Hu
  16. Optimal Maturity Structure of Sovereign Debt in Situation of Near Default By Gabriel Desgranges; Céline Rochon
  17. How Does Government Borrowing Affect Corporate Financing and Investment? By John Graham; Mark T. Leary; Michael R. Roberts

  1. By: Scharnagl, Michael; Stapf, Jelena
    Abstract: We tackle two questions in this paper: In the sovereign debt crisis, what moves the euro area inflation outlook and has the firm anchoring of medium to long-term inflation expectations been touched? Deriving densities from a new data set on options on the euro area harmonized index of consumer prices provides us with the full distribution of inflation expectations. The daily data set allows us to analyze effects of monetary policy announcements and macro news in a time varying event study framework despite the short sample period from 2009 to 2013. Due to renewed fears of deflation we compare option-implied and statistical density functions to gain insight into deflation risk. Inflation expectations show a decreasing mean but growing uncertainty especially since the intensification of the sovereign debt crisis in mid-2011. Around the same time the influence of monetary policy announcements on inflation expectations diminished. Tail events such as deflation although still contained became more probable. The impact of macroeconomic news to explain inflation probabilities overall decreased and shifted towards countries more affected by the crisis. Concerning the anchoring of inflation expectations the paper provides a twofold result: The mean and low sensitivity to actual news speak for anchored inflation expectations whereas the growing uncertainty reveals market participants concerns about possible extreme inflation or deflation outcomes in the future.
    Keywords: Inflation expectations,Deflation,Options,Monetary policy,Financial crisis
    JEL: C58 E31 E44 G13
    Date: 2014
  2. By: Dudley, William (Federal Reserve Bank of New York)
    Abstract: Remarks at the Central Bank of the United Arab Emirates, Abu Dhabi, United Arab Emirates.
    Keywords: dual mandate; emerging market economies (EMEs); Treasury Inflation-Protected Securities (TIPS); (PCE) deflator
    JEL: E52 F43
    Date: 2014–11–13
  3. By: Schabert, Andreas
    Abstract: This paper examines how credit market frictions affect optimal monetary policy and if there is a role for central bank asset purchases. We develop a sticky price model where money serves as the means of payment and ex-ante identical agents borrow/lend among each other. The credit market is distorted as borrowing is constrained by available collateral. We show that the central bank cannot implement the first best allocation and that optimal monetary policy mainly aims at stabilizing prices when only a single instrument is available. The central bank can however mitigate the credit market distortion in a welfare-enhancing way by purchasing loans at a favorable price, which relies on rationing the supply of money. JEL Classification: E4, E5, E32
    Keywords: borrowing constraints, central bank asset purchases, money rationing, nominal rigidities, optimal monetary policy
    Date: 2014–10
  4. By: Roy Havemann
    Abstract: Counter-cyclical capital buffers are increasingly popular new "macroprudential" tools. However, there is limited empirical evidence on both the intended and unintended consequences of using these buffers. During the pre-crisis period (2002--2007), South Africa increased capital adequacy ratios to curb rapid credit extension, and so provides a useful test case. Using a new data set from that period, this paper extends a standard large-scale macroeconomic model to include capital adequacy ratios as a policy lever. It is found that a 1 percentage point shock to the capital adequacy ratio has similar effects to an interest-rate shock of between 0.3 and 0.4 percentage points. These results are in line with those in other jurisdictions. The econometric results are only indicative -- if actively used as a tool, counter-cyclical capital buffers may have their own complexities, including asymmetric impacts and endogeneity problems. Monetary policy issues, such as signalling, time inconsistency, expectation and communication challenges also apply, reducing the usefulness of proactive macroprudential policy. Nevertheless, macroprudential policies have an important complementary role to play
    Keywords: macroprudential, counter-cyclical capital buffer, macro modelling.
    JEL: E58 G18 C53
    Date: 2014
  5. By: Pierre Siklos; Matthias Neuenkirch
    Abstract: The Bank of Canada should consider publicly disclosing the discussions and dissenting opinions of members of its interest-rate-setting committee, according to a new C.D. Howe Institute report. In “Good Governance of Monetary Policy in Canada: Lessons from the C.D. Howe Institute’s Shadow Council,” authors Pierre Siklos and Matthias Neuenkirch argue that the existing governance structure of the Bank is out of step with international practices that have spread quickly over the past decade.
    Keywords: Monetary Policy
    JEL: E52 E58
    Date: 2014–10
  6. By: Orphanides, Athanasios
    Abstract: Marvin Goodfriend's (2014) insightful, informative and provocative work explains concisely and convincingly why the Fed needs rules and boundaries. This paper reviews the broader institutional design problem regarding the effectiveness of the central bank in practice and confirms the need for rules and boundaries. The framework proposed for improving the Fed incorporates key elements that have already been adopted in the European Union. The case of ELA provision by the ECB and the Central Bank of Cyprus to Marfin-Laiki Bank during the crisis, however, suggests that the existence of rules and boundaries may not be enough to limit harmful discretion. During a crisis, novel interpretations of the legal authority of the central bank may be introduced to create a grey area that might be exploited to justify harmful discretionary decisions even in the presence of rules and boundaries. This raises the question how to ensure that rules and boundaries are respected in practice.
    Keywords: Rules,discretion,central bank mandates,ECB,Central Bank of Cyprus,ELA
    JEL: E58 E61
    Date: 2014
  7. By: Antoine Camous; Russell Cooper
    Abstract: The valuation of government debt is subject to strategic uncertainty, stemming from investors' sentiments. Pessimistic lenders, fearing default, bid down the price of debt. This leaves a government with a higher debt burden, increasing the likelihood of default and thus confirming the pessimism of lenders. This paper studies the interaction of monetary policy and debt fragility. It asks: do monetary interventions mitigate debt fragility? The answer depends in part on the nature of monetary policy, particularly the ability to commit to future state contingent actions. With commitment to a state contingent policy, the monetary authority can indeed overcome strategic uncertainty. Under discretion, debt fragility remains.
    JEL: E42 E58 E63 F33
    Date: 2014–10
  8. By: Eric Leeper (Indiana University); James Nason (North Carolina State University)
    Keywords: Financial frictions, incomplete markets, crises, new Keynesian, natural rate, monetary transmission mechanism
    JEL: E3 E4 E5 E6 G2 N12
    Date: 2014–11
  9. By: Steffen, Sascha
    Abstract: As we are moving toward a eurozone banking union, the European Central Bank (ECB) is going to take over the regulatory oversight of 128 banks in November 2014. To that end, the ECB conducted a comprehensive assessment of these banks, which included an asset quality review (AQR) and a stress test. The fundamental question is how accurately will the financial condition of these banks have been assessed by the ECB when it commences its regulatory oversight? And, can the comprehensive assessment lead to a full repair of banks' balance sheets so that the ECB takes over financially sound banks and is the necessary regulation in place to facilitate this? Overall, the evidence presented in this paper based on the design of the comprehensive assessment as well as own stress test exercises suggest that the ECB's assessment might not comprehensively deal with the problems in the financial sector and risks may remain that will pose substantial threats to financial stability in the eurozone.
    Keywords: Stress Test,Comprehensive Assessment,Asset Quality Review,European Central Bank,European Banking Authority,Single Supervisory Mechanism
    Date: 2014
  10. By: Naoyuki Yoshino (Asian Development Bank Institute (ADBI)); Farhad Taghizadeh-Hesary
    Abstract: Japan has reached the limits of conventional macroeconomic policy. In order to overcome deflation and achieve sustainable economic growth, the Bank of Japan (BOJ) recently set an inflation target of 2% and implemented an aggressive monetary policy so this target could be achieved as soon as possible. Although prices started to rise after the BOJ implemented monetary easing, this may have been for other reasons, such as higher oil prices. Oil became expensive as a result of the depreciated Japanese yen and this was one of the main causes of the rise in inflation. This paper shows that quantitative easing may not have stimulated the Japanese economy either. Aggregate demand, which includes private investment, did not increase significantly in Japan with lower interest rates. Private investment displays this unconventional behavior because of uncertainty about the future and because Japan’s population is aging. We believe that the remedy for Japan’s economic policy is not to be found in monetary policy. The government needs to implement serious structural changes and growth strategies.
    Keywords: Easing of Monetary Policy, the Japanese economy, energy price, Bank of Japan, aging population
    JEL: E47 E52 Q41 Q43
    Date: 2014–11
  11. By: Baerg, Nicole Rae
    Abstract: How does variation in the clarity of elites’ communication change the economy? Previous re- search shows that elites’ communication changes the economy, but not all messages are crafted equally. Models of strategic communication suggests that clearer and precise information can improve the economy more than ambiguous messages. In order to test this claim, I develop a new dataset of political elites’ inflation statements and measure each statements’ information precision. I then test whether or not economic performance depends on how precisely political elites communicate. I find evidence that an increase in information precision, through its attenuating effects on inflation expectations, lowers inflation. Furthermore, I find that this is true when examining a number of developing countries over a relatively volatile time period.
    Keywords: central bank communication, clarity, inflation, inflation expectations
    JEL: E31 E52 E58
    Date: 2014–04
  12. By: Matthes, Jürgen
    Abstract: The very expansive and unconventional monetary policy of the ECB reduced the tensions of the Euro debt crisis at the price of persistently very low interest rates. While the ECB was right to act at the peak of the crisis, the risks of the low-interest rate environment become increasingly obvious. Private savings suffer from very low yields, which is particularly detrimental for long-term retirement savings. Moreover, financial stability risks could arise, as ultra-low interest rates can cause a search for yield among investors. Banks and life insurance companies are exposed to reduced interest profits respectively lower yields. While life insurance companies can cope with a shorter period of low interest rates, a longer period, however, poses challenges, as contracts with guaranteed interest rates have to be served. Therefore, it is a positive sign that the economic conditions for an interest rate turnaround have improved significantly since 2012 and are expected to improve further. Economic activity is clearly on an upward trend which is expected to continue despite current uncertainties. Significant structural reforms have been implemented in most stressed Euro countries which will most likely increase growth potentials soon (as already appears to be the case in Spain). Due to a stronger economy fears of deflation should only be a temporary phenomenon. Stress indicators and fundamentals in the banking sector have also improved on the back of (late but eventually decisive) policy measures and will continue to do so in the course of the ECB's pending stress test. Public and private indebtedness should be manageable in an environment where a sustainable moderate economic growth and more normal inflation are present. These are the conditions which characterize the baseline scenario assumed here. (...)
    Keywords: Europische Zentralbank,Geldpolitik,Inflation
    Date: 2014
  13. By: Jung, Alexander; Latsos, Sophia
    Abstract: This paper examines whether the interest rate preferences of Federal Reserve Bank Presidents are subject to a regional bias. In order to evaluate the regional bias hypothesis, we augment individual Taylor rules for the Federal Reserve Bank Presidents (sample 1989 to 2006) with regional variables and test for their influence on the Presidents’ interest rate preferences. These preferences stem from FOMC (Federal Open Market Committee) transcripts. Estimates based on the augmented Taylor rules reveal that the preferences of some Federal Reserve Bank Presidents were not free of a regional bias. Augmented Taylor rules with inertia, however, show that this finding could also be due to the presence of an interest rate smoothing motive. JEL Classification: C12, C30, D72, E58
    Keywords: augmented Taylor rule, interest rate preferences, real-time data, regional bias, SUR model
    Date: 2014–09
  14. By: Eichengreen, Barry; Chiţu, Livia; Mehl, Arnaud
    Abstract: We investigate whether the role of national currencies as international reserves was fundamentally altered by the shift from fixed to flexible exchange rates (what we call the “upheaval hypothesis”), a view that gained adherents following the collapse of the Bretton Woods System. We extend standard data on the currency composition of foreign reserves backward and forward in time to test whether there was a shift in the determinants of reserve currency shares around the breakdown of Bretton Woods. We find evidence in favor of this hypothesis. The effects of inertia and the credibility of policies on international reserve currency choice have become stronger post-Bretton Woods, while those associated with network effects have weakened. We also show that negative policy interventions designed to discourage international use of a currency have been easier to implement than positive interventions to encourage international use. These findings speak to current discussions of the prospects of currencies, like the euro and the renminbi, seen to be seeking to acquire international reserve status and others like the U.S. dollar seeking to preserve it. JEL Classification: F30, N20
    Keywords: currency composition, fixed vs. floating exchange rates, international reserves, structural change
    Date: 2014–08
  15. By: S. M. Ali Abbas; Laura Blattner; Mark De Broeck; Asmaa El-Ganainy; Malin Hu
    Abstract: We examine how the composition of public debt, broken down by currency, maturity, holder profile and marketability, has responded to major debt accumulation and consolidation episodes during 1900-2011. Covering thirteen advanced economies, we focus on debt structure shifts that occurred around the two World Wars and global economic downturns, and the subsequent debt consolidations. Notwithstanding data gaps, we are able to recover some broad common patterns. Episodes of large debt accumulation—essentially, large increases in debt supply— were typically absorbed by increases in short-term, foreign currency-denominated, and banking-system-held debt. However, this pattern did not hold during the debt build-ups starting in the 1980s and 1990s, which were compositionally skewed toward long-term local-currency debt. We attribute this change to higher structural demand for sovereign paper, linked to capital account liberalization in advanced economies, the emergence of a large contractual saving sector, and innovative sovereign debt products. With regard to debt consolidations, we find support for the financial repression-cum-inflation channel for post World War II debt reductions. However, the scope for a repeat of this strategy appears limited unless financial liberalization and globalization were materially rolled back or the current globally agreed monetary policy regime built around price stability abandoned. Neither are significant favorable structural demand shifts, as witnessed in the 1980s and 1990s, likely.
    Keywords: Sovereign debt;Debt rescheduling;Debt reduction;Public debt management;Developed countries;sovereign debt composition, sovereign debt management, historical debt database
    Date: 2014–09–09
  16. By: Gabriel Desgranges; Céline Rochon
    Abstract: We study the relationship between default and the maturity structure of the debt portfolio of a Sovereign, under uncertainty. The Sovereign faces a trade-off between a future costly default and a high current fiscal effort. This results into a debt crisis in case a large initial issuance of long term debt is followed by a sequence of negative macro shocks. Prior uncertainty about future fundamentals is then a source of default through its effect on long term interest rates and the optimal debt issuance. Intuitively, the Sovereign chooses a portfolio implying a risk of default because this risk generates a correlation between the future value of long term debt and future fundamentals. Long term debt serves as a hedging instrument against the risk on fundamentals. When expected fundamentals are high, the Sovereign issues a large amount of long term debt, the expected default probability increases, and so does the long term interest rate.
    Keywords: Sovereign debt;Debt burden;Default;Financial institutions;Econometric models;Long Term Debt; Maturity Structure; Optimal Default; Rational Expectations; Sovereign Debt Crisis; Uncertainty
    Date: 2014–09–12
  17. By: John Graham; Mark T. Leary; Michael R. Roberts
    Abstract: Using a novel dataset of accounting and market information that spans most publicly traded nonfinancial firms over the last century, we show that U.S. federal government debt issuance significantly affects corporate financial policies and balance sheets through its impact on investors' portfolio allocations and the relative pricing of different assets. Government debt is strongly negatively correlated with corporate debt and investment, but strongly positively correlated with corporate liquidity. These relations are more pronounced in larger, less risky firms whose debt is a closer substitute for Treasuries. Indeed, we find a strong negative relation between the BAA-AAA yield spread and government debt, highlighting the greater sensitivity of more highly rated credit to variation in the supply of Treasuries. The channel through which this effect operates is investors' portfolio decisions: domestic intermediaries actively substitute between lending to the federal government and the nonfinancial corporate sector. The relations between government debt and corporate policies, as well as the substitution between government and corporate debt by intermediaries, are stronger after 1970 when foreign demand increased competition for Treasury securities. In concert, our results suggest that large, financially healthy corporations act as liquidity providers by supplying relatively safe securities to investors when alternatives are in short supply, and that this financial strategy influences firms' capital structures and investment policies.
    JEL: E22 E44 G20 G31 G32
    Date: 2014–10

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