nep-cba New Economics Papers
on Central Banking
Issue of 2014‒12‒29
twenty-one papers chosen by
Maria Semenova
Higher School of Economics

  1. Optimal monetary policy in a new Keynesian model with animal spirits and financial markets By Lengnick, Matthias; Wohltmann, Hans-Werner
  2. Monetary Policy in Times of Financial Stress. By Kontonikas, Alexandros; Nolan, Charles; Zekaite, Zivile
  3. The Impact of U.S. Monetary Policy Normalization on Capital Flows to Emerging-Market Economies By Tatjana Dahlhaus; Garima Vasishtha
  4. Loss Aversion and the Asymmetric Transmission of Monetary Policy By Gaffeo, Edoardo; Petrella, Ivan; Pfajfar, Damjan; Santoro, Emiliano
  5. International Monetary Coordination and the Great Deviation By John B. Taylor
  6. Inflation, debt and the zero lower bound By Stefano Neri; Alessandro Notarpietro
  7. A New Approach to Construct Core Inflation By Sartaj Rasool Rather; S. Raja Sethu Durai; M. Ramachandran
  8. A Novel Banking Supervision Method using the Minimum Dominating Set By Periklis Gogas; Theophilos Papadimitriou; Maria-Artemis Matthaiou
  9. The limits of model-based regulation By Behn, Markus; Haselmann, Rainer; Vig, Vikrant
  10. Testimony on improving financial institution supervision: examining and addressing regulatory capture By Dudley, William
  11. Market Perceptions of US and European Policy Actions Around the Subprime Crisis By Theoharry Grammatikos; Thorsten Lehnert; Yoichi Otsubo
  12. Integrating Uncertainty and Monetary Policy-Making: A Practitioner’s Perspective By Stephen S. Poloz
  13. Limited Deposit Insurance Coverage and Bank Competition By Shy, Oz; Stenbacka, Rune; Yankov, Vladimir
  14. Analysis of aggregated inflation expectations based on the ECB SPF survey By Oinonen, Sami; Paloviita, Maritta
  15. The Financial and Macroeconomic Effects of OMT Announcements By Altavilla, Carlo; Giannone, Domenico; Lenza, Michele
  16. Is there any causality between inflation and FDI in an ‘inflation targeting’ regime? Evidence from South Africa By Valli, Mohammed; Masih, Mansur
  17. The Effect of the Federal Reserve’s Tapering Announcements on Emerging Markets By Vikram Rai1; Lena Suchanek
  18. The persistence of real exchange rates in the Central and Eastern European countries By Ahmad Zubaidi Baharumshah; Siew-Voon Soon; Stilianos Fountas; Nurul Sima Md. Shariff
  19. Assessing the Basel II Internal Ratings-Based Approach: Empirical Evidence from Australia By Marek Rutkowski; Silvio Tarca
  20. Real Effective Exchange Rate Imbalances and Macroeconomic Adjustments: evidence from the CEMAC zone By Asongu Simplice
  21. Assessing the effect of monetary policy on economic growth in franc zone By Douanla Tayo, Lionel

  1. By: Lengnick, Matthias; Wohltmann, Hans-Werner
    Abstract: This paper relates to the literature on macro-finance-interaction models. We modify the boundedly rational New Keynesian model of De Grauwe (2010a) using a completely microfounded IS equation, and combine it with the agent-based financial market model of Westerhoff (2008). For this purpose we derive four interactive channels between the financial and real sector where two channels are strictly microfounded. We analyze the impact of the different channels on economic stability and derive optimal (simple) monetary policy rules. We find that coefficients of optimal simple Taylor rules do not significantly change if financial market stabilization becomes part of the central bank's objective function. Additionally, we show that rule-based, backward-looking monetary policy creates huge instabilities if expectations are boundedly rational.
    Keywords: agent-based financial markets,New Keynesian macroeconomics,microfoundation,optimal monetary policy,unconventional monetary policy
    JEL: E5 G02
    Date: 2014
  2. By: Kontonikas, Alexandros; Nolan, Charles; Zekaite, Zivile
    Abstract: Some studies argue that the Fed reacts to financial market developments. Using data covering the period 1985:Q1 - 2008:Q4 and employing an augmented Taylor rule specification, we re-examine that conjecture. We find that evidence in favour of such a reaction is largely driven by the Fed’s behaviour during the 2007-2008 financial crisis.
    Keywords: Monetary Policy, Taylor Rule, Financial Crisis,
    Date: 2014
  3. By: Tatjana Dahlhaus; Garima Vasishtha
    Abstract: The Federal Reserve’s path for withdrawal of monetary stimulus and eventually increasing interest rates could have substantial repercussions for capital flows to emerging-market economies (EMEs). This paper examines the potential impact of U.S. monetary policy normalization on portfolio flows to major EMEs by using a vector autoregressive model that explicitly accounts for market expectations of future monetary policy. The “policy normalization shock” is defined as a shock that increases both the yield spread of U.S. long-term bonds and monetary policy expectations while leaving the policy rate per se unchanged. Results indicate that the impact of this shock on portfolio flows as a share of GDP is expected to be economically small. The estimated impact is closely in line with that seen during the end-May to August 2013 episode in response to a comparable rise in the yield spread of U.S. long-term bonds. However, as the events during the summer of 2013 have shown, relatively small changes in portfolio flows can be associated with significant financial turmoil in EMEs. Further, there is also a strong association between the countries that are identified by our model as being the most affected and the ones that saw greater outflows of portfolio capital over May to September 2013.
    Keywords: International topics; Transmission of monetary policy
    JEL: C32 E52 F33 F42
    Date: 2014
  4. By: Gaffeo, Edoardo; Petrella, Ivan; Pfajfar, Damjan; Santoro, Emiliano
    Abstract: There is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity, while price responses display no sizeable asymmetry. To rationalize these facts we develop a dynamic general equilibrium model where households’ utility depends on consumption deviations from a reference level below which loss aversion is displayed. State-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and inflation. Contractions face the Central Bank with higher responsiveness of output to interest rate changes, as well as a flatter aggregate supply schedule.
    Keywords: asymmetry; business cycle; monetary policy; prospect theory
    JEL: D03 D11 E32 E42 E52
    Date: 2014–08
  5. By: John B. Taylor (Department of Economics, Stanford University)
    Abstract: Research in the early 1980s found that the gains from international coordination of monetary policy were quantitatively small compared to simply getting domestic policy right. That prediction turned out to be a pretty good description of monetary policy in the 1980s, 1990s, and until recently. Because this balanced international picture has largely disappeared, the 1980s view about monetary policy coordination needs to be reexamined. The source of the problem is not that the models or the theory are wrong. Rather there was a deviation from the rule-like monetary policies that worked well in the 1980s and 1990s, and this deviation helped break down the international monetary balance. There were similar deviations at many central banks, an apparent spillover culminating in a global great deviation. The purpose of this paper is to examine the possible causes and consequences of these spillovers, and to show that uncoordinated responses of central banks to the deviations can create an amplification mechanism which might be overcome by some form of policy coordination.
    Date: 2013–01
  6. By: Stefano Neri (Banca d'Italia); Alessandro Notarpietro (Banca d'Italia)
    Abstract: This paper analyses the macroeconomic effects of a protracted period of low and falling inflation rates when monetary policy is constrained by the zero lower bound (ZLB) on nominal interest rates and the private sector is indebted in nominal terms (debt-deflation channel). In this scenario, even cost-push shocks that in normal circumstances would reduce inflation and stimulate output are found to have contractionary effects on economic activity, especially when the interplay of ZLB and debt deflation is considered.
    Keywords: zero lower bound, monetary policy, disinflation, debt-deflation channel.
    JEL: E21 E31 E37 E52
    Date: 2014–10
  7. By: Sartaj Rasool Rather (Madras School of Economics); S. Raja Sethu Durai (Department of Economics, Pondicherry University, Puducherry); M. Ramachandran (Department of Economics, Pondicherry University, Puducherry)
    Abstract: We propose a new methodology to construct core inflation which is, unlike other conventional methods, not based on ad hoc elimination/trimming of prices. The underlying inflation derived from our method is found to be a powerful leading indicator of headline inflation while other conventional measures do not seem to reflect such fundamental property of core inflation.
    Keywords: Core inflation, Skewness, Leading indicator
    JEL: C43 E31 E52
    Date: 2014–09
  8. By: Periklis Gogas (Department of Economics, Democritus University of Thrace; The Rimini Centre for Economic Analysis, Italy); Theophilos Papadimitriou (Department of Economics, Democritus University of Thrace); Maria-Artemis Matthaiou (Department of Economics, Democritus University of Thrace)
    Abstract: The magnitude of the recent financial crisis, which started from the U.S. and expanded in Europe, change the perspective on banking supervision. The recent consensus is that to preserve a healthy and stable banking network, the monitoring of all financial institutions should be under a single regulator, the Central Bank. In this paper we study the interrelations of banking institutions under the framework of Complex Networks. Specifically, our goal is to provide an auxiliary early warning system for the banking system’s supervisor that would be used in addition to the existing schemes of control. We employ the Minimum Dominating Set (MDS) methodology to reveal the most strategically important banks of the banking network and use them as alarm triggers. By monitoring the MDS subset the regulators can have an overview of the whole network. Our dataset is formed from the 200 largest American banks and we examine their interconnection through their total deposits. The MDS concept is applied for the first time in this setting and the results show that it may be an essential supplementary tool to the arsenal of a Central Bank.
    Date: 2014–11
  9. By: Behn, Markus; Haselmann, Rainer; Vig, Vikrant
    Abstract: In this paper, we investigate how the introduction of complex, model-based capital regulation affected credit risk of financial institutions. Model-based regulation was meant to enhance the stability of the financial sector by making capital charges more sensitive to risk. Exploiting the staggered introduction of the model-based approach in Germany and the richness of our loan-level data set, we show that (1) internal risk estimates employed for regulatory purposes systematically underpredict actual default rates by 0.5 to 1 percentage points; (2) both default rates and loss rates are higher for loans that were originated under the model-based approach, while corresponding risk-weights are significantly lower; and (3) interest rates are higher for loans originated under the model-based approach, suggesting that banks were aware of the higher risk associated with these loans and priced them accordingly. Further, we document that large banks benefited from the reform as they experienced a reduction in capital charges and consequently expanded their lending at the expense of smaller banks that did not introduce the model-based approach. Counter to the stated objectives, the introduction of complex regulation adversely affected the credit risk of financial institutions. Overall, our results highlight the pitfalls of complex regulation and suggest that simpler rules may increase the efficacy of financial regulation.
    Keywords: capital regulation,internal ratings,Basel regulation
    JEL: G01 G21 G28
    Date: 2014
  10. By: Dudley, William (Federal Reserve Bank of New York)
    Abstract: Testimony before the Senate Committee on Banking, Housing, and Urban Affairs Financial Institutions and Consumer Protection Subcommittee.
    Keywords: regulatory capture; conscientious supervision; effective supervision; This American Life; Basel III Liquidity Coverage Ratio; stress tests
    JEL: E50 G21 G28
    Date: 2014–11–25
  11. By: Theoharry Grammatikos (University of Luxembourg (E-mail: theoharry.; Thorsten Lehnert (University of Luxembourg (E-mail:; Yoichi Otsubo (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: This paper explores the impacts of key policy actions by US and European authorities on stock returns of systemically important banks in Europe and US around the subprime crisis. We find that the US policy announcements had a stronger impact on the European and US banking industry than the European policy announcements. In particular, the announcements of monetary policies by the US authorities were accompanied by higher abnormal returns compared to related announcements of European authorities. We also find that the policy announcements, regardless of which side of the Atlantic the news arrived from, has increased the return volatility during the crisis. We further analyze the reactions of implied volatility. The findings suggest that the currency swaps had a non-negligible effect in reducing future uncertainty.
    Keywords: Event study, Policy announcement, Subprime crisis
    JEL: G01 G14 G18 G21 G28
    Date: 2014–11
  12. By: Stephen S. Poloz
    Abstract: This paper discusses how central banking is evolving in light of recent experience, with particular emphasis on the incorporation of uncertainty into policy decision-making. The sort of post-crisis uncertainty that central banks are dealing with today is more profound than that which is typically subjected to rigorous analysis and does not lend itself easily to formal modelling. As a practical matter, the policy-maker is dependent on macro models to develop a coherent monetary policy plan, and this burden of coherence means that fundamental uncertainty must be incorporated explicitly into the policy formulation process. As suggested here, doing so transforms policy formulation from an exercise in reverse engineering to one of risk management, one consequence of which is to inject a little more realism about uncertainty into the policy narrative, while trusting markets to wrestle with the data flow and deliver two-way trading. The evolution is likely to be a long one - researchers are encouraged to keep focusing on developing a practical understanding of how the economy works, one that admits that rules around economic behaviour are not cast in stone, but are almost certainly subject to variation through time and events.
    Keywords: Economic models; Financial stability; Monetary policy framework; Uncertainty and monetary policy
    JEL: C50 E37 E5 E61
    Date: 2014
  13. By: Shy, Oz (Federal Reserve Bank of Boston); Stenbacka, Rune (Hanken School of Economics); Yankov, Vladimir (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Deposit insurance designs in many countries place a limit on the coverage of deposits in each bank. However, no limits are placed on the number of accounts held with different banks. Therefore, under limited deposit insurance, some consumers open accounts with different banks to achieve higher or full deposit insurance coverage. We compare three regimes of deposit insurance: No deposit insurance, unlimited deposit insurance, and limited deposit insurance. We show that limited deposit insurance weakens competition among banks and reduces total welfare relative to no or unlimited deposit insurance.
    Keywords: Limited deposit insurance coverage; deposit rates; bank competition
    JEL: G21
    Date: 2014–10–15
  14. By: Oinonen, Sami (Bank of Finland Research); Paloviita, Maritta (Bank of Finland Research)
    Abstract: This paper examines aggregated inflation expectations based on the ECB Survey of Professional Forecasters (ECB SPF). We analyse possible impacts of changing panel composition on short and long term point forecasts and forecast uncertainties using approach, which is based on a set of sub-panels of fixed composition. Our results indicate that the unbalanced panel data do not cause systematic distortions to aggregated survey information. However, micro level analysis of expectations would also be useful, especially in times of wide disagreement across forecasters and high levels of inflation uncertainty.
    Keywords: survey data; expectations; changing panel composition
    JEL: C53 E31 E37
    Date: 2014–12–01
  15. By: Altavilla, Carlo; Giannone, Domenico; Lenza, Michele
    Abstract: This study evaluates the macroeconomic effects of Outright Monetary Transaction (OMT) announcements by the European Central Bank (ECB). Using high-frequency data, we find that OMT announcements decreased the Italian and Spanish 2-year government bond yields by about 2 percentage points, while leaving unchanged the bond yields of the same maturity in Germany and France. These results are used to calibrate a scenario in a multi-country model describing the macrofinancial linkages in France, Germany, Italy, and Spain. The scenario analysis suggests that the reduction in bond yields due to OMT announcements is associated with a significant increase in real activity, credit, and prices in Italy and Spain with relatively muted spillovers in France and Germany.
    Keywords: event study; multi-country vector autoregressive model; news; Outright Monetary Transactions
    JEL: C54 E47 E58
    Date: 2014–06
  16. By: Valli, Mohammed; Masih, Mansur
    Abstract: This paper attempts to examine whether a long-run theoretical relationship does indeed exist between the level of inflation in South Africa and the amount of FDI eventually received by the country. It also attempts to provide insight into the purported macroeconomic benefits of the policy of ‘inflation targeting’, by ascertaining whether any causality exists between stable inflation levels and improved FDI inflows from a South African perspective. Utilising annual data ranging from 1970 to 2012, we employ time series techniques to answer our research objectives. Our results indicate that there is a long-run inverse relationship between the level of inflation and FDI inflow in South Africa, implying that a rise in the level of inflation would have a negative impact on the amount of FDI received by South Africa. Furthermore, the paper successfully demonstrates that a degree of causality does exist between stable inflation levels and improved FDI inflows from a South African perspective, suggesting that the policy change that occurred with the adoption of ‘inflation targeting’ by the South African authorities did have a significant impact on the average level of FDI inflow to the country. Consequently, one of the implications of our findings is that the policy of ‘inflation targeting’, if well-implemented, actively managed and consistently applied, could represent a vital organ of the policy toolkit available to governmental authorities and policymakers in South Africa and indeed all developing countries, in their bid to enhance the inflow of FDI to their respective countries.
    Keywords: inflation; foreign direct investment (FDI); South Africa; timeseries techniques
    JEL: C22 C58 E44 G15
    Date: 2014–08–24
  17. By: Vikram Rai1; Lena Suchanek
    Abstract: The Federal Reserve’s quantitative easing (QE) program has been accompanied by a flow of funds into emerging-market economies (EMEs) in search of higher returns. When Federal Reserve officials first mentioned an eventual slowdown and end of purchases under the central bank’s QE program in May and June 2013, foreign investors started to withdraw some of these funds, leading to capital outflows, a drop in EME currencies and stock markets, and a rise in bond yields. Using an event-study approach, this paper estimates the impact of “Fed tapering” on EME financial markets and capital flows for 19 EMEs. Results suggest that EMEs with strong fundamentals (e.g., stronger growth and current account position, lower debt, and higher growth in business confidence and productivity), saw more favourable responses to Fed communications on tapering. Capital account openness initially played a role as well, but diminished in importance in subsequent tapering announcements.
    Keywords: International financial markets; Transmission of monetary policy; International topics
    JEL: C33 E58 F32 G14
    Date: 2014
  18. By: Ahmad Zubaidi Baharumshah; Siew-Voon Soon; Stilianos Fountas (Department of Economics, University of Macedonia); Nurul Sima Md. Shariff
    Abstract: This paper investigates the mean reversion in real exchange rates for Central and Eastern European countries. In contrast to previous studies, we use the local-persistent model to measure the half-life. We find that the adjustment to purchasing power parity is more rapid after accounting for structural breaks, taking less than 18 months to be cut in half. The empirical evidence shows that there is no clear-cut difference in the speed of adjustment to shocks between the transition economies and the larger member countries of the European Union. The narrow confidence intervals for the half-lives that accord with the standard sticky-price models provide strong support for purchasing power parity. The purchasing power parity puzzle does not seem to hold in these transition countries. The practical implication of our findings is that the transition countries have successfully adopted trade policies that mimic those of the European Union, with a view to alignment in readiness for European Union membership..
    Keywords: half-lives; local persistence; structural breaks; real exchange rate; PPP puzzle; transition economies.
    JEL: C0 F21 F36
    Date: 2014–11
  19. By: Marek Rutkowski; Silvio Tarca
    Abstract: The Basel II internal ratings-based (IRB) approach to capital adequacy for credit risk implements an asymptotic single risk factor (ASRF) model. Measurements from the ASRF model of the prevailing state of Australia's economy and the level of capitalisation of its banking sector find general agreement with macroeconomic indicators, financial statistics and external credit ratings. However, given the range of economic conditions, from mild contraction to moderate expansion, experienced in Australia since the implementation of Basel II, we cannot attest to the validity of the model specification of the IRB approach for its intended purpose of solvency assessment. With the implementation of Basel II preceding the time when the effect of the financial crisis of 2007-09 was most acutely felt, our empirical findings offer a fundamental assessment of the impact of the crisis on the Australian banking sector. Access to internal bank data collected by the prudential regulator distinguishes our research from other empirical studies on the recent crisis.
    Date: 2014–11
  20. By: Asongu Simplice (Yaoundé/Cameroun)
    Abstract: We assess the behavior of real effective exchange rates (REERs) of members of the CEMAC zone with respect to their long-term equilibrium paths. A reduced form of the fundamental equilibrium exchange rate (FEER) model is estimated and associated misalignments are derived for the period 1980 to 2009. Our findings suggest that for majority of countries, macroeconomic fundamentals have the expected associations with the exchange rate fluctuations. The analysis also reveals that, only the REER adjustments of Cameroon and Gabon are significant in restoring the long-term equilibrium in event of a shock. The Cameroonian economic fundamentals of terms of trade, government expenditure and openness have different long-term relations with the REER in comparison to those of other member states. Ultimately, there is no need for an adjustment in the level of the peg based on the present quantitative analysis of REER paths.
    Keywords: Exchange rate; Macroeconomic impact; CEMAC zone
    JEL: F31 F33 F42 O55
    Date: 2014–01
  21. By: Douanla Tayo, Lionel
    Abstract: This study aims at assessing the effect of monetary policy on economic growth for the fourteen countries of the Franc zone over the period 1985-2012 using a dynamic panel model. The system estimator of the generalized method of moments has allowed us to demonstrate a significant and negative effect of domestic credit provided by banking sector on economic growth. The analysis reveals that money supply has significant positive effect on economic growth, while total reserves and inflation have a negative effect. However the negative effect of domestic credit provided by banking sector can be reversed through allocation of funds to those projects for which the social returns are the highest and through allocation of funds to productive local industries.
    Keywords: Domestic credit, real GDP, dynamic panel, GMM
    JEL: E5
    Date: 2014–11–25

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