nep-cba New Economics Papers
on Central Banking
Issue of 2015‒02‒05
twenty-one papers chosen by
Maria Semenova
Higher School of Economics

  1. Monetary Policy Independence under Flexible Exchange Rates: An Illusion? By Sebastian Edwards
  2. Monetary policy, bank bailouts and the sovereign-bank risk nexus in the euro area By Fratzscher, Marcel; Rieth, Malte
  3. Optimal monetary responses to oil discoveries By Samuel Wills
  4. The relationship between the variance of inflation and the variance of output under different types of monetary policy By Alejandro Rodríguez Arana
  5. Signaling Effects of Monteray Policy By Leonardo Melosi
  6. Scarcity of Safe Assets, Inflation, and the Policy Trap By Andolfatto, David; Williamson, Stephen D.
  7. Estimating Central Bank Preferences Combining Topic and Scaling Methods By Baerg, Nicole Rae; Lowe, Will
  8. Optimal monetary policy in the presence of human capital depreciation during unemployment By Lien Laureys
  9. Accounting for Post-Crisis Inflation and Employment: A Retro Analysis By Fratto, Chiara; Uhlig, Harald
  10. Fighting the Last War: Economists on the Lender of Last Resort By Grossman, Richard; Rockoff, Hugh T
  11. Banks Exposure to Interest Rate Risk and The Transmission of Monetary Policy By Landier, Augustin; Sraer, David; Thesmar, David
  12. A model of monetary policy shocks for financial crises and normal conditions By Smith, Andrew Lee; Keating, John W.; Kelly, Logan J.; Valcarcel, Victor J.
  13. Efficient Financial Crises By Ariel Zetlin-Jones
  14. US inflation dynamics on long range data By Plakandaras, Vasilios; Gogas, Periklis; Gupta, Rangan; Papadimitriou, Theophilos
  15. Estimating DSGE models with forward guidance By Mariano Kulish; James Morley; Tim Robinson
  16. The Effects of Financial and Real Shocks, Structural Vulnerability and Monetary Policy on Exchange Rates from the Perspective of Currency Crises Models By Ryota Nakatani
  17. Bailouts And Moral Hazard: How Implicit Government Guarantees Affect Financial Stability By Mariathasan, Mike; Merrouche, Ouarda; Werger, Charlotte
  18. Regulating financial market infrastructures By Guido Ferrarini; Paolo Saguato
  19. Pushing on a string: US monetary policy is less powerful in recessions By Silvana Tenreyro; Gregory Thwaites
  20. Uncertainty And Monetary Policy In The US: A Journey Into Non-Linear Territory By Giovanni Pellegrino
  21. Systemic sovereign risk: macroeconomic implications in the euro area By Saleem A. Bahaj

  1. By: Sebastian Edwards
    Abstract: I analyze whether countries with flexible exchange rates are able to pursue an independent monetary policy, as suggested by traditional theory. I use data for three Latin American countries with flexible exchange rates, inflation targeting, and capital mobility – Chile, Colombia and Mexico – to investigate the extent to which Federal Reserve actions are translated into local central banks’ policy rates. The results indicate that there is significant “policy contagion,” and that these countries tend to “import” Fed policies. The degree of monetary policy independence is lower than what traditional models suggest.
    JEL: E5 E52 E58 F30 F31 F32
    Date: 2015–01
  2. By: Fratzscher, Marcel; Rieth, Malte
    Abstract: The paper analyses the empirical relationship between bank risk and sovereign credit risk in the euro area. Using structural VAR with daily financial markets data for 2003-13, the analysis confirms two-way causality between shocks to sovereign risk and bank risk, with the former being overall more important in explaining bank risk, than vice versa. The paper focuses specifically on the impact of non-standard monetary policy measures by the European Central Bank and on the effects of bank bailout policies by national governments. Testing specific hypotheses formulated in the literature, we find that bank bailout policies have reduced solvency risk in the banking sector, but partly at the expense of raising the credit risk of sovereigns. By contrast, monetary policy was in most, but not all cases effective in lowering credit risk among both sovereigns and banks. Finally, we find spillover effects in particular from sovereigns in the euro area periphery to the core countries.
    Keywords: bank bailout; banks; credit risk; heteroscedasticity; monetary policy; sovereigns; spillovers
    JEL: E52 E60 G10
    Date: 2015–01
  3. By: Samuel Wills
    Abstract: This paper studies how monetary policy should respond to news about an oil discovery, using a workhorse New Keynesian model. Good news about future production can create a recession today under exchange rate pegs and a simple Taylor rule, as seen in practice. This is explained by forward-looking inflation. Recession is avoided by a Taylor rule that accommodates changes in the natural level of output, which closely approximates optimal policy. Central banks have an incentive to exploit oil revenues by appreciating the terms of trade, creating “Dutch disease” and a deflationary bias which is overcome by committing to future policy.
    Keywords: natural resources; oil; optimal monetary policy; small open economy; news shock
    JEL: E52 E62 F41 O13 Q30 Q33
    Date: 2014–04
  4. By: Alejandro Rodríguez Arana (Department of Economics, Universidad Iberoamericana, Mexico City. Mexico)
    Abstract: When the central bank minimizes a quadratic loss function depending upon the inflation gap and the output gap, a negative association between the variance of inflation and the variance of output emerges. The variance of output will be higher the greater is the preference of the central bank for stabilizing inflation. The use of certain ad-hoc interest rate rules analyzed in the literature may break the described negative relation. Central banks could reduce both variances. Data mainly from the US suggests that central banks use adhoc interest rate rules more than the minimization of the quadratic loss function.
    Date: 2014
  5. By: Leonardo Melosi (Federal Reserve Bank of Chicago)
    Abstract: We develop a DSGE model in which the policy rate signals to price setters the central bank's view about macroeconomic developments. The model is estimated with likelihood methods on a U.S. data set that includes the Survey of Professional Forecasters as a measure of price setters' inflation expectations. The estimated model with signaling effects delivers large and persistent real effects of monetary disturbances, even though the average duration of price contracts is fairly short. While the signaling effects do not substantially alter the transmission of technology shocks, they bring about deflationary pressures in the aftermath of positive demand shocks. In the 1970s, the Federal Reserve's disinflation policy, which was characterized by gradual increases in the policy rate, was counterproductive because it ended up signaling inflationary shocks.
    Date: 2014
  6. By: Andolfatto, David (Federal Reserve Bank of St. Louis); Williamson, Stephen D. (Federal Reserve Bank of St. Louis)
    Abstract: We construct a model in which all consolidated government debt is used in transactions, with money being more widely acceptable. When asset market constraints bind, the model can deliver low real interest rates and positive rates of inflation at the zero lower bound. Optimal monetary policy in the face of a financial crisis shock implies a positive nominal interest rate. The model reveals some novel perils of Taylor rules.
    JEL: E4 E5
    Date: 2015–01–23
  7. By: Baerg, Nicole Rae; Lowe, Will
    Abstract: Scholars often use Federal Open Market Committee (FOMC) votes to estimate the preferences of central bankers. However, rarely do committee members on the FOMC cast dissenting votes. This article demonstrates the usefulness of using what central bankers say in FOMC meetings rather than how they vote to better measure central bank preferences. Using automated text analysis tools and scaling methods, we develop a new measure of central bank preferences on the FOMC leading up to the financial crisis (2005 - 2008).
    Keywords: Central Banking, Federal Reserve Bank, Monetary Policy, Ideal Point Estimation, Textual Analysis
    JEL: E52 E58
    Date: 2015–01–22
  8. By: Lien Laureys
    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 flexibleprice allocation is no longer constrained-efficient even when the standard Hosios (1990) 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. Although optimal price inflation is no longer zero, strict inflation targeting is shown to stay close to the optimal policy.
    JEL: N0 R14 J01 F3 G3
    Date: 2014–06
  9. By: Fratto, Chiara; Uhlig, Harald
    Abstract: Why was there no deflation and what accounts for inflation after 2008? We use the prominent pre-crisis Smets-Wouters (2007) model to address this question. We find that due to price markup shocks alone inflation would have been 1%higher than observed and 0.5% higher that the long-run average. Their standard deviation is similar to its pre-crisis level. Price markup shocks were also responsible for the slow recovery of employment, though not for the initial drop. Monetary policy shocks predict an inflation rate 0.5% below average. Government expenditure innovations do not contribute much either to inflation or to employment dynamics
    JEL: E31 E32 E52
    Date: 2014–12
  10. By: Grossman, Richard; Rockoff, Hugh T
    Abstract: In this paper we trace the evolution of the lender of last resort doctrine—and its implementation—from the nineteenth century through the panic of 2008. We find that typically the most influential economists “fight the last war”: formulating policy guidelines that would have dealt effectively with the last crisis or in some cases the last two or three. This applies even to the still supreme voice among lender-of-last-resort theorists, Walter Bagehot, who wrestled with the how to deal with the financial crises that hit Britain between the end of the Napoleonic Wars and the panic of 1866. Fighting the last war may leave economists unprepared for meeting effectively the challenge of the next war.
    Keywords: Bagehot; Bank of England; central banks; lender of last resort; subprime crisis
    JEL: B0 N2
    Date: 2015–01
  11. By: Landier, Augustin; Sraer, David; Thesmar, David
    Abstract: We show that banks' cash flow exposure to interest rate risk, or income gap, plays a crucial role in their lending behavior following monetary policy shocks. In a first step, we show that the sensitivity of bank profits to interest rates increases significantly with their income gap, even when banks use interest rate derivatives. In a second step, we show that the income gap also predicts the sensitivity of bank lending to interest rates, both for commercial & industrial loans and for mortgages. Quantitatively, a 100 basis point increase in the Fed funds rate leads a bank at the 75th percentile of the income gap distribution to increase lending by about 1.6 percentage points annually relative to a bank at the 25th percentile. We conclude that banks' exposure to interest rate risk is an important determinant of the bank-level intensity of the lending channel.
    Keywords: bank lending; interest rate risk; monetary policy
    JEL: E44 E52 G21
    Date: 2014–12
  12. By: Smith, Andrew Lee (Federal Reserve Bank of Kansas City); Keating, John W.; Kelly, Logan J.; Valcarcel, Victor J.
    Abstract: In late 2008, deteriorating economic conditions led the Federal Reserve to lower the federal funds rate to near zero and inject massive liquidity into the financial system through novel facilities. The combination of conventional and unconventional measures complicates the challenging task of characterizing the effects of monetary policy. We develop a novel method of identifying these effects that maintains the classic assumptions that a central bank reacts to output and the price level contemporaneously and may only affect these variables with a lag. A New-Keynesian DSGE model augmented with a representative financial structure motivates our empirical specification. The equilibrium model provides theoretical support for our choice of different series to replace variables that were popular in models of monetary policy but became problematic in the aftermath of the 2008 financial crisis. One of our most important innovations is to utilize the Divisia M4 index of money as the policy indicator variable. The model is bolstered by its ability to produce plausible responses to a monetary policy shock in samples that include or exclude the recent crisis period.
    Keywords: Monetary policy rules; Dynamic Stochastic General Equilibrium (DSGE) models; money; output puzzle; price puzzle; liquidity puzzle; financial crisis; Divisia; Identification assumptions; Structural Vector Autoregressions (SVARs)
    JEL: E3 E4 E5
    Date: 2014–10–01
  13. By: Ariel Zetlin-Jones (Carnegie Mellon University)
    Abstract: We analyze the optimal capital structure and investment strategy of banks and other financial institutions. We develop conditions under which banks optimally choose a fragile capital structure that is subject to runs. We show that when bank depositors have limited ability to commit to long-term lending arrangements, they strictly prefer to lend to banks using short-term debt rather than with long-term debt or equity. We argue that when there are multiple banks, the same limited commitment of depositors leads them to prefer a financial system in which banks pursue correlated, risky investments as opposed to one in which banks pursue independent, less risky investments. The optimal financial system features occasional crises in which all banks are subject to ex-post inefficient liquidations, and in this sense, financial crises are efficient.
    Date: 2014
  14. By: Plakandaras, Vasilios (Democritus University of Thrace, Department of Economics); Gogas, Periklis (Democritus University of Thrace, Department of Economics); Gupta, Rangan (University of Pretoria, Department of Economics); Papadimitriou, Theophilos (Democritus University of Thrace, Department of Economics)
    Abstract: In this paper we evaluate inflation persistence in the U.S. using long range monthly and annual data. The importance of inflation persistence is crucial to policy authorities and market participants, since the level of inflation persistence provides an indication on the susceptibility of the economy to exogenous shocks. Departing from classic econometric approaches found in the relevant literature, we evaluate inflation persistence through the nonparametric Hurst exponent within both a global and a rolling window framework. Moreover, we expand our analysis to detect the potential existence of chaos in the data generating process, in order to enhance the robustness of our conclusions. Overall, we find that inflation persistence is high from 1775 to 2013 for the annual dataset and from February 1876 to May 2014 in monthly frequency, respectively. Especially from the monthly dataset, the rolling window approach allows us to derive that inflation persistence has reached to historically high levels in the post Bretton Woods period and remained there ever since.
    Keywords: Inflation; Persistence; Hurst exponent; Detrended Fluctuation Analysis; Lyapunov exponent
    JEL: C14 E31 E60
    Date: 2015–01–29
  15. By: Mariano Kulish (School of Economics, Australian School of Business, the University of New South Wales); James Morley (School of Economics, Australian School of Business, the University of New South Wales); Tim Robinson (Melbourne Institute of Applied Economics and Social Research, University of Melbourne)
    Abstract: Motivated by the use of forward guidance, we propose a method to estimate DSGE models in which the central bank holds the policy rate fixed for an extended period. Private agents’ beliefs about how long the fixed-rate regime will last influences, among other observable variables, current output, inflation and interest rates of longer maturities. We estimate the shadow policy rate and construct counterfactual scenarios to quantify the severity of the zero lower bound constraint. Using the Smets and Wouters (2007) model, we find that the expected duration of the zero interest rate policy has been around 2 years, that the shadow rate has been around -3 per cent and that the zero lower bound has imposed a significant output loss.
    Keywords: zero lower bound, forward guidance
    JEL: E52 E58
    Date: 2014–12
  16. By: Ryota Nakatani (Bank of Japan)
    Abstract: Is there any factor that is not analyzed in the literature but is important for preventing currency crises? What kind of shock is important as a trigger of a currency crisis? Given the same shock, how does the impact of a currency crisis differ across countries depending on the degree of each country’s structural vulnerability? To answer these questions, this paper analyzes currency crises both theoretically and empirically. In the theoretical part, I argue that exports are an important factor to prevent currency crises that has not been frequently analyzed in the existing theoretical literature. Using the third generation model of currency crises, I derive a simple and intuitive formula that captures an economy’s structural vulnerability characterized by the elasticity of exports and repayments for foreign currency denominated debt. I graphically show that the possibility of currency crisis equilibrium depends on this structural vulnerability. In the empirical part, I use unbalanced panel data comprising 51 emerging countries from 1980 to 2011. The results obtained here are consistent with the prediction of the theoretical models. First, I found that monetary tightening by the central banks can have a significant effect on exchange rates. Second, I found that both productivity shocks in the real sector and shocks to a country’s risk premium in the financial markets affect exchange rate dynamics, while productivity shocks appeared more quantitatively important during the Asian currency crisis. Finally, the structural vulnerability of the country plays a statistically significant role for propagating the effects of the shock.
    Keywords: Currency Crisis; Foreign Currency Debt; Exports; Productivity Shock; Risk Premium; Monetary Policy; Elasticity
    JEL: E22 E4 E5 F1 F3 F4 G15 G2 O43
    Date: 2014–12
  17. By: Mariathasan, Mike; Merrouche, Ouarda; Werger, Charlotte
    Abstract: The recent crisis has shown that banks in distress can often expect to benefit from (implicit) government guarantees. This paper analyzes a panel of 781 banks from 90 countries to test whether the expectation of individual and systemic government support induces moral hazard. It shows that banks tend to be more leveraged, funded with capital of lower quality, more heavily invested in risky assets and exposed to more severe liquidity mismatch when they themselves -but also when their competitors- are perceived as being more likely to benefit from government support. We show that the default of Lehman Brothers in 2008 reduced moral hazard in the short-run, but not in the long-run, as the systemic consequences of Lehman’s failure became apparent. In addition, our large country coverage allows us to provide new results on policies, institutions, and regulations that can be put in place to reduce moral hazard induced by implicit guarantees to the banking sector.
    Keywords: bailout; banking; government guarantees; moral hazard
    JEL: G20 G21 G28
    Date: 2014–12
  18. By: Guido Ferrarini; Paolo Saguato
    Abstract: This paper focuses on the impact of financial market infrastructures (FMIs) and of their regulation on the post-crisis transformation of securities and derivatives markets. It examines, in particular, the role that trading and post-trading FMIs, and their new regulatory regime, are playing in the expansion of ‘public’ securities and derivatives markets, and the progressive shrinkage of ‘private’ markets (which broadly coincide with the ‘unregulated’ or ‘less regulated’ over-the-counter (OTC) markets). The paper provides an overview of the policy approaches underlying the international crisis-era reforms to FMIs, and focuses on the dichotomy between the ‘systemic risk’ and ‘transaction costs’ approaches to financial markets and FMIs regulation. By reviewing the current move from ‘private’ markets to ‘public’ markets internationally, and with respect to the EU and US regimes, we analyze the role of trading infrastructures as liquidity providers, both in the securities markets and in the derivatives markets. And, shifting the focus to post-trading infrastructures – central clearing houses (CCPs), central securities depositories (CSDs), and trade repositories (TRs) – we address their role in supporting financial stability and market transparency. We conclude by identifying how regulators are now more deeply involved in FMIs’ governance and operation. We argue that such policy approach resulted in regulatory initiatives which move in the direction of increasing the systemic scope of FMIs, introducing elements of publicity in private markets, and calling for higher public supervision. - This paper is a draft chapter for a forthcoming volume, "The Oxford Handbook on Financial Regulation," edited by Eilís Ferran, Niamh Moloney, and Jennifer Payne, (Oxford University Press).
    Keywords: financial markets; financial market infrastructure; exchange; clearing house; central securities depository; systemic risk; transaction cost; securities market; derivatives market; MiFID II; EMIR; MiFIR; Dodd-Frank Act
    JEL: G15 G18 G21 G23 G28 G38 K22 K23
    Date: 2014–06
  19. By: Silvana Tenreyro; Gregory Thwaites
    Abstract: We estimate the impulse response of key US macro series to the monetary policy shocks identified by Romer and Romer (2004), allowing the response to depend flexibly on the state of the business cycle. We find strong evidence that the effects of monetary policy on real and nominal variables are more powerful in expansions than in recessions. The magnitude of the difference is particularly large in durables expenditure and business investment. The effect is not attributable to differences in the response of fiscal variables or the external finance premium. We find some evidence that contractionary policy shocks have more powerful effects than expansionary shocks. But contractionary shocks have not been more common in booms, so this asymmetry cannot explain our main finding.
    Keywords: asymmetric effects of monetary policy; transmission mechanism
    JEL: E32 E52
    Date: 2013–04
  20. By: Giovanni Pellegrino (University of Verona)
    Abstract: This paper investigates the interaction between uncertainty and monetary policy by estimating a non-linear VAR with US post-WWII data. The uncertainty indicator is treated both as an endogenous variable in the VAR and as the transition indicator discriminating "high" vs. "low" uncertainty states. The impact of monetary policy shocks in different phases of the "uncertainty cycle" is assessed via the computation of Generalized Impulse Response Functions. Monetary policy shocks are found to be less effective when uncertainty is high, with the peak reactions of a battery of real variables being about two-thirds milder than those conditional on an initially low level of uncertainty. The framework is then put at work to investigate the effects of uncertainty shocks in the presence of the Zero Lower Bound. The "drop and rebound" response of real variables to uncertainty shocks documented by Bloom (2009) is found to be present only if the policy rate is a long way from its ZLB. Conversely, an uncertainty shock occurring when the economy is near the ZLB triggers longer-lasting recessions and does not lead to any significant ÒreboundÓ.
    Keywords: Monetary policy shocks, Uncertainty shocks, non-linear Structural VAR, Interacted-VAR, Generalized impulse responses, Zero Lower Bound.
    JEL: C32 E32 E52 E61
    Date: 2014–09
  21. By: Saleem A. Bahaj
    Abstract: What are the macroeconomic implications of changes in sovereign risk premia? In this paper, I use a novel identification strategy coupled with a new dataset for the Euro Area to answer this question. I show that exogenous innovations in sovereign risk premia were an important driver of the economic dynamics of crisis-hit countries, explaining 30-50% of the forecast error of unemployment. I also shed light on the mechanisms through which this occurs. Fluctuations in sovereign risk premia explain 20-40% of the variance of private borrowing costs. Increases in sovereign risk result in substantial capital flight, external adjustment and import compression. In contrast, governments appear not to increase their primary balances in response to increases in sovereign risk. Identifying these causal effects involves isolating a source of fluctuations in sovereign borrowing costs exogenous to the economy in question. I address this problem by relying upon the transmission of country-specific events during the crisis in Europe to the sovereign risk premia in the remainder of the union. I construct a new dataset of critical events in foreign crisis-hit countries and I measure the impact of these events on yields in the economy of interest at an intraday frequency. An aggregation of foreign events serve as a proxy variable for structural innovations to the yield to identify shocks in a proxy SVAR. I extend this methodology into a Bayesian setting to allow for flexible panel assumptions. A counterfactual analysis is used to remove the impact of foreign events from the bond yields of crisis hit countries: I find that 40-60% of the trough-to-peak moves in bond yields in crisis-hit countries are explained by foreign events, thereby suggesting that the crisis was not purely a function of weak local economic conditions.
    Keywords: high frequency identification; narrative identification; contagion; Bayesian VARs; proxy SVARs; panel VAR
    JEL: E44 E65 F42
    Date: 2014–05

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