nep-cba New Economics Papers
on Central Banking
Issue of 2015‒08‒01
seventeen papers chosen by
Maria Semenova
Higher School of Economics

  1. Maintaining Central-Bank Financial Stability under New-Style Central Banking By Hall, Robert E; Reis, Ricardo
  2. Forward Guidance: Communication, Commitment, or Both? By Marco Bassetto
  3. What Measure of Inflation Should a Developing Country Central Bank Target? By Rahul Anand; Eswar Prasad; Boyang Zhang
  4. Risk-adjusted expectations of inflation By Marco Casiraghi; Marcello Miccoli
  5. Inflation forecasting models for Uganda: is mobile money relevant? By Aron, Janine; Muellbauer, John; Sebudde, Rachel
  6. Aggregate Inflation Forecast with Bayesian Vector Autoregressive Models By Cesar Carrera; Alan Ledesma
  7. Tail comovement in option-implied inflation expectations as an indicator of anchoring By Sara Cecchetti; Filippo Natoli; Laura Sigalotti
  8. Inflation Dynamics and Agricultural Supply Shocks in Uganda By Joseph, Mawejje; Musa, Mayanja Lwanga
  9. The Impact of Treasury Supply on Financial Sector Lending and Stability By Krishnamurthy, Arvind; Vissing-Jorgensen, Annette
  10. The Revolving Door - Evidence from the United Kingdom, Germany, France, Spain, Belgium, Greece and Brazil By Dias, A.C., Dos Santos, A.R., Sousa, A., Crisóstomo, D., Pinto, G.,; Pereira, L., Alexandre, M., Capaz, R., Paulo, T. and Ramiro, P.
  11. The Carry Trade and UIP when Markets are Incomplete By Lorenzo Garlappi; Jack Favilukis
  12. A Reinterpretation of the Gordon and Barro Model in Terms of Financial Stability By Beteto Wegner, Danilo Lopomo
  13. On the Welfare and Cyclical Implications of Moderate Trend Inflation By Guido Ascari; Louis Phaneuf; Eric Sims
  14. Monetary Policy Pass-Through: Household Consumption and Voluntary Deleveraging By Rodney Ramcharan; Amir Kermani; Marco Di Maggio
  15. Optimal in‡ation targeting rule under positive hazard functions for price changes By Di Bartolomeo Giovanni; Di Pietro Marco
  16. US trend inflation reinterpreted. The role of fiscal policies and time-varying nominal rigidities By Acocella Nicola; Di Bartolomeo Giovanni; Tirelli Patrizio
  17. "Making the Euro Viable: The Euro Treasury Plan" By Jorg Bibow

  1. By: Hall, Robert E; Reis, Ricardo
    Abstract: Since 2008, the central banks of advanced countries have borrowed trillions of dollars from their commercial banks in the form of interest-paying reserves and invested the proceeds in portfolios of risky assets. We investigate how this new style of central banking aects central banks' solvency. A central bank is insolvent if its requirement to pay dividends to its government exceeds its income by enough to cause an unending upward drift in its debts to commercial banks. We consider three sources of risk to central banks: interest-rate risk (the Federal Reserve), default risk (the European Central Bank), and exchange-rate risk (central banks of small open economies). We nd that a central bank that pays dividends equal to a standard concept of net income will always be solvent|its reserve obligations will not explode. In some circumstances, the dividend will be negative, meaning that the government is making a payment to the bank. If the charter does not provide for payments in that direction, then reserves will tend to grow more in crises than they shrink in normal times. To prevent this buildup, the charter needs to provide for makeup reductions in payments from the bank to the government. We compute measures of the nancial strength of central banks, and discuss how dierent institutions interact with quantitative easing policies to put these banks in less or more danger of instability. We conclude that the risks to nancial stability are real in theory, but remote in practice today.
    Keywords: central bank capital; central bank solvency; monetary policy; quantitative easing
    JEL: E42 E58
    Date: 2015–07
  2. By: Marco Bassetto (University College of London)
    Abstract: Faced with the constraint of the zero lower bound on interest rates, central banks around the world have engaged in "forward guidance" as one instrument to stimulate the economy. To properly ascertain the potential benefits of forward guidance as an independent tool of monetary policy, it is important to understand how it can work. Forward guidance comes in two different versions, which have been defined as "Odyssean" and "Delphic." Under Delphic forward guidance, the central bank communicates private information to the public, which is relevant to forecast the future path of monetary policy. In contrast, Odyssean forward guidance communicates a path to which monetary authorities wish to commit in order to avoid time inconsistency. Forward guidance of either sort is conducted by means of public statements; these statements do not bind the actions of the central bank directly. Nonetheless, deviating from a previously-announced path can be costly ex post, because it affects credibility. I analyze the strategic interaction between households and the central bank as a game in which the central bank has access to cheap talk. In the absence of private information, I prove that the set of equilibria is independent of the announcements of the central bank; hence, pure Odyssean forward guidance does not expand the set of possible equilibrium outcomes. There is no need for the central bank to communicate its commitment to support a trigger-strategy equilibrium. However, when private information is present and Delphic forward guidance has social value, there exist equilibria in which central bank communications act as a substitute for commitment: in this case, the potential loss of credibility acts as a further deterrent against ex post deviations.
    Date: 2015
  3. By: Rahul Anand; Eswar Prasad; Boyang Zhang
    Abstract: In closed or open economy models with complete markets, targeting core inflation enables monetary policy to maximize welfare by replicating the flexible price equilibrium. We analyze this result in the context of developing economies, where a large proportion of households are credit constrained and the share of food expenditures in total consumption expenditures is high. We develop an open economy model with incomplete financial markets to show that headline inflation targeting improves welfare outcomes. We also compute the optimal price index, which includes a positive weight on food prices but, unlike headline inflation, assigns zero weight to import prices.
    JEL: E31 E52 E61
    Date: 2015–07
  4. By: Marco Casiraghi (Banca d'Italia); Marcello Miccoli (Banca d'Italia)
    Abstract: We propose a new way to compute market-based risk-adjusted measures of inflation expectations. Borrowing from the finance literature, we study the ex-post excess return on inflation swap contracts – the difference between the swap rate at a given maturity and the realized inflation rate over the same horizon – which is an unbiased proxy of risk premia under the rational expectations hypothesis. The empirical results show that the risk premia on inflation swap rates at short-to-medium maturities can be predicted by macroeconomic variables that are present in agents’ information set at the time the contract is signed, and that they vary counter-cyclically. This econometric analysis is then used to construct a measure of risk-adjusted inflation expectations so as to assess the role of risk premia in determining inflation swap rates. On this basis we find that the observed decline in inflation swap rates at short-to-medium maturities in 2014 was driven mainly by changes in inflation expectations.
    Keywords: Monetary Policy, Inflation swap, Inflation expectations, Risk premia
    JEL: E52 G13
    Date: 2015–07
  5. By: Aron, Janine; Muellbauer, John; Sebudde, Rachel
    Abstract: Forecasting inflation is challenging in emerging markets, where trade and monetary regimes have shifted, and the exchange rate, energy and food prices are highly volatile. Mobile money is a recent financial innovation giving financial transaction services via a mobile phone, including to the unbanked. Stable models for the 1-month and 3-month-ahead rates of inflation in Uganda, measured by the consumer price index for food and non-food, and for the domestic fuel price, are estimated over 1994-2013. Key features are the use of multivariate models with equilibrium-correction terms in relative prices; introducing non-linearities to proxy state dependence in the inflation process; and applying a ‘parsimonious longer lags’ (PLL) parameterisation to feature lags up to 12 months. International influences through foreign prices and the exchange rate (including food prices in Kenya after regional integration) have an important influence on the dependent variables, as does the growth of domestic credit. Rainfall deviation from the long-run mean is an important driver for all, most dramatically for food. The domestic money stock is irrelevant for food and fuel inflation, but has a small effect on non-food inflation. Other drivers include the trade and current account balances, fiscal balance, terms of trade and trade openness, and the international interest rate differential. Parameter stability tests suggest the models could be useful for short-term forecasting of inflation. There is no serious evidence of a link between mobile money and inflation.
    Keywords: error correction models; mobile money; model selection; modelling inflation
    JEL: C22 C51 C52 C53 E31 E37 E52
    Date: 2015–07
  6. By: Cesar Carrera (Banco Central de Reserva del Perú); Alan Ledesma (UC Santa Cruz)
    Abstract: We forecast 18 groups of individual components of the Consumer Price Index (CPI) using a large Bayesian vector autoregressive model (BVAR) and then aggregate those forecasts in order to obtain a headline inflation forecast (bottom-up approach). De Mol et al. (2006) and Banbura et al. (2010) show that BVAR's forecasts can be significantly improved by the appropriate selection of the shrinkage hyperparameter. We follow Banbura et al. (2010)’s strategy of “mixed priors," estimate the shrinkage parameter, and forecast inflation. Our findings suggest that this strategy for modeling outperform the benchmark random walk as well as other strategies for forecasting inflation.
    Keywords: Inflation forecasting, aggregate forecast, Bayesian VAR
    JEL: C22 C52 C53 E37
    Date: 2015–07
  7. By: Sara Cecchetti (Bank of Italy); Filippo Natoli (Bank of Italy); Laura Sigalotti (Bank of Italy)
    Abstract: We analyse the degree of anchoring of inflation expectations in the euro area. Using a new estimation technique, we look at the tail co-movement between the moments of short- and long-term distributions of inflation expectations, where those distributions are estimated from daily quotes of inflation derivatives. We find that, since mid-2014, negative tail events impacting short-term inflation expectations have been increasingly channelled to long-term views, igniting both downward revisions in expectations and upward changes in uncertainty; instead, positive short-term tail events have left long-term moments mostly unaffected. This asymmetric behaviour may signal a disanchoring from below of long-term inflation expectations.
    Keywords: disanchoring, inflation swaps, inflation options, option-implied density, tail comovement
    JEL: C14 C58 E31 E44 G13
    Date: 2015–07
  8. By: Joseph, Mawejje; Musa, Mayanja Lwanga
    Abstract: We estimate the contribution of agricultural supply shocks to inflation in Uganda. Using monthly data for the time period January 2000 to December 2012, we develop an empirical model for inflation processes in Uganda. The model is estimated as a single equation that includes lagged vector error correction terms from the money, external, and domestic agricultural markets. We include in our model a measure for shocks to the agricultural sector, the agricultural output gap, estimated as the monthly deviations of realized from potential agricultural output. The analysis is augmented by a VAR model that allows us to account for inflation persistence. Results indicate that disequilibria in the money, external and agricultural sectors feed into the Ugandan inflation process in the long run. Importantly, the agricultural sector is one of the important sources of inflation in the short run. Our findings have important implications for policy in Uganda. Specifically, policies geared towards improving agricultural productivity on the one hand and limiting supply rigidities on the other will be crucial in controlling inflation in Uganda
    Keywords: Inflation, agricultural shocks, money market, external sector, energy sector, Agribusiness, Agricultural Finance, Consumer/Household Economics, Demand and Price Analysis, Financial Economics, Institutional and Behavioral Economics, Labor and Human Capital, Production Economics,
    Date: 2015–03
  9. By: Krishnamurthy, Arvind; Vissing-Jorgensen, Annette
    Abstract: We present a theory in which the key driver of short-term debt issued by the financial sector is the portfolio demand for safe and liquid assets by the non-financial sector. This demand drives a premium on safe and liquid assets that the financial sector exploits by owning risky and illiquid assets and writing safe and liquid claims against those. The central prediction of the theory is that safe and liquid government debt should crowd out financial sector lending financed by short-term debt. We verify this prediction in U.S. data from 1875-2014. We take a series of approaches to rule out “standard" crowding out via real interest rates and to address potential endogeneity concerns.
    Keywords: banking; financial stability; monetary economics; treasury supply
    JEL: E4 G12 G2
    Date: 2015–07
  10. By: Dias, A.C., Dos Santos, A.R., Sousa, A., Crisóstomo, D., Pinto, G.,; Pereira, L., Alexandre, M., Capaz, R., Paulo, T. and Ramiro, P.
    Abstract: The following study analyses the academic background and careers of 175 members of Governments and Central Banks of seven countries (Belgium, Brazil, France, Germany, Greece, Spain and United Kingdom) for the years 1975 and 2015, in order to verify whether the “Revolving Door Theory” can be applied to these cases. After some research on the curricula vitae of the members of Governments and Central Banks, we found that, for instance, that more Government and Central Bank members studied abroad for the case of the UK and US than for the other countries. We also found that it is more common for Central Bank executive members to obtain PhDs than it is the case for Government members. Moreover, external promotions in the Central Banks in 1975 were quite relevant but no cases were registered for 2015; for Governments, the trend was the exact opposite, no external promotions in 1975 but many cases in 2015. While it is not possible to find irrefutable evidence to sustain the Revolving Door hypothesis, it is still possible to find recurrent patterns in different countries that may be explained by that theory. More expanded databases and a larger selection of countries is required for that analysis.
    Keywords: Revolving Door, Political Connections, Governments, Central Banks
    Date: 2015–07
  11. By: Lorenzo Garlappi (UBC); Jack Favilukis (University of British Columbia)
    Abstract: We propose a new model to explain the failure of UIP and the profitability of the carry trade and to link these two phenomena to the Balassa-Samuelson effect and the Backus-Smith puzzle. The key features of our model are market incompleteness and partial risk sharing through tradable goods. In the model, carry trade profits are due to two independent channels. First, a purely nominal channel, which works even in complete markets, makes the carry trade risky due to (endogenously) counter-cyclical inflation. Second, a real channel, which, due to imperfect risk sharing, makes the carry trade risky exactly when risk sharing is needed most. The model is consistent with several empirical facts. In particular: (i) real and nominal currency appreciations are positively related to local output growth, (ii) carry trade profits are positively related to output growth and negatively to inflation in the target (high interest rate) country, (iii) ex-ante, target countries are smaller and have higher expected inflation volatility, but there do not appear to be systematic differences between high and low interest rate countries in loadings on world output growth, in expected output growth, or in output volatility. Leading existing models give opposite predictions.
    Date: 2015
  12. By: Beteto Wegner, Danilo Lopomo
    Abstract: A government bailout model based on the framework of time-consistent mone- tary policy of Barro and Gordon (1983) is developed. In the model, the banking sector and the government play a game where the former chooses a bailout expec- tation whereas the later reacts by choosing its optimal bailout policy. The banking sector is assumed to be perfectly competitive, aiming only at anticipating the bailout policy. An excess of credit ensues and firms over-invest, which can be amended by an appropriately chosen reserve requirement. The government faces a trade-off be- tween efficiency and stability in trying to minimize the costs of intervention.
    Keywords: Government intervention, bailout, real investment, Financial Economics, G1, G2, G3,
    Date: 2014–08–12
  13. By: Guido Ascari; Louis Phaneuf; Eric Sims
    Abstract: We offer a comprehensive evaluation of the welfare and cyclical implications of moderate trend inflation. In an extended version of a medium-scale New Keynesian model, recent proposals to increase trend inflation from 2 to 4 percent would generate a consumption-equivalent welfare loss of 3.7 percent based on the non-stochastic steady state and of 6.9 percent based on the stochastic mean. Welfare costs of this magnitude are driven by four main factors: i) multiperiod nominal wage contracting, ii) trend growth in investment-specific and neutral technology, iii) roundaboutness in the U.S. production structure, and iv) and the interaction between trend inflation and shocks to the marginal efficiency of investment (MEI), insofar that this type of shock is sufficiently persistent. Moreover, moderate trend inflation has important cyclical implications. It interacts much more strongly with MEI shocks than with either productivity or monetary shocks.
    JEL: E31 E32
    Date: 2015–07
  14. By: Rodney Ramcharan (Federal Reserve Board); Amir Kermani (UC Berkeley); Marco Di Maggio (Columbia)
    Abstract: Do households benefit from expansionary monetary policy? We investigate how indebted households' consumption and saving decisions are affected by anticipated changes in monthly interest payments. We focus on borrowers with adjustable rate mortgages originated between 2005 and 2007 featuring an automatic reset of the interest rate after five years. The monthly payment due from the average borrower falls by 52 percent ($900) upon reset, resulting in an increase in disposable income totaling tens of thousands of dollars over the remaining life of the mortgage. We uncover three patterns. First, the average household increases monthly car purchases by 40 percent ($150) upon reset. Second, this expansionary effect is attenuated by the borrowers' voluntary deleveraging, as a significant fraction of the increased income is deployed to accelerate debt repayment. Third, the marginal propensity to consume is significantly higher for low income borrowers and for those that had experienced a larger decline in housing wealth. To complement these household-level findings, we employ county-level data to provide evidence that consumption responded more to a reduction in short-term interest rates in counties with a larger fraction of adjustable rate mortgage debt. Our results shed light on the income channel of monetary policy as well as the role of debt rigidity in reducing the effectiveness of monetary policy.
    Date: 2015
  15. By: Di Bartolomeo Giovanni; Di Pietro Marco
    Date: 2015–05
  16. By: Acocella Nicola; Di Bartolomeo Giovanni; Tirelli Patrizio
    Date: 2014–09
  17. By: Jorg Bibow
    Abstract: The euro crisis remains unresolved and the euro currency union incomplete and extraordinarily vulnerable. The euro regime's essential flaw and ultimate source of vulnerability is the decoupling of central bank and treasury institutions in the euro currency union. We propose a "Euro Treasury" scheme to properly fix the regime and resolve the euro crisis. This scheme would establish a rudimentary fiscal union that is not a transfer union. The core idea is to create a Euro Treasury as a vehicle to pool future eurozone public investment spending and to have it funded by proper eurozone treasury securities. The Euro Treasury could fulfill a number of additional purposes while operating mainly on the basis of a strict rule. The plan would also provide a much-needed fiscal boost to recovery and foster a more benign intra-area rebalancing.
    Keywords: Economic and Monetary Union; Euro Crisis; Euro Treasury; Fiscal Union; Public Investment
    JEL: E32 E62 E63 H62 H63
    Date: 2015–07

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