nep-cba New Economics Papers
on Central Banking
Issue of 2015‒09‒18
35 papers chosen by
Maria Semenova
Higher School of Economics

  1. Learning and the effectiveness of central bank forward guidance By Cole, Stephen
  2. Monetary policy during financial crises: Is the transmission mechanism impaired? By Jannsen, Nils; Potjagailo, Galina; Wolters, Maik H.
  3. Monetary policy effects on bank risk taking By Angela Abbate; Dominik Thaler
  4. Monetary Policy and Controlling Asset Bubbles By Masaya Sakuragawa
  5. Fiscal and monetary policy rules in an unstable economy By Soon, Ryoo; Skott, Peter
  6. A heterogeneous agent model for assessing the effects of capital regulation on the interbank money market under a corridor system By Jackson, Christopher; Noss, Joseph
  7. Bond markets and monetary policy dilemmas for the emerging markets By Jhuvesh Sobrun; Philip Turner
  8. Interest on Reserves, Interbank Lending, and Monetary Policy By Williamson, Stephen D.
  9. Trend Fundamentals and Exchange Rate Dynamics By Daniel Kaufmann; Florian Huber
  10. 'Inflation Targeting and Inflation Persistence' By George J. Bratsiotis; Jakob Madsen; Christopher Martin
  11. Fear of liftoff: Uncertainty, rules and discreation in monetary policy normalization By Orphanides, Athanasios
  12. Risk Management for Monetary Policy at the Zero Lower Bound By Francois Gourio; Jonas Fisher
  13. Critique of accommodating central bank policies and the 'expropriation of the saver' - A review By Bindseil, Ulrich; Domnick, Clemens; Zeuner, Jörg
  14. The Financial Market Impact of Unconventional Monetary Policies in the U.S., the U.K., the Eurozone, and Japan By Kaoru Hosono; Shogo Isobe
  15. What has driven inflation dynamics in the Euro area, the United Kingdom and the United States By Melolinna, Marko
  16. Euro area macro-financial stability: A flow-of-funds perspective By Beck, Günter W.; Kotz, Hans-Helmut; Zabelina, Natalia
  17. The (De-)Anchoring of Inflation Expectations: New Evidence from the Euro Area By Laura Pagenhardt; Dieter Nautz; Till Strohsal; Strohsal
  18. Choice of market in the monetary economy By Ryoji Hiraguchi; Keiichiro Kobayashi
  19. Monetary Shocks and Bank Balance Sheets By Sebastian Di Tella; Pablo Kurlat
  20. Sovereign stress, unconventional monetary policy, and SME access to finance By Ferrando, Annalisa; Popov, Alexander; Udell, Gregory F.
  21. Regulatory arbitrage in action: evidence from banking flows and macroprudential policy By Reinhardt, Dennis; Sowerbutts, Rhiannon
  22. Housing Debt and the Transmission of Monetary Policy By Paolo Surico; Clodomiro Ferreira; James Cloyne
  24. Liquidity trap and secular stagnation By Yannick Kalantzis; Kenza Benhima; Philippe Bacchetta
  25. Global Factors in the Term Structure of Interest Rates By Mirko Abbritti; Salvatore Dell'Erba; ​Antonio Moreno; Sergio Sola
  26. Capital regulation in a macroeconomic model with three layers of default By Derviz, Alexis; Mendicino, Caterina; Moyen, Stéphane; Nikolov, Kalin; Stracca, Livio; Clerk, Laurent; Suarez, Javier; Vardoulakis, Alexandros P.
  27. A Small Open Economy with the Balassa-Samuelson Effect By Robert Ambrisko
  28. Financial stability challenges in EU candidate and potential candidate countries By IRC expert group of the ESCB; Ramon-Ballester, Francisco; Pulst, Daniela; Posch, Michaela; Savelin, Li; Manolov, Stoyan; Huljak, Ivan; Kuhles, Winona; Jimborean, Ramona; Oláh, Zsolt; Dancsik, Bálint; Colabella, Andrea; Moder, Isabella; Macki, Piotr; Cervena, Marianna; Other contributors; Shehu, Klodion; Maloku, Krenare; Vaskov, Mihajlo; Bozovic, Borko; Vlahovic, Ana; Vasilijev, Dejan; Çakmak, Bahadır
  29. The role of information in exchange rate policy and the reaction of banks during the 2007/08 crisis By Geoffrey Minne
  30. External debt and real exchange rates' adjustment in the euro area: New evidence from a nonlinear NATREX model By Cécile COUHARDE; Serge REY; Audrey SALLENAVE
  31. Enhancing Financial Stability in Developing Asia By Adam Posen; Nicolas Veron
  32. A false sense of security in applying handpicked equations for stress test purposes By Gross, Marco; Población, Javier
  33. The Changing Dynamics of South Africa's Inflation Persistence: Evidence from a Quantile Regression Framework By Rangan Gupta; Charl Jooste; Omid Ranjbar
  34. Optimal capital requirements over the business and financial cycles By Malherbe, Frederic
  35. Shoe-leather costs in the euro area and the foreign demand for euro banknotes By Calza, Alessandro; Zaghini, Andrea

  1. By: Cole, Stephen
    Abstract: The unconventional monetary policy of forward guidance operates through the management of expectations about future paths of interest rates. This paper examines the link between expectations formation and the effectiveness of forward guidance. A standard New Keynesian model is extended to include forward guidance shocks in the monetary policy rule. Agents form expectations about future macroeconomic variables via either the standard rational expectations hypothesis or a more plausible theory of expectations formation called adaptive learning. The results show the efficacy of forward guidance depends on the manner in which agents form their expectations. In response to forward guidance, the paths of the output gap and inflation under adaptive learning overshoot and undershoot those implied by rational expectations. The adaptive learning impulse responses of the endogenous variables to a forward guidance shock exhibit more persistence before and after the forward guidance shock has been realized upon the economy. During an economic crisis (e.g. a recession), the assumption of rational expectations overstates the effects of forward guidance relative to adaptive learning. Specifically, the output gap is higher under rational expectations than adaptive learning. Thus, if monetary policy is based on a model with rational expectations, which is the standard assumption in the macroeconomic literature, the results of forward guidance could be potentially misleading.
    Keywords: Forward Guidance; Monetary Policy; Adaptive Learning; Expectations
    JEL: D84 E30 E50 E52 E58 E60
    Date: 2015–09–07
  2. By: Jannsen, Nils; Potjagailo, Galina; Wolters, Maik H.
    Abstract: We study the macroeconomic effects of monetary policy during financial crises using a Bayesian panel vector autoregressive (PVAR) model for 20 advanced economies. We interact all of the endogenous variables with financial crisis dummies, which are constructed using the narrative approach. We also distinguish between an acute initial phase of financial crises and a subsequent recovery phase. We show that an expansionary monetary policy shock has large positive effects on output and inflation during the acute phase of a financial crisis. These effects are larger than those during non-crisis periods. Decreased uncertainty as well as increases in consumer confidence and share prices explain these large effects, whereas these variables are much less relevant for monetary policy transmission outside financial crises. Counterfactual analysis shows that the transmission mechanism would be impaired without the effects of monetary policy on these variables, where credit would not react at all and the response of output would be substantially lower. During the recovery phase of a financial crisis, output and inflation are generally non-responsive to monetary policy shocks.
    Keywords: monetary policy transmission,financial crisis,financial stability,state-dependence,uncertainty,panel VAR
    JEL: C33 E52 E58 G01
    Date: 2015
  3. By: Angela Abbate (Deutsche Bundesbank and European University Institute, Department of Economics); Dominik Thaler (European University Institute, Department of Economics)
    Abstract: Motivated by VAR evidence on the risk-taking channel in the US, we develop a New Keynesian model where low levels of the risk-free rate induce banks to grant credit to riskier borrowers. In the model an agency problem between depositors and equity holders incentivizes banks to take excessive risk. As the real interest rate declines these incentives become stronger and risk taking increases. We estimate the model on US data using Bayesian techniques and assess optimal monetary policy conduct in the estimated model, assuming that the interest rate is the only available instrument. Our results suggest that in a risk taking channel environment, the monetary authority should seek to stabilize the path of the real interest rate, trading off more inflation volatility in exchange for less interest rate and output volatility.
    Keywords: Bank Risk; Monetary policy; DSGE Models
    JEL: E12 E44 E58
    Date: 2015–09
  4. By: Masaya Sakuragawa (Faculty of Economics, Keio University)
    Abstract: A great concern is whether there is any means of monetary policy that works for the "leaning against the wind" policy in the bubbly economy. This paper explores the scope for monetary policy that can control bubbles within the framework of the stochastic version of overlapping-generations model with rational bubbles. The policy that raises the cost of external finance, could be identified as monetary tightening, represses the boom, but appreciate bubbles. In contrast, an open market operation using public bonds is conductive as the "leaning against the wild" policy. Selling public bonds in the open market by the central bank raises the interest rate, represses the boom, and depreciates bubbles. In conducting monetary tightening, the central bank faces the tradeoff between the loss from killing the boom and the gain from lessening the loss of the bursting of bubbles.
    Keywords: rational bubbles, monetary policy, open market operation
    JEL: E52
    Date: 2015–02
  5. By: Soon, Ryoo (Department of Finance and Economics, Adelphi University); Skott, Peter (Department of Economics, University of Massachusetts, Amherst, MA 01003,USA, and Aalborg University)
    Abstract: This paper examines the implications of different monetary and fiscal policy rules in an economy characterized by Harrodian instability. We show that (i) a monetary rule along Taylor lines can be stabilizing for low debt ratios but becomes de-stabilizing if the debt ratio exceeds a certain threshold, (ii) a `Keynesian' fiscal policy rule can stabilize the economy at full employment, (iii) a fiscal `austerity' rule that links fiscal parameters to deviations from a target debt ratio fails to adjust the `warranted' to the `natural' growth rate and destabilizes the warranted path, (iv) instability may arise from a combination of fiscal and monetary policy rules which separately would stabilize the system, and (v) austerity rules can in some circumstances enhance the stabilizing effects of monetary policy.
    Keywords: functional finance, fiscal policy rule, austerity, public debt, Harrodian instability
    JEL: E12 E52 E62 E63
    Date: 2015
  6. By: Jackson, Christopher (Bank of England); Noss, Joseph (Bank of England)
    Abstract: Money markets play an important role in the implementation of monetary policy. Their structure and dynamics have, however, changed significantly in recent years. In particular, a number of new banking regulations will affect the behaviour of money market participants, and so have the potential to affect money market interest rates. This paper offers a model to examine how prudential regulation might affect interbank overnight interest rates where the central bank implements monetary policy using a corridor system. Combined with a set of assumptions as to the cost banks might incur in meeting regulatory capital requirements, it offers a framework with which to explore how such prudential regulation might affect the dynamics of overnight interest rates. The results — which are illustrative — estimate the interest rates at which banks might borrow and lend reserves overnight in the presence of prudential regulation. They suggest that risk-weighted capital requirements might increase the average level of overnight interbank interest rates, while the regulatory minimum leverage ratio might decrease it. If applied to real-world data on central bank reserves balances and regulatory metrics, this model also offers an insight into how central bank policymakers could — if they so choose — amend their operational frameworks to account for the effects of regulation.
    Keywords: Monetary policy implementation; money markets; bank regulation; central bank operations.
    JEL: E43 E43 E58 G12
    Date: 2015–09–11
  7. By: Jhuvesh Sobrun; Philip Turner
    Abstract: Financial conditions in the emerging markets (EMs) have become more dependent on the 'world' long-term interest rate, which has been driven down by monetary policies in the advanced economies - notably Quantitative Easing (QE) - and by several non-monetary factors. This paper analyses some new mechanisms that link global long-term rates to monetary policy and to domestic bank lending in the EMs. Understanding these mechanisms could help EM central banks prepare for the exit from QE and higher (and perhaps divergent) policy rates in advanced economies. Although monetary policy in the EMs has continued to be guided by domestic objectives, it has nevertheless lost some traction. Difficult trade-offs now confront central banks.
    Keywords: Exit from QE, long-term interest rate, emerging market economies, bond markets
    Date: 2015–08
  8. By: Williamson, Stephen D. (Federal Reserve Bank of St. Louis)
    Abstract: A two-sector general equilibrium banking model is constructed to study the functioning of a floor system of central bank intervention. Only retail banks can hold reserves, and these banks are also subject to a capital requirement, which creates “balance sheet costs” of holding reserves. An increase in the interest rate on reserves has very different qualitative effects from a reduction in the central bank’s balance sheet. Increases in the central bank’s balance sheet can have redistributive effects, and can reduce welfare. A reverse repo facility at the central bank puts a floor un- der the interbank interest rate, and is always welfare improving. However, an increase in reverse repos outstanding can increase the margin between the interbank interest rate and the interest rate on government debt.
    JEL: E4 E5
    Date: 2015–09–13
  9. By: Daniel Kaufmann (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Florian Huber (Oesterreichische Nationalbank, Vienna, Austria)
    Abstract: We estimate a multivariate unobserved components-stochastic volatility model to explain the dynamics of a panel of six exchange rates against the US Dollar. The empirical model is based on the assumption that both countries' monetary policy strategies may be well described by Taylor rules with a time-varying inflation target, a time-varying natural rate of unemployment, and interest rate smoothing. The estimates closely track major movements along with important time-series properties of the real and nominal exchange rates across all currencies considered. The model generally outperforms a simple benchmark model that does not account for changes in trend inflation and trend unemployment.
    Keywords: Exchange rate models, trend inflation, natural rate of unemployment, Taylor rule, unobserved components-stochastic volatility model
    JEL: F31 E52 F41 C5 E31
    Date: 2015–09
  10. By: George J. Bratsiotis; Jakob Madsen; Christopher Martin
    Abstract: This paper argues that the adoption of an inflation target reduces the persistence of inflation. We develop the theoretical literature on inflation persistence by introducing a Taylor Rule for monetary policy into a model of persistence and showing that inflation targets reduce inflation persistence. We investigate changes in the time series properties of inflation in seven countries that introduced inflation targets in the late 1980s or early 1990s. We find that the persistence of inflation is greatly reduced or eliminated following the introduction of inflation targets.
    Date: 2015
  11. By: Orphanides, Athanasios
    Abstract: The Federal Reserve's muddled mandate to attain simultaneously the incompatible goals of maximum employment and price stability invites short-term-oriented discretionary policymaking inconsistent with the systematic approach needed for monetary policy to contribute best to the economy over time. Fear of liftoff-the reluctance to start the process of policy normalization after the end of a recession-serves as an example. Causes of the problem are discussed, drawing on public choice and cognitive psychology perspectives. The Federal Reserve could adopt a framework that relies on a simple policy rule subject to periodic reviews and adaptation. Replacing meeting-by-meeting discretion with a simple policy rule would eschew discretion in favor of systematic policy. Periodic review of the rule would allow the Federal Reserve the flexibility to account for and occasionally adapt to the evolving understanding of the economy. Congressional legislation could guide the Federal Reserve in this direction. However the Federal Reserve may be best placed to select the simple rule and could embrace this improvement on its own, within its current mandate, with the publication of a simple rule along the lines of its statement of longer-run goals.
    Keywords: Federal Reserve,liftoff,discretion,policy rules,policy normalization
    JEL: E32 E52 E58 E61
    Date: 2015
  12. By: Francois Gourio (FRB Chicago); Jonas Fisher (Federal Reserve Bank of Chicago)
    Abstract: As labor markets improve and projections have inflation heading back toward target, the Fed has begun to contemplate lifting the federal funds rate from its zero lower bound (ZLB). Under what conditions should the Fed start raising rates? We lay out an argument that calls for caution. It is founded on a risk management principle that says policy should be formulated taking into account the dispersion of outcomes around the mean forecast. On the one hand, raising rates early increases the likelihood of adverse shocks driving a fragile economy back to the ZLB. On the other hand, delaying lift-off when the economy turns out to be resilient could lead to an unwelcome bout of inflation. Since the tools available to counter the first scenario are hard to implement and may be less effective than the traditional tool of raising rates to counter the second scenario, the costs of premature lift-o exceed those of delay. This article shows in a canonical framework that uncertainty about being constrained by the ZLB in the future implies an optimal policy of delayed lift-o. We present evidence that such a risk manage- ment policy is consistent with past Fed actions and that unconventional tools will be hard to implement if the economy were to be constrained by the ZLB after a hasty exit.
    Date: 2015
  13. By: Bindseil, Ulrich; Domnick, Clemens; Zeuner, Jörg
    Abstract: In parts of the German media, with the support of a number of German economists, the ECB’s low nominal interest rate policy is criticised as unnecessary, ineffective and as expropriating the German saver. This paper provides a review of the relevant arguments. It is recalled that returns on savings are anchored to the real rate of return on capital. Good monetary policy tries to avoid being a source of disturbance in itself, and may be able to smooth the effects of temporary external shocks, but beyond that cannot structurally improve the real rate of return on capital. Against this general background, the paper critically analyses a number of recent arguments as to why low interest rate policies could actually be counterproductive. Finally, the paper reviews what can be done about the medium to long-term real rate of return on capital, which remains in any case the basic issue for the saver, focusing on the specific case of Germany. The key policies identified relate to demographics, education, labour markets, infrastructure and technology. Low growth dynamics in the coming decades and correspondingly low real rates of return on investments are not inevitable. JEL Classification: D81
    Keywords: growth, natural rate, real interest rate, zero lower bound
    Date: 2015–05
  14. By: Kaoru Hosono (Professor Faculty of Economics, Gakushuin University); Shogo Isobe (Researcher, Policy Research Institute)
    Abstract: This paper investigates the impact of the unconventional policies implemented by the Federal Reserve, the Bank of England, the European Central Bank, and the Bank of Japan on the returns on a broad class of assets in a comprehensive and consistent manner. Controlling for market expectations, we find that for most economies and periods, policies had the effect of lowering long-term government bond yields and the exchange rate of the home currency; for some economies and periods we also find an impact on corporate bond spreads, interbank loan spreads, and stock prices. We further find that policy announcements that were accompanied by forward guidance tended to have a more significant and greater impact on a broad range of assets than policy announcements without forward guidance.
    Keywords: Unconventional monetary policies; Event study; Announcement
    JEL: E58 G12 F31
  15. By: Melolinna, Marko
    Abstract: This paper studies factors behind inflation dynamics in the euro area, the UK and the US. It introduces a factor-augmented vector autoregression (FAVAR) framework with sign restrictions to study the effects of fundamental macroeconomic shocks on inflation in the three economies. The FAVAR model framework is also applied to study the effects on inflation subcomponents in the more recent past. The FAVAR models suggest that headline inflation in the three economies has reacted in a relatively similar fashion to macroeconomic shocks over the last four decades, with demand shocks causing the most persistent effects on inflation. According to the subcomponent FAVAR models, the responses of inflation subcomponents to macroeconomic shocks have also been relatively similar in the three economies. However, there is evidence of a stronger foreign exchange channel of monetary policy transmission as well as supply shocks in the responses of non-energy tradable goods prices in the UK than the other two economies, while the reaction of services inflation has been more muted to all types of shocks in the euro area than the other two economies. JEL Classification: C22, C32, E31, E52
    Keywords: FAVAR, inflation, macroeconomic shocks, sign restrictions
    Date: 2015–06
  16. By: Beck, Günter W.; Kotz, Hans-Helmut; Zabelina, Natalia
    Abstract: The global financial crisis (as well as the European sovereign debt crisis) has led to a substantial redesign of rules and institutions - aiming in particular at underwriting financial stability. At the same time, the crisis generated a renewed interest in properly appraising systemic financial vulnerabilities. Employing most recent data and applying a variety of largely only recently developed methods we provide an assessment of indicators of financial stability within the Euro Area. Taking a "functional" approach, we analyze comprehensively all financial intermediary activities, regardless of the institutional roof - banks or non-bank (shadow) banks - under which they are conducted. Our results reveal a declining role of banks (and a commensurate increase in non-bank banking). These structural shifts (between institutions) are coincident with regulatory and supervisory reforms (implemented or firmly anticipated) as well as a non-standard monetary policy environment. They might, unintendedly, actually imply a rise in systemic risk. Overall, however, our analyses suggest that financial imbalances have been reduced over the course of recent years. Hence, the financial intermediation sector has become more resilient. Nonetheless, existing (equity) buffers would probably not suffice to face substantial volatility shocks.
    Keywords: bank and non-bank financial intermediation,shadow banking,financial stability,systemic risk,financial regulation
    Date: 2015
  17. By: Laura Pagenhardt; Dieter Nautz; Till Strohsal; Strohsal
    Abstract: Well-anchored inflation expectations are a key factor for achieving economic stability. This paper provides new empirical results on the anchoring of long-term inflation expectations in the euro area. In line with earlier evidence, we find that euro area inflation expectations have been anchored until fall 2011. Since then, however, they respond significantly to macroeconomic news. Our results obtained from multiple endogenous break point tests suggest that euro area inflation expectations have remained de-anchored ever since.
    Keywords: Anchoring of Inflation Expectations, Break-Even Inflation Rates, News-Regressions, Multiple Structural Break Tests
    JEL: E31 E52 E58 C22
    Date: 2015–09
  18. By: Ryoji Hiraguchi; Keiichiro Kobayashi
    Abstract: We investigate a monetary model `a la Lagos and Wright (2005), in which there are two kinds of decentralized markets, and each agent stochastically chooses which one to participate in by expending effort. In one market, the pricing mechanism is competitive, whereas in the other market, the terms of trade are determined by Nash bargaining. It is shown that the optimal monetary policy may deviate from the Friedman rule. As the nominal interest rate deviates from zero, buyers expend more effort because a higher interest rate increases the gain for buyers from entering the competitive market, while the marginal increase in social welfare by entering the competitive market is also positive.
    Date: 2015–08
  19. By: Sebastian Di Tella (Stanford GSB); Pablo Kurlat (Stanford University)
    Abstract: We propose a model to explain why banks' balances sheets are exposed to interest rate risk despite the existence of markets where that risk can be hedged. A rise in nominal interest rates raises the opportunity cost of holding currency; since bank liabilities are close substitutes of currency, demand for bank liabilities rises and banks earn higher spreads. If risk aversion is higher than 1, the optimal dynamic hedging strategy is to sustain capital losses when nominal interest rates rise and, conversely, capital gains when they fall. A traditional bank balance sheet with long duration nominal assets achieves that.
    Date: 2015
  20. By: Ferrando, Annalisa; Popov, Alexander; Udell, Gregory F.
    Abstract: We investigate the effect of sovereign stress and of unconventional monetary policy on small firms’ financing patterns during the euro area debt crisis. We find that after the crisis started, firms in stressed countries were more likely to be credit rationed, both in the quantity and in the price dimension, and to increase their use of debt securities. We also find evidence that the announcement of the ECB’s Outright Monetary Transactions Program was followed by an immediate decline in the share of credit rationed firms and of firms discouraged from applying. In addition, firms reduced their use of debt securities, trade credit, and government-subsidized loans. Firms with improved outlook and credit history were particularly likely to benefit from easier credit access. JEL Classification: D22, E58, G21, H63
    Keywords: Credit Access, SMEs, Sovereign debt, unconventional monetary policy
    Date: 2015–06
  21. By: Reinhardt, Dennis (Bank of England); Sowerbutts, Rhiannon (Bank of England)
    Abstract: We use a new database on macroprudential policy actions to examine whether macroprudential regulations affect international banking flows. We find evidence that borrowing by the domestic non-bank sector from foreign banks increases after home authorities take a macroprudential capital action. We find no increase in borrowing from foreign banks after an action which tightens lending standards (such as limits on loan-to-value ratios for house purchase). Evidence on reserve requirements is mixed. Differences in the application of regulation for lending standards and capital regulation for international banks mean that while there is a level playing field for lending standards regulation, this does not always apply for capital regulation, giving foreign branches regulated by their home authorities a competitive advantage. Our results are, at first sight, different from the literature on regulatory arbitrage: we find that foreign banks expand their lending into host countries where regulation is tightened. But this does not occur when regulations apply also to them. The results have implications for macroprudential instrument choice and calibration, and for reciprocating regulation internationally.
    Keywords: Macroprudential policies; cross-border banking flows; leakages.
    JEL: F32 F34 G21
    Date: 2015–09–11
  22. By: Paolo Surico (London Business School); Clodomiro Ferreira (European University Institute); James Cloyne (Bank of England)
    Abstract: In response to an unanticipated change in interest rates, households with mortgage debt adjust markedly their expenditure, especially on durable goods, renters react to a lesser extent and outright home-owners do not react at all. All housing tenure groups experience a significant change in disposable income (over and above the direct impact on mortgage repayments). The response of house prices is sizable, driving a significant adjustment in loan-to-income ratios but little change in loan-to-value ratios. A simple collateral constraint model augmented with durable goods and renters generates predictions consistent with these novel empirical findings and suggests that heterogeneity in housing debt positions plays an important role in the transmission of monetary policy.
    Date: 2015
  23. By: Pippenger, John E
    Abstract: The Forward-Bias Puzzle, failure of uncovered interest parity and related puzzles suggest that there is a fundamental failure in international financial markets.  Many theories attempt to explain this bias and failure.  But none of them has been widely accepted; at least partly because they are not consistent with the related puzzles.  The model of monetary policy in Table 6 explains the Forward-Bias Puzzle and UIP failure without appealing to information failures.  It also explains, or is at least consistent with, the related puzzles.  Finally it suggests that we need to change the way we think about UIP.
    Keywords: Social and Behavioral Sciences, exchange rates, interest rates, risk premia, rational expectations, uncovered and covered interest parity, forward bias, speculation, arbitrage.
    Date: 2015–09–14
  24. By: Yannick Kalantzis (Banque de France); Kenza Benhima (University of Lausanne (HEC)); Philippe Bacchetta (University of Lausanne)
    Abstract: In this paper we analyze the link between the ZLB and slow growth in a model with heterogeneous agents and explicit money demand. While the model is neoclassical with small shocks, a large deleveraging shock in the spirit of Eggertsson and Krugman (2012) has permanent effects even with flexible prices. It affects supply rather than demand and implies a long-term decrease in potential output and an increase in cash holding. The basic reason is that in a liquidity trap, saving is allocated to cash rather than physical capital. With short-term price stickiness, monetary policy in the form of an expansion in money supply is effective in reducing unemployment in the short-run, but not in affecting the long term output level. An increase in debt may help exiting the ZLB, but it may lower the capital stock because of higher interest rates.
    Date: 2015
  25. By: Mirko Abbritti (​University of Navarra); Salvatore Dell'Erba (International Monetary Fund); ​Antonio Moreno (University of Navarra); Sergio Sola (International Monetary Fund)
    Abstract: This paper introduces global factors within a FAVAR framework in an empirical affine term structure model. We apply our method to a panel of international yield curves and show that global factors account for more than 80 percent of term premia in advanced economies. In particular they tend to explain long-term dynamics in yield curves, as opposed to domestic factors which are instead more relevant to short-run movements. We uncover the key role for global curvature in shaping term premia dynamics. We show that this novel factor precedes global economic and financial instability. In particular, it coincides with immediate expectations of permanent expansionary monetary policy during the recent crisis
    Date: 2014–01–01
  26. By: Derviz, Alexis; Mendicino, Caterina; Moyen, Stéphane; Nikolov, Kalin; Stracca, Livio; Clerk, Laurent; Suarez, Javier; Vardoulakis, Alexandros P.
    Abstract: We develop a dynamic general equilibrium model for the positive and normative analysis of macroprudential policies. Optimizing financial intermediaries allocate their scarce net worth together with funds raised from saving households across two lending activities, mortgage and corporate lending. For all borrowers (households, firms, and banks) external financing takes the form of debt which is subject to default risk. This “3D model” shows the interplay between three interconnected net worth channels that cause financial amplification and the distortions due to deposit insurance. We apply it to the analysis of capital regulation. JEL Classification: E3, E44, G01, G21
    Keywords: Default risk, Financial frictions, Macroprudential policy
    Date: 2015–07
  27. By: Robert Ambrisko
    Abstract: The Balassa-Samuelson (B-S) effect implies that highly productive countries have higher inflation and appreciating real exchange rates because of larger productivity growth differentials between tradable and nontradable sectors relative to advanced economies. The B-S effect might pose a threat to converging European countries, which would like to adopt the Euro because of the limits imposed on inflation and nominal exchange rate movements by the Maastricht criteria. The main goal of this paper is to judge whether the B-S effect is a relevant issue for the Czech Republic to comply with selected Maastricht criteria before adopting the Euro. For this purpose, a two-sector DSGE model of a small open economy is built and estimated using Bayesian techniques. The simulations from the model suggest that the B-S effect is not an issue for the Czech Republic when meeting the inflation and nominal exchange rate criteria. The costs of early adoption of the Euro are not large in terms of additional inflation pressures, which materialize mainly after the adoption of the single currency. Also, nominal exchange rate appreciation, driven by the B-S effect, does not breach the limit imposed by the ERM II mechanism.
    Keywords: Balassa-Samuelson effect; DSGE; European Monetary Union; exchange rate regimes; Maastricht convergence criteria;
    JEL: E31 E52 F41
    Date: 2015–08
  28. By: IRC expert group of the ESCB; Ramon-Ballester, Francisco; Pulst, Daniela; Posch, Michaela; Savelin, Li; Manolov, Stoyan; Huljak, Ivan; Kuhles, Winona; Jimborean, Ramona; Oláh, Zsolt; Dancsik, Bálint; Colabella, Andrea; Moder, Isabella; Macki, Piotr; Cervena, Marianna; Other contributors; Shehu, Klodion; Maloku, Krenare; Vaskov, Mihajlo; Bozovic, Borko; Vlahovic, Ana; Vasilijev, Dejan; Çakmak, Bahadır
    Abstract: This paper reviews financial stability challenges in countries preparing for EU membership, i.e. Albania, Bosnia and Herzegovina, Kosovo*, Iceland, the former Yugoslav Republic of Macedonia, Montenegro, Serbia and Turkey. The paper has been prepared by an expert group of staff from the European System of Central Banks (ESCB) in which experts from EU candidate and potential candidate country central banks also participated. The paper finds that near-term challenges to financial stability primarily relate to credit risks from the generally weak economic dynamics in combination with already high non-performing loan burdens in many banking systems, especially in the Western Balkans. In the medium-term, challenges to financial stability stem from indirect market risks to banks related to foreign currency lending as well as lingering exposures to funding risks, with Western Balkan economies again appearing as relatively more vulnerable. Looking further ahead, the paper highlights that the magnitude of the challenge to reach a ‘new banking normal’ for banking systems in these countries appears to remain sizeable, while noting that the establishment of adequate home-host cooperation channels would be important to help maximise the potential benefits to third parties stemming from centralised banking supervision under the Single Supervisory Mechanism (SSM). JEL Classification: G32, E44
    Keywords: banking sector, banking union, cross-border flows, deleveraging, emerging markets, Europe, foreign exchange lending
    Date: 2015–08
  29. By: Geoffrey Minne
    Abstract: The disclosure of information about the policy making process and the release of new databases may add relevant information about the exchange rate to guide the public's expectation, but may also mislead it. Asymmetric information also reinforces the importance of the learning process for policy makers and financial markets. This dissertation focuses on the role of information in the political economics of exchange rates. The two first chapters provide empirical studies of how access to information shapes and constraints the choice of exchange rate policy (official statement and implemented policy). The last chapter considers the question of whether international banks learn from their previous crisis experiences and reduce their lending to developing countries as a result of a financial crisis. It focuses on the experience accumulated with past financial crises.
    Keywords: International Monetary Fund; Global Financial Crisis, 2008-2009; Crise financière mondiale, 2008-2009; financial crisis; foreign banks; fear of floating; information; exchange rate regime
    Date: 2014–10–01
  30. By: Cécile COUHARDE; Serge REY; Audrey SALLENAVE
    Abstract: In this paper we revisit medium- to long-run real exchange rate determination within the euro area, focusing on the role of external debt. Accordingly, we rely on the NATREX approach which provides an explicit framework of the external debt-real exchange rates nexus. In particular, given the indebtedness levels reached by the euro area economies, we investigate potential non-linearity in real exchange rates dynamics, according to the level of the external debt. Our results evidence that during the monetary union, gross and net external debt positions of the euro area countries have exerted pressures on real exchange rate dynamics within the area. Moreover, we find that, beyond a threshold reached by the external debt, euro area countries are found to be in a vulnerable position, leading to an unavoidable adjustment process. Nevertheless, the adjustment process, while effective, is found to be low and occurs slowly.
    Keywords: Euro area; External debt; NATREX approach; Panel Smooth Transition Regression models; Real exchange rates
    JEL: C23 F31 O47
    Date: 2015–09
  31. By: Adam Posen (Peterson Institute for International Economics); Nicolas Veron (Peterson Institute for International Economics)
    Abstract: Given no generally accepted framework for financial stability, policymakers in developing Asia need to manage, not avoid, financial deepening. This paper supports Asian policymakers’ judgment through analysis of the recent events in the United States and Europe and of earlier crisis episodes, including Asia during the 1990s. There is no simple linear relationship between financial repression and stability—financial repression not only has costs but, so doing can itself undermine stability. Bank-centric financial systems are not inherently safer than systems that include meaningful roles for securities and capital markets. Domestic financial systems should be steadily diversified in terms of both number of domestic competitors and types of savings and lending instruments available (and thus probably types of institutions). Financial repression should be focused on regulating the activities of financial intermediaries, not on compressing interest rates for domestic savers. Cross-border lending should primarily involve creation of multinational banks’ subsidiaries in the local economy—and local currency lending and bond issuance should be encouraged. Macroprudential tools can be useful, and, if anything, are more effective in less open or less financially deep economies than in more advanced financial centers.
    Keywords: Financial stability, fi nancial development, nonbank institutions, macroprudential policy, capital flows
    JEL: E44 G28 O16
    Date: 2015–09
  32. By: Gross, Marco; Población, Javier
    Abstract: The purpose of this paper is to promote the use of Bayesian model averaging for the design of satellite models that financial institutions employ for stress testing. Banks employing ’handpicked’ equations – while meeting standard economic and econometric soundness criteria – risk significantly underestimating the response of risk parameters and therefore overestimating their capital absorption capacity. We present a set of credit risk models for 18 EU countries based both on the model averaging scheme as well as a series of handpicked equations and apply them to a sample of 108 SSM banks. We thereby aim to illustrate that the handpicked equations may indeed imply significantly lower default flow estimates and therefore overoptimistic estimates for the banks’ capital absorption capacity. The model averaging scheme that we promote should mitigate that risk and also help establish a level playing field with regard to a common level of conservatism across banks. JEL Classification: C11, C22, C51, E58, G21
    Keywords: bank regulation and supervision, model averaging, satellite modeling, stress testing
    Date: 2015–09
  33. By: Rangan Gupta (Department of Economics, University of Pretoria); Charl Jooste (Department of Economics, University of Pretoria); Omid Ranjbar (Ministry of Industry, Mine and Trade, Tehran, Iran)
    Abstract: We study inflation persistence in South Africa using a quantile regression approach. We control for structural breaks using a quantile structural break test on a long span of inflation data. Our study includes persistence estimates for headline and core inflation - thus controlling for possible biases emanating from extremely volatile periods. South Africa's inflation persistence is lowest during the inflation targeting period regardless of the inflation measure. Inflation persistence is also constant over all quantiles during the inflation targeting regime for core inflation. There is a difference between the estimates from headline and core - headline persistence increases in relation to higher quantiles. Thus energy and food price shocks might de-stabilise inflation altogether.
    Keywords: Inflation persistence, quantile regression, structural breaks
    JEL: C21 E31
    Date: 2015–08
  34. By: Malherbe, Frederic
    Abstract: I study economies where banks do not fully internalize the social costs of default, which distorts their lending decisions. In all these economies, a common general equilibrium effect leads to aggregate over-investment. As a result, under laissez-faire, crises are too frequent and too costly from a social point of view. In response, the regulator sets a capital requirement to trade off expected output against financial stability. The capital requirement that ensures investment efficiency depends on the state of the economy. Because of the general equilibrium effect, the more aggregate banking capital the tighter the optimal requirement. A regulation that fails to take this effect into account exacerbates economic fluctuations and allows for excessive build-up of risk in the financial sector during booms. Government guarantees amplify this mechanism and, at the peak of a boom, even a small adverse shock can trigger a banking sector collapse, followed by an excessively severe credit crunch. JEL Classification: E44, G01, G21, G28
    Keywords: Basel regulation, capital requirement, countercyclical buffers, financial cycles, financial regulation, overinvestment
    Date: 2015–07
  35. By: Calza, Alessandro; Zaghini, Andrea
    Abstract: We estimate the shoe-leather costs of inflation in the euro area using monetary data adjusted for holdings of euro banknotes abroad. While we find evidence of marginally negative shoe-leather costs for very low levels of the nominal interest rate, our estimates suggest that the shoe-leather costs are non-negligible even for relatively moderate levels of anticipated inflation. We conclude that, despite the increased circulation of euro banknotes abroad, in the euro area the inflation tax is still predominantly borne by domestic agents, with transfers of resources from abroad remaining small. JEL Classification: E41, C22
    Keywords: currency abroad, euro, money demand, welfare cost of inflation
    Date: 2015–07

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