nep-cba New Economics Papers
on Central Banking
Issue of 2015‒10‒25
twenty-one papers chosen by
Maria Semenova
Higher School of Economics

  1. Global standards for liquidity regulation By Liebmann, Eva; Peek, Joe
  2. Real-Exchange-Rate-Adjusted Inflation Targeting in an Open Economy: Some Analytical Results By Richard T. Froyen; Alfred V Guender
  3. Monetary and fiscal policy in the Great Moderation and the Great Recession By Allsopp, Christopher; Vines, David
  4. Objectives and Challenges of Macroprudential Policy By Alfred Duncan; Charles Nolan
  5. More on Three Challenges to Central Bank Orthodoxy By Bullard, James B.
  6. Are Low Interest Rates Deflationary? A Paradox of Perfect-Foresight Analysis By García-Schmidt, Mariana; Woodford, Michael
  7. The evolution of inflation expectations in Canada and the US By James Yetman
  8. CAPITAL REGULATION IN A MACROECONOMIC MODEL WITH THREE LAYERS OF DEFAULT By Laurent Clerc; Alexis Derviz; Caterina Mendicino; Stéphane Moyen; Kalin Nikolov; Livio Stracca; Javier Suarez; Alexandros P. Vardoulakis
  9. International Evidence on the Role of Monetary Policy in the Uncovered Interest Rate Parity Puzzle By Alfred V Guender
  10. Optimal inflation with corporate taxation and financial constraints By Daria Finocchiaro; Giovanni Lombardo; Caterina Mendicino; Philippe Weil
  11. QE and the Bank Lending Channel in the United Kingdom By Nick Butt; Rohan Churm; Michael McMahon; Arpad Morotz; Jochen Schanz
  12. Fighting the Last War: economists on the lender of last resort By Richard S. Grossman; Hugh Rockoff
  13. Distributional Effects of Monetary Policy By Veronika Selezneva; Martin Schneider; Matthias Doepke
  14. The Optimal Coordination of Fiscal and Monetary Policy in a New Keynesian Framework By Luk, Paul; Vines, David
  15. Exchange Rate Pass-Through to Consumer Prices: Theory and Recent Evidence By Laurence Savoie-Chabot; Mikael Khan
  16. Monetary Policy Objectives and Money's Role in U.S. Business Cycles By Eurilton Araújo
  17. Quantifying Contagion Risk in Funding Markets: A Model-Based Stress-Testing Approach By Kartik Anand; Céline Gauthier; Moez Souissi
  18. Countering the debt crisis: national parliaments and EU economic governance By Davor Jancic
  19. Real Exchange Rates Persistence in the West African Monetary Zone: A Revisit of the PPP Puzzle By Njindan Iyke, Bernard
  20. Monetary Development and Transmission in the Eurosystem By Anton, Roman
  21. Scotland's Lender of Last Resort Options By Angus Armstrong

  1. By: Liebmann, Eva (Austrian Federal Ministry of Finance); Peek, Joe (Federal Reserve Bank of Boston)
    Abstract: Liquidity risk has received increased attention recently, especially in light of the 2007 - 2009 financial crisis, when banks' extensive reliance on short-term funding, maturity mismatches between assets and liabilities, and insufficient liquidity buffers made them quite susceptible to liquidity risk. To mitigate such risk, the Basel Committee on Banking Supervision (BCBS) introduced an improved global capital framework and new global liquidity standards for banks in December 2010 in the form of the new Basel Accord (Basel III). This brief offers insights from the crisis experience, identifies the problems that the new liquidity regulation aims to address, and summarizes underlying differences between the United States and Europe that may affect the ability to design and implement consistent global standards.
    JEL: F33 G01 G28
    Date: 2015–07–01
  2. By: Richard T. Froyen; Alfred V Guender (University of Canterbury)
    Abstract: Under optimal policy from a timeless perspective, a central bank targeting an inflation measure which is adjusted for changes in the real exchange rate (REX inflation) has the ability to stabilize the output gap and inflation against demand disturbances in an open economy. This distinct advantage is lost if a central bank follows a Taylor-type rule. The bank has an incentive to add the real exchange rate to the Taylor rule because it duplicates the performance of the optimal policy for portfolio shocks. The Taylor-type rule becomes a Monetary Conditions Index (MCI) that outperforms Taylor-type rules which accord no weight at all or a higher weight to the real exchange rate. In the current environment of concern about sudden increases in U.S. interest rates, the properly designed MCI would have a considerable advantage.
    Keywords: REX Inflation, Optimal Policy, Taylor-Type Rules, MCI, Openness, Portfolio Shocks
    JEL: E3 E5 F5
    Date: 2015–06–19
  3. By: Allsopp, Christopher; Vines, David
    Abstract: In this paper we argue for a new approach to monetary and fiscal policy. During the Great Moderation, the inflation targeting regime worked well. Central banks used the interest rate to stabilize inflation, and—subject to inflation being controlled—stabilized the level of demand. Fiscal policy exerted discipline over the public-sector deficits, thereby—indirectly—managing the level of public debt. Such ‘fiscal housekeeping’ worked well, because the monetary authorities were stabilizing the economy. But once private-sector deleveraging led to the Great Recession, and interest rates hit their zero bound, the economy could no longer be managed by monetary policy. Since then, recovery has come to depend on the ‘automatic stabilizers’: as output and tax revenues have fallen, public debt has been created, producing the assets which a deleveraging private sector wishes to hold. But the effect has been very gradual. Recovery would have been faster if fiscal policy had been responsible for the restoration of full employment, in an environment which tolerated the necessary rises in public debt. Conversely, policies of austerity, designed to reduce public debt, have slowed the recovery. Growth will not be resumed until the private sector begins to invest strongly again, creating the financial assets which the private sector wishes to hold, thereby enabling public debt to be retired. This has not yet happened because the private sector, correctly, does not believe that macroeconomic policy is capable of sustaining a strong recovery.
    Keywords: fiscal policy; inflation targeting; monetary policy; quantitative easing; zero lower bound
    JEL: E44 E52 E58 E61 E62
    Date: 2015–10
  4. By: Alfred Duncan; Charles Nolan
    Abstract: The establishment of the UK Financial Policy Committee is a landmark development in macroprudential oversight. However, its purview may be overly narrow. Macroprudential policy ought to be concerned with the overall eciency of the nancial system. Macroprudential policymakers should have a role as much concerned with providing authoritative, public advice on areas of policy relevant to aggregate nancial eciency as with imposing additional restrictions on bank lending. Issues of independence and transparency loom large under the current regime as well as with some suggestions we make.
    Keywords: Macroprudential policy; monetary economics; risk; financial markets.
    JEL: E13 E44 G11 G24 G28
    Date: 2015–09
  5. By: Bullard, James B. (Federal Reserve Bank of St. Louis)
    Abstract: During the 57th NABE annual meeting, St. Louis Fed President James Bullard discussed the orthodox view of current monetary policy, which emphasizes that the FOMC's objectives have essentially been met while monetary policy settings remain far from normal. He also discussed three challenges to that view, which relate to strict inflation targeting, low real interest rates and globalization. He noted that the orthodoxy suggests a prudent policy of returning policy settings to more normal levels gradually over time, providing plenty of monetary accommodation during the transition to guard against macroeconomic risks.
    Date: 2015–10–13
  6. By: García-Schmidt, Mariana; Woodford, Michael
    Abstract: A prolonged period of extremely low nominal interest rates has not resulted in high inflation. This has led to increased interest in the “Neo-Fisherian" proposition according to which low nominal interest rates may themselves cause inflation to be lower. The fact that standard models of the effects of monetary policy have the property that perfect foresight equilibria in which the nominal interest rate remains low forever necessarily involve low inflation (at least eventually) might seem to support such a view. Here, however, we argue that such a conclusion depends on a misunderstanding of the circumstances under which it makes sense to predict the effects of a monetary policy commitment by calculating the perfect foresight equilibrium consistent with the policy. We propose an explicit cognitive process by which agents may form their expectations of future endogenous variables. Under some circumstances, such as a commitment to follow a Taylor rule, a perfect foresight equilibrium (PFE) can arise as a limiting case of our more general concept of reflective equilibrium, when the process of reflection is pursued sufficiently far. But we show that an announced intention to fix the nominal interest rate for a long enough period of time creates a situation in which reflective equilibrium need not resemble any PFE. In our view, this makes PFE predictions not plausible outcomes in the case of policies of the latter sort. According to the alternative approach that we recommend, a commitment to maintain a low nominal interest rate for longer should always be expansionary and inflationary, rather than causing deflation; but the effects of such “forward guidance" are likely, in the case of a long-horizon commitment, to be much less expansionary or inflationary than the usual PFE analysis would imply.
    JEL: E31 E43 E52
    Date: 2015–10
  7. By: James Yetman
    Abstract: We model inflation forecasts as monotonically diverging from an estimated long-run anchor point towards actual inflation as the forecast horizon shortens. Fitting the model with forecaster-level data for Canada and the US, we identify three key differences between the two countries. First, the average estimated anchor of US inflation forecasts has tended to decline gradually over time in rolling samples, from 3.4% for 1989-1998 to 2.2% for 2004-2013. By contrast, it has remained close to 2% since the mid-1990 for Canadian forecasts. Second, the variance of estimates of the long-run anchor is considerably lower for the panel of Canadian forecasters than US ones following Canada's adoption of inflation targets. And third, forecasters in Canada look much more alike than those in the US in terms of the weight that they place on the anchor. One explanation for these results is that an explicit inflation targeting regime (Canada) provides for less uncertainty about future monetary policy actions than a monetary policy regime where there was no explicit numerical inflation target (the US before 2012) to anchor expectations.
    Keywords: Inflation expectations, decay function, inflation targeting
    Date: 2015–10
  8. By: Laurent Clerc (Banque de France); Alexis Derviz (Czech National Bank); Caterina Mendicino (Banco de Portugal); Stéphane Moyen (Deutsch Bundesbank); Kalin Nikolov (European Central Bank); Livio Stracca (European Central Bank); Javier Suarez (CEMFI, Centro de Estudios Monetarios y Financieros); Alexandros P. Vardoulakis (Board of Governors of the Federal Reserve System)
    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.
    Keywords: Default risk, financial frictions, macroprudential policy.
    JEL: E3 E44 G01 G21
    Date: 2014–12
  9. By: Alfred V Guender (University of Canterbury)
    Abstract: CPI inflation targeting necessitates a flexible exchange rate regime. This paper embeds an endogenous target rule into a simple open economy macro model to explain the UIP puzzle. The model predicts that the change in the exchange rate is inversely related to the lagged interest rate differential. Openness and aversion to inflation variability determine the strength of this linkage. Foreign inflation and the foreign interest rate also affect exchange rate changes. This hypothesis is tested on data from three small open economies, Canada, Norway, and Switzerland, all of which target CPI inflation and maintain extensive trade and finance links with a larger neighboring country. Supportive evidence is strongest for Switzerland during a clean float period before the outbreak of the Global Financial Crisis.
    Keywords: Uncovered Interest Rate Parity (UIP) Puzzle, Target Rule, Optimal Monetary Policy, Openness, Aversion to Inflation Variability
    JEL: E4 E5 F3
    Date: 2015–08–01
  10. By: Daria Finocchiaro; Giovanni Lombardo; Caterina Mendicino; Philippe Weil
    Abstract: This paper revisits the equilibrium and welfare effects of long-run inflation in the presence of distortionary taxes and financial constraints. Expected inflation interacts with corporate taxation through the deductibility of i) capital expenditures at historical value and ii) interest payments on debt. Through the first channel, inflation increases firms' taxable profits and further distorts their investment decisions. Through the second, expected inflation affects the effective real interest rate, relaxes firms' financial constraints and stimulates investment. We show that, in the presence of collateralized debt, the second effect dominates. Therefore, in contrast to earlier literature, we find that when the tax code creates an advantage of debt financing, a positive rate of long-run inflation is beneficial in terms of welfare as it mitigates the financial distortion and spurs capital accumulation.
    Keywords: optimal monetary policy, Friedman rule, credit frictions, tax benefits of debt
    Date: 2015–10
  11. By: Nick Butt; Rohan Churm; Michael McMahon; Arpad Morotz; Jochen Schanz
    Abstract: We test whether quantitative easing (QE), in addition to boosting aggregate demand and inflation via portfolio rebalancing channels, operated through a bank lending channel (BLC) in the UK. Using Bank of England data together with an instrumental variables approach, we find no evidence of a traditional BLC associated with QE. We show, in a simple framework, that the traditional BLC is diminished if the bank receives `flighty’ deposits (deposits that are likely to quickly leave the bank). We show that QE gave rise to such flighty deposits which may explain why we find no evidence of a BLC.
    Keywords: Monetary policy, Bank lending channel, Quantitative Easing
    JEL: E51 E52 G20
    Date: 2015–10
  12. By: Richard S. Grossman (Department of Economics Wesleyan University and Institute for Quantitative Social Science Harvard University); Hugh Rockoff (Department of Economics Rutgers University)
    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 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: lender of last resort, panic
    JEL: B0 N2
    Date: 2015–10–15
  13. By: Veronika Selezneva (Northwestern University); Martin Schneider (Stanford University); Matthias Doepke (Northwestern University)
    Abstract: We assess the distributional consequences of monetary policy in the current economic environment in the United States. Through its effect on inflation, monetary policy affects the real value of nominal assets and liabilities, and therefore redistributes wealth between borrowers and lenders in the economy. In addition, unconventional policies such as 'quantitative easing' affect real interest rates and the availability of credit, once again leading to redistributional effects. We first document the potential exposure to redistribution effects on the U.S. economy using recent data from the Flow of Funds accounts and the Survey of Consumer Finance. We then quantify the redistribution effects of monetary policy using a rich life-cycle model with idiosyncratic risk, financial constraints, a housing sector, and nominal borrowing and lending. We also discuss the extent to which the recent financial crisis, which has lowered net worth of many households and tightened financial constraints, has changed the nature of distributional consequences of monetary policy.
    Date: 2015
  14. By: Luk, Paul; Vines, David
    Abstract: This paper studies the coordination of monetary and fiscal policy in a simple New Keynesian model. We show that, in such a setup and when the policymaker acts with commitment, it is optimal not to use fiscal policy to stabilise inflation. We illustrate this result using additively separable preferences and Greenwood-Hercowitz-Huffman (1988) preferences, and we discuss the intuition behind this result.
    Keywords: fiscal policy; monetary policy; New Keynesian model
    JEL: E52 E61 E62
    Date: 2015–10
  15. By: Laurence Savoie-Chabot; Mikael Khan
    Abstract: In an open economy such as Canada’s, exchange rate movements can have a material impact on consumer prices. This is particularly important in the current context, with the significant depreciation of the Canadian dollar vis-a-vis the U.S. dollar since late 2012. This paper provides a broad overview of the various mechanisms by which exchange rate movements pass through to consumer prices and discusses the implications of exchange rate pass-through (ERPT) for the conduct of monetary policy. It then describes some of the tools used at the Bank of Canada to help quantify ERPT. We conclude by taking a closer look at the current situation in Canada, presenting a range of evidence that suggests ERPT has played an important role in recent inflation dynamics.
    Keywords: Exchange rates, Inflation and prices
    JEL: E31 E52 F31
    Date: 2015
  16. By: Eurilton Araújo
    Abstract: In a sticky-price model in which money can potentially play a key role in business cycles, I estimate monetary policy preference parameters under commitment in a timeless perspective. Empirical findings suggest that inflation stabilization and interest rate smoothing are the main objectives of monetary policy, with a very small role for output gap stabilization. Though the money growth rate is irrelevant as an argument in the Fed's objective function, its presence in structural equations improves model fit. Moreover, marginal likelihood comparisons show that the data favor Taylor rules over optimal policies. Finally, the way of describing monetary policy matters for macroeconomic dynamics
    Date: 2015–09
  17. By: Kartik Anand; Céline Gauthier; Moez Souissi
    Abstract: We propose a tractable, model-based stress-testing framework where the solvency risks, funding liquidity risks and market risks of banks are intertwined. We highlight how coordination failure between a bank’s creditors and adverse selection in the secondary market for the bank’s assets interact, leading to a vicious cycle that can drive otherwise solvent banks to illiquidity. Investors’ pessimism over the quality of a bank’s assets reduces the bank’s recourse to liquidity, which exacerbates the incidence of runs by creditors. This, in turn, makes investors more pessimistic, driving down other banks’ recourse to liquidity. We illustrate these dynamics in a calibrated stress-testing exercise.
    Keywords: Financial stability, Financial system regulation and policies
    JEL: G01 G21 G28 C72 E58
    Date: 2015
  18. By: Davor Jancic
    Abstract: While the sovereign debt crisis was ravaging the Eurozone and while the European Council was dominating the decision-making scene, even the most informed onlookers harboured little expectation that this would have a positive impact on the democratisation of the European Union.
    JEL: E6
    Date: 2014–06
  19. By: Njindan Iyke, Bernard
    Abstract: The purchasing power parity (PPP) is important in the development of key theories in economics. The balance of payment and the portfolio-balance theories, for example, are developed on the notion that PPP exists. Also, key exchange rate and trade policies are formulated on the basis that PPP holds. As The Gambia, Ghana, Guinea, Liberia, Nigeria and Sierra Leone propose to form a monetary union—the West African Monetary Zone (WAMZ), the validity of PPP is crucial to prevent member countries from gaining arbitrages by trading with one another. This paper examines whether the PPP holds for these countries using a mixture of time series techniques over varying sample periods. Consistent with some existing studies, we find the PPP not to hold for these countries, implying that the WAMZ agenda may face some challenges, since member countries can potentially gain from trade and investment arbitrages by trading with one another.
    Keywords: Real Exchange Rates, Persistence, PPP Puzzle, WAMZ
    JEL: F31
    Date: 2015–06–14
  20. By: Anton, Roman
    Abstract: Since the launch of the European Economic and Monetary Union (EMU) in January 1999 till today in 2015, the Euro has ascended to become the second largest reference currency in the world. With about €1.6 trillion of currency in circulation it is at present even positioned above the US dollar with €1.3 trillion. The Eurosystem now comprises 19 EU countries with about 340 million people and inherits an outstanding role for the economy of the EMU, world trade, and international finance. Despite its importance, a recent independent empirical review that conclusively analyzes all key factors and efficiencies remains much obsolete. Thus, this research and review sets out to empirically-theoretically compile the last 16 years of the EMU with a focus on monetary developments, functioning of monetary transmission channels (MTCs) and mechanisms, as well as the performance of the Eurosystem and its ECB governed monetary policies (MP). For the first time it reviews a complete set of 16 MTCs and systematically evaluates the functioning of the Eurosystem and its role for the real economy and its people. It finds a high efficiency loss in all MTCs related to fractional reserve banking, excessive EU indebtedness, or legal frameworks such as MFI, financial, or equity law. Scientifically, based on all data and results, there is no way to reach a different conclusion and reminder that stresses the need, exigency and must to replace an old-fashioned reserve banking system by digital full-reserve banking via monetary reform at the earliest feasible date possible.
    Keywords: Europe; EU; EMU; monetary; money; system; fractional; full; reserve; developments; ECB; ESCB; Euro; transmission; trends; process; EU; policy; currency; efficiency; effectiveness; review; research; empirical; financial; crisis, sovereign; debt; reform; union; quantitative; easing; model; systematic; creation; bank; financial; institution; MFI; real; economy; economic; inflation; prices; level; stability; GDP; output; employment; theory; theories; independent; digital; dollar; euro; area; euroland; eurosystem; central; banking;
    JEL: A1 A10 E0 E00 E01 E02 E4 E40 E42 E43 E44 E47 E6 E60 P4 P44
    Date: 2015–10–07
  21. By: Angus Armstrong
    Abstract: Scotland’s lender of last resort options depends on its choice of currency. If Scotland becomes independent, there is no question that it could use sterling. But this looks likely to be without the backing of the UK government and therefore without the Bank of England. Using sterling in these circumstances would constitute an informal currency union or ‘dollarization’.
    Date: 2014–08

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