nep-cba New Economics Papers
on Central Banking
Issue of 2015‒11‒01
twenty papers chosen by
Maria Semenova
Higher School of Economics

  1. Monetary Seigniorage in an Emerging Economy: Is there a scope for "free lunch" in financing public investment? By Chakraborty, Lekha S
  2. Central bank credibility and the expectations channel: Evidence based on a new credibility index By Grégory Levieuge; Yannick Lucotte; Sébastien Ringuedé
  3. Monetary policy in Turkey after Central Bank independence By Gürkaynak, Refet S.; Kantur, Zeynep; Tas, M. Anil; Yildirim, Secil
  4. Euro crash risk By Kräussl, Roman; Lehnert, Thorsten; Senulyte, Sigita
  5. Optimal Liquidity Regulation With Shadow Banking By Grochulski, Borys; Zhang, Yuzhe
  6. The Coming U.S. Interest Rate Tightening Cycle: Smooth Sailing or Stormy Waters? By Carlos Arteta; M. Ayhan Kose; Franziska Ohnsorge; Marc Stocke
  7. Optimal Capital Requirements over the Business and Financial Cycles By Frederic Malherbe
  8. Notes on the Underground: Monetary Policy in Resource-Rich Economies By Andrea Ferrero; Martin Seneca
  9. The Role of Uncertain Government Preferences For Fiscal and Monetary Policy Interaction By Olga S. Kuznetsova; Sergey A. Merzlyakov
  10. "Is Monetary Financing Inflationary? A Case Study of the Canadian Economy, 1935-75" By Josh Ryan-Collins
  11. Capital Controls as an Instrument of Monetary Policy By Ignacio Presno; Scott Davis
  12. Central Bank Independence and Inflation in Transition Economies: A Comparative Meta-Analysis with Developed and Developing Economies By Iwasaki, Ichiro; Uegaki, Akira
  13. A New Model of Inflation, Trend Inflation, and Long-Run Inflation Expectations By Chan, Joshua C C; Clark, Todd E.; Koop, Gary
  14. Lending-of-last-resort is as lending-of-last-resort does: Central bank liquidity provision and interbank market functioning in the euro area By Garcia de Andoain, Carlos; Heider, Florian; Hoerova, Marie; Manganelli, Simone
  15. Monetary policy in Argentina: From the inflation of the 1970s to the default of the new millennium By Ferrandino, Vittoria; Sgro, Valentina
  16. Sovereign Defaults: has the current system resulted in lasting (re)solutions? By Rodrigo Mariscal; Andrew Powell; Guido Sandleris; Pilar Tavella
  17. The Pitfalls of External Dependence: Greece, 1829-2015 By Reinhart, Carmen M.; Trebesch, Christoph
  19. Effects of Monetary Policy Shocks on UK Regional Activity: A Constrained MFVAR Approach By Zeyyad Mandalinci
  20. Runs versus Lemons: Information Disclosure and Fiscal Capacity By Thomas Philippon; Joseba Martinez; Miguel de Faria e Castro

  1. By: Chakraborty, Lekha S
    Abstract: It is often emphasised that seigniorage financing of public sector deficits is technically a “free lunch” if the economy has not attained the full employment levels. However, conservative macroeconomic policies in many emerging and developing economies, especially in the last two decades, have moved away from seigniorage financing to debt financing of deficits to give greater autonomy to the Central Banks. Against this backdrop, the paper analyses the fiscal and monetary policy co-ordination in India by constructing a monetary seigniorage Laffer curve. If such a curve exists, it is possible to derive a seigniorage-maximizing inflation rate to estimate the optimal level of seigniorage financing of deficits. The illustrative estimates from the Indian data using error correction mechanism models confirm the possibility of a monetary Seigniorage Laffer curve.
    Keywords: Fiscal-Monetary Policy Co-ordination, Seigniorage, Fiscal Deficits, error correction mechanism, Seigniorage Laffer Curve
    JEL: E5 E52 E58 E62 E63 H62
    Date: 2014
  2. By: Grégory Levieuge; Yannick Lucotte; Sébastien Ringuedé
    Abstract: This article investigates the relationship between central bank credibility and the volatility of the key monetary policy instrument. Two main contributions are proposed. First, we propose a time-varying measure of central bank credibility based on the gap between inflation expectations and the official inflation target. While this new index addresses the main limitations of the existing indicators, it also appears particularly suited to assess the monetary experiences of a large sample of inflation-targeting emerging countries. Second, by means of EGARCH estimations, we formally prove the existence of a negative effect of credibility on the volatility of the short-term interest rate. Thus, in line with the expectations channel of monetary policy, the higher the credibility of the central bank, the lower the need to move its instruments to efficiently fulfill its objective.
    Keywords: Credibility, Inflation targeting, Emerging countries, EGARCH, Expectations
    JEL: E43 E52 E58
    Date: 2015
  3. By: Gürkaynak, Refet S.; Kantur, Zeynep; Tas, M. Anil; Yildirim, Secil
    Abstract: We present an accessible narrative of the Turkish economy since its great 2001 crisis. We broadly survey economic developments and pay particular attention to monetary policy. The data suggests that the Central Bank of Turkey was a strong inflation targeter early in this period but began to pay less attention to inflation after 2009. Loss of the strong nominal anchor is visible in the break we estimate in Taylor-type rules as well as in asset prices. We also argue that recent discrete jumps in Turkish asset prices, especially the exchange value of the lira, are due more to domestic factors. In the post-2009 period the Central Bank was able to stabilize expectations and asset prices when it chose to do so, but this was the exception rather than the rule.
    Keywords: Turkey,CBRT,monetary policy,fiscal policy
    JEL: E52 E62 E31 E32 E02
    Date: 2015
  4. By: Kräussl, Roman; Lehnert, Thorsten; Senulyte, Sigita
    Abstract: We identify crucial events during the European sovereign debt crisis and investigate their impact on the euro currency. In particular, we analyse how specific announcements related to vulnerable Eurozone member states, European Central Bank (ECB) actions, and credit rating downgrades affect the value and the crash risk of the euro. We proxy the value changes of the euro by its abnormal foreign exchange (FX) rate returns with respect to 35 currencies. The crash risk of the euro is proxied by the conditional skewness of the FX rate return distribution with respect to the same currencies. We find that the market reacts positively to news related to countries under the European and International Monetary Fund (IMF) rescue umbrella. We discover that ECB actions on average result in a euro depreciation on the day of the announcement reflecting obvious concerns of market participants, but the effect is partly corrected the day after. Our analysis also shows that sovereign credit rating downgrades tend to lead to a depreciation of the euro and, more importantly, to an increase of the euro crash risk. Interestingly, we find that specific announcements about Greece on average do not substantially affect the euro exchange rate directly, however, it does have an overall significant effect on the euro rash risk, imposing a substantial risk for the stability of the common currency in the Eurozone.
    Keywords: Sovereign debt crisis,News announcements,Euro value,Euro crash risk
    JEL: G01 G14
    Date: 2015
  5. By: Grochulski, Borys (Federal Reserve Bank of Richmond); Zhang, Yuzhe (Texas A&M University)
    Abstract: We study the impact of shadow banking on optimal liquidity regulations in a Diamond-Dybvig maturity mismatch environment. A pecuniary externality arising out of the banks' access to private retrade renders competitive equilibrium inefficient. Shadow banking provides an outside option for banks, which adds a new constraint in the mechanism design problem that determines the optimal allocation. A tax on illiquid assets and a subsidy to the liquid asset similar to the payment of interest on reserves (IOR) constitute an optimal liquidity regulation policy in this economy. During expansions, i.e., when the return on illiquid assets is high, the threat of investors flocking out to shadow banking pins down optimal policy rates. These rates do not respond to business cycle fluctuations as long as the economy stays out of recession. In recessions, when the return on illiquid assets is low, optimal liquidity regulation policy becomes sensitive to the business cycle: both policy rates are reduced, with deeper discounts given in deeper recessions. In addition, when high aggregate demand for liquidity is anticipated, the IOR rate is reduced and, unless the shadow banking constraint binds, the tax rate on illiquid assets is increased.
    Date: 2015–10–23
  6. By: Carlos Arteta (World Bank, Development Prospects Group); M. Ayhan Kose (World Bank, Development Prospects Group); Franziska Ohnsorge (World Bank, Development Prospects Group); Marc Stocke (World Bank, Development Prospects Group)
    Abstract: The U.S. Federal Reserve (Fed) is expected to start raising policy interest rates in the near term and thus commence a tightening cycle for the first time in nearly a decade. The taper tantrum episode of May‐June 2013 is a reminder that even a long anticipated change in Fed policies can trigger substantial financial market volatility in Emerging and Frontier Market Economies (EFEs). This paper provides a comprehensive analysis of the potential implications of the Fed tightening cycle for EFEs. We report three major findings: First, since the tightening cycle will take place in the context of a robust U.S. economy, it could be associated with positive real spillovers to EFEs. Second, while the tightening cycle is expected to proceed smoothly, there are risks of a disorderly adjustment of market expectations. The sudden realization of these risks could lead to a significant decline in EFE capital flows. For example, a 100 basis point jump in U.S. long‐term yields could temporarily reduce aggregate capital flows to EFEs by up to 2.2 percentage point of their combined GDP. Third, in anticipation of the risks surrounding the tightening cycle, EFEs should prioritize monetary and fiscal policies that reduce vulnerabilities and implement structural policy measures that improve growth prospects.
    Keywords: Federal Reserve, liftoff, tightening, interest rates, monetary policy, emerging markets, frontier markets, capital flows, sudden stops, crises.
    JEL: E52 E58 F30 G15
    Date: 2015–11
  7. By: Frederic Malherbe (London Business School)
    Abstract: I propose a simple theory of intertwined business and financial cycles, where financial regulation both optimally responds to and influences the cycles. In this model, banks do not internalize the effect of their credit expansion on other banks' expected bankruptcy costs, which leads to excessive aggregate lending. 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 and, because of a general equilibrium effect, its stringency increases with aggregate banking capital. A regulation that fails to take this effect into account would exacerbate economic fluctuations and result in excessive aggregate lending during a boom. It would also allow for an excessive build-up of risk in the financial sector, which implies that, at the peak of a boom, even a small adverse shock could trigger a banking sector collapse, followed by an excessively severe credit crunch.
    Date: 2015
  8. By: Andrea Ferrero; Martin Seneca
    Abstract: How should monetary policy respond to a commodity price shock in a resource-rich economy? As in the baseline New Keynesian model, the central bank of a small oil-exporting economy faces a tradeoff, between the stabilization of domestic infl ation and an appropriately defined output gap. But in our framework the output gap depends on oil technology, and the weight on output gap stabilization is increasing in the importance of the oil sector. Given substantial spillovers to the rest of the economy, optimal policy calls for a reduction of the interest rate following a drop in the oil price. In contrast, a central bank with a mandate to stabilize consumer price infl ation would raise interest rates to limit the infl ationary impact of an exchange rate depreciation.
    Keywords: small open economy, oil export, monetary policy
    JEL: E52 E58 J11
    Date: 2015
  9. By: Olga S. Kuznetsova (National Research University Higher School of Economics); Sergey A. Merzlyakov (National Research University Higher School of Economics)
    Abstract: This paper explores the role of uncertain government preferences for fiscal and monetary policy interaction. Our analysis shows that the uncertainty about government preferences does not affect the macroeconomic equilibrium if the fiscal multiplier is known. In the case of multiplicative uncertainty, uncertain government preferences make fiscal policy more contractionary, while monetary policy becomes more expansionary. This leads to higher expected inflation and lower expected output, which means a stronger inflation bias
    Keywords: fiscal and monetary policy interaction, multiplicative uncertainty, uncertain preferences.
    JEL: E52 E58 E62 E63
    Date: 2015
  10. By: Josh Ryan-Collins
    Abstract: Historically high levels of private and public debt coupled with already very low short-term interest rates appear to limit the options for stimulative monetary policy in many advanced economies today. One option that has not yet been considered is monetary financing by central banks to boost demand and/or relieve debt burdens. We find little empirical evidence to support the standard objection to such policies: that they will lead to uncontrollable inflation. Theoretical models of inflationary monetary financing rest upon inaccurate conceptions of the modern endogenous money creation process. This paper presents a counter-example in the activities of the Bank of Canada during the period 1935-75, when, working with the government, it engaged in significant direct or indirect monetary financing to support fiscal expansion, economic growth, and industrialization. An institutional case study of the period, complemented by a general-to-specific econometric analysis, finds no support for a relationship between monetary financing and inflation. The findings lend support to recent calls for explicit monetary financing to boost highly indebted economies and a more general rethink of the dominant New Macroeconomic Consensus policy framework that prohibits monetary financing.
    Keywords: Monetary Policy; Monetary Financing; Inflation; Central Bank Independence; Fiscal Policy; Debt; Credit Creation
    JEL: B22 B25 E02 E12 E31 E42 E51 E52 E58 E63 N12 N22 O43
    Date: 2015–10
  11. By: Ignacio Presno (Universidad de Montevideo); Scott Davis (Federal Reserve Bank of Dallas)
    Abstract: Large swings in capital flows into and out of emerging markets can potentially lead to excessive volatility in asset prices and credit supply. In order to lessen the impact of capital flows on financial instability, a number of researchers and policy makers have recently proposed the use of capital controls. This paper considers the benefit of adding capital controls as a potential instrument of monetary policy in a small open economy. In a DSGE framework, we find that when domestic agents are subject to collateral constraints and the value of collateral is subject to fluctuations driven by foreign capital inflows and outflows, the adoption of temporary capital controls can lead to a significant welfare improvement. The benefits of capital controls are present even when monetary policy is determined optimally, implying that there may be a role for capital controls to exist side-by-side with conventional monetary tools as an instrument of monetary policy.
    Date: 2015
  12. By: Iwasaki, Ichiro; Uegaki, Akira
    Abstract: This paper aims to evaluate the central bank reforms in Central and Eastern Europe and the former Soviet countries through a comparative meta-analysis between studies of transition economies and those of other developed and developing economies that empirically examined the effect of central bank independence (CBI) on inflation. The results of a meta-synthesis using a total of 282 estimates collected from existing literature indicates that both transition and non-transition studies have successfully identified a negative relationship between CBI and inflation. Moreover, our meta-regression analysis suggested that the choice of estimator, inflation variable type, degree of freedom, and quality level of the study strongly affected the empirical results concerning transition economies. We also found that no significant difference exists between the two types of studies in terms of both effect size and statistical significance so long as we control for the degree of freedom and quality level of the study, implying that the socioeconomic setting of the society has so substantially developed in transition economies that the relation between CBI and its disinflation effect is observed in the same way as in non-transition economies.
    Keywords: central bank independence, inflation, transition economies, Central and Eastern Europe, former Soviet Union, meta-analysis, publication selection bias
    JEL: E31 E58 G18 P24 P34
    Date: 2015–08
  13. By: Chan, Joshua C C (Australian National University); Clark, Todd E. (Federal Reserve Bank of Cleveland); Koop, Gary (University of Strathclyde)
    Abstract: A knowledge of the level of trend inflation is key to many current policy decisions, and several methods of estimating trend inflation exist. This paper adds to the growing literature which uses survey-based long-run forecasts of inflation to estimate trend inflation. We develop a bivariate model of inflation and long-run forecasts of inflation which allows for the estimation of the link between trend inflation and the long-run forecast. Thus, our model allows for the possibilities that long-run forecasts taken from surveys can be equated with trend inflation, that the two are completely unrelated, or anything in between. By including stochastic volatility and time-variation in coefficients, it extends existing methods in empirically important ways. We use our model with a variety of inflation measures and survey-based forecasts. We find that long-run forecasts can provide substantial help in refining estimates of trend inflation over popular alternatives. But simply equating trend inflation with the long-run forecasts is not appropriate.
    Keywords: trend inflation; inflation expectations; state space model; stochastic volatility
    JEL: C11 C32 E31
    Date: 2015–10–21
  14. By: Garcia de Andoain, Carlos; Heider, Florian; Hoerova, Marie; Manganelli, Simone
    Abstract: This paper investigates the impact of ample liquidity provision by the European Central Bank on the functioning of the overnight unsecured interbank market from 2008 to 2014. We use novel data on interbank transactions derived from TARGET2, the main euro area payment system. To identify exogenous shocks to central bank liquidity, we exploit the timing of ECB liquidity operations and use a simple structural vector auto-regression framework. We argue that the ECB acted as a de-facto lender-of-last-resort to the euro area banking system and identify two main effects of central bank liquidity provision on interbank markets. First, central bank liquidity replaces the demand for liquidity in the interbank market, especially during the financial crisis (2008-2010). Second, it increases the supply of liquidity in the interbank market in stressed countries (Greece, Italy and Spain) during the sovereign debt crisis (2011-2013).
    Keywords: central bank policy; financial crisis; interbank markets; lender-of-last-resort; sovereign debt crisis
    JEL: E58 F36 G01 G21
    Date: 2015–10
  15. By: Ferrandino, Vittoria; Sgro, Valentina
    Abstract: Since the end of World War II, Argentina has been through an uninterrupted series of financial/fiscal and monetary crises that have gradually eroded the credibilityof the economic institutions of the country. In the period from 1970 to 1990 alone, the Argentine economy experienced seven currency crises and three banking crises. The main objective of this contribution is to investigate the reasons for economic policy choices that, since the military dictatorship of Colonel Perón, have led the country to default, causing unemployment, runs on banks and popular uprisings.
    Keywords: monetary policy,financial crisis,Argentina
    JEL: N16 N26 N46
    Date: 2015
  16. By: Rodrigo Mariscal; Andrew Powell; Guido Sandleris; Pilar Tavella
    Abstract: The current system of sovereign debt renegotiation has tended to produce restructuring agreements with low haircuts and relatively few events with deeper haircuts. Although this may seem like a successful outcome we uncovered a new empirical fact that throws some doubts on this interpretation, namely that renegotiations that end up in relatively low haircuts are frequently followed by a subsequent renegotiation soon afterwards. Low haircuts and re-renegotiations seems to be the name of the game under the current system. Yet most models of sovereign default consider only a single type of default and ignore multiple renegotiations completely. In this paper, we develop a DSGE model where countries can default in different ways and in which multiple credit events are possible. We solve the model numerically and show how countries may default in different ways and renegotiate debt multiple times. We discuss how recent changes in the international financial architecture may affect the way in which countries default in the future.
    Date: 2015
  17. By: Reinhart, Carmen M.; Trebesch, Christoph
    Abstract: Two centuries of Greek debt crises highlight the pitfalls of relying on external financing. Since its independence in 1829, the Greek government has defaulted four times on its external creditors – with striking historical parallels. Each crisis is preceded by a period of heavy borrowing from foreign private creditors. As repayment difficulties arise, foreign governments step in, help to repay the private creditors, and demand budget cuts and adjustment programs as a condition for the official bailout loans. Political interference from abroad mounts and a prolonged episode of debt overhang and financial autarky follows. We conclude that these cycles of external debt and dependence are a perennial theme of Greek history, as well as in other countries that have been “addicted” to foreign savings.
    Keywords: Bailouts; Crisis Resolution; External Debt; Sovereign Default
    JEL: E6 F3 H6 N0
    Date: 2015–10
  18. By: Pál Gróf (University of Miskolc)
    Abstract: The economic crisis of 2008 highlighted several weaknesses in the operation of the banks. There were austerities of the regulatory environment in the pre-crisis period, but the previous reforms were not enough to avoid the recession. The recession also pointed out the necessity of more rigid regulation of liquidity management at banks, because several institutions got into bankruptcy situation, thanks to the inadequate liquidity management. The focusing on liquidity is justified by the fact that the current recommendations of Basel Committee on Banking Supervision regulate not only capital, but also the liquidity. I intended to analyse the liquidity state of the Hungarian banking sector from 2007 until 2013, based on the data published by the supervisory authority. I paid special attention to the analysis of the changes of liquidity reserves, and the evaluation of the liquidity rates, which have been created from the data of annual reports. Considering the results having been received from the process of the examination, I think that the tendencies of the domestic banking sector are positive in the given period; at the end of the studied term the liquidity state can be judged appropriate, related to that of the beginning of the examined term.
    Date: 2015–10–15
  19. By: Zeyyad Mandalinci (Queen Mary University of London)
    Abstract: This paper examines the effects of monetary policy shocks on UK regional economic growth and dispersion in a novel Constrained Mixed Frequency Vector Autoregressive framework. Compared to a standard MFVAR, the model partially accounts for missing quarterly observations for regional growth by exploiting national growth data. Results suggest significant heterogeneity in the importance of monetary policy shocks across regions. Mortgage indebtedness is highly related to regional sensitivity to monetary policy shocks. Also, there is some evidence suggesting that regions with larger share of manufacturing output and small and medium sized firms in employ ment are more sensitive to monetary policy shocks.
    Keywords: Regional growth, Monetary policy, Bayesian analysis, VAR, Mixed frequency data
    JEL: E01 E3 E52 C11 C32 C5
    Date: 2015–10
  20. By: Thomas Philippon (NEW YORK UNIVERSITY); Joseba Martinez (New York University); Miguel de Faria e Castro (NYU)
    Abstract: We argue that, during financial crises, governments are forced to choose between runs and lemons. Revealing information about assets' quality can improve welfare by reducing adverse selection, but it can also create runs on weak banks. A credible fiscal backstop mitigates these risks and allows the government to pursue efficient but risky strategies of high disclosure. Our theory sheds light on optimal interventions and provides an explanation for the different choices that governments make during financial crises.
    Date: 2015

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