nep-cba New Economics Papers
on Central Banking
Issue of 2016‒03‒06
twenty papers chosen by
Maria Semenova
Higher School of Economics

  1. Inflation Expectations and Monetary Policy Design: Evidence from the Laboratory By Pfajfar, Damjan; Žakelj, Blaž
  2. Monetary Policy, Incomplete Information, and the Zero Lower Bound By Gust, Christopher J.; Johannsen, Benjamin K.; Lopez-Salido, J. David
  3. Optimal Monetary and Macroprudential Policies: Gains and Pitfalls in a Model of Financial Intermediation By Kiley, Michael T.; Sim, Jae W.
  4. Managing price and financial stability objectives - what can we learn from the Asia-Pacific region? By Soyoung Kim; Aaron Mehrotra
  5. Basel III capital surcharges for G-SIBs fail to control systemic risk and can cause pro-cyclical side effects By Sebastian Poledna; Olaf Bochmann; Stefan Thurner
  6. Monetary transmission under competing corporate finance regimes By De Grauwe, Paul; Gerba, Eddie
  7. Why does the FDIC sue? By Koch, Christoffer; Okamura, Ken
  8. The Signaling Effect and Optimal LOLR Policy By Mei Li; Frank Milne; Junfeng Qiu
  9. Monetary policy and the asset risk-taking channel By Abbate, Angela; Thaler, Dominik
  10. Self-oriented monetary policy, global financial markets and excess volatility of international capital flows By Ryan Niladri Banerjee; Michael B Devereux; Giovanni Lombardo
  11. The effect of monetary policy on bank wholesale funding By Choi, Dong Boem; Choi, Hyun-Soo
  12. Over-the-Counter Markets, Intermediation, and Monetary Policy By Han, Han
  13. International liquidity and the European sovereign debt crisis: Was euro area unconventional monetary policy successful? By Everett, Mary M.
  14. Equity Premium and Monetary Policy in a Model with Limited Asset Market Participation By Roman Horvath; Lorant Kaszab
  15. Exchange Rate Pass-Through in the Euro Area By Mirdala, Rajmund
  16. Quantitative Easing and the Labor Market in Japan By Chun-Hung Kuo; Hiroaki Miyamoto
  17. Higher Bank Capital Requirements and Mortgage Pricing: Evidence from the Countercyclical Capital Buffer (CCB) By Basten, Christhoph; Koch, Cathérine
  18. Regime-Switching Models for Estimating Inflation Uncertainty By Nalewaik, Jeremy J.
  19. Assessing the efficacy of borrower-based macroprudential policy using an integrated micro-macro model for European households By Gross, Marco; Población García, Francisco Javier
  20. Risky Mortgages, Bank Leverage and Credit Policy By Ferrante, Francesco

  1. By: Pfajfar, Damjan (Board of Governors of the Federal Reserve System (U.S.)); Žakelj, Blaž (Universitat Pompeu Fabra)
    Abstract: Using laboratory experiments within a New Keynesian framework, we explore the interaction between the formation of inflation expectations and monetary policy design. The central question in this paper is how to design monetary policy when expectations formation is not perfectly rational. Instrumental rules that use actual rather than forecasted inflation produce lower inflation variability and reduce expectational cycles. A forward-looking Taylor rule where a reaction coefficient equals 4 produces lower inflation variability than rules with reaction coefficients of 1.5 and 1.35. Inflation variability produced with the latter two rules is not significantly different. Moreover, the forecasting rules chosen by subjects appear to vary systematically with the policy regime, with destabilizing mechanisms chosen more often when inflation control is weaker.
    Keywords: Inflation expectations; laboratory experiments; monetary policy design; New Keynesian model
    JEL: C91 C92 E37 E52
    Date: 2015–06–11
  2. By: Gust, Christopher J.; Johannsen, Benjamin K. (Board of Governors of the Federal Reserve System (U.S.)); Lopez-Salido, J. David (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: In the context of a stylized New Keynesian model, we explore the interaction between imperfect knowledge about the state of the economy and the zero lower bound. We show that optimal policy under discretion near the zero lower bound responds to signals about an increase in the equilibrium real interest rate by less than it would when far from the zero lower bound. In addition, we show that Taylor-type rules that either include a time-varying intercept that moves with perceived changes in the equilibrium real rate or that respond aggressively to deviations of inflation and output from their target levels perform similarly to optimal discretionary policy. Our analysis of first-difference rules highlights that rules with interest rate smoothing terms carry forward current and past misperceptions about the state of the economy and can lead to suboptimal performance.
    Date: 2015–11–05
  3. By: Kiley, Michael T. (Board of Governors of the Federal Reserve System (U.S.)); Sim, Jae W. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: We estimate a quantitative general equilibrium model with nominal rigidities and financial intermediation to examine the interaction of monetary and macroprudential stabilization policies. The estimation procedure uses credit spreads to help identify the role of financial shocks amenable to stabilization via monetary or macroprudential instruments. The estimated model implies that monetary policy should not respond strongly to the credit cycle and can only partially insulate the economy from the distortionary effects of financial frictions/shocks. A counter-cyclical macroprudential instrument can enhance welfare, but faces important implementation challenges. In particular, a Ramsey planner who adjusts a leverage tax in an optimal way can largely insulate the economy from shocks to intermediation, but a simple-rule approach must be cautious not to limit credit expansions associated with efficient investment opportunities. These results demonstrate the importance of considering both optimal Ramsey policies and simpler, but more practical, approaches in an empirically grounded model.
    Keywords: Bayesian estimation; DSGE models; Macroprudential policy; Monetary policy
    JEL: E58 E61 G18
    Date: 2015–09–04
  4. By: Soyoung Kim; Aaron Mehrotra
    Abstract: The international financial crisis led many central banks to adopt explicit financial stability objectives. This raises the question of how central banks deal with policy trade-offs resulting from potential conflicts between price and financial stability objectives. We analyse this issue in the Asia-Pacific region, where many economies with inflation targeting central banks have adopted macroprudential policies in order to safeguard financial stability. Using structural vector autoregressions that identify both monetary and macroprudential policy actions, our results highlight similarities in the effects of monetary and macroprudential policies on the real economy. Tighter macroprudential policies used to contain credit growth have also had a negative impact on output and inflation. The similar effects of monetary and macroprudential policies could create challenges for policy, given the frequency of episodes where low inflation coincides with buoyant credit growth.
    Keywords: multiple objectives, financial stability, price stability, macroprudential instruments, monetary policy
    Date: 2015–12
  5. By: Sebastian Poledna; Olaf Bochmann; Stefan Thurner
    Abstract: In addition to constraining bilateral exposures of financial institutions, there are essentially two options for future financial regulation of systemic risk (SR): First, financial regulation could attempt to reduce the financial fragility of global or domestic systemically important financial institutions (G-SIBs or D-SIBs), as for instance proposed in Basel III. Second, future financial regulation could attempt strengthening the financial system as a whole. This can be achieved by re-shaping the topology of financial networks. We use an agent-based model (ABM) of a financial system and the real economy to study and compare the consequences of these two options. By conducting three "computer experiments" with the ABM we find that re-shaping financial networks is more effective and efficient than reducing leverage. Capital surcharges for G-SIBs can reduce SR, but must be larger than those specified in Basel III in order to have a measurable impact. This can cause a loss of efficiency. Basel III capital surcharges for G-SIBs can have pro-cyclical side effects.
    Date: 2016–02
  6. By: De Grauwe, Paul; Gerba, Eddie
    Abstract: The behavioural agent-based framework of De Grauwe and Gerba (2015) is extended to allow for a counterfactual exercise on the role of banks for monetary transmissions. A bank-based corporate financing friction is introduced and the relative contribution of that friction to the effectiveness of monetary policy is evaluated. We find convincing evidence that the monetary transmission channel is stronger in the bank-based system compared to the market-based. Impulse responses to a monetary expansion are around the double of those in the market-based framework. The (asymmetric) effectiveness of monetary policy in counteracting busts is, on the other hand, relatively higher in the market-based model. The statistical fit of the bank-based behavioural model is also improved compared to the benchmark model. Lastly, we find that a market-based (bankbased) financing friction in a general equilibrium produces highly asymmetric (symmetric) distributions and more (less) pronounced business cycles.
    Keywords: monetary policy in the EA,monetary transmissions,banks,financial frictions,market based finance
    JEL: E52 E44 G21 G32
    Date: 2016
  7. By: Koch, Christoffer (Federal Reserve Bank of Dallas); Okamura, Ken (University of Oxford)
    Abstract: Cases the Federal Deposit Insurance Corporation (FDIC) pursues against the directors and officers of failed commercial banks for (gross) negligence are important for the corporate governance of U.S. commercial banks. These cases shape the kernel of bank corporate governance, as they guide expectations of bankers and regulators in defining the limits of acceptable behavior under financial distress. We examine the differences in behavior of all 408 U.S. commercial banks that were taken into receivership between 2007–2012. Sued banks had different balance sheet dynamics in the three years prior to failure. These banks were generally larger, faster growing, obtained riskier funding and were more “optimistic”. We find evidence that the behavior of bank boards adjusts in an out-of-sample set of banks. Our results suggest the FDIC does not only pursue “deep pockets”, but sets corporate governance standards for all banks by suing negligent directors and officers.
    Keywords: Financial stability; corporate governance; bank failures; financial ratios
    JEL: G21 G28 G33 G34
    Date: 2016–01–25
  8. By: Mei Li (Univeristy of Guelph); Frank Milne (Queen's University); Junfeng Qiu (Central University of Finance and Economics)
    Abstract: When a central bank implements the LOLR policy in a financial crisis, bank creditors often infer a bank’s quality from whether or not it borrows from the central bank. We establish a formal model to study the optimal LOLR policy in the presence of this signaling effect, assuming that the central bank aims to encourage central bank borrowing to avoid inefficiencies caused by contagion. In our model, there are two types of banks: a high quality type with high expected asset returns and a low quality type with lower returns. Both types of banks need to roll over their short-term debts. A central bank offers to lend to both types of banks. After private creditors observe whether banks borrow from the central bank, banks try to borrow from the private market. We find that there may exist a separating equilibrium where only low quality banks borrow from the central bank; and two pooling equilibria where both types of banks do and do not borrow from the central bank. Our major results are as follows: (1) Considering the signaling effect, the central bank should set its lending rate lower than the prevailing market rate to induce both types of banks to borrow from the central bank. (2) Hiding the identity of banks borrowing from the central bank will encourage banks to borrow from the central bank. (3) The central bank may serve as a coordinator for the realization of its favored equilibrium.
    Keywords: Signaling, Lender of Last Resort
    JEL: E58 G28
    Date: 2016–01
  9. By: Abbate, Angela; Thaler, Dominik
    Abstract: Motivated by VAR evidence, we develop a monetary DSGE model where an agency problem between bank financiers, stemming from limited liability and unobservable risk taking, distorts banks' incentives leading them to choose excessively risky investments. A monetary policy expansion magnifies these distortions, increasing excessive risk taking and lowering the expected return on investment. We estimate the model on US data using Bayesian techniques and assess how this novel channel affects optimal monetary policy. Our results suggest that the monetary authority should stabilize the real interest rate, trading off more inflation volatility in exchange for less volatility in risk taking and output.
    Keywords: Bank Risk,Monetary policy,DSGE Models
    JEL: E12 E44 E58
    Date: 2015
  10. By: Ryan Niladri Banerjee; Michael B Devereux; Giovanni Lombardo
    Abstract: This paper explores the nature of macroeconomic spillovers from advanced economies to emerging market economies (EMEs) and the consequences for independent use of monetary policy in EMEs. We first empirically document the effects of US monetary policy shocks on a sample group of EMEs. A contractionary monetary shock leads a retrenchment in EME capital flows, a fall in EME GDP, and an exchange rate depreciation. We construct a theoretical model which can help to account for these findings. In the model, macroeconomic spillovers are exacerbated by financial frictions. We assess the extent to which domestic monetary policy can mitigate the negative spillovers from foreign shocks. Absent financial frictions, international spillovers are minor, and an inflation targeting rule represents an effective policy for the EME. With frictions in financial intermediation, however, spillovers are substantially magnified, and an inflation targeting rule has little advantage over an exchange rate peg. However, an optimal monetary policy markedly improves on the performance of naive inflation targeting or an exchange rate peg. Furthermore, optimal policies don't need to be coordinated across countries. Under the specific set of assumptions maintained in our model, a non-cooperative, self-oriented optimal policy gives results very similar to those of a global cooperative optimal policy.
    Keywords: International spillovers, Local Projections, Capital flows, Financial intermediaries, Monetary policy
    Date: 2016–01
  11. By: Choi, Dong Boem (Federal Reserve Bank of New York); Choi, Hyun-Soo (Singapore Management University)
    Abstract: We study how monetary policy affects the funding composition of the banking sector. When monetary tightening reduces the retail deposit supply owing to, for example, a decrease in bank reserves or in money demand, banks try to substitute the deposit outflows with more wholesale funding in order to mitigate the policy impact on their lending. Banks have varying degrees of accessibility to wholesale funding sources because of financial frictions, and those banks that are large or that have a greater reliance on wholesale funding increase their wholesale funding more. As a result, monetary tightening increases both the reliance on and the concentration of wholesale funding within the banking sector, indicating that monetary tightening could increase systemic risk. Our findings also suggest that introducing liquidity requirements can bolster monetary policy transmission through the bank lending channel by limiting the funding substitution of large banks.
    Keywords: bank funding; monetary policy transmission; systemic stability; liquidity regulation; bank lending channel
    JEL: E52 E58 G21 G28
    Date: 2016–01–01
  12. By: Han, Han
    Abstract: During the Great Recession, the Federal Reserve implemented two monetary policies: cutting interest rates and quantitative easing (QE). I develop a model to examine these two policies in a frictional financial environment. In this model, agents sell assets to acquire money when a consumption opportunity arises, which can only be done through over-the-counter (OTC) markets. In equilibrium, when the interest rate is low (not necessarily zero), households who trade in OTC markets achieve their optimal consumption. When the interest rate is high, QE will raise asset prices and lower households’ consumption. The asset price increase indicates a higher liquidity premium, which reflects inefficiency in money reallocation.
    Keywords: OTC markets, Middlemen, Monetary Policy, QE, Asset Pricing
    JEL: E44 E52 E58 G12
    Date: 2015–12–18
  13. By: Everett, Mary M.
    Abstract: Using novel data on individual euro area bank balance sheets this paper shows that exposure to stressed European sovereigns is associated with a contraction in international funding. The loan component of euro area bank asset portfolios is most adversely affected by this decline in international liquidity. Controlling for bank risk and credit demand, during the sovereign debt crisis credit supply to households declined less for non-stressed country banks, with relatively greater exposure to stressed sovereigns, and that accessed the ECB's unconventional monetary policy measures in the form of the first 3-year Long-Term Refinancing Operations (VLTROs) in December 2011. In contrast, the VLTROs in February 2012 were not effective in mitigating the effect of the European sovereign debt crisis on private non-financial sector credit supply.
    Keywords: European sovereign crisis, cross-border banking, international shock transmission, unconventional monetary policy, ECB liquidity
    JEL: G21 G15 H63
    Date: 2015–06
  14. By: Roman Horvath (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic); Lorant Kaszab (Central Bank of Hungary)
    Abstract: This short paper shows that a New Keynesian model with limited asset market participation can generate a high risk-premium on unlevered equity relative to short-term risk-free bonds and high variability of equity returns driven by monetary policy shocks with zero persistence.
    Keywords: Limited Participation, Monetary Policy, DSGE, Equity Premium
    JEL: E32 E44 G12
    Date: 2016–02
  15. By: Mirdala, Rajmund
    Abstract: Time-varying exchange rate pass-through effects to domestic prices under fixed euro exchange rate perspective represent one of the most challenging implications of the common currency. The problem is even more crucial when examining crisis related redistributive effects associated with relative price changes. The degree of the exchange rate pass-through to domestic prices reveals its role as the external price shocks absorber especially in the situation when the leading path of exchange rates is less vulnerable to the changes in the foreign prices. Adjustments in domestic prices followed by exchange rate shifts induced by sudden external price shocks are associated with changes in the relative competitiveness among member countries of the currency area. In the paper we examine exchange rate pass-through to domestic prices in the Euro Area member countries to examine crucial implications of the nominal exchange rate rigidity. Our results indicate that absorption capabilities of nominal effective exchange rates clearly differ in individual countries. As a result, an increased exposure of domestic prices to the external price shocks in some countries represents a substantial trade-off of the nominal exchange rate stability.
    Keywords: exchange rate pass-through, inflation, Euro Area, VAR, impulse-response function
    JEL: C32 E31 F41
    Date: 2015–06
  16. By: Chun-Hung Kuo (International Univeristy of Japan); Hiroaki Miyamoto (The University of Tokyo)
    Abstract: This paper studies the effectiveness of unconventional monetary policy on the labor market. By using the Japan's data, we estimate structural vector autoregressive models. Our empirical analysis demonstrates that while unconventional monetary policy boosts output and employment significantly, its effects on inflation and nominal wages are limited.
    Keywords: Quantitative easing, unemployment, wages, Japanese economy
    JEL: E24 E52 J60
    Date: 2016–02
  17. By: Basten, Christhoph; Koch, Cathérine
    Abstract: We examine how the CCB affects mortgage pricing after Switzerland was first to activate this macroprudential tool of Basel III. Observing multiple offers per request, we obtain three core findings. First, the CCB changes the composition of mortgage supply, as capital-constrained and mortgage-specialized banks raise prices relatively more. Second, risk-weighting schemes do not amplify the CCB effect. Third, CCB-subjected banks and CCB-exempt insurers both raise mortgage rates. To conclude, changes in the supply composition hint at the CCB’s success in shifting mortgages from less to more resilient banks, but stricter capital requirements do not discourage banks from risky mortgage lending.
    Keywords: macroprudential policy, capital requirement, mortgage pricing
    JEL: G21 E51
    Date: 2015–06
  18. By: Nalewaik, Jeremy J. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper constructs regime-switching models for estimating the probability of inflation returning to its relatively high levels of variability and persistence in the 1970s and 1980s. Forecasts and probabilities of extreme events from the models are evaluated against comparable estimates from other statistical models, from surveys, and from financial markets. The paper then uses the models to construct prediction intervals around Federal Reserve Board staff forecasts of PCE price inflation, combining the recent non-parametric forecast error distribution with parametric information from the model. The outer tails of the prediction intervals depend importantly on the probability inflation is in its high-variance, high-persistence regime.
    Keywords: Inflation; Markov-Switching; Uncertainty
    JEL: E30
    Date: 2015–09–01
  19. By: Gross, Marco; Población García, Francisco Javier
    Abstract: We develop an integrated micro-macro model framework that is based on household survey data for a subset of the EU countries that the Household Finance and Consumption Survey (HFCS) contains. The model can be used for conducting scenario and sensitivity analyses with regard to the factors that drive households' income and expenses as well as their asset values and hence the structure of their balance sheet. Moreover, we use it for the purpose of assessing the efficacy of borrower-based macroprudential instruments, namely loan-to-value (LTV) ratio and debt service to income (DSTI) ratio caps. The simulation results from the model can be attached to bank balance sheets and their risk parameters to derive the impact of the policy measures on their capital position. The model framework also allows quantifying the macroeconomic feedback effects that would result from the policy-induced reduction of demand for mortgage loans. The model allows answering the question as to which of the two measures – LTV or DSTI caps – are more effective, both with respect to their ability to reduce household loss rates as well as their impact on the economy. JEL Classification: C33, E58, G18
    Keywords: household balance sheets, macro-financial linkages, macroprudential policy, stress-testing
    Date: 2016–02
  20. By: Ferrante, Francesco (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Two key channels that allowed the 2007-2009 mortgage crisis to severely impact the real economy were: a housing net worth channel, as defined by Mian and Sufi (2014), which affected the wealth of leveraged households; and a bank net worth channel, which reduced the ability of financial intermediaries to provide credit. To capture these features of the Great Recession, I develop a DSGE model with balance-sheet constrained banks financing both risky mortgages and productive capital. Mortgages are provided to agents facing idiosyncratic housing depreciation risk, implying an endogenous default decision and a link between their borrowing capacity and house prices. The interaction among the housing net worth channel, the bank net worth channel and endogenous foreclosures generates novel amplification mechanisms. I analyze the quantitative implications of these new channels by considering two different shocks linked to the supply of mortgage credit: an increase in the variance of housing risk and a deterioration in the collateral value of mortgages for bank funding. Both shocks are able to produce co-movements in house prices, business investment, consumption and output. Finally, I study two types of policy interventions that are able to reduce the severity of a mortgage crisis: debt relief for borrowing households and central bank credit intermediation.
    Keywords: Bank runs; deposit insurance; large depositors
    JEL: E32 E44 E58 G21
    Date: 2015–12–18

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