nep-cba New Economics Papers
on Central Banking
Issue of 2016‒04‒09
eighteen papers chosen by
Maria Semenova
Higher School of Economics

  1. The Theory of Unconventional Monetary Policy By Roger Farmer; Pawel Zabczyk
  2. The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises By Giancarlo Corsetti; Luca Dedola; ;
  3. Theoretical Foundations for Quantitative Easing By Sohei Kaihatsu; Koichiro Kamada; Mitsuru Katagiri
  4. Macroprudential theory: advances and challenges By Henrique S. Basso; James Costain
  5. Debt Thresholds and Real Exchange Rates: An Emerging Markets Perspective By Vahagn Galstyan; Adnan Velic
  6. Exchange Rate Pass-through in Emerging Countries: Do the Inflation Environment, Monetary Policy Regime and Institutional Quality Matter? By Antonia Lopez-Villavicencio; Valérie Mignon
  7. Deflation risk in the euro area and central bank credibility By Gabriele Galati; Zion Gorgi; Richhild Moessner; Chen Zhou
  8. The speed of the exchange rate pass-through By Bonadio, Barthélémy; Fischer, Andreas M; Sauré, Philip
  9. Monetary transmission in developing countries: Evidence from India By Prachi Mishra; Peter Montiel; Rajeswari Sengupta
  10. Monetary Policy and Large Crises in a Financial Accelerator Agent-Based Model By Giri, Federico; Riccetti, Luca; Russo, Alberto; Gallegati, Mauro
  11. The evolution of the anchoring of inflation expectations By Ines Buono; Sara Formai
  12. On the Optimal Inflation Rate By Markus K. Brunnermeier; Yuliy Sannikov
  13. Asymmetric pass-through effects from monetary policy to housing prices in South Africa By Phiri, Andrew
  14. Stitching together the global financial safety net By Edd Denbee; Carsten Jung; Francesco Paternò
  15. All's Well that Ends Well? Resolving Iceland's Failed Banks By Baldursson, Fridrik Mar; Portes, Richard; Thorlaksson, Eirikur Elis
  16. Countercyclical versus Procyclical Taylor Principles By Chatelain, Jean-Bernard; Ralf Kirsten
  17. Capital Inflow Transmission of Monetary Policy to Emerging Markets By Adugna Olani
  18. Individual inflation expectations in a declining-inflation environment: Evidence from survey data By Malka de Castro Campos; Federica Teppa

  1. By: Roger Farmer; Pawel Zabczyk
    Abstract: This paper is about the effectiveness of qualitative easing, a form of unconventional monetary policy that changes the risk composition of the central bank balance sheet with the goal of stabilizing economic activity. We construct a general equilibrium model where agents have rational expectations and there is a complete set of financial securities, but where some agents are unable to participate in financial markets. We show that a change in the risk composition of the central bank's balance sheet will change equilibrium asset prices and we prove that, in our model, a policy in which the central bank stabilizes non-fundamental fluctuations in the stock market is Pareto improving and self-financing.
    JEL: E02 E6 G11 G21
    Date: 2016–03
  2. By: Giancarlo Corsetti; Luca Dedola; ;
    Abstract: Sovereign debt crises may be driven by either self-fulfilling expectations of default or fundamental fiscal stress. This paper studies the mechanisms by which either conventional or unconventional monetary policy can rule out the former. Conventional monetary policy is modelled as a standard choice of inflation, while unconventional policy as outright purchases in the debt market. By intervening in the sovereign debt market, the central bank effectively swaps risky government paper for monetary liabilities only exposed to inflation risk and thus yielding a lower interest rate. We show that, provided fiscal and monetary authorities share the same objective function, there is a minimum threshold for the size of interventions at which a backstop rules out self-fulfilling default without eliminating the possibility of fundamental default under fiscal stress. Fundamental default risk does not generally undermine the credibility of a backstop, nor does it foreshadow runaway inflation, even when the central bank is held responsible for its own losses.
    Keywords: Sovereign risk and default, Lender of last resort, Seigniorage, inflationary financing
    JEL: E58 E63 H63
    Date: 2014–09–19
  3. By: Sohei Kaihatsu (Director and Senior Economist, Monetary Affairs Department, Bank of Japan (E-mail:; Koichiro Kamada (Associate Director-General and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Mitsuru Katagiri (Deputy Director and Economist, Research and Statistics Department, Bank of Japan (E-mail:
    Abstract: This paper presents theoretical foundations for quantitative easing (QE). Since the late 2000s, with no room for lowering policy interest rates, central banks in the major advanced economies have adopted various unconventional monetary policies. QE is one of those unconventional policies and has so far achieved visible results in practice. However, our theoretical understanding of how QE achieves these results remains incomplete. The purpose of this paper is to introduce an inflation-sensitive money provision rule and show theoretically how QE helps an economy escape from a liquidity trap.
    Keywords: Liquidity trap, Quantitative easing, Monetary policy rule
    JEL: E31 E52 E58
    Date: 2016–03
  4. By: Henrique S. Basso (Banco de España); James Costain (Banco de España)
    Abstract: This note discusses recent theoretical work analyzing the causes of financial instability, its consequences for the macroeconomy, and thus the potential role for macroprudential policy. After discussing how information asymmetries and strategic complementarities can cause balance sheet losses to propagate through the financial system and over time, we discuss the role of the major classes of macroprudential instruments in preventing instability ex ante and containing it ex post. We conclude with a discussion of current challenges for macroeconomic modeling and for the design of regulation and policy.
    Keywords: banks, financial stability, financial regulation, macroeconomic policy.
    JEL: E44 E6 G2 G28
    Date: 2016–03
  5. By: Vahagn Galstyan (Department of Economics, Trinity College Dublin); Adnan Velic (Dublin Intitute of Technology)
    Abstract: In this paper we empirically analyze nonlinearities in short-run real exchange rate dynamics. Our findings suggest that real exchange rate misalignments are considerably less persistent and more volatile during times of high debt. Assessing the variance of changes in misalignments, we retrieve evidence indicating that the nominal exchange rate and inflation differentials are more important determinants in states of high debt than in states of low debt. Overall, our results imply that nonlinearities have non-negligible implications for the mechanics of real exchange rate adjustment in emerging markets.
    Date: 2016–03
  6. By: Antonia Lopez-Villavicencio; Valérie Mignon
    Abstract: In this paper, we estimate the exchange rate pass-through (ERPT) to consumer prices and assess its dynamics for a sample of 15 emerging countries over the 1994-2015 period. To this end, we augment the traditional bivariate relationship between the nominal effective exchange rate and inflation by accounting for the inflation environment, monetary policy regime, as well as domestic institutional factors. We show that both the level and volatility of inflation matter in the sense that declining ERPT is evidenced with more stable and anti-inflationary environment. Monetary policy also plays a key role since adopting an inflation target—especially de jure—leads to a significant reduction in ERPT for most countries. Adopting exchange rate targeting regime matters as well, contributing to a diminishing ERPT. Finally, we find evidence that transparency of monetary policy decisions clearly reduces ERPT, while this is not the case for central bank independence.
    Keywords: exchange rate pass-through;inflation;emerging countries;monetary policy
    JEL: E31 E52 F31
    Date: 2016–04
  7. By: Gabriele Galati; Zion Gorgi; Richhild Moessner; Chen Zhou
    Abstract: This paper investigates how the perceived risk that the euro area will experience deflation has evolved over time, and what this risk implies for the credibility of the ECB. We use a novel dataset on market participants' perceptions of short- to long-term deflation risk implied by year-on-year options on forward inflation swaps. We investigate whether long-term inflation expectations have become de-anchored, by studying whether long-term deflation risk has been affected by changes in oil prices and by short-term deflation risk. Our analysis suggests that the anchoring properties of euro area inflation expectations have weakened, albeit in a still subtle way.
    Keywords: Deflation; inflation expectations; monetary policy; financial crisis
    JEL: E31 E44 E52 E58
    Date: 2016–04
  8. By: Bonadio, Barthélémy; Fischer, Andreas M; Sauré, Philip
    Abstract: This paper analyzes the speed of the exchange rate pass-through into importer and exporter unit values for a large, unanticipated, and unusually 'clean' exchange rate shock. Our shock originates from the Swiss National Bank's decision to lift the minimum exchange rate policy of one euro against 1.2 Swiss francs on January 15, 2015. This policy action resulted in a permanent appreciation of the Swiss franc by more than 11% against the euro. We analyze the response of unit values to this exchange rate shock at the daily frequency for different invoicing currencies using the universe of Switzerland's transactions-level trade data. The main finding is that the speed of the exchange rate pass-through is fast: it starts on the second working day after the exchange rate shock and reaches the medium-run pass-through after eight working days on average. Moreover, we decompose the pass-through by invoicing currencies and find strong evidence that underlying price adjustments occurred within a similar time frame. Our observations suggest that nominal rigidities play only a minor role in the face of large exchange rate shocks.
    Keywords: daily exchange rate pass-through; large exchange rate shock; speed
    JEL: F14 F31 F41
    Date: 2016–03
  9. By: Prachi Mishra; Peter Montiel; Rajeswari Sengupta (Indira Gandhi Institute of Development Research)
    Abstract: There are strong a priori reasons to believe that monetary transmission may be weaker and less reliable in low- than in high-income countries. This is as true in India as it is elsewhere. While its floating exchange rate gives the RBI monetary autonomy, the country's limited degree of integration with world financial markets and RBI's interventions in the foreign exchange markets limit the strength of the exchange rate channel of monetary transmission. The country lacks large and liquid secondary markets for debt instruments, as well as a well-functioning stock market. This means that monetary policy effects on aggregate demand would tend to operate primarily through the bank-lending channel. Yet the formal banking sector is small, and does not intermediate for a large share of the economy. Moreover, there is evidence both that the costs of financial intermediation are high and that the banking system may not be very competitive. The presence of all of these factors should tend to weaken the process of monetary transmission in India. This paper examines what the empirical evidence has to say about the strength of monetary transmission in India, using the structural vector autoregression (SVAR) methods that have been applied broadly to investigate this issue in many countries, including high-,middle-, and low-income ones. We estimate a monthly VAR with data from April 2001 to December 2014. Applying a variety of methods to identify exogenous movements in the policy rate in the data, we find consistently that positive shocks to the policy rate result in statistically significant effects (at least at confidence levels typically used in such applications) on the bank-lending rate in the direction predicted by theory. Specifically, a tightening of monetary policy is associated with an increase in bank lending rates, consistent with evidence for the first stage of transmission in the bank-lending channel. While passthrough from the policy rate to bank lending rates is in the right (theoretically-expected) direction, the passthrough is incomplete. When the monetary policy variable is ordered first, effects on the real effective exchange rate are also in the theoretically expected direction on impact, but are extremely weak and not statistically significant, even at the 90 percent confidence level, for any of the four monetary policy variants that we investigate. Finally, we are unable to uncover evidence for any effect of monetary policy shocks on aggregate demand, as recorded either in the industrial production (IIP) gap or the inflation rate. None of these effects is estimated with strong precision, which may reflect either instability in monetary transmission or the limitations of the empirical methodology. Overall, the empirical tests yield a mixed message on the effectiveness of monetary policy in India, but perhaps one that is more favourable than is typical of many countries at similar income levels.
    Keywords: monetary policy, bank lending, exchange rate, interest rate, institutions
    JEL: E5 E4 F4
    Date: 2016–03
  10. By: Giri, Federico; Riccetti, Luca; Russo, Alberto; Gallegati, Mauro
    Abstract: An accommodating monetary policy followed by a sudden increase of the short term interest rate often leads to a bubble burst and to an economic slowdown. Two examples are the Great Depression of 1929 and the Great Recession of 2008. Through the implementation of an Agent Based Model with a financial accelerator mechanism we are able to study the relationship between monetary policy and large scale crisis events. The main results can be summarized as follow: a) sudden and sharp increases of the policy rate can generate recessions; b) after a crisis, returning too soon and too quickly to a normal monetary policy regime can generate a "double dip" recession, while c) keeping the short term interest rate anchored to the zero lower bound in the short run can successfully avoid a further slowdown.
    Keywords: Monetary Policy; Large Crises; Agent Based Model; Financial Accelerator; Zero Lower Bound.
    JEL: C63 E32 E44 E58
    Date: 2016–03–30
  11. By: Ines Buono (Bank f Italy); Sara Formai (Bank f Italy)
    Abstract: We investigate the degree of anchoring in inflation expectations for different advanced economies using data from professional forecasters' surveys. We define expectations as anchored when movements in short-run expectations do not trigger movements in expectations at longer horizons. Using time-varying parameter regressions, we provide evidence that anchoring has varied noticeably across economies and over time. In particular, we find that starting from the second half of 2008, inflation expectations in the euro area, unlike in the US and in the UK, have shown signs of a de-anchoring.
    Keywords: anchoring, inflation expectations, nonparametric estimation
    JEL: E31 E52 D84 C14
    Date: 2016–03
  12. By: Markus K. Brunnermeier; Yuliy Sannikov
    Abstract: In our incomplete markets economy financial frictions affect the optimal inflation target. Households choose portfolios consisting of risky (uninsurable) capital and money. Money is a bubbly store of value. The market outcome is constrained Pareto inefficient due to a pecuniary externality. Each individual agent takes the real interest rate as given, while in the aggregate it is driven by the economic growth rate, which in turn depends on individual portfolio decisions. Higher inflation due to higher money growth lowers the real interest rate (on money) and tilts the portfolio choice towards physical capital investment. The optimal inflation target boosts growth and welfare and is higher for emerging market economies.
    JEL: E44 E51 E52
    Date: 2016–03
  13. By: Phiri, Andrew
    Abstract: Following the recent financial crisis, spurred by the crash of house prices in the US, there has been a renewed interest by academics in examining the pass-through effects of monetary policy instrument to house price inflation. This study examines the asymmetric pass through effects from monetary policy to house price inflation for the case of South Africa. Our study uses a momentum threshold autoregressive model and a corresponding threshold error correction model (MTAR-TECM). The empirical results reveal a negative and significant pass through from interest rates to house price inflation, even though such pass-through effects are relatively weak. Overall, these findings undermine the ability of the South African Reserve Bank (SARB) to control real house price inflation.
    Keywords: asymmetric cointegration; monetary policy instrument; house price inflation; South Africa.
    JEL: C22 C52 E31 E52
    Date: 2016–03–24
  14. By: Edd Denbee (Bank of England); Carsten Jung (Bank of England); Francesco Paternò (Bank f Italy)
    Abstract: Financial globalisation brings a number of benefits but can also increase the risk of financial crisis. In recent years, to reduce these risks to stability, countries have reformed financial regulation, enhanced frameworks for central bank liquidity provision and developed new elements, and increased the resources of the global financial safety net (GFSN). The traditional GFSN consisted of countries’ own foreign exchange reserves with the IMF acting as a backstop. But since the global financial crisis there have been a number of new arrangements added to the GFSN, in particular the expansion of swap lines between central banks and regional financing arrangements (RFAs). The new look GFSN is more fragmented than in the past, with multiple types of liquidity insurance and individual countries and regions having access to different size and types of financial safety nets. This paper finds that the components of the GFSN are not fully substitutable. We argue that while swap lines and RFAs can play an important role in the GFSN they are not a substitute for having a strong, well resourced, IMF at the centre of it. By running a series of stress scenarios we find that for all but the most severe crisis scenarios, the current resources of the GFSN are likely to be sufficient. However, this finding relies upon the IMF’s overall level of resources (including both permanent and temporary) being maintained at their current leveland masks some vulnerabilities at the country level.
    Keywords: balance of payments, global financial safety net, IMF, foreign exchange reserves, regional financing arrangements, swap lines
    JEL: F33 E58
    Date: 2016–03
  15. By: Baldursson, Fridrik Mar; Portes, Richard; Thorlaksson, Eirikur Elis
    Abstract: Iceland's capital controls were imposed in October 2008 in order to prevent massive capital flight and a complete collapse of the exchange rate. The controls have not been lifted yet; until recently this was primarily because of the risk of large outflows of domestic holdings of the failed Icelandic banks. As argued in a precursor to this paper (Baldursson and Portes, 2014), significant restructuring of domestic holdings of foreign creditors of the banks was required before the controls can be lifted. Such a restructuring was finally accomplished in January 2016 and gradual lifting of the capital controls now appears to be within reach. Broadly in line with the recommendations of Baldursson and Portes (2014), the resolution involved a voluntary - in much the same sense as the Greek debt restructuring was voluntary - restructuring of the banks' debt, under which most of the Icelandic krona assets of the banks were relinquished to the state or tied up in Iceland. Resolution of the old banks will cut Iceland's public debt, but it will still be substantially higher than before the crisis. The net international investment position of Iceland is, however, stronger than it has been in decades.
    Keywords: capital controls; cross-border banking; Icelandic banks; resolution of failed banks
    JEL: E58 F31 G21
    Date: 2016–03
  16. By: Chatelain, Jean-Bernard; Ralf Kirsten
    Abstract: Assuming inflation is a forward variable in Taylor (1999) model, this paper finds opposite policy rule recommandations with counter-cyclical policy rule parameters (Taylor principle: inflation rule larger than one and bounded upwards) in the case of optimal policy under commitment versus pro-cyclical policy rule parameters (inflation rule parameter below zero) in the case of discretionary policy. For the observed high inertia of the Fed with variations of the nominal policy rate within the range [0%,4%] during the great moderation, the cost of time-inconsistency is negligible for optimal policy. Time-inconsistency cannot be the ultimate argument to reject counter-cyclical Taylor principle.
    Keywords: Monetary policy,Optimal policy under commitment,Time consistent discretionary policy,Taylor rule
    JEL: C6 E4 E5
    Date: 2016
  17. By: Adugna Olani (Queen's University)
    Abstract: In this paper, I examine the effects of advanced economies' conventional monetary policy on gross foreign direct and portfolio investment inflows to emerging economies. I use structural vector autoregressions to analyse and compare the response of each inflow category to world interest rate and emerging economies' monetary and exchange rate shocks. Gross foreign direct inflows respond slowly to shocks while gross portfolio reacts on impact. Furthermore, the reaction of foreign direct investment to the shocks is not as high. These results suggest that monetary and exchange rate policies of emerging economies influence portfolio inflows more than they impact foreign direct investment in ows. These results also imply the existence of fundamental differences in capital flow categories beyond what we know to date. I address the "push" and "pull" debate in categories capital flows by quantitatively comparing the forecast error variance decomposition. I do not find evidence of "push" over "pull" factors in either class of inflows.
    Keywords: Monitary Policy, Capital Flows, Emerging Markets, Exchange Rate, Interest Rates
    JEL: E52 F32 E43 E58 F37
    Date: 2016–03
  18. By: Malka de Castro Campos; Federica Teppa
    Abstract: The paper analyses individual inflation expectations in the Netherlands over the period 2008-2014. The empirical evidence is based on the DNB Household Survey, a longitudinal online panel survey representative of Dutch-speaking population. The focus is on inflation measures based on information about the general price level, the aggregate real estate price and the price of the own house. Both individual background microeconomic characteristics and macroeconomic variables are taken into account in our empirical models devoted to explain the main determinants of inflation expectations. We find that inflation expectations decrease over the years, suggesting that individuals can pick up the direction of the price change, but respondents do not report high risk of deflation. The target inflation of 2 percent seems to be well anchored in individual expectations.
    Keywords: Inflation Risk; Survey Data; Subjective expectations
    JEL: C23 C5 C8 D12 D84
    Date: 2016–03

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