nep-cba New Economics Papers
on Central Banking
Issue of 2016‒04‒16
twenty papers chosen by
Maria Semenova
Higher School of Economics

  1. Should Central Banks Target Investment Prices? By Susanto Basu; Pierre De Leo
  2. The Deposits Channel of Monetary Policy By Itamar Drechsler; Alexi Savov; Philipp Schnabl
  3. Lobbying on Regulatory Enforcement Actions: Evidence from Banking By Thomas Lambert
  4. Predicting bank failures: The leverage versus the risk-weighted capital ratio By Xi Yang
  5. Bank regulation under fire sale externalities By Kara, Gazi; Ozsoy, S. Mehmet
  6. A comparative analysis of developments in central bank balance sheet composition By Christiaan Pattipeilohy
  7. How can it work? On the impact of quantitative easing in the Eurozone By Saraceno, Francesco; Tamborini , Roberto
  9. Quantitative Easing Policy, Exchange Rates and Business Activity by Industry in Japan from 2001-2006 By Hiroyuki Ijiri; Yoichi Matsubayashi
  10. Investment and forward-looking monetary policy: A Wicksellian solution to the problem of indeterminacy By Stephen McKnight
  11. Monetary Policy and Large Crises in a Financial Accelerator Agent-Based Model By Giri, Federico; Riccetti, Luca; Russo, Alberto; Gallegati, Mauro
  12. The speed of the exchange rate pass-through By Bonadio, Barthélémy; Fischer, Andreas M; Sauré, Philip
  13. Countercyclical versus Procyclical Taylor Principles By Chatelain, Jean-Bernard; Ralf Kirsten
  14. Individual inflation expectations in a declining-inflation environment: Evidence from survey data By Malka de Castro Campos; Federica Teppa
  15. Central Banks' Predictability: An Assessment by Financial Market Participants By Bernd Hayo; Matthias Neuenkirch
  16. A Stable 4% Inflation Could Get Canadians One Half Million More Jobs By Pierre Fortin
  17. Empirical Assessment of the Impact of Monetary Policy Communication on the Financial Market By Masahiko Shibamoto
  18. Sustainable international monetary policy cooperation By Ippei Fujiwara; Timothy Kam; Takeki Sunakawa
  19. The Impact of Government-Driven Loans in the Monetary Transmission Mechanism: what can we learn from firm-level data? By Marco Bonomo and Bruno Martins
  20. Nonlinear Pass-Through of Exchange Rate Shocks on Inflation: A Bayesian Smooth Transition VAR Approach By Hernán Rincón-Castro; Norberto Rodríguez-Niño

  1. By: Susanto Basu (Boston College; NBER); Pierre De Leo (Boston College)
    Abstract: Yes, they should. Central banks nearly always state explicit or implicit inflation targets in terms of consumer price inflation. If there are nominal rigidities in the pricing of both consumption and investment goods and if the shocks to the two sectors are not identical, then monetary policy cannot stabilize inflation and output gaps in both sectors. Thus, the central bank faces a tradeoff between targeting consumption price inflation and investment price inflation. In this setting, ignoring investment prices typically leads to substantial welfare losses because the intertemporal elasticity of substitution in investment is much higher than in consumption. In our calibrated model, consumer price targeting leads to welfare losses that are at least three times the loss under optimal policy. A simple rule that puts equal weight on stabilizing consumption and investment price comes close to replicating the optimal policy. Thus, GDP deflator targeting is not a good approximation to optimal policy. We conclude that significant welfare gains can be achieved if central banks shift to targeting a weighted average of consumer and investment price inflation, although this would require a major change in current central banking practice.
    Keywords: Inflation Targeting; Investment-Specific Technical Change; Investment Price Rigidity; Optimal Monetary Policy
    JEL: E52 E58 E32 E31
    Date: 2016–03–25
  2. By: Itamar Drechsler; Alexi Savov; Philipp Schnabl
    Abstract: We propose and test a new channel for the transmission of monetary policy. We show that when the Fed funds rate increases, banks widen the interest spreads they charge on deposits, and deposits flow out of the banking system. We present a model in which imperfect competition among banks gives rise to these relationships. An increase in the nominal interest rate increases banks' effective market power, inducing them to increase deposit spreads. Households respond by substituting away from deposits into less liquid but higher-yielding assets. Using branch-level data on all U.S. banks, we show that following an increase in the Fed funds rate, deposit spreads increase by more, and deposit supply falls by more, in areas with less deposit competition. We control for changes in banks' lending opportunities by comparing branches of the same bank. We control for changes in macroeconomic conditions by showing that deposit spreads widen immediately after a rate change, even if it is fully expected. Our results imply that monetary policy has a significant impact on how the financial system is funded, on the quantity of safe and liquid assets it produces, and on its lending to the real economy.
    JEL: E52 E58 G12 G21
    Date: 2016–04
  3. By: Thomas Lambert
    Abstract: This paper analyzes the relationship between bank lobbying and supervisory decisions of regulators, and documents its moral hazard implications. Exploiting bank-level information on the universe of commercial and savings banks in the United States, I find that regulators are less likely to initiate enforcement actions against lobbying banks. In addition, I show that lobbying banks are riskier and reliably underperform their non-lobbying peers. Overall, these results appear rather inconsistent with an information-based explanation of bank lobbying, but consistent with the theory of regulatory capture.
    Keywords: Banking supervision; enforcement actions; lobbying; moral hazard; risk taking
    JEL: D72 G21 G28
    Date: 2016–03–15
  4. By: Xi Yang
    Abstract: This paper investigates the efficiency of leverage ratios and risk-weighted capital ratios as bank failure predictors during the global financial crisis. Analyzing 417 bank failures between 2008 and 2012, we find that the predictive power of different capital ratios is not homogeneous across banks. The simple leverage ratio outperforms the risk-weighted ratio in predicting failures of large banks, while both capital ratios are important in predicting the failure of smaller banks. The better performance of the leverage ratio in the case of large banks is especially important during the crisis period of 2008-2010. The findings support the regulatory reforms proposed by Basel Committee on Banking Supervision on the adoption of a supplementary minimum leverage ratio in order to strengthen the resilience of the bank sector.
    Keywords: leverage ratio, risk-weighted capital ratio, bank failure, CAMELS, Logit model
    JEL: G21 G28 G33
    Date: 2016
  5. By: Kara, Gazi; Ozsoy, S. Mehmet
    Abstract: This paper examines the optimal design of and interaction between capital and liquidity regulations in a model characterized by fire sale externalities. In the model, banks can insure against potential liquidity shocks by hoarding sufficient precautionary liquid assets. However, it is never optimal to fully insure, so realized liquidity shocks trigger an asset fire sale. Banks, not internalizing the fire sale externality, overinvest in the risky asset and underinvest in the liquid asset in the unregulated competitive equilibrium. Capital requirements can lead to less severe fire sales by addressing the inefficiency and reducing risky assets -- however, we show that banks respond to stricter capital requirements by decreasing their liquidity ratios. Anticipating this response, the regulator preemptively sets capital ratios at high levels. Ultimately, this interplay between banks and the regulator leads to inefficiently low levels of risky assets and liquidity. Macroprudential liquidity requirements that complement capital regulations, as in Basel III, restore constrained efficiency, improve financial stability and allow for a higher level of investment in risky assets.
    Keywords: Bank capital regulation ; liquidity regulation ; fire sale externality ; Basel III
    JEL: G20 G21 G28
    Date: 2016–03
  6. By: Christiaan Pattipeilohy
    Abstract: In this paper we analyse developments in the composition of central bank balance sheets for a large set of central banks in a unified framework. Since 2007, central banks in advanced economies have experienced pronounced changes in balance sheet composition as a consequence of unconventional monetary policy measures. In addition, we document a convergence in balance sheet composition from 2007 until 2009, as the initial crisis response was fairly homogeneous across advanced economies, mostly driven by financial stability concerns. However, since 2009 design of balance sheet policies has been more diverse, reflecting diverging policy challenges across regions. By contrast, balance sheets of central banks in emerging market economies have remained broadly unchanged in terms of composition in the period under review.
    Keywords: Central bank balance sheet; unconventional monetary policy; dissimilarity analysis
    JEL: E40 E42 E50 E58
    Date: 2016–04
  7. By: Saraceno, Francesco (LUISS School of European Political Economy); Tamborini , Roberto (University of Trento)
    Abstract: How can the quantitative easing (QE) programme launched in March 2015 by the ECB be successful in the Eurozone (EZ)? What will be its impact on the member countries? And how will it relate to countries' fiscal policies? To address these questions, we use a simple extension of the three-equation New Keynesian model. We modify the benchmark model in two respects: 1) we (re)-introduce an LM money supply and demand equation to capture the fact that the ECB operates at the zero lower bound and hence cannot use a standard Taylor rule; and 2) we extend the model to a two-country framework. The model supports the ECB official view that the channel whereby QE is meant to operate is the reversal of deflationary expectations. It also highlights that instrumental to this goal is the elimination of persistent output gaps, both at the EZ and at the country level, and hence the reduction of country-specific interest-rate spreads - the "unofficial" objective of the programme. We show that QE, if large enough, can succeed for the EZ as a whole. The ECB nevertheless cannot also close individual countries' output gaps, unless specific and unrealistic conditions are met. In this case fiscal accommodation at the country level should also intervene. We show that QE can enhance the effectiveness of fiscal policy, and therefore conclude that the coordination of fiscal and monetary policies is of paramount importance.
    Keywords: Monetary Policy; ECB; Deflation; Zero-­Lower-­Bound; Fiscal Policy
    JEL: E30 E40 E50
    Date: 2016–03–15
  8. By: Olivier Bruno (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - CNRS - Centre National de la Recherche Scientifique); Alexandra Girod (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We investigate the impact the risk sensitive regulatory ratio may have on banks' risk taking behaviours during the business cycle. We show that the risk sensitivity of capital requirements introduce by Basel II adds either an "equity surplus" or an "equity deficit" on a bank that owns a fixed capital endowment and a constant leverage ratio. Depending on the magnitude of cyclical variations into requirements, the "surplus" may be exploited by the bank to increase its value toward the selection of a riskier asset or the "deficit" may restrict the bank to opt for a less risky asset. Whether the optimal asset risk level swings among classes of risk through the cycle, the risk level of bank's portfolio may increase during economic upturns, or decrease in downturns, leading to a rise in financial fragility or a "fly to quality" phenomenon.
    Keywords: Bank capital,Basel capital accord,risk incentive
    Date: 2016–03–31
  9. By: Hiroyuki Ijiri (Graduate School of Economics, Kobe University); Yoichi Matsubayashi (Graduate School of Economics, Kobe University)
    Abstract: This study empirically investigates the dynamic effect of Japan's quantitative easing (QE) policy on industry-specific business activity using a time-varying parameter model and monthly data spanning 2001-2006. This model yields more reliable and precise results than earlier fixed effects models using quarterly data. Its first major finding is that the effect of QE on yen-dollar exchange rates varied during the period and is most evident in its final phases, whereas its effect on stock prices persisted almost continuously. Second, QE's effect on Japan's real economy-that is, on industrial production- varies by industry and over time. Most notably, QE raised production via yen-dollar depreciation in the machinery sector (e.g. General and Transport machinery), Chemical, Nonferrous metal, and Iron and steel during its latter phases. This study is the first to investigate how unconventional monetary policy influences Japan's real economy by analyzing the yen-dollar exchange rate during the second half of QE implementation in Japan.
    Keywords: Quantitative easing (QE) policy, Time-Varying Parameter vector autoregressive (TVP-VAR) model, exchange rates, stock prices, export.
    JEL: E44 E52 E58
    Date: 2016–03
  10. By: Stephen McKnight (El Colegio de México)
    Abstract: Recent research has shown that forward-looking Taylor rules are subject to indeter- minacy in New Keynesian models with capital and investment spending. This paper shows that adopting a forward-looking Wicksellian rule that responds to the price level, rather than to inflation, is one potential remedy to the indeterminacy problem. This result is shown to be robust to variations in both the labor supply elasticity and the degree of price stickiness, the inclusion of capital adjustments costs, and if output also enters into the interest-rate feedback rule. Finally, it is shown that the superiority of Wicksellian rules over Taylor rules is not only confined to forward-looking policy, but also extends to both backward-looking and contemporaneous-looking specifications of the monetary policy rule.
    Keywords: equilibrium determinacy, interest-rate rules, monetary policy; investment; Taylor rule
    JEL: E22 E31 E52 E58
    Date: 2016–03
  11. 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
  12. 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
  13. 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
  14. 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
  15. By: Bernd Hayo; Matthias Neuenkirch
    Abstract: In this paper, we examine the relationship between market participants' perception of central bank predictability and their assessment of central bank communication skills and success in conveying objectives as well as the importance of transparency-enhancing measures, such as voting records, transcripts or minutes of policy meetings, and conditional interest rate projections. Our analysis is based on a unique dataset of almost 500 market participants worldwide who were asked questions with respect to the performance of the Bank of England, the Bank of Japan, the European Central Bank, and the Federal Reserve. Our results indicate a positive and economically notable relationship between central banks’ ability to convey their objectives and their overall communication skills on the one hand, and market participants’ perception of the banks’ predictability on the other hand, for all four central banks. The dissemination of more specific information does not appear to contribute to better central bank predictability. This raises doubts about the widely-held notion that implementing ever more transparency-enhancing measures will improve central bank predictability.
    Keywords: Central Bank, Communication, Financial Market Participants, Objectives, Predictability, Survey, Transparency
    JEL: E52 E58
    Date: 2016
  16. By: Pierre Fortin
    Abstract: The Inflation-Control Agreement between the Government and the Bank of Canada is reviewed and renewed every five years. In this paper, I propose that the upcoming 2016 agreement increase the inflation target by 2 percentage points, from the current 2% to 4%. I first note that the room to stimulate economic activity and employment when the Bank of Canada judges that it is needed has narrowed dangerously in the past 25 years. I argue that the only fully effective means of freeing the Bank from the operational straightjacket into which it has fallen is setting the inflation target at 4% instead of 2%. I then report of evidence that the strong resistance of Canadian employers and employees to money wage cuts generates a significant permanent trade-off between inflation and unemployment at the macro level when inflation is less than 5%. Combining these two strands of observations, I conclude that moving to 4% inflation would generate about one half million more permanent jobs for Canadians and, over time, add some $50 billion per year to domestic income.
    Keywords: Inflation target, zero lower bound, anchoring of expectations, downward nominal wage rigidity, Bank of Canada, inflation-control agreement, monetary policy.
    JEL: E5 E6 H3 J3
    Date: 2016
  17. By: Masahiko Shibamoto (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan)
    Abstract: This paper proposes an empirical framework to explore the role of monetary policy communication. We develop an econometric methodology to impose restrictions for the identification of communication effects distinct from the effects of policy decisions. The empirical results support the hypothesis that both policy decision and communication factors are required to adequately capture the financial market reactions to monetary policy news. By applying a text mining approach focused on phrases that appear in press conferences on policy meeting days, we find that the communication factors identified are characterized by the policy intentions and preferences of the central bank.
    Keywords: Monetary policy communication, Policy surprise, Financial market, Event study, Text mining
    JEL: E52 E58 C30
    Date: 2016–04
  18. By: Ippei Fujiwara; Timothy Kam; Takeki Sunakawa
    Abstract: We provide new insight on international monetary policy cooperation using a two-country model based on Benigno and Benigno (2006). Assuming symmetry, save for the volatility of (markup) shocks, we show that an incentive feasibility problem exists between the policymakers across national borders: The country faced with a relatively more volatile markup shock has an incentive to deviate from an assumed Cooperation regime to one with Noncooperation. More generally, a similar result obtains if countries differ in size. This motivates our study of a history-dependent Sustainable Cooperation regime which is endogenously sustained by a cross-country, state-contingent contract between policymakers. Under Sustainable Cooperation, the responses of inflation and the output gap in both countries are different from those induced by the Cooperation and Noncooperation regimes reflecting the endogenous welfare redistribution between countries under the state-contingent contract. Such history-contingent welfare redistributions are supported by resource transfers affected through incentive-compatible variations in the terms of trade (or net exports). Such an endogenous cooperative solution may also provide a theoretical rationale for perceived occasional cooperation between national central banks in reality.
    Keywords: Monetary policy cooperation, Sustainable plans, Welfare
    JEL: E52 F41 F42
    Date: 2016–04
  19. By: Marco Bonomo and Bruno Martins
    Abstract: Government-driven credit had been expanding in Brazil since the financial crisis of 2007/2008, reaching almost half of the total credit in 2012. While this large participation may buffer the banking system from external shocks, it undoubtedly affects the transmission of monetary policy. Using a huge repository of corporate loan contracts, composing an unbalanced panel of almost 300,000 non-financial firms between 2006 and 2012, this paper investigates its impact on the monetary transmission mechanism. Our results show that the credit channel of monetary policy is less effective for firms with government-driven loans access. This effect is shown in the smaller variation both in the total amount of loans and in the lending rate charged by private banks on free loan market. Merging loans database with employment data from RAIS (Annual Social Information Report), we also investigate the effects of monetary policy rate on employment. Our results indicate that changes in policy rate have smaller effect on the level of employment for firms with more access to earmarked and government-owned banks loans. Additionally, we examine whether firms with larger fraction of government-driven loans are better able to insulate themselves from the effects of external shocks, with resulting attenuated impact of those shocks on loans growth, interest rate on private loans and employment growth. The evidence we found confirms this hypothesis
    Date: 2016–03
  20. By: Hernán Rincón-Castro; Norberto Rodríguez-Niño
    Abstract: Determining the exchange rate pass-through on inflation is a necessity for central banks as well as for firms and households. This is an apparently easy and intuitive task, but it faces high complexity and uncertainty. This paper examines the short and long-term impact of an exchange rate shock on inflation along the distribution chain in the presence of endogeneity, nonlinearity and asymmetry. The econometric model is a smooth transition autoregressive vector estimated by Bayesian methods. This incorporates a model of pricing and the endogenous nature of the exchange rate pass-through (PT). The paper uses monthly data from Colombia for the period 2002 to 2015. The main findings are that PT is incomplete, endogenous and then changes over time, nonlinear and asymmetric in the short and long terms to the state of the economy (i.e., PT is nonlinear state-dependent) and to exchange rate shocks. Findings showed that historically the accumulated PT on inflation of import prices rises from 20% in the first month of the exchange rate shock to a maximum of around 66% in the first year. The equivalent figures on the inflation of producer goods go from 13% to 52%; on the inflation of imported consumer goods from 6% to 48%, and on the CPI inflation from 4% to 30%. At four years, the respective figures for accumulated PT are 98%, 84%, 94% and 80%, but uncertainty about these estimates increases rapidly over time.
    Keywords: Exchange rate pass-through, pricing along the distribution chain, endogeneity, nonlinearity, asymmetry, logistic smooth transition VAR (LST-VAR), Bayesian approach
    JEL: F31 E31 E52 C51 C52
    Date: 2016–03–02

This nep-cba issue is ©2016 by Maria Semenova. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.