nep-cba New Economics Papers
on Central Banking
Issue of 2016‒05‒21
23 papers chosen by
Maria Semenova
Higher School of Economics

  1. Effects of US monetary policy shocks during financial crises - A threshold vector autoregression approach By Renee Fry-McKibbin; Jasmine Zheng
  2. On the limits of macroprudential policy By Marcin Kolasa
  3. Countercyclical capital rules for small open economies By Daragh Clancy
  4. Effective macroprudential policy: Cross-sector substitution from price and quantity measures By Janko Cizel; Jon Frost; Aerdt Houben; Peter Wierts
  5. Communicating dissent on monetary policy: Evidence from central bank minutes By David-Jan Jansen; Richhild Moessner
  6. International dynamics of inflation expectations By Aleksei Netšunajev; Lars Winkelmann; ;
  7. Soft budget constraints, European Central Banking and the financial crisis By Jannik, Jäger; Grigoriadis, Theocharis
  8. Measuring the effect of the zero lower bound on monetary policy By Carvalho, Carlos; Hsu, Eric; Nechio, Fernanda
  9. Circumventing the Zero Lower Bound with Monetary Policy Rules Based on Money By Michael T. Belongia; Peter N. Ireland
  10. The spillovers, interactions, and (un)intended consequences of monetary and regulatory policies By Forbes, Kristin; Reinhardt, Dennis; Wieladek, Tomasz
  11. Regulation and Bankers’ Incentives By Fabiana Gómez; Jorge Ponce
  12. Disentangling the Monetary Policy Stance By Filippo Gori
  13. When does the cost channel pose a challenge to inflation targeting central banks? By Smith, Andrew Lee
  14. Monetary Policy in the Presence of Islamic Banking By Mariam El Hamiani Khatat
  15. Optimal Forward Guidance By Bilbiie, Florin Ovidiu
  16. Optimal monetary policy in open economies revisited By Fujiwara, Ippei; Wang, Jiao
  17. Foreign exchange rates with the Taylor rule and VECMs By Piersanti, Fabio Massimo; Rizzati, Massimiliano; Nakmai, Siwat
  18. Macroprudential and Monetary Policy Interactions in a DSGE Model for Sweden By Jiaqian Chen; Francesco Columba
  19. Finding the Equilibrium Real Interest Rate in a Fog of Policy Deviations By Taylor, John B.; Wieland, Volker
  20. Financial Stability and Interest-Rate Policy; A Quantitative Assessment of Costs and Benefits By Andrea Pescatori; Stefan Laseen
  21. Heterogeneity in euro-area monetary policy transmission: Results from a large multi-country BVAR model By Mandler, Martin; Scharnagl, Michael; Volz, Ute
  22. Macroprudential Policy: a Blessing or a Curse? By Lilit Popoyan
  23. A Theory of Deflation: Can Expectations Be Influenced by a Central Bank? By Harashima, Taiji

  1. By: Renee Fry-McKibbin; Jasmine Zheng
    Abstract: This paper analyzes the impact of monetary policy during periods of low and high financial stress in the US economy using a Threshold Vector Autoregression model. There is evidence that expansionary monetary policy is effective during periods of high financial stress with larger responses having a higher proportionate effect on output. The existence of a cost channel effect during periods of high financial stress implies the existence of a short run output-inflation trade off during financial crises. Large expansionary monetary shocks also increase the likelihood of moving the economy out of a high financial stress regime.
    Keywords: Monetary policy, financial stress, threshold vector autoregression models
    JEL: F44 E44 E52
    Date: 2016–05
  2. By: Marcin Kolasa
    Abstract: This paper studies how macroprudential policy tools can complement the interest ratebased monetary policy in achieving a selection of dual stabilization objectives. We show analytically in a canonical New Keynesian model with collateral constraints that using the loan-to-value ratio as an additional policy instrument does not resolve the inflation-output volatility tradeoff. Perfect targeting of inflation and either credit or house prices with monetary and macroprudential policy is possible only if the role of credit in the economy is sufficiently small. Any of these three dual stabilization objectives can be achieved with the monetary-fiscal policy mix. The identified limits to the LTV ratio-based policy are related to its predominantly intertemporal effect on decisions made by financially constrained agents.
    Keywords: macroprudential policy, monetary policy, stabilization tradeoffs
    JEL: E32 E58 E63 G21 G28
    Date: 2016
  3. By: Daragh Clancy (European Stability Mechanism)
    Abstract: The growing literature on macroprudential regulation focuses on how a combination monetary and macroprudential policies can boost financial stability. We contribute to this literature by developing a DSGE model that assesses the effectiveness of countercyclical capital regulation in small open economies, in monetary unions or with exchange rate pegs, where policymakers do not have full control over traditional stabilisation instruments such as nominal interest and exchange rates. Our model shows that, in such economies, macroprudential policy must play an outsized role in mitigating the adverse effects of macro-financial feedback loops. To validate the model’s ability to replicate the stylised facts of financial crises, we calibrate using data for the Irish economy the recent housing crash. Our results demonstrate that the pro-active use of countercyclical capital regulation can indeed help ensure financial stability. In terms of policy advice, we find that bestowing even greater flexibility on regulators to act against the credit cycle has positive benefits. We also find that more aggressive action during the release phase can bolster the economy’s ability to absorb a negative shock.
    Keywords: small open economy, macroprudential policy, macro-financial linkages
    JEL: E44 E51 G10 G28
    Date: 2016–03
  4. By: Janko Cizel; Jon Frost; Aerdt Houben; Peter Wierts
    Abstract: Macroprudential policy is increasingly being implemented worldwide. Key questions are its effectiveness in influencing bank credit and substitution effects beyond banking. Our results confirm the expected effects of macroprudential policies on bank credit, both for advanced economies and emerging market economies. But results also confirm substitution effects towards non-bank credit, especially in advanced economies, reducing the policies' effect on total credit. Quantity restrictions are particularly potent in constraining bank credit but also cause the strongest substitution effects. Policy implications indicate a need to extend macroprudential policy beyond banking, especially in advanced economies.
    Keywords: Financial cycle; macroprudential regulation; financial supervision; (shadow) banking
    JEL: E58 G10 G18 G20
    Date: 2016–04
  5. By: David-Jan Jansen; Richhild Moessner
    Abstract: We study whether differences in views during monetary policy meetings affect central bank transparency. Using data published by four central banks, we find that dissent among committee members increases the file size of minutes of policy meetings. However, dissent does not affect the readability of these minutes. We conclude that minutes can still be useful in providing accountability when views differ without necessarily impairing transparency.
    Keywords: monetary policy; minutes; dissent; transparency; accountability
    JEL: E52 E58
    Date: 2016–05
  6. By: Aleksei Netšunajev; Lars Winkelmann; ;
    Abstract: To what extent are US and Euro Area (EA) inflation expectations determined by foreign shocks? How do transmissions change during the great recession and European sovereign debt crisis? We address these questions with a flexible structural VAR model of weekly financial markets’ inflation expectations and an index of commodity futures. For the identification of the model, we exploit the heteroscedasticity of the data. We propose instrument-type regressions to uncover the economic nature and origin of identified shocks. In line with the discussion about global inflation, we find that inflation expectations can be labeled global over short expectations horizons but local at long horizons. While large US macro shocks explain the strong drop in US and EA inflation expectations during the great recession, expectations shocks are the important driver from 2009 on.
    Keywords: Spillover, monetary policy, expectations shocks, financial crisis, identification through heteroskedasticity
    JEL: E31 F42 E52
    Date: 2016–03
  7. By: Jannik, Jäger; Grigoriadis, Theocharis
    Abstract: During the European financial crisis, the European Central Bank implemented a series of unconventional monetary policy measures. We argue that these unconventional monetary policy measures created soft budget constraints for the Eurozone countries by lowering their bond yield spreads. This hypothesis is tested using pooled OLS estimations and two different datasets: monetary policy event dummies and the purchase volumes of the Securities Markets Programme (SMP). We find significantly negative effects on bond yield spreads for both datasets, leading us to accept the hypothesis. The results are confirmed by robustness checks that directly estimate the effect of unconventional monetary policy on central government debt.
    Keywords: soft budget constraints,bond yield spreads,monetary policy events,securities markets programme,European Central Bank
    JEL: F34 F37 F42 P17 P51
    Date: 2016
  8. By: Carvalho, Carlos (PUC-Rio); Hsu, Eric (UC Berkeley); Nechio, Fernanda (Federal Reserve Bank of San Francisco)
    Abstract: The Zero Lower Bound (ZLB) on interest rates is often regarded as an important constraint on monetary policy. To assess how the ZLB affected the Fed’s ability to conduct policy, we estimate the effects of Fed communication on yields of different maturities in the pre-ZLB and ZLB periods. Before the ZLB period, communication affects both short and long-dated yields. In contrast, during the ZLB period, the reaction of yields to communication is concentrated in longer-dated yields. Our findings support the view that the ZLB did not put such a critical constraint on monetary policy, as the Fed retained some ability to affect long-term yields through communication.
    JEL: E43 E52 E58
    Date: 2016–04–01
  9. By: Michael T. Belongia (University of Mississippi); Peter N. Ireland (Boston College)
    Abstract: Discussions of monetary policy rules after the 2008-2009 recession highlight the potential impotence of a central bank's actions when the short-term interest rate under its control is limited by the zero lower bound. This perspective assumes, in a manner consistent with the canonical New Keynesian model, that the quantity of money has no role to play in transmitting a central bank's actions to economic activity. This paper examines the validity of this claim and investigates the properties of alternative monetary policy rules based on control of the monetary base or a monetary aggregate in lieu of a short-term interest rate. The results indicate that rules of this type have the potential to guide monetary policy decisions toward the achievement of a long run nominal goal without being constrained by the zero lower bound on a nominal interest rate. They suggest, in particular, that by exerting its influence over the monetary base or a broader aggregate, the Federal Reserve could more effectively stabilize nominal income around a long-run target path, even in a low or zero interest-rate environment.
    Keywords: Adjusted monetary base, Divisia monetary aggregates, Monetary policy rules, Nominal income targeting, Zero lower bound
    JEL: E31 E32 E37 E42 E51 E52 E58
    Date: 2016–05–01
  10. By: Forbes, Kristin (Monetary Policy Committee Unit, Bank of England); Reinhardt, Dennis (Monetary Policy Committee Unit, Bank of England); Wieladek, Tomasz (Monetary Policy Committee Unit, Bank of England)
    Abstract: Have bank regulatory policies and unconventional monetary policies — and any possible interactions — been a factor behind the recent ‘deglobalisation’ in cross-border bank lending? To test this hypothesis, we use bank-level data from the United Kingdom — a country at the heart of the global financial system. Our results suggest that increases in microprudential capital requirements tend to reduce international bank lending and some forms of unconventional monetary policy can amplify this effect. Specifically, the United Kingdom’s Funding for Lending Scheme (FLS) significantly amplified the effects of increased capital requirements on external lending. Quantitative easing may also have had an amplification effect, but these estimates are usually insignificant and smaller in magnitude. We find that this interaction between microprudential regulations and the FLS can explain roughly 30% of the contraction in aggregate UK cross-border bank lending between mid-2012 and end-2013, corresponding to around 10% of the contraction globally. This suggests that unconventional monetary policy designed to support domestic lending can have the unintended consequence of reducing foreign lending.
    Keywords: Capital requirements; Funding for Lending Scheme; financial deglobalisation
    JEL: G21 G28
    Date: 2016–01–22
  11. By: Fabiana Gómez (University of Bristol); Jorge Ponce (Banco Central del Uruguay and Departamento de Economía, Facultad de Ciencias Sociales, Universidad de la República)
    Abstract: We formally compare the effects of minimum capital requirements, capital buffers, liquidity requirements and loan loss provisions on the incentives of bankers to exert effort and take excessive risk. We find that these regulations impact differently the behavior of bankers. In the case of investment banks, the application of capital buffers and liquidity requirements makes it more difficult to achieve the first best solution. In the case of commercial banks, capital buffers, reserve requirements and traditional loan loss provisions for expected losses provide adequate incentives to bank managers, although the capital buffer is the most powerful instrument. Counter-cyclical (so-called dynamic) loan loss provisions may provide bank managers with incentives to gamble. The results inform policy makers in the ongoing debate about the harmonization of banking regulation and the implementation of Basel III.
    Keywords: Banking regulation, minimum capital requirement, capital buffer, liquidity requirement, (counter-cyclical) loan loss provision, commercial banks, investment banks, bankers’ incentives, effort, risk.
    JEL: G21 G28
    Date: 2015–11
  12. By: Filippo Gori (The Graduate Institute of International and Development Studies)
    Abstract: This paper presents an account of the monetary policy stance for euro area countries from 1999 to the beginning of the crisis in 2008. The analysis starts with the derivation of a synthetic index measuring the average tightness of monetary policy across euro area members. The index is constructed using pseudo-Taylor residuals, obtained from an estimated monetary policy rule for the whole euro area and country speci c fundamentals. This measure is then decomposed to disentangle the role of in ation and fundamental economic dynamics. Results suggest that there were signi cant di erences in monetary policy stance across euro area members over the period considered. Such di erences are primarily driven by wedges in price dynamics, most of which are disconnected from real economic activity.
    Keywords: Monetary policy, Eonia, euro area.
    JEL: E52 E58 E61
    Date: 2016–05–09
  13. By: Smith, Andrew Lee (Federal Reserve Bank of Kansas City)
    Abstract: In a sticky-price model where firms finance their production inputs, there is both a lower and an upper bound on the central bank's inflation response necessary to rule out the possibility of self-fulfilling inflation expectations. This paper shows that real wage rigidities decrease this upper bound, but coefficients in the range of those on the Taylor rule place the economy well within the determinacy region. However, when there is time-variation in the share of firms who finance their inputs (i.e. Markov-Switching) then inflation targeting interest rate rules are often found to result in indeterminacy, even if the central bank also targets output. In this case, adding money growth as an intermediate target in the Taylor rule can alleviate this indeterminacy and anchor inflation expectations. Whether the money growth target should be a constant feature of the central bank's policy rule or Markov-Switch depends on the weight the central bank places on output stability relative to inflation stability and the size of money demand shocks.
    Keywords: Taylors principle; Determinacy; Regime switching; Money; Cost channel; T Cost Channel; Taylor principle; Determinacy; Regime switching; Money
    JEL: C62 E3 E4 E5
    Date: 2015–06–01
  14. By: Mariam El Hamiani Khatat
    Abstract: This paper discusses key issues related to the conduct of monetary policy in countries that have Islamic banks. It describes the macrofinancial background and monetary policy frameworks where Islamic banks typically operate, and discusses the monetary transmission mechanism in economies where Islamic and conventional banking coexist. Most economies with Islamic banks also have conventional banks and this calls for a comprehensive approach to monetary policy. At the same time, a dual approach to monetary policy should be considered whenever the Islamic segment of the financial system is not as developed as the conventional one. The paper tries to shed light on potential spillovers between conventional and Islamic financial systems, and proposes specific recommendations on the design of Islamic monetary policy operations and for facilitating monetary transmission through the Islamic financial system.
    Keywords: Monetary policy;Islamic banking;Commercial banks;Monetary transmission mechanism;Islamic finance;Financial systems;Islamic banks, dual financial systems, monetary policy, monetary transmission mechanism, monetary operations, Sukuk markets, lender of last resort.
    Date: 2016–03–18
  15. By: Bilbiie, Florin Ovidiu
    Abstract: For how long should central banks prolong a low interest rates policy beyond the end of a liquidity trap? I solve analytically for the optimal, welfare-maximizing duration of forward guidance FG, modelled stochastically---through a probability of low interest rates once out of the trap. Optimal FG balances the welfare benefit of higher consumption (and lower volatility) today with the welfare cost of higher consumption volatility once the trap is over. Its main determinants are the trap duration and the severity of the recession. Reassuringly for policymakers, a simple rule consisting of announcing an expected FG duration equal to half the duration of the trap, times a factor proportional to interest rate spreads is close to optimal. I extend this analytical apparatus to more sophisticated models with heterogenous agents: informational asymmetries, and financial frictions
    Keywords: forward guidance; hand-to-mouth.; heterogenous agents; heterogenous beliefs; incomplete markets; liquidity trap; Optimal monetary policy; unemployment risk; zero lower bound
    JEL: E21 E31 E40 E50
    Date: 2016–04
  16. By: Fujiwara, Ippei (Keio University); Wang, Jiao (Australian National University)
    Abstract: This paper revisits optimal monetary policy in open economies, in particular, focusing on the noncooperative policy game under local currency pricing in a two-country dynamic stochastic general equilibrium model. We first derive the quadratic loss functions which noncooperative policy makers aim to minimize. Then, we show that noncooperative policy makers face extra trade-offs regarding stabilizing the real marginal costs induced by deviations from the law of one price under local currency pricing. As a result of the increased number of stabilizing objectives, welfare gains from cooperation emerge even when two countries face only technology shocks, which usually leads to equivalence between cooperation and noncooperation. Still, gains from cooperation are not large, implying that frictions other than nominal rigidities are necessary to strongly recommend cooperation as an important policy framework to increase global welfare.
    JEL: E52 F41 F42
    Date: 2016–05–01
  17. By: Piersanti, Fabio Massimo; Rizzati, Massimiliano; Nakmai, Siwat
    Abstract: In this project, we challenge the conventional wisdom on exchange rate predictability with the Taylor rule (Molodtsova & Papell, 2009; Rossi, 2013) by employing the vector error correction model (VECM) when the cointegration (CI) rank of our multivariate model is greater than one and less than full. Even though our approach is quite bounded to the finding of a suitable CI rank, our predictions are quite good when compared to a driftless random walk as a benchmark in the long run, whilst the performance in the short run is not. Notwithstanding we claim that we could also obtain better results had we been able to perform a static forecast for three months ahead rather than one (the latter is the only case admitted by the gretl software).
    Keywords: Foreign exchange rates, the Taylor rule, VECMs
    JEL: C53 F31
    Date: 2016–03–30
  18. By: Jiaqian Chen; Francesco Columba
    Abstract: We analyse the effects of macroprudential and monetary policies and their interactions using an estimated dynamic stochastic general equilibrium (DSGE) model tailored to Sweden. Households face a ceiling on their loan-to-value ratio and must amortize their mortgages. The government grants mortgage interest payment deductions. Lending rates are affected by mortgage risk weights. We find that demand-side macroprudential measures are more effective in curbing household debt ratios than monetary policy, and they are less costly in terms of foregone consumption. A tighter macroprudential stance is also found to be welfare improving, by promoting lower consumption volatility in response to shocks, especially when using a combination of macroprudential instruments.
    Keywords: Housing;Sweden;Mortgages;Housing prices;Debt;Macroprudential Policy;Monetary policy;General equilibrium models;Macroprudential Policies; Monetary Policy; Collateral Constraints
    Date: 2016–03–23
  19. By: Taylor, John B.; Wieland, Volker
    Abstract: Recently there has been an explosion of research on whether the equilibrium real interest rate has declined, an issue with significant implications for monetary policy. A common finding is that the rate has declined. In this paper we provide evidence that contradicts this finding. We show that the perceived decline may well be due to shifts in regulatory policy and monetary policy that have been omitted from the research. In developing the monetary policy implications, it is promising that much of the research approaches the policy problem through the framework of monetary policy rules, as uncertainty in the equilibrium real rate is not a reason to abandon rules in favor of discretion. But the results are still inconclusive and too uncertain to incorporate into policy rules in the ways that have been suggested.
    Keywords: equilibrium real interest rate; interest rate rules; Monetary policy
    JEL: E43 E52
    Date: 2016–05
  20. By: Andrea Pescatori; Stefan Laseen
    Abstract: Should monetary policy use its short-term policy rate to stabilize the growth in household credit and housing prices with the aim of promoting financial stability? We ask this question for the case of Canada. We find that to a first approximation, the answer is no— especially when the economy is slowing down.
    Keywords: Interest rate policy;Canada;Household credit;Housing prices;Credit expansion;Financial risk;Monetary policy;Financial stability;Monetary Policy, Endogenous Financial Risk, Bayesian VAR, Non-Linear Dynamics, Policy Evaluation.
    Date: 2016–03–21
  21. By: Mandler, Martin; Scharnagl, Michael; Volz, Ute
    Abstract: We study cross-country differences in monetary policy transmission across the large four euro-area countries (France, Germany, Italy and Spain) using a large Bayesian vector autoregressive model with endogenous prior selection. Drawing both on the posterior distributions of the cross-country differences in impulse responses as well as on a battery of other tests, we find real output to respond less negatively in Spain to monetary policy tightening than in the other three countries, while the decline in the price level is weaker in Germany. Bond yields rise more strongly and more persistently in France and Germany than in Italy and Spain.
    Keywords: monetary policy,transmission mechanism,euro area,Bayesian vector autoregression
    JEL: C11 C54 E52
    Date: 2016
  22. By: Lilit Popoyan
    Abstract: After the destructive impact of the global financial crisis of 2008, many believe that pre-crisis financial market regulation did not take the "big picture" of the system suffciently into account and, subsequently, financial supervision mainly "missed the forest for the trees". As a result, the need for macroprudential aspects of regulation emerged, which has recently become the focal point of many policy debates. This has also led to intense discussion on the contours of monetary policy after the post-crisis "new normal". Here, I review recent progress in empirical and theoretical research on the effectiveness of macroprudential tools, as well as the current state of the debate, in order to extract common policy conclusions. The work highlights that, despite the achievements in the literature, the current experience and knowledge of how macroprudential instruments work, their calibration, and the mechanisms through which they interact with each other and with monetary policy are rather limited and conflicting. Moreover, I critically survey and note the current challenges faced by macroprudential regulation in creating stable, yet effcient financial systems. At the same time, I emphasize the importance of accepting that many risks may remain, requiring that we proceed prudently and develop better plans for future crises.
    Keywords: macroprudential policy; Basel III regulation; capital adequacy ratio; counter-cyclical capital buffer; leverage requirement; systemic risk; crisis management; financial stability
    Date: 2016–05–16
  23. By: Harashima, Taiji
    Abstract: This paper examines how to reverse deflation to inflation. Once deflation takes root, it is not easy to reverse because of the zero lower bound in nominal interest rates. My model indicates that there are two steady states where both inflation/deflation (i.e., changes in prices) and real activity (i.e., quantities) remain unchanged: that is, there are inflationary and deflationary steady states. The model indicates that, to switch a deflationary steady state to an inflationary steady state, a central bank needs to influence the time preference rates of the government and the representative household. It is not easy, however, to do so, and the best way of switching deflation to inflation may be to wait for a lucky event (i.e., an exogenous shock).
    Keywords: Deflation; The zero lower bound; Monetary policies; Quantitative easing; Time preference
    JEL: E31 E52 E58
    Date: 2016–05–15

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