nep-cba New Economics Papers
on Central Banking
Issue of 2016‒05‒28
nineteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Monetary Policy, Bank Bailouts and the Sovereign-Bank Risk Nexus in the Euro Area By Marcel Fratzscher, DIW Berlin, Humboldt-University Berlin and CEPR; Malte Rieth, DIW Berlin
  2. Targeting Constant Money Growth at the Zero Lower Bound By Michael T. Belongia; Peter N. Ireland
  3. Foreign Exchange Intervention under Policy Uncertainty By Gustavo Adler; Ruy Lama; Juan Pablo Medina Guzman
  4. How to escape a liquidity trap with interest rate rules By Duarte, Fernando M.
  5. Cost channel, interest rate pass-through and optimal monetary policy under zero lower bound By Siddhartha Chattopadhyay; Taniya Ghosh
  6. Challenges for Central Banks´ Macro Models By Lindé, Jesper; Smets, Frank; Wouters, Rafael
  7. Effective Macroprudential Policy; Cross-Sector Substitution from Price and Quantity Measures By Janko Cizel; Jon Frost; Aerdt G. F. J. Houben; Peter Wierts
  8. Money and Velocity During Financial Crises: From the Great Depression to the Great Recession By Richard G. Anderson; Michael Bordo; John V. Duca
  9. Monetary policy and volatility in the sterling money market By Osborne, Matthew
  10. The Real Effects of Capital Requirements and Monetary Policy: Evidence from the United Kingdom By De Marco, Filippo; Wieladek, Tomasz
  11. Optimal Inflation Rate in a Life-Cycle Economy By Takemasa Oda
  12. Analyzing and Comparing Basel's III Sensitivity Based Approach for the interest rate risk in the trading book By Mabelle Sayah
  13. Deposit Insurance: Theories and Facts By Charles W. Calomiris; Matthew Jaremski
  14. Assessment of Macroprudential Policy in a Dual Banking Sector By Zulkhibri, Muhamed; Naiya, Ismaeel
  15. Central Bank Transparency and Cross-border Banking By Stefan Eichler; Helge Littke; Lena Tonzer
  16. Policy implications of learning from more accurate Central Bank Forecasts By Paul Hubert
  17. VAR meets DSGE; Uncovering the Monetary Transmission Mechanism in Low-Income Countries By Bin Grace Li; Stephen A. O'Connell; Christopher Adam; Andrew Berg; Peter Montiel
  18. Financing Channel and Monetary Policy: Evidence from Islamic Banking in Indonesia By Zulkhibri, Muhamed; Sukmana, Raditya
  19. Accounting in central banks By Bholat, David; Darbyshire, Robin

  1. By: Marcel Fratzscher, DIW Berlin, Humboldt-University Berlin and CEPR; Malte Rieth, DIW Berlin
    Abstract: The paper analyses the empirical relationship between bank risk and sovereign credit risk in the euro area. Using structural VAR with daily financial markets data for 2003-13, the analysis confirms twoway causality between shocks to sovereign risk and bank risk, with the former being overall more important in explaining bank risk, than vice versa. The paper focuses specifically on the impact of non-standard monetary policy measures by the European Central Bank and on the effects of bank bailout policies by national governments. Testing specific hypotheses formulated in the literature, we find that bank bailout policies have reduced credit risk in the banking sector, but partly at the expense of raising the credit risk of sovereigns. By contrast, monetary policy was in most, but not all cases effective in lowering credit risk among both sovereigns and banks. Finally, we find spillover effects in particular from sovereigns in the euro area periphery to the core countries.
    JEL: E52 G10 E60
    Date: 2015–09
  2. By: Michael T. Belongia (University of Mississippi); Peter N. Ireland (Boston College)
    Abstract: Unconventional policy actions, including quantitative easing and forward guidance, taken by the Federal Reserve during and since the financial crisis and Great Recession of 2007-2009, have been widely interpreted as attempts to influence long-term interest rates after the federal funds rate hit its zero lower bound. Alternatively, similar actions could have been directed at stabilizing the growth rate of a monetary aggregate, so as to maintain a more consistent level of policy accommodation in the face of severe disruptions to the financial sector and the economy at large. This paper bridges the gap between these two views, by developing a structural vector autoregression that uses information contained in both interest rates and a Divisia monetary aggregate to infer the stance of Federal Reserve policy and to gauge its effects on aggregate output and prices. Counterfactual simulations from the SVAR suggest that targeting money growth at the zero lower bound would not only have been feasible, but would also have supported a stronger and more rapid economic recovery since 2010.
    Keywords: Constant money growth rate rules, Divisia monetary aggregates, Quantitative easing, Structural vector autoregressions, Zero lower bound
    JEL: E31 E32 E37 E41 E43 E47 E51 E52 E65
    Date: 2016–05–25
  3. By: Gustavo Adler; Ruy Lama; Juan Pablo Medina Guzman
    Abstract: We study the use of foreign exchange (FX) intervention as an additional policy instrument in an environment with learning, where agents infer the central bank policy rules from its policy actions. Under full information, a central bank focused on stabilizing output and inflation can achieve better outcomes by using FX intervention as an additional policy tool. Under policy uncertainty, where agents perceive that monetary policy may also have exchange rate stabilization goals, the use of FX intervention entails a trade-off, reducing output volatility while increasing inflation volatility. While having an additional policy tool is always beneficial, we find that the optimal magnitude of intervention is higher in monetary policy regimes with lower uncertainty. These results indicate that the benefits of using FX intervention as an additional stabilization tool are greater in regimes where monetary policy is credibly focused on output and inflation stabilization.
    Keywords: Foreign exchange;Central banks and their policies;Foreign Exchange Intervention, Monetary Policy, Learning, inflation, central bank, exchange, currency, Open Economy Macroeconomics,
    Date: 2016–03–17
  4. By: Duarte, Fernando M. (Federal Reserve Bank of New York)
    Abstract: I give necessary and sufficient conditions under which interest-rate feedback rules eliminate aggregate instability by inducing a globally unique optimal equilibrium in a canonical New Keynesian economy with a binding zero lower bound. I consider a central bank that initially keeps interest rates pegged at zero for a length of time that depends on the state of the economy and then switches to a standard Taylor rule. There are two crucial principles to achieving global uniqueness. In response to deepening deflationary expectations, the central bank must, first, sufficiently extend the initial period of zero interest rates and, afterward, follow a Taylor rule that does not obey the Taylor principle. I obtain all results assuming a passive or Ricardian fiscal policy stance, so that it is monetary policy alone that eliminates undesired equilibria. The interest rate rules that I consider do not require central banks to undergo any significant institutional change and do not rely on the Neo-Fisherian mechanism of inducing an increase in inflation by first increasing interest rates.
    Keywords: zero lower bound (ZLB); liquidity trap; New Keynesian model; indeterminacy; monetary policy; Taylor rule; Taylor principle; interest rate rule; forward guidance
    JEL: E43 E52 E58
    Date: 2016–05–01
  5. By: Siddhartha Chattopadhyay (Indian Institute of Technology, Kharagpur); Taniya Ghosh (Indira Gandhi Institute of Development Research)
    Abstract: Cost channel introduces trade-off between inflation rate and output gap. Unlike the canonical New Keynesian DSGE model, optimal monetary policy cannot set both inflation rate and output gap simultaneously to zero under a demand shock. Using a perfect foresight New Keynesian model with cost channel, this paper analyzes the optimal discretionary monetary policy under Zero Lower Bound (ZLB) for varying degree of interest rate pass-through. We find (i) exit date from ZLB becomes endogenous due to the trade-off between output gap and inflation introduced by the cost channel; (ii) presence of cost channel delays the exit from ZLB compared to models without cost channel; and (iii) exit date rises monotonically with the magnitude of demand shock and degree of interest rate pass-through.
    Keywords: New-Keynesian Model, Inflation Target, Liquidity Trap
    JEL: E63 E52 E58
    Date: 2016–05
  6. By: Lindé, Jesper (Research Department, Central Bank of Sweden); Smets, Frank (ECB, KU Leuven and CEPR); Wouters, Rafael (National Bank of Belgium and CEPR)
    Abstract: In this paper we discuss a number of challenges for structural macroeconomic models in the light of the Great Recession and its aftermath. It shows that a benchmark DSGE model that shares many features with models currently used by central banks and large international institutions has difficulty explaining both the depth and the slow recovery of the Great Recession. In order to better account for these observations, the paper analyses three extensions of the benchmark model. First, we estimate the model allowing explicitly for the zero lower bound constraint on nominal interest rates. Second, we introduce time-variation in the volatility of the exogenous disturbances to account for the non-Gaussian nature of some of the shocks. Third and finally, we extend the model with a financial accelerator and allow for time-variation in the endogenous propagation of financial shocks. All three extensions require that we go beyond the linear Gaussian assumptions that are standard in most policy models. We conclude that these extensions go some way in accounting for features of the Great Recession and its aftermath, but they do not suffice to address some of the major policy challenges associated with the use of non-standard monetary policy and macroprudential policies.
    Keywords: Monetary policy; DSGE; and VAR models; Regime-Switching; Zero Lower Bound; Financial Frictions; Great Recession; Macroprudential policy; Open economy
    JEL: E52 E58
    Date: 2016–05–01
  7. By: Janko Cizel; Jon Frost; Aerdt G. F. J. Houben; Peter Wierts
    Abstract: Macroprudential policy is increasingly being implemented worldwide. Its effectiveness in influencing bank credit and its substitution effects beyond banking have been a key subject of discussion. Our empirical analysis confirms the expected effects of macroprudential policies on bank credit, both for advanced economies and emerging market economies. Yet we also find evidence of substitution effects towards nonbank 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.
    Date: 2016–04–21
  8. By: Richard G. Anderson; Michael Bordo; John V. Duca
    Abstract: This study offers a single, consistent model that tracks the velocity of broad money (M2) since 1929, including the Great Depression, the global financial crisis, and the Great Recession. The model emphasizes the roles of changes in uncertainty and risk premia, financial innovation, and major banking regulations. Our findings suggest an enhanced role of a broad, liquid money aggregate as a policy guide during crises and their unwinding. Following crises, policymakers face the challenge of not only unwinding their balance sheet so as to prevent excess reserves from fueling a surge in M2, but also countering a fall in the demand for money as risk premia return to normal amid velocity shifts stemming from relevant financial reforms.
    Keywords: money demand, financial crises, monetary policy, liquidity, financial innovation
    JEL: E41 E50 G11
    Date: 2016–05
  9. By: Osborne, Matthew (Bank of England)
    Abstract: Money market volatility may disrupt the transmission mechanism of monetary policy as well as increase uncertainty for market participants. This paper assesses the impact of reforms to the Bank of England’s operating framework over the last two decades. These reforms have been successful in reducing overnight volatility. A new framework in 2006 which introduced reserves averaging and voluntary reserve targets was associated with lower volatility of overnight rates. Further reductions in volatility were associated with interim reforms and communications prior to the launch of this new framework. The injection of excess reserves under the floor system introduced in 2009 has been associated with a further reduction in volatility. Despite these encouraging findings, further analysis shows that the volatility of overnight rates had little effect on the volatility of longer-term rates except in the pre-2006 ‘zero reserves’ period and no effect at all on three-month Libor rates, which are the key benchmark for many derivatives and bank loans. Since longer-term rates are more important than overnight rates for the transmission of monetary policy to the real economy, the results provide limited support for prioritising the reduction of volatility in the design of central banks’ operating frameworks. The results also suggest that additional communication regarding likely future monetary policy decisions is associated with lower volatility of term rates.
    Keywords: Money market; monetary policy; interest rates; Bank of England
    JEL: E43 E44 E52 E58 G21
    Date: 2016–04–08
  10. By: De Marco, Filippo; Wieladek, Tomasz
    Abstract: We study the effects of bank-specific capital requirements on Small and Medium Enterprises (SMEs) in the UK from 1998 to 2006. Following a 1% increase in capital requirements, SMEs' asset growth contracts by 6.9% in the first year of a new bank-firm relationship, but the effect declines over time. We also compare the effects of capital requirements to those of monetary policy. Monetary policy only affects firms with higher credit risk and those borrowing from small banks, whereas capital requirements affect both. Capital requirement changes, instead, do not affect firms with alternative sources of finance, but monetary policy shocks do.
    Keywords: Capital requirements; Firm-level real effects; prudential and monetary policy.; relationship lending; SMEs
    JEL: E51 G21 G28
    Date: 2016–05
  11. By: Takemasa Oda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: This paper investigates long-run effects of inflation and deflation in a monetary life-cycle model that incorporates both capital stock and elastic labor supply as production factors. The model also introduces the zero lower bound on the nominal interest rate. The findings of this paper are twofold. First, in contrast to a result obtained from most neoclassical monetary models with an infinitely lived representative agent, the Friedman rule is not optimal and mild inflation can be desirable in this model. The Tobin effect on capital stock is encouraged by redistribution among households and therefore dominates distortionary effects of the inflation tax on labor supply and consumption. Importantly, the optimal rate of inflation depends on how inflation tax revenues are rebated to households. Second, there is a remarkable asymmetry in terms of welfare costs between inflation and deflation. For a lower rate of inflation than the rate that makes the nominal interest rate just zero, the Tobin effect works strongly in a deflationary direction because households are willing to hold more money, thus depressing aggregate output and social welfare significantly. This result reinforces the validity of pursuing mild inflation to evade the risk of hitting the zero lower bound.
    Keywords: Friedman rule, Zero lower bound, Tobin effect, Inflation tax, Redistribution
    JEL: E31 E58 O42
    Date: 2016–04
  12. By: Mabelle Sayah (SAF - Laboratoire de Sciences Actuarielle et Financière - UCBL - Université Claude Bernard Lyon 1, ISFA - Institut des Science Financière et d'Assurances - PRES Université de Lyon, Faculte des Sciences - Universite Saint Joseph - USJ - Université Saint-Joseph de Beyrouth)
    Abstract: A bank's capital charge computation is a widely discussed topic with new approaches emerging continuously. Each bank is computing this figure using internal methodologies in order to reflect its capital adequacy; however, a more homogeneous model is recommended by the Basel committee to enable judging the situation of these financial institutions and comparing different banks among each other. In this paper, we compare different numerical and econometric models to the sensitivity based approach (SBA) implemented by BCBS under Basel III in its February 2015 publication in order to compute the capital charge, we study the influence of having several currencies and maturities within the portfolio and try to define the time horizon and confidence level implied by Basel s III approach through an application on bonds portfolios. By implementing several approaches, we are able to find equivalent VaRs to the one computed by the SBA on a pre-defined confidence level (97.5 %). However, the time horizon differs according to the chosen methodology and ranges from 1 month up to 1 year.
    Keywords: interest rate risk,ICA,Dynamic Nelson Siegel,bonds portfolio,PCA,Basel III,GARCH,Capital charge,Sensitivity Based approach,trading book
    Date: 2016–02–01
  13. By: Charles W. Calomiris; Matthew Jaremski
    Abstract: Economic theories posit that bank liability insurance is designed as serving the public interest by mitigating systemic risk in the banking system through liquidity risk reduction. Political theories see liability insurance as serving the private interests of banks, bank borrowers, and depositors, potentially at the expense of the public interest. Empirical evidence – both historical and contemporary – supports the private-interest approach as liability insurance generally has been associated with increases, rather than decreases, in systemic risk. Exceptions to this rule are rare, and reflect design features that prevent moral hazard and adverse selection. Prudential regulation of insured banks has generally not been a very effective tool in limiting the systemic risk increases associated with liability insurance. This likely reflects purposeful failures in regulation; if liability insurance is motivated by private interests, then there would be little point to removing the subsidies it creates through strict regulation. That same logic explains why more effective policies for addressing systemic risk are not employed in place of liability insurance. The politics of liability insurance also should not be construed narrowly to encompass only the vested interests of bankers. Indeed, in many countries, it has been installed as a pass-through subsidy targeted to particular classes of bank borrowers.
    JEL: E44 G21 G28
    Date: 2016–05
  14. By: Zulkhibri, Muhamed (The Islamic Research and Teaching Institute (IRTI)); Naiya, Ismaeel (Islamic Development Bank (IDB))
    Abstract: The paper synthesizes the growing literature on macroprudential policy in particular countries with a dual banking system. In a dual banking system, both conventional and Islamic financial institutions operate side-by-side, but specific laws and regulations have been introduced for the Islamic financial institutions. Based on the analysis there is no “one size fits all”; different models might be effective depending on the country specifics. The choice among the different macroprudential models is mostly influenced by traditions, current institutional frameworks for other policies and political economy considerations. Furthermore, there is no differentiation on macroprudential policy framework between conventional and Islamic financial institutions has been practiced by the authorities with dual banking system. The reason is to avoid regulatory arbitrage between these two financial institutions and the fact that Islamic financial institution is still largely based on mark-up or profit margin techniques in its operation
    Keywords: Macroprudential; Islamic Finance; Regulation; Systemic Risks
    JEL: G20 G21 G28
    Date: 2016–05–01
  15. By: Stefan Eichler; Helge Littke; Lena Tonzer
    Abstract: We analyze the effect of central bank transparency on cross-border bank activities. Based on a panel gravity model for cross-border bank claims for 21 home and 47 destination countries from 1998 to 2010, we find strong empirical evidence that a rise in central bank transparency in the destination country, on average, increases cross-border claims. Using interaction models, we find that the positive effect of central bank transparency on cross-border claims is only significant if the central bank is politically independent. Central bank transparency and credibility are thus considered complements by banks investing abroad.
    Keywords: central bank transparency, cross-border banking, gravity model
    JEL: E58 F30 G15
    Date: 2016–05
  16. By: Paul Hubert (OFCE)
    Abstract: How might central bank communication of its internal forecasts assist the conduct of monetary policy? The literature has shown that heterogeneous expectations may have destabilizing effects on aggregate dynamics. This paper analyzes through adaptive learning the policy implications of central bank influence of private forecasts stemming from more accurate central bank forecasts. In this case, the central bank must only respect the Taylor principle to ensure macroeconomic stability, in contrast to the situation where private agents are learning from less accurate central bank forecasts.
    Keywords: Adaptive Learning; Taylor Principle; Monetary Policy
    JEL: E5 D8
    Date: 2015–03
  17. By: Bin Grace Li; Stephen A. O'Connell; Christopher Adam; Andrew Berg; Peter Montiel
    Abstract: VAR methods suggest that the monetary transmission mechanism may be weak and unreliable in low-income countries (LICs). But are structural VARs identified via short-run restrictions capable of detecting a transmission mechanism when one exists, under research conditions typical of these countries? Using small DSGEs as data-generating processes, we assess the impact on VAR-based inference of short data samples, measurement error, high-frequency supply shocks, and other features of the LIC environment. The impact of these features on finite-sample bias appears to be relatively modest when identification is valid—a strong caveat, especially in LICs. However, many of these features undermine the precision of estimated impulse responses to monetary policy shocks, and cumulatively they suggest that “insignificant†results can be expected even when the underlying transmission mechanism is strong.
    Keywords: Monetary transmission mechanism;Low-income developing countries;Variables (Mathematics);Vector autoregression;General equilibrium models;Monetary Transmission Mechanism; Monetary Policy; Low Income Countries; Vector Autoregression Methods; Monte Carlo Methods
    Date: 2016–04–11
  18. By: Zulkhibri, Muhamed (The Islamic Research and Teaching Institute (IRTI)); Sukmana, Raditya (The Islamic Research and Teaching Institute (IRTI))
    Abstract: Using Indonesia Islamic banks data from 2003 to 2014, this paper employs panel regression methodology by investigating the responses of Islamic banks to changes in financing rate and monetary policy may differ, depending on their characteristics. The results suggest that the financing rate has negative impact on Islamic bank financing, while bank-specific characteristics have positive influence on Islamic bank financing. The degree of size and capital have greater impact than liquidity on Islamic bank financing. On the other hand, changes in monetary policy is insignificant on bank financing, which implies that the transmission of monetary policy through the Islamic segment of the banking sector is weak. Furthermore, the weak impact of monetary policy on bank financing can be explained by the dramatic expansion of Islamic banks during this sample period, which contributed to substantial increase in deposit growth and high liquidity position.
    Keywords: Islamic Banks; Financing Rate; Financing Channels; Monetary Policy; Panel Regression
    JEL: E44 E52
    Date: 2016–03–01
  19. By: Bholat, David (Bank of England); Darbyshire, Robin
    Abstract: This paper examines the important but not often discussed issue of accounting in central banks. It highlights the distinguishing factors that make the financial statements of central banks unique relative to those produced by other bodies. We begin by explaining why central banks produce financial statements. We then discuss a variety of specific topics in central bank accounting. In terms of balance sheet items, we discuss banknotes, shareholders’ equity, gold, foreign exchange and financial instruments. Our discussion of the income statement then centres on profit recognition and distribution.
    Keywords: Central bank accounting; central bank balance sheet; seigniorage; central bank capital;
    JEL: E58 G20 H83 M40 M41 M48
    Date: 2016–05–20

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