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on Central Banking |
| By: | Woodford, Michael |
| Abstract: | This paper compares three alternative dimensions of central-bank policy --- conventional interest-rate policy, quantitative easing, and macroprudential policy --- showing in the context of a simple intertemporal general-equilibrium model why they are logically independent dimensions of policy, and how they jointly determine financial conditions, aggregate demand, and the severity of risks to financial stability. Quantitative easing policies increase financial stability risk less than either of the other two policies, relative to the magnitude of aggregate demand stimulus; and a combination of expansion of the cental bank's balance sheet with a suitable tightening of macroprudential policy can have a net expansionary effect on aggregate demand with no increased risk to financial stability. This suggests that quantitative easing policies may be useful as an approach to aggregate demand management not only when the zero lower bound precludes further use of conventional interest-rate policy, but also when it is not desirable to further reduce interest rates because of financial stability concerns. |
| Keywords: | macroprudential policy; money premium; zero lower bound |
| JEL: | E44 E52 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11287&r=cba |
| By: | Emmanuel Farhi; Matteo Maggiori |
| Abstract: | We propose a simple model of the international monetary system. We study the world supply and demand for reserve assets denominated in different currencies under a variety of scenarios: a Hegemon vs. a multipolar world; abundant vs. scarce reserve assets; a gold exchange standard vs. a floating rate system; away from vs. at the zero lower bound (ZLB). We rationalize the Triffin dilemma, which posits the fundamental instability of the system, as well as the common prediction regarding the natural and beneficial emergence of a multipolar world, the Nurkse warning that a multipolar world is more unstable than a Hegemon world, and the Keynesian argument that a scarcity of reserve assets under a gold standard or at the ZLB is recessive. We show that competition among few countries in the issuance of reserve assets can have perverse effects on the total supply of reserve assets. We analyze forces that lead to the endogenous emergence of a Hegemon. Our analysis is both positive and normative. |
| JEL: | E12 E42 E43 E44 E52 E61 F02 F31 F32 F33 F34 F36 F38 F42 F44 F53 F55 G11 G12 G15 G18 G21 G23 G28 H12 H63 H87 N1 N10 N11 N12 N13 N14 N2 N20 N21 N22 N23 N24 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22295&r=cba |
| By: | Hjortsoe, Ida (Monetary Policy Committee Unit, Bank of England); Weale, Martin (Monetary Policy Committee Unit, Bank of England); Wieladek, Tomasz (Monetary Policy Committee Unit, Bank of England) |
| Abstract: | Does the current account improve or deteriorate following a monetary policy expansion? We examine this issue theoretically and empirically. We show that a standard open economy DSGE model predicts that the current account response to a monetary policy shock depends on the degree of economic regulation in different markets. In particular, financial (product market) liberalisation makes it more likely that the current account deteriorates (improves) following a monetary expansion. We test these theoretical predictions with a varying coefficient Bayesian panel VAR model, where the coefficients are allowed to vary as a function of the degree of financial, product and labour market regulation on data from 1976 Q1–2006 Q4 for 19 OECD countries. Our empirical results support the theory. We therefore conclude that following a monetary policy expansion, the current account is more likely to go into deficit (surplus) in countries with more liberalised financial (product) markets. |
| Keywords: | Balance of payments; current account; Bayesian panel VAR; economic liberalisation; monetary policy |
| JEL: | C11 C23 E52 F32 |
| Date: | 2016–03–04 |
| URL: | http://d.repec.org/n?u=RePEc:mpc:wpaper:0045&r=cba |
| By: | Speck, Christian |
| Abstract: | Did the decline in inflation rates from 2012 to 2015 and the low levels of market-based inflation expectations lead to de-anchored inflation dynamics in the euro area? This paper is the first time-varying event study to investigate the reaction of inflation-linked swap (ILS) rates - a market-based measure of inflation expectations - to macroeconomic surprises in the euro area. Compared to the pre-crisis period, surprises have a much stronger effect on spot ILS rates during the crisis. Medium-term forward ILS rates remain insensitive to news most of the time, which implies inflation anchoring. Only short periods of sensitivity on the part of medium-term forward ILS rates are identified at times of low inflation or recession. The sensitivity is lower over more distant forecast horizons such that medium-term sensitivity represents an inflation adjustment process and provides evidence for a de-anchoring of inflation expectations or a loss of credibility for the Eurosystem's policy target. |
| Keywords: | Inflation Anchoring,Inflation Expectations,Inflation-Linked Swaps,Event Study,Central Banking |
| JEL: | E31 E44 G12 G14 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:042016&r=cba |
| By: | Davide Romelli; Cristina Terra; Enrico Vasconcelos |
| Abstract: | This article investigates the impact of trade openness on the relationship between current account and real exchange rates, during episodes of sudden stops and of abrupt exchange rate depreciations. Using data for developed and emerging economies for the period 1970--2011, we find that more open economies are associated with lower exchange rate depreciations during sudden stops. We also provide evidence that, during abrupt exchange rate depreciation episodes, economies that are more open to trade experience a larger change in current account and trade balance. In other words, our results indicate that improvements in current account and trade balance are accompanied by a smaller exchange rate depreciation in more open economies. These findings are robust to different measures of openness to trade and methodologies of identifying sudden stops and abrupt exchange rate depreciations |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:437&r=cba |
| By: | Aytug, Huseyin |
| Abstract: | After the invention of the Reserve Option Mechanism (ROM) by the Central Bank of Turkey, it has been debated whether it can help decrease the volatility of foreign exchange rate. In this study, I apply a new micro-econometric technique, the synthetic control method, in order to construct a counterfactual foreign exchange rate volatility in the absence of the ROM. I find that, USD/TRY rate is less volatile under the ROM. However, the ROM has not worked efficiently after the announcement of FED's tapering in May 2013. Furthermore, the ROM could have decreased the volatility of foreign exchange rate if FED had not started tapering. |
| Keywords: | FX Intervention, Synthetic Control Method, Required Reserves |
| JEL: | C31 E58 F31 |
| Date: | 2016–01–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:71400&r=cba |
| By: | Honkapohja, Seppo; Mitra, Kaushik |
| Abstract: | We examine global dynamics under learning in New Keynesian models with price level targeting that is subject to the zero lower bound. The role of forward guidance is analyzed under transparency about the policy rule. Properties of transparent and non-transparent regimes are compared to each other and to the corresponding cases of inflation targeting. Robustness properties for different regimes are examined in terms of the domain of attraction of the targeted steady state and volatility of inflation, output and interest rate. We analyze the effect of higher inflation targets and large expectational shocks for the performance of these policy regimes. |
| Keywords: | adaptive learning, monetary policy, inflation targeting, zero interest rate lower bound |
| JEL: | E63 E52 E58 |
| Date: | 2015–04–07 |
| URL: | http://d.repec.org/n?u=RePEc:bof:bofrdp:2015_009&r=cba |
| By: | Kalatie, Simo; Laakkonen, Helinä; Tölö, Eero |
| Abstract: | According to EU legislation, the national authorities should use the principle of 'guided discretion' in setting the countercyclical capital buffer (CCB), which increases banks' resilience against systemic risk associated with periods of excessive credit growth. This means that the decision should be based on signals from a pre-determined set of early warning indicators, but that there should also be room for discretion, as there is always uncertainty associated with the use of early warning indicators. The European Systemic Risk Board (ESRB) recommends that the authorities use the deviation of the credit-to-GDP ratio from its long term trend value (credit-to-GDP gap) as the primary indicator in setting the CCB. In addition, designated authorities should use in their decision making indicators that measure private sector credit developments and debt burden, overvaluation of property prices, external imbalances, mispricing of risk, and strength of bank balance sheets. Based on an empirical analysis of data on EU countries and a large assortment of potential indicators, we propose a set of suitable early warning indicators for each of these categories. |
| Keywords: | countercyclical capital buffer, macroprudential policy, early warning indicators |
| JEL: | G01 G28 |
| Date: | 2015–03–16 |
| URL: | http://d.repec.org/n?u=RePEc:bof:bofrdp:2015_008&r=cba |
| By: | Crowley, Patrick M.; Hudgins, David |
| Abstract: | This paper first applies the MODWT (Maximal Overlap Discrete Wavelet Transform) to Euro Area quarterly GDP data from 1995 – 2014 to obtain the underlying cyclical structure of the GDP components. We then design optimal fiscal and monetary policy within a large state-space LQ-tracking wavelet decomposition model. Our study builds a MATLAB program that simulates optimal policy thrusts at each frequency range where: (1) both fiscal and monetary policy are emphasized, (2) only fiscal policy is relatively active, and (3) when only monetary policy is relatively active. The results show that the monetary authorities should utilize a strategy that influences the short-term market interest rate to undulate based on the cyclical wavelet decomposition in order to compute the optimal timing and levels for the aggregate interest rate adjustments. We also find that modest emphasis on active interest rate movements can alleviate much of the volatility in optimal government spending, while rendering similarly favorable levels of aggregate consumption and investment. This research is the first to construct joint fiscal and monetary policies in an applied optimal control model based on the short and long cyclical lag structures obtained from wavelet analysis. |
| Keywords: | discrete wavelet analysis, euro area, fiscal policy, LQ tracking, monetary policy, optimal control |
| JEL: | C49 C61 C63 C88 E52 E61 |
| Date: | 2015–08–12 |
| URL: | http://d.repec.org/n?u=RePEc:bof:bofrdp:2015_012&r=cba |
| By: | Aruoba, S. Boragan (Federal Reserve Bank of Philadelphia) |
| Abstract: | In this paper, I use a statistical model to combine various surveys to produce a term structure of inflation expectations--inflation expectations at any horizon--and an associated term structure of real interest rates. Inflation expectations extracted from this model track realized inflation quite well, and in terms of forecast accuracy, they are at par with or superior to some popular alternatives. Looking at the period 2008.2015, I conclude that long-run inflation expectations remained anchored, and the policies of the Federal Reserve provided a large level of monetary stimulus to the economy. |
| Keywords: | Surveys; TIPS; Inflation swaps; Unconventional monetary policy; Treasury Inflation-Protected Securities (TIPS) |
| JEL: | C32 E31 E43 E58 |
| Date: | 2016–03–14 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:16-9&r=cba |
| By: | Ambrogio Cesa-Bianchi; Alessandro Rebucci |
| Abstract: | This paper develops a model featuring both a macroeconomic and a financial friction that speaks to the interaction between monetary and macro-prudential policy and to the role of U.S. monetary and regulatory policy in the run up to the Great Recession. There are two main results. First, real interest rate rigidities in a monopolistic banking system increase the probability of a financial crisis (relative to the case of flexible interest rate) in response to contractionary shocks to the economy, while they act as automatic macro-prudential stabilizers in response to expansionary shocks. Second, when the interest rate is the only available policy instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to contractionary shocks. An implication of our analysis is that the weak link in the U.S. policy framework in the run up to the Global Recession was not excessively lax monetary policy after 2002, but rather the absence of an effective second policy instrument aimed at preserving financial stability. |
| JEL: | E44 E52 E58 E65 |
| Date: | 2016–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22283&r=cba |
| By: | Cole, Stephen J. (Department of Economics Marquette University) |
| Abstract: | Central bank forward guidance emerged as a pertinent tool for monetary policymakers since the Great Recession. Nevertheless, the effects of forward guidance remain unclear. This paper investigates the effectiveness of forward guidance while relaxing two standard macroeconomic assumptions: rational expectations and frictionless financial markets. Agents forecast future macroeconomic variables via either the rational expectations hypothesis or a more plausible theory of expectations formation called adaptive learning. A standard Dynamic Stochastic General Equilibrium (DSGE) model is extended to include the financial accelerator mechanism. The results show that the addition of financial frictions amplifies the differences between rational expectations and adaptive learning to forward guidance. The macroeconomic variables are overall more responsive to forward guidance under rational expectations than under adaptive learning. During a period of economic crisis (e.g. a recession), output under rational expectations displays more favorable responses to forward guidance than under adaptive learning. These differences are exacerbated when compared to a similar analysis without financial frictions. Thus, monetary policymakers should consider the way in which expectations and credit frictions are modeled when examining the effects of forward guidance. |
| Keywords: | Forward Guidance, Monetary Policy, Adaptive Learning, Expectations, Financial Frictions |
| JEL: | D84 E30 E44 E50 E52 E58 E60 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:mrq:wpaper:2016-02&r=cba |
| By: | Micossi, Stefano; Bruzzone, Ginevra; Cassella, Miriam |
| Abstract: | This paper discusses the application of the new European rules for burden-sharing and bail-in in the banking sector, in view of their ability to accommodate broader policy goals of aggregate financial stability. It finds that the Treaty principles and the new discipline of state aid and the restructuring of banks provide a solid framework for combating moral hazard and removing incentives that encourage excessive risk-taking by bankers. However, the application of the new rules may have become excessively attentive to the case-by-case evaluation of individual institutions, while perhaps losing sight of the aggregate policy needs of the banking system. Indeed, in this first phase of the banking union, while large segments of the EU banking sector still require a substantial restructuring and recapitalisation, the market may not be able to provide all the needed resources in the current environment of depressed profitability and low growth. Thus, a systemic market failure may be making the problem impossible to fix without resorting to temporary public support. But the risk of large write-offs of capital instruments due to burden-sharing and bail-in may represent an insurmountable obstacle to such public support as it may set in motion an investors’ flight. The paper concludes by showing that existing rules do contain the flexibility required to accommodate aggregate policy requirements in the general interest, and outlines a public support scheme for the precautionary recapitalisation of solvent banks that would be compliant with EU law. |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:eps:cepswp:11505&r=cba |
| By: | Nuutilainen, Riikka |
| Abstract: | This paper focuses on monetary policy in China. A set of different specifications for the monetary policy reaction function are empirically evaluated using monthly data for 1999––2012. Variation is allowed both in the policy targets as well as in the monetary policy instrument itself. Overall, the performance of the estimated policy rules is surprisingly good. Chinese monetary policy displays countercyclical reactions to in‡ation and leaning-against-the-wind behaviour. The paper shows that there is a notable increase in the overall responsiveness of Chinese monetary policy over the course of the estimation period. The central bank interest rate is irresponsive to economic conditions during the earlier years of the sample but does respond in the later years. This finding supports the view that the monetary policy settings of the People's Bank of China have come to place more weight on price-based instruments. A time-varying estimation procedure suggests that the two monetary policy objectives are assigned to different instruments. The money supply instrument is utilised to control the price level and (after 2008) the interest rate instrument has been used to achieve the targeted output growth. |
| Keywords: | China, Monetary policy, Taylor rule, McCallum rule |
| JEL: | E52 E58 |
| Date: | 2015–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:bof:bofitp:2015_010&r=cba |
| By: | Edda Claus; Iris Claus; Leo Krippner (Reserve Bank of New Zealand) |
| Abstract: | To conduct monetary policy effectively, central banks need to understand the transmission of monetary policy into financial markets. In this paper, we investigate the effects of United States and Japanese monetary policy shocks on their own asset markets, and the spillovers into each other's markets. However, because short-term nominal interest rates have been effectively zero in Japan since January 1998 and the United States from late 2008, monetary policy shocks cannot be quantified by considering observable changes in short-term market interest rates. Therefore, in our analysis we use a shadow short rate - a quantitative measure of overall conventional and unconventional monetary policy that is estimated from the term structure of interest rates. Our results suggest that the operation of monetary policy at the zero lower bound of interest rates alters the transmission of shocks. In particular, we find a limited response of exchange rates during the first episode of unconventional monetary policy in Japan but a significant impact since 2006. |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:nzb:nzbdps:2016/08&r=cba |
| By: | Crowley, Patrick M.; Trombley, Christopher |
| Abstract: | Within currency unions, the conventional wisdom is that there should be a high degree of macroeconomic synchronicity between the constituent parts of the union. But this conjecture has never been formally tested by comparing sample of monetary unions with a control sample of countries that do not belong to a monetary union. In this paper we take euro area data, US State macro data, Canadian provincial data and Australian state data — namely real Gross Domestic Product (GDP) growth, the GDP deflator growth and unemployment rate data — and use techniques relating to recurrence plots to measure the degree of synchronicity in dynamics over time using a dissimilarity measure. The results show that for the most part monetary unions are more synchronous than non-monetary unions, but that this is not always the case and particularly in the case of real GDP growth. Furthermore, Australia is by far the most synchronous monetary union in our sample. |
| Keywords: | business cycles, growth cycles, frequency domain, optimal currency area, macroeconomic synchronization, monetary policy, single currency |
| JEL: | C49 E32 F44 |
| Date: | 2015–07–31 |
| URL: | http://d.repec.org/n?u=RePEc:bof:bofrdp:2015_011&r=cba |
| By: | Christoph Aymanns; Fabio Caccioli; J. Doyne Farmer; Vincent W.C. Tan |
| Abstract: | We investigate a simple dynamical model for the systemic risk caused by the use of Value-at-Risk, as mandated by Basel II. The model consists of a bank with a leverage target and an unleveraged fundamentalist investor subject to exogenous noise with clustered volatility. The parameter space has three regions: (i) a stable region, where the system has a fixed point equilibrium; (ii) a locally unstable region, characterized by cycles with chaotic behavior; and (iii) a globally unstable region. A calibration of parameters to data puts the model in region (ii). In this region there is a slowly building price bubble, resembling the period prior to the Global Financial Crisis, followed by a crash resembling the crisis, with a period of approximately 10-15 years. We dub this the Basel leverage cycle. To search for an optimal leverage control policy we propose a criterion based on the ability to minimize risk for a given average leverage. Our model allows us to vary from the procyclical policies of Basel II or III, in which leverage decreases when volatility increases, to countercyclical policies in which leverage increases when volatility increases. We find the best policy depends on the market impact of the bank. Basel II is optimal when the exogenous noise is high, the bank is small and leverage is low; in the opposite limit where the bank is large and leverage is high the optimal policy is closer to constant leverage. In the latter regime systemic risk can be dramatically decreased by lowering the leverage target adjustment speed of the banks. While our model does not show that the financial crisis and the period leading up to it were due to VaR risk management policies, it does suggest that it could have been caused by VaR risk management, and that the housing bubble may have just been the spark that triggered the crisis. |
| Keywords: | Financial stability; capital regulation; systemic risk |
| JEL: | G11 G20 |
| Date: | 2016–03–03 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:65676&r=cba |