nep-cba New Economics Papers
on Central Banking
Issue of 2016‒08‒07
eighteen papers chosen by
Maria Semenova
Higher School of Economics

  1. The Role of Central Banks in Promoting Financial Stability: An International Perspective By Rose Cunningham; Christian Friedrich
  2. Cost Channel, Interest Rate Pass-Through and Optimal Policy under Zero Lower Bound By Chattopadhyay, Siddhartha; Ghosh, Taniya
  3. International Trade Fluctuations and Monetary Policy By Ana Maria Santacreu; Fernando Leibovici
  4. Monetary Policy and Sovereign Debt Vulnerability By Carlos Thomas; Galo Nuño
  5. Bank Lending Channel of Transmission of Monetary Policy: Does the Financial Structure of Banks Matter? By Jose E. Gomez-Gonzalez; Ali M. Kutan; Jair N. Ojeda-Joya; María Camila Ortiz
  6. Assessing the appropriateness of zero and negative interest rate regimes: recent developments and comparative analyses By Ojo, Marianne; Newton, Sarah
  7. Central bank and asymmetric preferences: An application of sieve estimators to the U.S. and Brazil By de Sá, Rodrigo; Savino Portugal, Marcelo
  8. Starting from a Blank Page? Semantic Similarity in Central Bank Communication and Market Volatility By Michael Ehrmann; Jonathan Talmi
  9. “One size does not fit all” – institutional determinantsof financial safety net effectiveness By Aleksandra Masłowska-Jokinen; Anna Matysek-Jędrych
  10. The signalling content of asset prices for inflation: Implications for Quantitative Easing By Leo de Haan; Jan Willem van den End
  11. Liquidity Management and Central Bank Strength: Bank of England Operations Reloaded, 1889-1910 By Stefano Ugolini
  12. Danger to the Old Lady of Threadneedle Street? The Bank Restriction Act and the Regime Shift to Paper Money, 1797-1821 By Patrick K. O’Brien; Nuno Palma
  13. Liquidity Traps and Monetary Policy: Managing a Credit Crunch By Juan Pablo Nicolini
  14. How Central Banks End Crises By Guillermo Ordonez; Gary Gorton
  15. Functional Systemic Risk, Complementarities and Early Warnings By Cañón Salazar Carlos Iván;Gallón Santiago;Olivar Santiago
  16. Do Fed forecast errors matter? By Pao-Lin Tien; Tara M. Sinclair; Edward N. Gamber
  17. The re-pricing of sovereign risks following the global financial crisis By Dimitris Malliaropulos; Petros M. Migiakis
  18. Russia’s Monetary Policy in 2015 By Bozhechkova Alexandra; Trunin Pavel; Kiyutsevskaya Anna

  1. By: Rose Cunningham; Christian Friedrich
    Abstract: The 2007–09 global financial crisis has led policy-makers around the world, including central banks, to refocus their efforts to promote financial stability. As part of this process, central banks became quite active in supporting financial stability in a variety of ways, such as publicly sharing their assessments of financial system vulnerabilities and risks and helping to strengthen regulation, supervision and macroprudential measures. However, the use of monetary policy instruments for managing financial stability risks is more widely debated because central banks may face a trade-off between attaining their inflation targets in a timely manner and exacerbating financial stability risks. Recent research suggests that central banks that tend to have stronger financial stability mandates and less influence over regulatory and macroprudential tools are more likely to use monetary policy to address financial stability risks.
    Keywords: Financial stability, Financial system regulation and policies
    JEL: E5 G01 G28
    Date: 2016
  2. By: Chattopadhyay, Siddhartha; Ghosh, Taniya
    Abstract: This paper analyzes optimal monetary policy under zero lower bound in the presence of cost channel. Cost channel introduces trade-off between output and inflation when economy is out of ZLB. As a result, exit time both under discretion and commitment is endogenous in the presence of cost channel. We also find that commitment outperforms discretion by promising future boom and inflation and a T-only policy closely replicates commitment both under presence and absence of cost channel. Moreover, the exit date (from ZLB) under discretion, commitment and T-only policy rises with the magnitude of demand shock given the degree of interest rate pass-through irrespective if the cost channel is present. We also show that, while exit date both under discretion and T-only policy rises with the degree of interest rate pass-through/credit market imperfection, it falls under commitment given demand shock.
    Keywords: New-Keynesian Model, Cost Channel, Liquidity Trap
    JEL: E52 E58 E63
    Date: 2016–07–20
  3. By: Ana Maria Santacreu (Federal Reserve Bank of Saint Louis and); Fernando Leibovici (York University)
    Abstract: This paper studies the role of trade openness for the design of monetary policy. We extend a standard small open economy model of monetary policy to capture cyclical fluctuations of international trade flows, and parameterize it to match key features of the data. We find that accounting for trade fluctuations matters for monetary policy: when the monetary authority follows a Taylor rule, inflation and the output gap are more volatile. Moreover, we find that the volatility of these variables is significantly higher when the central bank follows the optimal policy based on a model that cannot account for international trade fluctuations.
    Date: 2016
  4. By: Carlos Thomas (Banco de España); Galo Nuño (Banco de España)
    Abstract: We investigate the trade-o¤s between price stability and sovereign debt sustainability, in a small-open-economy model where the government issues nominal debt without committing not to default or inflate. Inflation allows to absorb the e¤ect of aggregate shocks on the debt ratio, which improves sovereign debt sustainability. But the government incurs an ‘inflationary bias’: it creates (costly) inflation even when default is distant. For plausible calibrations, we find that abandoning the ability to inflate debt away raises welfare, even when the economy is close to default: the benefits from eliminating the inflationary bias dominate the costs from losing inflation’s debt-stabilizing role.
    Date: 2016
  5. By: Jose E. Gomez-Gonzalez (Banco de la República de Colombia); Ali M. Kutan; Jair N. Ojeda-Joya (Banco de la República de Colombia); María Camila Ortiz
    Abstract: This paper tests the importance of the financial structure of banks in the bank lending channel of monetary policy transmission in Colombia, using an unbalanced panel of 51 banks for the period of 1996:4-2014:8. We find that an increase in the interbank rate (proxy of the intervention rate) has a response of a drop in the growth of the total loan portfolio of banks. When we breakdown by type of policy, the bank lending channel works better in times of monetary contraction, exhibiting significant reactions from banks with low levels of solvency rather than those with high solvency. In contrast, when the policy is expansionary, the high solvency banks are the only segment exhibiting the presence of the bank lending channel. We discuss the policy implications of findings. Classification JEL: E5, E52, E59, G21
    Keywords: Monetary Policy Transmission, Bank Lending Channel, Bank Financial Structure, Solvency, Heterogeneous Effects, Colombia
    Date: 2016–08
  6. By: Ojo, Marianne; Newton, Sarah
    Abstract: This paper explores the widely held theoretical view that zero interest rates should result in lower borrowing costs – propelling the demand for borrowing, “the theory and practice of monetary policy”, against the practical and broader acknowledgements that further negative consequences, namely bank runs - as well as the possibility of the occurrence of concerns of banks becoming more prone to the probabilities of greater unwillingness to lend, could occur. The latter negative consequence of banks’ unwillingness to lend, being considered to arise where “banks absorb the cost of negative rates themselves” such that this phenomenon “squeezes” the profit margin between their lending and deposit rates. However, as will be illustrated, different sources and authorities on the literature agree that it is still too early to draw conclusions on the impact of negative interest rates – be it in respect of i) whether it will work, ii) its wider impact and repercussions for the economy – as well as those economies where the policy has not yet been implemented (even where the policy is on the cards – namely in jurisdictions such as the United States), as well as (iii) its impact on the behavior of individuals (households) and firms. In exploring the appropriateness of its adoption – given prevailing global financial conditions and the economic environment, the paper also contributes to the extant literature from a theoretical, practical, empirical, as well as comparative jurisdictional perspective.
    Keywords: interest rates; monetary policy; central banks; market rates; lending rates
    JEL: E5 E58 E6 F3 G2 G3 K2 M4
    Date: 2016–07–28
  7. By: de Sá, Rodrigo; Savino Portugal, Marcelo
    Abstract: Whether central banks place the same weights on positive and negative deviations of inflation and of the output gap from their respective targets is an interesting question regarding monetary policy. The literature has sought to address this issue using a specific asymmetric function, the so-called Linex loss function. However, is the Linex an actually asymmetric specification? In an attempt to answer this question, we applied the sieve estimation method, a fully nonparametric approach, in which the result could be any proper loss function. This way, our results could corroborate the quadratic or Linex loss functions used in the literature or suggest an entirely new function. We applied the sieve estimation method to the United States and to Brazil, an emergent country which has consistently followed an inflation targeting regime. The economy was modeled with forward-looking agents and central bank commitment. Our results indicate that the FED was more concerned with inflation rates below the target, but no asymmetry was found in the inflation–output process in the Volcker–Greenspan period. As to Brazil, we found asymmetries in output gaps from 2004 onwards, when the Brazilian Central Bank was more concerned with positive output gaps; but we did not find any statistically significant asymmetries in inflation.
    Keywords: Monetary policy; Central bank's preference; Asymmetric preferences; Sieve estimators
    JEL: C14 E52
    Date: 2015–12
  8. By: Michael Ehrmann; Jonathan Talmi
    Abstract: Press releases announcing and explaining monetary policy decisions play a critical role in the communication strategy of central banks. Because of their market-moving potential, it is particularly important how they are drafted. Often, central banks start from the previous statement and update the earlier text with only small changes. This way, it is straightforward to compare statements and see how the central bank’s thinking has evolved. This paper studies to what extent such similarity in central bank statements matters for the reception of their content in financial markets. Using the case of the Bank of Canada (the G7 central bank that had to rely the least on unconventional monetary policy following the global financial crisis and has therefore broadly continued standard monetary policy communications), the paper shows that press releases with larger differences in wording lead to higher volatility in financial markets, suggesting that their content is more difficult to absorb. At the same time, while press releases that are similar to the previous one generate less market volatility, once their wording is updated, volatility increases substantially.
    Keywords: Central bank research, Financial markets, Interest rates
    JEL: E43 E52 E58
    Date: 2016
  9. By: Aleksandra Masłowska-Jokinen; Anna Matysek-Jędrych
    Abstract: The main objective of the study is to identify both similarities and differences among seemingly homogenous countries (OECD) in respect to their safety net de-sign and a supervisory role played by central banks. This goal is achieved using an extensive data set, describing financial supervisory institutions between 2000-2013, hence including recent modifications in response to global financial crisis. The data show the existence of similar supervisory standards in both crisis- and non-crisis countries. Whether it is a presence of single supervisory authority, allocation of macroprudential responsibilities in a country, or implementing capital adequacy re-quirements, while working well in certain countries, did not make others immune to a crisis. At the same time, data show that non-crisis countries implemented stricter rules than those in crisis-countries, and that this process started way before the burst of the Global Financial Crisis. Often, these more rigorous rules were observed in countries with past crisis experience, indicating an importance of learning mecha-nism. With empirical analysis, we prove that certain basic safety net elements (oblig-atory reserve requirements or sufficient coverage of deposit insurance scheme), as well as high level of central bank financial transparency are negatively correlated with the speed of credit growth. Based on our results and discussion on previous empirical analyses we give recommendations for institutions involved in the financial safety net.
    Keywords: central bank, financial regulation, financial supervision, monetary pol-icy, financial crisis, macroprudential policy, safety net
    JEL: E52 E58 G01 G18 G21 H12
    Date: 2016
  10. By: Leo de Haan; Jan Willem van den End
    Abstract: We investigate the information content of financial variables as signalling devices of two abnormal inflationary regimes: (1) very low inflation or deflation, and (2) high inflation. Specifically, we determine the information content of equity and house prices, private credit volumes, and sovereign and corporate bond yields, for 11 advanced economies over the past three decades, using both the receiver operating characteristic (ROC) curve and a logit model. The outcomes show that high asset prices more often signal high inflation than low inflation/deflation. However, in some countries, high asset prices and low bond yields are a significant indicator of low inflation or deflation as well. The transmission time of financial developments to inflation can be quite long (up to 8 quarters). For monetary policy, these findings imply that stimulating asset prices through Quantitative Easing (QE) can effectively influence inflation, but that the effects are quite uncertain, both in timing and direction.
    Keywords: Quantitative Easing; Inflation; Financial markets
    JEL: E31 E44 E52
    Date: 2016–07
  11. By: Stefano Ugolini (University of Toulouse (Institute of Political Studies and LEREPS))
    Abstract: Is a strong commitment to monetary stability enough to ensure credibility? The recent literature suggests it might not be if the central bank cannot perform pure interest rate policy and has to resort to balance sheet policy: the central bank’s financial strength (i.e. the long-term sustainability of its policy) is also a determinant of credibility. This paper provides historical evidence on the issue by focusing on the case of the Bank of England at the heyday of the classical gold standard. It shows that as the Bank was not perceived as having the means to fulfil all of its obligations, the efficacy of its interest rate policy was poor. Failing to reform for political economy reasons, the Bank eventually had to default on its formal convertibility mandate.
    Keywords: Central banking, institutional design, monetary policy implementation, reverse repos, term structure of interest rates, gold standard
    JEL: E42 E43 E58 N13
    Date: 2016–07–01
  12. By: Patrick K. O’Brien; Nuno Palma
    Abstract: The Bank Restriction Act of 1797 made legal the Bank of England’s suspension of the convertibility of its banknotes. The current historical consensus is that it was a result of the state's need to finance the war, France’s remonetisation, a loss of confidence in the English country banks, and a run on the Bank of England’s reserves. We argue that while these factors help us understand the timing of the Restriction period, they cannot explain its success. We deploy new long-term data which leads us to a complementary explanation: the policy succeeded thanks to the reputation of the Bank of England, achieved through a century of monetary stability.
    Keywords: Bank of England, financial revolution, fiat money, money supply, monetary policy commitment, reputation, and time-consistency, regime shift, financial sector growth
    JEL: N13 N23 N43
    Date: 2016–07
  13. By: Juan Pablo Nicolini (Minneapolis Fed)
    Abstract: We study a model with heterogeneous producers that face collateral and cash in advance constraints. A tightening of the collateral constraint results in a credit-crunch generated recession that reproduces several features of the financial crisis that unraveled in 2007. The model can suitable be used to study the effects on the main macroeconomic variables and of alternative policies following the credit crunch. The policy implications are in sharp contrast with the prevalent view in most Central Banks, based on the New Keynesian explanation of the liquidity trap.
    Date: 2016
  14. By: Guillermo Ordonez (University of Pennsylvania); Gary Gorton (Yale School of Management)
    Abstract: To end a financial crisis, the central bank is to lend freely, against good collateral, at a high rate, according to Bagehot’s Rule. We argue that in theory and in practice there is a missing ingredient to Bagehot’s Rule: secrecy. Re-creating confidence requires that the central bank lend in secret, hiding the identities of the borrowers, to prevent information about individual collateral from being produced and to create an information externality by raising the perceived value of average collateral. Ironically, the participation of “bad†borrowers, with low quality collateral, in the central bank’s lending program is a desirable part of re-creating confidence because it creates stigma. Stigma is critical to sustain secrecy because no borrower wants to reveal his participation in the lending program, and it is limited by the central bank charging a high rate for its loans.
    Date: 2016
  15. By: Cañón Salazar Carlos Iván;Gallón Santiago;Olivar Santiago
    Abstract: This paper proposes a systemic risk index based on Functional Data Analysis (FDA), overcoming salient shortcomings of standard methodologies related to data usage, data sparseness, and high dimensionality issues. Using Mexican data, a set of systemic risk indexes are constructed and we show that the proposed functional index captures new information, and through simulations, that it outperforms previous methods when the indicators become increasingly nonlinear. Finally, we show which indexes serve as complements, and which are the best early warning indicators.
    Keywords: Systemic Risk; Functional Data Analysis; Dimensionality Reduction; Signal Informativeness
    JEL: G01 G10 G17 G18
    Date: 2016–07
  16. By: Pao-Lin Tien; Tara M. Sinclair; Edward N. Gamber
    Abstract: There is a large literature evaluating the forecasts of the Federal Reserve by testing their rationality and measuring the size of their forecast errors. There is also a substantial literature and debate on the impact of the Fed’s monetary policy on the economy. We know little, however about the impact of the Fed’s forecast errors on economic outcomes. This paper constructs a measure of a forecast error shock for the Federal Reserve based on the assumption that the Fed follows a forward-looking Taylor rule. Given the effort the Fed puts towards producing forecasts that do not have an endogenous error component, we treat the Fed’s forecast errors as a shock, analogous to a monetary policy shock. Our shock, however, is different in that it is completely unintended by the monetary authority rather than simply unanticipated by the public. We follow Romer and Romer (2004) and investigate the effect of the forecast error shock on output and price movements. Our results suggest that although the absolute magnitude of the forecast error shock is large, the impact of the shock on the macroeconomy is quite small. This finding is robust across a range of different specifications. The maximum impact suggests a decline of less than 0.3 percent of real GDP and less than 0.4 percent of GDP deflator in response to a 100 basis point contractionary forecast error shock.
    Keywords: Federal Reserve, Taylor rule, forecast evaluation, monetary policy shocks
    JEL: E32 E31 E52 E58
    Date: 2016–07
  17. By: Dimitris Malliaropulos (Bank of Greece and University of Piraeus); Petros M. Migiakis (Bank of Greece and University of Piraeus)
    Abstract: How strong has been the effect of the Global Financial Crisis (GFC) on systemic risk in sovereign bond markets? Was the increase in credit spreads relative to triple-A benchmarks which followed the GFC the result of higher sovereign credit risk or the result of a re-pricing that reflected changes in broader market conditions and risk aversion? In this paper we examine these issues by specifying a sovereign credit yield curve which relates sovereign yield spreads to credit ratings and global variables. The model allows for time-variation in both the price of credit risk and the average spread across all rating categories, which proxies the effect of global risk factors on yield spreads. We use daily data of ten-year bond yields and ratings from a large database of 64 countries, covering both emerging markets and developed economies, for the period from 1/1/2000 to 1/1/2015. Our estimates suggest that sovereign risk premia increased significantly after the GFC with most of the increase due to a re-pricing of broader market risks rather than an increase in the quantity or price of sovereign risk per se. This increase in global risk could be the result of a flight-to-quality from lower-rated sovereign bonds to AAA benchmark bonds. Interestingly, we find that global risk in the sovereign bond market is driven by global variables that relate to investor confidence, volatility risk, central bank liquidity and the slope of the yield curve in the US.
    Keywords: sovereign risk; credit yield curve; Global Financial Crisis; credit ratings.
    JEL: C58 G12 G17 G24
    Date: 2016–07
  18. By: Bozhechkova Alexandra (Gaidar Institute for Economic Policy); Trunin Pavel (Gaidar Institute for Economic Policy); Kiyutsevskaya Anna (Gaidar Institute for Economic Policy)
    Abstract: In 2015, the Bank of Russia faced global challenges while implementing measures as part of its monetary policy. The economic situation in 2015 was marked by the following: Western sanctions and Russia’s countersanctions remained in effect, prices of Russia’s key export commodities continued to fall, economic agents’ expectations for high inflation remained intact. The sweeping depreciation of the Russian ruble in late 2014/early 2015 resulted in an inflation shock which kept the year-end inflation at high level: the Consumer Price Index (CPI) stood at 12.9% at the 2015 year-end, much higher than the 2017 mid-term target level (4%) set forth in the central bank’s Guidelines for the Single State Monetary Policy for 2015–2017. In its official 2015 forecast, Russia’s Ministry of Economic Development predicted inflation will not move beyond 6.3% in late 2014/early 2015, and Russia’s central bank expected it to stay at 8.2–8.7% under the baseline scenario and 9.3–9.8% under the risk scenario. At the same time, the Bank of Russia cut its key rate gradually from 17% in January down to 11% in December 2015 as inflation slowed down over the course of the year.
    Keywords: Russian economy, monetary policy, money market, exchange rate, INFLATION, BALANCE OF PAYMENTS
    JEL: E31 E43 E44 E51 E52 E58
    Date: 2016

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