nep-cba New Economics Papers
on Central Banking
Issue of 2016‒09‒04
fifteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Banks and Sovereigns: A Model of Mutual Contagion By Gruber, Alexander; Kogler, Michael
  2. Sustainable International Monetary Policy Cooperation By Ippei Fujiwara; Timothy Kam; Takeki Sunakawa
  3. The Currency Composition of Sovereign Debt By Diego Perez; Pablo Ottonello
  4. Intraday dynamics of euro area sovereign credit risk contagion By Lubos Komarek; Kristyna Ters
  5. Assessing the effects of unconventional monetary policy on pension funds risk incentives By Boubaker, Sabri; Gounopoulos, Dimitrios; Nguyen, Duc Khuong; Paltalidis, Nikos
  6. Asset Price Support Policy During Crises: How Aggressive Should it Be? By Romain Ranciere; Aaron Tornell; Yannick Kalantzis
  7. Monetary versus macroprudential policies causal impacts of interest rates and credit controls in the era of the UK Radcliffe Report By Aikman, David; Bush, Oliver; Davis, Alan
  8. Managing Heterogeneous and Unanchored Expectations: A Monetary Policy Analysis By Hommes, C.H.; Lustenhouwer, J.
  9. Quadrilemma not Trilemma: Fiscal Policy Matters By Hao Jin
  10. Financial Safety Nets By Bengui, Julien; Bianchi, Javier; Coulibaly, Louphou
  11. Score-Driven Systemic Risk Signaling for European Sovereign Bond Yields and CDS Spreads By Rutger-Jan Lange; Andre Lucas; Arjen H. Siegmann
  12. Monetary Policy and Asset Valuation: Evidence From a Markov-Switching cay By Francesco Bianchi; Martin Lettau; Sydney C. Ludvigson
  13. Leaning Within a Flexible Inflation-Targeting Framework: Review of Costs and Benefits By Denis Gorea; Oleksiy Kryvtsov; Tamon Takamura
  14. Qualitative Guidance and Predictability of Monetary Policy in South Africa By Alain Kabundi; NtuthukoTsokodibane
  15. Sovereign Debt Restructuring After Argentina By Porzecanski, Arturo C.

  1. By: Gruber, Alexander; Kogler, Michael
    Abstract: The recent crisis has revealed that bank and sovereign risks are inherently intertwined. This paper develops a model of the bank-sovereign nexus to identify the main spillovers and to study the implications of guarantees and capital regulation. We show how banks’ asset risk may trigger a sovereign default through taxation and deposit insurance. The latter can be contagious because of its cost or stabilizing by avoiding liquidation losses. Since sovereign risks receive preferential regulatory treatment, banks purchase government bonds. This creates the opportunity for adverse feedback loops such that a sovereign default is the very reason for bank failure.
    Keywords: Sovereign Debt Crisis, Financial Risk, Contagion, Deposit Insurance
    JEL: G11 G21 G28 H63
    Date: 2016–08
  2. By: Ippei Fujiwara (Keio University and The Australian National University (E-mail:; Timothy Kam (The Australian National University (E-mail:; Takeki Sunakawa (The University of Tokyo (E-mail:
    Abstract: We provide new insight on international monetary policy cooperation using a two-country model based on Benigno and Benigno (2006). Assuming symmetry, save for the volatility of (markup) shocks, we show that an incentive feasibility problem exists between the policymakers across national borders: The country faced with a relatively more volatile markup shock has an incentive to deviate from an assumed Cooperation regime to a Non-cooperation regime. More generally, a similar result obtains if countries differ in size. This motivates our study of a history-dependent Sustainable Cooperation regime which is endogenously sustained by a cross-country, state-contingent contract between policymakers. Under the Sustainable Cooperation regime, the responses of inflation and the output gap in both countries are different from the ones under the Cooperation and Non-cooperation regimes reflecting the endogenous welfare redistribution between countries under the state- contingent contract. Such history-contingent welfare redistributions are supported by resource transfers effected through incentive-compatible variations in the terms of trade (or net exports). Such an endogenous cooperative solution may also provide a theoretical rationale for perceived occasional cooperation between national central banks in reality.
    Keywords: Monetary policy cooperation, Sustainable plans, Welfare
    JEL: E52 F41 F42
    Date: 2016–08
  3. By: Diego Perez (New York University); Pablo Ottonello (University of Michigan)
    Abstract: The currency composition of sovereign external debt in emerging market economies is tilted towards foreign currency and the share of debt denominated in local currency is highly pro-cyclical. We study these facts through the lens of a quantitative model of optimal currency-composition of sovereign debt when the government lacks commitment regarding monetary policy. High levels of debt in local currency give rise to incentives to dilute debt repayment through nominal currency depreciation. Governments tilt the currency-composition of debt towards foreign currency to avoid the inflationary costs associated with currency depreciation. This is done at the expense of foregoing the hedging properties of debt in local currency. The cyclicality of the currency-composition of sovereign debt responds to the cyclical properties of the benefits associated to debt dilution, which are higher in recessions. Inflation-linked bonds do not eliminate the time inconsistency problem of monetary policy.
    Date: 2016
  4. By: Lubos Komarek; Kristyna Ters
    Abstract: We examine the role of the CDS and bond markets during and before the recent euro area sovereign debt crisis as transmission channels for credit risk contagion between sovereign entities. We analyse an intraday dataset for GIIPS countries as well as Germany, France and central European countries. Our findings suggest that, prior to the crisis, the CDS and bond markets were similarly important in the transmission of sovereign risk contagion, but that the importance of the bond market waned during the crisis. We find flight-to-safety effects during the crisis in the German bond market that are not present in the pre-crisis sample. Our estimated sovereign risk contagion was greater during the crisis, with an average timeline of one to two hours in GIIPS countries. By using an exogenous macroeconomic news shock, we can show that, during the crisis period, increased credit risk was not related to economic fundamentals. Further, we find that central European countries were not affected by sovereign credit risk contagion, independent of their debt level and currency.
    Keywords: sovereign credit risk, credit default swaps, contagion, spillover, sovereign debt crisis, panel VAR
    Date: 2016–07
  5. By: Boubaker, Sabri; Gounopoulos, Dimitrios; Nguyen, Duc Khuong; Paltalidis, Nikos
    Abstract: US public pension funds deficits remain stubbornly high even though market conditions have improved in the post-crisis period. This article examines the role of lower short- and long-term interest rates imposed by the use of unconventional monetary policy on pension funds risk taking and asset allocation behavior. We quantify the effects of the Zero Lower Bound policy and the launch of unconventional monetary policy measures by using two structural Vector AutoRegression (VAR) models, a Bayesian VAR and a Markov switching-structural VAR. We provide the first comprehensive evidence showing that persistently low interest rates and falling Treasury yields cause a substantial increase in pension funds risk and portfolios beta. Additionally, we document that the severe funding shortfall in many pension schemes is, to a large extent, associated with and prompted by changes in the monetary policy framework.
    Keywords: Pension funds; Unconventional monetary policy; Asset allocation; Zero lower bound
    JEL: E52 G11 G23
    Date: 2015–05
  6. By: Romain Ranciere (Paris School of Economics); Aaron Tornell (UCLA); Yannick Kalantzis (Banque de France)
    Abstract: Should a Central Bank (CB) aim at smoothing out all asset price volatility in crisis times? We consider an economy where leverage is endogenously determined by the CB asset price support policy during crises. By keeping the price of distressed assets above a critical level, the CB can induce a high-leverage equilibrium with high output but with infrequent financial crises. The optimal CB policy depends on whether the interventions necessary to support the high-leverage equilibrium are costly or not. If the CB does not require any net wealth to credibly promise the minimal intervention that will keep asset prices above the critical level, it is optimal to commit all its wealth to intervention. In contrast, if interventions are costly, there is a trade-off between enjoying higher leverage and output now, but withstanding a lower number of crises before falling into a low-leverage low-output trap, and a more prudent policy that can keep the economy longer in the high-leverage equilibrium. We find that more prudent policies tend to be optimal when leverage is more socially valuable or the Central Bank has more wealth.
    Date: 2016
  7. By: Aikman, David (Bank of England); Bush, Oliver (London School of Economics); Davis, Alan (University of California)
    Abstract: We have entered a world of conjoined monetary and macroprudential policies. But can they function smoothly in tandem, and with what effects? Since this policy cocktail has not been seen for decades, the empirical evidence is almost non-existent. We can only fix this shortcoming in a historical laboratory. The Radcliffe Report (1959), notoriously sceptical about the efficacy of monetary policy, embodied views which led the United Kingdom to a three-decade experiment of using credit controls alongside conventional changes in the central bank interest rate. These non-price tools are similar to policies now being considered or used by macroprudential policymakers. We describe these tools, document how they were used by the authorities, and craft a new, largely hand-collected dataset to help estimate their effects. We develop a novel identification strategy, which we term Factor-Augmented Local Projection (FALP), to investigate the subtly different impacts of both monetary and macroprudential policies. Monetary policy acted on output and inflation broadly in line with consensus views today, but credit controls had markedly different effects and acted primarily to modulate bank lending.
    Keywords: Monetary policy; macroprudential policy; credit controls
    JEL: E50 G18 N14
    Date: 2016–08–19
  8. By: Hommes, C.H. (University of Amsterdam); Lustenhouwer, J. (University of Amsterdam)
    Abstract: We study monetary policy in a New Keynesian model with heterogeneity in expectations. Agents may choose from a continuum of forecasting rules and adjust their expectations based on relative past performance. The extent to which expectations are anchored to the fundamentals of the economy turns out to be crucial in determining whether the central bank (CB) can stabilize the economy. When expectations are strongly anchored, little is required of the CB for local stability. Only when expectations are unanchored, the Taylor principle becomes a necessary condition. More aggressive policy may however be required to prevent coordination on almost self-fulfilling optimism or pessimism. When the zero lower bound on the nominal interest rate (ZLB) is accounted for, the inflation target must furthermore be high enough, in order to prevent coordination on self-fulfilling liquidity traps and deflationary spirals.
    Date: 2016
  9. By: Hao Jin (Wang Yanan Institute for Studies in Economics (WISE) and Department of International Economics and Trade, School of Economics, Xiamen University)
    Abstract: This paper examines the interactions between fiscal policy and the open economy macroeconomic policy trilemma in a small open economy dynamic stochastic general equilibrium model. I show that the trilemma policy regime choices require fiscal accommodation. Otherwise, when future budget fail to stabilize government liabilities, fiscal imbalance generates exchange rate depreciation, regardless of monetary and capital account policy regimes. In this active fiscal policy regime, fiscal and monetary policy interact to determine the magnitude of exchange rate depreciation, while monetary policy and capital controls manage the timing of the depreciation.
    Keywords: Trilemma, Fiscal Policy, Capital Account Policy, Exchange Rate Stability, Monetary Policy
    Date: 2016–08
  10. By: Bengui, Julien (Université de Montréal); Bianchi, Javier (Federal Reserve Bank of Minneapolis); Coulibaly, Louphou (Université de Montréal)
    Abstract: In this paper, we study the optimal design of financial safety nets under limited private credit. We ask when it is optimal to restrict ex ante the set of investors that can receive public liquidity support ex post. When the government can commit, the optimal safety net covers all investors. Introducing a wedge between identical investors is inefficient. Without commitment, an optimally designed financial safety net covers only a subset of investors. Compared to an economy where all investors are protected, this results in more liquid portfolios, better social insurance, and higher ex ante welfare. Our result can rationalize the prevalent limited coverage of safety nets, such as the lender of last resort facilities.
    Keywords: Bailouts; Safety nets; Time inconsistency; Public liquidity provision
    JEL: E58 E61 G28
    Date: 2016–08–25
  11. By: Rutger-Jan Lange (VU University Amsterdam, Erasmus University Rotterdam, the Netherlands); Andre Lucas (VU University Amsterdam, the Netherlands); Arjen H. Siegmann (VU University Amsterdam, the Netherlands)
    Abstract: We compute joint sovereign default probabilities as coincident systemic risk indicators. Instead of commonly used CDS spreads, we use government bond yield data which provide a longer data history. We show that for the more recent sample period 2008--2015, joint default probabilities based on CDS and bond yield data yield similar results. For the period 1987-2008, only the bond yield data can be used to shed light on European sovereign systemic stress. We also show that simple averages of rolling pairwise correlations do not always yield intuitive systemic risk indicators.
    Keywords: systemic risk; conditional default; credit default swaps; bond yields
    JEL: G01 G17 C32
    Date: 2016–08–29
  12. By: Francesco Bianchi; Martin Lettau; Sydney C. Ludvigson
    Abstract: This paper presents evidence of infrequent shifts, or "breaks," in the mean of the consumption-wealth variable cay_{t}, an asset market valuation ratio driven by fluctuations in stock market wealth relative to economic fundamentals. Conventional estimates of cay_{t}, which presume a constant mean, display increasing persistence over the sample. We introduce a Markov-switching version of cay_{t} that adjusts for infrequent shifts in its mean. The Markov-switching cay_{t}, denoted cay_{t}^{MS}, is less persistent and has superior forecasting power for excess stock market returns compared to the conventional estimate. Evidence from a Markov-switching VAR shows that these low frequency swings in post-war asset valuation are strongly associated with low frequency swings in the long-run expected value of the Federal Reserve's primary policy rate, with low expected values for the real federal funds rate associated with high asset valuations, and vice versa. By contrast, there is no evidence that the infrequent shifts to high asset valuations and low policy rates are associated with higher expected economic growth or lower economic uncertainty; indeed the opposite is true.
    JEL: E02 E4 E52 G12
    Date: 2016–08
  13. By: Denis Gorea; Oleksiy Kryvtsov; Tamon Takamura
    Abstract: This note examines the merits of monetary policy adjustments in response to financial stability concerns, taking into account changes in the state of knowledge since the renewal of the inflation-targeting agreement in 2011. A key financial system vulnerability in Canada is elevated household indebtedness: as more and more households are nearing their debt-capacity limits, the likelihood and severity of a large negative correction in housing markets are also increasing. Adjusting the path of policy rates can be effective in reducing the buildup of household debt and the likelihood of a house price correction over the medium term. Such adjustments can also generate a fall in inflation and in output over the short term compared with the case without a policy-rate adjustment. Overall, the estimated benefits of a leaning adjustment tend to be smaller than its social losses, since its impact on the buildup of vulnerabilities is modest and the reduction in the incidence of house price corrections or financial crises is limited.
    Keywords: Financial stability, Monetary policy framework
    JEL: E0 E44 E52 E58 G18
    Date: 2016
  14. By: Alain Kabundi; NtuthukoTsokodibane
    Abstract: With the adoption of the in‡ation targeting (IT) regime in 2000, the South African Reserve Bank (SARB) became independent. With the independence of monetary policy comes accountability to the public at large, which in turn leads to transparency in the conduct of monetary policy. The SARB has come a long way in its communication strategy. In 2014 it adds another layer in its communication strategy by announcing explicitly throughout 2014 that monetary policy was on the rising cycle until normalisation is reached. Monetary policy committee (MPC) statements of March and May 2014 refer to normalisation as the return of the policy rate (repo rate) from the historical lowest level of 5 per cent to the normal level in the long run. Like many central banks, the SARB reduced the policy rate from 12 per cent to 5 per cent following the Global Financial Crisis (GFC).
    Keywords: are Monetary Policy, Central Bank Communication, and Nonparametric Change Point.
    JEL: C14 E43 E52 E58 G14
    Date: 2016–08
  15. By: Porzecanski, Arturo C.
    Abstract: Sovereign debt restructurings may experience marginal changes as a result of recent modifications in contractual terms being incorporated into new bond issues, but for the most part they will likely resemble what has generally worked so well in recent decades to the satisfaction of most governments and private creditors. The statutory reforms that have been proposed to date are highly unlikely to gain traction for a variety of reasons, including the prospect that they would have been stymied when confronted with a rogue sovereign debtor such as Argentina.
    Keywords: Argentina, default, debt, sovereign, restructuring, statutory; contractual; collective action; pari passu; finance
    JEL: E6 F3 F34 F51 F65 H63 K4 N26
    Date: 2016–08

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