nep-cba New Economics Papers
on Central Banking
Issue of 2016‒11‒20
fifteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Trust in the Central Bank and Inflation Expectations By Dimitris Christelis; Dimitris Georgarakos; Tullio Jappelli; Maarten van Rooij
  2. What Do Latin American Inflation Targeters Care About? A Comparative Bayesian Estimation of Central Bank Preferences By Stephen McKnight; Alexander Mihailov; Antonio Pompa Rangel
  3. Speaking to the people? Money, trust, and central bank legitimacy in the age of quantitative easing By Braun, Benjamin
  4. Monetary Policy Tradeoffs Between Financial Stability and Price Stability By Shukayev, Malik; Ueberfeldt, Alexander
  5. The Perils of Nominal Targets By Armenter, Roc
  6. Does the Fed's unconventional monetary policy weaken the link between the financial and the real sector? By Yimin Xu; Jakob de Haan
  7. A positive analysis of bank behaviour under capital requirements By Bahaj, Saleem; Malherbe, Frédéric
  8. The optimal conduct of central bank asset purchases By Darracq Pariès, Matthieu; Kühl, Michael
  9. Regulation and Rational Banking Bubbles in Infinite Horizon By Claire Océane Chevallier; Sarah El Joueidi
  10. “Conditional PPP” and Real Exchange Rate Convergence in the Euro Area By Bergin, Paul R.; Glick, Reuven; Wu, Jyh-Lin
  11. Understanding Inflation as a Joint Monetary-Fiscal Phenomenon By Campbell Leith
  12. Banks' internal rating models - time for a change? The system of floors as proposed by the Basel committee By Haselmann, Rainer; Wahrenburg, Mark
  13. Housing and the Redistributive Effects of Monetary Policy By Michael Reiter; Philipp Hergovich
  14. Interest rate pass-through in Poland since the global financial crisis By Mariusz Kapuściński; Ewa Stanisławska
  15. Appropriate Exchange Rate Regime for economic structure of Pakistan By Ali, Faran; Mamoon, Dawood; Tahir, Naveed

  1. By: Dimitris Christelis (University of Naples Federico II, CSEF, CFS and CEPAR); Dimitris Georgarakos (European Central Bank, CFS and University of Leicester); Tullio Jappelli (Università di Napoli Federico II, CSEF and CEPR); Maarten van Rooij (De Nederlandsche Bank and Netspar)
    Abstract: Using micro data from the 2015 Dutch CentERpanel, we examine whether trust in the European Central Bank (ECB) influences individuals’ expectations and uncertainty about future inflation, and also whether it anchors inflation expectations. We find that higher trust in the ECB lowers inflation expectations on average, and significantly reduces uncertainty about future inflation. Moreover, results from quantile regressions suggest that trusting the ECB increases (lowers) inflation expectations when the latter are below (above) the ECB’s inflation target. These findings hold after controlling for people’s knowledge about the objectives of the ECB. In addition, higher trust in the ECB raises expectations about GDP growth. The findings suggest that a central bank can influence the economy through people’s expectations, even in times when conventional monetary policy tools likely have weak effects.
    Keywords: Inflation expectations, Inflation uncertainty, Anchoring, Trust in the ECB, Subjective Expectations
    JEL: D12 D81 E03 E40 E58
    Date: 2016–11–14
  2. By: Stephen McKnight (Centro de Estudios Económicos, El Colegio de México); Alexander Mihailov (Department of Economics, University of Reading); Antonio Pompa Rangel (
    Abstract: This paper uses Bayesian estimation techniques to uncover the central bank preferences of the big five Latin American inflation targeting countries: Brazil, Chile, Colombia, Mexico, and Peru. The target weights of each central bank's loss function are estimated using a medium-scale small open economy New Keynesian model with incomplete international asset markets and imperfect exchange-rate pass-through. Our results suggest that all central banks in the region place a high priority on stabilizing inflation and interest rate smoothing. While stabilizing the real exchange rate is a concern for all countries except Brazil, only Mexico is found to assign considerable weight to reducing real exchange rate fluctuations. Overall, Brazil, Colombia, and Peru show evidence of implementing a strict inflation targeting policy, whereas Chile and Mexico follow a more flexible policy by placing a sizeable weight to output gap stabilization. Finally, the posterior distributions for the central bank preference parameters are found to be strikingly different under complete asset markets. This highlights the sensitivity of Bayesian estimation, particularly when uncovering central bank preferences, to alternative international asset market structures.
    Keywords: Bayesian estimation, central bank preferences, inflation targeting, Latin America, small open economies, incomplete asset markets, monetary policy
    JEL: C51 E52 F41
    Date: 2016
  3. By: Braun, Benjamin
    Abstract: Financial upheaval and unconventional monetary policies have made money a salient political issue. This provides a rare opportunity to study the under-appreciated role of monetary trust in the politics of central bank legitimacy which, for the first time in decades, appears fragile. While research on central bank communication with "the markets" abounds, little is known about if and how central bankers speak to "the people." A closer look at the issue immediately reveals a paradox: while a central bank's legitimacy hinges on it being perceived as acting in line with the dominant folk theory of money, this theory accords poorly with how money actually works. How central banks cope with this ambiguity depends on the monetary situation. Using the Bundesbank and the European Central Bank as examples, this paper shows that under inflationary macro-economic conditions, central bankers willingly nourished the folk-theoretical notion of money as a quantity under the direct control of the central bank. By contrast, the Bank of England's recent refutation of the folk theory of money suggests that deflationary pressures and rapid monetary expansion have fundamentally altered the politics of monetary trust and central bank legitimacy.
    Abstract: Die durch die Finanzkrise und die unkonventionellen Maßnahmen der Zentralbanken bewirkte Politisierung des Geldes erlaubt einen seltenen Einblick in den Zusammenhang zwischen Geldvertrauen und Zentralbanklegitimität. Die Kommunikation von Zentralbanken mit der breiten Öffentlichkeit - im Gegensatz zur gut erforschten Kommunikation mit Finanzmärkten bisher weitgehend vernachlässigt - sieht sich mit einem Dilemma konfrontiert. Einerseits hängt die Legitimität der Zentralbank davon ab, ob ihr Handeln den Maximen entspricht, die sich aus der in der Öffentlichkeit vorherrschenden Theorie des Geldes ableiten. Andererseits weicht diese Theorie in wichtigen Punkten von der tatsächlichen Funktionsweise des Geldsystems ab. Wie Zentralbanken mit diesem Dilemma umgehen, hängt von der allgemeinen geldpolitischen Situation ab. Anhand der Beispiele der Deutschen Bundesbank und der Europäischen Zentralbank wird argumentiert, dass Zentralbanker unter inflationären Bedingungen die Öffentlichkeit gerne in dem Glauben lassen, die Geldmenge sei vollständig von der Zentralbank kontrolliert. Die außergewöhnliche Initiative der Bank of England, die Öffentlichkeit von der Irrtümlichkeit dieser Vorstellung zu überzeugen, zeigt hingegen, dass deflationärer Druck und rapide geldpolitische Expansion das diskursive Verhältnis zwischen Geldvertrauen und Zentralbanklegitimität grundlegend verändert haben.
    Date: 2016
  4. By: Shukayev, Malik (University of Alberta, Department of Economics); Ueberfeldt, Alexander (Bank of Canada)
    Abstract: We analyze the impact of interest rate policy on financial stability in an environment where banks can experience runs on their short-term liabilities forcing them to sell assets at fire sale prices. Price adjustment frictions and a state-dependent risk of financial crisis create the possibility of a policy tradeoff between price stability and financial stability. Focusing on Taylor rules with monetary policy possibly reacting to banks' short-term liabilities, we find that the optimized policy uses the extra tool to support investment at the expense of higher inflation and output volatility.
    Keywords: Fire sales externality; short-term bank funding; business cycles; financial crisis
    JEL: D62 E32 E44 G01
    Date: 2016–11–11
  5. By: Armenter, Roc (Federal Reserve Bank of Philadelphia)
    Abstract: A monetary authority can be committed to pursuing an inflation, price-level, or nominal-GDP target yet systematically fail to achieve the prescribed goal. Con- strained by the zero lower bound on the policy rate, the monetary authority is unable to implement its objectives when private-sector expectations stray far enough from the target. Low-inflation expectations become self-fulfilling, resulting in an additional Markov equilibrium in which the monetary authority falls short of the nominal target, average output is below its efficient level, and the policy rate is typically low. Introducing a stabilization goal for long-term nominal rates can implement a unique Markov equilibrium without fully compromising stabilization policy.
    Keywords: inflation targeting; zero lower bound; Markov equilibria
    JEL: E52 E58
    Date: 2016–11–10
  6. By: Yimin Xu; Jakob de Haan
    Abstract: After the global financial crisis, several central banks introduced unconventional monetary policies, such as QE. If QE increases asset prices, but does not boost the real economy to the same extent, the relationship between the financial and the real sector will weaken. This study investigates this issue for the US using the predictive power of the credit spread for future employment growth as measure for the strength of the real-financial link in a moving-window framework. Our results suggest that the real-financial link is lower during bubbles and recessions. We also find that the relationship weakened after the Fed introduced QE.
    Keywords: Financial-real Linkages; unconventional monetary policies; QE; Federal Reserve
    JEL: E22 G31 G32 D92
    Date: 2016–11
  7. By: Bahaj, Saleem; Malherbe, Frédéric
    Abstract: We propose a theory of bank behaviour under capital requirements. The sign of the lending response to a change in capital requirement is ambiguous due to the interplay between risk-taking incentives and debt overhang considerations. Optimal lending is typically U-shaped in the capital requirement. Changes in expected returns on loans shift this relationship. The lower expected returns the lower its slope. Using UK regulatory data (1989-2007), we find support for this prediction. It follows that a bank mainly adjusts to a higher capital requirement through cutting lending when expected returns are low, and by raising capital when they are high.
    JEL: G21 G28
    Date: 2016–11
  8. By: Darracq Pariès, Matthieu; Kühl, Michael
    Abstract: We analyse the effects of central bank government bond purchases in an estimated DSGE model for the euro area. In the model, central bank asset purchases are relevant in so far as agency costs distort banks asset allocation between loans and bonds, and households face transaction costs when trading government bonds. Such frictions in the banking sector induce inefficient time-variation in the term premia and open up for a credit channel of central bank government bond purchases. Considering first ad hoc asset purchase programmes like the one implemented by the ECB, we show that their macroeconomic multipliers are stronger as the lower bound on the policy rate becomes binding and when the purchasing path is fully communicated and anticipated by economic agents. From a more normative standpoint, interest rate policy and asset purchases feature strong strategic complementarities during both normal and crisis times. In a lower bound environment, optimal policy conduct features long lower bound periods and activist asset purchase policy. Our results also point to a clear sequencing of the exit strategy, stopping first the asset purchases and later on, lifting off the policy rate. In terms of macroeconomic stabilisation, optimal asset purchase strategies bring sizeable benefits and have the potential to largely offset the costs of the lower bound on the policy rate. JEL Classification: C61, E52, G11
    Keywords: banking, DSGE, portfolio optimisation, quantitative easing
    Date: 2016–11
  9. By: Claire Océane Chevallier (CREA, Université du Luxembourg); Sarah El Joueidi (CREA, Université du Luxembourg)
    Abstract: This chapter develops a dynamic stochastic general equilibrium model in infinite horizon with a regulated banking sector where stochastic banking bubbles may arise endogenously. We analyze the conditions under which stochastic bubbles exist and their impact on macroeconomic key variables. We show that when banks face capital requirements based on Value-at- Risk, two different equilibria emerge and can coexist: the bubbleless and the bubbly equilibria. Alternatively, under a regulatory framework where capital requirements are based on credit risk only, as in Basel I, bubbles are explosive and, as a consequence, cannot exist. The stochastic bubbly equilibrium is characterized by positive or negative bubbles depending on the tightness of capital requirements based on Value-at-Risk. We find a maximum value of capital requirements under which bubbles are positive. Below this threshold, the stochastic bubbly equilibrium provides larger wel- fare than the bubbleless equilibrium. In particular, our results suggest that a change in banking policies might lead to a crisis without external shocks.
    Keywords: Banking bubbles; banking regulation; DSGE; infinitely lived agents; multiple equilibria; Value-at-Risk
    JEL: E2 E44 G01 G20
    Date: 2016
  10. By: Bergin, Paul R. (University of California at Davis); Glick, Reuven (Federal Reserve Bank of San Francisco); Wu, Jyh-Lin (National Sun Yat-Sen University)
    Abstract: While economic theory highlights the usefulness of flexible exchange rates in promoting adjustment in international relative prices, flexible exchange rates also can be a source of destabilizing shocks. We find that when countries joining the euro currency union abandoned their national exchange rates, the adjustment of real exchange rates toward their long-run equilibrium surprisingly became faster. To investigate, we distinguish between differing rates of purchasing power parity (PPP) convergence conditional on alternative shocks, which we refer to as “conditional PPP.” We find that the loss of the exchange rate as an adjustment mechanism after the introduction of the euro was more than compensated by the elimination of the exchange rate as a source of shocks, in combination with faster adjustment in national prices. These findings support claims that flexible exchange rates are not necessary to promote long-run international relative price adjustment.
    JEL: F00 F15 F31
    Date: 2016–10–18
  11. By: Campbell Leith (University of Glasgow)
    Abstract: We develop the fiscal theory of the price level in a range of models using both ad hoc policy rules and jointly optimal monetary and fiscal policies. The article is prepared for the Handbook of Macroeconomics, volume 2 (John B. Taylor and Harald Uhlig, editors, Elsevier Press).
    Keywords: inflation, fiscal policy, fiscal theory of the price level, Monetary Policy, Debt Management
    Date: 2016
  12. By: Haselmann, Rainer; Wahrenburg, Mark
    Abstract: We provide an assessment of the Basel Committee on Banking Supervision (BCBS) proposal to restrict the internal ratings-based approach on bank risk and to introduce risk-weighted asset floors. If well enforced, risk-sensitive capital regulation results in a more efficient credit allocation compared to the standard approach. Thus, the internal ratings-based approach should be maintained. Further, the use of internal ratings-based output floors potentially results in unintended negative side effects. Input floors are likely a valuable tool to achieve risk-weighted assets comparability. Finally, the proposed measures have a potential detrimental impact for European banks as compared to others.
    Keywords: internal rating models,floors,banking regulation,BCBS
    Date: 2016
  13. By: Michael Reiter (Institute for Advanced Studies); Philipp Hergovich (University of Vienna)
    Abstract: We study the redistributive effects of monetary policy in the framework of a large OLG model, with endogenous housing choice, downpayment constraints, and different types of shocks. We pay special attention to the structure of debt, whether it is short-term or long-term, nominal or real. We find that monetary policy shocks have long-lasting effects on the inter-generational wealth distribution. While the debt structure only has a mild effect on aggregate statistics, it matters a lot for how different types of shocks under different monetary policy regimes affect the distribution.
    Date: 2016
  14. By: Mariusz Kapuściński; Ewa Stanisławska
    Abstract: We analyse why loan rates in Poland have diverged from interbank interest rates since the beginning of the global financial crisis. Following Illes et al. (2015) we calculate a weighted average cost of liabilities, which might be considered as a more accurate proxy for a marginal cost of funding for banks than an interbank interest rate. Then, we investigate the interest rate pass-through on bank-level panel data using both measures. We find that an increase in the weighted average cost of liabilities, relative to interbank interest rates, explains some of the increase in credit spreads. However, deterioration of economic outlook, an increase in uncertainty and non-performing loans, as well as tightening of capital regulation have also been at play. That the cost of funding matters for loan rates has important implications for the current discussion on the potency of negative interest rates, as they rather cannot be transmitted to deposit rates, which are the main component of bank funding.
    Keywords: interest rate pass-through, monetary policy, global financial crisis, lending spreads, panel data models
    JEL: E43 E52 C23
    Date: 2016
  15. By: Ali, Faran; Mamoon, Dawood; Tahir, Naveed
    Abstract: This study empirically finds the appropriate exchange rate regime for economic structure of Pakistan. To find long run association between exchange rate regime and its determinants; ARDL bond testing approach is concern however for the estimation of short run analysis Error correction model (ECM) is applied. Time series data is used over the period from 1984 to 2012. Findings reveal that Trade openness, foreign exchange reserves, rate of inflation and financial development are important determinant while choosing appropriate exchange-rate regime for economy having features like Pakistan. On the basis of analysis, this study suggests that both extreme ends hard peg and free float are unfavorable for it. Still, lot of attention is required on this topic. Choice of regime is a difficult task in empirical analysis because few factors cannot explain actual regime.
    Keywords: Exchange Rate Regime,
    JEL: E5 E58
    Date: 2016–10–01

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