nep-cba New Economics Papers
on Central Banking
Issue of 2016‒12‒18
twenty-two papers chosen by
Maria Semenova
Higher School of Economics

  1. Financial Fragility in Monetary Economies By Fernando Martin; Aleksander Berentsen; David Andolfatto
  2. Lifecycle Central Bank Reputation, Cheap Talk and Transparency as Substitutes for Commitment: Experimental Evidence By John Duffy; Frank Heinemann
  3. Do central banks respond timely to developments in the global economy? By Hilde C. Bjørnland; Leif Anders Thorsrud; Sepideh K. Zahiri
  4. What do Latin American inflation targeters care about? A comparative Bayesian estimation of central bank preferences By Stephen McKnight; Alexander Mihailov; Antonio Pompa Rangel
  5. Labor Market Frictions and Monetary Policy Design By Anna Almosova;
  6. 'Institutional Mandates for Macroeconomic and Financial Stability' By Pierre-Richard Agénor; Alessandro Flamini
  7. An Augmented Taylor rule for India’s Monetary Policy: Does Governor Regime Matters? By Bhuyan, Biswabhusan; Sethi, Dinabandhu
  8. Bank capital requirements and balance sheet management practices: has the relationship changed after the crisis? By de-Ramon, Sebastian J A; Francis, William; Harris, Qun
  9. Bank response to higher capital requirements: Evidence from a quasi-natural experiment By Gropp, Reint; Mosk, Thomas; Ongena, Steven; Wix, Carlo
  10. The Effects of Monetary Policy and Other Announcements By Chao Gu; Han Han; Randall Wright
  11. Trend Inflation and Exchange Rate Dynamics : A New Keynesian Approach By KANO, Takashi
  12. QE: the story so far By Haldane, Andrew; Roberts-Sklar, Matt; Wieladek, Tomasz; Young, Chris
  13. Monetary Policy and Durable Goods By Barsky, Robert; Boehm, Christoph E.; House, Christopher L.; Kimball, Miles
  14. Monetary Policy and Covered Interest Parity in the Post GFC Period: Evidence from Australian Dollar and the NZ Dollar By Shin-ichi Fukuda; Mariko Tanaka
  15. Should the Reserve Bank worry about the exchange rate? By Nguyen, Luan
  16. Inflation Perceptions and Inflation Expectations By Alan K. Detmeister; David E. Lebow; Ekaterina V. Peneva
  17. Financing of Firms, Labor Reallocation and the Distributional Role of Monetary Policy By Salem Abo-Zaid; Anastasia Zervou
  18. Macroeconomic Stabilization, Monetary-fiscal Interactions, and Europe's monetary Union By Corsetti, G.; Dedola, L.; Jarociński, M.; Mańkowiak, B.; Schmidt, S.
  19. Response of Turkish Financial Markets to Negative Interest Rate Announcements of the ECB By Gokhan Sahin Gunes; Sumru Oz
  20. Credit, Money, Interest, and Prices By Yuliy Sannikov; Saki Bigio
  21. European banking supervision, the role of stress test. Some brief considerations By Simone Manduchi
  22. Too Little, Too Late? Monetary Policymaking Inertia and Psychology: A Behavioral Model By Federico Favaretto; Donato Masciandaro

  1. By: Fernando Martin (Federal Reserve Bank of St. Louis); Aleksander Berentsen (University of Basel); David Andolfatto (Federal Reserve Bank of St. Louis)
    Abstract: We integrate the Diamond and Dybvig (1983) theory of financial fragility with the Lagos and Wright (2005) model of monetary exchange. Non-bank monetary economies with well-functioning secondary markets for capital can allocate risk reasonably well, but are never efficient. When secondary markets are subject to ``market freeze'' events, risk-sharing deteriorates accordingly. A fractional-reserve bank can dominate a monetary economy because: (i) it provides superior risk-sharing even when market freeze events are absent; and (ii) it bypasses the need for a secondary capital market to begin with. Indeed, fractional reserve banks can implement the optimal allocation when monetary policy follows the Friedman rule. However, the desirability of fractional reserve banking is diminished if the structure is subject to ``bank runs''. In the event of a run, an open secondary market allows banks to liquidate capital at a price that permits honoring all deposit obligations. If bank runs are expected to occur with a sufficiently high probability, then a narrow banking structure may be preferred. Narrow banks are more stable, but offer less risk-sharing. We find that high inflation economies penalize narrow banking systems relatively more than fractional reserve systems. Special interests are not generally aligned over the choice of bank regime.
    Date: 2016
  2. By: John Duffy (Department of Economics, University of California-Irvine); Frank Heinemann (Department of Economics, Technische Universitat Berlin)
    Abstract: We implement a repeated version of the Barro-Gordon monetary policy game in the laboratory and ask whether reputation serves as a substitute for commitment, enabling the central bank to achieve the efficient Ramsey equilibrium and avoid the inefficient, time-inconsistent one-shot Nash equilibrium. We find that reputation is a poor substitute for commitment. We then explore whether central bank cheap talk, policy transparency, both cheap talk and policy transparency or economic transparency yield improvements in the direction of the Ramsey equilibrium under the discretionary policy regime. Our findings suggest that these mechanisms have only small or transitory effects on welfare. Surprisingly, the real effects of supply shocks are better mitigated by a commitment regime than by any discretionary policy. Thus, we find that there is no trade-off between flexibility and credibility.
    Keywords: Monetary policy; Repeated games; Central banking; Commitment; Discretion; Cheap talk; Transparency; Experimental economics
    JEL: C92 D83 E52 E58
    Date: 2016–12
  3. By: Hilde C. Bjørnland; Leif Anders Thorsrud; Sepideh K. Zahiri
    Abstract: Our analysis suggests; they do not! To arrive at this conclusion we construct a real-time data set of interest rate projections from central banks in three small open economies; New Zealand, Norway, and Sweden, and analyze if revisions to these projections (i.e., forward guidance) can be predicted by timely information. Doing so, we find a systematic role for forward looking international indicators in predicting the revisions to the interest rate projections in all countries. In contrast, using similar indexes for the domestic economy yields largely insignificant results. Furthermore, we find that revisions to forward guidance matter. Using a VAR identified with external instruments based on forecast errors from the predictive regressions, we show that the responses to output, inflation, the exchange rate and asset returns resemble those one typically associates with a conventional monetary policy shock.
    Keywords: Monetary policy, interest rate path, forecast revisions and global indicators
    Date: 2016–11
  4. By: Stephen McKnight (El Colegio de Mexico); Alexander Mihailov (University of Reading); Antonio Pompa Rangel (Banco de México)
    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 in.ation 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 .uctuations. 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 di¤erent 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 Amer- ica, small open economies, incomplete asset markets, monetary policy
    JEL: C51 E52 F41
    Date: 2016–11
  5. By: Anna Almosova;
    Abstract: This paper estimates a New Keynesian DSGE model with search frictions and monetary rules augmented with di erent labor market indicators. In accordance with a theoretical literature I nd that a central bank reacts to a labor market tightness, employment or unemployment. Posterior odds tests speak in favor of models with augmented Taylor rules versus a model with a model with a standard rule. The augmented rules were also shown to be more ecient in terms of welfare.
    JEL: E52 E24 C11
    Date: 2016–12
  6. By: Pierre-Richard Agénor; Alessandro Flamini
    Abstract: The performance of alternative institutional policy mandates for achieving macroeconomic and financial stability is studied in a model with financial frictions. These mandates involve goal-integrated, goal-distinct, and common-goal mandates for the monetary authority and the financial regulator. In the first case both monetary and macroprudential policies are set optimally, but in the last two cases monetary policy only is set optimally whereas macroprudential policy is implemented through a simple, credit-based reserve requirement rule. The model is parameterized and used to simulate responses to a financial shock. The analysis shows that it is optimal to use both the policy rate and the required reserve ratio only under the goal-integrated mandate. In addition, it is optimal to delegate the financial stability goal solely to the monetary authority when the financial regulator is only equipped with a credit-based reserve rule. The key reason is that only the integrated mandate can fully internalize the policy spillovers which adversely affect economic stability..
    Date: 2016
  7. By: Bhuyan, Biswabhusan; Sethi, Dinabandhu
    Abstract: This paper examined the monetary policy stance in India during the governors’ regime of Jalan- Reddy-Subbarao- Rajan. An Augmented Taylor Rule is employed to estimate monetary policy response for each period using monthly data. The results revealed that the governor regime matters in the monetary policy response. When output gap has been an important concern during Jalan, Subbarao and Rajan’s period, inflation remained a major concern for Reddy and Rajan’s regime. Interestingly, the interest rate is highly responsive to changes in exchange rate during Rajan period. These findings are consistent with the conditions of economy during those periods. In addition, the exchange rate and output gap remained a greater concern for policy maker in post-crisis period. Nevertheless, we find policy inertia during all regimes.
    Keywords: Monetary policy, Taylor’s rule, Inflation, Output gap, Hodrick-Prescott filter
    JEL: C22 E52 E58
    Date: 2016–12–04
  8. By: de-Ramon, Sebastian J A (Bank of England); Francis, William (Bank of England); Harris, Qun (Bank of England)
    Abstract: We use a proprietary database of individual UK capital requirements spanning 1989 to 2013 and panel regression techniques to evaluate whether the effects of capital requirements on banks’ balance sheet adjustments changed after the 2008–09 financial crisis. We find that after the crisis banks placed more emphasis on overall asset de-leveraging. A 1 percentage point increase in capital requirements lowered total asset growth by 14 basis points before the crisis and 20 basis points after the crisis. We also find evidence of a structural change in banks’ capital management practices, with banks increasing better-quality, Tier 1 capital significantly more in response to higher requirements after the crisis than they did before the crisis. However, the effects of capital requirements on lending and risk-weighted asset growth both before and after the crisis are similar. Our results suggest that both before and after the crisis, a 1 percentage point increase in capital requirements lowered annual loan (risk-weighted asset) growth by 8 (12) basis points.
    Keywords: Banking; regulatory capital requirements; bank capital ratios; bank credit supply; macroprudential tools
    JEL: D21 G21 G28
    Date: 2016–12–09
  9. By: Gropp, Reint; Mosk, Thomas; Ongena, Steven; Wix, Carlo
    Abstract: We study the impact of higher capital requirements on banks' balance sheets and its transmission to the real economy. The 2011 EBA capital exercise provides an almost ideal quasi-natural experiment, which allows us to identify the effect of higher capital requirements using a difference-in-differences matching estimator. We find that treated banks increase their capital ratios not by raising their levels of equity, but by reducing their credit supply. We also show that this reduction in credit supply results in lower firm-, investment-, and sales growth for firms which obtain a larger share of their bank credit from the treated banks.
    Keywords: banking,regulation,real effects of finance
    JEL: E22 E44 G21
    Date: 2016
  10. By: Chao Gu; Han Han (School of Economics, Peking University); Randall Wright (FRB Chicago, FRB Minneapolis, University of Wisconsin and NBER)
    Abstract: We analyze the impact of news (information shocks) in economies where liquidity plays a role. While we also consider news about real factors, like productivity, one motivation is that central bank announcements evidently affect markets, as taken for granted by advocates of forward guidance policy. The dynamic effects can be complicated, with information about monetary policy or real factors affecting markets for goods, equity, housing, credit and foreign exchange. Even news about neutral policy can induce cyclic or boom-bust responses. More generally, we show that central bank announcements can induce rather than reduce volatility, and might increase or decrease welfare.
    Keywords: Announcements, Monetary Policy, News, Dynamics
    JEL: E30 E44 E52 G14 D53 D83
  11. By: KANO, Takashi
    Abstract: The paper studies exchange rate implications of trend inflation within a two-country New Keynesian (NK) model under incomplete international financial markets. A NK Phillips curve generalized by trend inflation with a positive long-run mean implies an expectational difference equation of inflation with higher-order leads of expected inflation. The resulting two-country inflation differential is smoother, more persistent, and more insensitive to a real exchange rate. General equilibrium then yields (i) a persistent real exchange rate with an autoregressive root close to one, (ii) a hump-shaped impulse response of a real exchange rate with a half-life longer than four years, (iii) a volatile real exchange rate relative to cross-country inflation differential, (iv) an almost perfect co-movement between real and nominal exchange rates. and (v) a sharp rise in the volatility of a real exchange rate from a managed nominal exchange rate regime to a flexible one within an otherwise standard two-country NK model. Trend inflation, therefore, approaches empirical puzzles of exchange rates dynamics.
    Keywords: Real and Nominal Exchange Rates, Trend Inflation, New Keynesian Models
    JEL: E31 E52 F31 F41
    Date: 2016–12
  12. By: Haldane, Andrew; Roberts-Sklar, Matt; Wieladek, Tomasz; Young, Chris
    Abstract: In the past decade or so, a number of central banks have purchased assets financed by the creation of central bank reserves as a tool for loosening monetary policy - a policy often known as "quantitative easing" or "QE". The first half of the paper reviews the international evidence on the impact on financial markets and economic activity of this policy. It finds that these central bank balance sheet expansions had a discernible and significant impact on financial markets and the economy. The second half of the paper provides new empirical analysis on the macroeconomic impact of central bank balance sheet expansions, across time and countries. It finds three key results. First, it is only when central bank balance sheet expansions are used as a monetary policy tool that they have a significant macro-economic impact. Second, there is evidence for the US that the effectiveness of QE may vary over time, depending on the state of the economy and liquidity of the financial system. And third, QE can have strong spill-over effects cross-border, acting mainly via financial channels. For example, the impact of US QE on UK economic activity may be as large as the impact on US economic activity.
    Keywords: central bank balance sheet.; QE; Quantitative easing; Unconventional Monetary Policy
    JEL: E43 E44 E52 E58 E6
    Date: 2016–12
  13. By: Barsky, Robert (Federal Reserve Bank of Chicago); Boehm, Christoph E. (University of Michigan); House, Christopher L. (University of Michigan); Kimball, Miles (University of Michigan)
    Abstract: We analyze monetary policy in a New Keynesian model with durable and nondurable goods each with a separate degree of price rigidity. The model behavior is governed by two New Keynesian Phillips Curves. If durable goods are sufficiently long-lived we obtain an intriguing variant of the well-known “divine coincidence.” In our model, the output gap depends only on inflation in the durable goods sector. We then analyze the optimal Taylor rule for this economy. If the monetary authority wants to stabilize the aggregate output gap, it places much more emphasis on stabilizing durable goods inflation (relative to its share of value-added in the economy). In contrast, if the monetary authority values stabilizing aggregate inflation, then it is optimal to respond to sectoral inflation in direct proportion to their shares of economic activity. Our results flow from the inherently high interest elasticity of demand for durable goods. We use numerical methods to verify the robustness of our analytical results for a broader class of model parameterizations.
    Keywords: Taylor rule; inflation targeting; economic stabilization
    JEL: E31 E32 E52
    Date: 2016–11–06
  14. By: Shin-ichi Fukuda (The University of Tokyo); Mariko Tanaka (Musashino University)
    Abstract: Unlike the other major currencies, the Australian Dollar and the NZ dollar had lower interest rate than the US dollar on forward contract in the post GFC period. The purpose of this paper is to explore why this happened through estimating the covered interest parity (CIP) condition. In the analysis, we focus on a unique feature of Australia and New Zealand where short-term interest rates remained significantly positive even after the GFC. The paper first constructs a theoretical model where increased liquidity risk causes deviations from the CIP condition. It then tests this theoretical implication by using daily data of six major currencies. We find that both money market risk measures and policy rates had significant effects on the CIP deviations. The result implies that unique monetary policy feature in Australia and New Zealand made deviations from the CIP condition distinct on the forward contract.
    Date: 2016–11
  15. By: Nguyen, Luan
    Abstract: This research paper is focused on estimating a set of parameters for a simple monetarypolicy model of New Zealand and calibrate these parameters to compute viability kernels. We found output gap to be persistent across our sample period. There is weak evidence of a downward sloping IS curve and an upward sloping Phillips curve. The estimation results for thereal exchange rate parameter in the IS equation and the uncovered interest rate parity do notconfirm the theoretical predictions. By calibrating the estimated parameters to our viability analysis, we recommend that the Reserve Bank should not worry about the exchange rate, the OCR be lowered further and increasing the scope of fiscal policy in sharing the burden with monetary policy.
    Keywords: Monetary policy; Viability theory; Viability kernels; Central bank; Real exchange rate
    JEL: E52 E58 E61 F41
    Date: 2016–10–17
  16. By: Alan K. Detmeister; David E. Lebow; Ekaterina V. Peneva
    Abstract: In this note, we discuss new data on consumers' perceptions of recent inflation from the University of Michigan Surveys of Consumers (MSC). Our preliminary results show that survey responses indicate inflation perceptions differ widely across individuals (with a slightly wider distribution than for inflation expectations) but the bulk of responses are between zero and five percent.
    Date: 2016–12–05
  17. By: Salem Abo-Zaid (Texas Tech University, Department of Economics); Anastasia Zervou (Texas A&M University, Department of Economics)
    Abstract: We analyze monetary policy in a heterogenous firms environment where cash con- strained firms finance operations through external financing and cash unconstrained firms operate by using internal funds. We show that firms respond differently to shocks: expansionary monetary policy sharply increases the relative employment of the cash constrained firms while positive productivity shocks induce a rise in the relative employment of the cash unconstrained firms. Our analysis points to a clear role of monetary policy in reallocating resources across sectors that differ in their financing capabilities. Furthermore, the predictions of our model match the empirical evidence implying that financially constrained firms react sharply to monetary policy shocks but are less cyclical than unconstrained firms following productivity shocks.
    Keywords: Heterogeneous Firms, Monetary Policy, Labor Reallocation, Firms’ financing
    JEL: E32 E44 E52
    Date: 2016–10–20
  18. By: Corsetti, G.; Dedola, L.; Jarociński, M.; Mańkowiak, B.; Schmidt, S.
    Abstract: The euro area has been experiencing a prolonged period of weak economic activity and very low inflation. This paper reviews models of business cycle stabilization with an eye to formulating lessons for policy in the euro area. According to standard models, after a large recessionary shock accommodative monetary and fiscal policy together may be necessary to stabilize economic activity and inflation. The paper describes practical ways for the euro area to be able to implement an effective monetary-fiscal policy mix.
    Keywords: Lower Bound on Nominal Interest Rates; Self-fulfilling Sovereign Default; Eurobond; Government Bonds; Joint Analysis of Fiscal and Monetary Policy
    JEL: E31 E62 E63
    Date: 2016–12–15
  19. By: Gokhan Sahin Gunes (Koc University-TUSIAD ERF and Koc University); Sumru Oz (Koc University-TUSIAD ERF)
    Abstract: This paper examines the impact of negative interest rate announcements of the ECB on Turkish financial markets. Negative Interest Rate Policies (NIRP) are expected to affect emerging market and developing economies (EMDEs) through an increase in the inflow of capital searching for higher yields. The expectation for an increase in short-term capital inflows to an EMDE might have transmission channels to the whole economy similar to those of expansionary monetary policies, except for a sign change in case of the exchange rate channel. The rest of the transmission channels are portfolio, interest rate, and credit channels. The latter is excluded from the analysis since it takes time to realize. Accordingly, we analyze the impact of negative interest rate announcements of the ECB on EUR/TRY and USD/TRY exchange rates; 1-month and 3-month TRLibor rates; BIST 100 Index, as well as 2-year and 10-year bond returns using GARCH (1,1) model. The results show that the announcements significantly affect both the volatility of Turkey's financial indicators and their returns especially through interest rate and portfolio channels. The robustness of the results on volatility is tested by using an event study.
    Keywords: NIRP, transmission channels, financial indicators, Turkey.
    JEL: E58 F30 G10
    Date: 2016–12
  20. By: Yuliy Sannikov (Princeton University); Saki Bigio (UCLA)
    Abstract: We develop a monetary theory where monetary policy operates exclusively through the bank-lending channel. Credit demand and deposit creation are dynamically linked. Policy tools affect lending through the provision of reserves and their influence on interbank market rates. A credit crunch causes debt-deflation episode that sends agents to their borrowing constraints. Unemployment increases because firms reduce utilization to avoid the risk of violating borrowing limits. Standard monetary policy has power only if credit is extended. We study the cross-section and aggregate dynamics of credit, monetary aggregates, nominal interest, and prices after several policy experiments.
    Date: 2016
  21. By: Simone Manduchi
    Abstract: A quick review of European financial stability institutions and the role of stress tests in the current juridical system.
    Date: 2016–12
  22. By: Federico Favaretto; Donato Masciandaro
    Abstract: Can the inertia in the monetary policymaking be attributed to psychological drivers? Our model shows two results. First, our baseline model with individual loss aversion explains inertia in a monetary policy committee (MPC) where holds a de jure majority rule. Second, our second model shows that introducing a specication of loss aversion for all members in a MPC leads to inertial decisions when status-quo ination is below the ination target. Conversely when status-quo ination is above the target rate, inertial policy does not occur until the level of ination discounts the loss aversion mechanism. In the framework of a hawk-dove dimension we conclude that loss aversion favors inertial monetary policy.
    Keywords: Monetary Policy, Behavioral Economics
    JEL: D7 E5
    Date: 2016

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