nep-cba New Economics Papers
on Central Banking
Issue of 2017‒02‒05
seventeen papers chosen by
Maria Semenova
Higher School of Economics

  1. Backtesting European Stress Tests By Thomas Philippon; Pierre Pessarossi; Boubacar Camara
  2. Optimal Dynamic Capital Requirements By Caterina Mendicino; Kalin Nikolov; Javier Suarez; Dominik Supera
  3. Central bank communications: a case study By Davis, J. Scott; Wynne, Mark A.
  4. Do central banks respond timely to developments in the global economy? By Hilde C. Bjørnland; Leif Anders Thorsrud; Sepideh K. Zahiri
  5. Foreign Banks and International Transmission of Monetary Policy: Evidence from the Syndicated Loan Market By Asli Demirguc-Kunt; Balint Horvath; Harry Huizinga
  6. Collateral, Central Bank Repos, and Systemic Arbitrage By Falko Fecht; Kjell G. Nyborg; Jörg Rocholl; Jiri Woschitz
  7. Exchange Rate Pass-Through in the Euro Area By Mariarosaria Comunale; Davor Kunovac
  8. Expected Inflation Regimes in Japan By OKIMOTO, Tatsuyoshi
  9. Pass-through with low inflation and volatile exchange rates By Alexius, Annika; Holmberg, Mikaela
  10. The roles of inflation expectations, core inflation, and slack in real-time inflation forecasting By Kishor, N. Kundan; Koenig, Evan F.
  11. Asset Prices, Nominal Rigidities, and Monetary Policy: Case of Housing Price By Kengo Nutahara
  12. Large and State-Dependent Effects of Quasi-Random Monetary Experiments By Jorda, Oscar; Schularick, Moritz; Taylor, Alan M.
  13. The European sovereign debt crisis: What have we learned? By Kräussl, Roman; Lehnert, Thorsten; Stefanova, Denitsa
  14. Aggregate Investment Externalities and Macroprudential Regulation By Hans Gersbach; Jean-Charles Rochet
  15. Confidence Interval Projections of the Federal Reserve Balance Sheet and Income By Erin E. Syron Ferris; Soo Jeong Kim; Bernd Schlusche
  16. Economic policy uncertainty and the credit channel: aggregate and bank level U.S. evidence over several decades By Bordo, Michael D.; Duca, John V.; Koch, Christoffer
  17. CoCo Design, Risk Shifting Incentives and Financial Fragility By Chan, Stephanie; Wijnbergen, Sweder

  1. By: Thomas Philippon; Pierre Pessarossi; Boubacar Camara
    Abstract: We provide a first evaluation of the quality of banking stress tests in the European Union. We use stress tests scenarios and banks’ estimated losses to recover bank level exposures to macroeconomic factors. Once macro outcomes are realized, we predict banks’ losses and compare them to actual losses. We find that stress tests are informative and unbiased on average. Model-based losses are good predictors of realized losses and of banks’ equity returns around announcements of macroeconomic news. When we perform our tests for the Union as a whole, we do not detect biases in the construction of the scenarios, or in the estimated losses across banks of different sizes and ownership structures. There is, however, some evidence that exposures are underestimated in countries with ex-ante weaker banking systems. Our results have implications for the modeling of credit losses, quality controls of supervision, and the political economy of financial regulation.
    JEL: G01 G18 G2 G21 G28 G32
    Date: 2017–01
  2. By: Caterina Mendicino (European Central Bank); Kalin Nikolov (European Central Bank); Javier Suarez (CEMFI); Dominik Supera (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: We characterize welfare maximizing capital requirement policies in a macroeconomic model with household, firm and bank defaults calibrated to Euro Area data. We optimize on the level of the capital requirements applied to each loan class and their sensitivity to changes in default risk. We find that getting the level right (so that bank failure risk remains small) is of foremost importance, while the optimal sensitivity to default risk is positive but typically smaller than under Basel IRB formulas. When starting from low levels, initially both savers and borrowers benefit from higher capital requirements. At higher levels, only savers are in favour of tighter and more time-varying capital charges.
    Keywords: Macroprudential policy, bank fragility, capital requirements, financial frictions, default risk.
    JEL: E3 E44 G01 G21
    Date: 2016–12
  3. By: Davis, J. Scott (Federal Reserve Bank of Dallas); Wynne, Mark A. (Federal Reserve Bank of Dallas)
    Abstract: Over the past twenty five years, central bank communications have undergone a major revolution. Central banks that previously shrouded themselves in mystery now embrace social media to get their message out to the widest audience. The Federal Reserve System has not always been at the forefront of these changes, but the volume of information about monetary policy that the Federal Open Market Committee (FOMC) now releases dwarfs what it was releasing a quarter century ago. In this paper we focus on just one channel of FOMC communications, the post-meeting statement. We document how it has evolved over time, and in particular the extent to which it has become more detailed, but also more difficult to understand. We then use a VAR with daily financial market data to estimate a daily time series of U.S. monetary policy shocks. We show how these shocks on Fed statement release days have gotten larger as the statement has gotten longer and more detailed, and we show that the length and complexity of the statement has a direct effect on the size of the monetary policy shock following a Fed decision.
    JEL: E58 E65
    Date: 2016–09–01
  4. 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
  5. By: Asli Demirguc-Kunt; Balint Horvath; Harry Huizinga
    Abstract: This paper uses loan-level data from 124 countries over 1995–2015 to examine the transmission of monetary policy through the cross-border syndicated loan market. The results show that the expansion of monetary policy increases cross border credit supply especially to weaker firms. However, greater foreign bank presence in the borrower country appears to reduce the potentially destabilizing impact of lower policy interest rates on cross-border lending, as it attenuates increases in loan volume and maturity while magnifying increases in collateralization and covenant use. The mitigating effect of foreign banking presence in the borrowing country on the transmission of monetary policy is robust to controlling for borrower-country economic and financial development, and a range of borrower and lender country policies and institutions, including the strength of bank regulation and supervision, exchange rate flexibility, and restrictions on capital flows. The findings qualify the characterization of international banks as sources of credit instability, and suggest that foreign bank entry can improve the stability of cross-border credit in the face of international monetary policy shocks.
    Keywords: Cross-border lending, monetary transmission, banking FDI, bank regulation, capital controls.
    JEL: E44 E52 F34 F38 F42 G15 G20
    Date: 2017–01–25
  6. By: Falko Fecht (Frankfurt School of Finance & Management); Kjell G. Nyborg (University of Zurich, Centre for Economic Policy Research (CEPR), and Swiss Finance Institute); Jörg Rocholl (ESMT European School of Management and Technology); Jiri Woschitz (University of Zurich)
    Abstract: Central banks are under increased scrutiny because of the rapid growth in, and composition of, their balance sheets. Therefore, understanding the processes that shape these balance sheets and their consequences is crucial. We contribute by studying an extensive dataset of banks’ liquidity uptake and pledged collateral in central bank repos. We document systemic arbitrage whereby banks funnel credit risk and low-quality collateral to the central bank. Weaker banks use lower quality collateral to demand disproportionately larger amounts of central bank money (liquidity). This holds both before and after the financial crisis and may contribute to financial fragility and fragmentation.
    Keywords: Collateral, repo, systemic arbitrage, central bank, collateral policy, banks, liquidity, interbank market, financial stability, financial fragmentation
    JEL: G12 G21 E42 E51 E52 E58
  7. By: Mariarosaria Comunale (Bank of Lithuania); Davor Kunovac (Bank of Finland)
    Abstract: In this paper we analyse the exchange rate pass-through (ERPT) in the euro area as a whole and for four euro area members - Germany, France, Italy and Spain. For that purpose we use Bayesian VARs with identification based on a combination of zero and sign restrictions. Our results emphasize that pass-through in the euro area is not constant over time - it may depend on a composition of economic shocks governing the exchange rate. Regarding the relative importance of individual shocks, it seems that pass-through is the strongest when the exchange rate movement is triggered by (relative) monetary policy shocks and the exchange rate shocks. Our shock-dependent measure of ERPT points to a large but volatile pass-through to import prices and overall very small pass-through to consumer inflation in the euro area.
    Keywords: Exchange rate pass-through, import prices, consumer prices, in?ation, bayesian vector autoregression.
    JEL: C38 E31 F31
    Date: 2017–01–29
  8. By: OKIMOTO, Tatsuyoshi
    Abstract: This paper examines the dynamics of expected inflation regimes in Japan over the last three decades based on the smooth transition Phillips curve model. We find that there is a strong connection between the expected inflation and monetary policy regimes. The results also suggest that the introduction of the inflation targeting policy, and quantitative and qualitative easing in the beginning of 2013 have successfully escaped from the deflationary regime, but was not enough to achieve the 2% inflation target. Finally, our results indicate the significance of exchange rates in explaining the recent fluctuations of inflation, and the importance of oil and stock prices in maintaining the positive expected inflation regime.
    Keywords: Hybrid Phillips curve, monetary policy, inflation targeting, qualitative and quantitative easing, smooth transition model
    JEL: C22 E31 E52
    Date: 2017–01
  9. By: Alexius, Annika (Dept. of Economics, Stockholm University); Holmberg, Mikaela (Dept. of Economics, Stockholm University)
    Abstract: As central banks struggle to boost inflation rates in the face of low global inflation and volatile foreign exchange markets, it has become particularly important to understand how inflation in open economies is affected by movements in exchange rates and foreign inflation. Using a time-varying parameter Bayesian VAR, we analyze the behavior of pass-through across time and in relation to macroeconomic variables. We find little support for the Taylor (2000) hypothesis that pass-through is lower when inflation is close to target. In our data, inflation rates are often below rather than above target, and pass-through does not appear to increase significantly at low inflation rates. Furthermore, inflation persistence is unrelated to pass-through. The pass-through of foreign prices is much higher than the pass through of exchange rates. It is positively associated with the variance of foreign inflation, which is consistent with Calvo pricing.
    Keywords: Pass through; inflation; Bayesian time varying parameter VAR
    JEL: E31 F41
    Date: 2017–01–27
  10. By: Kishor, N. Kundan (University of Wisconsin); Koenig, Evan F. (Federal Reserve Bank of Dallas)
    Abstract: Using state-space modeling, we extract information from surveys of long-term inflation expectations and multiple quarterly inflation series to undertake a real-time decomposition of quarterly headline PCE and GDP-deflator inflation rates into a common long-term trend, common cyclical component, and high-frequency noise components. We then explore alternative approaches to real-time forecasting of headline PCE inflation. We find that performance is enhanced if forecasting equations are estimated using inflation data that have been stripped of high-frequency noise. Performance can be further improved by including an unemployment-based measure of slack in the equations. The improvement is statistically significant relative to benchmark autoregressive models and also relative to professional forecasters at all but the shortest horizons. In contrast, introducing slack into models estimated using headline PCE inflation data or conventional core inflation data causes forecast performance to deteriorate. Finally, we demonstrate that forecasting models estimated using the Kishor-Koenig (2012) methodology-which mandates that each forecasting VAR be augmented with a flexible state-space model of data revisions-consistently outperform the corresponding conventionally estimated forecasting models.
    Keywords: Inflation; real-time forecasting; unobserved component model; slack
    JEL: E31 E37
    Date: 2016–11–01
  11. By: Kengo Nutahara
    Abstract: Carlstrom and Fuerst (2007) ["Asset Prices, Nominal Rigidities, and Monetary Policy," Review of Economic Dynamics 10, 256-275] find that monetary policy response to share prices is a source of equilibrium indeterminacy in a stickyprice economy. We find that if housing price is a target of a central bank, monetary policy response to asset price is helpful for equilibrium determinacy.
    Date: 2017–01
  12. By: Jorda, Oscar (Federal Reserve Bank of San Francisco); Schularick, Moritz (Department of Economics, University of Bonn); Taylor, Alan M. (University of California, Davis)
    Abstract: Fixing the exchange rate constrains monetary policy. Along with unfettered cross-border capital flows, the trilemma implies that arbitrage, not the central bank, determines how interest rates fluctuate. The annals of international finance thus provide quasi-natural experiments with which to measure how macroeconomic outcomes respond to policy rates. Based on historical data since 1870, we estimate the local average treatment effect (LATE) of monetary policy interventions and examine its implications for the population ATE with a trilemma instrument. Using a novel control function approach we evaluate the robustness of our findings to possible spillovers via alternative channels. Our results prove to be robust. We find that the effects of monetary policy are much larger than previously estimated, and that these effects are state-dependent.
    JEL: E01 E30 E32 E44 E47 E51 F33 F42 F44
    Date: 2017–01–13
  13. By: Kräussl, Roman; Lehnert, Thorsten; Stefanova, Denitsa
    Abstract: This paper sets the background for the Special Issue of the Journal of Empirical Finance on the European Sovereign Debt Crisis. It identifies the channel through which risks in the financial industry leaked into the public sector. It discusses the role of the bank rescues in igniting the sovereign debt crisis and reviews approaches to detect early warning signals to anticipate the buildup of crises. It concludes with a discussion of potential implications of sovereign distress for financial markets.
    Keywords: sovereign debt crisis,systemic risk,contagion,bank bail-outs,financial regulation
    JEL: G01 G15 G21 G28
    Date: 2017
  14. By: Hans Gersbach (Swiss Federal Institute of Technology Zurich, Institute for the Study of Labor (IZA), CESifo (Center for Economic Studies and Ifo Institute) and Centre for Economic Policy Research (CEPR)); Jean-Charles Rochet (University of Zurich, University of Toulouse I, Ecole Polytechnique Fédérale de Lausanne, and Swiss Finance Institute)
    Abstract: Evidence suggests that banks tend to lend a lot during booms, and very little during recessions. We propose a simple explanation for this phenomenon. We show that, instead of dampening productivity shocks, the banking sector tends to exacerbate them, leading to excessive fluctuations of credit, output and asset prices. Our explanation relies on three ingredients that are characteristic of modern banks' activities. The first ingredient is moral hazard: banks are supposed to monitor the small and medium sized enterprises that borrow from them, but they may shirk on their monitoring activities, unless they are given sufficient informational rents. These rents limit the amount that investors are ready to lend them, to a multiple of the banks' own capital. The second ingredient is the banks' high exposure to aggregate shocks: banks' assets have positively correlated returns. Finally the third ingredient is the ease with which modern banks can reallocate capital between different lines of business. At the competitive equilibrium, banks offer privately optimal contracts to their investors but these contracts are not socially optimal: banks' decisions of reallocating capital react too strongly to aggregate shocks. This is because banks do not internalize the impact of their decisions on asset prices. This generates excessive fluctuations of credit, output and asset prices. We examine the efficacy of several possible policy responses to these properties of credit markets, and show that it can provide a rationale for macroprudential regulation.
    Keywords: Bank Credit Fluctuations, Macroprudential Regulation, Investment Externalities
    JEL: G21 G28 D86
  15. By: Erin E. Syron Ferris; Soo Jeong Kim; Bernd Schlusche
    Abstract: In response to the financial crisis of 2008 and the subsequent recession, the Federal Reserve employed large-scale asset purchases (LSAPs) and a maturity extension program (MEP) with the purpose of reducing longer-term interest rates, and thereby promoting more accommodative financial conditions at a time when the conventional monetary policy tool, the federal funds rate, was at its effective lower bound. In this note, we presented the implications for the Federal Reserve's balance sheet and income arising from a range of future potential macroeconomic outcomes.
    Date: 2017–01–13
  16. By: Bordo, Michael D. (Rutgers University); Duca, John V. (Federal Reserve Bank of Dallas); Koch, Christoffer (Federal Reserve Bank of Dallas)
    Abstract: Economic policy uncertainty aspects decisions of households, businesses, policy makers and financial intermediaries. We first examine the impact of economic policy uncertainty on aggregate bank credit growth. Then we analyze commercial bank entity level data to gauge the effects of policy uncertainty on financial intermediaries' lending. We exploit the cross-sectional heterogeneity to back out indirect evidence of its effects on businesses and households. We ask (i) whether, conditional on standard macroeconomic controls, economic policy uncertainty affected bank level credit growth, and (ii) whether there is variation in the impact related to banks' balance sheet conditions; that is, whether the effects are attributable to loan demand or, if impact varies with bank level financial constraints, loan supply. We find that policy uncertainty has a significant negative effect on bank credit growth. Since this impact varies meaningfully with some bank characteristics - particularly the overall capital-to-assets ratio and bank asset liquidity-loan supply factors at least partially (and significantly) help determine the influence of policy uncertainty. Because other studies have found important macroeconomic effects of bank lending growth on the macroeconomy, our findings are consistent with the possibility that high economic policy uncertainty may have slowed the U.S. economic recovery from the Great Recession by restraining overall credit growth through the bank lending channel.
    Keywords: money and banking; economic policy uncertainty; business cycles
    JEL: E40 E50 G21
    Date: 2016–07–08
  17. By: Chan, Stephanie; Wijnbergen, Sweder
    Abstract: Contingent convertible capital (CoCo) is a debt instrument that converts to equity or is written off if the issuing bank fails to meet a distress threshold. The conversion increases the issuer’s loss-absorption capacity, but results in wealth transfers between CoCo holders and shareholders, which in turn gives rise to risk-shifting incentives to shareholders. Using the framework of call options, this paper finds that the risk-shifting incentives arising from issuing CoCos relative to subordinated debt have two opposite effects: higher risk increases the probability of CoCo conversion, while lowering the benefit of the wealth transfer relative to the same amount of subordinated debt. For writedown CoCos, the risk-shifting incentive is always positive, while for equity-converting CoCos, it depends on the dilutive power of the CoCo. While recent regulation has deemed CoCos suitable for increasing loss absorption capacity, our results show that some CoCos are potentially riskier than issuing subordinated debt in their place. To sidestep these consequences, their use by banks must be tempered by increasing capital requirements, and as such, they should not be treated as true substitutes for equity.
    Date: 2017–01

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