nep-cba New Economics Papers
on Central Banking
Issue of 2017‒03‒19
sixteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Optimal Monetary Policy under Rigid Wages and Decreasing Returns By Kohlbrecher, Britta
  2. Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense? By Davide Debortoli; Jinill Kim; Jesper Lindé; Ricardo Nunes
  3. Agency Costs and the Monetary Transmission Mechanism By Reiter, Michael; Sveen, Tommy; Weinke, Lutz
  4. Countercyclical Capital Regulation in a Small Open Economy DSGE Model By Lozej, Matija; Onorante, Luca; Rannenberg, Ansgar
  5. Do central banks respond timely to developments in the global economy? By Hilde C. Bjornland; Leif Anders Thorsrud; Sepideh Khayati Zahiri
  6. Has the Fed responded to house and stock prices? A time-varying analysis By Knut Are Aastveit; Francesco Furlanetto; Francesca Loria
  7. Banks’ Adjustment to Basel III Reform; A Bank-Level Perspective for Emerging Europe By Michal Andrle; Vladimír Tomšík; Jan Vlcek
  8. Case Study of the Moldovan Bank Fraud: Is Early Intervention the Best Central Bank Strategy to Avoid Financial Crises? By Alexandru Monahov; Thomas Jobert
  9. Czech Magic; Implementing Inflation-Forecast Targeting at the CNB By Kevin Clinton; Tibor Hlédik; Tomás Holub; Douglas Laxton; Hou Wang
  10. Inflation Targeting and the Forward Bias Puzzle in Emerging Countries By Dramane Coulibaly; Hubert Kempf
  11. The Joint Dynamics of U.S. and Euro-area Inflation Rates: Expectations and Time-varying Uncertainty. By O. Grishchenko; S. Mouabbi; J.-P. Renne
  12. Agregados monetarios Divisia y demanda de dinero en Uruguay By José Ignacio González Giangrossi
  13. Real Exchange Rate Persistence and Country Characteristics By Michael Curran; Adnan Velic
  14. Show me the money: the monetary policy risk premium By Ozdagli, Ali K.; Velikov, Mihail
  15. Monetary Policy, Hot Money and Housing Price Growth across Chinese Cities By Xiaoyu Huang; Tao Jin; Ji Zhang
  16. Inflation-Forecast Targeting for India; An Outline of the Analytical Framework By Jaromir Benes; Kevin Clinton; Asish George; Joice John; Ondra Kamenik; Douglas Laxton; Pratik Mitra; G.V. Nadhanael; Hou Wang; Fan Zhang

  1. By: Kohlbrecher, Britta
    Abstract: This paper is the first to study optimal Ramsey monetary policy in a search and matching model that combines real wage rigidity and decreasing returns to scale in production. Adding decreasing returns to scale significantly reduces the trade-off between employment and inflation stabilization usually associated with real wage rigidity. As firms adjust employment in response to an aggregate productivity shock, the resulting change in the marginal product of labor partly offsets the effect of a rigid real wage on marginal costs. The effect is quantitatively important. Optimal inflation volatility is reduced by a factor of four compared to a model with constant returns.
    JEL: E24 E52 J64
    Date: 2016
  2. By: Davide Debortoli; Jinill Kim; Jesper Lindé; Ricardo Nunes
    Abstract: Yes, it makes a lot of sense. This paper studies how to design simple loss functions for central banks, as parsimonious approximations to social welfare. We show, both analytically and quantitatively, that simple loss functions should feature a high weight on measures of economic activity, sometimes even larger than the weight on inflation. Two main factors drive our result. First, stabilizing economic activity also stabilizes other welfare relevant variables. Second, the estimated model features mitigated inflation distortions due to a low elasticity of substitution between monopolistic goods and a low interest rate sensitivity of demand. The result holds up in the presence of measurement errors, with large shocks that generate a trade-off between stabilizing inflation and resource utilization, and also when ensuring a low probability of hitting the zero lower bound on interest rates.
    Keywords: Central banks’ objectives, simple loss function, monetary policy design, sticky prices and sticky wages, DSGE models
    JEL: C32 E58 E61
    Date: 2017–03
  3. By: Reiter, Michael (Institute for Advanced Studies, Vienna); Sveen, Tommy (BI Norwegian Business School); Weinke, Lutz (Humboldt Universitaet zu Berlin)
    Abstract: Once New Keynesian (NK) theory (see, e.g., Woodford 2003) is combined with a standard model of investment (see, e.g., Thomas 2002), the resulting framework loses its ability to generate a realistic monetary transmission mechanism. This is the puzzle uncovered in Reiter et al. (2013). The simple economic reason behind it is the unrealistically large interest rate elasticity of investment, as implied by standard investment theory. In order to address this puzzle we develop a NK model featuring fully flexible investment combined with a financial friction in the spirit of Carlstrom and Fuerst (1997). This model is used to isolate the quantitative importance of the financial friction for the monetary transmission mechanism.
    Keywords: Financial Frictions, Sticky Prices
    JEL: E22 E31 E32
    Date: 2017–03
  4. By: Lozej, Matija (Central Bank of Ireland); Onorante, Luca; Rannenberg, Ansgar (Central Bank of Ireland)
    Abstract: We assess the macroeconomic performance of different countercyclical capital buffer rules, where regulatory capital responds to deviation from a long-run trend in the credit-to-GDP ratio (the credit gap), in a medium scale DSGE model of the Irish economy. We find that rules based on the credit gap create a trade-off between the stabilisation of fluctuations originating in the housing market (which are attenuated) and stabilisation of fluctuations caused by foreign demand shocks (which are amplified) because the credit gap is not always procyclical. The trade-off disappears if the regulator follows a rule based on house prices instead of the credit gap.
    Keywords: Bank capital, Countercyclical capital regulation, Housing bubbles, boom-and-bust.
    JEL: F41 G21 G28 E32 E44
    Date: 2017–01
  5. By: Hilde C. Bjornland; Leif Anders Thorsrud; Sepideh Khayati 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
    JEL: C11 C53 C55 E58 F17
    Date: 2017–03
  6. By: Knut Are Aastveit (Norges Bank (Central Bank of Norway)); Francesco Furlanetto (Norges Bank (Central Bank of Norway)); Francesca Loria
    Abstract: In this paper we use a structural VAR model with time-varying parameters and stochastic volatility to investigate whether the Federal Reserve has responded systematically to asset prices and whether this response has changed over time. To recover the systematic component of monetary policy, we interpret the interest rate equation in the VAR as an extended monetary policy rule responding to inflation, the output gap, house prices and stock prices. We find some time variation in the coefficients for house prices and stock prices but fairly stable coefficients over time for inflation and the output gap. Our results indicate that the systematic component of monetary policy in the US i) attached a positive weight to real house price growth but lowered it prior to the crisis and eventually raised it again and ii) only episodically took real stock price growth into account.
    Keywords: Bayesian VAR, Time-varying parameters, Monetary policy, House prices, Stock market
    JEL: C32 E44 E52 E58
    Date: 2017–03–07
  7. By: Michal Andrle; Vladimír Tomšík; Jan Vlcek
    Abstract: The paper seeks to identify strategies of commercial banks in response to higher capital requirements of Basel III reform and its phase-in. It focuses on a sample of nine EU emerging market countries and picks up 5 largest banks in each country assessing their response. The paper finds that all banking sectors raised CAR ratios mainly through retained earnings. In countries where the banking sector struggled with profitability, banks have resorted to issuance of new equity or shrunk the size of their balance sheets to meet the higher capital-adequacy requirements. Worries echoed at the early stage of Basel III compilation, namely that commercial banks would shrink their balance sheet by reducing their lending to meet stricter capital requirements, did materialize only in banks struggling with profitability.
    Keywords: Banking sector;Europe;Commercial banks;Emerging markets;Bank supervision;Basel Core Principles;Bank reforms;capital adequacy, Basel III, balance sheet
    Date: 2017–02–10
  8. By: Alexandru Monahov (Université Côte d'Azur; GREDEG CNRS); Thomas Jobert (Université Côte d'Azur; GREDEG CNRS)
    Abstract: In this paper, we study the means by which a billion dollar fraud that was perpetuated in the Moldovan banking sector evolved into a severe financial crisis in which the Central Bank’s inaction came under scrutiny. We examine the financial operations through which money was taken out of the banking system and reconstruct the fraudulent schemes that led to the demise of three systemically important banks. We also create an agent-based simulation of the banking system which replicates the pre-crisis environment and the fraudulent schemes to determine whether Central Bank intervention could have improved the outcome of the crisis.
    Keywords: Financial Fraud, Prudential supervision, Central Bank Intervention, Agent Based Model, Multi-Agent Simulation
    JEL: C61 C63 E58 E65 G28
    Date: 2017–03
  9. By: Kevin Clinton; Tibor Hlédik; Tomás Holub; Douglas Laxton; Hou Wang
    Abstract: This paper describes the CNB’s experience implementing an inflation-forecast targeting (IFT) regime, and the building of a system for providing the economic information that policymakers need to implement IFT. The CNB’s experience has been very successful in establishing confidence in monetary policy in the Czech Republic and should provide useful guidance for other central banks that are considering adopting an IFT regime.
    Keywords: Inflation targeting;Czech Republic;Central banks;Monetary policy;Forecasting models;Inflation Targeting, Monetary Policy, Optimal Control
    Date: 2017–01–30
  10. By: Dramane Coulibaly; Hubert Kempf
    Abstract: Based on quarterly data on 31 emerging countries (among which 16 are inflation targeting countries) from 1990Q1 to 2014Q3, we obtain a strong support for the conjecture that the implementation of inflation targeting weakens the Fisherian relation between expected depreciation and the interest rate differential (uncovered interest parity condition) and thus is conducive to the appearance of the forward bias puzzle in emerging countries. We show that this reects the performance of inflation targeting regimes in lowering the level and volatility of inflation which leads non-Fisherian fundamentals to be predominant. Our finding holds when controlling for country-specific effects, time-specific effects, global disinflationation, exchange rate management and using different econometric techniques.
    Keywords: Inflation targeting, uncovered interest parity, forward bias puzzle, emerging countries.
    JEL: E31 E52 F31
    Date: 2017
  11. By: O. Grishchenko; S. Mouabbi; J.-P. Renne
    Abstract: We use several U.S. and euro-area surveys of professional forecasters to estimate a dynamic factor model of inflation with time-varying uncertinty. We obtain survey-consistent distributions of future inflation at any horizon, both in the United States and in the euro area. Our methodology allows us to compute, in closed form, survey-consistent measures of inflation expectations, inflation uncertainty, inflation expectations anchoring, deflation probabilities and U.S. and euro-area inflation co-movements. Our results suggest strong commonalities between inflation dynamics in the two economies.
    Keywords: inflation, surveys of professional forecasters, dynamic factor model with stochastic volatility, term structure of inflation expectations and inflation uncertainty, anchoring of inflation expectations
    JEL: C32 E31 E44
    Date: 2017
  12. By: José Ignacio González Giangrossi (Banco Central del Uruguay; Universidad de la República. Facultad de Ciencias Sociales. Departamento De Economía)
    Abstract: In this paper Divisia monetary aggregates were built for Uruguay in the period 1998.Q4- 2015Q2 and compared with traditional monetary aggregates. The difference increases in broader aggregates, being very small for M1 but significant for the case of M2 + bonds. Then these measures were incorporated into a money demand function and using error correction models short-run dynamics was examined, finding a quick adjustment towards long run equilibrium and with Divisia models a higher semi-elasticity for the opportunity cost of money. Over the six candidates, Divisia M2 model perform better and is the appropriate measure to track money demand and complement monetary policy analysis.
    Keywords: Monetary aggregates, Divisia index, money demand, cointegration, Uruguay; Agregados monetarios, índices Divisia, demanda de dinero, cointegración
    JEL: C22 C52 E41 E51 N16
    Date: 2016
  13. By: Michael Curran (Villanova University); Adnan Velic (Dublin Institute of Technology)
    Abstract: This paper examines the persistence of real exchange rates across the world. We employ univariate time series techniques on a country-by-country basis allowing for deterministic structural breaks and nonlinearities in the adjustment process. Our findings suggest that bilateral exchange rates and industrial countries display the highest rates of persistence. We retrieve evidence indicating that higher inflation, nominal exchange rate volatility, trade openness and proximity to reference country are associated with faster rates of real exchange rate convergence. Conversely, international financial integration is only found to be a significant factor at the country group level, with differential effects across cohorts.
    Keywords: Real Exchange Rate, Parity Deviations, Cross-Country Persistence Differences, Structural Determinants
    JEL: F31 F41
    Date: 2017–03
  14. By: Ozdagli, Ali K. (Federal Reserve Bank of Boston); Velikov, Mihail (Federal Reserve Bank of Richmond)
    Abstract: We study how monetary policy affects the cross-section of expected stock returns. For this purpose, we create a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that are theoretically linked to how firms react to monetary policy. We find that stocks whose prices react more positively to expansionary monetary policy surprises earn lower average returns. This finding is consistent with the intuition that monetary policy is expansionary in bad economic times when the marginal value of wealth is high, and thus high MPE stocks serve as a hedge against bad times. A long-short trading strategy designed to exploit this effect achieves an annualized value-weighted return of 9.96 percent with an associated Sharpe Ratio of 0.93 between 1975 and 2015. This return premium cannot be explained by standard factor models and survives a battery of robustness tests.
    Keywords: monetary policy; asset pricing; risk factors
    JEL: E12 E31 E44 E52 G12 G14
    Date: 2016–12–01
  15. By: Xiaoyu Huang; Tao Jin; Ji Zhang
    Abstract: We use a dynamic hierarchical factor model to identify the national, regional, and local factors of the city-level housing price growth in China from 2005 to 2014. We find that city-specific factors account for a large proportion of the variations in city-level housing price growth for most cities. However, the national factor also plays an important role in explaining the fluctuations of city-level housing price growth rates especially after 2009---the average explaining power of the national factor for housing price growth fluctuations reaches 18%. We use a VAR model to investigate the driving forces of the national factor and find that unexpected PBoC policy and hot money flow changes can affect the national housing prices significantly. A positive monetary policy shock has a significant negative impact on the national factor, which lasts for more than two years. Meanwhile, a positive hot money shock does cause a significant increase in the national factor. However, this effect is relatively transitory and reverses in half a year. Monetary policy also affects the national factor by responding positively to positive hot money and price shocks---the reversed effect of hot money shocks and the negative impact of positive price shocks on the national factor result from the tightening of monetary policy triggered by these shocks.
    Date: 2017–03
  16. By: Jaromir Benes; Kevin Clinton; Asish George; Joice John; Ondra Kamenik; Douglas Laxton; Pratik Mitra; G.V. Nadhanael; Hou Wang; Fan Zhang
    Abstract: India formally adopted flexible inflation targeting (FIT) in June 2016 to place price stability, defined in terms of a target CPI inflation, as the primary objective of monetary policy. In this context, the paper draws on Indian macroeconomic developments since 2000 and the experience of other countries that adopted FIT to bring out insights on how credible policy with an emphasis on a strong nominal anchor can reduce the impact of supply shocks and improve macroeconomic stability. For illustrating the key issues given the unique structural characteristics of India and the policy options under an FIT framework, the paper describes an analytical framework using the core quarterly projection model (QPM). Simulations of the QPM are carried out to illustrate the monetary policy responses under different types of uncertainty and to bring out the importance of gaining credibility for improving monetary policy efficacy.
    Keywords: Inflation targeting;India;Disinflation;Price stabilization;Monetary policy;Forecasting models;inflation targeting; Reserve Bank of India; inflation episodes in India; forecasting models; monetary policy models; model calibration; monetary policy rules; monetary policy simulations.
    Date: 2017–02–13

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