nep-cba New Economics Papers
on Central Banking
Issue of 2017‒05‒28
23 papers chosen by
Maria Semenova
Higher School of Economics

  1. The impact of macroprudential policies and their interaction with monetary policy: an empirical analysis using credit registry data By Gambacorta, Leonardo; Murcia, Andrés
  2. Central Bank Independence, financial instability and politics: new evidence for OECD and non-OECD countries By Barbara Pistoresi; Maddalena Cavicchioli; Giulio Brevini
  3. Macroprudential Policy, Incomplete Information and Inequality; The case of Low-Income and Developing Countries By Margarita Rubio; Filiz D Unsal
  4. Exchange Rate Regimes in Central, Eastern and Southeastern Europe; A Euro Bloc and a Dollar Bloc? By Slavi T Slavov
  5. Real effects of bank capital regulations: Global evidence By Deli, Yota; Hasan, Iftekhar
  6. Assessing the Predictive Ability of Sovereign Default Risk on Exchange Rate Returns By Claudia Foroni; Francesco Ravazzolo; Barbara Sadaba
  7. Further Results on Preference Uncertainty and Monetary Conservatism By Keiichi Morimoto
  8. Optimal Fiscal and Monetary Policy, Debt Crisis and Management By Cristiano Cantore; Paul L Levine; Giovanni Melina; Joseph G Pearlman
  9. The Fiscal-Monetary Policy Mix in the Euro Area: Challenges at the Zero Lower Bound By Orphanides, Athanasios
  10. Foreign Exchange Intervention and the Dutch Disease By Julia Faltermeier; Ruy Lama; Juan Pablo Medina
  11. Une perspective macroprudentielle pour la stabilité financière By Pinshi, Christian
  12. Hopf Bifurcation from new-Keynesian Taylor rule to Ramsey Optimal Policy By Jean-Bernard, Chatelain; Kirsten, Ralf
  14. Chocs macroéconomiques et intégration d’une union économique et monétaire: cas du Nigéria By Nassirou, Aïchat
  15. Does Prolonged Monetary Policy Easing Increase Financial Vulnerability? By Stephen Cecchetti; Tommaso Mancini Griffoli; Machiko Narita
  16. Government guarantees and the two-way feedback between banking and sovereign debt crises By Leonello, Agnese
  17. Current Account Imbalances, Real Exchange Rates, and Nominal Exchange Rate Variability By Adnan Velic
  18. A Note on the Impact of Unconventional Monetary Policy Shocks in the US on Emerging Market REITs: A Qual VAR Approach By Rangan Gupta; Hardik A. Marfatia
  19. Should Unconventional Monetary Policies Become Conventional? By Dominic Quint; Pau Rabanal
  20. How is the likelihood of fire sales in a crisis affected by the interaction of various bank regulations? By Divya Kirti; Vijay Narasiman
  21. When Multiple Objectives Meet Multiple Instruments: Identifying Simultaneous Monetary Shocks By Daniel Ordoñez-Callamand; Juan D. Hernandez-Leal; Mauricio Villamizar-Villegas
  22. Monetary Policy, Fisal Federalism, and Capital Intensity By Nadav Ben Zeev; Ohad Raveh
  23. The Nexus of Monetary Policy and Shadow Banking in China By Kaiji Chen; Jue Ren; Tao Zha

  1. By: Gambacorta, Leonardo; Murcia, Andrés
    Abstract: This paper summarises the results of a joint research project by eight central banks in the Americas region to evaluate the effectiveness of macroprudential tools and their interaction with monetary policy. In particular, using meta-analysis techniques, we summarise the results for five Latin American countries (Argentina, Brazil, Colombia, Mexico and Peru) that use confidential bank-loan data. The use of granular credit registry data helps us to disentangle loan demand from loan supply effects without making strong assumptions. Results from another three countries (Canada, Chile and the United States) corroborate the analysis using data for credit origination and borrower characteristics. The main conclusions are that (i) macroprudential policies have been quite effective in stabilising credit cycles. The propagation of the effects to credit growth is more rapid (they materialise after one quarter) for policies aimed at curbing the cycle than for policies aimed at fostering resilience (which take effect within a year); and (ii) macroprudential tools have a greater effect on credit growth when reinforced by the use of monetary policy to push in the same direction.
    Keywords: bank lending; credit registry data; macroprudential policies; meta-analysis
    JEL: E43 E58 G18 G28
    Date: 2017–05
  2. By: Barbara Pistoresi; Maddalena Cavicchioli; Giulio Brevini
    Abstract: This paper analyses the determinants of a new index of central bank independence, recently provided by Dincer and Eichengreen (2014), using a large database of economic, political and institutional variables. Our sample includes data for 31 OECD and 49 non-OECD economies and covers the period 1998-2010. To this aim, we implement factorial and regression analysis to synthesize information and overcome limitations such as omitted variables, multicollinearity and overfitting. The results confirm the role of the IMF loans program to guide all the economies in their choice of more independent central banks. Financial instability, recession and low inflation work in the opposite direction with governments relying extensively on central bank money to finance public expenditure and central banks’ political and operational autonomy is inevitably undermined. Finally, only for non-OECD economies, the degree of central bank independence responds to various measures of strength of political institutions and party political instability.
    Keywords: central bank independence; economic, political and institutional determinants; multicollinearity; factor model; linear regression
    Date: 2017–05
  3. By: Margarita Rubio; Filiz D Unsal
    Abstract: In this paper, we use a DSGE model to study the passive and time-varying implementation of macroprudential policy when policymakers have noisy and lagged data, as commonly observed in lowincome and developing countries (LIDCs). The model features an economy with two agents; households and entrepreneurs. Entrepreneurs are the borrowers in this economy and need capital as collateral to obtain loans. The macroprudential regulator uses the collateral requirement as the policy instrument. In this set-up, we compare policy performances of permanently increasing the collateral requirement (passive policy) versus a time-varying (active) policy which responds to credit developments. Results show that with perfect and timely information, an active approach is welfare superior, since it is more effective in providing financial stability with no long-run output cost. If the policymaker is not able to observe the economic conditions perfectly or observe with a lag, a cautious (less aggressive) policy or even a passive approach may be preferred. However, the latter comes at the expense of increasing inequality and a long-run output cost. The results therefore point to the need for a more careful consideration toward the passive policy, which is usually advocated for LIDCs.
    Keywords: Credit;Low-income developing countries;Macroprudential Policy;incomplete information, collateral requirements, inequality, Financial Markets and the Macroeconomy, Government Policy and Regulation
    Date: 2017–03–22
  4. By: Slavi T Slavov
    Abstract: There are 13 countries in Central, Eastern and Southeastern Europe (CESEE) with floating exchange rate regimes, de jure. This paper uses the framework pioneered by Frankel and Wei (1994) and extended in Frankel and Wei (2008) to show that most of them have been tracking either the euro or the US dollar in recent years. Eight countries, all of them current or aspiring EU members, track the euro. Of the five countries keying on the US dollar in various degrees, all but one belong to the Commonwealth of Independent States. The paper shows that the extent to which each country’s currency tracks the euro (or the dollar) is correlated with the structure of its external trade and finance. However, some countries appear to track the EUR or USD to an extent which appears inconsistent with inflation targeting, trade or financial integration, or the extent of business cycle synchronization. The phenomenon is particularly pronounced among the countries in the CESEE euro bloc, which may be deliberately gravitating around the euro in anticipation of eventually joining the Euro Area.
    Keywords: Foreign exchange;United States;Western Hemisphere;Central, Eastern and Southeastern Europe; exchange rate regimes; fixed versus floating; de jure versus de facto, Eastern and Southeastern Europe, exchange rate regimes, fixed versus floating, de jure versus de facto, International Monetary Arrangements and Institutions
    Date: 2017–03–31
  5. By: Deli, Yota; Hasan, Iftekhar
    Abstract: We examine the effect of the full set of bank capital regulations (capital stringency) on loan growth, using bank-level data for a maximum of 125 countries over the period 1998-2011. Contrary to standard theoretical considerations, we find that overall capital stringency only has a weak negative effect on loan growth. In fact, this effect is completely offset if banks hold moderately high levels of capital. Interestingly, the components of capital stringency that have the strongest negative effect on loan growth are those related to the prevention of banks to use as capital borrowed funds and assets other than cash or government securities. In contrast, compliance with Basel guidelines in using Basel- and credit-risk weights has a much less potent effect on loan growth.
    Keywords: capital regulation, loan growth, bank capital
    JEL: E60 G0 G2 O40
    Date: 2017
  6. By: Claudia Foroni; Francesco Ravazzolo; Barbara Sadaba
    Abstract: Increased sovereign credit risk is often associated with sharp currency movements. Therefore, expectations of the probability of a sovereign default event can convey important information regarding future movements of exchange rates. In this paper, we investigate the possible pass-through of risk in the sovereign debt markets to currency markets by proposing a new risk premium factor for predicting exchange rate returns based on sovereign default risk. We compute it from the term structure at different maturities of sovereign credit default swaps and conduct an out-of-sample forecasting exercise to test whether we can improve upon the benchmark random walk model. Our results show that the inclusion of the default risk factor improves the forecasting accuracy upon the random walk model at short forecasting horizons.
    Keywords: Econometric and statistical methods, Exchange rates, International financial markets
    JEL: C22 C52 C53 F31
    Date: 2017
  7. By: Keiichi Morimoto (Meisei University)
    Abstract: This study re-examines the optimal delegation problem of monetary policy under preference uncertainty of the central banker. Liberal central bankers are desirable when uncertainty is strong, which is emphasized when the slope of the Phillips curve is flatter, as some empirical works report. However, appointing conservative central bankers is optimal with standard parameter values when monetary policies are conducted by committees, as in most actual economies.
    Keywords: monetary policy, delegation, uncertain preferences, committee
    JEL: E58
    Date: 2017–01
  8. By: Cristiano Cantore; Paul L Levine; Giovanni Melina; Joseph G Pearlman
    Abstract: The initial government debt-to-GDP ratio and the government’s commitment play a pivotal role in determining the welfare-optimal speed of fiscal consolidation in the management of a debt crisis. Under commitment, for low or moderate initial government debt-to-GPD ratios, the optimal consolidation is very slow. A faster pace is optimal when the economy starts from a high level of public debt implying high sovereign risk premia, unless these are suppressed via a bailout by official creditors. Under discretion, the cost of not being able to commit is reflected into a quick consolidation of government debt. Simple monetary-fiscal rules with passive fiscal policy, designed for an environment with “normal shocks†, perform reasonably well in mimicking the Ramsey-optimal response to one-off government debt shocks. When the government can issue also long-term bonds–under commitment–the optimal debt consolidation pace is slower than in the case of short-term bonds only, and entails an increase in the ratio between long and short-term bonds.
    Keywords: Crisis management;Debt consolidation;Optimal fiscal-monetary policy, long-term debt, fiscal limits, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2017–03–30
  9. By: Orphanides, Athanasios
    Abstract: This paper explores the reasons for the suboptimal fiscal-monetary policy mix in the euro area in the aftermath of the global financial crisis and ways in which the status quo can be improved. A comparison of fiscal and monetary policies and of economic outcomes in the euro area and the United States suggests that both fiscal and monetary policy in the euro area have been overly tight. Fiscal policy has been hampered by the institutional framework which constrains individual states and lacks instruments to secure an appropriate aggregate stance. ECB monetary policy has been hampered by the distributional effects of balance sheet policies which needed to be adopted at the zero lower bound, and by discretionary decisions taken before the crisis such as the reliance on credit rating agencies for determining collateral eligibility for monetary operations. The compromising of the "safe asset" status of euro area sovereign debt during the crisis complicated fiscal and monetary policy. Changes in the discretionary decisions governing the implementation of monetary policy in the euro area can potentially reduce the distributional effects of policy and improve the fiscal-policy mix and longer-term prospects for the euro area.
    Keywords: collateral eligibility; credit risk.; ECB; Euro crisis; loss sharing; Quantitative easing; redenomination risk; safe assets; Sovereign debt; zero lower bound
    JEL: E52 E58 E61 E62 G01
    Date: 2017–05
  10. By: Julia Faltermeier; Ruy Lama; Juan Pablo Medina
    Abstract: We study the optimal foreign exchange (FX) intervention policy in response to a positive terms of trade shock and associated Dutch disease episode in a small open economy model. We find that during a Dutch disease episode tradable production drops below the socially optimal level, resulting in lower welfare under learningby- doing (LBD) externalities. FX reserves accumulation improves welfare by preventing a large appreciation of the real exchange rate and by inducing an efficient reallocation between the tradable and non-tradable sectors. For an empirically plausible parametrization of LBD externalities, the model predicts that in response to a 10 percent increase in commodity prices FX reserves should increase by 1.5 percent of GDP. We also find that the welfare gains from optimally using FX reserves are twice as high as the gains from relying only on monetary policy. These results suggest that FX intervention is a beneficial policy to counteract the loss of competitiveness during a Dutch disease episode.
    Keywords: Central banks and their policies;Foreign exchange;Dutch Disease; Learning-by-Doing Externalities; Foreign Exchange Intervention, Dutch Disease, Learning-by-Doing Externalities, Foreign Exchange Intervention, Open Economy Macroeconomics
    Date: 2017–03–27
  11. By: Pinshi, Christian
    Abstract: The need to strengthen the macroprudential orientation of financial regulatory and supervisory frameworks stays a priority for financial and real good health. Stability financial is threatened with endogenous and exogenous risks translating crises, hence it has to a healthy regulation for the reduction risks. Macroprudential policy proves to be a best regulation limiting systemic risk. We wonder about adoption a framework macroprudential for stability financial in Democratic Republic of Congo (DRC). The great correlation between countercyclical capital buffer and stability financial justify to make use of framework macroprudential. The causality analysis put in light the effect of policy macroprudential on financial stability. The coefficient of reserve requirements, used like an indicator par excellence, and countercyclical capital buffer cause financial stability. That’s justify an adoption of framework macroprudential in DRC. Then, we showed that credit growth in DRC is below crisis threshold, banks should grant more credit as much as they are below crisis threshold instead of credit crunch. Finally, we suggest a best Framework governance for a macroprudential policy in DRC. The game must be cooperative but flexible with monetary policy, it means, we must create a general management or autonomous institution macroprudential. However monetary policy must have a power supreme or a low of veto on this financial stability general management.
    Keywords: Monetary Policy, financial stability, macroprudential policy
    JEL: E37 E51 E58 G13 G18
    Date: 2017–05–17
  12. By: Jean-Bernard, Chatelain; Kirsten, Ralf
    Abstract: This paper shows that a shift from Ramsey optimal policy under short term commitment (based on a negative-feedback mechanism) to a Taylor rule (based on positive-feedback mechanism) in the new-Keynesian model is in fact a Hopf bifurcation, with opposite policy advice. The number of stable eigenvalues corresponds to the number of predetermined variables including the interest rate and its lag as policy instruments for Ramsey optimal policy. With a new-Keynesian Taylor rule, however, these policy instruments are arbitrarily assumed to be forward-looking variables when policy targets (inflation and output gap) are forward-looking variables. For new-Keynesian Taylor rule, this Hopf bifurcation implies a lack of robustness and multiple equilibria if public debt is not set to zero for all observation.
    Keywords: Bifurcations, Taylor rule, Taylor principle, new-Keynesian model, Ramsey optimal policy, Finite horizon commitment
    JEL: C61 C62 E43 E44 E47 E52 E58
    Date: 2017–05–20
  13. By: Bruno Albuquerque (-)
    Abstract: I investigate the extent to which a common US monetary policy affects regional asymmetries through different household debt levels across states. After constructing a novel indicator of consumer prices at the state level, I compute a state-specific monetary policy stance measure as deviations from an aggregate Taylor rule for a panel of 30 states. Using local projection methods over 1999-2015, I find that a common monetary policy contributes to amplifying regional asymmetries. While a looser monetary policy stance stimulates borrowing and growth in states with low household debt, it is only the case in the short term for high debt states: household debt and real GDP decline over the medium to longer run in high debt states.
    Keywords: Monetary policy, Household debt, Regional asymmetries, Local Projections, Taylor rule
    JEL: C33 E32 E52 G21
    Date: 2017–05
  14. By: Nassirou, Aïchat
    Abstract: This study analyzes the choice of the optimal exchange rate regime for a small open economy, Nigeria. On the basis of structural VAR modeling, we introduced the pass-through question in order to respond to the choice of the optimal exchange rate regime for Nigeria, based on the anchoring of the future currency of the Ecowas area that will be chosen. The results show that the Nigerian economy is very vulnerable to real shocks, particularly those related to the exchange rate and the price of oil. Nigeria could only join the union if the anchoring of the new common currency is flexible in relation to an international currency. Otherwise, he has no interest in joining the union. Hence the idea that exchange rate flexibility is an optimal solution for Nigeria because its entry into the union will be a source of gains and not penalized by losses in terms of economic policies. It is then necessary for Nigeria to define the floating amplitude of the exchange rate within this floating regime. In other words, Nigeria should reduce the volatility of its exchange rate vis-à-vis the price of oil in order to be able to cope with external shocks.
    Keywords: Union économique et monétaire, méthode pass-through, flexibilité optimale du taux de change, chocs macroéconomiques, Nigeria.
    JEL: C32 E52 F33 F41
    Date: 2017–01–03
  15. By: Stephen Cecchetti; Tommaso Mancini Griffoli; Machiko Narita
    Abstract: Using firm-level data for approximately 1,000 bank and nonbank financial institutions in 22 countries over the past 15 years we study the impact of prolonged monetary policy easing on risk-taking behavior. We find that the leverage ratio, as well as other measures of firm-level vulnerability, increases for banks and nonbanks as domestic monetary policy easing persists. Cross-border effects are also notable. We find effects of roughly similar magnitude on foreign financial sector firms when the U.S. eases policy. Results appear robust to a variety of specifications, and to be non-linear, with risk-taking behavior rising most quickly at the onset of monetary policy easing.
    Keywords: Spillovers;Banks;Financial stability;nonbank financial institutions, prolonged monetary policy easing, financial vulnerability, risk-taking behavior, Financial Markets and the Macroeconomy, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2017–03–24
  16. By: Leonello, Agnese
    Abstract: This paper studies the effects of government guarantees on the interconnection between banking and sovereign debt crises in a framework where both the banks and the government are fragile and the credibility and feasibility of the guarantees are determined endogenously. The analysis delivers some new results on the role of guarantees in the bank-sovereign nexus. First, guarantees emerge as a key channel linking banks’and sovereign stability, even in the absence of banks’holdings of sovereign bonds. Second, depending on the specific characteristics of the economy and the nature of banking crises, an increase in the size of guarantees may be beneficial for the bank-sovereign nexus, in that it enhances …financial stability without undermining sovereign solvency. JEL Classification: G01, G18, H63
    Keywords: bank runs, government bond yield, sovereign default, strategic complementarity
    Date: 2017–05
  17. By: Adnan Velic (Dublin Institute of Technology)
    Abstract: This paper analyzes the bivariate relation between large current account imbalances and the real exchange rate over different degrees of nominal exchange rate variability. Employing both linear and nonlinear panel estimation procedures, we find an inverse link between large imbalances and the real exchange rate at lower nominal exchange rate rigidity levels. This is in contrast to the often non-existent or positive comovement that materializes under regimes entailing lower nominal exchange rate variation. Our results thus suggest that greater nominal exchange rate adjustment can induce a stabilizing current account-real exchange rate relation. Along the cross-section, the most salient findings are i) the striking positive relation between current account persistence and real exchange rate persistence based on country-specific estimates and ii) the inverse correlation between persistence in either the current account or real exchange rate and nominal exchange rate volatility.
    Keywords: external imbalances, current account adjustment, real exchange rate, nominal exchange rate volatility, flexibility, persistence
    JEL: F00 F31 F32 F41
    Date: 2017–05
  18. By: Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, South Africa); Hardik A. Marfatia (Department of Economics, Northeastern Illinois University, Chicago, USA)
    Abstract: In this paper, we estimate a Qualitative Vector Autoregressive (Qual VAR) model, which combines binary information of Quantitative Easing (QE) announcements with an otherwise standard VAR model that includes US and emerging market Real Estate Investment Trusts (REITs) returns. The Qual VAR uncovers the Federal Reserve’s latent, unobservable propensity for QE and generates impulse responses for the emerging market REITs returns. The results show that QE has (strong) positively significant, but short-lived, effects on the returns of emerging market REITs.
    Keywords: Qual VAR, Unconventional Monetary Policy, Emerging Markets, REITs
    JEL: C32 E52 R33
    Date: 2017–05
  19. By: Dominic Quint; Pau Rabanal
    Abstract: The large recession that followed the Global Financial Crisis of 2008-09 triggered unprecedented monetary policy easing around the world. Most central banks in advanced economies deployed new instruments to affect credit conditions and to provide liquidity at a large scale after shortterm policy rates reached their effective lower bound. In this paper, we study if this new set of tools, commonly labeled as unconventional monetary policies (UMP), should still be used when economic conditions and interest rates normalize. In particular, we study the optimality of asset purchase programs by using an estimated non-linear DSGE model with a banking sector and long-term private and public debt for the United States. We find that the benefits of using such UMP in normal times are substantial, equivalent to 1.45 percent of consumption. However, the benefits from using UMP are shock-dependent and mostly arise when the economy is hit by financial shocks. When more traditional business cycle shocks (such as supply and demand shocks) hit the economy, the benefits of using UMP are negligible or zero.
    Keywords: United States;Banking;Western Hemisphere;Unconventional Monetary Policy, Optimal Rules, Time-Series Models, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2017–03–31
  20. By: Divya Kirti; Vijay Narasiman
    Abstract: We present a model that describes how different types of bank regulation can interact to affect the likelihood of fire sales in a crisis. In our model, risk shifting motives drive how banks recapitalize following a negative shock, leading banks to concentrate their portfolios. Regulation affects the likelihood of fire sales by giving banks the incentive to sell certain assets and retain others. Ex-post incentives from high risk weights and the interaction of capital and liquidity requirements can make fire sales more likely. Time-varying risk weights may be an effective tool to prevent fire sales.
    Keywords: Macroprudential Policy;Capital requirements;Bank regulation, liquidity requirements, Government Policy and Regulation
    Date: 2017–03–24
  21. By: Daniel Ordoñez-Callamand (Banco de la República de Colombia); Juan D. Hernandez-Leal (Banco de la República de Colombia); Mauricio Villamizar-Villegas (Banco de la República de Colombia)
    Abstract: Central banks generally target multiple objectives while having at least the same number of monetary instruments. However, some instruments can be inadvertently collinear, leading to indeterminacy and identification failures. Paradoxically, most empirical studies have shied away from this dependence. In this paper we propose a novel method of identifying simultaneous monetary shocks by introducing a Tobit model within a VAR. An advantage of our method is that it can be easily estimated using only least squares and a maximum likelihood function. Also, the impulse-response analysis can be carried out as in the traditional time-series setting and can be applied in a structural framework. Hence, we model a dual process consisting of a censored foreign exchange intervention policy along with a linear interest rate intervention policy. In simulation exercises we show that our method outperforms a benchmark case of estimating policy functions separately. In fact, as the covariance between shocks increases, so does the performance of our method. In our empirical approach, we estimate the policy covariance for the case of Colombia and Turkey and find significant differences when compared to the benchmark case. Classification JEL: C34, E52, E58
    Keywords: Simultaneous policies, Instrumental VAR; Tobit-VAR; Central bank intervention; Monetary trilemma
    Date: 2017–05
  22. By: Nadav Ben Zeev; Ohad Raveh
    Abstract: Does monetary policy play a role in scal federalism? This paper presents a novel implication of monetary policy shocks by studying their heterogeneous e ects across federal-states and their consequent connection to scal equalization. A two-region monetary union DSGE model with a federal equalization mechanism shows that capital intensive states experience a relatively larger contraction following a positive monetary policy shock, due to the greater share that capital takes in their production process. This, in turn, brings them greater in ows of federal grants. We show that state-heterogeneity in capital intensity is explained by levels of natural resource abundance over large periods, and hence by pre-determined geographical characteristics. Based on this identi cation strategy, we test the model's predictions using a panel of U.S. states over the period 1969-2007 and nd that following a one standard deviation monetary policy shock, output growth (output share of federal transfers) in capital intensive states contemporaneously decreases (increases) by 1% relative to their counterparts, on average. In addition, we nd no di erential e ects on other state-level economic indicators, consistent with the model.
    Keywords: natural monetary policy, fiscal federalism, capital intensity
    JEL: E52 H77
    Date: 2017
  23. By: Kaiji Chen; Jue Ren; Tao Zha
    Abstract: We estimate the quantity-based monetary policy system in China. We argue that China's rising shadow banking was inextricably linked to banks' balance-sheet risk and hampered the effectiveness of monetary policy on the banking system during the 2009-2015 period of monetary policy contractions. By constructing two micro datasets at the individual bank level, we substantiate this argument with three empirical findings: (1) in response to monetary policy tightening, nonstate banks actively engaged in intermediating shadow banking products; (2) these banks, in sharp contrast to state banks, brought shadow banking products onto the balance sheet via risky investments; (3) bank loans and risky investment assets in the banking system respond in opposite directions to monetary policy tightening, which makes monetary policy less effective. We build a theoretical framework to derive the above testable hypotheses and explore implications of the interaction between monetary and regulatory policies.
    JEL: E02 E5 G11 G12 G28
    Date: 2017–05

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