nep-cba New Economics Papers
on Central Banking
Issue of 2017‒07‒30
thirteen papers chosen by
Maria Semenova
Higher School of Economics

  1. (Un)expected Monetary Policy Shocks and Term Premia By Martin Kliem; Alexander Meyer-Gohde
  2. Monetary Conservatism, Default Risk, and Political Frictions By Joost Roettger
  3. Monetary Policy, Target Inflation and the Great Moderation: An Empirical Investigation By Qazi Haque
  4. Uncovering covered interest parity: the role of bank regulation and monetary policy By Brauning, Falk; Puria, Kovid
  5. Monetary and macroprudential policy with foreign currency loans By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  6. The Optimal Degree of Monetary-Discretion in a New Keynesian Model with Private Information By Waki, Yuichiro; Dennis, Richard; Fujiwara, Ippei
  7. Good Policies or Good Luck? New Insights on Globalization and the International Monetary Policy Transmission Mechanism By Martinez-Garcia, Enrique
  8. Should Inflation Measures Used by Central Banks Incorporate House Prices? The Czech Approach By Mojmir Hampl; Tomas Havranek
  9. The Dire Effects of the Lack of Monetary and Fiscal Coordination By Francesco Bianchi; Leonardo Melosi
  10. Financial Development and Monetary Policy: Loan Applications, Rates, and Real Effects By Abuka, Charles; Alinda, Ronnie; Minoiu, Camelia; Peydró, José Luis; Presbitero, Andrea
  11. Fintech: Is This Time Different? A Framework for Assessing Risks and Opportunities for Central Banks By Meyer Aaron; Francisco Rivadeneyra; Samantha Sohal
  12. A Risk-centric Model of Demand Recessions and Macroprudential Policy By Ricardo J. Caballero; Alp Simsek
  13. Inflation Convergence In East African Countries By Dridi, Jemma; Nguyen, Anh D. M.

  1. By: Martin Kliem; Alexander Meyer-Gohde
    Abstract: We analyze an estimated stochastic general equilibrium model that replicates key macroeconomic and financial stylized facts during the Great Moderation of 1983-2007. Our model predicts a sizeable and volatile nominal term premium - comparable to recent reduced-form empirical estimates - with real risk two times more important than in ation risk for the average nominal term premia. The model enables us to address salient questions about the effects of monetary policy on the term structure of interest rates. We nd that monetary policy shocks can have differing effects on risk premia. Actions by the monetary authority with a persistent effect on households' expectations have substantial effects on nominal and real risk premia. Our model rationalizes many of the opposing ndings on the effects of monetary policy on term premia in the empirical literature.
    Keywords: DSGE model, Bayesian estimation, Term structure, Monetary policy
    JEL: E13 E31 E43 E44 E52
    Date: 2017–07
  2. By: Joost Roettger (University of Cologne)
    Abstract: This paper studies the consequences of delegating monetary policy to an inflation conservative central banker as in Rogoff (1985) for an emerging economy that faces three frictions which might undermine the success of such a policy reform: (i) incomplete financial markets, (ii) risk of default and (iii) political distortions. To do so, a quantitative sovereign default model is developed in which monetary and fiscal policies are set by two different authorities that both cannot commit to future policies. Inflation conservatism tends to result in lower and more stable inflation as well as a higher average debt burden, more frequent default events and more volatile fiscal policy. Whether the economy benefits from the appointment of a conservative central banker depends on the degree of inflation conservatism, the amount of political distortions and the volatility of fiscal shocks.
    Date: 2017
  3. By: Qazi Haque (School of Economics, University of Adelaide)
    Abstract: This paper compares the empirical fit of a Taylor rule featuring constant versus time-varying inflation target by estimating a Generalized New Keynesian model under positive trend inflation while allowing for indeterminacy. The estimation is conducted over two different periods covering the Great Inflation and the Great Moderation. We find that the rule embedding time variation in target inflation turns out to be empirically superior and determinacy prevails in both sample periods. Counterfactual simulations point toward both `good policy' and `good luck' as drivers of the Great Moderation. We find that better monetary policy, both in terms of a more active response to inflation gap and a more anchored inflation target, has resulted in the decline in inflation gap volatility and predictability. In contrast, the reduction in output growth variability is mainly explained by reduced volatility of technology shocks.
    Keywords: Monetary policy; Great Inflation; Great Moderation; Equilibrium Indeterminacy; Generalized New Keynesian Phillips curve; Taylor rules; Time-varying inflation target; Good policy; Good luck; Sequential Monte Carlo
    JEL: C11 C52 C62 E31 E32 E52 E58
    Date: 2017–07
  4. By: Brauning, Falk (Federal Reserve Bank of Boston); Puria, Kovid (Federal Reserve Bank of Boston)
    Abstract: We analyze the factors underlying the recent deviations from covered interest parity. We show that these deviations can be explained by tighter post-crisis bank capital regulations that made the provision of foreign exchange swaps more costly. Moreover, the recent monetary policy and related interest rate divergence between the United States and other major foreign countries has led to a surge in demand for swapping low interest rate currencies into the U.S. dollar. Given the higher bank balance sheet costs resulting from these regulatory changes, the increased demand for U.S. dollars in the swap market could not be supplied at a constant price, thereby amplifying violations of covered interest parity. Furthermore, we show that dollar swap line agreements existing between the Federal Reserve and foreign central banks mitigate pressure in the swap market. However, the current conditions that govern the provision of dollar funding through foreign central banks are not favorable enough to reduce deviations from covered interest parity to zero.
    Keywords: covered interest parity; banking; monetary policy
    JEL: E52 F31 G15 G18 G2
    Date: 2017–06–01
  5. By: Michał Brzoza-Brzezina (Narodowy Bank Polski; Warsaw School Economics); Marcin Kolasa (Narodowy Bank Polski; Warsaw School Economics); Krzysztof Makarski (Narodowy Bank Polski; Warsaw School Economics; Group for Research in Applied Economics (GRAPE))
    Abstract: In a number of countries a substantial proportion of mortgage loans is denominated in foreign currency. In this paper we demonstrate how their presence affects economic policy and agents' welfare. To this end we construct a small open economy model with financial frictions, where housing loans can be denominated in domestic or foreign currency. The model is calibrated for Poland - a typical small open economy with a large share of foreign currency loans (FCL). We show that the presence of FCLs negatively affects the transmission of monetary policy and deteriorates the output-inflation volatility trade-off it faces. The trade-off can be improved with macroprudential policy but the outcomes are still worse than under this same policy mix applied to an economy with domestic currency debt. We also demonstrate that a high share of FCLs is harmful for social welfare, even if financial stability considerations are not taken into account. Finally, we show that regulatory policies that discriminate against FCLs may have a negative impact on economic activity and discuss the redistributive consequences of forced currency conversion of household debt.
    Keywords: foreign currency loans, monetary policy, macroprudential policy, DSGE models
    JEL: E32 E44 E58
    Date: 2017
  6. By: Waki, Yuichiro (University of Queensland); Dennis, Richard (University of Glasgow); Fujiwara, Ippei (Keio University)
    Abstract: This paper considers the optimal degree of monetary-discretion when the central bank conducts policy based on its private information about the state of the economy and is unable to commit. Society seeks to maximize social welfare by imposing restrictions on the central bank's actions over time, and the central bank takes these restrictions and the New Keynesian Phillips curve as constraints. By solving a dynamic mechanism design problem we find that it is optimal to grant “constrained discretion” to the central bank by imposing both upper and lower bounds on permissible inflation, and that these bounds should be set in a historydependent way. The optimal degree of discretion varies over time with the severity of the timeinconsistency problem, and, although no discretion is optimal when the time-inconsistency problem is very severe, it is a transient phenomenon and some discretion is granted eventually.
    JEL: E52 E61
    Date: 2017–07–01
  7. By: Martinez-Garcia, Enrique (Federal Reserve Bank of Dallas)
    Abstract: The open-economy dimension is central to the discussion of the trade-offs that monetary policy faces in an increasingly integrated world. I investigate the monetary policy transmission mechanism in a two-country workhorse New Keynesian model where policy is set according to Taylor (1993) rules. I find that a common monetary policy isolates the effects of trade openness on the cross-country dispersion, and that the establishment of a currency union as a means of deepening economic integration may lead to indeterminacy. I argue that the common (coordinated) monetary policy equilibrium is the relevant benchmark for policy analysis showing that in that case open economies tend to experience lower macro volatility, a flatter Phillips curve, and more accentuated trade-offs between inflation and slack. Moreover, I show that the trade elasticity often magnifies the effects of trade integration (globalization) beyond what conventional measures of trade openness would imply. I also discuss how other features such as the impact of a stronger anti-inflation bias, technological diffusion across countries, and the sensitivity of labor supply to real wages influence the quantitative effects of policy and openness in this context. Finally, I conclude that the theoretical predictions of the workhorse open-economy New Keynesian model are largely consistent with the stylized facts of the globalization era started in the 1960s and the Great Moderation period that followed.
    JEL: C11 C13 F41
    Date: 2017–07–01
  8. By: Mojmir Hampl (Czech National Bank); Tomas Havranek (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic; Czech National Bank)
    Abstract: In this paper we describe the Czech National Bank’s approach to incorporating macroprudential considerations into monetary policy decision making: the use of a broader inflation measure that gives substantial weight to house prices and is considered along with headline CPI inflation. We argue that, in terms of theory, the broader inflation gauge is at least as suitable for measuring the value of money as headline CPI inflation is, but we also acknowledge practical problems that arise from the use of the broader index.
    Keywords: Consumer price index, financial stability, house prices, macroprudential policy, monetary policy, owner-occupied housing
    JEL: E31 E44 E50 R30
    Date: 2017–07
  9. By: Francesco Bianchi; Leonardo Melosi
    Abstract: What happens if the government's willingness to stabilize a large stock of debt is waning, while the central bank is adamant about preventing a rise in inflation? The large fiscal imbalance brings about inflationary pressures, triggering a monetary tightening, further debt accumulation, and additional inflationary pressure. Thus, the economy will go through a spiral of higher inflation, output contraction, and further debt accumulation. A coordinated commitment to inflate away the portion of debt resulting from a large recession leads to better macroeconomic outcomes by separating the issue of long-run fiscal sustainability from the need for short-run fiscal stabilization. This strategy can also be used to rule out episodes in which the central bank becomes constrained by the zero lower bound.
    JEL: D83 E31 E52 E62 E63
    Date: 2017–07
  10. By: Abuka, Charles; Alinda, Ronnie; Minoiu, Camelia; Peydró, José Luis; Presbitero, Andrea
    Abstract: The finance-growth literature argues that institutional constraints in developing countries impede financial intermediation and monetary policy transmission. Recent studies using aggregate data document a weak bank lending channel. For identification, we instead exploit Uganda's super- visory credit register, with loan applications and rates, and unanticipated variation in monetary policy. A monetary tightening strongly reduces credit supply - increasing loan application rejections and tightening volume and rates - especially for banks with more leverage and sovereign debt exposure (even within the same borrower-period). There are spillovers on inflation and eco- nomic activity, especially in more financially-developed areas, including on commercial building, trade, and social unrest.
    Keywords: Bank credit; bank lending channel; developing countries; Financial Development; monetary policy; Real effects
    JEL: E42 E44 E52 E58 G21 G28
    Date: 2017–07
  11. By: Meyer Aaron; Francisco Rivadeneyra; Samantha Sohal
    Abstract: We investigate the risks and opportunities to the mandates of central banks arising from fintech developments. Fintech may affect the different areas of responsibility of central banks—mainly monetary policy and financial stability—by changing money demand and by changing the industrial organization of the financial system. We present a competitive strategy framework to help evaluate the likelihood of these changes.
    Keywords: Central bank research, Digital Currencies, Financial Institutions, Payment clearing and settlement systems
    JEL: G1 G2 L1 E42
    Date: 2017
  12. By: Ricardo J. Caballero; Alp Simsek
    Abstract: A productive capacity generates output and risks, both of which need to be absorbed by economic agents. If they are unable to do so, output and risk gaps emerge. Risk gaps close quickly: A decline in the interest rate increases the Sharpe ratio of the risky assets and equilibrates the risk markets. If the interest rate is constrained from below (or the policy response is slow), the risk markets are instead equilibrated via a decline in asset prices. However, the drop in asset prices also drags down aggregate demand, which further drags prices down, and so on. If economic agents are optimistic about the speed of recovery, a decline in asset prices leads to a large increase in the Sharpe ratio that stabilizes the drop. If they are pessimistic, the economy becomes highly susceptible to downward spirals due to the feedback between asset prices and aggregate demand. When beliefs are heterogenous, optimists take too much risk from a social point of view since they do not internalize their positive effect on asset prices and aggregate demand during recessions. Macroprudential policy can improve outcomes, and is procyclical as the negative aggregate demand effect of prudential tightening is more easily offset by interest rate policy during booms than during recessions. Forward guidance policies are also effective, but their robustness weakens as agents become more pessimistic. Our model also illustrates that interest rate rigidities and speculation generate endogenous price volatility that exacerbates demand recessions.
    JEL: E00 E12 E21 E22 E30 E40 G00 G01 G11
    Date: 2017–07
  13. By: Dridi, Jemma; Nguyen, Anh D. M.
    Abstract: The paper investigates inflation convergence in five East African Countries: Burundi, Kenya, Rwanda, Tanzania, and Uganda, as they aspire to form a monetary union by 2024 under the umbrella of the East African Community. Based on various panel unit root tests, we find that inflation rates in these countries have been converging. An explanation for the convergence is also provided from the perspective of a Global Vector Autoregressive (GVAR) model, which attributes this convergence to a similarity in terms of the nature of shocks affecting EAC countries as well as the role of foreign factors as drivers of inflation given that inflation has been low and less volatile in industrial and emerging countries since the early 1990s.
    Keywords: Inflation, Global VAR (GVAR), Panel Unit Root Tests, Spillovers, East African Community.
    JEL: C32 C33 E31 F40
    Date: 2017–07

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