nep-cba New Economics Papers
on Central Banking
Issue of 2017‒10‒01
seventeen papers chosen by
Maria Semenova
Higher School of Economics

  1. Systemic Risk: A New Trade-Off for Monetary Policy? By Laséen, Stefan; Pescatori, Andrea; Turunen, Jarkko
  2. Capital Control, Exchange Rate Regime, and Monetary Policy: Indeterminacy and Bifurcation By William, Barnett; Hu, Jingxian
  3. Central Banks: Evolution and Innovation in Historical Perspective By Michael D. Bordo; Pierre L. Siklos
  4. International Spillovers of (Un)Conventional Monetary Policy: The Effect of the ECB and US Fed on Non-Euro EU Countries By Jan Hajek; Roman Horvath
  5. Interest on reserves and monetary policy of targeting both interest rate and money supply By Ngotran, Duong
  6. On Targeting Frameworks and Optimal Monetary Policy By Martin Bodenstein; Junzhu Zhao
  7. Optimal Monetary Policy when Information is Market-Generated By Kenza Benhima; Isabella Blengini
  8. How Does the Fed Adjust its Securities Holdings and Who is Affected? By Jane E. Ihrig; Lawrence Mize; Gretchen C. Weinbach
  9. Exchange Market Pressure and Monetary Policies in ASEAN5 By Ratnasari, Anggraeni; Widodo, Tri
  10. Life after default: Private vs. official sovereign debt restructurings By Silvia, Marchesi; Tania, Masi
  11. Projected Evolution of the SOMA Portfolio and the 10-year Treasury Term Premium Effect By Brian Bonis; Jane E. Ihrig; Min Wei
  12. Sovereign Default Resolution Through Maturity Extension By Gabriel Mihalache
  13. The Euro Area’s Common Pool Problem Revisited: Has the Single Supervisory Mechanism Ameliorated Forbearance and Evergreening? By Sven Steinkamp; Aaron Tornell; Frank Westermann
  14. Optimal Bank Regulation in the Presence of Credit and Run Risk By Anil K. Kashyap; Dimitrios P. Tsomocos; Alexandros Vardoulakis
  15. Deposit Insurance and Depositor Monitoring: Quasi-Experimental Evidence from the Creation of the Federal Deposit Insurance Corporation By Haelim Park Anderson; Gary Richardson; Brian S. Yang
  16. The Demand for Money for EMU: A Flexible Functional Form Approach By Barnett, William; Gaekwad, Neepa
  17. Competitive Supply of Money in a New Monetarist Model By Waknis, Parag

  1. By: Laséen, Stefan (Monetary Policy Department, Central Bank of Sweden); Pescatori, Andrea (International Monetary Fund); Turunen, Jarkko (International Monetary Fund)
    Abstract: We introduce time-varying systemic risk (à la He and Krishnamurthy, 2014) in an otherwise standard New-Keynesian model to study whether simple leaning-against-the-wind interest rate rules can reduce systemic risk and improve welfare. We find that while financial sector leverage contains additional information about the state of the economy that is not captured in inflation and output leaning against financial variables can only marginally improve welfare because rules are detrimental in the presence of falling asset prices. An optimal macroprudential policy, similar to a countercyclical capital requirement, can eliminate systemic risk raising welfare by about 1.5%. Also, a surprise monetary policy tightening does not necessarily reduce systemic risk, especially during bad times. Finally, a volatility paradox a la Brunnermeier and Sannikov (2014) arises when monetary policy tries to excessively stabilize output.
    Keywords: Monetary Policy; Endogenous Financial Risk; DSGE models; Non-Linear Dynamics; Policy Evaluation
    JEL: E30 E44 E52 E58 E61 G12 G20
    Date: 2017–08–01
  2. By: William, Barnett; Hu, Jingxian
    Abstract: Will capital controls enhance macro economy stability? How will the results be influenced by the exchange rate regime and monetary policy reaction? Are the consequences of policy decisions involving capital controls easily predictable, or more complicated than may have been anticipated? We will answer the above questions by investigating the macroeconomic dynamics of a small open economy. In recent years, these matters have become particularly important to emerging market economies, which have often adopted capital controls. We especially investigate two dynamical characteristics: indeterminacy and bifurcation. Four cases are explored, based on different exchange rate regimes and monetary policy rules. With capital controls in place, we find that indeterminacy depends upon how inflation and output gap coordinate with each other in their feedback to interest rate setting in the Taylor rule. When forward-looking, both passive and positive monetary policy feedback can lead to indeterminacy. Compared with flexible exchange rates, fixed exchange rate regimes produce more complex indeterminacy conditions, depending upon the stickiness of prices and the elasticity of substitution between labor and consumption. We find Hopf bifurcation under capital control with fixed exchange rates and current-looking monetary policy. To determine empirical relevance, we test indeterminacy empirically using Bayesian estimation. Fixed exchange rate regimes with capital controls produce larger posterior probability of the indeterminate region than a flexible exchange rate regime. Fixed exchange rate regimes with current-looking monetary policy lead to several kinds of bifurcation under capital controls. We provide monetary policy suggestions on achieving macroeconomic stability through financial regulation.
    Keywords: Capital controls, open economy monetary policy, exchange rate regimes, Bayesian methods, bifurcation, indeterminacy.
    JEL: C11 C62 E52 F3 F31 F41
    Date: 2017–09–16
  3. By: Michael D. Bordo; Pierre L. Siklos
    Abstract: Central banks have evolved for close to four centuries. This paper argues that for two centuries central banks caught up to the strategies followed by the leading central banks of the era; the Bank of England in the eighteenth and nineteenth centuries and the Federal Reserve in the twentieth century. It also argues that, by the late 20th century, small open economies were more prone to adopt a new policy regime when the old one no longer served its purpose whereas large, less open, and systemically important economies were more reluctant to embrace new approaches to monetary policy. Our study blends the quantitative with narrative explanations of the evolution of central banks. We begin by providing an overview of the evolution of monetary policy regimes taking note of the changing role of financial stability over time. We then provide some background to an analysis that aims, via econometric means, to quantify the similarities and idiosyncrasies of the ten central banks and the extent to which they represent a network of sorts where, in effect, some central banks learn from others.
    JEL: E02 E31 E32 E42 E58
    Date: 2017–09
  4. By: Jan Hajek; Roman Horvath
    Abstract: We estimate a global vector autoregression model to examine the effects of euro area and US monetary policy stances, together with the effect of euro area consumer prices, on economic activity and prices in non-euro EU countries using monthly data from 2001-2016. Along with some standard macroeconomic variables, our model contains measures of the shadow monetary policy rate to address the zero lower bound and the implementation of unconventional monetary policy by the European Central Bank and US Federal Reserve. We find that these monetary shocks have the expected qualitative effects but their magnitude differs across countries, with Southeastern EU economies being less affected than their peers in Central Europe. Euro area monetary shocks have greater effects than those that emanate from the US. We also find certain evidence that the effects of unconventional monetary policy measures are weaker than those of conventional measures. The spillovers of euro area price shocks to non-euro EU countries are limited, suggesting that the law of one price materializes slowly.
    Keywords: Global VAR, international spillovers, monetary policy, shadow rate
    JEL: E52 E58
    Date: 2017–09
  5. By: Ngotran, Duong
    Abstract: We build a dynamic model with currency, demand deposits and bank reserves. The monetary base is controlled by the central bank, while the money supply is determined by the interactions between the central bank, banks and public. In banking crises when banks cut loans, a Taylor rule is not efficient. Negative interest on reserves or forward guidance is effective, but deflation is still likely to be persistent. If the central bank simultaneously targets both the interest rate and the money supply by a Taylor rule and a Friedman's k-percent rule, inflation and output are stabilized.
    Keywords: interest on reserves; negative interest on reserves; forward guidance; monetary base; endogenous money supply
    JEL: E4 E42 E5 E51
    Date: 2017–08–30
  6. By: Martin Bodenstein; Junzhu Zhao
    Abstract: Speed limit policy, a monetary policy strategy that focuses on stabilizing inflation and the change in the output gap, consistently delivers better welfare outcomes than flexible inflation targeting or flexible price level targeting in empirical New Keynesian models when policymakers lack the ability to commit to future policies. Even if the policymaker can commit under an inflation targeting strategy, the discretionary speed limit policy performs better for most empirically plausible model parameterizations from a normative perspective.
    Keywords: Delegation ; Inflation targeting ; Optimal monetary policy ; Price level targeting ; Speed limit policy
    JEL: E52 E58
    Date: 2017–09–22
  7. By: Kenza Benhima; Isabella Blengini
    Abstract: Endogenous - i.e. market-generated - signals observed by firms have crucial implications for monetary policy. When information is endogenous, firms gather a demand signal from their market that is both real and nominal. As a result, the traditional surprise channel of monetary policy is absent. Instead, monetary policy works through a signaling channel, as it affects firms' information through the demand signal. The optimal policy is then the signaling policy, i.e. the policy that maximizes the information content of the demand signal. In our setup, the signaling policy targets a positive correlation between money supply and prices, which emphasizes the natural response of prices to real shocks. On the contrary, in the more traditional case of exogenous information, optimal monetary policy would stabilize prices as it acts through the surprise channel. We show that the signaling policy is optimal regardless of the amount of attention that firms pay to central bank communication.
    Keywords: Optimal monetary policy; information frictions; expectations; central bank communication
    JEL: D83 E32 E52
    Date: 2017–07
  8. By: Jane E. Ihrig; Lawrence Mize; Gretchen C. Weinbach
    Abstract: The Federal Open Market Committee indicated in its September 2017 post-meeting statement that it will initiate in October a balance sheet normalization program to gradually reduce its securities holdings. This action will put in place a policy of reinvesting and redeeming portions of the principal payments received by the Federal Reserve from its holdings of Treasury and agency securities. How are these adjustments to the Federal Reserve’s securities holdings transacted and who is affected? This paper provides a primer regarding how the Federal Reserve accounts for these securities transactions. It also illustrates the numerous ways that the Federal Reserve's actions can play out across other sectors of the economy, including those that engage directly with the Federal Reserve and those that are involved indirectly as funds change hands.
    Keywords: FOMC ; Federal Reserve Board and Federal Reserve System ; Balance sheet management ; Balance sheet policy ; Monetary policy normalization ; Securities redemption ; Securities reinvestment
    JEL: E52 E58 M41
    Date: 2017–09–22
  9. By: Ratnasari, Anggraeni; Widodo, Tri
    Abstract: The aim of this research is to analyze the relationship between Exchange Market Pressure (EMP) and monetary policies in ASEAN5 (Indonesia, Malaysia, the Philippines, Thailand, and Singapore). This research applies Vector Error Correction Model (VECM) and monthly data for the periods January 2006 – December 2016 for individual country estimation. The results show that the ASEAN5 monetary authorities have responded the increase of EMP by contracting domestic credit in the non-crisis periods, and by providing more liquidity to the bank system in the crisis periods. In addition, in the case of ASEAN5 the increase in interest rate differential has reduced the EMP.
    Keywords: Exchange Market Pressure, Domestic Credit, Interest Rates Differential, Monetary Policy
    JEL: F31 F33 F37
    Date: 2017–09–22
  10. By: Silvia, Marchesi; Tania, Masi
    Abstract: This paper studies the relationship between sovereign debt default and annual GDP growth taking into account the depth of a debt restructuring and distinguishing between commercial and o¢ cial sovereign debt restructurings. Analyzing 73 default episodes in 117 countries over the period 1975-2013, we find that defaults are correlated with contraction of short-term output growth. Most importantly, controlling for the severity of the default, we are able to detect a more lasting and negative link between default and growth. While higher private haircuts imply a negative stigma which is associated to lower growth over a longer period, higher amount of official restructuring may have some costs in the short-run, but are associated to an increase in growth in the long run. Using the Synthetic Control Method, we present further evidence for the heterogeneity of the economic impact of debt restructurings, confirming that official and private defaults may have different effects on GDP growth and should then be treated differently.
    Keywords: Haircuts, Output losses, Sovereign defaults
    JEL: F34 G15 H63
    Date: 2017–09–22
  11. By: Brian Bonis; Jane E. Ihrig; Min Wei
    Abstract: An earlier Feds note used staff models to provide a projection for the evolution of the SOMA portfolio and an estimate of the associated term premium effect (TPE) on the 10-year Treasury yield. That analysis relied on economic, financial, and monetary policy assumptions as of April 2017. With the Federal Open Market Committee (FOMC) announcing a change in its reinvestment policy in its September 2017 post-meeting statement, this note provides updated projections.
    Date: 2017–09–22
  12. By: Gabriel Mihalache
    Abstract: Sovereigns resolve their default status by offering bond swaps to their lenders, usually following negotiations. We model this interaction in a quantitative model of borrowing and default, and focus on its consequences for debt levels, default risk, and haircuts. The empirical literature finds that the bulk of debt relief is implemented by lengthening the maturity of debt, rather than changing face value. Countries exit renegotiations with less debt but with a greater share of long-term debt in total, compared to the maturity structure at the time of default. A standard maturity choice model, augmented with a renegotiation phase, is unable to replicate this critical feature of the data. We explain this negative result by showing an equivalence between the choice of maturity during the swap and and at issuance, in key states of the world. Introducing a demand shock solves the puzzle. We interpret this reduced-form shock in the context of the literature on political turnover risk. It captures in a parsimonious way the notion that emerging markets may elect policy-makers more prone to short-termism.
    Date: 2017
  13. By: Sven Steinkamp (University Osnabrueck); Aaron Tornell (UC Los Angeles); Frank Westermann (University Osnabrueck)
    Abstract: The Single Supervisory Mechanism was introduced to eliminate the common-pool problem and limit uncontrolled lending by national central banks (NCBs). We analyze its effectiveness. Second, we model how, by forbearing and providing refinancing credit, NCBs avoid domestic resolution costs and, instead, share potential losses within the Euro Area. This results in “evergreening” of bad loans. Third, we construct a new evergreening index based on a large worldwide survey administered by the ifo institute. Regressions show evergreening is significantly greater in the Euro Area and where banks are in distress. Finally, greater evergreening accompanies higher growth of NCB-credit and Target2-liabilities.
    Keywords: Single Supervisory Mechanism; Evergreening; Non-performing Loans; Common-pool Problem
    JEL: F33 F55 E58
    Date: 2017–09–15
  14. By: Anil K. Kashyap; Dimitrios P. Tsomocos; Alexandros Vardoulakis
    Abstract: We modify the Diamond and Dybvig (1983) model of banking to jointly study various regulations in the presence of credit and run risk. Banks choose between liquid and illiquid assets on the asset side, and between deposits and equity on the liability side. The endogenously determined asset portfolio and capital structure interact to support credit extension, as well as to provide liquidity and risk-sharing services to the real economy. Our modifications create wedges in the asset and liability mix between the private equilibrium and a social planner's equilibrium. Correcting these distortions requires the joint implementation of a capital and a liquidity regulation.
    Keywords: Bank runs ; Capital ; Credit risk ; Limited liability ; Liquidity ; Regulation
    JEL: E44 G01 G21 G28
    Date: 2017–09–22
  15. By: Haelim Park Anderson; Gary Richardson; Brian S. Yang
    Abstract: In the Banking Acts of 1933 and 1935, the United States created the Federal Deposit Insurance Corporation, which ensured deposits in commercial banks up to $5,000. Congress capped the size of insured deposits so that small depositors would not run on banks, but large and informed depositors – such as firms and investors – would continue to monitor banks’ behavior. This essay asks how that insurance scheme influenced depositors’ reactions to news about the health of the economy and information on bank’s balance sheets. An answer arises from our treatment-and-control estimation strategy. When deposit insurance was created, banks with New York state charters accepted regular and preferred deposits. Preferred depositors received low, fixed interest rates, but when banks failed, received priority in repayment. Deposit-insurance legislation diminished differences between preferred and regular deposits by capping interest rates and protecting regular depositors from losses. We find that before deposit insurance, regular depositors reacted more to news about banks’ balance sheets and economic aggregates; while preferred depositors reacted less. After deposit insurance, this difference diminished, but did not disappear. The change in the behavior of one group relative to the other indicates that deposit insurance reduced depositor monitoring, although the continued reaction of depositors to some information suggests that, as intended, the legislation did not entirely eliminate depositor monitoring.
    JEL: E42 E65 G21 G28 N22 P34
    Date: 2017–09
  16. By: Barnett, William; Gaekwad, Neepa
    Abstract: Monetary aggregates have a special role under the "two pillar strategy" of the ECB. Hence, the need for a theoretically consistent measure of monetary aggregates for the European Monetary Union (EMU) is needed. This paper analyzes aggregation over monetary assets for the EMU. We aggregate over the monetary services for the EMU-11 countries, which include Estonia, Finland, France, Germany, Ireland, Italy, Luxembourg, Malta, Netherlands, Slovakia, and Slovenia. We adopt the Divisia monetary aggregation approach, which is consistent with index number theory and microeconomic aggregation theory. The result is a multilateral Divisia monetary aggregate in accordance with Barnett (2007). The multilateral Divisia monetary aggregate for the EMU-11 is found to be more informative and a better signal of economic trends than the corresponding simple sum aggregate. We then analyze substitutability among monetary assets for the EMU-11 within the framework of a representative consumer's utility function, using Barnett’s (1983) locally flexible functional form, the minflex Laurent Indirect utility function. The analysis of elasticities with respect to the asset’s user-cost prices shows that: (i) transaction balances (TB) and deposits redeemable at notice (DRN) are income elastic, (ii) the DRN display large variation in price elasticity, and (iii) the monetary assets are not good substitutes for each other within the EMU-11. Simple sum monetary aggregation assumes that component assets are perfect substitutes. Hence simple sum aggregation distorts measurement of the monetary aggregate. The ECB has Divisia monetary aggregates provided to the Governing Council at its meetings, but not to the public. Our European Divisia monetary aggregates will be expanded and refined, in collaboration with Wenjuan Chen at the Humboldt University of Berlin, to a complete EMU Divisia monetary aggregates database to be supplied to the public by the Center for Financial Stability in New York City.
    Keywords: Divisia monetary aggregation, European Monetary Union, monetary aggregation theory, multilateral aggregation, minflex Laurent, elasticities of demand
    JEL: C43 C82 D12 E51 F33
    Date: 2017–09–19
  17. By: Waknis, Parag
    Abstract: Whether currency can be efficiently provided by private competitive money suppliers is arguably one of the fundamental questions in monetary theory. It is also one with practical relevance because of the emergence of multiple competing financial assets as well as competing cryptocurrencies as means of payments in certain class of transactions. In this paper, a dual currency version of Lagos and Wright (2005) money search model is used to explore the answer to this question. The centralized market sub-period is modeled as infinitely repeated game between two long lived players (money suppliers) and a short lived player (a continuum of agents), where longetivity of the players refers to the ability to influence aggregate outcomes. There are multiple equilibria, however we show that equilibrium featuring lowest inflation tax is weakly renegotiation proof, suggesting that better inflation outcome is possible in an environment with currency competition.
    Keywords: currency competition, repeated games, long lived- short lived players, inflation tax, money search, weakly renegotiation proof.
    JEL: E52 E61
    Date: 2017–09–11

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