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on Central Banking |
| By: | Marine Charlotte André; Meixing Dai |
| Abstract: | This paper studies how learning affects the interactions between monetary policy and stock prices. Learning modifes the intertemporal trade-off of the central bank by giving to the latter the possibility to manipulate private expectations. The result of this manipulation is not socially optimal since it reduces excessively the stabilization bias. To remedy this, the government should appoint a central banker that is less conservative than the society. The turnover rate in the stock market is the key factor that determines the interactions between monetary policy (hence delegation) and stock prices. A positive turnover rate means that the presence of stocks in the households' portfolios distorts the optimal consumption path. This type of distortion compensates somehow these induced by learning. The central bank should be more conservative to avoid the effect of distortions on social welfare induced by learning than in the absence of stocks. |
| Keywords: | adaptive learning, stabilization bias, inflation penalty, optimal monetary delegation, central bank conservatism, stock prices. |
| JEL: | C62 D83 D84 E52 E58 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:ulp:sbbeta:2017-37&r=cba |
| By: | Chris Garbers (Department of Economics, University of Stellenbosch); Guangling Liu (Department of Economics, University of Stellenbosch) |
| Abstract: | This paper presents a generic small open economy real business cycle model with banking and foreign borrowing. We incorporate capital requirements, reserve requirements, and loan-to-value (LTV) regulation into this framework, and subject the model to a positive foreign interest rate shock that raises the country risk premium and reduces the supply of foreign funds. The results show that these macroprudential instruments can attenuate the impact of such a shock, and that this attenuation property increases with the strictness of the regulatory regime. Capital requirements and LTV regulation deliver the largest attenuation benefits and are shown to be close substitutes. That being said, capital requirements are shown to be more effective at leaning against the financial cycle whereas LTV regulation is more effective at stimulating the financial cycle. The analysis indicates that capital and reserve requirements can interact such that reserve requirements are most effective when used to supplement existing capital requirement or LTV measures. We find that financial and macroeconomic stability objectives are aligned following a positive foreign interest rate shock such that a macroprudential response to such shocks can be to the benefit of both objectives. Lastly, our results show that capital requirements and LTV regulation exhibit decreasing returns to scale. |
| Keywords: | Macroprudential policy, Open economy macroeconomics, Financial stability, Business cycle, Welfare, DSGE |
| JEL: | E32 E44 E58 F41 G28 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:sza:wpaper:wpapers291&r=cba |
| By: | Guillermo Ordonez (University of Pennsylvania); Selman Erol (MIT, CMU) |
| Abstract: | Optimal regulatory restrictions on banks have to solve a delicate balance. Tighter regulations reduce the likelihood of banks’ distress. Looser regulations foster the allocation of funds towards productive investments. With multiple banks, optimal regulation becomes even more challenging. Banks form partnerships in the interbank lending market to face liquidity needs and meet investment possibilities. We show that the interbank network may suddenly collapse once regulations are pushed above a critical level, with a discontinuous increase in systemic risk as banks’ cross-insurance collapses. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1125&r=cba |
| By: | Jeffrey Campbell (Federal Reserve Bank of Chicago) |
| Abstract: | This paper considers monetary and fiscal policy when tangible assets can be created and stored after shocks that increase desired savings, like Joseph's biblical prophecy of seven fat years followed by seven lean years. The model's flexible-price allocation mimics Joseph's saving to smooth consumption. With nominal rigidities, monetary policy that eliminates liquidity traps leaves the economy vulnerable to confidence recessions with low consumption and investment. Josephean Quantitative Easing, a fiscal policy that purchases either obligations collateralized by reproducible tangible assets or the assets themselves, eliminates both liquidity traps and confidence recessions by putting a floor under future consumption. This requires no commitment to a time-inconsistent plan. In a small open economy, the monetary authority can implement Josephean Quantitative Easing with a sterilized currency-market intervention that accumulates foreign reserves. This can improve outcomes even if it leaves nominal exchange rates unchanged. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1165&r=cba |
| By: | Sivec, Vasja; Volk, Matjaz |
| Abstract: | This paper uncovers current, and estimates future, responses by banks which are under notification of increased capital requirements. We collect notifications on regulatory capital requirements sent to Slovenian banks in the period 2009-2015 and construct a forward-looking measure of capital surplus/shortfall. Using a differences-in-differences model we show that the same firm has on average a 3.54 p.p. lower loan growth when the loan is obtained through a bank with 1 p.p. higher capital shortfall. Once the capital surplus/shortfall is included in the regression model, the coefficient on the capital adequacy ratio, often used as the main policy variable in empirical literature, becomes insignificant. It is insignificant because surplus/shortfall is a forward-looking measure of bank capitalization and conveys more information about future lending. Finally, we show that in response to an increase in capital requirements banks engage in more risk-taking behaviour. Our paper carries policy implications for regulators in countries with distressed banking sector. |
| Keywords: | capital requirement, credit, regulation, risk taking, policy |
| JEL: | G01 G21 G28 |
| Date: | 2017–11–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:83058&r=cba |
| By: | Trevor Serrao (Federal Reserve Bank of Chicago); Luca Benzoni (Federal Reserve Bank of Chicago); Marco Bassetto (Federal Reserve Bank of Chicago) |
| Abstract: | We study the interplay between monetary policy and financial conditions shocks. Such shocks have a significant and similar impact on the real economy, though with different degrees of persistence. The systematic fed funds rate response to a financial shock contributes to bringing the economy back towards trend, but a zero lower bound on policy rates can prevent this from happening, with a significant cost in terms of output and investment. In a retrospective analysis of the U.S. economy over the past 20 years, we decompose the realization of economic variables into the contributions of financial, monetary policy, and other shocks. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1124&r=cba |
| By: | Marek Dabrowski |
| Abstract: | The recent wave of financial innovation, particularly innovation related to the application of information and communication technologies, poses a serious challenge to the financial industry’s business model in both its banking and non-banking components. It has already revolutionised financial services and, most likely, will continue to do so in the future. If not responded to adequately and timely by regulators, it may create new risks to financial stability, as occurred before the global financial crisis of 2007-2009. However, financial innovation will not seriously affect the process of monetary policymaking and is unlikely to undermine the ability of central banks to perform their price stability mission. The recent wave of financial innovation, particularly innovation related to the application of information and communication technologies, poses a serious challenge to the financial industry’s business model in both its banking and non-banking components. It has already revolutionised financial services and, most likely, will continue to do so in the future. If not responded to adequately and timely by regulators, it may create new risks to financial stability, as occurred before the global financial crisis of 2007-2009. However, financial innovation will not seriously affect the process of monetary policymaking and is unlikely to undermine the ability of central banks to perform their price stability mission. |
| Keywords: | monetary policy, financial innovation, electronic money |
| JEL: | E41 E44 E51 E52 E58 G21 |
| Date: | 2017–07 |
| URL: | http://d.repec.org/n?u=RePEc:sec:report:0488&r=cba |
| By: | Andrew Foerster (Federal Reserve Bank of Kansas City); Troy Davig (Federal Reserve Bank of Kansas City) |
| Abstract: | Sixty-two countries around the world use some form of inflation targeting as their monetary policy framework, though none of these countries express explicit policy rules. In contrast, models of monetary policy typically assume policy is set through a rule such as a Taylor rule or optimal monetary policy formulation. Central banks often connect theory with their practice by publishing inflation forecasts that can, in principle, implicitly convey their reaction function. We return to this central idea to show how a central bank can achieve the gains of a rule-based policy without publicly stating a specific rule. The approach requires central banks to specify an inflation target, tolerance bands, and economic projections. When inflation moves outside the band, the central bank must also specify a time frame over which inflation will return to within the band. We show how communication about time horizons and tolerance bands can uniquely pin down a policy rule, and highlight how different types of communication can be used to convey different policy rules. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1133&r=cba |
| By: | Bubeck, Johannes; Habib, Maurizio Michael; Manganelli, Simone |
| Abstract: | This paper studies the impact of major ECB monetary policy announcements on the portfolio allocation of euro area fund investors, using daily data between 2012 and mid-2016, a period that includes a variety of unconventional measures. We distinguish between active portfolio reallocation, driven by redemptions or injections of investors, and passive portfolio rebalancing, triggered by valuation effects related to changes in asset prices and exchange rates. We find that, for this class of fund investors, policy announcements work mainly through valuation effects (the signalling channel), rather than via active reallocation (the portfolio rebalancing channel). Notably, since the autumn of 2014, monetary policy shocks triggered large asset price and exchange rate effects and prompted a passive shift of euro area investors into riskier assets, in particular European and Emerging Market equity funds and out of bond funds. JEL Classification: G11, G15 |
| Keywords: | asset allocation, euro area, European Central Bank, investment funds, monetary policy |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20172116&r=cba |
| By: | Arlene Wong (Federal Reserve Bank of Minneapolis); Aaron Kirkman (Northwestern University); Alejandro Justiniano (Federal Reerve Chicago) |
| Abstract: | We study the transmission of monetary policy to consumption and the accumulation of mortgage debt. Using a comprehensive and representative borrower-loan level panel the analysis focuses on how decisions to obtain new mortgages or refinance existing ones following policy driven changes in interest rates vary with individual characteristics, particularly age. Furthermore, we document whether this heterogeneity varies by type of refinancing and so look separately at refinancing with and without an increase in mortgage balance. We then explore how these differences in accessing mortgages interact with decisions to tap into housing net worth through home equity loans and lines of credit. Finally, we extended the analysis to other forms of borrowing such as credit card debt and car loans. The latter in turn informs the pass-through to a crucial component of durable consumption. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed017:1195&r=cba |
| By: | Sebastian Di Tella; Pablo Kurlat |
| Abstract: | We propose a model of banks’ exposure to movements in interest rates and their role in the transmission of monetary shocks. Since bank deposits provide liquidity, higher interest rates allow banks to earn larger spreads on deposits. Therefore, if risk aversion is higher than one, banks' optimal dynamic hedging strategy is to take losses when interest rates rise. This risk exposure can be achieved by a traditional maturity-mismatched balance sheet, and amplifies the effects of monetary shocks on the cost of liquidity. The model can match the level, time pattern, and cross-sectional pattern of banks’ maturity mismatch. |
| JEL: | E41 E43 E44 E51 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24076&r=cba |
| By: | Philippe Andrade; Jordi Galí; Hervé Le Bihan; Julien Matheron |
| Abstract: | We study how changes in the value of the steady-state real interest rate affect the optimal inflation target, both in the U.S. and the euro area, using an estimated New Keynesian DSGE model that incorporates the zero (or effective) lower bound on the nominal interest rate. We find that this relation is downward sloping, but its slope is not necessarily one-for-one: increases in the optimal inflation rate are generally lower than declines in the steady-state real interest rate. Our approach allows us not only to assess the uncertainty surrounding the optimal inflation target, but also to determine the latter while taking into account the parameter uncertainty facing the policy maker, including uncertainty with regard to the determinants of the steady-state real interest rate. We find that in the currently empirically relevant region for the US as well as the euro area, the slope of the curve is close to -0.9. That finding is robust to allowing for parameter uncertainty. |
| Keywords: | inflation target, effective lower bound. |
| JEL: | E31 E52 E58 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1591&r=cba |
| By: | Jamel Saadaoui (CEPN - Centre d'Economie de l'Université Paris Nord - UP13 - Université Paris 13 - USPC - Université Sorbonne Paris Cité - CNRS - Centre National de la Recherche Scientifique, BETA - Bureau d'Economie Théorique et Appliquée - UNISTRA - Université de Strasbourg - UL - Université de Lorraine - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | From the onset of the euro crisis to the Brexit vote, we have witnessed impressive reductions of current account imbalances in peripheral countries of the euro area. These reductions can be the result of either a compression of internal demand or an improvement in external competitiveness. In this paper, we compute exchange rate misalignments within the euro area to assess whether peripheral countries have managed to improve their external competitiveness. After controlling for the reduction of business cycle synchronization within the EMU, we find that peripheral countries have managed to reduce their exchange rate misalignments thanks to internal devaluations. To some extent, these favourable evolutions reflect improvements in external competitiveness. Nevertheless, these gains could only be temporary if peripheral countries do not improve their non-price competitiveness, their trade structures and their international specializations in the long run. |
| Keywords: | Internal Devaluation,Equilibrium Exchange Rate,External Competitiveness |
| Date: | 2017–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cepnwp:halshs-01633389&r=cba |