nep-cba New Economics Papers
on Central Banking
Issue of 2018‒01‒22
twenty papers chosen by
Maria Semenova
Higher School of Economics

  1. Monetary policy and prudential supervision: From functional separation to a holistic approach? By Goldmann, Matthias
  2. Making Discretion in Monetary Policy More Rule-Like By Frederic S. Mishkin
  3. Quantitative Easing and the “New Normal” in Monetary Policy By Michael T. Kiley
  4. Rules Versus Discretion: Assessing the Debate Over the Conduct of Monetary Policy By John B. Taylor
  5. Are Negative Nominal Interest Rates Expansionary? By Gauti B. Eggertsson; Ragnar E. Juelsrud; Ella Getz Wold
  6. The Uncovered Interest Parity Puzzle, Exchange Rate Forecasting, and Taylor Rules By Charles Engel; Dohyeon Lee; Chang Liu; Chenxin Liu; Steve Pak Yeung Wu
  7. Ambiguity, monetary policy and trend inflation By Masolo, Riccardo M.; Monti, Francesca
  8. Credit Risk, Excess Reserves and Monetary Policy: The Deposits Channel By Bratsiotis, George
  9. When is foreign exchange intervention effective? Evidence from 33 countries By Fratzscher, Marcel; Gloede, Oliver; Menkhoff, Lukas; Sarno, Lucio; Stoerh, Tobias
  10. The transmission of monetary policy shocks By Miranda-Agrippino, Silvia; Ricco, Giovanni
  11. Optimal Dynamic Capital Requirements By Kalin Nikolov; Javier Suarez; Dominik Supera; Caterina Mendicino
  12. Temporary Price Changes, Inflation Regimes and the Propagation of Monetary Shocks By Fernando Alvarez; Francesco Lippi
  13. How Do Central Bank Projections and Forward Guidance Influence Private-Sector Forecasts? By Monica Jain; Christopher S. Sutherland
  14. Unconventional Monetary Policy in a Small Open Economy By Margaux MacDonald; Michał Ksawery Popiel
  15. Does Size Matter? Bailouts with Large and Small Banks By Eduardo Dávila; Ansgar Walther
  16. Risk and Monetary Policy in a New Keynesian Model By Mikhail Golosov; David Evans; anmol bhandari
  17. Does Monetary Policy Influence Banks' Perception of Risks? By Simona Malovana; Dominika Kolcunova; Vaclav Broz
  18. Can Macroprudential Measures Make Cross-Border Lending More Resilient? Lessons from the Taper Tantrum By Elod Takats; Judit Temesvary
  19. Unconventional monetary policy and the portfolio choice of international mutual funds By Cenedese, Gino; Elard, Ilaf
  20. Pegging the Interest Rate on Bank Reserves By Diba Behzad; Olivier Loisel

  1. By: Goldmann, Matthias
    Abstract: When prudential supervision was put in the hands of the European Central Bank (ECB), it was the political understanding that the ECB should follow a policy of meticulous separation between monetary policy and financial supervision. However, the financial crisis showed that monetary policy and prudential supervision deeply affect each other and that an overly strict separation might generate systemic risk. As a consequence, the prevalent model of "functional separation" - central banking and financial supervision in separate entities - has been questioned and calls for a more holistic approach increased. This policy letter states that from a legal perspective, such a holistic approach would be in conformity with the current legal framework of the Economic and Monetary Union. Although the realization of a holistic approach might intensify the doubts of democratic legitimation under the framework of the ESCB, the independence of the ECB should not be given up. As viable alternatives to protect monetary policy against the time inconsistency problem that would render central bank independence moot do not seem to be available and given the great importance of the independence of the European institutions for the European integration, the democratic control over the ECB should be strengthened instead of stripping the ECB of its independence.
    Keywords: monetary policy,financial stability,financial supervision
    Date: 2018
  2. By: Frederic S. Mishkin
    Abstract: This paper argues that the rules versus discretion debate has been miscast because a central bank does not have to choose only between adopting a policy rule versus pure discretion, both of which have serious shortcomings. Rather it can choose a constrained discretionary regime that has rule-like attributes. Monetary policy discretion can be made more rule-like, by 1) adopting a nominal anchor such as an inflation target, and 2) communication of a monetary policy reaction process, especially through data-based forward guidance, in which the monetary policy authorities describe how the future policy path will change as economic circumstances change.
    JEL: E5 E52 E58
    Date: 2017–12
  3. By: Michael T. Kiley
    Abstract: Interest rates may remain low and fall to their effective lower bound (ELB) often. As a result, quantitative easing (QE), in which central banks expand their balance sheet to lower long-term interest rates, may complement policy approaches focused on adjustments in short-term interest rates. Simulation results using a large-scale model (FRB/US) suggest that QE does not improve economic performance if the steady-state interest rate is high, confirming that such policies were not advantageous from 1960 to 2007. However, QE can offset a significant portion of the adverse effects of the ELB when the equilibrium real interest rate is low. These improvements in economic performance exceed those associated with moderate increases in the inflation target. Active QE is primarily required when nominal interest rates are near the ELB, pointing to benefits within the model from QE as a secondary tool while relying on short-term interest rates as the primary tool.
    Keywords: Interest rates ; Macroeconomic models ; Monetary policy
    JEL: E52 E47 E37
    Date: 2018–01–17
  4. By: John B. Taylor
    Abstract: This paper reviews the state of the debate over rules versus discretion in monetary policy, focusing on the role of economic research in this debate. It shows that proposals for policy rules are largely based on empirical research using economic models. The models demonstrate the advantages of a systematic approach to monetary policy, though proposed rules have changed and generally improved over time. Rules derived from research help central bankers formulate monetary policy as they operate in domestic financial markets and the global monetary system. However, the line of demarcation between rules and discretion is difficult to establish in practice which makes contrasting the two approaches difficult. History shows that research on policy rules has had an impact on the practice of central banking. Economic research also shows that while central bank independence is crucial for good monetary policy making, it has not been enough to prevent swings away from rules-based policy, implying that policy-makers might consider enhanced reporting about how rules are used in monetary policy. The paper also shows that during the past year there has been an increased focus on policy rules in implementing monetary policy in the United States.
    JEL: E52 E58 F33
    Date: 2017–12
  5. By: Gauti B. Eggertsson; Ragnar E. Juelsrud; Ella Getz Wold
    Abstract: Following the crisis of 2008 several central banks engaged in a radical new policy experiment by setting negative policy rates. Using aggregate and bank-level data, we document a collapse in pass-through to deposit and lending rates once the policy rate turns negative. Motivated by these empirical facts, we construct a macro-model with a banking sector that links together policy rates, deposit rates and lending rates. Once the policy rates turns negative the usual transmission mechanism of monetary policy breaks down. Moreover, because a negative interest rate on reserves reduces bank profits, the total effect on aggregate output can be contractionary.
    JEL: E3 E30 E31 E32 E4 E41 E42 E43 E5 E50 E52 E58 E65
    Date: 2017–11
  6. By: Charles Engel; Dohyeon Lee; Chang Liu; Chenxin Liu; Steve Pak Yeung Wu
    Abstract: Recent research has found that the Taylor-rule fundamentals have power to forecast changes in U.S. dollar exchange rates out of sample. Our work casts some doubt on that claim. However, we find strong evidence of a related in-sample anomaly. When we include U.S. inflation in the well-known uncovered interest parity regression of the change in the exchange rate on the interest-rate differential, we find that the inflation variable is highly significant and the interest-rate differential is not. Specifically, high U.S. inflation in one month forecasts dollar appreciation in the subsequent month. We introduce a model in which a Taylor rule determines monetary policy, but in which not only monetary shocks but also liquidity shocks drive nominal interest rates. This model can potentially account for the empirical findings.
    JEL: F3 F31 F41
    Date: 2017–11
  7. By: Masolo, Riccardo M.; Monti, Francesca
    Abstract: Allowing for ambiguity, or Knightian uncertainty, about the behavior of the policymaker helps explain the evolution of trend inflation in the US in a simple new-Keynesian model, without resorting to exogenous changes in the inflation target. Using Blue Chip survey data to gauge the degree of private sector confidence, our model helps reconcile the difference between target inflation and the inflation trend measured in the data. We also show how, in the presence of ambiguity, it is optimal for policymakers to lean against the private sectors pessimistic expectations.
    Keywords: Ambiguity aversion; monetary policy; trend inflation
    JEL: D84 E31 E43 E52 E58
    Date: 2017–02–06
  8. By: Bratsiotis, George
    Abstract: This paper examines the role of the precautionary demand for liquidity and the interest on reserves as two potential determinants of the deposits channel that can help explain the role of monetary policy, particularly at the near zero-bound. At high levels of precautionary liquidity hoarding the optimal policy response of a Taylor rule is shown to indicate a zero weight on inflation. This is a determinate outcome, despite the violation of the Taylor Principle, because of the effect that the demand for liquidity has on the deposit rate which determines the intertemporal choices of households. Similarly, through its effect on the deposits channel the interest on reserves can act as the main monetary policy tool that can provide determinacy and replace the Taylor rule. This result holds at the zero-bound and it is independent of precautionary demand for liquidity, or fiscal theory of the price level properties.
    Keywords: Deposits channel,zero-bound monetary policy,excess reserves,credit risk,welfare,required reserve ratio,interest on reserves,balance sheet channel,DSGE models
    Date: 2017
  9. By: Fratzscher, Marcel; Gloede, Oliver; Menkhoff, Lukas; Sarno, Lucio; Stoerh, Tobias
    Abstract: This paper examines foreign exchange intervention based on novel daily data covering 33 countries from 1995 to 2011. We find that intervention is widely used and an effective policy tool, with a success rate in excess of 80 percent under some criteria. The policy works well in terms of smoothing the path of exchange rates, and in stabilizing the exchange rate in countries with narrow band regimes. Moving the level of the exchange rate in flexible regimes requires that some conditions are met, including the use of large volumes and that intervention is made public and supported via communication.
    Keywords: Foreign exchange intervention; exchange rate regimes; effectiveness measures; communication.
    JEL: E58 F31 F33
    Date: 2017–12
  10. By: Miranda-Agrippino, Silvia; Ricco, Giovanni
    Abstract: Despite years of research, there is still uncertainty around the effects of monetary policy shocks. We reassess the empirical evidence by combining a new identification that accounts for informational rigidities, with a flexible econometric method robust to misspecifications that bridges between VARs and Local Projections. We show that most of the lack of robustness of the results in the extant literature is due to compounding unrealistic assumptions of full information with the use of severely misspecified models. Using our novel methodology, we find that a monetary tightening is unequivocally contractionary, with no evidence of either price or output puzzles.
    Keywords: Monetary Policy; Local Projections; VARs; Expectations; Information Rigidity; Survey Forecasts; External Önancial markets; International transfers; Optimal currency area
    JEL: C32 E52 G14
    Date: 2017–02–28
  11. By: Kalin Nikolov (European Central Bank); Javier Suarez (CEMFI); Dominik Supera (European Central Bank); Caterina Mendicino (European Central Bank)
    Abstract: We characterize welfare maximizing capital requirement policies in a macroeconomic model with household, firm and bank defaults calibrated to Euro Area data. We optimize on the level of the capital requirements applied to each loan class and their sensitivity to changes in default risk. We find that getting the level right (so that bank failure risk remains small) is of foremost importance, while the optimal sensitivity to default risk is positive but typically smaller than under Basel IRB formulas. When starting from low levels, initially both savers and borrowers benefit from higher capital requirements. At higher levels, only savers are in favour of tighter and more time-varying capital charges.
    Date: 2017
  12. By: Fernando Alvarez (University of Chicago); Francesco Lippi (University of Sassari and EIEF)
    Abstract: We analyze a sticky price model where firms choose a price plan, namely a set of two prices. Changing the plan entails a “menu cost”, but either price in the plan can be charged at any point in time. We analytically solve for the optimal policy and for the output response to a monetary shock. The setup rationalizes the coexistence of many price changes, most of which are temporary, with a modest flexibility of the aggregate price level. We present evidence consistent with the model implications using CPI data for Argentina across a wide range of inflation rates.
    Date: 2018
  13. By: Monica Jain; Christopher S. Sutherland
    Abstract: We construct a 23-country panel data set to consider the effect of central bank projections and forward guidance on private-sector forecast disagreement. We find that central bank projections and forward guidance matter mainly for private-sector forecast disagreement surrounding upcoming policy rate decisions and matter less for private-sector macroeconomic forecasts. Further, neither central banks’ provision of policy rate path projections nor their choice of policy rate assumption used in their macroeconomic projections appear to matter much for private-sector forecast disagreement.
    Keywords: Central bank research, Inflation targets, Monetary Policy, Monetary policy communications, Transmission of monetary policy
    JEL: D83 E37 E52 E58
    Date: 2018
  14. By: Margaux MacDonald; Michał Ksawery Popiel
    Abstract: This paper investigates the effects of unconventional monetary policy in a small open economy. Using recently proposed shadow interest rates to capture unconventional monetary policy at the zero lower bound (ZLB) we estimate a Bayesian structural vector autoregressive model for Canada - a useful case where foreign shocks can be proxied by U.S. variables alone. We find that, during the ZLB period, Canadian unconventional monetary policy increased output (measured by industrial production) by 0.013 percent per month on average while US unconventional monetary policy raised Canadian output by 0.127 percent per month on average. Our results demonstrate the effectiveness of domestic unconventional monetary policy and the strong positive spillover effects that foreign unconventional monetary policies can have in a small open economy.
    Date: 2017–12–01
  15. By: Eduardo Dávila; Ansgar Walther
    Abstract: We explore how large and small banks make funding decisions when the government provides system-wide bailouts to the financial sector. We show that bank size, purely on strategic grounds, is a key determinant of banks' leverage choices, even when bailout policies treat large and small banks symmetrically. Large banks always take on more leverage than small banks because they internalize that their decisions directly affect the government's optimal bailout policy. In equilibrium, small banks also choose strictly higher borrowing when large banks are present, since banks' leverage choices are strategic complements. Overall, the presence of large banks increases aggregate leverage and the magnitude of bailouts. The optimal ex-ante regulation features size-dependent policies that disproportionally restrict the leverage choices of large banks. A quantitative assessment of our model implies that an increase in the share of assets held by the five largest banks from 50% to 70% is associated with a 3.5 percentage point increase in aggregate debt-to-asset ratios (from 90.1% to 93.6%). Under the optimal policy, large banks face a “size tax” of 40 basis points (0.4%) per dollar of debt issued.
    JEL: E61 G21 G28
    Date: 2017–12
  16. By: Mikhail Golosov (Princeton University); David Evans (University of Oregon); anmol bhandari (university of minnesota)
    Abstract: Asset pricing data indicates that shocks to the nominal interest rates are primarily reflected in changes in risk premium. In this paper we build a New Keynesian model in which the behavior of interest rates and risk premium is consistent with this observation. We show that monetary shocks affect the real and nominal variables through the novel channel -- when nominal price adjustment is costly, firms need to balance needs to maximize current period profit and minimize future cost of price adjustments. Increase in risk, which follows a decrease in interest rates, increases firm's weight of future costs in inflationary environments, and leads to an increase in inflation, nominal and real marginal costs and output. Effectiveness of monetary policy varies with the state of the economy and generally is low in low inflationary environments. We also show that a number of well-known predictions of New Keynesian models reverses when interest rate shocks affect risk premium.
    Date: 2017
  17. By: Simona Malovana; Dominika Kolcunova; Vaclav Broz
    Abstract: This paper studies the extent to which monetary policy may affect banks' perception of credit risk and the way banks measure risk under the internal ratings-based approach. Specifically, we analyze the effect of different monetary policy indicators on banks' risk weights for credit risk. We present robust evidence of the existence of the risk-taking channel in the Czech Republic. Further, we show that the recent prolonged period of accommodative monetary policy has been instrumental in establishing this relationship. Finally, we obtain comparable results by extending the analysis to cover all the Visegrad Four countries. The presented findings have important implications for the prudential authority, which should be aware of the possible side-effects of monetary policy on how banks measure risk.
    Keywords: Banks, financial stability, internal ratings-based approach, risk-taking channel
    JEL: E52 E58 G21 G28
    Date: 2017–12
  18. By: Elod Takats; Judit Temesvary
    Abstract: We study the effect of macroprudential measures on cross-border lending during the taper tantrum, which saw a strong slowdown of cross-border bank lending to some jurisdictions. We use a novel dataset combining the BIS Stage 1 enhanced banking statistics on bilateral cross-border lending flows with the IBRN’s macroprudential database. Our results suggest that macroprudential measures implemented in borrowers’ host countries prior to the taper tantrum significantly reduced the negative effect of the tantrum on cross-border lending growth. The shock-mitigating effect of host country macroprudential rules are present both in lending to banks and non-banks, and are strongest for lending flows to borrowers in advanced economies and to the non-bank sector in general. Source (lending) banking system measures do not affect bilateral lending flows, nor do they enhance the effect of host country macroprudential measures. Our results imply that policymakers may consider applying macroprudential tools to mitigate international shock transmission through cross-border bank lending.
    Keywords: Diff-in-diff analysis ; Taper tantrum ; Cross-border claims ; Macroprudential policy
    JEL: F34 F42 G21 G38
    Date: 2017–12–18
  19. By: Cenedese, Gino (Bank of England); Elard, Ilaf (Shanghai University of International Business and Economics)
    Abstract: Unconventional monetary policy (UMP) by the US Federal Reserve, Bank of England, Bank of Japan, and European Central Bank affects the geographical portfolio choice of international mutual fund managers. UMP prompts managers of mutual funds to rebalance their portfolios away from the country conducting UMP, and increase their geographical allocation to other developed markets; there is little evidence of rebalancing towards emerging markets. The international spillover effects from UMP announcement surprises are of small economic magnitude, in contrast to the effects of actual UMP operations in the form of large-scale asset purchases (LSAPs). The results imply that while not contributing to QE-induced capital flows to emerging markets, mutual fund managers play a role in the transmission of unconventional monetary policy, in particular LSAPs, across developed markets.
    Keywords: Unconventional monetary policy; portfolio rebalancing; international spillovers; asset allocation; mutual funds
    JEL: F30 G11 G15 G23
    Date: 2018–01–18
  20. By: Diba Behzad (Department of Economics; Georgetown University); Olivier Loisel (CREST; ENSAE)
    Abstract: We develop a model of monetary policy with a small departure from the basic New Keynesian (NK) model. In this model, the central bank can set the interest rate on bank reserves and the nominal stock of bank reserves independently, because these reserves reduce the costs of banking (i.e., have a convenience yield). The model delivers local-equilibrium determinacy under a permanent interest-rate peg. Consequently, it does not share the puzzling and paradoxical implications of the basic NK model under a temporary peg (e.g., in the context of a liquidity trap). More specifically, it offers a resolution of the \forward guidance puzzle," a related puzzle about scal multipliers, and the \paradox of exibility," even for an arbitrarily small departure from the basic NK model (i.e., arbitrarily small banking costs and convenience yield of reserves).

This nep-cba issue is ©2018 by Maria Semenova. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.