nep-cba New Economics Papers
on Central Banking
Issue of 2018‒01‒29
twenty-one papers chosen by
Maria Semenova
Higher School of Economics

  1. Will macroprudential policy counteract monetary policy’s effects on financial stability? By Itai Agur; Maria Demertzis
  2. 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
  3. Inflation Targeting and Financial Stability: does the quality of institutions matter? By Dimas Mateus Fazio; Thiago Christiano Silva; Benjamin Miranda Tabak; Daniel Oliveira Cajueiro
  4. Moral Hazard Misconceptions: the Case of the Greenspan Put By Gideon Bornstein; Guido Lorenzoni
  5. Banks’ Capital Surplus and the Impact of Additional Capital Requirements By Simona Malovana
  6. Dynamics and Factors of Inflation Convergence in the European Union By Vaclav Broz; Evzen Kocenda
  7. Measuring the systemic importance of banks By Georgios Moratis; Plutarchos Sakellaris
  8. Regulation of Islamic banks: Basel III capital framework and profit-sharing investment accounts By Kévin Spinassou; Leo Indra Wardhana
  9. The Effects of Quantitative Easing: Taking a Cue from Treasury Auctions By Yuriy Gorodnichenko; Walker Ray
  10. Did the bank capital relief induced by the supporting factor enhance SME lending? By Sergio Mayordomo; María Rodríguez-Moreno
  11. The European Deposit Insurance Scheme: Assessing risk absorption via SYMBOL By Lucia, Alessi; Giuseppina, Cannas; Sara, Maccaferri; Marco, Petracco Giudici
  12. Did Central Banks apply the right strategies after the financial crisis? By De Koning, Kees
  13. Monetary Policy Uncertainty and the Response of the Yield Curve to Policy Shocks By Peter Tillmann
  14. How does monetary policy influence bank lending? Evidence from the market for banks' wholesale funding By Max Breitenlechner; Johann Scharler
  15. Money and Monetary Stability in Europe, 1300-1914 By Karaman, Kivanc; Pamuk, Sevket; Yildirim, Secil
  16. Optimal Monetary and Fiscal Policy with Migration in a Currency Union By Pedro, Gomis-Porqueras; Cathy, Zhang
  17. Dynamic Bank Capital Requirements By Tetiana Davydiuk
  18. Should we Get rid of the Natural Rate Hypothesis? By Olivier J. Blanchard
  19. Versatile Forward Guidance: Escaping or Switching? By Gersbach, Hans; Liu, Yulin; Tischhauser, Martin
  20. Quantitative Easing without Rational Expectations By Dmitriy Sergeyev; Luigi Iovino
  21. Misallocation Costs of Digging Deeper into the Central Bank Toolkit By David Zeke; Robert Kurtzman

  1. By: Itai Agur; Maria Demertzis
    Abstract: How does monetary policy impact upon macroprudential regulation? This paper models monetary policy’s transmission to bank risk taking, and its interaction with a regulator’s optimization problem. The regulator uses its macroprudential tool, a leverage ratio, to maintain financial stability, while taking account of the impact on credit provision. A change in the monetary policy rate tilts the regulator’s entire trade-off. The authors show that the regulator allows interest rate changes to partly “pass through” to bank soundness by not neutralizing the risk-taking channel of monetary policy. Thus, monetary policy affects financial stability, even in the presence of macroprudential regulation
    Date: 2018–01
  2. By: Jan Hajek (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic; Czech National Bank, Na Prikope 28, 115 03 Prague 1, Czech Republic); Roman Horvath (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic)
    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: International spillovers, monetary policy, global VAR, shadow rate
    JEL: E52 E58
    Date: 2017–09
  3. By: Dimas Mateus Fazio; Thiago Christiano Silva; Benjamin Miranda Tabak; Daniel Oliveira Cajueiro
    Abstract: Inflation targeting (IT) has recently been seen as one of the main causes of the authorities' unresponsiveness to the build up of financial imbalances during the recent financial crisis. We take data from banks from 66 countries for the period of 1998-2014 and compare how institutional quality as perceived by the national population impacts financial stability in countries that adopted IT with those that did not. We find that, while banks from IT countries with high quality of institutions do not have their stability significantly enhanced by this policy (the ``paradox of credibility''), countries with average levels of quality of institutions seem to benefit from it. In addition, in the estimations, IT and financial stability are negatively associated in countries with low levels of institutional quality, which is consistent with the fact that governments must have at least some trust of their population in order to conduct effective economic policies. This inverted U-shaped relationship between IT and financial stability as function of the institutional quality reflects the two opposing views in the literature regarding this topic
    Date: 2018–01
  4. By: Gideon Bornstein; Guido Lorenzoni
    Abstract: Policy discussions on financial market regulation tend to assume that whenever a corrective policy is used ex post to ameliorate the effects of a crisis, there are negative side effects in terms of moral hazard ex ante. This paper shows that this is not a general theoretical prediction, focusing on the case of monetary policy interventions ex post. In particular, we show that if the central bank does not intervene by monetary easing following a crisis, this creates an aggregate demand externality that makes borrowing ex ante inefficient. If instead the central bank follows the optimal discretionary policy and intervenes to stabilize asset prices and real activity, we show examples in which the aggregate demand externality disappears, reducing the need for ex ante intervention.
    JEL: E52 E61 G38
    Date: 2017–11
  5. By: Simona Malovana (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic; Czech National Bank, Na Prikope 28, 115 03 Prague 1, Czech Republic)
    Abstract: Banks in the Czech Republic maintain their regulatory capital ratios well above the level required by their regulator. This paper discusses the main reasons for this capital surplus and analyses the impact of additional capital requirements stemming from capital buffers and Pillar 2 add-ons on the capital ratios of banks holding such extra capital. The results provide evidence that banks shrink their capital surplus in response to higher capital requirements. A substantial portion of this adjustment seems to be delivered through changes in average risk weights. For this and other reasons, it is desirable to regularly assess whether the evolution and current level of risk weights give rise to any risk of underestimating the necessary level of capital.
    Keywords: Banks, capital requirements, capital surplus, panel data, partial adjustment model
    JEL: G21 G28 G32
    Date: 2017–12
  6. By: Vaclav Broz (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic; Czech National Bank, Na Prikope 28, 115 03 Prague 1, Czech Republic); Evzen Kocenda (Institute of Economic Studies, Faculty of Social Sciences, Charles University in Prague, Smetanovo nabrezi 6, 111 01 Prague 1, Czech Republic; CESifo, Munich; IOS, Regensburg)
    Abstract: We provide comprehensive evidence of the widespread occurrence of inflation convergence between all countries of the European Union from 1999 to 2016. We also show that convergence was more inclusive in the years after the global financial crisis—including the European sovereign debt crisis and the period of zero lower bound—and that price-stabilityoriented monetary strategies might have in fact facilitated this convergence. Our results are robust with respect to the use of three inflation benchmarks (the cross-sectional average, the inflation target of the European Central Bank, and the Maastricht criterion), structural breaks, and a core inflation measure. Our main findings imply that further enlargement of the euro area is feasible from the perspective of the convergence of inflation rates between the countries of the European Union.
    Keywords: inflation convergence, European Union, global financial crisis, zero lower bound, monetary strategy
    JEL: C32 E31 E58 G01 K33
    Date: 2017–11
  7. By: Georgios Moratis (Athens University of Economics and Business); Plutarchos Sakellaris (Athens University of Economics and Business)
    Abstract: We measure the systemic importance of all banks that issue publicly traded CDS contracts among the world’s biggest 150. Systemic importance is captured by the intensity of spillovers of daily CDS movements. Our new empirical tool uses Bayesian VAR to address the dimensionality problem and identifies banks that may trigger instability in the global financial system. For the period January 2008 to June 2017, we find the following: A bank’s systemic importance is not adequately captured by its size. European banks have been the main source of global systemic risk with strong interconnections to US banks. For the global system, we identify periods of increased interconnections among banks, during which systemic and idiosyncratic shocks are propagated more intensely via the network. Using principal components analysis, we identify a single dominant factor associated with fluctuations in CDS spreads. Individual banks’ exposure to this factor is related to their government’s ability to support them and to their retail orientation but not to their size.
    JEL: E30 E50 E58 E60
    Date: 2017–12
  8. By: Kévin Spinassou (LC2S - Laboratoire Caribéen de Sciences Sociales - CNRS - Centre National de la Recherche Scientifique - Université des Antilles (Pôle Martinique) - UA - Université des Antilles); Leo Indra Wardhana (Universitas Gadjah Mada)
    Abstract: This paper theoretically examines the impact of capital requirements on Islamic banks. Given the large use of profit-sharing investment accounts (PSIA) in Islamic banking and the recent implementation of Basel III capital framework, we develop a simple model where banks are able to offer PSIA contracts under a regulation applying risk-weighted capital ratios and leverage ratio restrictions. We find that banks with high or low returns on assets prefer " conventional " banking, while banks with intermediate returns on assets operate as Islamic banks, by selecting PSIA instead of deposits. We further highlight that capital requirements tend to increase this incentive to opt for Islamic banking, especially when Islamic banks benefit from a less competitive environment and from a locally tailored capital regulation.
    Keywords: Basel III,profit- sharing investment accounts,Islamic finance,bank capital regulation,IFSB
    Date: 2018–01–02
  9. By: Yuriy Gorodnichenko; Walker Ray
    Abstract: To understand the effects of large-scale asset purchase programs recently implemented by central banks, we study how markets absorb large demand shocks for risk-free debt. Using high-frequency identification, we exploit the structure of the primary market for U.S. Treasuries to isolate demand shocks. These shocks are sizable, leading to large movements in Treasury yields and impacting corporate borrowing rates. Informed by a calibrated “preferred habitat” model of the term structure, we test for “local” demand effects and find evidence consistent with theoretical predictions. Crucially, this local effect is strongest when the risk-bearing capacity of arbitrageurs is low. Our estimates are consistent with the view that quantitative easing worked mainly via market segmentation, with a potentially limited role for other channels.
    JEL: E43 E44 E52
    Date: 2017–12
  10. By: Sergio Mayordomo (Banco de España); María Rodríguez-Moreno (Banco de España)
    Abstract: The introduction of the SME Supporting Factor (SF) allows banks to reduce capital requirements for credit risk on exposures to SME. This means that banks can free up capital resources that can be redeployed in the form of new loans. Our study documents that the SF alleviates credit rationing for medium-sized firms that are eligible for the application of the SF but not for micro/small firms. These results suggest that European banks were aware of this policy measure and optimized both their regulatory capital and their credit exposures by granting loans to the medium-sized firms, which are safer than micro/small firms.
    Keywords: SME, credit access, supporting factor, bank lending
    JEL: E51 E58 G21
    Date: 2017–12
  11. By: Lucia, Alessi (European Commission – JRC); Giuseppina, Cannas (European Commission - JRC); Sara, Maccaferri (European Commission - JRC); Marco, Petracco Giudici (European Commission - JRC)
    Abstract: In November 2015, the European Commission adopted a legislative proposal to set up a European Deposit Insurance Scheme (EDIS), a single deposit insurance system for all bank deposits in the Banking Union. JRC was requested to quantitatively assess the effectiveness of introducing a single deposit insurance scheme and to compare it with other alternative options for the set-up of such insurance at European level. JRC compared national Deposit Guarantee Schemes and EDIS based on their respective ability to cover insured deposits in the face of a banking crisis. Analyses are based upon the results of the SYMBOL model simulation of banks’ failures.
    Keywords: banking regulation; banking crisis; deposit insurance
    JEL: C15 G01 G21 G28
    Date: 2017–12
  12. By: De Koning, Kees
    Abstract: Nearly ten years have past since the last financial crisis occurred, making it easier to reflect on whether the policies applied by the Federal Reserve, the Bank of England and the ECB had the intended effect on restoring economic and financial stability. While stability has in time been restored, it has not been restored for all. Was it a stability action plan for the banking sector, for the financial markets generally or for the collective of individual households? This question matters as the possible solutions are quite different for each sector of an economy. In a previous paper: “Why it makes economic sense to help the have-nots in times of a financial crisis” the author highlighted three interrelated issues. The first one was timing. In the U.S. a (mortgage) borrowers’ crisis occurred in 2003, when the income and house price gap forced new borrowers to accept an amount of a mortgage loan far exceeding their income earnings growth over the period 1996-2003. The second issue was the macro-economic volume of lending. Between 1996-2007 there was a strong correlation between the volume of mortgage lending and the increases in house prices in the U.S. – not wholly surprising. The third issue was that mortgage lending volumes were not kept in line with average income growth over the period 2000-2007, which had already from 2006, resulted in a rapidly increasing level of foreclosure filings, completed foreclosures and home repossessions. By 2007-2008 the resultant financial crisis had occurred. In 2008, the threat to the banking sector forced central banks to come to their rescue. The solutions chosen: Liquidity supply, Quantitative Easing, lowering of interest rates to historical lows, reform of banking supervision, and legal reform in the case of the U.S. in the shape of the Dodd-Frank Act. The banking sector and the financial sector both benefitted from these measures. The collective of individual households did not. They were under tremendous pressure to pay back the mortgage loans, which the U.S. banking sector had so recklessly granted them. The lowest interest rates on record failed to entice them to borrow more. This paper will look at what went wrong, what rescue measures were adopted and examining the position of the collective households and borrowers and will set out the difference between consumer price inflation and house price inflation. The first affects current incomes, the latter the debt position of households.
    Keywords: financial crisis,bank rescues, U.S. mortgage borrowing levels 1996-2016, median nominal income growth 1996-2016, the house price-income gap, liquidity support scheme for households
    JEL: E32 E44 E58 E6
    Date: 2017–11–15
  13. By: Peter Tillmann (Philipps-University Marburg)
    Abstract: This paper studies the non-linear response of the term structure of interest rates to monetary policy shocks. We show that uncertainty about monetary policy changes the way the term structure responds to monetary policy. A policy tightening leads to a significantly smaller increase in long-term bond yields if policy uncertainty is high at the time of the shock. We also look at the decomposition of bond yields into expectations about policy and the term premium. The weaker response of yields is driven by the fall in term premia, which fall even more if uncertainty about policy is high. These findings are robust to the measurement of monetary policy uncertainty and the definition of the monetary policy shock. We argue that short-term uncertainty about monetary policy tends to make yields of longer maturities relatively more attractive. As a consequence, investors demand lower term premia. This intuition is supported by the fact that long-term monetary policy uncertainty leads to opposite effects with term premia increasing even more after a policy shock.
    Keywords: Monetary policy uncertainty, term structure, term premium, unconventional monetary policy, local projections
    JEL: E43 E58 G12
    Date: 2017
  14. By: Max Breitenlechner; Johann Scharler
    Abstract: We study the transmission of monetary policy shocks to loan volumes using a structural VAR. To disentangle different transmission channels, we use aggregated data from the market for large certificates of deposits and apply a sign restrictions approach. We find that although the standard bank lending channel as well as the recently formulated risk-pricing channel (Disyatat, 2011; Kishan and Opiela, 2012) contribute to the transmission of policy shocks, the effects associated with the risk-pricing channel are quantitatively stronger. Our results also show that policy shocks give rise to non-negligible effects on loan demand.
    Keywords: bank lending channel, risk-pricing channel, external finance premium, structural vector autoregression, sign restrictions
    JEL: C32 E44 E52
    Date: 2018–01
  15. By: Karaman, Kivanc; Pamuk, Sevket; Yildirim, Secil
    Abstract: This paper investigates the determinants of monetary stability in Europe from the late medieval era until World War I. Through this period, the nominal anchor for monetary policy was the silver/gold equivalent of the monetary unit. States, however, frequently abandoned this anchor, some depreciating their monetary units against silver/gold less than 10 times and others more than 10,000 times between 1500 and 1914. To document patterns of monetary stability and put alternative theories of stability to test, we compile a new data set of silver/gold equivalents of monetary units for all major European states. We find strong support for political and fiscal theories arguing that states with weak executive constraints and intermediate levels of fiscal capacity had less stable monetary units. In contrast, the empirical support for monetary theories emphasizing the mechanics of the monetary system is weak. These findings support the primacy of political and fiscal factors over mechanical factors for monetary stability.
    Keywords: depreciation; fiat standard; fiscal capacity; gold standard; money; price stability; silver standard
    JEL: E31 E42 E52 N13 N43 O23 O43
    Date: 2018–01
  16. By: Pedro, Gomis-Porqueras; Cathy, Zhang
    Abstract: We develop an open economy model of a currency union with frictional goods markets and costly migration to study optimal monetary and fiscal policy for the union. Households finance consump- tion with a common currency and can migrate across regions given regional differences in goods market characteristics and microstructure. Equilibrium is generically inefficient due to regional spillovers from migration. While monetary policy alone cannot correct this distortion, fiscal policy can help by taxing or subsidizing at the regional level. When households of only one region can migrate, optimal policy entails a deviation from the Friedman rule and a production subsidy (tax) if there is underinvestment (overinvestment) in migration. Optimal policy when households from both region can migrate is the Friedman rule and zero taxes in both regions.
    Keywords: currency unions, costly migration, search frictions, optimal monetary and fiscal policy
    JEL: D8 E4
    Date: 2018–01–07
  17. By: Tetiana Davydiuk (Wharton School, University of Pennsylvania)
    Abstract: The Basel III Accord requires countercyclical capital buffers to protect the banking system against potential losses associated with excessive credit growth and buildups of systemic risk. In this paper, I provide a rationale for time-varying capital requirements in a dynamic general equilibrium setting. An optimal policy trades off reduced inefficient lending with reduced liquidity provision. Quantitatively, I find that the optimal Ramsey policy requires a capital ratio that mostly varies between 4% and 6% and depends on economic growth, bank supply of credit, and asset prices. Specifically, a one standard deviation increase in the bank credit-to-GDP ratio (GDP) translates into a 0.1% (0.7%) increase in capital requirements, while each standard deviation increase in the liquidity premium leads to a 0.1% decrease. The welfare gain from implementing this dynamic policy is large when compared to the gain from having an optimal fixed capital requirement.
    Date: 2017
  18. By: Olivier J. Blanchard
    Abstract: 50 years ago, Milton Friedman articulated the natural rate hypothesis. It was composed of two sub-hypotheses: First, the natural rate of unemployment is independent of monetary policy. Second, there is no long-run trade-off between the deviation of unemployment from the natural rate and inflation. Both propositions have been challenged. The paper reviews the arguments and the macro and micro evidence against each. It concludes that, in each case, the evidence is suggestive, but not conclusive. Policy makers should keep the natural rate hypothesis as their null hypothesis, but keep an open mind and put some weight on the alternatives.
    JEL: E30 E31 E32 E52
    Date: 2017–11
  19. By: Gersbach, Hans; Liu, Yulin; Tischhauser, Martin
    Abstract: We examine how forward guidance should be designed when an economy faces negative natural real interest-rate shocks and subsequent supply shocks. Besides a standard approach for forward guidance, we introduce two flexible designs: escaping and switching. With escaping forward guidance, the central banker commits to low interest rates in the presence of negative natural real interest-rate shocks, contingent on a self-chosen inflation rate threshold. With switching forward guidance, the central banker can switch from interest-rate forecasts to inflation forecasts any time in order to stabilize supply shocks. We show that for small and large natural real interest-rate shocks, escaping forward guidance is preferable to any of the other approaches, while switching forward guidance is optimal for intermediate natural real interest-rate shocks. Furthermore, with the polynomial chaos expansion method, we show that our findings are globally robust to parameter uncertainty. In addition, using Sobol' Indices, we identify the structural parameters with the greatest effect on the results.
    Keywords: central banks; forward guidance; global robustness; polynomial chaos expansion; Sobol' Indices; transparency; zero lower bound
    JEL: E31 E49 E52 E58
    Date: 2018–01
  20. By: Dmitriy Sergeyev (Bocconi University); Luigi Iovino (Bocconi University)
    Abstract: We study the effects of risky assets purchases financed by issuance of riskless debt by the government (quantitative easing) in a model with nominal frictions but without rational expectations. We use the concept of reflective equilibrium that converges to the rational expectations equilibrium in the limit. This equilibrium notion rationalizes the idea that it is difficult to change expectations about economic outcomes even if it is easy to shift expectations about the policy. Without additional assumptions about non-pecuniary demand for safe assets or segmentation of assets markets, we find that in the reflective equilibrium quantitative easing policy increases the price of risky assets and stimulates output, while it is neutral in the rational expectations equilibrium.
    Date: 2017
  21. By: David Zeke (University of Southern California); Robert Kurtzman (Federal Reserve Board of Governors)
    Abstract: This paper examines the potential misallocation of resources induced by Central Bank large-scale asset purchases, particularly the purchase of corporate bonds of nonfinancial firms, through their heterogeneous effect on firms' cost of capital. First, we analytically demonstrate the mechanism in a static model with heterogeneous agents. We then evaluate the misallocation of resources induced by corporate bond buys and the associated output losses in a calibrated DSGE model of which Gertler Karadi (2013) is a special case.
    Date: 2017

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