nep-cba New Economics Papers
on Central Banking
Issue of 2018‒02‒12
eleven papers chosen by
Maria Semenova
Higher School of Economics

  1. Monetary Policy Normalization in the Euro Area By Daniel Privitera; Malte Rieth
  2. Systematic risk, bank moral hazard, and bailouts By Lucchetta, Marcella; Moretto, Michele; Parigi, Bruno M.
  3. Redefining Liquidity for Monetary Policy By Kim, Kyunghun; Lee, Il Houng; Shim, Won
  4. Some Unpleasant Euro Arithmetic By Guillaume Gaulier; Vincent Vicard
  5. Monetary policy spillovers, global commodity prices and cooperation By Andrew Filardo; Jacopo Lombardi; Carlos Montoro
  6. Government financing, inflation, and the financial sector By Bernardino Adao; Andre C. Silva
  7. Capital allocation under Fundamental Review of Trading Book By Luting Li; Hao Xing
  8. Is there a trade-off between free capital mobility, financial stability and fiscal policy flexibility in the EMU? By Canale, Rosaria Rita; de Grauwe, Paul; Foresti, Pasquale; Napolitano, Oreste
  9. Fiscal Shocks and Helicopter Money in Open Economy By Giorgio Di Giorgio; Guido Traficante
  10. Has the Grexit news affected euro area financial markets? By Wildmer, Gregori; Agnese, Sacchi
  11. Monetary policy and speculative stock markets By Boehl, Gregor

  1. By: Daniel Privitera; Malte Rieth
    Abstract: The ECB announced in October 2018 that it would begin to cut back the amount of monthly asset purchases starting January 2018 while extending the duration of the purchases until at least September 2018. At it latest Governor’s Council meeting in January 2019 it decided to remain on this track despite a sharp appreciation of the euro in the meanwhile. These steps were just two on a longer and potentially slippery path back towards standard monetary policy. Market turbulences like the so-called “Taper Tantrum”, which followed the Fed’s 2013 announcement that it was considering to cut back its asset purchasing program, have made central banks wary of the risks of premature or overly explicit announcements of monetary policy normalization. This article provides a short review of quantitative easing (QE) in the euro area since 2015 and of the debate about the right timing for terminating QE.
    Date: 2018
  2. By: Lucchetta, Marcella; Moretto, Michele; Parigi, Bruno M.
    Abstract: We show that the impact of government bailouts (liquidity injections) on a representative bank’s risk taking depends on the level of systematic risk of its loans portfolio. In a model where bank’s output follows a geometric Brownian motion and the government guarantees bank’s liabilities, we show first that more generous bailouts may or may not induce banks to take on more risk depending on the level of systematic risk; if systematic risk is high (low), a more generous bailout decreases (increases) bank’s risk taking. Second, the optimal liquidity policy itself depends on systematic risk. Third, the relationship between bailouts and bank’s risk taking is not monotonic. When systematic risk is low, the optimal liquidity policy is loose and more generous bailouts induce banks to take on more risk. If systematic risk is high and the optimal liquidity policy is tight, less generous bailouts induce banks to take on less risk. However, when high systematic risk makes a very tight liquidity policy optimal, a less generous bailout could increase bank’s risk taking. While in this model there is only one representative bank, in an economy with many banks, a higher level of systematic risk could also be a source of systemic risk if a tighter liquidity policy induces correlated risk taking choices by banks.
    JEL: G00 G20 G21
    Date: 2018–01–23
  3. By: Kim, Kyunghun (Korea Institute for International Economic Policy); Lee, Il Houng (Bank of Korea); Shim, Won (Bank of Korea)
    Abstract: This paper proposes a monetary aggregate “Liquidity” that could serve as a useful indicator for gauging the appropriateness of monetary policy. If liquidity rises above a certain threshold, it is signaling that monetary policy is losing traction due to structural and other impediments even when the inflation gap remains open. This indicator supplements the financial cycle approach but adds value by providing a benchmark that is derived from the national account, and not based on its own trend. Over the last two decades, each time this measure rose above the threshold range, it was followed by a decline in GDP growth. The latter was greater when accompanied by a high physical asset value to GDP, e.g., an elevated property market.
    Keywords: Liquidity; Monetary policy; Inflation targeting; Financial stability
    JEL: E31 E32 E52 G01
    Date: 2018–01–19
  4. By: Guillaume Gaulier; Vincent Vicard
    Abstract: Current estimates of misalignments in real effective exchange rates show that euro area imbalances are still large: Germany exhibits a 20 percentage point undervaluation compared to the rest of the euro area (EA). Within a monetary union, rebalancing requires price adjustments through differentials in inflation rates. The rebalancing process therefore involves a 2 percentage point higher inflation in Germany than in the rest of the EA over a decade, or a 1 pp over two decades. It also requires above 2% inflation in surplus countries to meet the 2% ECB inflation target. At the current pace, rebalancing is a 20 year process and requires sustained very low inflation rates in the rest of the euro area.
    Keywords: Current account imbalances;Euro area;Exchange rates misalignments
    JEL: E31 F32
    Date: 2018–01
  5. By: Andrew Filardo; Jacopo Lombardi; Carlos Montoro
    Abstract: How do monetary policy spillovers complicate the trade-offs faced by central banks face when responding to commodity prices? This question takes on particular relevance when monetary authorities find it difficult to accurately diagnose the drivers of commodity prices. If monetary authorities misdiagnose commodity price swings as being driven primarily by external supply shocks when they are in fact driven by global demand shocks, this conventional wisdom - to look through the first-round effects of commodity price fluctuations - may no longer be sound policy advice. To analyse this question, we use the multi-country DSGE model of Nakov and Pescatori (2010) which breaks the global economy down into commodity-exporting and non-commodity-exporting economies. In an otherwise conventional DSGE setup, commodity prices are modelled as endogenously changing with global supply and demand developments, including global monetary policy conditions. This framework allows us to explore the implications of domestic monetary policy decisions when there is a risk of misdiagnosing the drivers of commodity prices. The main findings are: i) monetary authorities deliver better economic performance when they are able to accurately identify the source of the shocks, ie global supply and demand shocks driving commodity prices; ii) when they find it difficult to identify the supply and demand shocks, monetary authorities can limit the deterioration in economic performance by targeting core inflation; and iii) the conventional wisdom approach of responding to global commodity price swings (as external supply shocks when they are truly global demand shocks) results in an excessive procyclicality of global inflation, output and commodity prices. In light of recent empirical studies documenting a significant role of global demand in driving commodity prices, we conclude that the systematic misdiagnoses inherent in the conventional wisdom applied at the country level have contributed to destabilising procyclicality at the global level. These findings support calls for greater attention to global factors in domestic monetary policymaking and highlight potential gains from greater monetary policy cooperation focused on accurate diagnoses of domestic and global sources of shocks.
    Keywords: commodity prices, monetary policy, spillovers, global economy
    JEL: E52 E61
    Date: 2018–01
  6. By: Bernardino Adao; Andre C. Silva
    Abstract: We calculate the effects of an increase in government spending financed with labor income taxes or inflation. We consider government spending in the form of government consumption or transfers. We use a model in which agents increase the use of financial services to avoid losses from inflation, as empirically the financial sector increases with inflation. The financial sector size is constant in standard cash-in-advance models, which implies optimal positive inflation. We reverse this result when we take into account the increase in the financial sector. In our framework, it is optimal to use taxes to finance the government. This result is robust to alternative specifications and definitions of seigniorage and government spending. JEL codes: E52, E62, E63
    Keywords: fiscal policy, monetary policy, government financing, demand for money, financial sector
    Date: 2018
  7. By: Luting Li; Hao Xing
    Abstract: The Fundamental Review of Trading Book (FRTB) from the Basel Committee overhauls the regulatory framework for minimum capital requirements for market risk. Facing the tightened regulation, banks need to allocate their capital to each of their risk positions to evaluate the capital efficiency of their strategies. This paper proposes two computational efficient allocation methods under the FRTB framework. Simulation analysis shows that both these two methods provide more liquidity horizon weighted, more stable, and less negative allocations than the standard methods under the current regulatory framework.
    Date: 2018–01
  8. By: Canale, Rosaria Rita; de Grauwe, Paul; Foresti, Pasquale; Napolitano, Oreste
    Abstract: The recent dynamics characterizing the Eurozone economy suggest the existence of a new policy trilemma faced by its member countries. According to this policy trilemma, there is a trade-off between free capital mobility, financial stability and fiscal policy flexibility. In this paper, we analyze the foundations of such a trade-off and, based on the data for 11 Eurozone countries, present an empirical investigation on the existence of the trilemma. The results highlight the existence of the trade-off, with some differences between member countries. The existence of this trilemma in the Eurozone provides arguments for implementing centralized financial supervision together with fiscal and monetary reforms that should strengthen the currency union.
    Keywords: EMU; policy trilemma; Eurozone; free capital mobility; fiscal policy; financial stability; financial crisis
    JEL: C21 C23 E61 F41
    Date: 2018–02–01
  9. By: Giorgio Di Giorgio (LUISS Guido Carli and CASMEF); Guido Traficante (European University of Rome and CASMEF)
    Abstract: We study the effects of expansionary fiscal shocks in a two-country DSGE model with perpetual youth. We consider two alternative financing regimes, monetary financing and debt financing, and find that a money-financed fiscal stimulus is more expansionary on output and infl ation. We investigate how the transmission mechanism is related to the open-economy dimension and how structural parameters affect macroeconomic dynamics.
    Keywords: Exchange Rate, Fiscal Shocks, Helicopter Drop.
    JEL: E32 E52 F41 F42
    Date: 2018–01
  10. By: Wildmer, Gregori (European Commission – JRC); Agnese, Sacchi (Sapienza University of Rome)
    Abstract: This paper investigates whether rumours about Greek exit from the euro area have spilled over into other European countries’ sovereign bond yields. Our empirical analysis is based on more than 64,000 daily news items on Grexit between December 2014 and October 2015. We build a Grexit intensity index based on the daily change of Grexit news items to capture policy uncertainty about the euro area break-up. Our results suggest that higher intensity of Grexit news drives up government bond yields in peripheral countries (Italy, Portugal, and Spain, excluding Ireland), but that there are no effects on core countries. The asymmetric reaction to Grexit news seems to support a more general ‘market-based fiscal disciplining’ mechanism at work in monetary unions.
    Keywords: Grexit; financial markets; government bond; news; euro area; GARCH
    JEL: E43 E62 G12 G14
    Date: 2017–12
  11. By: Boehl, Gregor
    Abstract: Financial market interactions can lead to large and persistent booms and recessions. Instability is an inherent threat to economies with speculative financial markets. A central bank's interest rate setting can amplify the expectation feedback in the financial market and this can lead to unstable dynamics and excess volatility. The paper suggests that policy institutions may be well-advised to handle tools like asset price targeting with care since such instruments might add a structural link between asset prices and macroeconomic aggregates. Neither stock prices nor indices are a good indicator to base decisions on.
    Keywords: monetary policy,asset pricing,nonlinearity,heterogeneous expectations,credit constraints
    JEL: E44 E52 C63
    Date: 2017

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