nep-cba New Economics Papers
on Central Banking
Issue of 2018‒03‒19
twenty-one papers chosen by
Maria Semenova
Higher School of Economics

  1. Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-off By Giancarlo Corsetti; Luca Dedola; Sylvain Leduc
  2. Financial markets effects of ECB unconventional monetary policy announcements By Guido Bulligan; Davide Delle Monache
  3. Leverage Ratio as a Macroprudential Policy Instrument By Nijolë Valinskytë; Erika Ivanauskaitë; Darius Kulikauskas; Simonas Krëpðta
  4. Monetary policy spillovers in the first age of financial globalisation: a narrative VAR approach 1884–1913 By Green, Georgina
  5. Gilded Bubbles By David Perez-Reyna; Xavier Freixas
  6. Price level targeting with evolving credibility By Honkapohja, Seppo; Kaushik, Mitra
  7. Deflation expectations By Ryan Niladri Banerjee; Aaron Mehrotra
  8. The macroeconomic effects of asset purchases revisited By Hesse, Henning; Hofmann, Boris; Weber, James
  9. Positive and Normative Implications of Liability Dollarization for Sudden Stops Models of Macroprudential Policy By Enrique G. Mendoza; Eugenio I. Rojas
  10. The Optimal Inflation Target and the Natural Rate of Interest By Philippe Andrade; Jordi Galí; Hervé Le Bihan; Julien Matheron
  11. One Money, Many Markets By Giancarlo Corsetti; Joao B. Duarte; Samuel Mann
  12. Estimating the Effective Lower Bound for the Czech National Bank's Policy Rate By Kolcunova, Dominika; Havranek, Tomas
  13. Is Chinese monetary policy forward-looking? By Zhang, Chengsi; Dang, Chao
  14. The negative interest rate policy and the yield curve By Dora Xia; Jing Cynthia Wu
  15. An introduction of a simple monetary policy with savings taxation in the overlapping generations model By Taro Ikeda
  16. Monetary Policy and Models of Currency Demand By Mariam El Hamiani Khatat
  17. Money Aggregates and Determinacy : A Reinterpretation of Monetary Policy During the Great Inflation By Qureshi, Irfan
  18. A comprehensive classification of monetary policy frameworks for advanced and emerging economies By Cobham, David
  19. The side effects of safe asset creation By Acharya, Sushant; Dogra, Keshav
  20. The perils of approximating fixed-horizon inflation forecasts with fixed-event forecasts By James Yetman
  21. Effects of official and unofficial central bank communication on the Brazilian interest rate curve By Azevedo, Luis Fernando Pereira; Pereira, Pedro L. Valls

  1. By: Giancarlo Corsetti (Centre for Economic Policy Research (CEPR); Centre for Macroeconomics (CFM); University of Cambridge); Luca Dedola (Centre for Macroeconomics (CFM); European Central Bank); Sylvain Leduc (Bank of Canada)
    Abstract: What determines the optimal monetary trade-off between internal objectives (inflation and output gap) and external objectives (competitiveness and trade imbalances) when inefficient capital flows cause exchange rate misalignment and distort current account positions? We characterize this trade-off analytically, using the workhorse model of modern monetary theory in open economies under incomplete markets–where inefficient capital flows and exchange rate misalignments can arise independently of nominal distortions. We derive aquadratic approximation of the utility-based global policy loss function under fairly general assumptions on preferences and openness, and solve for the optimal targeting rules under cooperation. We show that, in economies with a low degree of exchange rate pass-through, the optimal response to inefficient capital inflows associated with real appreciation is contractionary, above and beyond the natural rate: the optimal policy curbs excessive demand at the cost of exacerbating currency overvaluation. In contrast, a high degree of pass-through, and/or low trade elasticities, warrants expansionary policies that lean against exchange rate appreciation and competitive losses, at the cost of inefficient inflation.
    Keywords: Currency misalignments, Trade imbalences, Asset markets and risk sharing, Optimal targeting rules, International Policy, Exchange rate pass-through
    JEL: E44 E52 E61 F41 F42
    Date: 2018–03
  2. By: Guido Bulligan (Banca d’Italia); Davide Delle Monache (Banca d’Italia)
    Abstract: This paper provides empirical evidence about the announcement effects of the ECB unconventional monetary policies carried out during the period September 2014 - July 2017. The variables considered are selected looking at the various transmission channels through which unconventional measures operate. We find that monetary policy news had significant effects on the exchange rate and sovereign long term yields, especially in those countries that were most severely hit by the crisis. Unlike previous studies, we look at the impact of announcements over different sub-periods in order to identify time-varying effects possibly due to different market conditions, policy instruments and communication strategies. We find that the strongest effects on the exchange rates and on sovereign bonds occurred in the initial phase of the Asset Purchase Programme; over the more recent period a statistically significant rise of inflation expectations was instead detected.
    Keywords: monetary policy announcements, event study, financial markets, unconventional monetary policy
    JEL: E44 E52 E58 E65 G14
    Date: 2018–02
  3. By: Nijolë Valinskytë (Bank of Lithuania); Erika Ivanauskaitë (Bank of Lithuania); Darius Kulikauskas (Bank of Lithuania); Simonas Krëpðta (Bank of Lithuania)
    Abstract: This paper aims to explain the relationship between risk-based and LR requirements and the motivation for the macroprudential use of LR requirements. The rest of the paper is structured as follows. First, we define the LR and the microprudential requirement that is based on it (Chapter 1) and discuss the merits and drawbacks of risk-weighted and nonrisk-weighted capital requirements, assessing how LR requirements can improve the current capital regulation framework (Chapter 2). Then, we turn to the stylized quantitative relationship between the two kinds of requirements and illustrate the rationale for macroprudential LR add-ons (Chapter 3). Further on, we consider legal issues, with a focus on the EU (Chapter 4) and review the country experience with LR requirements (Chapter 5). Finally, we take a look at the LR situation in the Lithuanian banking sector (Chapter 6) and conclude.
    Date: 2018–03–07
  4. By: Green, Georgina (Bank of England)
    Abstract: This paper investigates whether movements in the Bank of England’s interest rate hindered the development of the United States by transmitting or amplifying crises during the first age of financial globalisation. Evidence that US monetary and financial developments entered into the Bank’s reaction function implies that a Bank Rate series must include some endogenous rate changes. In order to clean Bank Rate of such movements the narrative approach is applied to a previously unexploited source in the Bank’s archives, ‘The Record of Outstanding Events’. The Bank also followed a known rule of adjusting Bank Rate to preserve its reserves to liabilities ratio. Bank Rate is also cleaned of the contemporaneous impact of this ratio in order to control for any reflex policy movements that could have been anticipated. This ensures that only true monetary policy shocks to the United States are identified. Estimates derived from this new measure indicate that although the Bank was able, via abrupt rate rises, to attract gold to the United Kingdom and replenish its reserves ratio, it was not responsible for causing or aggravating US crises. This result runs counter to conventional wisdom in the literature and contradicts the hypothesis that many US financial crises extended directly back to Threadneedle Street.
    Keywords: Bank of England; monetary policy; business cycles; financial crises; international economic history; central banking
    JEL: E52 E58 F44 G01 G20 N10 N12
    Date: 2018–03–09
  5. By: David Perez-Reyna (Universidad de los Andes); Xavier Freixas (Universitat Pompeu Fabra)
    Abstract: Excessive credit growth and high asset prices increase the probability of a crisis. Because these two variables are determined in equilibrium, the analysis of systemic risk and the cost-benefit analysis of macroprudential regulation requires a specific framework consistent with the empirical observation. We argue that an overlapping generation model of rational bubbles can explain some of the main features of banking crises and, therefore, provide a microfounded framework for the rigorous analysis of macroprudential policy. We find that credit financed bubbles may have a role as a buffer in reducing excessive investiment at the firms' level and, thus, increasing efficiency. Still, when banks have a risk of going bankrupt a trade-off appears between financial stability and efficiency. When this is the case, macroprudential policy has a key role in improving efficiency while preserving financial stability.
    Date: 2017
  6. By: Honkapohja, Seppo; Kaushik, Mitra
    Abstract: We examine global dynamics under learning in a nonlinear New Keynesian model when monetary policy uses price-level targeting and compare it to inflation targeting. Domain of attraction of the targeted steady state gives a robustness criterion for policy regimes. Robustness of price-level targeting depends on whether a known target path is incorporated into learning. Credibility is measured by accuracy of this forecasting method relative to simple statistical forecasts. Credibility evolves through reinforcement learning. Initial credibility and initial level of target price are key factors influencing performance. Results match the Swedish experience of price level stabilization in 1920's and 30s.
    JEL: E63 E52 E58
    Date: 2018–02–23
  7. By: Ryan Niladri Banerjee; Aaron Mehrotra
    Abstract: We analyse the behaviour of inflation expectations during periods of deflation, using a large cross-country data set of individual professional forecasters' expectations. We find some evidence that expectations become less well anchored during deflations. Deflations are associated with a downward shift in inflation expectations and a somewhat higher backward-lookingness of those expectations. We also find that deflations are correlated with greater forecast disagreement. Delving deeper into such disagreement, we find that deflations are associated with movements in the lefthand tail of the distribution. Econometric evidence indicates that such shifts may have consequences for real activity.
    Keywords: deflation; inflation expectations; forecast disagreement; monetary policy
    JEL: E31 E58
    Date: 2018–02
  8. By: Hesse, Henning; Hofmann, Boris; Weber, James
    Abstract: This paper revisits the macroeconomic effects of the large-scale asset purchase programmes launched by the Federal Reserve and the Bank of England from 2008. Using a Bayesian VAR, we investigate the macroeconomic impact of shocks to asset purchase announcements and assess changes in their effectiveness based on subsample analysis. The results suggest that the early asset purchase programmes had significant positive macroeconomic effects, while those of the subsequent ones were weaker and in part not significantly different from zero. The reduced effectiveness seems to reflect in part better anticipation of asset purchase programmes over time, since we find significant positive macroeconomic effects when we consider shocks to survey expectations of the Federal Reserve's last asset purchase programme. Finally, in all estimations we find a significant and persistent positive impact of asset purchase shocks on stock prices.
    Keywords: unconventional monetary policy,asset purchases,monetary transmission
    JEL: E50 E51 E52
    Date: 2018
  9. By: Enrique G. Mendoza; Eugenio I. Rojas
    Abstract: "Liability dollarization,'' namely intermediation of capital inflows in units of tradables into domestic loans in units of aggregate consumption, adds three important effects driven by real-exchange-rate fluctuations that alter standard models of Sudden Stops significantly: Changes on the debt repayment burden, on the price of new debt, and on a risk-taking incentive (i.e. a negative premium on domestic debt). Under perfect foresight, the first effect makes Sudden Stops milder and multiple equilibria harder to obtain. The three effects add an ``intermediation externality'' to the macroprudential externality of standard models, which is present even without credit constraints. Optimal policy under commitment can be decentralized equally by taxing domestic credit or capital inflows, and hence capital controls as a separate instrument are not justified. This optimal policy is time-inconsistent and follows a complex, non-linear schedule. Quantitatively, an optimized pair of constant taxes on domestic debt and capital inflows makes crises slightly less likely and yields a small welfare gain, but other pairs reduce welfare sharply. For high effective debt taxes, capital controls and domestic debt taxes are again equivalent, and for low ones welfare is higher with higher taxes on domestic debt than on capital inflows.
    JEL: E44 F34 F41
    Date: 2018–02
  10. 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
    JEL: E31 E51 E58
    Date: 2018–02
  11. By: Giancarlo Corsetti (Centre for Macroeconomics (CFM); University of Cambridge); Joao B. Duarte (University of Cambridge; Nova School of Business and Economics); Samuel Mann (Centre for Macroeconomics (CFM); University of Cambridge)
    Abstract: We reconsider the effects of common monetary policy shocks across countries in the euro area, using a data-rich factor model and identifying shocks with high-frequency surprises around policy announcements. We show that the degree of heterogeneity in the response to shocks, while being low in financial variables and output, is significant in consumption, consumer prices and macro variables related to the labour and housing markets. Mirroring country-specific institutional and market differences, we find that home ownership rates are significantly correlated with the strength of the housing channel in monetary policy transmission. We document a high dispersion in the response to shocks of house prices and rents and show that, similar to responses in the US, these variables tend to move in different directions.
    Keywords: Monetary policy, High-frequency identification, Monetary union, Labour market, Housing market
    JEL: E21 E31 E44 E52 E44
    Date: 2018–02
  12. By: Kolcunova, Dominika; Havranek, Tomas
    Abstract: The paper focuses on the estimation of the effective lower bound for the Czech National Bank's policy rate. The effective lower bound is determined by the value below which holding and using cash would be more convenient than deposits with negative yields. This bound is approximated based on storage, the insurance and transportation costs of cash and the costs associated with the loss of the convenience of cashless payments and complemented with the estimate based on interest charges, which present direct costs to the profitability of the bank. Overall, the estimated value is below -1% and is approximately in the interval -1.6%, -1.1%. In addition, by means of a vector autoregression, we show that the potential of negative rates would not be sufficient to deliver monetary policy easing with effects similar to those of the exchange rate commitment.
    Keywords: effective lower bound; zero lower bound; negative interest rates; costs of holding cash; transmission of monetary policy
    JEL: E43 E44 E52 E58
    Date: 2018–02–20
  13. By: Zhang, Chengsi; Dang, Chao
    Abstract: This paper investigates the empirical validity of the claim that China employed a forward-looking monetary policy rule from 2001 to 2016. Survey expectations are used in conjunction with competing money supply and interest rate rules. The paper contributes to the literature by addressing the problems of serial correlation and structural breaks in the underlying policy reaction function. Un-like earlier studies indicating a strong role for expectations in Chinese monetary policy, we find expectations only began to play a significant role after 2008. This finding is robust for expectations series based on surveys of both households and forecasting experts. We also find that the People’s Bank of China promotes economic growth in procyclical fashion, but applies countercyclical policy in managing inflation.
    JEL: E58 E31
    Date: 2018–02–22
  14. By: Dora Xia; Jing Cynthia Wu
    Abstract: We extract the market's expectations about the ECB's negative interest rate policy from the euro area's yield curve and study its impact on the yield curve. To capture the rich dynamics taking place at the short end of the yield curve, we introduce two policy indicators that summarise the immediate and longer-horizon future monetary policy stances. The ECB has cut interest rates four times under zero. We find that the June 2014 and December 2015 cuts were expected one month ahead but that the September 2014 cut was unanticipated. Most interestingly, the March 2016 cut was expected four months ahead of the actual cut.
    Keywords: negative interest rate policy, effective lower bound, term structure of interest rates, shadow rate term structure model, regime-switching model
    JEL: E43 E52 E58
    Date: 2018–02
  15. By: Taro Ikeda (Graduate School of Economics, Kobe University)
    Abstract: In this paper, we introduce a simple monetary policy with savings taxation into Samuelson’s (1958) overlapping generations model. In our model, we confirm that the real market interest rate increases in response to an increase in the rate of the savings taxation as a policy lending rate.
    Keywords: overlapping generations model; monetary policy; savings taxation
    JEL: E10 E20 E52
    Date: 2018–03
  16. By: Mariam El Hamiani Khatat
    Abstract: Two types of currency in circulation models are identified: (1) a first generation derived from the theory of money demand and (2) a second generation aimed at producing daily forecasts of currency in circulation. In this paper, we transform the currency demand function into a VAR to capture the dynamic link between interest rates and the demand for cash. We also apply ARIMA modeling to forecast the daily currency in circulation for Brazil, Kazakhstan, Morocco, New Zealand, and Sudan. Our empirical work shows that some of the conclusions in the economic literature on the impact of interest rates on the demand for currency do not necessarily hold, and that central banks would benefit from running both generations of currency in circulation models. The fundamental longer-run determinants of the demand for cash are distinct from its short-run determinants.
    Date: 2018–02–16
  17. By: Qureshi, Irfan (Department of Economics,University of Warwick)
    Abstract: Should a policy rule include money? Including money exerts policy inertia and increases inflation aversion. In a New-Keynesian model with trend inflation,these features guarantee price determinacy even when the Taylor principle is not satisfied. Novel Greenbook data confirm money aggregates as U.S.Federal Open Market Committee policy objectives, enabling monetary policy to insulate the U.S.economy from self-fulfilling fluctuations despite positive trend inflation. A high response to inflation and lowtrend inflation guarantees determinacy post-1982. Cross-country applications highlight the superiority of the rule with money. Raising the inflation target from 2 percent to 4 percent violates the Taylor principle ; including money resolves this issue
    Keywords: Determinacy, Great Inflation, Inflation Target, Money Aggregates, Time-Varying Policy
    JEL: E41 E42 E51 E52 E58 E61 E65
    Date: 2018
  18. By: Cobham, David
    Abstract: The paper presents a new classification of monetary policy frameworks which it applies to ‘advanced’ and 'emerging' economies for the period since the end of the Bretton Woods international monetary system. The classification is multi-dimensional, in particular while the main focus is on the monetary authorities' objectives and account is taken of both pre-announced targets and actual performance, it also emphasises the development of the underlying monetary and financial infrastructure which conditions the instruments available to the monetary authorities and therefore the coherence of different policy frameworks. It is based in large part on information obtained from a close reading of the monetary policy elements of IMF Article IV consultations. The two major changes which can be seen in the data are the swing over time in these countries towards a heavier focus on inflation, and the trend towards more systematic and coherent monetary arrangements which are typically associated with lower inflation and better, or at least not lower, economic growth. The classification, which will eventually be extended to cover developing countries as well, should enable researchers in the future to address a number of questions about comparative economic performance in a more nuanced way than has so far been possible.
    Keywords: monetary policy framework, monetary targeting, exchange rate targeting, inflation targeting
    JEL: E42 E52 F33
    Date: 2018–02–20
  19. By: Acharya, Sushant (Federal Reserve Bank of New York); Dogra, Keshav (Federal Reserve Bank of New York)
    Abstract: We present an incomplete markets model to understand the costs and benefits of increasing government debt in a low interest rate environment. Higher risk increases the demand for safe assets, lowering the natural rate of interest below zero, constraining monetary policy at the zero lower bound, and raising unemployment. Higher government debt satiates the demand for safe assets, raising the natural rate and restoring full employment. While this permanently lowers investment, a policymaker committed to low inflation has no alternative. Higher inflation targets, instead, permit both full employment and high investment, but allow for harmful bubbles. Aggressive fiscal policy can prevent bubbles.
    Keywords: safe assets; negative natural rate; crowding out; risk premium; liquidity traps; bubbles
    JEL: E3 E4 E5 G1 H6
    Date: 2018–03–01
  20. By: James Yetman
    Abstract: A common practice in studies using inflation forecasts is to approximate fixed-horizon forecasts with fixed-event ones. Here we show that this may be problematic. In a panel of US inflation forecast data that allows us to compare the two, the approximation results in a mean absolute approximation error of around 0.2-0.3 percentage points (around 10% of the level of inflation), and statistically significant differences in both the variances and persistence of the approximate inflation forecasts relative to the actual forecasts. To reduce these problems, we propose an adjustment to the approximation, consistent with a model where longer-horizon forecasts are more heavily "anchored", while shorter-horizon forecasts more closely reflect current inflation levels.
    Keywords: fixed-event forecasts, fixed-horizon forecasts, inflation expectations
    JEL: C43 E31
    Date: 2018–02
  21. By: Azevedo, Luis Fernando Pereira; Pereira, Pedro L. Valls
    Abstract: In order to provide greater transparency in their opinions and decisions, central banks around the world use both their official channels and the specialized media to communicate with the general public. Using an unique news dataset with intraday frequency, this paper finds evidence that the volatility of the long end of the interest curve in Brazil is higher in days of official publications on the website of the Central Bank of Brazil and that the short end is affected on days on which the president or any director of the institution is quoted in the specialized media. The effects are greater from 2014.
    Date: 2018–03

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