nep-cba New Economics Papers
on Central Banking
Issue of 2018‒04‒16
twenty-two papers chosen by
Maria Semenova
Higher School of Economics

  1. Exchange rate misalignment, capital flows, and optimal monetary policy trade-offs By Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
  2. Resurrecting the New-Keynesian Model: (Un)conventional Policy and the Taylor Rule By Olaf Posch
  3. Monetary policy with non-homothetic preferences By Cavallari, Lilia
  4. Monetary Policy obeying the Taylor Principle Turns Prices into Strategic Substitutes By Camille Cornand; Frank Heinemann
  5. Disinflation and improved anchoring of long-term inflation expectations - The Icelandic experience By Thórarinn G. Pétursson
  6. Monetary Policy Communication of the Bank of Japan: Computational Text Analysis By Yusuke Oshima; Yoichi Matsubayashi
  7. Monetary Policy Transmission in the Eastern Caribbean Currency Union By Alla Myrvoda; Julien Reynaud
  8. One money, many markets: a factor model approach to monetary policy in the Euro Area with high-frequency identification By Corsetti, Giancarlo; Duarte, Joao B.; Mann, Samuel
  9. Monetary policy and cross-border interbank market fragmentation: lessons from the crisis By Blattner, Tobias Sebastian; Swarbrick, Jonathan M.
  10. The international transmission of monetary policy By Buch, Claudia M.; Bussiere, Matthieu; Goldberg, Linda S.; Hills, Robert
  11. Deflation forces and inequality By Rod Tyers; Yixiao Zhou
  12. A Decade After Lehman: Taking Stock of Quantitative Easing and Regulation By Ramaswamy, R.
  13. A Quantitative Easing Experiment By Adrian Penalver; Nobuyuki Hanaki; Eizo Akiyama; Yukihiko Funaki; Ryuichiro Ishikawa
  14. The Anchoring of Inflation Expectations in Japan: A Learning-Approach Perspective By Yoshihiko Hogen; Ryoichi Okuma
  15. How does monetary policy affect income inequality in Japan? Evidence from grouped data By Feldkircher, Martin; Kakamu, Kazuhiko
  16. A well-timed raise in inflation targets By Javier G. Gómez-Pineda
  17. How safe is a safe asset? By De Grauwe, Paul; Ji, Yuemei
  19. On real interest rates, tariff policy, exchange rates and the ZLB By Sweder van Wijnbergen
  20. On Fairness of Systemic Risk Measures By Francesca Biagini; Jean-Pierre Fouque; Marco Frittelli; Thilo Meyer-Brandis
  21. Historical reasons for the focus on broad monetary aggregates in post-World War II Britain and the ‘Seven Years War’ with the IMF By Goodhart, Charles A. E.; Needham, Duncan J.
  22. Monetary policy coordination leader followership By Raputsoane, Leroi

  1. By: Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
    Abstract: What determines the optimal monetary trade-o§ 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-o§ 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 a quadratic 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 imbalances; asset markets and risk sharing; optimal targeting rules; international policy cooperation; exchange rate pass-through
    JEL: E44 E52 E61 F41 F42
    Date: 2018–03
  2. By: Olaf Posch
    Abstract: This paper explores the ability of the New-Keynesian (NK) model to explain the recent periods of quiet and stable inflation at near-zero nominal interest rates. We show how (conventional and unconventional) monetary policy shocks enlarge the ability to explain the facts, such that the theory supports both a negative and a positive response of inflation. Central to our finding is that monetary policy shocks may have temporary and/or permanent components. We find that the NK model can explain the recent episodes, even if one considers an active role of monetary policy and restrict ourselves to the regions of (local) determinacy. We also show that a new global solution, capturing highly nonlinear dynamics, is necessary to generate a prolonged period of near-zero interest rates as a policy choice.
    Keywords: continuous-time dynamic equilibrium models, Calvo price setting
    JEL: E32 E12 C61
    Date: 2018
  3. By: Cavallari, Lilia
    Abstract: This paper studies the role of non-homothetic preferences for monetary policy from both a positive and a normative perspective. It draws on a dynamic stochastic general equilibrium model characterized by preferences with a variable elasticity of substitution among goods and with price adjustment costs à la Rotemberg. These preferences have remarkable implications for monetary policy. Three main results stand out from a comparison of models with an increasing and a constant elasticity. First, an increasing elasticity induces novel intertemporal substitution effects that amplify the propagation of monetary and technology shocks. Second, it weakens the ability of a simple Taylor rule to attain a given level of macroeconomic stabilization. Third, the smallest welfare losses can be attained by stabilizing both inflation and output, in contrast to the prevailing view - based on models with a constant elasticity - that the best thing the monetary authority can do is to control inflation only.
    Keywords: non-homothetic preferences; monetary policy; output stabilization; inflation stabilization; Taylor rule; new-Keynesian model; time-varying elasticity.
    JEL: E12 E32 E52 E61
    Date: 2018–02
  4. By: Camille Cornand (Univ Lyon, CNRS, GATE L-SE UMR 5824, F-69131 Ecully, France); Frank Heinemann (Technische Universitaet Berlin, Chair of Macroeconomics, H 52 - Strasse des 17. Juni 135 - 10 623 Berlin, Germany)
    Abstract: Monetary policy affects the degree of strategic complementarity in firms’ pricing decisions if it responds to the aggregate price level. In normal times, when monopolistic competitive firms increase their prices, the central bank raises interest rates, which lowers consumption demand and creates an incentive for firms to reduce their prices. Thereby, monetary policy reduces the degree of strategic complementarities among firms’ pricing decisions and even turns prices into strategic substitutes if the effect of interest rates on demand is sufficiently strong. We show that this condition holds when monetary policy follows the Taylor principle. By contrast, in a liquidity trap where monetary policy is restricted by the zero lower bound, pricing decisions are strategic complements. Our main contribution consists in relating the determinacy and stability of equilibria to strategic substitutability in prices. We discuss the consequences for dynamic adjustment processes and some policy implications.
    Keywords: monopolistic competition, monetary policy rule, pricing decisions, strategic complementarity, strategic substitutability
    JEL: E52 C72
    Date: 2018
  5. By: Thórarinn G. Pétursson
    Abstract: After rising sharply following the Global Financial Crisis, inflation in Iceland has been low and stable in recent years despite a strong cyclical recovery. This not only reflects good luck – stemming from low global inflation, declining commodity prices, and a currency appreciation – but also a significant improvement in monetary policy credibility as reflected in a large decline in long-term inflation expectations. To quantify these effects, a forward-looking, open-economy Phillips curve is estimated for the inflation-targeting period since 2001. The empirical results suggest a structural shift in the average relation between inflation and its key drivers occurring around 2012. It is argued that this reflects the convergence of long-term inflation expectations of households and firms towards the downward trending inflation expectations in financial markets. Long-term inflation expectations of households and firms are not observed, but using a Markov switching model and a time-varying parameter model suggests that this unobserved component of long-term inflation expectations has declined from an average of about 2 percentage points in 2003-2011 to zero in late 2016. Together with the large decline in imported inflation, the improved anchoring of long-term inflation expectations goes a long way towards explaining the large disinflation of the last five years and the low recent inflation despite the strong pickup in economic activity. It also seems that an important part of the persistent over-prediction of inflation in Iceland by most forecasters in recent years can be explained by the failure to take the gradual improvement in monetary policy credibility since 2012 into account. Finally, this combination of imported deflation and a firmer anchoring of inflation expectations can explain why the post-2012 disinflation episode did not coincide with any loss of output.
    Date: 2018–03
  6. By: Yusuke Oshima (Graduate School of Economics, Kobe University); Yoichi Matsubayashi (Graduate School of Economics, Kobe University)
    Abstract: In this study, we empirically examine the effects of the Bank of Japan (BOJ)'s communications through its meeting minutes on the financial markets, especially during Mr. Kuroda's administration from April 2013 to September 2017. Using computational linguistic models and the Latent Dirichlet Allocation, we quantify the contents of the BOJ minutes and extract topics form these minutes, including the bank's historical monetary policy and policymakers' views on current economic conditions. The empirical results suggest that a relationship exists between the estimated topics and the market reactions on the days on which the minutes are released. Although the market paid attention to the monetary policy description in the minutes in the early period of the introduction of quantitative and qualitative monetary easing (QQE), the significance of monetary policy information under the October 2014 expansion of the QQE on financial markets faded. In contrast, information on fund-provisioning measures to support Japanese companies' activities, including a negative interest rate policy, induced a decline in the stock market. We found that the market pays attention to meeting members' opinions on current economic conditions.
    Date: 2018–04
  7. By: Alla Myrvoda; Julien Reynaud
    Abstract: This paper empirically investigates international and domestic monetary policy transmission mechanisms in the Eastern Caribbean Currency Union (ECCU). We assess interest rate pass-through of both the U.S. policy rate and the ECCU minimum saving deposit rate (MSR) into domestic interest rates through the interest rate channel. While economic theory suggests that the international pass-through should be high in small open economies with fixed exchange rates and open capital accounts, our findings, based on regression analysis, point to a low long-run pass-through coefficient of the U.S. interest rate. The domestic transmission channel, however, is found to operate through changes in the MSR. The results hold for different interest rates (deposit and lending) and are supported by survey-based findings.
    Date: 2018–03–29
  8. By: Corsetti, Giancarlo; Duarte, Joao B.; Mann, Samuel
    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 E44 E52
    Date: 2018–02
  9. By: Blattner, Tobias Sebastian; Swarbrick, Jonathan M.
    Abstract: We present a two-country model with an enhanced banking sector featuring risky lending and cross-border interbank market frictions. We find that (i) the strength of the financial accelerator, when applied to banks operating under uncertainty in an interbank market, will critically depend on the economic and financial structure of the economy; (ii) adverse shocks to the real economy can be the source of banking crisis, causing an increase in interbank funding costs, aggravating the initial shock; and (iii) central bank asset purchases and long-term refinancing operations can be effective substitutes for, or supplements to, conventional monetary policy. JEL Classification: E44, E52, F32, F36
    Keywords: cross-border capital flows, financial frictions, interbank market, monetary union, unconventional monetary policy
    Date: 2018–04
  10. By: Buch, Claudia M. (Deutsche Bundesbank); Bussiere, Matthieu (Banque de France); Goldberg, Linda S. (Federal Reserve Bank of New York); Hills, Robert (Bank of England)
    Abstract: This paper presents the novel results from an internationally coordinated project by the International Banking Research Network (IBRN) on the cross-border transmission of conventional and unconventional monetary policy through banks. Teams from seventeen countries use confidential micro-banking data for the years 2000 through 2015 to explore the international transmission of monetary policies of the United States, the euro area, Japan, and the United Kingdom. Two other studies use international data with different degrees of granularity. International spillovers into lending to the private sector do occur, especially for U.S. policies, and bank-specific heterogeneity influences the magnitudes of transmission. The effects are supportive of the international bank lending channel and the portfolio channel of monetary policy transmission. They also show that the frictions that banks face matter; in particular, foreign currency funding and hedging considerations can be a key source of heterogeneity. The forms of bank balance sheet heterogeneity that differentiate spillovers across banks are not uniform across countries. International spillovers into lending can be large for some banks, even while the average international spillovers of policies into nonbank lending generally are not large.
    Keywords: monetary policy; international spillovers; cross-border transmission; global bank; global financial cycle
    JEL: E52 F3 F4 G15 G21
    Date: 2018–03–01
  11. By: Rod Tyers; Yixiao Zhou
    Abstract: Proximity to short yield zero lower bounds has challenged the inflation targeting central banks of the advanced regions. Central to this development are three-decade declining trends in long yields and underlying real, equilibrium interest rates that have flattened yield curves, restricting “normalisation” and adding deflationary pressure by boosting demand for portfolio money. Inflationary forces, such as fiscal deficits, industrial protection and resurgent regional growth, have proved comparatively weak. In this paper global modelling is used to show that key deflationary forces in these regions include automation, the race to the bottom in capital taxation and immigration. Each is shown to redistribute income so as to expand the welfare gap between the low-skilled and capital owners by 2.5 to 3.5 per cent per year. The high saving rates of capital owners depress real equilibrium rates and their expanding portfolios demand monetary expansion. These forces ensure that the challenges of macro stabilisation and distributional policy making are both intertwined and urgent.
    Keywords: Inflation, deflation, productivity, automation, income distribution, tax, transfers, general equilibrium analysis
    JEL: D33 E52 J11 O33
    Date: 2018–04
  12. By: Ramaswamy, R.
    Abstract: The Lehman failure precipitated the Great Recession and forced economic policy into unchartered terrain. This paper provides a retrospective on the policy response and links to the underwhelming economic recovery. The exposition is kept non-technical to facilitate wider access. Contrary to perceptions that banks remain vulnerable, this paper argues that regulation strengthened U.S. banks across a variety of dimensions. The deleveraging involved in the transition to stronger banks tightened financial conditions and offset the significant monetary stimulus. The failure to fully capture these offsetting policy forces explains the systematic forecasting errors—both markets and the Fed have consistently overestimated the strength of the economic cycle. Quantitative Easing resulted in a ballooning of excess reserves in the banking system, but payment of interest on excess reserves helped bank recapitalisation. The combination of stronger banks and excess reserves has the potential, unlike in previous cycles, to drive a late cycle surge in growth.
    Keywords: Quantitative Easing, financial regulation, deleveraging
    JEL: E4 E5 G1 G2
    Date: 2018–04–04
  13. By: Adrian Penalver (Banque de France); Nobuyuki Hanaki (Université Côte d'Azur; CNRS, GREDEG; IUF); Eizo Akiyama (University of Tsukuba, Japan); Yukihiko Funaki (Waseda University, Japan); Ryuichiro Ishikawa (University of Tsukuba)
    Abstract: We experimentally investigate the effect of a central bank buying bonds for cash in a quantitative easing (QE) operation. In our experiment, the bonds are perfect substitute for cash, and have a constant fundamental value (FV) which is not affected by QE in the rational expectations equilibrium. We found that QE raised the bond prices beyond those in the benchmark treatment without QE and these differences became larger as subjects gained experience. While subjects in the benchmark treatment learned to trade the bonds at its FV, those in treatments with QE became more convinced that QE boosts bond prices.
    Keywords: Quantitative easing, experimental asset market, expectation dynamics JEL Code: C90, D84
    JEL: C90 D84
    Date: 2018–04
  14. By: Yoshihiko Hogen (Bank of Japan); Ryoichi Okuma (Bank of Japan)
    Abstract: This paper employs a model of learning about long-term inflation to jointly estimate long-term inflation expectations and the degree to which they have been anchored to the 2 percent inflation mark over the last half century in Japan. The estimated model shows that long-term inflation expectations declined to about 2 percent in the late 1980s and remained anchored to the 2 percent mark until the mid-1990s. They fell below 2 percent in the late 1990s, which resulted in a low degree of anchoring until the early 2010s. Following the introduction of the price stability target of 2 percent and the launch of Qualitative and Quantitative Monetary Easing in early 2013, inflation expectations rose until early 2015, but have not yet been anchored to the target. A further VAR analysis demonstrates that markups in domestic goods and services markets are one important reason why expectations have not been anchored at 2 percent since the late 1990s.
    Keywords: Inflation expectations; Anchoring; Learning
    JEL: D83 D84 E31 E58
    Date: 2018–04–06
  15. By: Feldkircher, Martin; Kakamu, Kazuhiko
    Abstract: We examine the effects of monetary policy on income inequality in Japan using a novel econometric approach that jointly estimates the Gini coefficient based on micro-level grouped data of households and the dynamics of macroeconomic quantities. Our results indicate different effects on income inequality for different types of households: A monetary tightening increases inequality when income data is based on households whose head is employed (workers' households), while the effect reverses over the medium term when considering a broader definition of households. Differences in the relative strength of the transmission channels can account for this finding. Finally we demonstrate that the proposed joint estimation strategy leads to more informative inference while results based on the frequently used two-step estimation approach yields inconclusive results.
    Keywords: Income inequality; Monetary policy; Grouped data; Bayesian analysis
    Date: 2018
  16. By: Javier G. Gómez-Pineda (Banco de la República de Colombia)
    Abstract: A raise in inflation targets would be viable if implemented strategically, that is, at the time of a pickup in demand. Policy interest rates would not be constrained by the zero-bound as the result of a balance between two forces: first, policy interest rates must drop under a raise in the inflation target; and second, policy interest rates must rise under a pickup in demand. We use a simple new-Keynesian, semi-structural model to find the natural rate as well as other non observables, including inflation expectations, for a group of advanced economies. We also use the model to explain the role of demand and monetary policy in the evolution of inflation and the output gap. The document shows how a sizable drop in the natural rate pushed policy interest rates against the zero-bound. **** Un aumento en las metas de inflación es viable, si se implementa estratégicamente, es decir, durante un repunte de la demanda. Las tasas de interés no estarían restringidas por el límite cero como resultado de un balance entre dos fuerzas: primero, las tasas de política deben caer bajo un aumento en la meta de inflación; y segundo, deben aumentar ante un aumento en la demanda. Utilizamos un modelo sencillo, neo keynesiano y semi estructural para encontrar la tasa natural así como otros no observables, incluidas las expectativas de inflación, para un grupo de economías avanzadas. También utilizamos el modelo para estudiar el papel de la demanda y la política monetaria en la evolución de la inflación y la brecha del producto. El documento muestra cómo una considerable caída en la tasa natural empujó las tasas de interés de política contra el límite cero. Classification JEL: E58; E37; E43; Q43
    Keywords: Natural rate, Zero-bound, Strategic policy, Monetary policy stance, Taylor rule
    Date: 2018–04
  17. By: De Grauwe, Paul; Ji, Yuemei
    Abstract: This contribution focuses on a recent proposal put forward by the European Systemic Risk Board to create a “safe asset” for the eurozone based on a repackaging of the risks of sovereign bonds, in the hope of stabilising an otherwise unstable system of sovereign bond markets. In the present paper, however, authors Paul De Grauwe and Yuemei Ji argue that a financial system that is fundamentally unstable cannot be stabilised by financial engineering. To this end, they first describe the nature of the instability of the government bond markets in a monetary union and then analyse whether this proposal of creating a safe asset will succeed in stabilising government bond markets in the eurozone.
    Date: 2018–02
    Date: 2018
  19. By: Sweder van Wijnbergen (UvA, CEPR)
    Abstract: What could be the drivers of low real rates? What are the implications of the Zero Lower Bound for economic policy? To discuss these questions we introduce a full general equilibrium model of the world economy with a simple (2 period) intertemporal structure. The model is simple enough to allow for full analytical solution yet sufficiently complex to allow us to address the impact of anticipated future productivity slow down, aging, structural reform and fiscal policy on real interest rates if markets clear and on aggregate economic activity if they do not because of the ZLB. We extend both the equilibrium model and the ZLB variant to a more-goods-per-period set up with complete specialization to address (real) exchange rate policy and the macroeconomic impact of trade tariffs.
    Keywords: equilibrium real interest rates; aging; productivity change; the ZLB; real exchange rates; import tariffs
    JEL: E62 F13 F40 F41 H30
    Date: 2018–03–30
  20. By: Francesca Biagini; Jean-Pierre Fouque; Marco Frittelli; Thilo Meyer-Brandis
    Abstract: In our previous paper \cite{BFFMB}, we have introduced a general class of systemic risk measures that allow random allocations to individual banks before aggregation of their risks. In the present paper, we address the question of fairness of these allocations and we propose a fair allocation of the total risk to individual banks. We show that the dual problem of the minimization problem which identify the systemic risk measure, provides a valuation of the random allocations which is fair both from the point of view of the society/regulator and from the individual financial institutions. The case with exponential utilities which allows for explicit computation is treated in details.
    Date: 2018–03
  21. By: Goodhart, Charles A. E.; Needham, Duncan J.
    Abstract: The British monetary authorities have traditionally focused on broader monetary aggregates than their counterparts elsewhere. The reasons include: the willingness of UK banks to allow customers to make payments by drawing on time deposits, the particularities of the UK approach to managing the national debt and the foreign exchange reserves, and the flow-of-funds system of national accounts developed after World War II. This article outlines these reasons, and explores the implications for the UK's often fractious relationship with the International Monetary Fund during the 1950s and 1960s. It explains why IMF conditionality on loans to the UK focused on broad aggregates.
    JEL: N0
    Date: 2018–01–11
  22. By: Raputsoane, Leroi
    Abstract: This paper analyses the leader followership phenomenon in monetary policy coordination in South Africa, the Advanced, Developed and Emerging counties. The coordination of monetary policy in Advanced counties is examined in individual countries while such coordination in Developed and Emerging countries is examined in groups of countries. These countries comprise South Africa, United States, Euro area, United Kingdom and Japan while the groups of countries comprise the Developed, BRIC, Eastern Europe, East Asia and Latin American countries. The results show that monetary policy coordination is led by the United States and Developed countries, that monetary policy coordination in United Kingdom, Eastern European countries and the Euro area is intermediate while South Africa and Latin America are followers in monetary policy coordination. The results further show that Japan, BRIC and Eastern Europe coordinate monetary policy independent of the rest of the selected countries.
    Keywords: Central bank, Monetary policy, Causal Inference
    JEL: C11 C70 E43 E58
    Date: 2018–04–03

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.