nep-cba New Economics Papers
on Central Banking
Issue of 2018‒04‒30
thirteen papers chosen by
Maria Semenova
Higher School of Economics

  1. The Interplay between Financial Regulations, Resilience, and Growth By Allen, Franklin; Goldstein, Itay; Jagtiani, Julapa
  2. Exchange Rate Misalignment, Capital Flows, and Optimal Monetary Policy Trade-offs By Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
  3. Monetary policy rule under inflation targeting: the case of Mongolia By Taguchi, Hiroyuki
  4. Policy Conflicts and Inflation Targeting: The Role of Credit Markets By Woon Gyu Choi; David Cook
  5. Optimal monetary policy under bounded rationality By Benchimol, Jonathan; Bounader, Lahcen
  6. International monetary policy coordination in a new Keynesian model with NICE features By Jean-Christophe Poutineau; Gauthier Vermandel
  7. Countercyclical capital regulation in a small open economy DSGE model By Lozej, Matija; Onorante, Luca; Rannenberg, Ansgar
  8. (Real-)Time Is Money By Christian Pfister
  9. From the horse’s mouth: surveying responses to stress by banks and insurers By Brinkhoff, Jeroen; Langfield, Sam; Weeken, Olaf
  10. The Impact of the Dodd-Frank Act on Small Business By Michael D. Bordo; John V. Duca
  11. Who benefits from the corporate QE? A regression discontinuity design approach By Abidi, Nordine; Miquel-Flores, Ixart
  12. A new approach for detecting shifts in forecast accuracy By Chiu, Ching-Wai (Jeremy); hayes, simon; kapetanios, george; Theodoridis, Konstantinos
  13. An historical perspective on financial stability and monetary policy regimes: A case for caution in central banks current obsession with financial stability By Michael D. Bordo

  1. By: Allen, Franklin; Goldstein, Itay; Jagtiani, Julapa
    Abstract: Interconnectedness has been an important source of market failures, leading to the recent financial crisis. Large financial institutions tend to have similar exposures and thus exert externalities on each other through various mechanisms. Regulators have responded by putting more regulations in place with many layers of regulatory complexity, leading to ambiguity and market manipulation. Mispricing risk in complex models and arbitrage opportunities through regulatory loopholes have provided incentives for certain activities to become more concentrated in regulated entities and for other activities to move into new areas in the shadow banking system. How can we design an effective regulatory framework that would perfectly rule out bank runs and TBTF (too big to fail) and to do so without introducing incentives for financial firms to take excessive risk? It is important for financial regulations to be coordinated across regulatory entities and jurisdictions and for financial regulations to be forward looking, rather than aiming to address problems of the past.
    Keywords: bank capital regulations; bank liquidity; Basel III; CET1; Dodd–Frank Act; Financial Stability; high-quality liquid assets (HQLAs)
    JEL: G12 G18 G21 G28
    Date: 2018–04
  2. By: Corsetti, Giancarlo; Dedola, Luca; Leduc, Sylvain
    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 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 co- operation. 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: asset markets and risk sharing; Currency misalignments; exchange rate pass-through; international policy cooperation; optimal targeting rules; trade imbalances
    JEL: E44 E52 E61 F41 F42
    Date: 2018–04
  3. By: Taguchi, Hiroyuki
    Abstract: This article aims to review the monetary policy rule under inflation targeting framework focusing on Mongolia. The empirical analysis estimates the policy reaction function to see if the inflation targeting has been linked with a monetary policy rule emphasizing on inflation stabilization since its adoption in 2007. The study contributes to the literature by examining the linkage between Mongolian monetary policy rule and inflation targeting directly and thoroughly for the first time and also by taking into account a recent progress in the inflation targeting framework toward forward-looking mode. The main findings were: the Mongolian current monetary policy rule under inflation targeting is characterized as inflation-responsive rule with forward-looking manner (one quarter ahead); the inflation responsiveness is, however, weak enough to be pro-cyclical to inflation pressure; and the rule is also responsive to exchange rate due to the “fear of floating”, which weakens the policy reaction to inflation and output gap.
    Keywords: Monetary policy rule, Inflation targeting, The Bank of Mongolia, Policy reaction function, and Fear of floating
    JEL: E52 E58 O53
    Date: 2018–04
  4. By: Woon Gyu Choi; David Cook
    Abstract: This paper shows that stabilizing volatility in credit growth often conflicts with price stability: unusual credit expansions often occur when inflation is low relative to goals, and credit slumps often appear when inflation is overshooting. We find that central banks with inflation targeting (IT) are responsive to credit conditions in both advanced economies and emerging-market economies (EMEs). However, EMEs are more sensitive to inflation conditions, responding to credit growth only when consistent with IT. Macroprudential measures are also deployed to address credit growth volatility when orthodox policy moves would be inconsistent with IT, complementing monetary policy.
    Date: 2018–04–06
  5. By: Benchimol, Jonathan; Bounader, Lahcen
    Abstract: Optimal monetary policy under discretion, commitment, and optimal simple rules regimes is analyzed through a behavioral New Keynesian model. Flexible price level targeting dominates under discretion; flexible inflation targeting dominates under commitment; and strict price level targeting dominates when using optimal simple rules. The optimality of a particular regime is found to be independent of bounded rationality and only regime 's stabilizing properties condition its hierarchy. For every targeting regime, the policymaker 's knowledge of agents' myopia is decisive in terms of policy reactions. Welfare evaluation of different targeting regimes reveals that bounded rationality is not necessarily associated with decreased welfare. Several forms of economic inattention can increase welfare.
    JEL: C53 E37 E52 D01 D11
    Date: 2018–04–19
  6. By: Jean-Christophe Poutineau (CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR1 - Université de Rennes 1 - CNRS - Centre National de la Recherche Scientifique); Gauthier Vermandel (LEDa - Laboratoire d'Economie de Dauphine - Université Paris-Dauphine)
    Abstract: This paper provides a static two country new Keynesian model to teach two related questions in international macroeconomics: the international transmission of unilateral monetary policy decisions and the gains coming from the coordination monetary rules. We concentrate on “normal times” and use a thoroughly graphical approach to analyze the questions at hands. In this setting monetary policy is conducted using interest rates rules and economic integration between nations does not necessarily create the case for the coordination of monetary policy. In particular, we show that the conduct of optimal national monetary policies does not make any difference with the coordination of national policies, as this creates a situation where the international monetary system operates “Near an International Cooperative Equilibrium”.
    Keywords: monetary policy,New Keynesian macroeconomics,international macroeconomics,economic policy,optimal interest rate rules,A20,E10,E50,F41
    Date: 2018
  7. By: Lozej, Matija; Onorante, Luca; Rannenberg, Ansgar
    Abstract: We examine, conditional on structural shocks, the macroeconomic performance of different countercyclical capital buffer (CCyB) rules in small open economy estimated medium scale DSGE. We find that rules based on the credit gap create a trade-off between the stabilization of fluctuations originating in the housing market and fluctuations caused by foreign demand shocks. The trade-off disappears if the regulator targets house prices instead. As a result, the optimal simple CCyB rule depends only on the house price but not the credit gap. Moreover, the optimal simple rule leads to significant welfare gains compared to the no CCyB case. JEL Classification: F41, G21, G28, E32, E44
    Keywords: bank capital, boom-and-bust, countercyclical capital regulation, housing bubbles
    Date: 2018–04
  8. By: Christian Pfister
    Abstract: In the age of high-frequency trading in financial markets and faster payment services in account-to-account (A2A) transactions of bank retail customers, it may seem odd that the shortest maturity that is traded in the money market is overnight. This situation reflects policies implemented by central banks, which provide banks with free intraday liquidity. Such policies are difficult to ground in theory and have limitations which central banks could remedy by conducting real-time monetary policies. The article details how, following that decision, central banks could adapt some features of their monetary policy operational frameworks and of their real-time gross settlement systems. In any case, the potential benefits of such a move should be carefully weighed against the costs for the central banks, financial intermediaries and society.
    Keywords: Intraday liquidity, Real-time gross settlement systems, Monetary policy, Financial stability
    JEL: E40 E52 E58 G12 G21
    Date: 2018
  9. By: Brinkhoff, Jeroen; Langfield, Sam; Weeken, Olaf
    Abstract: Existing stress tests do not capture feedback loops between individual institutions and the financial system. To identify feedback loops, the European Systemic Risk Board has developed macroprudential surveys that ask banks and insurers how they would behave in a macroeconomic stress scenario. In a pilot application of these surveys, we find evidence of herding behaviour in the banking sector, notably concerning credit retrenchment. Results show that the consequences can be large, potentially undoing the initial effects of banks’ remedial actions by worsening their solvency position. In contrast, insurers’ responses to the survey provide little evidence of herding in response to macroeconomic stress. These results highlight the usefulness of macroprudential surveys in identifying feedback loops. JEL Classification: E30, E44, G10, G18, G21, G22, G28
    Keywords: financial instability, macroprudential, stress tests, surveys
    Date: 2018–04
  10. By: Michael D. Bordo; John V. Duca
    Abstract: There are concerns that the Dodd-Frank Act (DFA) has impeded small business lending. By increasing the fixed regulatory compliance requirements needed to make business loans and operate a bank, the DFA disproportionately reduced the incentives for all banks to make very modest loans and reduced the viability of small banks, whose small-business share of C&I loans is generally much higher than that of larger banks. Despite an economic recovery, the small loan share of C&I loans at large banks and banks with $300 or more million in assets has fallen by 9 percentage points since the DFA was passed in 2010, with the magnitude of the decline twice as large at small banks. Controlling for cyclical effects and bank size, we find that these declines in the small loan share of C&I loans are almost all statistically attributed to the change in regulatory regime. Examining Federal Reserve survey data, we find evidence that the DFA prompted a relative tightening of bank credit standards on C&I loans to small versus large firms, consistent with the DFA inducing a decline in small business lending through loan supply effects. We also empirically model the pace of business formation, finding that it had downshifted around the time when the DFA and the Sarbanes-Oxley Act were announced. Timing patterns suggest that business formation has more recently ticked higher, coinciding with efforts to provide regulatory relief to smaller banks via modifying rules implementing the DFA. The upturn contrasts with the impact of the Sarbanes-Oxley Act, which appears to persistently restrain business formation.
    JEL: E40 E50 G21
    Date: 2018–04
  11. By: Abidi, Nordine; Miquel-Flores, Ixart
    Abstract: On March 10, 2016, the European Central Bank (ECB) announced the Corporate Sector Purchase Programme (CSPP) – commonly known as corporate quantitative easing (QE) – to improve the financing conditions of the Eurozone’s real economy and strengthen the pass-through of unconventional monetary interventions. Using a regression discontinuity design framework that exploits the rating wedge between the ECB and market participants, we show that: (i) bond yield spreads decline by around 15 basis points at the announcement of the programme, (ii) the impact is mostly noticeable in the sample of CSPP-eligible bonds that are perceived as high yield from the viewpoint of market participants and, (iii) the CSPP seems to have stimulated new issuance of corporate bonds. Overall, our results are consistent with the explanation that highlights the portfolio rebalancing mechanism and the liquidity channel. JEL Classification: E50, E52, G11, G30, G32
    Keywords: bond issuance, corporate quantitative easing (QE), cost of financing, liquidity, regression discontinuity design, unconventional monetary policy
    Date: 2018–04
  12. By: Chiu, Ching-Wai (Jeremy) (Bank of England); hayes, simon (Bank of England); kapetanios, george (Kings College); Theodoridis, Konstantinos (Cardiff University)
    Abstract: Forecasts play a critical role at inflation-targeting central banks, such as the Bank of England. Breaks in the forecast performance of a model can potentially incur important policy costs. Commonly used statistical procedures, however, implicitly put a lot of weight on type I errors (or false positives), which result in a relatively low power of tests to identify forecast breakdowns in small samples. We develop a procedure which aims at capturing the policy cost of missing a break. We use data-based rules to find the test size that optimally trades off the costs associated with false positives with those that can result from a break going undetected for too long. In so doing, we also explicitly study forecast errors as a multivariate system. The covariance between forecast errors for different series, though often overlooked in the forecasting literature, not only enables us to consider testing in a multivariate setting but also increases the test power. As a result, we can tailor the choice of the critical values for each series not only to the in-sample properties of each series but also to how the series for forecast errors covary.
    Keywords: Forecast breaks; statistical decision making; central banking
    JEL: C53 E47 E58
    Date: 2018–04–13
  13. By: Michael D. Bordo (Rutgers University, NBER and Hoover Institution, Stanford University)
    Abstract: This paper surveys the co-evolution of monetary policy and financial stability for a number of countries across four exchange rate regimes from 1880 to the present. Historical evidence is presented on the incidence, costs and determinants of financial crises along with some empirical evidence on the relationship between credit booms, asset price booms and serious financial crises. The results suggests that financial crises have many causes, including credit driven asset price booms, which have become more prevalent in recent decades, but that in general financial crises are very heterogeneous and hard to categorize. Two key historical examples stand out in the record of serious financial crises which were linked to credit driven asset price booms and busts: the 1920s and 30s and the Global Financial Crisis of 2007-2008. The question that arises is whether these two 'perfect storms' should be grounds for permanent changes in the monetary and financial environment.
    Keywords: monetary policy, financial stability, financial crises, credit driven asset price booms
    JEL: E3 E42 G01 N1 N2
    Date: 2017–12–23

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