nep-cba New Economics Papers
on Central Banking
Issue of 2018‒09‒17
twenty-two papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. The Risk-Taking Channel of Liquidity Regulations and Monetary Policy By Stephan Imhof; Cyril Monnet; Shengxing Zhang
  2. Monetary Policy News and Systemic Risk at the Zero Lower Bound By Pavel Kapinos
  3. Macroprudential Policy with Leakages By Bengui, Julien; Bianchi, Javier
  4. Uninsured Unemployment Risk and Optimal Monetary Policy By Edouard Challe
  5. A Behavioral Approach to Financial Supervision, Regulation, and Central Banking By Ashraf Khan
  6. The Spread of Deposit Insurance and the Global Rise in Bank Asset Risk since the 1970s By Charles W. Calomiris; Sophia Chen
  7. Lean against the wind or float with the storm? Revisiting the monetary policy asset price nexus by means of a novel statistical identification approach By Herwartz, Helmut; Maxand, Simone; Rohloff, Hannes
  8. 'Credit Risk, Excess Reserves and Monetary Policy: The Deposits Channel' By George Bratsiotis
  9. Virtual currencies and their potential impact on financial markets and monetary policy By Marek Dabrowski; Lukasz Janikowski
  10. Measuring the Effects of US Unconventional Monetary Policy on International Financial Markets By Francisco Ilabaca
  11. Optimal Capital Account Liberalization in China By Liu, Zheng; Spiegel, Mark M.; Zhang, Jingyi
  12. Evaluating the Effects of Forward Guidance and Large-scale Asset Purchases By Xu Zhang
  13. How to intervene in foreign exchange market without buying/selling dollars? By Pal, Sumantra
  14. The Paradox of Global Thrift By Luca Fornaro
  15. Requiem for the Interest-Rate Controls in China By Rongrong Sun
  16. Liability Structure and Risk-Taking: Evidence from the Money Market Fund Industry By Baghai, Ramin P.; Giannetti, Mariassunta; Jager, Ivika
  17. The stochastic lower bound By Masolo, Riccardo; Winant, Pablo
  18. Banks, money and the zero lower bound By Kumhof, Michael; Wang, Xuan
  19. Macroeconomic policy and the price of risk By Rohan Kekre; Moritz Lenel
  20. The Political Economy of Exchange Rate Stability During the Gold Standard. Spain 1874—1914 By MARTÍNEZ-RUIZ, Elena; NOGUES-MARCO, Pilar
  21. Inflation Expectations Anchoring Across Different Types of Agents: the Case of South Africa By Ken Miyajima; James Yetman
  22. Empirical analysis of fiscal dominance and the conduct of monetary policy in Nigeria By Afolabi, Joseph Olarewaju; Atolagbe, Oluwafemi

  1. By: Stephan Imhof; Cyril Monnet; Shengxing Zhang
    Abstract: We develop a theoretical model to study the implications of liquidity regulations and monetary policy on deposit-making and risk-taking. Banks give risky loans by creating deposits that firms use to pay suppliers. Firms and banks can take more or less risk. In equilibrium, higher liquidity requirements always lower risk at the cost of lower investment. Nevertheless, a positive liquidity requirement is always optimal. Monetary conditions affect the optimal size of liquidity requirements, and the optimal size is countercyclical. It is only optimal to impose a 100% liquidity requirement when the nominal interest rate is sufficiently low.
    Date: 2018
  2. By: Pavel Kapinos (FRB Dallas)
    Abstract: This paper employs a recent contribution to the construction of the shadow nominal interest rate during the zero lower bound episode of the Great Recession of 2008-2009 and the Greenbook forecasts to obtain a measure of monetary policy shocks over that time period. It then identifies monetary policy news shocks as a novel measure of the forward-looking conduct of monetary policy in the U.S. Using the data from 1987-2010 and impulse responses from the method of local projections, it shows that contractionary monetary surprise and news shocks tended to reduce systemic risk measures over the full sample. In contrast, expansionary monetary news shocks reduced systemic risk at the zero lower bound, whereas surprises had little effect. These findings suggest that the Federal Reserve's efforts at providing expansionary forward guidance at the zero lower bound were successful in stabilizing measures of systemic risk during the Great Recession.
    Date: 2018
  3. By: Bengui, Julien (University of Montreal); Bianchi, Javier (Federal Reserve Bank of Minneapolis)
    Abstract: The outreach of macroprudential policies is likely limited in practice by imperfect regulation enforcement, whether due to shadow banking, regulatory arbitrage, or other regulation circumvention schemes. We study how such concerns affect the design of optimal regulatory policy in a workhorse model in which pecuniary externalities call for macroprudential taxes on debt, but with the addition of a novel constraint that financial regulators lack the ability to enforce taxes on a subset of agents. While regulated agents reduce risk taking in response to debt taxes, unregulated agents react to the safer environment by taking on more risk. These leakages undermine the effectiveness of macroprudential taxes but do not necessarily call for weaker interventions. A quantitative analysis of the model suggests that aggregate welfare gains and reductions in the severity and frequency of financial crises remain, on average, largely unaffected by even significant leakages.
    Keywords: Macroprudential policy; Regulatory arbitrage; Financial crises; Limited regulation enforcement
    JEL: D62 E32 E44 F32 F41
    Date: 2018–09–11
  4. By: Edouard Challe (CREST & Ecole Polytechnique)
    Abstract: I study optimal monetary policy in a New Keynesian economy wherein house- holds precautionary-save against uninsured, endogenous unemployment risk. In this economy greater unemployment risk raises desired savings, causing aggregate demand to fall and ul- timately feed back to greater unemployment risk. I show this deationary feedback loop to be constrained-ine¢ cient and to call for an accommodative monetary policy response: after a contractionary aggregate shock the policy rate should be kept signi cantly lower and for longer than in the perfect-insurance benchmark. For example, the usual prescription obtained under perfect insurance of a hike in the policy rate in the face of a bad supply (i.e., productivity or cost-push) shock is easily overturned. If implemented, the optimal policy e¤ectively breaks the deflationary feedback loop and takes the dynamics of the imperfect-insurance economy close to that of the perfect-insurance benchmark.
    Date: 2018
  5. By: Ashraf Khan
    Abstract: This paper describes how behavioral elements are relevant to financial supervision, regulation, and central banking. It focuses on (1) behavioral effects of norms (social, legal, and market); (2) behavior of others (internalization, identification, and compliance); and (3) psychological biases. It stresses that financial supervisors, regulators, and central banks have not yet realized the full potential that these behavioral elements hold. To do so, they need to devise a behavioral approach that includes aspects relating to individual and group behavior. The paper provides case examples of experiments with such an approach, including behavioral supervision. Finally, it highlights areas for further research.
    Keywords: Governance;Central banks and their policies;Remuneration;Central banking;behavior, culture, financial supervision, financial regulation, risk management, behavioral economics, Microeconomic Behavior: Underlying Principles, General, Government Policy and Regulation, General, Illegal Behavior and the Enforcement of Law, Marketing and Advertising: Government Policy and Regulation, General, Religion
    Date: 2018–08–02
  6. By: Charles W. Calomiris; Sophia Chen
    Abstract: We construct a new measure of the changing generosity of deposit insurance for many countries, empirically model the international influences on the adoption and generosity of deposit insurance, and show that the expansion of deposit insurance generosity increased asset risk in banking systems. We consider three asset risk measures: higher loans-to-assets, a higher proportion of lending to households, and a higher proportion of mortgage lending. None of the observed increases in these indicators is offset by declines in banking system leverage. We show that increased asset risk explains at least part of the positive association between deposit insurance and the likelihood and severity of systemic banking crises.
    JEL: E32 F55 G01 G18 G21 G28
    Date: 2018–08
  7. By: Herwartz, Helmut; Maxand, Simone; Rohloff, Hannes
    Abstract: This paper revisits the monetary policy asset price nexus employing a novel identification approach for structural VARs in a framework of non-Gaussian independent shocks. This allows us to remain "agnostic" about the contemporaneous relations between the variables. We provide empirical evidence on the U.S. economy for monetary policy shocks and shocks originating from two asset markets: Equity and housing. Our results indicate that contractionary monetary policy shocks have a mildly negative impact on both asset prices. The effect is less pronounced for equity. Moreover, we find considerable differences in the speed of monetary policy transmission among both asset classes.
    JEL: C32 E44 E52
    Date: 2018
  8. By: George Bratsiotis
    Abstract: This paper examines the role of precautionary liquidity (reserves) and the interest on reserves as two potential determinants of the deposits channel that can help explain the role of monetary policy, particularly at the near zero-bound. Through the deposits channel and balance sheet channel either of these determinants can explain a number of effects including, (i) zero-bound optimal policy rates, (ii) a negative deposit rate spread, but also (iii) determinacy at the lower-zero bound. Similarly, through its effect on the deposits channel and balance sheet channel the interest on reserves can act as the main tool of monetary policy, that is shown to provide higher welfare gains in relation to a simple Taylor rule. This result is shown to hold at the zero-bound and it is independent of precautionary liquidity, or the fiscal theory of the price level.
    Date: 2018
  9. By: Marek Dabrowski; Lukasz Janikowski
    Abstract: Virtual currencies are a contemporary form of private money. Thanks to their technological properties, their global transaction networks are relatively safe, transparent, and fast. This gives them good prospects for further development. However, they remain unlikely to challenge the dominant position of sovereign currencies and central banks, especially those in major currency areas. As with other innovations, virtual currencies pose a challenge to financial regulators, in particular because of their anonymity and trans-border character.
    Keywords: virtual currency, private money, sovereign currency, free banking, monetary policy, central bank, financial regulation, financial market, currency substitution
    JEL: E42 E58 F31 G18 G28 N21 N23
    Date: 2018
  10. By: Francisco Ilabaca (University of California, Irvine)
    Abstract: I replicate the analysis of Swanson 2017 to separately identify the effects of U.S. forward guidance and large-scale asset purchases during the US zero lower bound period. I then estimate the effects of these two unconventional monetary policy tools on bond yields, stock indices, and exchange rates for the UK, Canada, Australia, Japan, and Germany. I find that these two factors have substantial effects on international bond yields, but these effects vary across countries and across maturities. I find small effects on exchange rates, and no effect on stock indices. I compute a spillover rate for each factor to facilitate cross country analysis. I extend this analysis to a larger panel of countries, and find similar results. I conclude that there are significant spillover effects on international bond yields from US monetary policy across countries and maturities.
    Date: 2018
  11. By: Liu, Zheng (Federal Reserve Bank of San Francisco); Spiegel, Mark M. (Federal Reserve Bank of San Francisco); Zhang, Jingyi (Shanghai University)
    Abstract: China maintains tight controls over its capital account. Its prevailing regime also features financial repression, under which banks are often required to extend a fraction of funds to state-owned enterprises (SOEs) at below-market interest rates. We incorporate these features into a general equilibrium model. We find that capital account liberalization under financial repression incurs a tradeoff between aggregate productivity and intertemporal allocative efficiency. Along a transition path with a declining SOE share, the second-best policy calls for a rapid removal of financial repression, but gradual liberalization of the capital account.
    JEL: G18 O41
    Date: 2018–08–02
  12. By: Xu Zhang (University of California, San Diego)
    Abstract: This paper evaluates the effects of forward guidance and large-scale asset purchases (LSAP) when the nominal interest rate reaches the zero lower bound. I investigate the effects of the two policies in a dynamic new Keynesian model with financial frictions adapted from Gertler & Karadi (2011, 2013), with changes implemented so that the framework delivers realistic predictions for the effects of each policy on the entire yield curve. I then match the change that the model predicts would arise from a linear combination of the two shocks with the observed change in the yield curve in a high-frequency window around Federal Reserve announcements, allowing me to identify the separate contributions of each shock to the effects of the announcement. My estimates correspond closely to narrative elements of the FOMC announcements. My estimates imply that forward guidance was more important in influencing inflation, while LSAP was more important in influencing output.
    Date: 2018
  13. By: Pal, Sumantra
    Abstract: The Emerging Market Economies are vulnerable to adverse external shocks. Such shocks cause excessive volatility in foreign exchange markets. Faced with high volatility, the central banks in EMEs often end up, in futility, depleting their foreign exchange reserves by selling dollars to restore stability. Few central banks use currency-options based intervention to contain volatility and anchor market expectations. In the Indian context, this paper demonstrates that such options-based intervention policies can be considered to contain excessive volatility and anchoring market expectations. Using the risk-neutral densities extracted from currency options data, it is demonstrated that certain options-trading strategy can be effective in stabilizing markets. Therefore, options-based intervention may be a viable policy alternative, which is more cost-effective than the conventional spot-market intervention.
    Keywords: Fx interventions,risk-neutral density,currency options
    JEL: O24 G13 G17
    Date: 2018
  14. By: Luca Fornaro (CREI and Universitat Pompeu Fabra)
    Abstract: This paper describes a paradox of global thrift. Consider a world in which interest rates are low and monetary policy is frequently constrained by the zero lower bound. Now imagine that governments implement prudential financial and fiscal policies, aiming at increasing national savings in good times to sustain aggregate demand and employment during busts. We show that these policies, while effective from the perspective of individual countries, might backfire if applied on a global scale. The reason is that prudential policies by booming countries generate a rise in the global supply of savings or, equivalently, a fall in global aggregate demand. In turn, weaker global aggregate demand exacerbates the recession in countries currently stuck in a liquidity trap. Therefore, paradoxically, the world might very well experience a fall in employment and output following the implementation of prudential policies.
    Date: 2018
  15. By: Rongrong Sun (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan)
    Abstract: This paper reviews the retail interest-rate-control deregulation in China over the 1993-2015 period and provides a preliminary assessment of the PBC’s replacement monetary framework. I show that the interest-rate controls triggered the development of deposit substitutes that banks used to circumvent the restrictions, which in turn drove deposits out of commercial banks. Concerned by deterioration of bank profits and build-up of financial frangibility, the PBC has been pushing strongly for interest-rate liberalization. I quantify the distortionary effects of these controls: disintermediation, a rising shadow banking system and financial repression. Despite the official lift-off of the controls, the retail interest rates are still subject to the PBC’s window guidance and other pricing mechanism guidance. The interest-rate corridor does not function well in confining money market rates. This suggests that the PBC adopt a target money market rate system.
    Keywords: interest-rate control, deregulation, China, financial repression, interest-rate corridor
    JEL: E52 E58
  16. By: Baghai, Ramin P.; Giannetti, Mariassunta; Jager, Ivika
    Abstract: We exploit a change in regulation of money market funds to investigate how the structure of liabilities impacts financial intermediaries' asset holdings. We show that following a change in regulation, which has made prime money market funds' liabilities less money-like, safer funds exited the industry. The remaining funds have increased the riskiness of their portfolios, possibly in response to an increase in the sensitivity of flows to performance. As a result, issuers with lower risk of default have less access to funding from US money market funds. To the best of our knowledge, our paper provides the first evidence in support of theories highlighting that the characteristics of financial intermediaries' assets and liabilities are jointly determined.
    Keywords: Money-ness; Liquidity; Money market funds; Risk taking; Fund exit; Regulation
    JEL: G1 G28
    Date: 2018–09
  17. By: Masolo, Riccardo (Bank of England); Winant, Pablo (Bank of England)
    Abstract: Since the Great Recession policy rates have been extremely low, but neither absolutely constant, nor exactly set to zero. We thus augment a standard zero lower bound model to study the effects of a stochastic lower bound (SLB) on policy rates. We find that a less predictable SLB helps keep inflation closer to target by lowering expectations of future values of the SLB when interest rate cuts are not an option.
    Keywords: Zero lower bound; DSGE
    JEL: E31 E52
    Date: 2018–08–24
  18. By: Kumhof, Michael (Bank of England); Wang, Xuan (University of Oxford)
    Abstract: We study a New Keynesian model where banks create deposits through loans, subject to increasing marginal cost of lending. Banks do not intermediate commodity deposits between savers and borrowers, instead they offer a payment system that intermediates ledger-entry deposits between different spenders. We discuss three implications. First, non-banks’ aggregate purchasing power consists not only of their income but also of new loans/deposits. Second, near the ZLB policy rate reductions compress spreads, and thereby reduce bank profitability, deposit creation and output. Third, near the ZLB Phillips curves are flatter, because lower factor cost inflation is partly offset by inflationary credit rationing.
    Keywords: Banks; financial intermediation; endogenous money creation; bank loans; bank deposits; money demand; deposits-in-advance; Phillips curve; zero lower bound; monetary policy rules.
    JEL: E41 E44 E51 G21
    Date: 2018–08–24
  19. By: Rohan Kekre (University of Chicago); Moritz Lenel (University of Chicago)
    Abstract: We study the consequences of heterogeneity in risk tolerance in a New Keynesian environment with incomplete markets. When markets are incomplete, the distribution of net worth affects the economy's effective price of risk; when monetary policy is non-neutral, the price of risk affects investment rather than the risk-free rate. Redistribution towards the risk-tolerant or shocks which facilitate greater risk-sharing can reduce the price of risk and raise economic activity. The transmission mechanism of monetary policy operates in part through the endogenous adjustment in the risk premium. Because agents do not internalize the effect of private porfolios on aggregate investment, aggregate demand externalities generate scope for Pareto improvements.
    Date: 2018
    Abstract: This article contributes to the literature on central bank independence and monetary stability during the classical gold standard era. On the eve of the First World War, European periphery had not achieved stable adherence to gold despite the protection of central banks against political pressures to monetize debt. In the 19th century, most issuing institutions were private banks whose main objective was profit maximization. As a result, monetary stability depended on negotiations between monetary and fiscal authorities and not directly on central bank independence as is the case nowadays. Strong governments were needed to impose the objective of monetary stability on central banks in negotiation practices. To test our argument, we have constructed indicators of government strength and central bank independence to measure bargaining power for the case of Spain. Results confirm that a highly independent private central bank avoided the responsibility of defending gold adherence when negotiating with weak government, even in a stable macroeconomic environment. Our research suggests that the success of central bank independence in generating monetary stability during the gold standard period depended on sound political institutions.
    Keywords: gold standard, monetary stability, political economy, central bank independence, institutional design, Spain
    JEL: E02 E42 E58 F33 N13
    Date: 2018–09
  21. By: Ken Miyajima; James Yetman
    Abstract: Inflation forecasts are modelled as monotonically diverging from an estimated long-run anchor point, or “implicit anchor”, towards actual inflation as the forecast horizon shortens. Fitting the model with forecasts by analysts, businesses and trade unions for South Africa, we find that inflation expectations have become increasingly strongly anchored. That is, the degree to which the estimated implicit anchor pins down inflation expectations at longer horizons has generally increased. Estimated inflation anchors of analysts lie within the 3–6 percent inflation target range of the central bank. However, the implicit anchors of businesses and trade unions, who are directly involved in the setting of wages and prices that drive the inflation process, have remained above the top end of the official target range. Possible explanations for these phenomena are discussed.
    Keywords: Inflation expectations;Central banks and their policies;South Africa;Sub-Saharan Africa;decay function, inflation anchoring, inflation targeting
    Date: 2018–08–02
  22. By: Afolabi, Joseph Olarewaju; Atolagbe, Oluwafemi
    Abstract: The study empirically investigates fiscal dominance and the conduct of monetary policy in Nigeria, using quarterly data from 1986Q1 to 2016Q4. It adopts the vector error correction mechanism (VECM) and cointegration technique to analyze the data and make inference. The findings reveal that there is no evidence of fiscal dominance in Nigeria. The empirical results show that budget deficit, domestic debt and money supply have no significant influence on the average price level. However, budget deficit and domestic debt are shown to have significant influence on money supply, but only in the short-run. The policy implication is that the government should enforce fiscal discipline through the appropriate institution and the Central Bank should be given autonomy to perform the primary function of long-term price stability, among other functions.
    Keywords: Fiscal dominance, fiscal policy, monetary policy, VECM, Nigeria.
    JEL: E52 E58 E62 E63
    Date: 2018–09–02

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