nep-cba New Economics Papers
on Central Banking
Issue of 2018‒10‒22
23 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. What inflation measure should a currency union target? By William Barnett; Chan Wang; Xue Wang; Liyuan Wu
  2. Understanding Lowflation By Andolfatto, David; Spewak, Andrew
  3. The Political Economy of Exchange Rate Stability During the Gold Standard. Spain 1874—1914 By MARTÍNEZ-RUIZ, Elena; NOGUES-MARCO, Pilar
  4. Overcoming the Original Sin: gains from local currency external debt By Ricardo Sabbadini
  5. Neo-Fisherianism in a Small Open-Economy New Keynesian Model By Eurilton Araújo
  6. Systemic Banking Crises Revisited By Luc Laeven; Fabian Valencia
  7. A Large Central Bank Balance Sheet? The Role of Interbank Market Frictions By Thaler, Dominik
  8. Whatever it takes. What's the impact of a major nonconventional monetary policy intervention? By Carlo Alcaraz; Stijn Claessens; Gabriel Cuadra; David Marques-Ibanez; Horacio Sapriza
  9. Financial Frictions, the Phillips Curve and Monetary Policy By Lieberknecht, Philipp
  10. Macroprudential Stress Tests and Policies: Searching for Robust and Implementable Frameworks By Ron Anderson; Jon Danielsson; Chikako Baba; Udaibir S Das; Heedon Kang; Miguel A. Segoviano Basurto
  11. Robust Macroprudential Policy Rules under Model Uncertainty By Binder, Michael; Lieberknecht, Philipp; Quintana, Jorge; Wieland, Volker
  12. With a little help from my friends: Survey-based derivation of euro area short rate expectations at the effective lower bound By Schupp, Fabian; Geiger, Felix
  13. All Fluctuations Are Not Created Equal: The Differential Roles of Transitory versus Persistent Changes in Driving Historical Monetary Policy By Ashley, Richard; Tsang, Kwok Ping; Verbrugge, Randal
  14. Assessing the Impact of Central Bank Digital Currency on Private Banks By Andolfatto, David
  15. (Un)conventional policy and the effective lower bound By De Fiore, Fiorella; Tristani, Oreste
  16. Bank Regulation and Monetary Policy Transmission: Evidence from the U.S. States Liberalization By Lakdawala, Aeimit; Minetti, Raoul; Schaffer, Matthew
  17. Understanding Euro Area Inflation Dynamics: Why So Low for So Long? By Yasser Abdih; Li Lin; Anne-Charlotte Paret
  18. Monetary Policy Volatility Shocks in Brazil By Angelo Marsiglia Fasolo
  19. Optimal Renminbi Exchange Rate Policy under Depreciation Anticipation By Mei Li
  20. Forward guidance and heterogeneous beliefs By Philippe Andrade; Gaetano Gaballo; Eric Mengus; Benoit Mojon
  21. Reducing moral hazard at the expense of market discipline: the effectiveness of double liability before and during the Great Depression By Anderson, Haelim; Barth, Daniel; Choi, Dong Beom
  22. Transmission of Monetary Policy and Bank Heterogeneity in Colombia By Carolina Ortega Londoño
  23. Monetary Policy with Negative Interest Rates: Decoupling Cash from Electronic Money By Katrin Assenmacher; Signe Krogstrup

  1. By: William Barnett (Department of Economics, The University of Kansas; Center for Financial Stability, New York City; IC2 Institute, University of Texas at Austin); Chan Wang (School of Finance, Central University of Finance and Economics, Beijing, China); Xue Wang (Department of Finance, Jinan University, Guangzhou, China); Liyuan Wu (Guanghua School of Management, Peking University, Beijing, China)
    Abstract: What is the appropriate inflation target for a currency union, when conducting monetary policy: core inflation or headline inflation? We answer the question in a two-country New Keynesian model with an energy sector. We derive the welfare loss function and find that optimal monetary policy should target output gaps, the terms of trade gap, the Prouder Price Index inflation rates, and the real marginal cost gaps. We use the welfare loss function to evaluate two alternative Taylor-type monetary policy rules. We find that the choice of preferred policy rule depends on the shocks. Specifically, when productivity shocks hit the economy, the policymaker should follow the headline inflation Taylor rule, while the core inflation Taylor rule should be followed when a negative energy endowment shock hits the economy.
    Keywords: Core inflation; Headline inflation; Optimal monetary policy; Currency union; Welfare.
    JEL: E5 F3 F4
    Date: 2018–05
  2. By: Andolfatto, David (Federal Reserve Bank of St. Louis); Spewak, Andrew (Federal Reserve Bank of St. Louis)
    Abstract: Central banks are viewed as having a demonstrated ability to lower long-run inflation. Since the financial crisis, however, the central banks in some jurisdictions seem almost powerless to accomplish the opposite. In this article, we offer an explanation for why this may be the case. Because central banks have limited instruments, long-run inflation is ultimately determined by fiscal policy. Central bank control of long-run inflation therefore ultimately hinges on its ability to gain fiscal compliance with its objectives. This ability is shown to be inherently easier for a central bank determined to lower inflation than for a central bank determined to accomplish the opposite. Among other things, the analysis here suggests that for the central banks of advanced economies, any stated inflation target is more credibly viewed as a ceiling.
    Keywords: Inflation; Inflation targeting; Fiscal policy
    JEL: E31 E52 E58 E62 E63
    Date: 2018–09–01
    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
  4. By: Ricardo Sabbadini
    Abstract: Is it better for emerging countries to issue external debt denominated in local (LC) or foreign currency (FC)? An economy issuing LC debt can avoid an explicit and costly default by inflating away its debt. However, in the hands of a discretionary policymaker, such tool might lead to excessive inflation and negative consequences for welfare. To investigate this question, I develop a quantitative model of sovereign default extended to incorporate real exchange rates and inflation. I find that an economy issuing LC debt defaults less often, sustains slightly lower debt levels, and presents positive average inflation. The net effect is a modest welfare loss when compared to issuing debt in FC. However, if monetary policy is credible, the welfare change is positive, but also of limited size. In this case, the real exchange rate serves as a buffer to accommodate negative output shocks and to prevent defaults
    Date: 2018–09
  5. By: Eurilton Araújo
    Abstract: In this study, the Neo-Fisherian hypothesis denotes the positive short-run co-movement between the nominal interest rate and inflation conditional on a monetary policy shock. To investigate the situations in which this hypothesis may arise in a simple small open-economy New Keynesian model, I extend the analysis of Garín et al. (2018) to the framework in Galí and Monacelli (2005). This paper shows that, under relatively high substitutability between domestic and foreign goods, this hypothesis most likely emerges in economies that are more open. Furthermore, targeting CPI inflation accentuates the forces leading to a Neo-Fisherian behavior
    Date: 2018–08
  6. By: Luc Laeven; Fabian Valencia
    Abstract: This paper updates the database on systemic banking crises presented in Laeven and Valencia (2008, 2013). Drawing on 151 systemic banking crises episodes around the globe during 1970-2017, the database includes information on crisis dates, policy responses to resolve banking crises, and the fiscal and output costs of crises. We provide new evidence that crises in high-income countries tend to last longer and be associated with higher output losses, lower fiscal costs, and more extensive use of bank guarantees and expansionary macro policies than crises in low- and middle-income countries. We complement the banking crises dates with sovereign debt and currency crises dates to find that sovereign debt and currency crises tend to coincide or follow banking crises.
    Date: 2018–09–14
  7. By: Thaler, Dominik
    Abstract: Recent quantitative easing (QE) policies implemented over the course of the Great Recession by the major central banks have had a profound impact on the working of money markets, giving rise to large excess reserves and pushing down key interbank rates against their floor .the interest rate on reserves. With macroeconomic fundamentals improving, central banks now face the dilemma as to whether to maintain this large balance sheet/floor system, or else to reduce balance sheet size towards pre-crisis trends and operate traditional corridor systems. We address this issue using a relatively simple New Keynesian model with two distinct features: heterogeneous banks that trade funds in an interbank market, and matching frictions in the latter market. We show that a large balance sheet allows for ampler .policy widening the average distance between the interest on reserves and its effective lower bound. Nonetheless, a lean-balance-sheet regime that resorts to temporary QE in response to recessions severe enough for the lower bound to bind achieves similar stabilization and welfare outcomes as a large-balance-sheet regime in which interest-rate policy is the primary adjustment margin thanks to the larger policy space. At the same time, the effectiveness of QE through the channel we model is limited. In line with the empirical evidence, the marginal effect vanishes as the balance sheet becomes very big.
    Keywords: central bank balance sheet,interbank market,search and matching frictions,reserves,zero lower bound
    JEL: E20 E30 G10 G20
    Date: 2018
  8. By: Carlo Alcaraz; Stijn Claessens; Gabriel Cuadra; David Marques-Ibanez; Horacio Sapriza
    Abstract: We assess how a major, unconventional central bank intervention, Draghi's "whatever it takes" speech, affected lending conditions. Similar to other large interventions, it responded to adverse financial and macroeconomic developments that also influenced the supply and demand for credit. We avoid such endogeneity concerns by comparing credit granted and its conditions by individual banks to the same borrower in a third country. We show that the intervention reversed prior risk-taking - in volume, price, and risk ratings - by subsidiaries of euro area banks relative to other local and foreign banks. Our results document a new effect of interventions and are robust along many dimensions.
    Keywords: unconventional monetary policy, credit conditions, spillovers
    JEL: E51 F34 G21
    Date: 2018–09
  9. By: Lieberknecht, Philipp
    Abstract: How does the presence of financial frictions alter the Phillips curve and the conduct of optimal monetary policy? I investigate this question in a tractable small-scale New Keynesian DSGE model with a financial accelerator. The accelerator amplifies shocks, decreases the slope of the Phillips curve and renders forward-looking behavior more relevant for current macroeconomic dynamics. I show analytically that these three factors imply an inflationary bias of discretionary monetary policy relative to the standard model and a stabilization bias relative to commitment policy. A conservative central banker who places a larger weight on inflation stabilization than society is able to reduce both biases and closely mimics the optimal policy under commitment. The required degree of inflation conservatism increases in the degree to which financial frictions are present.
    Keywords: Financial frictions, financial accelerator, Phillips curve, missing disinflation, optimal monetary policy, discretion, commitment, inflation conservatism, inflation targeting
    JEL: E4 E42 E44 E5 E52 E58
    Date: 2018–10–09
  10. By: Ron Anderson; Jon Danielsson; Chikako Baba; Udaibir S Das; Heedon Kang; Miguel A. Segoviano Basurto
    Abstract: Macroprudential stress testing (MaPST) is becoming firmly embedded in the post-crisis policy-frameworks of financial-sectors around the world. MaPSTs can offer quantitative, forward-looking assessments of the resilience of financial systems as a whole, to particularly adverse shocks. Therefore, they are well suited to support the surveillance of macrofinancial vulnerabilities and to inform the use of macroprudential policy-instruments. This report summarizes the findings of a joint-research effort by MCM and the Systemic-Risk-Centre, which aimed at (i) presenting state-of-the-art approaches on MaPST, including modeling and implementation-challenges; (ii) providing a roadmap for future-research, and; (iii) discussing the potential uses of MaPST to support policy.
    Keywords: Financial crises;Systemic risk;Macroprudential Policy;Financial stability;Macroprudential Stress testing, Asset Pricing, Financial Markets and the Macroeconomy, Bayesian Analysis, Semiparametric and Nonparametric Methods, Cross-Sectional Models, Model Evaluation and Testing, Financial Econometrics
    Date: 2018–09–11
  11. By: Binder, Michael; Lieberknecht, Philipp; Quintana, Jorge; Wieland, Volker
    Abstract: Against the backdrop of elevated model uncertainty in DSGE models with a detailed modeling of financial intermediaries, we investigate the performance of optimized macroprudential policy rules within and across models. Using three canonical banking DSGE models as a representative sample, we show that model-specific optimized macroprudential policy rules are highly heterogeneous across models and not robust to model uncertainty, implying large losses in other models. This is particularly the case for a perfect-coordination regime between monetary and macroprudential policy. A Stackelberg regime with the central bank as leader operating according to the rule by Orphanides and Wieland (2013) implies smaller potential costs due to model uncertainty. An even more effective approach for policymakers to insure against model uncertainty is to design Bayesian model-averaged optimized macroprudential rules. These prove to be more robust to model uncertainty by performing better across models than model-specific optimized rules, regardless of the regime of interaction between the two authorities.
    Keywords: Macroprudential Policy,Optimized Policy Rules,Model Uncertainty,Bayesian Model-Averaging,Robust Policy Rules
    JEL: E44 E52 E58 E61 G28
    Date: 2018
  12. By: Schupp, Fabian; Geiger, Felix
    Abstract: The estimation of dynamic term structure models (DTSMs) turns out to be challenging in the presence of a small sample. It is exacerbated if the sample is characterized by a prolonged period of low interest rates near a time-varying effective lower bound. These challenges all weigh heavily when estimating a DTSM for the euro area OIS yield curve sample. Against this background, we propose a shadow-rate term structure model (SRTSM) that includes a time-varying effective lower bound accounting for the spread between the policy and short-term OIS rate and it also allows for future changes in the effective lower bound. In addition, it incorporates survey information in order to pin down the level of longer-term rate expectations. The model allows to adequately assess short-term monetary policy rate expectations and it generates far-distant rate expectations that are correlated with an estimated equilibrium nominal short rate derived from a macroeconomic model set-up. Our results also highlight the signaling channel of non-standard monetary policy shocks in the run-up to asset purchases based on high frequency identification approach. Our model outperforms DTSM specifications without above modeling features from a statistical and economic perspective. We confirm our findings employing a Monte Carlo simulation.
    Keywords: Term structure modeling,short rate expectations,lower bound,survey information,yield curve decomposition,monetary policy,euro area
    JEL: E32 E43 E44 E52
    Date: 2018
  13. By: Ashley, Richard (Virginia Tech); Tsang, Kwok Ping (Virginia Tech); Verbrugge, Randal (Federal Reserve Bank of Cleveland)
    Abstract: The historical analysis of FOMC behavior using estimated simple policy rules requires the specification of either an estimated natural rate of unemployment or an output gap. But in the 1970s, neither output gap nor natural rate estimates appear to guide FOMC deliberations. This paper uses the data to identify the particular implicit unemployment rate gap (if any) that is consistent with FOMC behavior. While its ability appears to have improved over time, our results indicate that, both before the Volcker period and through the Bernanke period, the FOMC distinguished persistent movements in the unemployment rate from other movements; implicitly such movements were treated as an intermediate target, one that departs substantially from conventional estimates of the natural rate. We further investigate historical FOMC responses to inflation fluctuations. In this regard, FOMC behavior changed in the Volcker-Greenspan-Bernanke period: its response to the inflation rate became much stronger, and it focused more intensely on very persistent movements in this variable. Our results shed light on the “Great Inflation” experience of the 1970s, and are consistent with the view that political pressures effectively limited the FOMC response to the buildup of inflation. They also suggest new directions for DSGE modeling.
    Keywords: Taylor rule; Great Inflation; intermediate target; natural rate; persistence; dependence;
    JEL: C22 C32 E52
    Date: 2018–10–12
  14. By: Andolfatto, David (Federal Reserve Bank of St. Louis)
    Abstract: In this paper, I investigate the impact of central bank digital currency (CBDC) on banks in a model where the banking sector that is not perfectly competitive. The theoretical framework combines the Diamond (1965) model of government debt with the Klein (1971) and Monti (1972) model of a monopoly bank. There are two main results. First, the introduction of interest-bearing CBDC increases financial inclusion and diminishes the demand for cash. Second, the introduction of interest-bearing CBDC need not disintermediate banks in any way and may, in fact, expand their depositor base if the added competition compels banks to raise their deposit rates.
    Keywords: Digital Currency; Central Banks; Monopoly; Markups
    JEL: E4 E5
    Date: 2018–10–05
  15. By: De Fiore, Fiorella; Tristani, Oreste
    Abstract: We study the optimal combination of conventional (interest rates) and unconventional (credit easing) monetary policy in a model where agency costs generate a spread between deposit and lending rates. We show that unconventional measures can be a powerful substitute for interest rate policy in the face of certain financial shocks. Such measures help shield the real economy from the deterioration in financial conditions and warrant smaller reductions in interest rates. They therefore lower the likelihood of hitting the lower bound constraint. The alternative option to cut interest rates more deeply and avoid deploying unconventional measures is sub-optimal, as it would induce unnecessarily large changes in savers intertemporal consumption patterns. JEL Classification: E44, E52, E61
    Keywords: asymmetric information, optimal monetary policy, unconventional policies, zero-lower bound
    Date: 2018–10
  16. By: Lakdawala, Aeimit (Michigan State University, Department of Economics); Minetti, Raoul (Michigan State University, Department of Economics); Schaffer, Matthew (Department of Economics, University of North Carolina)
    Abstract: This paper studies the impact of geographic banking restrictions on monetary policy transmission. Exploiting the staggered deregulation of U.S. banking from the late 1970s to the early 1990s, we find that interstate deregulation significantly increased the responsiveness of bank lending to monetary shocks. This effect occurred primarily for small and illiquid banks, pointing to a strengthening of the bank lending channel. Changes in bank market structure and loan portfolio composition are unlikely to explain the effect of deregulation. This instead reflects a reduced propensity of small banks affiliated with complex bank holding companies to insulate borrowers from monetary contractions.
    Keywords: Bank regulation; Bank lending channel; Monetary policy
    JEL: E44 E52 G21
    Date: 2018–10–15
  17. By: Yasser Abdih; Li Lin; Anne-Charlotte Paret
    Abstract: Despite closing output gaps and tightening labor markets, inflation has remained low in the euro area. Based on an augmented Phillips Curve framework, we find that this phenomenon—sometimes attributed to low global inflation—has been primarily caused by a remarkable persistence of inflation, keeping it low despite the reduction in slack. This feature is shown to be specific to the euro area (in comparison with the United States). Monetary policy needs to stay accommodative to help guide inflation back to target.
    Keywords: Inflation;Inflation expectations;Inflation persistence;Monetary policy;Econometric models;Euro Area;Phillips curve, inflation persistence and expectations, General, Forecasting and Simulation, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2018–08–22
  18. By: Angelo Marsiglia Fasolo
    Abstract: This paper provides empirical evidence for the impact of changes in volatility of monetary policy in Brazil using a SVAR where the time-varying volatility of shocks directly affects the level of observed variables. Contrary to the literature, an increase in monetary policy volatility results in higher in inflation, combined with reduction in output. The qualitative differences of impulse responses functions, compared to the literature for developed economies, are explained using a calibrated small-scale DSGE model with habit persistence in consumption and stochastic volatility shocks in the Taylor rule. The DSGE model is capable of explaining the increase of inflation in the medium term after a monetary policy volatility shock
    Date: 2018–08
  19. By: Mei Li (Department of Economics and Finance, University of Guelph, Guelph ON Canada)
    Abstract: We establish formal models to study optimal foreign exchange intervention policy for a currency under depreciation pressure when a central bank aims both to discourage speculative capital flows and to reduce exchange rate misalignment. In particular, we study two cases where speculators have complete and incomplete information about the central bank’s long-run equilibrium exchange rate target and arrive at the following results: (1) With complete information, the central bank is better off pre-committing to a specific exchange rate level than deciding it discretionarily. (2) With incomplete information, the central bank cannot credibly reveal its exchange rate target to speculators through “cheap talk”. (3) With incomplete information, any action taken by the central bank will send a signal to speculators about the central bank’s preferences, causing a change in the speculators’ beliefs and subsequently in capital flows.
    Keywords: foreign exchange intervention, depreciation anticipation, renminbi exchange rate
    JEL: F31 F32
    Date: 2018
  20. By: Philippe Andrade; Gaetano Gaballo; Eric Mengus; Benoit Mojon
    Abstract: Central banks' announcements that rates are expected to remain low could signal either a weak macroeconomic outlook, which would slow expenditure, or a more accommodative stance, which may stimulate economic activity. We use the Survey of Professional Forecasters to show that, when the Fed gave guidance between Q3 2011 and Q4 2012, these two interpretations co-existed despite a consensus on low expected rates. We rationalise these facts in a New-Keynesian model where heterogeneous beliefs introduce a trade-off in forward guidance policy: leveraging on the optimism of those who believe in monetary easing comes at the cost of inducing excessive pessimism in non-believers.
    Keywords: signaling channel, disagreement, optimal policy, zero lower bound, survey forecasts
    JEL: E31 E52 E65
    Date: 2018–10
  21. By: Anderson, Haelim (Federal Deposit Insurance Corporation); Barth, Daniel (Office of Financial Research, U.S. Department of Treasury); Choi, Dong Beom (Federal Reserve Bank of New York)
    Abstract: Prior to the Great Depression, regulators imposed double liability on bank shareholders to ensure financial stability and protect depositors. Under double liability, shareholders of failing banks lost their initial investment and had to pay up to the par value of the stock in order to compensate depositors. We examine whether double liability was effective at mitigating bank risks and providing a safety net for depositors before and during the Great Depression. We first develop a model that demonstrates two competing effects of double liability: a direct effect that constrains bank risk taking as a result of increased skin in the game, and an indirect effect that promotes risk taking owing to weaker monitoring by better-protected depositors. We then test the model’s predictions using a novel identification strategy that compares state Federal Reserve member banks and national banks in New York and New Jersey. We find no evidence that double liability reduced bank risk prior to the Great Depression, but do find evidence that deposits in double-liability banks were stickier and less susceptible to runs during the Great Depression. Our findings suggest that the banking system was inherently fragile under double liability because of the conflict between shareholder incentive alignment and depositor market discipline; the depositor protection feature of double liability reduced the threat of funding outflows but may have undermined its effectiveness as a regulatory tool for reducing bank risk.
    Keywords: double liability; moral hazard; market discipline; bank runs; Great Depression
    JEL: G21 G28 N22
    Date: 2018–10–01
  22. By: Carolina Ortega Londoño
    Abstract: This study provides evidence of bank heterogeneity in Colombiafor the period 2002-2014 and analyzes how bank-specific character-istics determine the bank-lending channel for monetary policy. Toanalyze bank heterogeneity, this study estimates technical (cost) effi-ciency using Stochastic Frontier Analysis, which also allows for themeasurement of Returns to Scale and a Lerner Index to proxy mar-ket power in the loans market. This study also provides measuresof capitalization, liquidity, and the commonly used ratios of financialand operational efficiency with bank’s balance-sheet data. Further-more, using a long and unbalanced panel, this study finds evidence ofthe existence of a bank-lending channel and finds that this transmis-sion mechanism is determined by bank-specific characteristics. Theresults suggest higher technical and operational efficiency, capitaliza-tion, liquidity and market power, increase the sensitivity of loans dis-bursements to monetary policy shocks, while higher returns to scalelowers this sensitivity.
    Keywords: monetary policy transmission; bank lending channel; bank heterogeneity; bank efficiency
    JEL: G21 E52 E59
    Date: 2018–06–01
  23. By: Katrin Assenmacher; Signe Krogstrup
    Abstract: Monetary policy space remains constrained by the lower bound in many countries, limiting the policy options available to address future deflationary shocks. The existence of cash prevents central banks from cutting interest rates much below zero. In this paper, we consider the practical feasibility of recent proposals for decoupling cash from electronic money to achieve a negative yield on cash which would remove the lower bound constraint on monetary policy. We discuss how central banks could design and operate such a system, and raise some unanswered questions.
    Keywords: Central banks and their policies;Monetary policy;Negative interest rates;Currencies;Zero lower bound; Monetary policy framework, Dual local currency regime, Legal tender, Zero lower bound, Monetary policy framework, Monetary Policy (Targets, Instruments, and Effects)
    Date: 2018–08–27

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