nep-cba New Economics Papers
on Central Banking
Issue of 2019‒01‒21
nineteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. New VAR evidence on monetary transmission channels: temporary interest rate versus inflation target shocks By Elizaveta Lukmanova; Katrin Rabitsch
  2. Central Bank Policies and Financial Markets: Lessons from the Euro Crisis By Ashoka Mody; Milan Nedeljkovic
  3. Attenuating the forward guidance puzzle: implications for optimal monetary policy By Nakata, Taisuke; Ogaki, Ryota; Schmidt, Sebastian; Yoo, Paul
  4. A large central bank balance sheet? floor vs corridor systems in a new keynesian environment By Óscar Arce; Galo Nuño; Dominik Thaler; Carlos Thomas
  5. The fear of float of the Swiss National Bank By Berthold, Kristin; Stadtmann, Georg
  6. Classifying de facto exchange rate regimes of financially open and closed economies: A statistical approach By Dąbrowski, Marek A.; Papież, Monika; Śmiech, Sławomir
  7. Non-monetary news in central bank communication By Anna Cieslak; Andreas Schrimpf
  8. Exchange Rates and Uncovered Interest Differentials: The Role of Permanent Monetary Shocks By Stephanie Schmitt-Grohé; Martín Uribe
  9. Endogenous forward guidance By Boris Chafwehé; Rigas Oikonomou; Romanos Priftis; Lukas Vogel
  10. Inflation Globally By Jorda, Oscar; Nechio, Fernanda
  11. Forecasting and Trading Monetary Policy Effects on the Riskless Yield Curve with Regime Switching Nelson‐Siegel Models By Massimo Guidolin; Manuela Pedio
  12. Reasons for the declining real interest rates By Demary, Markus; Voigtländer, Michael
  13. The Redistributive Effects of a Money-Financed Fiscal Stimulus By Chiara Punzo; Lorenza Rossi
  14. Money growth and inflation : International historical evidence on high inflation episodes for developed countries By Gallegati, Marco; Giri, Federico; Fratianni, Michele
  15. “Has the ECB’s Monetary Policy Prompted Companies to Invest or Pay Dividends?” By Lior Cohen; Marta Gómez-Puig; Simón Sosvilla-Rivero
  16. Inflation Expectations and Firm Decisions: New Causal Evidence By Coibion, Olivier; Gorodnichenko, Yuriy; Ropele, Tiziano
  17. Interbank Connections, Contagion and Bank Distress in the Great Depression By Calomiris, Charles W.; Jaremski, Matthew; Wheelock, David C.
  18. Tighter Dollar Liquidity Exacerbates Pressure on Risk-parity Thesis By Xing, Victor
  19. Does Monetary Policy in Advanced Economies Have Differentiated Effects on Portfolio Flows to Emerging Economies? By Hernández Vega Marco A.

  1. By: Elizaveta Lukmanova (KU Leuven, Faculty of Economics and Business, Department of Economics); Katrin Rabitsch (Department of Economics, Vienna University of Economics and Business)
    Abstract: We augment a standard monetary VAR on output growth, inflation and the nominal interest rate with the central bank's inflation target, which we estimate from a New Keynesian DSGE model. Inflation target shocks give rise to a simultaneous increase in inflation and the nominal interest rate in the short run, at no output expense, which stands at the center of an active current debate on the Neo-Fisher effect. In addition, accounting for persistent monetary policy changes reflected in inflation target changes improves identification of a standard temporary nominal interest rate shock in that it strongly alleviates the price puzzle.
    Keywords: Monetary policy, Neo-Fisher effect, Time-varying inflation target, DSGE, VAR
    JEL: E12 E31 E52 E58
    Date: 2018–11
  2. By: Ashoka Mody; Milan Nedeljkovic
    Abstract: The European Central Bank (ECB) took many measures to combat the eurozone’s rolling financial crisis. For providing desperately scarce dollars to eurozone banks, the ECB relied on the U.S. Federal Reserve. Using a novel econometric framework, we identify financial markets’ response to the ECB’s liquidity injections and its more pro-active monetary stimulus between October 2009 and September 2012, the most intense phase of the eurozone crisis. Dollar liquidity clearly reduced stress in bond markets and improved economic sentiment, as reflected in higher equity prices. In contrast, passive euro liquidity provision and even active measures (policy rate reductions and bond market interventions) delivered modest results. Although government bond spreads did typically decline, markets remained worried that spreads could rise quickly; moreover, broad economic sentiment remained unchanged. Only the Outright Monetary Transactions (OMT) “bazooka” had a substantial beneficial effect. Overall, the results point to the ECB’s limits in helping improve financial market’s sentiment.
    Keywords: monetary policy, euro crises, uncertainty, conditional quantiles, MCMC, FAVAR
    JEL: E44 E58 C32 C38
    Date: 2018
  3. By: Nakata, Taisuke; Ogaki, Ryota; Schmidt, Sebastian; Yoo, Paul
    Abstract: We examine the implications of less powerful forward guidance for optimal policy using a sticky-price model with an effective lower bound (ELB) on nominal interest rates as well as a discounted Euler equation and Phillips curve. When the private-sector agents discount future economic conditions more in making their decisions today, an announced cut in future interest rates becomes less effective in stimulating current economic activity. While the implication of such discounting for optimal policy depends on its degree, we find that, under a wide range of plausible degrees of discounting, it is optimal for the central bank to compensate for the reduced effect of a future rate cut by keeping the policy rate at the ELB for longer. JEL Classification: E52, E58, E61
    Keywords: discounted euler equation, discounted phillips curve, effective lower bound, forward guidance, optimal policy
    Date: 2019–01
  4. By: Óscar Arce (Banco de España); Galo Nuño (Banco de España); Dominik Thaler (Banco de España); Carlos Thomas (Banco de España)
    Abstract: The quantitative easing (QE) policies implemented in recent years by 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 their balance sheet size towards pre-crisis trends and operate traditional corridor systems. We address this issue using a New Keynesian model featuring heterogeneous banks that trade funds in an interbank market characterized by matching frictions. In this environment, balance sheet expansions push market rates towards their floor by slackening the interbank market. A large balance sheet regime is found to deliver ampler “policy space” by widening the steady-state distance between the interest on reserves and its effective lower bound (ELB). Nonetheless, a lean-balance-sheet regime that resorts to temporary but prompt QE in response to recessions severe enough for the ELB 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.
    Keywords: central bank balance sheet, interbank market, search and matching frictions, reserves, zero lower bound
    JEL: E42 E44 E52 G21
    Date: 2018–12
  5. By: Berthold, Kristin; Stadtmann, Georg
    Abstract: We theoretically examine under which assumptions the impossible trinity holds. We also focus on the most recent Swiss experience and ask, if the SNB gained monetary independence by switching from a fixed to a floating exchange rate system in January 2015. The theoretical examination shows that the impossible trinity holds under the following assumptions: Equality of domestic and foreign real interest rates, the quantity theory of money holds, and that the relative PPP is fulfilled. The empirical analysis reveals that relative PPP does not hold for the Swiss case and it was necessary for the SNB to adopt its monetary policy in accordance with the ECB's expansive monetary policy. The paper shows that for a small open economy, such as Switzerland, it does not play a role for its monetary policy independence whether the central bank implements a fixed or a floating exchange rate system.
    Keywords: foreign exchange market,Swiss crisis,impossible trinity,monetary policy independence
    JEL: E52 E58 E42
    Date: 2018
  6. By: Dąbrowski, Marek A.; Papież, Monika; Śmiech, Sławomir
    Abstract: This paper offers a new de facto exchange rate regime classification that draws on the strengths of three popular classifications. Its two hallmarks are the careful treatment of a nexus between exchange rate regime and financial openness and the use of formal statistical tools (the trimmed k-means and k-nearest neighbour methods). It is demonstrated that our strategy minimises the impact of differences between market-determined and official exchange rates on the ‘fix’ and ‘float’ categories. Moreover, it is more suited to assess empirical relevance of the Mundellian trilemma and ‘irreconcilable duo’ hypotheses. Using comparative analysis we find that the degree of agreement between classifications is moderate: the null of no association is strongly rejected, but its strength ranges from low to moderate. Moreover, it is shown that our classification is the most strongly associated with each of the other classifications and as such can be considered (closest to) a centre of a space of alternative classifications. Finally, we demonstrate that unlike other classifications, ours lends more support to the Mundellian trilemma than to the ‘irreconcilable duo’ hypothesis. Overall, our classification cannot be considered a variant of any other de facto classification. It is a genuinely new classification.
    Keywords: exchange rate regime; financial openness; macroeconomic trilemma; cluster analysis
    JEL: C38 C82 F31 F33
    Date: 2019–01–09
  7. By: Anna Cieslak; Andreas Schrimpf
    Abstract: We quantify the importance of non-monetary news in central bank communication. Using evidence from four major central banks and a comprehensive classification of events, we decompose news conveyed by central banks into news about monetary policy, economic growth, and separately, shocks to risk premia. Our approach exploits high-frequency comovement of stocks and interest rates combined with monotonicity restrictions across the yield curve. We find significant differences in news composition depending on the communication channel used by central banks. Non-monetary news prevails in about 40% of policy decision announcements by the Fed and the ECB, and this fraction is even higher for communications that provide context to policy decisions such as press conferences. We show that non-monetary news accounts for a significant part of financial markets' reaction during the financial crisis and in the early recovery, while monetary shocks gain importance since 2013.
    Keywords: central bank communication, monetary policy shocks, yield curve, stock-bond comovement, central bank information effects, risk premia
    JEL: G12 E43 E52 E58
    Date: 2018–12
  8. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: We estimate an empirical model of exchange rates with transitory and permanent monetary shocks. Using monthly post-Bretton-Woods data from the United States, the United Kingdom, and Japan, we report four main findings: First, there is no exchange rate overshooting in response to either temporary or permanent monetary shocks. Second, a transitory increase in the nominal interest rate causes appreciation, whereas a permanent increase in the interest rate causes short-run depreciation. Third, transitory increases in the interest rate cause short-run deviations from uncovered interest-rate parity in favor of domestic assets, whereas permanent increases cause deviations against domestic assets. Fourth, permanent monetary shocks explain the majority of short-run movements in nominal exchange rates.
    JEL: E4 F3 F40
    Date: 2018–12
  9. By: Boris Chafwehé (Universit´e Catholique de Louvain and FNRS); Rigas Oikonomou (Universit´e Catholique de Louvain); Romanos Priftis (Bank of Canada); Lukas Vogel (Directorate General for Economic and Financial Affairs. European Commission)
    Abstract: We propose a novel framework where forward guidance (FG) is endogenously determined. Our model assumes that a monetary authority solves an optimal policy problem under com- mitment at the zero-lower bound. FG derives from two sources: 1. from commiting to keep interest rates low at the exit of the liquidity trap, to stabilize inflation today. 2. From debt sustainability concerns, when the planner takes into account the consolidated budget constraint in optimization. Our model is tractable and admits an analytical solution for interest rates in which 1 and 2 show up as separate arguments that enter additively to the standard Taylor rule. In the case where optimal policy reflects debt sustainability concerns (satisfies the consoli- dated budget) monetary policy becomes subservient to fiscal policy, giving rise to more volatile inflation, output and interest rates. Liquidity trap (LT) episodes are longer, however, the impact of interest rate policy commitments on inflation and output are moderate. ’Keeping interest rates low’ for a long period, does not result in positive inflation rates during the LT, in contrast our model consistently predicts negative inflation at the onset of a LT episode. In contrast, in the absence of debt concerns, LT episodes are shorter, but the impact of commitments to keep interest rates low at the exit from the LT, on inflation and output is substantial. In this case monetary policy accomplishes to turn inflation positive at the onset of the episode, through promising higher inflation rates in future periods. We embed our theory into a DSGE model and estimate it with US data. Our findings suggest that FG during the Great Recession may have partly reflected debt sustainability concerns, but more likely policy reflected a strong commitment to stabilize inflation and the output gap. Our quantitative findings are thus broadly consistent with the view that the evolution of debt aggregates may have had an impact on monetary policy in the Great Recession, but this impact is likely to be small.
    Keywords: Bayesian estimationDSGE modelfiscal policyforward guidanceinflationLiquidity trapmonetary policy
    JEL: E31 E52 E58 E62 C11
    Date: 2018–10
  10. By: Jorda, Oscar (Federal Reserve Bank of San Francisco); Nechio, Fernanda (Federal Reserve Bank of San Francisco)
    Abstract: The Phillips curve remains central to stabilization policy. Increasing financial linkages, international supply chains, and managed exchange rate policy have given core currencies an outsized influence on the domestic affairs of world economies. We exploit such influence as a source of exogenous variation to examine the effects of the recent financial crisis on the Phillips curve mechanism. Using a difference-in-differences approach, and comparing countries before and after the 2008 financial crisis sorted by whether they endured or escaped the crisis, we are able to assess the evolution of the Phillips curve globally.
    JEL: E01 E30 E32 E44 E47 E51 F33 F42 F44
    Date: 2018–12–07
  11. By: Massimo Guidolin; Manuela Pedio
    Abstract: We use monthly data on the US riskless yield curve for a 1982-2015 sample to show that mixing simple regime switching dynamics with Nelson-Siegel factor forecasts from time series models extended to encompass variables that summarize the state of monetary policy, leads to superior predictive accuracy. Such spread in forecasting power turns out to be statistically significant even controlling for parameter uncertainty and sample variation. Exploiting regimes, we obtain evidence that the increase in predictive accuracy is stronger during the Great Financial Crisis in 2007-2009, when monetary policy underwent a significant, sudden shift. Although more caution applies when transaction costs are accounted for, we also report that the increase in predictive power owed to the combination of regimes and of monetary variables that capture the stance of unconventional monetary policies is tradeable. We devise and test butterfly strategies that trade on the basis of the forecasts from the models and obtain evidence of riskadjusted profits both per se and in comparisons to simpler models. Key words: Term structure of interest rates, Dynamic Nelson-Siegel factors, regime switching, butterfly strategies, unconventional monetary policy.
    Date: 2019
  12. By: Demary, Markus; Voigtländer, Michael
    Abstract: The low nominal interest rate environment is a hotly debated phenomenon among politicians, financial market participants and households. Savers fear the erosion of their retirement savings, while financial supervisors warn of the stability risks caused by declining bank profitability and by the declining profitability of life insurers. Moreover, financial supervisors fear an increase in household debt triggered by a high demand for cheap loans. Most people are interested in whether inflation-adjusted interest rates will rise in the distant future, and, if this is the case, when and by how much they will increase. However, the possibility of increasing real interest rates depends on whether the evolution of real interest rates is due to a rebound of a long cycle or whether it is due to a longer-lasting trend. Whether the evolution of real interest rates is based on a trend or a cycle cannot be judged by data visualisation. Instead, it needs a more rigorous statistical analysis. Therefore, we first identify the drivers of real interest rates and use a panel data regression model to test whether these drivers are predictive of the evolution of real interest rates. We then use forecasts of the drivers of real interest rates, mostly demographic variables, to identify whether there is a future trend or a mean-reverting behaviour in real interest rates. The regression model for the real interest rate can be used to calculate the real interest rate that is determined by economic fundamentals. This model-implied interest rate can then be compared to the data in order to detect misalignments that could be caused by accommodative monetary policies or by risk premia. The detection of misalignments is important for our fore-casting exercise, because the correction of the misalignment back to a possible trend could be confused with an interest rate cycle. The analysis indicates that the current low interest rate levels are not solely caused by the accommodative monetary policies of central banks, but are also the outcome of a longer-term downward trend. Although interest rates are currently lower than indicated by macroeconomic factors and, thus, are likely to increase when central banks start to toughen their monetary policies, in the long-run real interest rates will decline predominantly because of demographic factors. This trend will be persistent, because demographic factors seem to be persistent. For Germany, for example, we find a rebound from currently -0.4 percent to 1.3 percent by 2025 due to the elimination of the misalignment when the ECB starts to normalise its monetary policy. After the normalisation of this interest rate cycle, the negative trend in the real interest rates leads to a decline to a real interest rate of 0.5 percent in 2035 and a real interest rate of 0.0 percent in 2050. The result of persistently low interest rates has important implications for the long-term invest-ment decisions of savers, life insurers and pension funds.
    JEL: E21 E22 E43 E44
    Date: 2018
  13. By: Chiara Punzo (Department of Economics and Finance, Università Cattolica del Sacro Cuore); Lorenza Rossi (Department of Economics and Management, University of Pavia)
    Abstract: This paper analyzes the redistributive channel of a money fi?nanced fiscal stimulus (MFFS). It shows that the way in which this regime is implemented is crucial to determine its redistributive effects and consequently its effectiveness. In normal times, the most effective regime is a MFFS with no additional intervention by the Central Bank to stabilize the real public debt using in?fation, whereas a MFFS accompanied by real debt stabilization - through the adjustment of seigniorage - is the most effective one in a ZLB scenario. In a TANK model this regime is so effective to avoid the recessionary effects implied by the ZLB. This result does not hold in a RANK model, where the redistributive channel is absent. Remarkably, contrary to the common wisdom a MFFS is followed by a moderate increase of infl?ation, which is only temporarily higher than the target.
    Date: 2019–01
  14. By: Gallegati, Marco; Giri, Federico; Fratianni, Michele
    Abstract: How long is the long run in the relationship between money growth and inflation? How important are high inflation episodes for the unit slope finding in the quantity theory of money? To answer these questions we study the relationship between excess money growth and inflation over time and across frequencies using annual data from 1871 to 2013 for several developed countries. Wavelet-based exploratory analysis shows the existence of a close stable relationship between excess money growth and inflation only over longer time horizons, i.e. periods greater than 16 and 24 years, with money growth mostly leading. When we investigate the sensitivity of the unit slope finding to inflation episodes using a scale-based panel data approach we find that low-frequency regression coefficients estimated over variable-length subsamples before and after WWII are largely affected by high inflation episodes. Taken together the results that inflationary upsurges affect regression coefficients but not the closeness of the long-run relationship call for a qualification of the Quantity Theory of Money and suggests that policymakers should not lose interest on monetary developments.
    JEL: C22 E40 E50 N10
    Date: 2019–01–09
  15. By: Lior Cohen (Department of Economics. Universidad de Barcelona.); Marta Gómez-Puig (Department of Economics and Riskcenter, Universidad de Barcelona.); Simón Sosvilla-Rivero (Complutense Institute for Economic Analysis, Universidad Complutense de Madrid.)
    Abstract: This paper focuses on how the European Central Bank’s (ECB) monetary policies influenced non-financial firms. The paper’s two main contributions are, first, to shed light on non-financial firms’ decisions on leverage, and how the ECB’s conventional and unconventional policies may have affected them. Second, the paper also examines how these policies influenced non-financial firms’ decisions on capital allocation – primarily capital spending and shareholder distribution (for example, dividends and shares repurchases). Towards this end, we use an exhaustive and unique dataset comprised of income statements and balance sheets of leading non-financial firms that operate in the European Economic and Monetary Union (EMU). The main results suggest that ECB’s monetary policies have encouraged firms to raise their debt burden especially after the global recession of 2008. Finally, the ECB’s policies, mainly after 2011, seem to have also stimulated non-financial firms to allocate more resources towards not only capital spending but also shareholder distribution
    Keywords: ECB’s monetary policy, capital structure, leverage, quantitative easing, capital expenditure, dividend’s policy, shareholder yield. JEL classification:E52, E58, G31, G32.
    Date: 2019–01
  16. By: Coibion, Olivier (University of Texas at Austin); Gorodnichenko, Yuriy (University of California, Berkeley); Ropele, Tiziano (Bank of Italy)
    Abstract: We use a unique design feature of a survey of Italian firms to study the causal effect of inflation expectations on firms' economic decisions. In the survey, a randomly chosen subset of firms is repeatedly treated with information about recent inflation (or the European Central Bank's inflation target) whereas other firms are not. This information treatment generates exogenous variation in inflation expectations. We find that higher inflation expectations on the part of firms leads them to raise their prices, increase their utilization of credit, and reduce their employment. However, when policy rates are constrained by the effective lower bound, demand effects are stronger, leading firms to raise their prices more and no longer reduce their employment.
    Keywords: inflation expectations, surveys, inattention
    JEL: E2 E3
    Date: 2018–12
  17. By: Calomiris, Charles W. (Columbia University); Jaremski, Matthew (Utah State University); Wheelock, David C. (Federal Reserve Bank of St. Louis)
    Abstract: Liquidity shocks transmitted through interbank connections contributed to bank distress during the Great Depression. New data on interbank connections reveal that banks were much more likely to close when their correspondents closed. Further, after the Federal Reserve was established, banks’ management of cash and capital buffers was less responsive to network risk, suggesting that banks expected the Fed to reduce network risk. Because the Fed’s presence removed the incentives for the most systemically important banks to maintain capital and cash buffers that had protected against liquidity risk, it likely contributed to the banking system’s vulnerability to contagion during the Depression.
    Keywords: Bank Contagion; Great Depression; Interbank Networks; Liquidity Risk; Federal Reserve System
    JEL: G21 L14 N22
    Date: 2019–01–01
  18. By: Xing, Victor
    Abstract: Global monetary authorities remained steadfast in policy normalization to pare unconventional easing programs, as Federal Reserve’s balance sheet run-off and China’s BRI loans created a perfect storm in dollar liquidity tightening. There are signs that risk-parity funds are in the grip of a pincer movement, with rising reflationary pressure from globalization’s retreat and tighter dollar liquidity spur deleveraging flows and deny investors safe harbors from cross asset risk shedding; this can be seen in short-covering and flight-to-quality flows to long-maturity Treasuries, which increased bond funds' vulnerabilities to higher interest rates. Some investors view tighter financial conditions as signs of “policy error” after past decade’s policy easing, but BIS cautioned that FCIs’ sensitivity to equities may induce policymakers to place excess weight on stock valuations, overstate easy financial conditions’ benefits, and overlook the distributional effects of monetary accommodation.
    Keywords: Risk-parity investments, quantitative tightening, dollar liquidity shortage, Belt and Road Initiative, financial conditions, distributional effects
    JEL: E0 E3 E4 E5 G1 G2
    Date: 2018–12–23
  19. By: Hernández Vega Marco A.
    Abstract: This work analyzes whether monetary policy in advanced economies has differentiated effects on portfolio flows towards emerging economies coming from the US, the Euro Area and the UK. The results show the following: First, portfolio flows' response to US monetary policy events is vastly homogeneous across regions, whilst the reaction to Euro Area or UK polices are more diverse. Second, US policies have a bigger effect on portfolio flows from each of the selected advanced economies. Third, the magnitude of investors' responses is stronger towards Emerging Europe and Latin America than to Emerging Asia. These results could be useful for policymakers in emerging economies as a benchmark to anticipate differentiated effects in portfolio flows caused by monetary policy in advanced economies.
    Keywords: Emerging Markets;Foreign Portfolio Investment;Monetary Policy Announcements
    JEL: E52 F21 G10
    Date: 2018–12

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