nep-cba New Economics Papers
on Central Banking
Issue of 2019‒03‒04
twenty papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Macroprudential Interventions in Liquidity Traps By William John Tayler; Roy Zilberman
  2. Bank Leverage Ratios, Risk and Competition - An Investigation Using Individual Bank Data By E Philip Davis; Dilruba Karim; Dennison Noel
  3. Banking Regulation with Risk of Sovereign Default By D'Erasmo, Pablo; Livshits, Igor; Schoors, Koen
  4. The first twenty years of the European Central Bank: monetary policy By Hartmann, Philipp; Smets, Frank
  5. House Price Dynamics, Optimal LTV Limits and the Liquidity Trap By Ferrero, Andrea; Harrison, Richard; Nelson, Benjamin
  6. Information effects of euro area monetary policy: New evidence from high-frequency futures data By Kerssenfischer, Mark
  7. Divergent Emerging Market Economy Responses to Global and Domestic Monetary Policy Shocks By Choi, Woon Gyu; Kang, Taesu; Kim, Geun-Young; Lee, Byongju
  8. An Improved IS-LM Model To Explain Quantitative Easing By Hiermeyer, Martin
  9. Global Spillover Effects of US Uncertainty By Saroj Bhattarai; Arpita Chatterjee; Woong Yong Park
  10. Transmission of monetary policy shocks: do input-output interactions matter? By Singh, Aarti; Tornielli di Crestvolant, Stefano
  11. Growth prospects, the natural interest rate, and monetary policy By Fiedler, Salomon; Gern, Klaus-Jürgen; Jannsen, Nils; Wolters, Maik H.
  12. Monetary Policy and the Cost of Heterogeneous Wage Rigidity: Evidence from the Stock Market By Faia, Ester; Pezone, Vincenzo
  13. Do Local Currency Bond Markets Enhance Financial Stability? By Park, Donghyun; Shin, Kwanho; Tian, Shu
  14. The Bank Capital-Competition-Risk Nexus - A Global Perspective By E Philip Davis; Dilruba Karim; Dennison Noel
  15. The Societal Benefits of Money and Interest Bearing Debt By Luis Araujo; Leo Ferraris
  16. Monetary Policy with Non-Separable Government Spending By Troug, Haytem
  18. Deposit Insurance, Market Discipline and Bank Risk By Alexei Karas; William Pyle; Koen Schoors
  20. Monetary policy implications of state-dependent prices and wages By Costain, James; Nakov, Anton; Petit, Borja

  1. By: William John Tayler; Roy Zilberman
    Abstract: We characterize the joint optimal implementation of macroprudential and monetary policies in a New Keynesian model where endogenous supply-side financial frictions generate inflationary credit spreads. State-contingent macroprudential interventions help to stabilize volatile spreads, and substantially alter the transmission of optimal monetary policy under both discretion and commitment. In 'normal times', macroprudential policies replicate the first-best allocation. In liquidity traps, financial interventions remove the zero lower bound restriction on the nominal policy rate, thus minimizing output costs following both deflationary (inflationary) demand (financial) shocks. Discretionary and commitment policies with macroprudential taxes deliver equivalent welfare gains.
    Keywords: financial taxation, monetary policy, optimal policy, credit cost channel, credit spreads, zero lower bound
    JEL: E32 E44 E52 E58 E63
    Date: 2019
  2. By: E Philip Davis; Dilruba Karim; Dennison Noel
    Abstract: Following experience in the global financial crisis (GFC), when banks with low leverage ratios were often in severe difficulty, despite high-risk-adjusted capital measures, a leverage ratio was introduced in Basel III to complement the risk-adjusted capital ratio (RAR). Empirical testing of the leverage ratio, individually and relative to regulatory capital is, however, sparse. More generally, the capital/risk/competition nexus has been neglected by regulators and researchers. In this paper, we undertake empirical research that sheds light on leverage as a regulatory tool controlling for competition. We assess the effectiveness of a leverage ratio relative to the risk-adjusted capital ratio (RAR) in predicting bank risk given competition for up to 8216 banks in the EU and 1270 in the US, using the Fitch-Connect database of banks’ financial statements. On balance, US banks tend to behave in a manner consistent with “skin in the game” (a negative relation of competition to risk) while European banks tend to follow the “regulatory hypothesis” (positive relation), although there are exceptions to these generalisations. Accordingly, the expected effect of changes in capital on risk needs careful attention by regulators. There is a tendency for the leverage ratio to be more often significant than the risk-adjusted measure in a number of the regressions. This observation favours its use in macroprudential policy. The effect of capital on risk varies considerably over time and cross sectionally for Europe vis a vis the US; effects often differ between low-leverage and high-leverage ratio banks as well as pre- and post-crisis and for individual EU countries. The overall results are robust to a number of variations in sample and specification. We consider the inclusion of competition as a control variable to be a major contribution that adds to the relevance of our study. The results show that bank competition, allowing for capital, is a significant macroprudential indicator in virtually all regressions and hence more note should be taken of this by regulators, notably in the US where there is mainly evidence of competition-fragility (a positive link of competition to risk). On the other hand we note that exclusion of competition does not markedly change the effect of capital. Finally there are differences in the relation of risk both to competition and capital adequacy for banks at different levels of risk that need to be taken into account by regulators both in Europe and the US. There is some evidence of greater vulnerability of weaker banks to low capital and high competition than would be shown by the sample average or median.
    Keywords: Macroprudential policy, capital adequacy, leverage ratio, bank competition, bank risks, panel estimation, quantile regressions
    JEL: E58 G28
    Date: 2019–02
  3. By: D'Erasmo, Pablo (Federal Reserve Bank of Philadelphia); Livshits, Igor (Federal Reserve Bank of Philadelphia); Schoors, Koen (Ghent, HSE)
    Abstract: Banking regulation routinely designates some assets as safe and thus does not require banks to hold any additional capital to protect against losses from these assets. A typical such safe asset is domestic government debt. There are numerous examples of banking regulation treating domestic government bonds as “safe,” even when there is clear risk of default on these bonds. We show, in a parsimonious model, that this failure to recognize the riskiness of government debt allows (and induces) domestic banks to “gamble” with depositors’ funds by purchasing risky government bonds (and assets closely correlated with them). A sovereign default in this environment then results in a banking crisis. Critically, we show that permitting banks to gamble this way lowers the cost of borrowing for the government. Thus, if the borrower and the regulator are the same entity (the government), that entity has an incentive to ignore the riskiness of the sovereign bonds. We present empirical evidence in support of the key mechanism we are highlighting, drawing on the experience of Russia in the run-up to its 1998 default and on the recent Eurozone debt crisis.
    Keywords: Banking; Sovereign default; Prudential regulation; Financial crisis
    JEL: F34 G01 G28
    Date: 2019–02–22
  4. By: Hartmann, Philipp; Smets, Frank
    Abstract: On 1 June 2018 the ECB celebrated its 20th anniversary. This paper provides a comprehensive view of the ECB's monetary policy over these two decades. The first section provides a chronological account of the macroeconomic and monetary policy developments in the euro area since the adoption of the euro in 1999, going through four cyclical phases "conditioning" ECB monetary policy. We describe the monetary policy decisions from the ECB's perspective and against the background of its evolving monetary policy strategy and framework. We also highlight a number of the key critical issues that were the subject of debate. The second section contains a partial assessment. We first analyze the achievement of the price stability mandate and developments in the ECB's credibility. Next, we investigate the ECB's interest rate decisions through the lens of a simple empirical interest rate reaction function. This is appropriate until the ECB hits the zero-lower bound in 2013. Finally, we present the ECB's framework for thinking about non-standard monetary policy measures and review the evidence on their effectiveness. One of the main themes of the paper is how ECB monetary policy responded to the challenges posed by the European twin crises and the subsequent slow economic recovery, making use of its relatively wide range of instruments, defining new ones where necessary and developing the strategic underpinnings of its policy framework.
    Keywords: crisis; euro area economy; European Central Bank; European Economic and Monetary Union; inflation; monetary policy; non-standard measures; zero-lower bound
    JEL: E31 E32 E42 E52 G01 N14
    Date: 2018–12
  5. By: Ferrero, Andrea; Harrison, Richard; Nelson, Benjamin
    Abstract: The inception of macro-prudential policy frameworks in the wake of the global financial crisis raises questions about the effects of the newly available policy tools and their interaction with the existing ones. We study the optimal setting of a loan-to-value (LTV) limit, and its implications for optimal monetary policy, in a model with nominal rigidities and financial frictions. The welfare-based loss function implies a role for macro-prudential policy to enhance risk-sharing. Following a house price boom-bust episode, macro-prudential policy alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap. In this scenario, optimal policy always entails countercyclical LTV limits, while the response of the nominal interest rate depends on the nature of the underlying shock driving house prices.
    Keywords: financial crisis; monetary and macro-prudential policy; zero lower bound
    JEL: E52 E58 G01 G28
    Date: 2018–12
  6. By: Kerssenfischer, Mark
    Abstract: Central bank announcements move financial markets. The response of inflation and growth expectations, on the other hand, is often small or even counterintuitive. Based on tick-by-tick futures prices on bonds and stock prices, I confirm these seemingly puzzling results for the euro area and provide evidence that they are due to central bank information effects. That is, ECB announcements convey information not only about monetary policy, but also about economic fundamentals. I separate these "information shocks" from "pure policy shocks" via sign restrictions and find intuitive effects of both shocks on a wide set of financial market prices and survey measures of economic expectations.
    Keywords: Monetary Policy,High-Frequency Identification,Central Bank Information
    JEL: E52 E44 E32 C32
    Date: 2019
  7. By: Choi, Woon Gyu (International Monetary Fund); Kang, Taesu (Bank of Korea); Kim, Geun-Young (Bank of Korea); Lee, Byongju (Bank of Korea)
    Abstract: We assess the effect of the United States (US) and domestic monetary policies on emerging market economies (EMEs) using a panel factor-augmented vector autoregressive model. We find a US policy rate hike outstrips a tantamount hike in EME policy rates in its impacts on EMEs and discover that bond flows are more sensitive to interest rate differentials than are equity flows. Tighter global or EME-specific policy entails divergent responses of growth and inflation in EMEs: in particular, the output loss is greater in those EMEs with higher inflation. When US monetary policy tightens, bond and equity markets in EMEs are prone to outflows. Domestic policy alone is not enough to counteract the effects of global policy shocks on capital flows in EMEs.
    Keywords: divergent responses; global liquidity; monetary transmission; panel factor-augmented VAR
    JEL: F32 F42
    Date: 2017–12–19
  8. By: Hiermeyer, Martin
    Abstract: The paper combines the IS-LM model with a Tobin-style ‎analysis of the banking system. As suggested by Krugman, the resulting model has great predictive power. It can explain quantitative easing and its effect on the economy, helicopter money and money creation by banks. Also, it is free of the normal shortcomings of the IS-LM model.
    Keywords: Monetary Policy, Money Supply
    JEL: E5
    Date: 2019–02–26
  9. By: Saroj Bhattarai (University of Texas at Austin); Arpita Chatterjee (UNSW Business School, UNSW); Woong Yong Park (Seoul National University)
    Abstract: Spillover effects of US uncertainty shocks are studied in a panel VAR of fifteen emerging market economies (EMEs). A US uncertainty shock negatively affects EME stock prices and exchange rates, raises EME country spreads, and decreases capital inflows into them. It decreases EME output and consumer prices while increasing net exports. Negative effects on output and asset prices are weaker, but effects on external balance stronger, for Latin American EMEs. We attribute such heterogeneity to differential EME monetary policy response to US uncertainty shocks. Analysis of central bank minutes shows Latin American EMEs pay less attention to smoothing capital flows.
    Keywords: US Uncertainty; Panel VAR; Emerging Market Economies; Monetary Policy Response; Emerging Market Monetary Policy Minutes
    JEL: C11 C33 E44 E52 E58 F32
    Date: 2019–02
  10. By: Singh, Aarti; Tornielli di Crestvolant, Stefano
    Abstract: We examine whether input-output interactions among industries impact the transmission of monetary policy shocks through the economy. Using Vector Autoregressive (VAR) methods we find evidence of heterogeneity in the output response to a monetary policy shock in both finished goods industries and intermediate goods industries. While output responses in finished goods industries can be related to heterogeneity in industry characteristics, this relationship is not so obvious for intermediate goods industries. For the intermediate goods industries in our sample we find new evidence of demand-spillover effects that impact the transmission of monetary policy via input-output linkages.
    Keywords: Monetary policy transmission; input-output; VAR; intermediate goods.
    Date: 2018–08
  11. By: Fiedler, Salomon; Gern, Klaus-Jürgen; Jannsen, Nils; Wolters, Maik H.
    Abstract: The recovery from the Global Financial Crisis was characterized by sluggish output growth and by inflation remaining persistently below the inflation targets of central banks in many advanced economies despite an unprecedented monetary expansion. Ten years after the Global Financial Crisis, GDP remains below its pre-crisis trend in many economies and interest rates continue to be very low. This raises the question of whether low GDP growth and low interest rates are a temporary phenomenon or are due to a decline in long-run growth prospects (potential output growth) and equilibrium real interest rates (natural interest rate). Addressing this question is important for central banks for conducting monetary policy and adjusting their strategy. In this paper, the authors address this question based on a review of the literature and an evaluation of the most recent data and discuss implications for monetary policy.
    Keywords: natural interest rate,potential output,output gap,monetary policy
    JEL: E31 E32 E43 E52 E58
    Date: 2019
  12. By: Faia, Ester; Pezone, Vincenzo
    Abstract: Using a unique confidential contract level dataset merged with firm-level asset price data, we find robust evidence that firms' stock market valuations and employment levels respond more to monetary policy announcements the higher the degree of wage rigidity. Data on the renegotiations of collective bargaining agreements allow us to construct an exogenous measure of wage rigidity. We also find that the amplification induced by wage rigidity is stronger for firms with high labor intensity and low profitability, providing evidence of distributional consequences of monetary policy. We rationalize the evidence through a model in which firms in different sectors feature different degrees of wage rigidity due to staggered renegotiations vis-a-vis unions.
    Date: 2018–12
  13. By: Park, Donghyun (Asian Development Bank); Shin, Kwanho (Korea University); Tian, Shu (Asian Development Bank)
    Abstract: It is widely believed that local currency bond markets (LCBMs) can promote financial stability in developing countries. For instance, they can help mitigate the currency and maturity mismatch that contributed to the outbreak of the Asian financial crisis of 1997–1998. In this paper, we empirically test such conventional wisdom on the stabilizing effect of LCBMs. To do so, we analyze and compare the financial vulnerability of developing countries during two episodes of financial stress—global financial crisis and taper tantrum. During the two episodes, we find a negative association between the growth of LCBMs and the degree of currency depreciation in emerging economies. Similar association is found of bank loans but not for the stock market.
    Keywords: Asian financial crisis; bonds; currency mismatch; developing countries; financial stability; local currency bond markets; maturity mismatch
    JEL: E44 F34 F42
    Date: 2018–10–19
  14. By: E Philip Davis; Dilruba Karim; Dennison Noel
    Abstract: The Global Financial Crisis (GFC) highlighted the importance of a number of unresolved empirical issues in the field of financial stability. First, there is the sign of the relationship between bank competition and financial stability. Second, there is the relation of capital adequacy of banks to risk. Third, the introduction of a leverage ratio in Basel III following the crisis leaves open the question of its effectiveness relative to the risk adjusted capital ratio (RAR). Fourth, there is the issue of the relative stability of advanced versus emerging market financial systems, and whether similar factors lead to risk, which may have implications for appropriate regulation. Finally, there is the nature of the relation between bank competition and bank capital. In this context, we address these five issues via estimates for the relation between capital adequacy, bank competition and other control variables and aggregate bank risk. We undertake this for different country groups and time periods, using macro data from the World Bank’s Global Financial Development Database over 1999-2015 for up to 120 countries globally, using single equation logit and GMM estimation techniques and panel VAR. This is an overall approach that to our knowledge is new to the literature. The results cast light on each of the issues outlined above, with important implications for regulation: (1) The results for the Lerner Index largely underpin the “competition-fragility” hypothesis of a positive relation of competition to risk rather than “competition stability” (a negative relation) and show a widespread impact of competition on risk generally. (2) There is a tendency for both the leverage ratio and the RAR to be significant predictors of risk, and for crises and Z score they are supportive of the “skin in the game” hypothesis of a negative relation between capital ratios and risk, whereas for provisions and NPLs they are consistent with the “regulatory hypothesis” of a positive relation of capital adequacy to risk. (3) The leverage ratio is much more widely relevant than the RAR, underlining its importance as a regulatory tool. The relative ineffectiveness of risk adjusted measures may relate to untruthful or inaccurate assessments of bank real risk exposure. (4) There are marked differences between advanced countries and EMEs in the capital-risk-competition nexus, with for example a wider impact of competition in EMEs (although both types of country need to pay careful attention to the evolution of competition in macroprudential surveillance). Similar pattern to EMEs are apparent in many cases for the global sample pre crisis, which arguably are more consistent with normal market functioning than post crisis. (5) Competition reduces leverage ratios significantly in a Panel VAR, with impulse responses showing that more competition leads to lower leverage ratios and vice versa. This result is consistent over a range of subsamples and risk variables. In the variance decomposition, we find that competition is autonomous, while the variance of both risk and capital ratios are strongly affected by competition. The Panel VAR results give some indication of the transmission mechanism from competition to risk and financial instability.
    Keywords: Macroprudential policy, capital adequacy, leverage ratio, bank competition, bank risks, emerging market economies, logit, GMM, Panel VAR
    JEL: E58 G28
    Date: 2019–02
  15. By: Luis Araujo (Michigan State University and Sao Paulo School of Economics-FGV); Leo Ferraris (DEF & CEIS,University of Rome "Tor Vergata")
    Abstract: A long standing issue in monetary theory is whether money and interest bearing debt may both play a beneficial role in facilitating transactions. This paper identifies in the misallocation of liquidity a key element to provide an answer. In a search model of money, we show that there exists an equilibrium which resembles a liquidity trap, in which debt and money are used interchangeably to trade goods and debt carries no interest, and a Pareto superior equilibrium in which money is used to trade goods and interest bearing debt to reshuffle misallocated liquidity. Monetary policy has no effect in the liquidity trap, and a liquidity e¤ect in the Pareto superior equilibrium.
    Keywords: Money,Debt,Bonds,Monetary Policy
    JEL: E40
    Date: 2019–02–19
  16. By: Troug, Haytem
    Abstract: The significant role of government consumption in affecting economic conditions raises the necessity for monetary policy to take into account the behaviour of fiscal policy and to also take into account how the presence of the fiscal sector might affect the transmission mechanism of monetary policy in the economy. To test for this, we build an otherwise standard New Keynesian model that incorporates non-separable government consumption. The simulations of the model show that when government consumption has a crowding in effect on private consumption, it will dampen the transmission mechanism of monetary policy, and vice versa. The empirical estimations of the paper also support the theoretical findings of the model, as the panel regression show that, in OECD countries, government consumption dampens the effect of the policy rate on private consumption. These results are robust to the zero lower bound era.
    Keywords: New Keynesian Models, Business Cycle, Monetary Policy, Joint Analysis of Fiscal and Monetary Policy.
    JEL: E12 E32 E52 E63
    Date: 2019–02–22
  17. By: Koen Schoors; Maria Semenova; Andrey Zubanov (-)
    Abstract: We analyze whether bank familiarity affects depositor behavior during financial crisis. Familiarity is measured by regional or local cues in the bank’s name. Depositor behavior is measured by the depositor’s sensitivity to observable bank risk (market discipline). Using 2001-2010 bank-level and region-level data for Russia, we find that depositors of familiar banks become less sensitive to bank risk after a financial crisis relative to depositors of unfamiliar banks. To validate that our results stem from a flight to familiarity during crisis and not from implicit guarantees from regional governments, we interact the variables of interest with measures of regional affinity and trust in local governments. The flight to familiarity effect is strongly confirmed in regions with strong regional affinity, while the effect is absent in regions with more trust in regional and local governments, lending support to the thesis that our results are driven a flight to familiarity rather than implicit guarantees.
    Keywords: Market discipline, Bank, Personal deposit, Region, Russia, Flight to familiarity, Trust, Implicit guaranty, Regional authorities.
    JEL: G21 G01 P2
    Date: 2019–02
  18. By: Alexei Karas; William Pyle; Koen Schoors (-)
    Abstract: Using evidence from Russia, we explore the e ect of the introduction of deposit insurance on bank risk. Drawing on within-bank variation in the ratio of firm deposits to total household and firm deposits, so as to capture the magnitude of the decrease in market discipline after the introduction of deposit insurance, we demonstrate for private, domestic banks that larger declines in market discipline generate larger increases in traditional measures of risk. These results hold in a di erence-in-di erence setting in which state and foreign-owned banks, whose deposit insurance regime does not change, serve as a control..
    Keywords: deposit insurance, market discipline, moral hazard, risk taking, banks, Russia
    JEL: E65 G21 G28 P34
    Date: 2019–01
  19. By: Mustafa Disli; Koen Schoors (-)
    Abstract: We analyze the dynamic effects of bank rebranding in a sample of Turkish banks. We hypothesize that bank rebranding resorts positive effects if the rebranding strategy exploits familiarity bias, which refers to the behavioral heuristic that investors favor firms they are more familiar with. We measure the effect of bank rebranding on depositor attitudes by the change in depositor discipline. In line with our hypothesis, rebranding from a foreign into a Turkish name (increased familiarity) is associated with reduced depositor discipline, while rebranding from a Turkish into a foreign name (reduced familiarity) is associated with increased depositor discipline instead. Local projections indicate that the positive familiarity bias effect of rebranding lasts up to four years.
    Keywords: depositor discipline; rebranding; familiarity bias
    Date: 2019–01
  20. By: Costain, James; Nakov, Anton; Petit, Borja
    Abstract: This paper studies the dynamic general equilibrium effects of monetary shocks in a "control cost" model of state-dependent retail price adjustment and state-dependent wage adjustment. Suppliers of retail goods and of labor are both monopolistic competitors that face idiosyncratic productivity shocks and nominal rigidities. Stickiness arises because precise choice is costly: decision-makers tolerate errors both in the timing of adjustments, and in the new level at which the price or wage is set, because making these choices with perfect precision would be excessively costly. The model is calibrated to microdata on the size and frequency of price and wage changes. We find that the impact multiplier of a money growth shock on consumption and labor in our calibrated state-dependent model is similar to that in a Calvo model with the same adjustment frequencies, though the response is less persistent than it would be under the Calvo mechanism. Wage rigidity accounts for most of the nonneutrality that occurs in a model where both prices and wages are sticky; hence, a model with both rigidities produces substantially larger real effects of monetary shocks than does a model with sticky prices only. We find that the state-dependence of nominal rigidity strongly decreases the slope of the Phillips curve as trend inflation declines. This result is not driven by downward wage rigidity; adjustment costs are symmetric in our model. Here, instead, price- and wage-setters prefer to adjust less frequently when trend inflation is low, making short-run inflation less reactive to shocks.
    Keywords: control costs; logit equilibrium; near rationality; state-dependent adjustment; sticky prices; sticky wages
    JEL: C73 D81 E31
    Date: 2018–12

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