nep-cba New Economics Papers
on Central Banking
Issue of 2019‒04‒01
twenty-two papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Macroprudential Policy in the New Keynesian World By Hans Gersbach; Volker Hahn; Yulin Liu
  2. New Financial Stability Governance Structures and Central Banks By Rochelle M. Edge; J. Nellie Liang
  3. Changes in the inflation target and the comovement between inflation and the nominal interest rate By Yunjong Eo; Denny Lie
  4. FX intervention and domestic credit: Evidence from high-frequency micro data By Boris Hofmann; Hyun Song Shin
  5. State-dependent Monetary Policy Regimes By Shayan Zakipour-Saber
  6. Monetary Policy and Financial System Resilience By Bruni, Franco; Lopez, Claude
  7. Dirty float or clean intervention? The Bank of England in the foreign exchange market By Naef, Alain
  8. The BOJ's ETF Purchases and Its Effects on Nikkei 225 Stocks By HARADA Kimie; OKIMOTO Tatsuyoshi
  9. International Spillovers of U.S. Monetary Policy By Demir, Ishak
  10. Inflation expectations: Review and evidence By M. Ayhan Kose; Hideaki Matsuoka; Ugo Panizza; Dana Vorisek
  11. On Banking Regulation and Lobbying By Hans Gersbach; Stylianos Papageorgiou
  12. The Macroprudential Policy Framework Needs to Be Global By Lopez, Claude; Bruni, Franco
  13. Stress Testing Networks: The Case of Central Counterparties By Berner, Richard; Cecchetti, Stephen G; Schoenholtz, Kermit
  14. Central Bank Intervention, Bubbles and Risk in Walrasian Financial Markets By Chang, C-L.; Ilomäki, J.; Laurila, H.; McAleer, M.J.
  15. Foreign Exchange Reserves as a Tool for Capital Account Management By Davis, J. Scott; Fujiwara, Ippei; Huang, Kevin X. D.; Wang, Jiao
  16. Exchange Rate Undershooting: Evidence and Theory By Hettig, Thomas; Müller, Gernot; Wolf, Martin
  17. Self-Fulfilling Debt Crises, Fiscal Policy and Investment By Carlo Galli
  18. Independent Monetary Policy Versus a Common Currency: A Macroeconomic Analysis for the Czech Republic Through the Lens of an Applied DSGE Model By Jan Bruha; Jaromir Tonner
  19. The Limits of Forward Guidance By Campbell, Jeffrey R; Ferroni, Filippo; Fisher, Jonas; Melosi, Leonardo
  20. Duration Dependence, Monetary Policy Asymmetries, and the Business Cycle By Travis J. Berge; Damjan Pfajfar
  21. A multi-agent methodology to assess the effectiveness of alternative systemic risk adjusted capital requirements By Iori, G.; Gurgone, A.
  22. Optimal Monetary Policy for the Masses By Bullard, James B.; DiCecio, Riccardo

  1. By: Hans Gersbach (ETH Zurich, Switzerland); Volker Hahn (University of Konstanz, Germany); Yulin Liu (ETH Zurich, Switzerland)
    Abstract: We integrate banks and the coexistence of bank and bond financing into an otherwise standard New Keynesian framework. There are two policy-makers: a central banker, who can decide on short-term nominal interest rates, and a macroprudential policy-maker, who can vary aggregate capital requirements. The two policy instruments can be used to stabilize shocks, to moderate bank credit cycles, and to induce a more efficient allocation of resources across sectors. Moreover, we investigate the optimal combination of simple policy rules for interest rates and capital requirements. The optimal policy rules imply that the central bank should focus exclusively on price stability and the macroprudential policy-maker should react exclusively to changes in loan rate premia.
    Keywords: central banks, banking regulation, capital requirements, optimal monetary policy
    JEL: E52 E58 G28
    Date: 2018–08
  2. By: Rochelle M. Edge; J. Nellie Liang
    Abstract: We evaluate the institutional frameworks developed to implement time-varying macroprudential policies in 58 countries. We focus on new financial stability committees (FSCs) that have grown dramatically in number since the global financial crisis, and their interaction with central banks, and infer countries’ revealed preferences for effectiveness versus political economy considerations. Using cluster analysis, we find that only one-quarter of FSCs have both good processes and good tools to implement macroprudential actions, and that instead most FSCs have been designed to improve communication and coordination among existing regulators. We also find that central banks are not especially able to take macroprudential actions when FSCs are not set up to do so. We conclude that about one-half of the countries do not have structures to take or direct actions and avoid risks of policy inertia. Rather countries’ decisions appear to be consistent with strengthening the political legitimacy of macroprudential policies with prominent roles for the ministry of finance and avoiding placing additional powers in central banks that already are strong in microprudential supervision and have high political independence for monetary policy. The evidence suggests that countries are placing a relatively low weight on the ability of policy institutions to take action and a high weight on political economy considerations in developing their financial stability governance structures.
    Keywords: Central bank independence ; Countercyclical capital buffer ; Financial stability committees ; Macroprudential policy
    JEL: G18 E58 H19 G28
    Date: 2019–03–25
  3. By: Yunjong Eo; Denny Lie
    Abstract: Does raising an inflation target require increasing the nominal interest rate in the short run? We answer this question using a standard New Keynesian model with rich backward-looking elements. We first analytically show that the short-run comovement between inflation and the nominal interest rate is less likely to be positive, all else equal, as the monetary authority reacts more aggressively to the deviation of inflation from its target or as more backward-looking elements are incorporated into the model. Meanwhile, features of the model that enhance forward-looking behavior, such as partial price indexation to the inflation target or a lower degree of price rigidity, are shown to help increase the likelihood of positive comovement. However, we find that this so called Neo-Fisherism is most likely to hold even with a significant degree of backward-lookingness in the model, unless the monetary authority reacts to inflation in an extremely aggressive manner, close to strict inflation targeting. In addition, we estimate New Keynesian models of the U.S. economy and confirm our results that the U.S. economy exhibits Neo-Fisherism: raising the inflation target necessitates a short-run increase in the nominal interest rate. This finding is robust to empirically-plausible parameterizations of the model and to the specification of price indexation to the inflation target in firms’ price-setting process.
    Keywords: Neo-Fisherism, inflation expectations, a Taylor-type rule, strict inflation targeting, hybrid NKPC
    JEL: E12 E32 E58 E61
    Date: 2019–03
  4. By: Boris Hofmann; Hyun Song Shin
    Abstract: We employ a rarely available high-frequency micro data set to study the impact of foreign exchange intervention on domestic credit growth. We find that sterilised purchases of dollars by the central bank dampens the flow of new domestic corporate loans in Colombia. Slowing the pace of currency appreciation plays a key role in dampening credit expansion. Our analysis sheds light on the role of FX intervention as part of the financial stability-oriented policy response to credit booms associated with capital inflow surges.
    Keywords: FX intervention, credit registry, emerging markets, financial channel of exchange rates
    JEL: E58 F31 F33 F41 G20
    Date: 2019–03
  5. By: Shayan Zakipour-Saber (Queen Mary University of London)
    Abstract: Are monetary policy regimes state-dependent? To answer the question this paper estimates New Keynesian general equilibrium models that allow the state of the economy to influence the monetary authority's stance on inflation. I take advantage of recent developments in solving rational expectations models with state-dependent parameter drift to estimate three models on U.S. data between 1965-2009. In these models, the probability of remaining in a monetary policy regime that is relatively accommodative towards inflation, varies over time and depends on endogenous model variables; in particular, either deviations of inflation or output from their respective targets or a monetary policy shock. The main contribution of this paper is that it finds evidence of state-dependent monetary policy regimes. The model that allows inflation to influence the monetary policy regime in place, fits the data better than an alternative model with regime changes that are not state-dependent. This finding points towards reconsidering how changes in monetary policy are modelled.
    Keywords: Markov-Switching DSGE, State-dependence, Bayesian Estimation
    JEL: C13 C32 E42 E43
    Date: 2019–02–14
  6. By: Bruni, Franco; Lopez, Claude
    Abstract: In a time of global crisis, international policy coordination is quite natural. Yet, in normal times such coordination becomes a challenge. This is an issue especially when it comes to monetary and macroprudential policy of globally influential countries. This is especially relevant now with the trend of monetary normalisation in many of these countries. In this brief, we propose four necessary steps to help addressing these challenges: (i) Monetary policy should take into account its spillovers on financial stability, (ii) Systemic central banks need to account for the global impact of their policy, (iii) Multilateral consultations may provide a useful platform to assess these impacts, (iv) The analysis that helps designing monetary and macroprudential policy should include global aggregates to capture the global economic and financial context.
    Keywords: Financial system resilience,
    JEL: E5 E6 F4 F5
    Date: 2019
  7. By: Naef, Alain (University of Cambridge)
    Abstract: The effectiveness of central bank intervention is debated and despite literature showing mixed results, central banks regularly intervene in the foreign exchange market, both in developing and developed economies. Does foreign exchange intervention work? Using over 60,000 new daily observations on intervention and exchange rates, this paper is the first study of the Bank of England’s foreign exchange intervention between 1952 and 1972. The main finding is that the Bank of England was unsuccessful in managing a credible exchange rate over that period. Running an event study, I demonstrate that betting systematically against the Bank of England would have been a profitable trading strategy. The Bank of England failed to maintain credibility in offshore markets and eventually manipulated the publication of its reserve figures to avoid a run on sterling.
    Keywords: intervention; foreign exchange; central bank; Bank of England; Bretton Woods
    JEL: E50 F31 N14 N24
    Date: 2019–03–20
  8. By: HARADA Kimie; OKIMOTO Tatsuyoshi
    Abstract: This paper examines the impacts of the Bank of Japan's (BOJ) exchange-traded funds (ETFs) purchasing program that has been conducted since December 2010. The program is a part of the BOJ's unconventional monetary policy and has accelerated since the introduction of the Quantitative and Qualitative Easing in April 2013. In this study, the influence of underlying stocks is assessed by comparing the performance of the stocks (those included in the Nikkei 225 and others) using a difference-in-difference analysis. We also separate morning and afternoon returns to control for the fact that the BOJ tends to purchase ETFs when performance of the stock market is weak, in the morning session. We find that the Nikkei 225 component stocks' afternoon returns are significantly higher than those of non-Nikkei 225 stocks when the BOJ purchases ETFs. However, the subsample analysis demonstrates that the impact on Nikkei 225 stock returns becomes smaller over time despite the growing purchase amounts. Overall, our results indicate that the cumulative treatment effects on the Nikkei 225 are around 20% as of October 2017.
    Date: 2019–03
  9. By: Demir, Ishak
    Abstract: We estimate a structural dynamic factor model on large panel quarterly data to analyse the spillovers of U.S. monetary policy to the advanced economies and emerging and frontier market economies. The estimated model suggests that monetary contraction in U.S. leads to a significant decrease in real GDP with typical inverted hump-shape almost for all countries. It reduces permanently aggregate price level, increases interest rate and leads appreciation of U.S. dollar. However, contagion of U.S. monetary policy to the individual countries shows heterogeneity. For instance, its impact is larger in developing countries. We also find that global financial crisis has amplified the impact of U.S monetary policy on the rest of world in particular on developing countries. Lastly, the empirical results suggest that the cross-country heterogeneity in responses may be consequence of difference in country-specific characteristics such as exchange rate regimes, currency of price settings of firms, central bank independence and geographical distance from Unites States.
    Keywords: cross-country heterogeneity,country-specific characteristic,international monetary spillovers,structural factor model,monetary policy
    JEL: C38 E43 E52 E58 F42 G12
    Date: 2019
  10. By: M. Ayhan Kose; Hideaki Matsuoka; Ugo Panizza; Dana Vorisek
    Abstract: This paper presents a comprehensive examination of the determination and evolution of inflation expectations, with a focus on emerging market and developing economies (EMDEs). The results suggest that long-term inflation expectations in EMDEs are not as well anchored as those in advanced economies, despite notable improvements over the past two decades. Indeed, in EMDEs, long-term inflation expectations are more sensitive to both domestic and global inflation shocks. However, EMDEs tend to be more successful in anchoring inflation expectations in the presence of an inflation targeting regime, high central bank transparency, strong trade integration, and a low level of public debt.
    Keywords: inflation, inflation expectations, monetary policy, emerging markets, developing economies
    JEL: E31 E37 E40 E50
    Date: 2019–03
  11. By: Hans Gersbach (ETH Zurich, Switzerland); Stylianos Papageorgiou (University of Cyprus, Cyprus)
    Abstract: We study the political economy of bank capital regulation from a positive and normative perspective. In a general equilibrium setting, capital requirements and lobbying contributions are determined as the outcome of bargaining between banks and politicians. We show that bankers and politicians agree on lobbying contributions and capital regulation that renders banks fragile, reducing efficiency and fairness. Consideration of all general equilibrium effects, or a bail-in provision and high capital regulation standards from international agreements eliminate lobbying incentives, yielding an efficient and fair allocation.
    Keywords: Banking regulation, lobbying, regulatory capture, capital requirements, bank resolution, risk-taking.
    JEL: D53 D72 G21 G28
    Date: 2019–01
  12. By: Lopez, Claude; Bruni, Franco
    Abstract: Basell III was a direct answer to the 2008 financial crisis. Now 10 years after the crisis, it is time to assess its timeliness and make the necessary adjustments so it becomes truly global. In this policy brief, we first clarify the goals of macroprudential policy before highlighting the main challenges that home and host countries may run into when global financial institutions lend beyond their home countries. We then suggest to focus on four priorities to address these vulnerabilities: (i) An adaptable and flexible global framework, (ii) The generalization of international standards and best practices, (iii) A stronger global data depository, (iv) Regulatory and monitoring cooperation.
    Keywords: macroprudential policy, G20
    JEL: E6 F5
    Date: 2019–03
  13. By: Berner, Richard; Cecchetti, Stephen G; Schoenholtz, Kermit
    Abstract: Stress tests applied to individual institutions are an important tool for evaluating financial resilience. However, financial systems are typically complex, heterogeneous and rapidly changing, raising questions about the adequacy of conventional tests. In this paper, we interpret the current stress test practice from a network perspective, highlighting central counterparties (CCPs) as an example of a critical network hub. Networks that include CCPs involve deep and broad interconnections, making stress testing a challenging task. We propose supplementing both private and supervisory CCP stress tests with a high-frequency indicator constructed from a market-based estimate of the conditional capital shortfall (SRISK) of the CCP's clearing members. Applying our measure to two large CCPs, we analyze how they can transmit and amplify shocks across borders, conditional on the exhaustion of prefunded resources. Our results highlight how the network created by central clearing can act as an important transmission mechanism for shocks emanating from Europe.
    Keywords: CCP; central counterparties; financial network; financial regulation; Financial Stability; Resolution; SRISK; Stress Testing
    JEL: G18 G23 G28 G32
    Date: 2019–03
  14. By: Chang, C-L.; Ilomäki, J.; Laurila, H.; McAleer, M.J.
    Abstract: The paper investigates the effects of central bank interventions in financial markets, composed of asymmetrically-informed rational investors and noise traders. If the central bank suspects a bubble, it should lift the real risk-free rate to deflate the bubble in “leaning against the wind”. A rise in the real risk-free rate reduces the risk of rational informed investors, and increases the risk of rational uninformed investors. If the central bank intervenes through the nominal risk-free rate and the Fisher arbitrage condition holds, an increase in the nominal rate is transferred to inflation, thereby dampening the policy effect. Conversely, this implies that the central bank can also deflate the bubble by inducing a reduction in inflationary expectations. The effect on the informed investor risk remains ambiguous, while the risk of he uninformed investor grows, but only if they suffer from money illusion.
    Keywords: Central bank intervention, asymmetric information, rational investors, noise traders, bubbles, risk-free rate, Fisherian arbitrage, inflation, expectations, money illusion
    JEL: D82 E58 G11 G14 G32
    Date: 2019–02–01
  15. By: Davis, J. Scott (Federal Reserve Bank of Dallas); Fujiwara, Ippei (Keio University); Huang, Kevin X. D. (Vanderbilt University); Wang, Jiao (University of Melbourne)
    Abstract: Many recent theoretical papers have argued that countries can insulate themselves from volatile world capital flows by using a variable tax on foreign capital as an instrument of monetary policy. But at the same time many empirical papers have argued that only rarely do we observe these cyclical capital taxes used in practice. In this paper we construct a small open economy model where the central bank can engage in sterilized foreign exchange intervention. When private agents can freely buy and sell foreign bonds, sterilized foreign exchange intervention has no effect. But we analytically prove that when private agents cannot freely buy and sell foreign bonds, that is, under acyclical capital controls, optimal sterilized foreign exchange intervention is equivalent to an optimally chosen tax on foreign capital. Numerical simulations of the model show that a variable capital tax is a reasonable approximation for sterilized foreign exchange intervention under the levels of capital controls observed in many emerging markets.
    Keywords: Central bank; small open economy; foreign exchange reserves; capital controls
    JEL: E30 E50 F40
    Date: 2019–02–05
  16. By: Hettig, Thomas; Müller, Gernot; Wolf, Martin
    Abstract: We run local projections to estimate the effect of US monetary policy shocks on the dollar. We find that monetary contractions appreciate the dollar and establish two results. First, the spot exchange rate undershoots: the appreciation is smaller on impact than in the longer run. Second, forward exchange rates also appreciate on impact, but their response is flat across tenors. Next, we develop and estimate a New Keynesian model with information frictions. In the model, investors do not observe the natural rate of interest directly. As a result, they learn only over time whether an interest rate surprise represents a monetary contraction. The model accurately predicts the joint dynamics of spot and forward exchange rates following a monetary contraction.
    Keywords: Forward Exchange Rate; Forward premium puzzle; information effect; Information Frictions; monetary policy; Spot Exchange Rate; UIP puzzle
    JEL: E43 F31
    Date: 2019–03
  17. By: Carlo Galli (Centre for Macroeconomics (CFM); University College London (UCL))
    Abstract: This paper studies the circular relationship between sovereign credit risk, government fiscal and debt policy, and output. I consider a sovereign default model with fiscal policy and private capital accumulation. I show that, when fiscal policy responds to borrowing conditions in the sovereign debt market, multiple equilibria exist where the expectations of lenders are self-fulfilling. In the bad equilibrium, pessimistic beliefs make sovereign debt costly. The government substitutes borrowing with taxation, which depresses private investment and future output, increases default probabilities and verifies lenders’ beliefs. This result is reminiscent of the European debt crisis of 2010-12: while recessionary, fiscal austerity may be the government best response to excessive borrowing costs during a confidence crisis.
    Keywords: Self-fulfilling debt crises, Soverign default, Multiple equilibria, Fiscal austerity
    JEL: E44 E62 F34
    Date: 2019–02
  18. By: Jan Bruha; Jaromir Tonner
    Abstract: The goal of this paper is to contribute to the understanding of the macroeconomic costs and benefits of euro adoption by the Czech economy through the lens of the CNB's official structural macroeconomic model - called g3. To do so, we perform simulations using the g3 model and a modification thereof with a fixed nominal exchange rate and with the policy rate given by the ECB. First, we compare the unconditional volatilities of selected macro variables implied by the two models. Second, we use the g3 model to filter the historical data to identify the structural shocks that affected the Czech economy in the past ten years, and we then use the modified model to simulate the counterfactual outcome of what would have happened to the Czech economy if the euro had been adopted in the past. Our results indicate that euro adoption would have had positive effects on the levels of macroeconomic variables at the cost of an increase in nominal volatility.
    Keywords: DSGE model, euro, monetary policy
    JEL: E47 E52 F47
    Date: 2018–12
  19. By: Campbell, Jeffrey R; Ferroni, Filippo; Fisher, Jonas; Melosi, Leonardo
    Abstract: The viability of forward guidance as a monetary policy tool depends on the horizon over which it can be communicated and its influence on expectations over that horizon. We develop and estimate a model of imperfect central bank communications and use it to measure how effectively the Fed has managed expectations about future interest rates and the influence of its communications on macroeconomic outcomes. Standard models assume central banks have perfect control over expectations about the policy rate up to an arbitrarily long horizon and this is the source of the so-called "forward guidance puzzle.'' Our estimated model suggests that the Fed's ability to affect expectations at horizons that are sufficiently long to give rise to the forward guidance puzzle is substantially limited. We also find that imperfect communication has a significant impact on the propagation of forward guidance. Finally, we develop a novel decomposition of the response of the economy to forward guidance and use it to show that empirically plausible imperfect forward guidance has a quantitatively important role bringing forward the effects of future rate changes and that poor communications have been a source of macroeconomic volatility.
    Keywords: business cycles; central bank communication; forward guidance puzzle; monetary policy; Risk management
    JEL: E0
    Date: 2019–03
  20. By: Travis J. Berge; Damjan Pfajfar
    Abstract: We produce business cycle chronologies for U.S. states and evaluate the factors that change the probability of moving from one phase to another. We find strong evidence for positive duration dependence in all business cycle phases but find that the effect is modest relative to other state- and national-level factors. Monetary policy shocks also have a strong influence on the transition probabilities in a highly asymmetric way. The effect of policy shocks depends on the current state of the cycle as well as the sign and size of the shock.
    Keywords: Duration analysis ; Business cycles ; Hazard rates ; Monetary policy asymmetries
    JEL: E32 C23 C25 E52
    Date: 2019–03–25
  21. By: Iori, G.; Gurgone, A.
    Abstract: We propose a multi-agent approach to compare the effectiveness of macro-prudential capital requirements, where banks are embedded in an artificial macroeconomy. Capital requirements are derived from systemic- risk metrics that reflect both the vulnerability or impact of financial in- stitutions. Our objective is to explore how systemic-risk measures could be translated in capital requirements and test them in a comprehensive framework. Based on our counterfactual scenarios, we find that macro- prudential capital requirements can mitigate systemic risk, but there is a trade-off between market- and balance-sheet-based policies in terms of banks’ losses and credit supply.
    Date: 2019
  22. By: Bullard, James B. (Federal Reserve Bank of St. Louis); DiCecio, Riccardo (Federal Reserve Bank of St. Louis)
    Abstract: We study nominal GDP targeting as optimal monetary policy in a simple and stylized model with a credit market friction. The macroeconomy we study has considerable income inequality, which gives rise to a large private sector credit market. There is an important credit market friction because households participating in the credit market use non-state contingent nominal contracts (NSCNC). We extend previous results in this model by allowing for substantial intra-cohort heterogeneity. The heterogeneity is substantial enough that we can approach measured Gini coefficients for income, financial wealth, and consumption in the U.S. data. We show that nominal GDP targeting continues to characterize optimal monetary policy in this setting. Optimal monetary policy repairs the distortion caused by the credit market friction and so leaves heterogeneous households supplying their desired amount of labor, a type of "divine coincidence" result. We also further characterize monetary policy in terms of nominal interest rate adjustment.
    Keywords: Optimal monetary policy; life cycle economies; heterogeneous households; credit market participation; nominal GDP targeting; non-state contingent nominal contracting; inequality; Gini coefficients
    JEL: E4 E5
    Date: 2019–03–22

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