nep-cba New Economics Papers
on Central Banking
Issue of 2019‒04‒29
fourteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Winter is possibly not coming: Mitigating financial instability in an agent-based model with interbank market By Lilit Popoyan; Mauro Napoletano; Andrea Roventini
  2. Distributional Impacts of Low for Long Interest Rates By Kronick, Jeremy M.; Villarreal, Francisco G.
  3. QE in the euro area: Has the PSPP benefited peripheral bonds? By Belke, Ansgar; Gros, Daniel
  4. The Neutral Rate in Canada: 2019 Update By Thomas J. Carter; Xin Scott Chen; José Dorich
  5. Does the lack of financial stability impair the transmission of monetary policy? By Acharya, Viral V.; Imbierowicz, Björn; Steffen, Sascha; Teichmann, Daniel
  6. Risk Management-Driven Policy Rate Gap By Giovanni Caggiano; Efrem Castelnuovo; Gabriela Nodari
  7. Positive Trend Inflation and Determinacy in a Medium-Sized New Keynesian Model By Jonas E Arias; Guido Ascari; Nicola Branzoli; Efrem Castelnuovo
  8. Central Bank Intervention in Foreign Exchange Market under Managed Float: A Three Regime Threshold VAR Analysis of Indian Rupee-US Dollar Exchange Rate By Ghosh, Sunandan; Kundu, Srikanta
  9. The impact of monetary conditions on bank lending to households By Gyöngyösi, Győző; Ongena, Steven; Schindele, Ibolya
  10. The low interest policy and the household saving behavior in Japan By Latsos, Sophia
  11. Irreversible monetary policy at the zero lower bound By Kohei Hasui; Teruyoshi Kobayashi; Tomohiro Sugo
  12. The Effects of Conventional and Unconventional Monetary Policy on Forecasting the Yield Curve By Eo, Yunjong; Kang, Kyu Ho
  13. Beyond Competitive Devaluations: The Monetary Dimensions of Comparative Advantage By Paul R. Bergin; Giancarlo Corsetti
  14. Market-Based Monetary Policy Uncertainty By Lakdawala, Aeimit; Bauer, Michael; Mueller, Philippe

  1. By: Lilit Popoyan; Mauro Napoletano; Andrea Roventini
    Abstract: We develop a macroeconomic agent-based model to study how financial instability can emerge from the co-evolution of interbank and credit markets and the policy responses to mitigate its impact on the real economy. The model is populated by heterogenous firms, consumers, and banks that locally interact in different markets. In particular, banks provide credit to firms according to a Basel II or III macro-prudential frameworks and manage their liquidity in the interbank market. The Central Bank performs monetary policy according to different types of Taylor rules. We find that the model endogenously generates market freezes in the interbank market which interact with the financial accelerator possibly leading to firm bankruptcies, bank- ing crises and the emergence of deep downturns. This requires the timely intervention of the Central Bank as a liquidity lender of last resort. Moreover, we find that the joint adoption of a three mandate Taylor rule tackling credit growth and the Basel III macro-prudential frame- work is the best policy mix to stabilize financial and real economic dynamics. However, as the Liquidity Coverage Ratio spurs financial instability by increasing the pro-cyclicality of banksù liquid reserves, a new counter-cyclical liquidity buffer should be added to Basel III to improve its performance further. Finally, we find that the Central Bank can also dampen financial in- stability by employing a new unconventional monetary-policy tool involving active management of the interest-rate corridor in the interbank market.
    Keywords: financial instability; interbank market freezes; monetary policy; macro-prudential policy; Basel III regulation; Tinbergen principle; agent-based models.
    Date: 2019–04–24
  2. By: Kronick, Jeremy M.; Villarreal, Francisco G.
    Abstract: This paper asks whether tepid inflation in Canada since the financial crisis can in part be explained by the effects of monetary policy on inequality. Using different structural vector autoregression models we show that expansionary monetary policy post-crisis has led to increased inequality as more resources are shifted away from lower-income individuals, which in general have higher marginal propensities to consume. As a result, aggregate demand has not risen as much as it otherwise would have, leading to a more muted inflationary response. Our results suggest that failure to account for the heterogeneity of consumption responses across the income distribution could lead to an underestimation of the magnitude of inflation’s response to a monetary policy shock.
    Keywords: monetary policy, inequality, inflation puzzles
    JEL: E25 E31 E52
    Date: 2019–04–23
  3. By: Belke, Ansgar; Gros, Daniel
    Abstract: The asset purchase programme of the euro area, active between 2015 and 2018, constitutes an interesting special case of Quantitative Easing (QE) because the ECB's Public Sector Purchase Programme (PSPP) involved the purchase of peripheral euro area government bonds, which were clearly not riskless. Moreover, these purchases were undertaken by national central banks at their own risk. Intuition suggests, and a simple model confirms, that, ceteris paribus, large purchases by a national central bank of the bonds of their own sovereign should increase the risk for the remaining private bond holders. This might seem incompatible with the observation that risk spreads on peripheral bonds fell when QE in the euro area was announced. However, the initial fall in risk premiums may have been due to expectations of the bond purchases proving effective in lowering risk-free rates. When these expectations were disappointed, risk premiums returned to their initial level. Formal statistical tests confirm that indeed risk premiums on peripheral bonds did not follow a random walk (contrary to what is assumed in event studies). Nor did the announcements of bond buying change the stochastics of these premiums. There is thus no reason to consider the impact effect to have been permanent.
    Keywords: European Central Bank,quantitative easing,unconventional monetary policies,spreads,structural breaks,time series econometrics
    JEL: E43 E58 G12 G15
    Date: 2019
  4. By: Thomas J. Carter; Xin Scott Chen; José Dorich
    Abstract: This note provides an update on Bank of Canada staff’s assessment of the Canadian neutral rate. The neutral rate is the policy rate needed to keep output at its potential level and inflation at target once the effects of any cyclical shocks have dissipated. This medium- to long-run concept serves as a benchmark for gauging the degree of monetary stimulus provided by a given policy setting. Staff’s overall assessment, which is based on the combined output of a suite of four distinct approaches, is that the Canadian neutral rate likely lies in a range of 2.25 to 3.25 per cent in nominal terms, lower than the range of 2.5 to 3.5 per cent reported at the time of the last update in April 2018. Although this downward shift stems mainly from a lower assessed global neutral rate, the overall assessment also reflects some improved modelling techniques enabling staff to better capture the medium- to long-run impact of macroeconomic risk on the level of the neutral rate. Moreover, while staff’s assessed range for the neutral rate captures important sources of uncertainty, it should not be interpreted as reflecting the full extent of the uncertainties surrounding the neutral rate.
    Keywords: Labour markets; Potential output; Productivity
    JEL: E40 E43 E50 E52 E58 F41
    Date: 2019
  5. By: Acharya, Viral V.; Imbierowicz, Björn; Steffen, Sascha; Teichmann, Daniel
    Abstract: We investigate the transmission of central bank liquidity to bank deposits and loan spreads in Europe over the January 2006 to June 2010 period. We find evidence consistent with an impaired transmission channel due to bank risk. Central bank liquidity does not translate into lower loan spreads for high-risk banks, even as it lowers deposit rates for both high-risk and low-risk banks. This adversely affects the balance sheets of high-risk bank borrowers, leading to lower payouts, lower capital expenditures, and lower employment. Overall, our results suggest that banks' capital constraints at the time of an easing of monetary policy pose a challenge to the effectiveness of the bank lending channel and the effectiveness of the central bank as a lender of last resort.
    Keywords: Central bank liquidity,Monetary policy transmission,Corporate deposits,Financial crisis,Lender of last resort,Banking crisis,Loans,Real effects
    JEL: E43 E58 G01 G21
    Date: 2019
  6. By: Giovanni Caggiano (Monash University and University of Padova); Efrem Castelnuovo (Melbourne Institute: Applied Economic & Social Research, The University of Melbourne); Gabriela Nodari (Reserve Bank of Australia)
    Abstract: We employ real-time data available to the US monetary policy makers to estimate a Taylor rule augmented with a measure of financial uncertainty over the period 1969-2008. We find evidence in favor of a systematic response to financial uncertainty over and above that to expected inflation, output gap, and output growth. However, this evidence regards the Greenspan-Bernanke period only. Focusing on this period, the "risk-management" approach is found to be responsible for monetary policy easings for up to 75 basis points of the federal funds rate.
    Keywords: Risk management-driven policy rate gap, uncertainty, monetary policy, Taylor rules, real-time data
    JEL: C2 E4 E5
    Date: 2018–08
  7. By: Jonas E Arias (FRB Philadelphia); Guido Ascari (University of Oxford, University of Pavia, Bank of Finland); Nicola Branzoli (Bank of Italy); Efrem Castelnuovo (Melbourne Institute: Applied Economic & Social Research, The University of Melbourne)
    Abstract: This paper studies the challenge that increasing the inflation target poses to equilibrium determinacy in a medium-sized New Keynesian model without indexation fitted to the Great Moderation era. For moderate targets of the inflation rate, such as 2 or 4 percent, the probability of determinacy is near one conditional on the monetary policy rule of the estimated model. However, this probability drops significantly conditional on model-free estimates of the monetary policy rule based on real-time data. The difference is driven by the larger response of the federal funds rate to the output gap associated with the latter estimates.
    Keywords: trend inflation, determinacy, monetary policy
    JEL: E52 E3 C22
    Date: 2018–07
  8. By: Ghosh, Sunandan; Kundu, Srikanta
    Abstract: We try to comprehensively analyze the nuances of Central Bank’s intervention in the foreign exchange market under a managed float exchange rate regime. We employ a three regime threshold VAR model and identify two endogenously determined threshold values of exchange rate cycle beyond which the Reserve Bank of India (RBI) intervenes in the Indian Rupee–US Dollar (Re/$) exchange rate market. We find that, as FIIs flow in, RBI’s interventions, mainly through open market operations, are successful in bringing the Re/$ exchange rate within the desired band. Within the band, the RBI tries only to mitigate domestic inflationary conditions.
    Keywords: Central bank intervention, Foreign exchange market, Managed float, Threshold VAR
    JEL: E58 F31
    Date: 2019–04–23
  9. By: Gyöngyösi, Győző; Ongena, Steven; Schindele, Ibolya
    Abstract: We study the impact of monetary conditions on the supply of mortgage credit by banks to households. Using comprehensive credit register data from Hungary, we first establish a "bank-lending-to-households" channel by showing that monetary conditions affect the supply of mortgage credit in volume. We then study the impact of monetary conditions on the composition of mortgage credit along its currency denomination and borrower risk. We find that expansionary domestic monetary conditions increase the supply of mortgage credit to all households in the domestic currency and to risky households in the foreign currency. Because most households are unhedged, bank lending in multiple currencies may involve additional risk taking. Changes in foreign monetary conditions affect lending in the foreign currency more than in the domestic currency, and also differ in their compositional impact along firm risk.
    Keywords: bank balance-sheet channel,household lending,monetary policy,foreign currency lending
    JEL: E51 F3 G21
    Date: 2019
  10. By: Latsos, Sophia
    Abstract: This paper scrutinizes the role of prolonged, expansionary monetary policy on the savings behavior of Japanese households, focusing on the dramatic change of the household savings behavior since 1998, from high to low savings. Existing literature generally attributes this behavioral change to the country's shift from a high-growth to a low-growth economy and its demographic change. In contrast, this paper empirically examines changes in the incentives for saving and the ability to save connected to monetary policy. It finds that monetary policy has had a significant impact on Japan's household behavior via three channels: the interest rate channel, the redistribution channel, and the wealth channel.
    Keywords: household saving,interest-rate elasticity of saving,Japanese household savings,Bank of Japan,low interest rate policy
    JEL: E21 E52
    Date: 2019
  11. By: Kohei Hasui (Faculty of Economics, Matsuyama University); Teruyoshi Kobayashi (Faculty of Economics, Kobe University); Tomohiro Sugo (Bank of Japan)
    Abstract: Real-world central banks have a strong aversion to policy reversals. Nevertheless, theoretical models of monetary policy within the dynamic general equilibrium framework normally ignore the irreversibility of interest rate control. In this paper, we develop a formal model that incorporates a central bank's discretionary optimization problem with an aversion to policy reversals. We show that, even under a discretionary regime, the optimal timing of liftoff from the zero lower bound is characterized by its history dependence, which arises from the option value to waiting, and there exists an optimal degree of reversal aversion at which the social loss is minimized.
    Keywords: Monetary policy, policy irreversibility, reversal aversion, liquidity trap
    JEL: E31 E52 E58 E61
    Date: 2019–04
  12. By: Eo, Yunjong; Kang, Kyu Ho
    Abstract: The period of unconventional monetary policy in the low-interest rate environment since the Great Recession has suggested that unconventional policy has a different transmission mechanism to the term structure of interest rates from that of conventional policy. We study how conventional and unconventional monetary policies affect forecasting performance of individual yield curve models and their mixtures. The individual models considered here are the dynamic Nelson-Siegel model, the arbitrage-free Nelson-Siegel model, and the random-walk model. Out-of-sample forecasts for U.S. bond yields show that the arbitrage-free Nelson-Siegel model and its mixtures with other models perform well in the period of conventional monetary policy, whereas the random-walk model outperforms all the other models in the period of unconventional monetary policy. We show that the tightly constrained cross-equation restrictions of the no-arbitrage condition are associated with high correlations of bond yields across different maturities. The diminishing role of the no-arbitrage restriction in forecasting the yield curve since 2009 can be attributed to unconventional monetary policy, which involved direct purchases of long-term bonds while the short-term interest rates were stuck near zero. This policy resulted in low correlations between short- and long-term bond yields and little variation in the short-term bond yields. The random-walk model performs well when the yields are less correlated and exhibit little variation over time. During the period of the maturity extension program (“Operation Twist”) in 2011-2012, which moved short- and long-term bond yields in opposite directions, the superiority of the random-walk forecasts is more pronounced; these results reinforce our finding that the monetary policy framework affects yield curve forecasts.
    Keywords: Quantitative Easing; Operation Twist; Dynamic Nelson-Siegel model; Arbitrage-free term structure model; Random-walk model; Markov-switching mixture;
    Date: 2019–04
  13. By: Paul R. Bergin; Giancarlo Corsetti
    Abstract: Motivated by the long-standing debate on the pros and cons of competitive devaluation, we propose a new perspective on how monetary and exchange rate policies can contribute to a country’s international competitiveness. We refocus the analysis on the implications of monetary stabilization for a country’s comparative advantage. We develop a two-country New-Keynesian model allowing for sectoral differences in the production of tradables in each economy: while in one sector firms are perfectly competitive, in another sector firms produce differentiated goods under monopolistic competition and subject to nominal rigidities, hence their performance is more sensitive to macroeconomic uncertainty. We show that, by stabilizing inflation and the output gap, monetary policy can foster the competitiveness of these firms, encouraging investment and entry in the differentiated goods sector, and ultimately affecting the composition of domestic output and exports. Welfare implications of alternative monetary policy rules that shift comparative advantage are found to be substantial in a calibrated version of the model.
    JEL: F41
    Date: 2019–04
  14. By: Lakdawala, Aeimit (Michigan State University, Department of Economics); Bauer, Michael (Federal Reserve Bank of San Francisco); Mueller, Philippe (Warwick Business School)
    Abstract: This paper investigates the role of monetary policy uncertainty for the transmission of FOMC actions to financial markets using a novel model-free measure of uncertainty based on derivative prices. We document a systematic pattern in monetary policy uncertainty over the course of the FOMC meeting cycle: On FOMC announcement days uncertainty tends to decline substantially, indicating the resolution of policy uncertainty. This decline is then reversed over the first two weeks of the intermeeting FOMC cycle. Both the level and the changes in uncertainty play an important role for the transmission of monetary policy to financial markets. First, changes in uncertainty have substantial effects on a variety of asset prices that are distinct from the effects of the conventional policy surprise measure. For example, the Fed's forward guidance announcements affected asset prices not only by adjusting the expected policy path but also by changing market-perceived uncertainty about this path. Second, at high levels of uncertainty a monetary policy surprise has only modest effects on assets, whereas with low uncertainty the impact is significantly more pronounced.
    Keywords: monetary policy uncertainty; Federal Reserve; event study; monetary transmission; implied volatility
    JEL: E43 E44 E47
    Date: 2019–04–12

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