nep-cba New Economics Papers
on Central Banking
Issue of 2019‒05‒20
fifteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Predicting China’s Monetary Policy with Forecast Combinations By Pauwels, Laurent
  2. Shocking Interest Rate Floors By Fabio Canetg, Daniel Kaufmann
  3. Gains from Wage Flexibility and the Zero Lower Bound By Billi, Roberto; Galí, Jordi
  4. Designing a Simple Loss Function for Central Banks: Does a Dual Mandate Make Sense? By Debortoli, Davide; Kim, Jinill; Lindé, Jesper; Nunes, Ricardo
  5. The Struggle Towards Macroeconomic Stability: Analytical Essay By Assaf Razin
  6. Bank capital forbearance By Martynova, Natalya; Perotti, Enrico; Suarez, Javier
  7. Measuring Inflation Uncertainty in Turkey By Eda Gulsen; Hakan Kara
  8. Tying down the anchor: monetary policy rules and the lower bound on interest rates By Mertens, Thomas M.; Williams, John C.
  9. Welfare and Political Economy Aspects of a Central Bank Digital Currency By Cukierman, Alex
  10. Implications of the permanent-transitory confusion for New-Keynesian modeling, inflation forecasts and the post-crisis era By Cukierman, Alex
  11. Global Liquidity and the Impairment of Local Monetary Policy Transmission By Salih Fendoglu; Eda Gulsen; Josè-Luis Peydro
  12. Financial Stability and the Fed: Evidence from Congressional Hearings By Arina Wischnewsky; David-Jan Jansen; Matthias Neuenkirch
  13. The Interaction Between Fiscal and Monetary Policies: Evidence from Sweden By Ankargren, Sebastian; Shahnazarian, Hovick
  14. Insulating property of the flexible exchange rate regime: A case of Central and Eastern European countries By Dąbrowski, Marek A.; Wróblewska, Justyna
  15. A game theory approach to optimizing the banking and financial resolution framework By Gabriel Mitache

  1. By: Pauwels, Laurent
    Abstract: China’s monetary policy is unconventional and constantly evolving as a result of its rapid economic development. This paper proposes to use forecast combinations to predict the People’s Bank of China’s monetary policy stance with a large set of 73 macroeconomic and financial predictors covering various aspects of China’s economy. The multiple instruments utilised by the People’s Bank of China are aggregated into a Monetary Policy Index (MPI). The intention is to capture the overall monetary policy stance of the People’s Bank of China into a single variable that can be forecasted. Forecast combination assign weights to predictors according to their forecasting performance to produce a consensus forecast. The out-of-sample forecast results demonstrate that optimal forecast combinations are superior in predicting the MPI over other models such as the Taylor rule and simple autoregressive models. The corporate goods price index and the US nominal effective exchange rate are the most important predictors.
    Keywords: Monetary policy indicators; China; forecast combination; optimal weights
    Date: 2019–05–14
  2. By: Fabio Canetg, Daniel Kaufmann
    Abstract: We identify the dynamic causal effects of interest rate floor shocks, exploiting regular auctions of Swiss central bank debt securities (SNB Bills). A theoretical model shows that variation in the volume of, and yield on, central bank debt changes the interest rate floor. In addition, the model establishes the equivalence between central bank debt and interest-bearing reserves when reserves are ample. Based on these insights, the empirical analysis identifies an interest rate floor shock in a dynamic event study of SNB Bill auctions. A restrictive interest rate floor shock causes an increase in the money market rate, a persistent appreciation of the Swiss franc, a decline in long-term interest rates, and a decline in stock prices. We then perform policy experiments under various identifying assumptions in which the central bank raises the interest rate floor from 0% to 0.25%. Such a policy change causes a 3-6% appreciation of the Swiss franc and a 5-20% decline in stock prices
    Keywords: Exit strategies, interest rate floors, central bank debt securities, interest on reserves, monetary policy shocks, identification through heteroscedasticity
    JEL: E41 E43 E44 E52 E58 C32
    Date: 2019–05
  3. By: Billi, Roberto (Research Department, Central Bank of Sweden); Galí, Jordi (CREI, UPF and Barcelona GSE)
    Abstract: We analyze the welfare impact of greater wage exibility while taking into account explicitly the existence of the zero lower bound (ZLB) constraint on the nominal interest rate. We show that the ZLB constraint generally amplifies the adverse effects of greater wage exibility on welfare when the central bank follows a conventional Taylor rule. When demand shocks are the driving force, the presence of the ZLB implies that an increase in wage exibility reduces welfare even under the optimal monetary policy with commitment.
    Keywords: labor market exibility; nominal rigidities; optimal monetary policy with commitment; Taylor rule; ZLB
    JEL: E24 E32 E52
    Date: 2019–03–01
  4. By: Debortoli, Davide (UPF, CREI and Barcelona GSE); Kim, Jinill (Korea University); Lindé, Jesper (Research Department, Central Bank of Sweden); Nunes, Ricardo (University of Surrey and CIMS)
    Abstract: Yes, it makes a lot of sense. This paper studies how to design simple loss functions for central banks, as parsimonious approximations to social welfare. We show, both analytically and quantitatively, that simple loss functions should feature a high weight on measures of economic activity, sometimes even larger than the weight on inflation. Two main factors drive our result. First, stabilizing economic activity also stabilizes other welfare-relevant variables. Second, the estimated model features mitigated inflation distortions due to a low elasticity of substitution between monopolistic goods and a low interest rate sensitivity of demand. The result holds up in the presence of measurement errors, with large shocks that generate a trade-off between stabilizing inflation and resource utilization, and also when imposing a moderate degree of interest rate volatility.
    Keywords: Central banksobjectives; simple loss function; monetary policy design; sticky prices and sticky wages; DSGE models
    JEL: C32 E58 E61
    Date: 2018–07–01
  5. By: Assaf Razin
    Abstract: This essay offers an economic-history perspective of the long struggle towards macroeconomic stability. The paper is a broad analytical overview of major exogenous shocks and shifts in macroeconomic policy and institutions in Israel since the 1977-1985 great inflation through the global financial crisis and the effects of those shifts on long term growth, inflation, the business cycle, the Phillips curve and related economic developments. The paper will discuss three main issues. The first one on the inflation crisis focuses on the 1985 stabilization and on its impact on subsequent reform of monetary institutions. The second discusses the impact of globalization on growth, inflation and the Phillips curve. The third contains a discussion of the reasons for the relatively good performance of Israel during the 2008 global crisis, including foreign exchange market intervention. Henceforth we highlight: (1) the role of macro-populism in generating hyperinflation; (2) the role of seigniorage revenue in generating the hyperinflation; (3) distributive effects of inflation stabilization, which are political driving forces behind the need for across-the-broad-coalition for a successful stabilization policy; (4) the effects of globalization on the Philips Curve and thereby on domestic inflation-- means of transforming an inflation regime to a one with price stability; (5) the role of financial prudence regulatory institutions, which serve to explain the Israeli macroeconomic robustness in the face of the 2008 external depression-deflation global forces; and, (6) Israel’s government-deficit and money-creation experience, which help evaluate recent theory—the Modern Monetary Theory (MMT).
    JEL: E0 F0
    Date: 2019–05
  6. By: Martynova, Natalya; Perotti, Enrico; Suarez, Javier
    Abstract: We analyze the strategic interaction between undercapitalized banks and a supervisor who may intervene by preventive recapitalization. Supervisory forbearance emerges because of a commitment problem, reinforced by fiscal costs and constrained capacity. Private incentives to comply are lower when supervisors have lower credibility, especially for highly levered banks. Less credible supervisors (facing higher cost of intervention) end up intervening more banks, yet producing higher forbearance and systemic costs of bank distress. Importantly, when public intervention capacity is constrained, private recapitalization decisions become strategic complements, leading to equilibria with extremely high forbearance and high systemic costs of bank failure. JEL Classification: G21, G28
    Keywords: bank recapitalization, bank supervision, forbearance
    Date: 2019–05
  7. By: Eda Gulsen; Hakan Kara
    Abstract: Measuring and monitoring inflation uncertainty is an essential ingredient of monetary policy analysis. This study constructs survey measures of inflation uncertainty for the Turkish economy. Using density and point inflation forecasts in the CBRT Survey of Expectations, we derive various uncertainty measures through standard deviation, entropy, and disagreement among forecasters. Our results suggest that survey-based inflation uncertainty measures are broadly consistent with market-implied indicators of inflation risk. Moreover, we find that an increase in observed inflation is associated with higher inflation uncertainty across all empirical specifications.
    Keywords: Inflation uncertainty, Inflation, Survey data, Density forecasts, Disagreement
    JEL: C53 E31 E37 E58
    Date: 2019
  8. By: Mertens, Thomas M. (Federal Reserve Bank of San Francisco); Williams, John C. (Federal Reserve Bank of New York)
    Abstract: This paper uses a standard New Keynesian model to analyze the effects and implementation of various monetary policy frameworks in the presence of a low natural rate of interest and a lower bound on interest rates. Under a standard inflation-targeting approach, inflation expectations will be anchored at a level below the inflation target, which in turn exacerbates the deleterious effects of the lower bound on the economy. Two key themes emerge from our analysis. First, the central bank can eliminate this problem of a downward bias in inflation expectations by following an average-inflation targeting framework that aims for above-target inflation during periods when policy is unconstrained. Second, dynamic strategies that raise inflation expectations by keeping interest rates “lower for longer” after periods of low inflation can both anchor expectations at the target level and further reduce the effects of the lower bound on the economy.
    Keywords: monetary policy; inflation expectations; lower bound; inflation target
    JEL: E52
    Date: 2019–05–01
  9. By: Cukierman, Alex
    Abstract: The point of departure of this paper is that, in order to preserve the effectiveness of monetary policy in a world increasingly flooded by private digital currencies, central banks will eventually have to issue their own digital currencies. Although a non-negligible number of central banks (CBs) are actively considering the pros and cons of a central bank digital currency (CBDC) there is yet no CB that has issued such a currency on a full scale. Following a brief survey of current CBs positions on the issuance of a CBDC the paper presents two proposals for the implementation of such a currency: A moderate proposal in which only the banking sector continues to have access to deposits at the CB and a radical one in which the entire private sector is allowed to hold digital currency deposits at the CB. The paper compares and contrasts the implications of those two polar paths to a CBDC for the funding of banks, the allocation of credit to the economy and their implications for welfare as well as for political feasibility. One section of the paper shows that the radical implementation may pave the way toward a narrow banking system and dramatically reduce the need for deposit insurance in the long run. The paper evaluates the relative merits of issuing a currency on a blockchain using a permissionless distributed ledger technology in comparison to a centralized (permissioned) blockchain ledger operated by the CB and concludes that the latter dominates the former in more than one dimension. But it does acknowledge that distributed ledger technologies have many actual and potential cost savings benefits in other segments of the financial and real sectors.
    Keywords: blockchain technology; Central bank digital currency; centralized versus decentralized currencies; narrow banking; permissioned; permissionless
    JEL: E4 E5 H41
    Date: 2019–05
  10. By: Cukierman, Alex
    Abstract: Decisions about consumption, work, leisure, pricing, investment and other private and public policy decisions rely on forecasts of the future. The permanent-transitory confusion (PTC) refers to the fact that even when they know all past and current information individuals are uncertain about the persistence of the current state. This all pervasive informational limitation makes it optimal, in general, to use all past information when forecasting the future even under rational expectations. The objective of this paper is to remind the profession of this basic fact and point out some of its implications by showing at both the theoretical and the empirical levels that forecasts of the future are generally adaptive in the sense that they depend on available past information even when information is utilized efficiently. This is done along the following dimensions. First by briefly surveying the literature on rational-adaptive expectations from Muth (1960) to Coibion-Gorodnichenko (2015). Second, by showing that the PTC injects the past even into purely forward looking New-Keynesian such as that of Clarida, Gali & Gertler (1999). Third, by showing empirically that inflationary expectations in the US Survey of Professional Forecasters rely on past inflation. The paper concludes with reflections on the persistence of economic and policy changes induced by the global financial crisis.
    Keywords: inflationary expectations; Permanent-transitory confusion; rationally adaptive expectations â?? implications for New-Keynesian framework
    JEL: D84 E12 E31
    Date: 2019–05
  11. By: Salih Fendoglu; Eda Gulsen; Josè-Luis Peydro
    Abstract: We show that global liquidity limits the transmission of local monetary policy on credit markets. For identification, we exploit global liquidity shocks in conjunction with monetary policy changes and exhaustive loan-level data (the credit and international interbank market registers) from a large emerging market, Turkey. We show that softer global liquidity conditions —proxied by lower VIX or expansionary US monetary policy— attenuate the pass-through of local monetary policy tightening on loan rates, especially for banks that borrow ex-ante more from international wholesale markets. Effects are also important for other credit margins and for bank risk-taking —especially for risky borrowers in FX loans. The mechanism at work is via a bank carry trade from international markets when local monetary conditions tighten.
    Keywords: Global liquidity, Global financial cycle, Monetary policy transmission, Emerging markets, Banks
    JEL: E52 F30 G01 G15 G21
    Date: 2019
  12. By: Arina Wischnewsky; David-Jan Jansen; Matthias Neuenkirch
    Abstract: This paper retraces how financial stability considerations interacted with U.S. monetary policy before and during the Great Recession. Using text-mining techniques, we construct indicators for financial stability sentiment expressed during testimonies of four Federal Reserve Chairs at Congressional hearings. Including these text-based measures adds explanatory power to Taylor-rule models. In particular, negative financial stability sentiment coincided with a more accommodative monetary policy stance than implied by standard Taylor-rule factors, even in the decades before the Great Recession. These findings are consistent with a preference for monetary policy reacting to financial instability rather than acting pre-emptively to a perceived build-up of risks.
    Keywords: monetary policy, financial stability, Taylor rule, text mining
    JEL: E52 E58 N12
    Date: 2019
  13. By: Ankargren, Sebastian (Uppsala University); Shahnazarian, Hovick (Monetary Policy Department, Central Bank of Sweden)
    Abstract: This paper estimates the interaction between monetary- and fiscal policy using a structural VAR model with time-varying parameters. For demand and supply shocks, the two policies are estimated to be complementary, while for monetary and fiscal policies shocks the two policies act as substitutes. The budget elasticity varies between 0.3–0.6, indicating that an economic downturn can get a non-negligible negative impact on public finances. The fiscal multiplier is estimated to be stable and higher than one suggesting that fiscal policy can be used to support monetary policy to stabilize the economy in case monetary policy is constrained by the lower effective bound.
    Keywords: Fiscal policy; monetary policy; time-varying parameter structural VAR; zero and sign restrictions; Bayesian estimation
    JEL: C11 C32 E52 E62 E63
    Date: 2019–02–01
  14. By: Dąbrowski, Marek A.; Wróblewska, Justyna
    Abstract: We examine the insulating property of flexible exchange rate in CEE economies using the fact that they have adopted different regimes. A set of Bayesian structural VAR models with common serial correlations is estimated on data spanning 1998q1-2015q4. The long-term identifying restrictions are derived from a macroeconomic model. We find that irrespective of the exchange rate regime output is driven mainly by real shocks. Its reactions to these shocks, however, are substantially stronger under less flexible regimes, whereas the responses to nominal shocks are similar. Hence, the insulating property of flexible regimes can reduce the costs from economic shocks.
    Keywords: open economy macroeconomics; exchange rate regimes; real and nominal shocks; Bayesian structural VAR; common serial correlation
    JEL: C11 E44 F33 F41
    Date: 2019–05–09
  15. By: Gabriel Mitache (Academy of Economic Studies, Bucharest and National Bank of Romania)
    Abstract: Before the 2007-2008 financial crisis, creditinstitutions were assured (though not officially or formally) that if they were large enough they would be rescued with tax-payers’ money, an action also known as bail-out, denoting what became known as the “too big to fail” paradigm. The introduction of the Bank Recovery and Resolution Directive (2014/59/EU) proposes a legal framework that aims at eliminating the possibility of bailing-out institutions. This paper has the objective of assessing througha game theory approachto what extent the BRRDirectivehas the potential to achieve its purpose and if there are identifiable possible improvements to this framework that could be considered for practical purposes or for a possible future review of the legal framework.The term institution, for the purpose of this paper, refers to credit institutions but can also be read as referring to other types of financial institutions such as investment firms or insurance companies
    Keywords: banking, banking union, bank resolution, central banking, bank recovery, bank supervision, BRRD, game theory
    JEL: D04 E61 G18 G21 G28 H12 K23
    Date: 2018–05

This nep-cba issue is ©2019 by Sergey E. Pekarski. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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