nep-cba New Economics Papers
on Central Banking
Issue of 2019‒07‒29
fifteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)* By Cristina Arellano; Yan Bai
  2. Macroprudential policy at the ECB: Institutional framework, strategy, analytical tools and policies By Cabral, Inês; Detken, Carsten; Fell, John; Henry, Jérôme; Hiebert, Paul; Kapadia, Sujit; Pires, Fatima; Salleo, Carmelo; Constâncio, Vítor; Altimar, Sergio Nicoletti
  3. The ECB’s monetary pillar after the financial crisis By T. Philipp Dybowski; Bernd Kempa
  4. Distributional impacts of low for long interest rates By Kronick, Jeremy M.; Villarreal, Francisco G.
  5. A New Look at Historical Monetary Policy and the Great Inflation through the Lens of a Persistence-Dependent Policy Rule By Ashley, Richard; Tsang, Kwok Ping; Verbrugge, Randal
  6. Evaluating Central Banks' Tool Kit: Past, Present, and Future By Eric R. Sims; Jing Cynthia Wu
  7. The Founding of the Federal Reserve, the Great Depression and the Evolution of the U.S. Interbank Network By Matthew S. Jaremski; David C. Wheelock
  8. Global Capital Flows and the Role of Macroprudential Policy By Sudipto Karmakar; Diogo Lima
  9. Monetary Policy, Housing Rents and Inflation Dynamics By Daniel A. Dias; Joao B. Duarte
  10. Going Dutch: The management of monetary policy in the Netherlands during the interwar gold standard By Colvin, Christopher L.; Fliers, Philip
  11. Growing and collapsing bubbles By Keiichiro Kobayashi
  12. Bounded Rationality, Monetary Policy, and Macroeconomic Stability By Francisco Ilabaca; Greta Meggiorini; Fabio Milani
  13. The benefits and costs of adjusting bank capitalisation: evidence from euro area countries By Katarzyna Budnik; Gaia Barbic; Giulio Nicoletti; Massimiliano Affinito; Fabrizio Venditti; Saiffedine Ben Hadj; Hans Dewachter; Edouard Chretien; Clara Isabel González; Javier Mencía; Jenny Hu; Jairo Rivera-Rozo; Lauri Jantunen; Otso Manninen; Ramona Jimborean; Ricardo Martinho; Ana Regina Pereira; Elena Mousarri; Constantinos Trikoupis; Laurynas Naruševicius; Michael O’Grady; Sofia Velasco; Selcuk Ozsahin
  14. Is the financial system sufficiently resilient: a research programme and policy agenda By Paul Tucker
  15. Behavioural Macroeconomic Policy: New perspectives on time inconsistency By Michelle Baddeley

  1. By: Cristina Arellano; Yan Bai
    Abstract: This paper develops a New Keynesian model with sovereign debt and default. We focus on domestic interest rules governing monetary policy and external foreign currency government debt that is defaultable. Monetary policy and default risk interact as they both impact domestic consumption and production. We find that default risk generates monetary frictions, which amplify the monetary response to shocks. Large sovereign default risk depresses domestic consumption and production. These monetary frictions in turn discipline sovereign borrowing, resulting in slower debt accumulation and lower spreads. Our framework replicates the positive co-movements of sovereign spreads with domestic nominal rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and sovereign spreads. A counterfactual experiment shows that, by raising the domestic rate, the Brazilian central bank not only reduced inflation but also alleviated the debt crisis.
    Date: 2019
  2. By: Cabral, Inês; Detken, Carsten; Fell, John; Henry, Jérôme; Hiebert, Paul; Kapadia, Sujit; Pires, Fatima; Salleo, Carmelo; Constâncio, Vítor; Altimar, Sergio Nicoletti
    Abstract: This occasional paper describes how the financial stability and macroprudential policy functions are organised at the ECB. Financial stability has been a key policy function of the ECB since its inception. Macroprudential policy tasks were later conferred on the ECB by the Single Supervisory Mechanism (SSM) Regulation. The paper describes the ECB’s macroprudential governance framework in the new institutional set-up. After reviewing the concept and origins of systemic risk, it reflects on the emergence of macroprudential policy in the aftermath of the financial crisis, its objectives and instruments, as well as specific aspects of this policy area in a monetary union such as the euro area. The ECB’s responsibilities required new tools to be developed to measure systemic risk at financial institution, country and system-wide level. The paper discusses selected analytical tools supporting financial stability surveillance and assessment work, as well as macroprudential policy analysis at the ECB. The tools are grouped into three broad areas: (i) methods to gauge the state of financial instability or prospects of near-term systemic stress, (ii) measures to capture the build-up of systemic risk focused on country-level financial cycle measurement and early warning methods, and (iii) the ECB stress testing framework for macroprudential purposes. JEL Classification: E37, F36, G20, G28, K23
    Keywords: ESRB, financial imbalances, financial regulation, Financial stability, macroprudential, monetary policy, SSM, stress testing, systemic risk
    Date: 2019–07
  3. By: T. Philipp Dybowski; Bernd Kempa
    Abstract: We apply a structural topic model (STM) to analyze European Central Bank (ECB) communication regarding the monetary pillar of its monetary policy strategy. We do so by quantifying the transcripts of the ECB Presidents introductory statements at the press conferences that accompany the regular meetings of the ECB Governing Council. Our evidence shows that, within its monetary pillar, the ECB has gradually shifted its focus away from a genuine monetary analysis towards monitoring the stability of the European financial system. We go on to augment a standard Taylor rule by quantitative indicators obtained from the STM to assess whether the monetary pillar in general, and the shift in focus in particular, has had a measurable impact on the ECBs monetary policy stance. We find weak evidence that the monetary analysis has had a bearing on the ECBs interest rate setting in the early years of the ECB's existence, but this influence completely disappears in the latter years of the sample. We also find that after the financial crisis, the monetary policy response to its financial sentiment communication has been accommodative rather than "leaning against the wind".
    Keywords: ECB, monetary policy, central bank communication, topic models
    JEL: C11 E52 E58
    Date: 2019–07
  4. 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 offset otherwise falling inequality through the shifting of resources 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 overestimation of the magnitude of inflation’s response to a monetary policy shock.
    Date: 2019–07–18
  5. By: Ashley, Richard (Virginia Tech); Tsang, Kwok Ping (Virginia Tech); Verbrugge, Randal (Federal Reserve Bank of Cleveland)
    Abstract: The origins of the Great Inflation, a central 20th century U.S. macroeconomic event, remain contested. Prominent explanations are poor forecasts or deficient activity gap estimates. An alternative view: the FOMC was unwilling to fight inflation, perhaps due to political pressures. Our findings, based on a novel approach, support the latter view. New econometric tools allow us to credibly identify the particular activity gap, if any, in use. Persistence-dependent unemployment (gap) responses in the 1970s were essentially the same pre- and post-Volcker. Conversely, FOMC behavior vis-à-vis inflation—also persistence-dependent—changed markedly starting with Volcker, consistent with (though not proving) the political pressures view.
    Keywords: Taylor Rule; Great Inflation; Intermediate Target; Natural Rate; Persistence Dependence;
    JEL: C22 C32 E52
    Date: 2019–07–18
  6. By: Eric R. Sims; Jing Cynthia Wu
    Abstract: We develop a structural DSGE model to systematically study the principal tools of unconventional monetary policy – quantitative easing (QE), forward guidance, and negative interest rate policy (NIRP) – as well as the interactions between them. To generate the same output response, the requisite NIRP and forward guidance interventions are twice as large as a conventional policy shock, which seems implausible in practice. In contrast, QE via an endogenous feedback rule can alleviate the constraints on conventional policy posed by the zero lower bound. Quantitatively, QE1-QE3 can account for two thirds of the observed decline in the “shadow” Federal Funds rate. In spite of its usefulness, QE does not come without cost. A large balance sheet has consequences for different normalization plans, the efficacy of NIRP, and the effective lower bound on the policy rate.
    JEL: E10 E32 E5 E52 E58
    Date: 2019–07
  7. By: Matthew S. Jaremski; David C. Wheelock
    Abstract: Financial network structure is an important determinant of systemic risk. This paper examines how the U.S. interbank network evolved over a long and important period that included two key events: the founding of the Federal Reserve and the Great Depression. Banks established connections to correspondents that joined the Federal Reserve in cities with Fed offices, initially reducing overall network concentration. The network became even more focused on Fed cities during the Depression, as survival rates were higher for banks with more existing connections to Fed cities, and as survivors established new connections to those cities over time.
    JEL: G21 L14 N22
    Date: 2019–07
  8. By: Sudipto Karmakar; Diogo Lima
    Abstract: Can countercyclical bank capital requirements reduce the negative effects ofglobal liquidity shocks? We use the Lehman Brothers bankruptcy as a natural experiment to document the role of the banking system as a transmission channel of global financial disturbances to domestic economies. Using granular and confidential data from the Bank of Portugal, our results suggest that in the aftermath of the Lehman collapse, domestic firms cut investment by 14% and employment by 2.3%.In order to evaluate the effectiveness of macroprudential regulation, we model an open-economy with a banking sector borrowing from domestic and in-ternational depositors. We show that, during a financial crises, in an economy with counter cyclical bank capital requirements(compared with an economy with constant capital requirements):(i) gross domestic product falls 5 p.p. less and (ii)the fall in investment is 3 p.p. lower. We show that imposing countercyclical capital requirements entails a trade-off between lower volatility and lower economic activity.Overall, we find that countercyclical bank capital requirements may not be welfare improving for the Portuguese economy.
    Date: 2019–07
  9. By: Daniel A. Dias; Joao B. Duarte
    Keywords: Monetary policy ; Housing rents ; Inflation dynamics ; “Price puzzle” ; Housing tenure
    JEL: E31 E43 R21
    Date: 2019–05–23
  10. By: Colvin, Christopher L.; Fliers, Philip
    Abstract: Under what conditions can policymakers make demonstrably poor policy choices? By providing a new account of monetary policy management in the Netherlands during the interwar gold standard, we show how policymakers can fail to escape their long-held beliefs and refuse to consider available policy alternatives. Using high-frequency macroeconomic data, we are the first to document that the Netherlands' policymakers were able to conduct an independent monetary policy in the 1930s. We then show how this independence was squandered on fixing the guilder's exchange rate, a policy which led only to deflation, trade deficits, corporate bankruptcies and mass unemployment. We explain the government's policy stance by documenting the beliefs of politicians and central bankers, and then by investigating how business leaders and public intellectuals attempted to influence these beliefs.
    Keywords: monetary policy,exchange rate policy,gold standard,interwar period,the Netherlands
    JEL: N14 E42 E52 E58
    Date: 2019
  11. By: Keiichiro Kobayashi
    Abstract: The large fluctuations of asset prices in financial crises are modeled as creditdriven bubbles, where agency problems in the banking sector raise the asset prices to unsustainable levels. The peak of a bubble and the timing of its collapse can be predictable because the bubble collapses when the price hits an endogenous threshold that is determined by structural parameters. Tighter monetary policy can dampen the size of the bubble, whereas tighter prudential regulations that cause credit rationing may exacerbate the bubble. Our theory recommends leaning against the bubbly wind, rather than screening the borrowers, as a stabilization policy.
    Date: 2019–04
  12. By: Francisco Ilabaca; Greta Meggiorini; Fabio Milani
    Abstract: This paper estimates a Behavioral New Keynesian model to revisit the evidence that passive US monetary policy in the pre-1979 sample led to indeterminate equilibria and sunspot-driven fluctuations, while active policy after 1982, by satisfying the Taylor principle, was instrumental in restoring macroeconomic stability. The model assumes “cognitive discounting”, i.e., consumers and firms pay less attention to variables further into the future. We estimate the model allowing for both determinacy and indeterminacy. The empirical results show that determinacy is preferred both before and after 1979. Even if monetary policy is found to react only mildly to inflation pre-Volcker, the substantial degrees of bounded rationality that we estimate prevent the economy from falling into indeterminacy.
    Keywords: Behavioral New Keynesian model, cognitive discounting, estimation under determinacy and indeterminacy, Taylor principle, active vs passive monetary policy
    JEL: E31 E32 E52 E58
    Date: 2019
  13. By: Katarzyna Budnik (European Central Bank); Gaia Barbic (European Central Bank); Giulio Nicoletti (European Central Bank); Massimiliano Affinito (Banca d’Italia); Fabrizio Venditti (Banca d’Italia); Saiffedine Ben Hadj (Banque Nationale de Belgique/Nationale Bank van België); Hans Dewachter (Banque Nationale de Belgique/Nationale Bank van België); Edouard Chretien (Autorité de contrôle prudentiel et de résolution); Clara Isabel González (Banco de España); Javier Mencía (Banco de España); Jenny Hu (De Nederlandsche Bank); Jairo Rivera-Rozo (De Nederlandsche Bank); Lauri Jantunen (Suomen Panki); Otso Manninen (Suomen Panki); Ramona Jimborean (Banque de France); Ricardo Martinho (Banco de Portugal); Ana Regina Pereira (Banco de Portugal); Elena Mousarri (Central Bank of Cyprus); Constantinos Trikoupis (Central Bank of Cyprus); Laurynas Naruševicius (Lietuvos Bankas); Michael O’Grady (Central Bank of Ireland); Sofia Velasco (Central Bank of Ireland); Selcuk Ozsahin (Banca Slovenije)
    Abstract: The paper proposes a framework for assessing the impact of system-wide and bank-level capital buffers. The assessment rests on a factor-augmented vector autoregression (FAVAR) model that relates individual bank adjustments to macroeconomic dynamics. We estimate FAVAR models individually for eleven euro area economies and identify structural shocks, which allow us to diagnose key vulnerabilities of national banking systems and estimate short-run economic costs of increasing banks’ capitalisation. On this basis, we run a fullyfledged cost-benefit assessment of an increase in capital buffers. The benefits are related to an increase in bank resilience to adverse shocks. Higher capitalisation allows banks to withstand negative shocks and moderates the reduction of credit to the real economy that ensues in adverse circumstances. The costs relate to transitory credit and output losses that are assessed both on an aggregate and bank level. An increase in capital ratios is shown to have a sharply different impact on credit and economic activity depending on the way banks adjust, i.e. via changes in assets or equity.
    Keywords: FAVAR, capital regulation, cost-benefit analysis, banking system resilience
    JEL: E51 G21 G28
    Date: 2019–07
  14. By: Paul Tucker
    Abstract: The paper discusses why the financial system is not as resilient as policymakers currently claim - despite extensive regulatory reforms from a very weak starting point.The paper discusses different policy strategies for making some of the debt of some banks "information-insensitive", so that they it would be treated as safe in all but the most stressed circumstances. For the current prudential strategy, which is centred on minimum equity requirements, the paper argues that central banks and other agencies should start publishing annual staff reports on where regulatory and supervisory policy has been surreptitiously tightened or loosened.The paper aims to spark and contribute to the debate on the second phase of stability reforms that will be needed. It sets out an alternative policy strategy based on 100% liquidity cover for the short-term debt of banks (and shadow banks), and for the creditor hierarchy of operating banks and holding companies. In this proposal, the haircut policy of central banks would become the key instrument in determining bank equity requirements and the terms on which they could borrow in secured money markets. As such, this strategy would operationalise the theoretical and empirical work of Bengt Holmström and Gary Gorton.
    Keywords: regulatory reforms, Basel III, great financial crisis
    JEL: E44 E58 G28
    Date: 2019–07
  15. By: Michelle Baddeley
    Abstract: This paper brings together divergent approaches to time inconsistency from macroeconomic policy and behavioural economics. Behavioural discount functions from behavioural microeconomics are embedded into a game-theoretic analysis of temptation versus enforcement to construct an encompassing model, nesting combinations of time consistent and time inconsistent preferences. The analysis presented in this paper shows that, with hyperbolic/quasihyperbolic discounting, the enforceable range of inflation targets is narrowed. This suggests limits to the effectiveness of monetary targets, under certain conditions. The paper concludes with a discussion of monetary policy implications, explored specifically in the light of current macroeconomic policy debates.
    Date: 2019–07

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