nep-cba New Economics Papers
on Central Banking
Issue of 2019‒08‒12
eighteen 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. Monetary policy, macroprudential policy, and financial stability By Martinez-Miera, David; Repullo, Rafael
  3. Macroprudential Regulation and Leakage to the Shadow Banking Sector By Stefan Gebauer; Falk Mazelis
  4. Monetary policy shocks and the health of banks By Jung, Alexander; Uhlig, Harald
  5. Digital Currencies and Central Banking: A Sense of Déjà Vu By Sigitas Siaudinis
  6. Expectations-driven liquidity traps: implications for monetary and fiscal policy By Nakata, Taisuke; Schmidt, Sebastian
  7. Do SVARs with sign restrictions not identify unconventional monetary policy shocks? By Jef Boeckx; Maarten Dossche; Alessandro Galesi; Boris Hofmann; Gert Peersman
  8. Do Negative Interest Rates Affect Bank Risk-Taking? By AAlessio Reghezza; Jonathan Williams; Alessio Bongiovanni; Riccardo Santamaria
  9. Behind the scenes of the beauty contest: window dressing and the G-SIB framework By Behn, Markus; Mangiante, Giacomo; Parisi, Laura; Wedow, Michael
  10. Complexity of ECB Communication and Financial Market Trading By Bernd Hayo; Kai Henseler; Marc Steffen Rapp
  11. The redistributive effects of bank capital regulation By Elena Carletti; Roberto Marquez; Silvio Petriconi
  12. Inflation and deflationary biases in inflation expectations By Michael J. Lamla; Damjan Pfajfar; Lea Rendell
  13. Time-Variant Safe-Haven Currency Status and Determinants By MASUJIMA Yuki
  14. Monetary policy spillovers, capital controls and exchange rate flexibility, and the financial channel of exchange rates By Georgios Georgiadis; Feng Zhu
  16. The Role of Central Banks and the Political Environment in Financial Stability: A Literature Review By Zoe Venter
  17. Banking, Capital Regulation, Risk and Dynamics By Larsson, Bo; Wijkander, Hans
  18. Helicopter Drops of Money under Secular Stagnation By Jean-Baptiste MICHAU

  1. By: Lilit Popoyan (Laboratory of Economics and Management); Mauro Napoletano (Observatoire français des conjonctures économiques); Andrea Roventini (Observatoire français des conjonctures économiques)
    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 dfferent 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 dfferent 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, banking 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 banks’ 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 monetarypolicy 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: 2019–07
  2. By: Martinez-Miera, David; Repullo, Rafael
    Abstract: This paper reexamines from a theoretical perspective the role of monetary and macroprudential policies in addressing the build-up of risks in the financial system. We construct a stylized general equilibrium model in which the key friction comes from a moral hazard problem in firms financing that banks’ equity capital serves to ameliorate. Tight monetary policy is introduced by open market sales of government debt, and tight macroprudential policy by an increase in capital requirements. We show that both policies are useful, but macroprudential policy is more effective in fostering financial stability and leads to higher social welfare. JEL Classification: G21, G28, E44, E52
    Keywords: bank monitoring, capital requirements, financial stability, intermediation margin, macroprudential policy, monetary policy
    Date: 2019–07
  3. By: Stefan Gebauer; Falk Mazelis
    Abstract: Macroprudential policies for financial institutions have received increasing prominence since the global financial crisis. These policies are often aimed at the commercial banking sector, while a host of other non-bank financial institutions, or shadow banks, may not fall under their jurisdiction. We study the effects of tightening commercial bank regulation on the shadow banking sector. For this purpose, we develop a DSGE model that differentiates between regulated, monopolistically competitive commercial banks and a shadow banking system that relies on funding in a perfectly competitive market for investments. After estimating the model using euro area data from 1999-2014 including information on shadow banks, we find that tighter capital requirements on commercial banks increase shadow bank lending, which may have adverse financial stability effects. Coordinating the macroprudential tightening with monetary easing can limit this leakage mechanism, while still bringing about the desired reduction in aggregate lending. We discuss how regulators that either do or do not consider credit leakage to shadow banks set policy in response to macroeconomic shocks. Lastly, in a counterfactual analysis, we then compare how a macroprudential policy implemented before the crisis on all financial institutions, or just on commercial banks, would have dampened the leverage cycle.
    Keywords: Macroprudential Regulation, Monetary Policy, Shadow Banking, Non-Bank Financial Institutions, Financial Frictions
    JEL: E58 G23 G28
    Date: 2019
  4. By: Jung, Alexander; Uhlig, Harald
    Abstract: Based on high frequency identification and other econometric tools, we find that monetary policy shocks had a significant impact on the health of euro area banks. Information effects, which made the private sector more pessimistic about future prospects of the economy and the profitability of the banking sector, were strongly present in the post-crisis period. We show that ECB communications at the press conference were crucial for the market response and that bank health benefitted from surprises, which steepened the yield curve. We find that the effects of monetary policy shocks on banks displayed some persistence. Other bank characteristics, in particular bank size, leverage and NPL ratios, amplified the impact of monetary policy shocks on banks. After the OMT announcement, we detect that the response of bank stocks to monetary policy shocks normalised. We discover that, in the post-crisis episode, Fed monetary policy shocks influenced euro area bank stock valuations. JEL Classification: E40, E52, G14, G21
    Keywords: high-frequency identification, information effects, local projections, panel of individual banks
    Date: 2019–07
  5. By: Sigitas Siaudinis (Bank of Lithuania)
    Abstract: This paper examines the implications of digital currencies – both private cryptocurrencies and central bank digital currencies (CBDCs) – for central banking. We discuss some déjà vu episodes from monetary history in order to obtain a clearer understanding the present and potential implications of these currencies. We find that not only the current limitations of private cryptocurrencies, but also their conceptual underpinnings, argue against their replacement of conventional money. The two main potential problems with broadly accessible (general purpose) CBDC are a digital run and an excessive involvement of a central bank in the funding of the real economy. Meanwhile, alternative reserve-backed accounts or tokens (an implicit CBDC known as Tobin’s alternative) would also be exposed to these problems, albeit in a less pronounced way. CBDC-related hopes for monetary policy to eliminate the effective lower bound constraint are found to be exaggerated, even in a cashless world. We argue that central banks’ response to the digitalisation trend should be an integrative solution which satisfies the public demand for a safe means of payment, safeguards private innovations, and ensures financial stability. We conclude that there is no observable form of CBDC that would serve as a best-choice central bank response in advanced economies. Such a response might be considered as a temporary solution (if any), however, in emerging economies with weak financial inclusion.
    Keywords: private cryptocurrencies, central bank digital currency (CBDC), fintechs, financial stability, monetary policy
    JEL: E51 E58 N20
    Date: 2019–08–06
  6. By: Nakata, Taisuke; Schmidt, Sebastian
    Abstract: We study optimal monetary and fiscal policy in a New Keynesian model where occasional declines in agents’ confidence can give rise to persistent liquidity trap episodes. Unlike in the case of fundamental-driven liquidity traps, there is no straightforward recipe for mitigating the welfare costs and the systematic inflation shortfall associated with expectations-driven liquidity traps. Raising the inflation target or appointing an inflation-conservative central banker improves inflation outcomes away from the lower bound but exacerbates the shortfall at the lower bound. Using government spending as an additional policy tool worsens stabilization outcomes both at and away from the lower bound. However, appointing a policymaker who is sufficiently less concerned with government spending stabilization than society can eliminate expectations-driven liquidity traps altogether. JEL Classification: E52, E61, E62
    Keywords: discretion, effective lower bound, fiscal policy, monetary policy, policy delegation, sunspot equilibria
    Date: 2019–08
  7. By: Jef Boeckx; Maarten Dossche; Alessandro Galesi; Boris Hofmann; Gert Peersman
    Abstract: A growing empirical literature has shown, based on structural vector autoregressions (SVARs) identified through sign restrictions, that unconventional monetary policies implemented after the outbreak of the Great Financial Crisis (GFC) had expansionary macroeconomic effects. In a recent paper, Elbourne and Ji (2019) conclude that these studies fail to identify true unconventional monetary policy shocks in the euro area. In this note, we show that their findings are actually fully consistent with a successful identification of unconventional monetary policy shocks by the earlier studies and that their approach does not serve the purpose of evaluating identification strategies of SVARs.
    Keywords: unconventional monetary policy, SVARs, shock identification
    JEL: C32 E52
    Date: 2019–06
  8. By: AAlessio Reghezza (Bangor University); Jonathan Williams (Bangor University); Alessio Bongiovanni (University of Turin); Riccardo Santamaria (Sapienza – University of Rome)
    Abstract: We offer early evidence on how negative interest rate policy affects bank risk-taking. We identify a dichotomy between monetary policy and prudential regulation. Our primary result suggests NIRP produced an unintended outcome, which we measure as a 10 per cent reduction in banks’ holdings of risky assets. It infers that banks deleverage their balance sheets and invest in safer, liquid assets to meet new and binding capital and liquidity requirements. We find risk-taking behaviour is sensitive to capitalisation and banks with stronger capital ratios take more risks. Similarly, tighter prudential requirements could inadvertently retard economic growth should poorly capitalised banks reduce investment in riskier assets in favour of zero risk-weighted assets, such as, sovereign bonds to comply with risk-based capital requirements. Risk-taking is greater in less competitive markets because stronger market power insulates net interest margins and profitability. We obtain our results from a sample of 2,371 banks from 33 OECD countries between 2012 and 2016, and a difference-in-differences framework.
    Keywords: NIRP, Bank risk-taking, Monetary Policy, Difference-in-Differences, Propensity-Score-Matching.
    JEL: E43 E44 E52 E58 G21 F34
    Date: 2019–05
  9. By: Behn, Markus; Mangiante, Giacomo; Parisi, Laura; Wedow, Michael
    Abstract: This paper illustrates that systemically important banks reduce a range of activities at year-end, leading to lower additional capital requirements in the form of G-SIB buffers. The effects are stronger for banks with higher incentives to reduce the indicators, and for banks with balance sheet structures that can more easily be adjusted. The observed reduction in activity may imply an overall underestimation of banks' systemic importance as well as a distortion in their relative ranking, with implications for banks' ability to absorb losses. Moreover, a reduction in the provision of certain services at year-end may adversely affect overall market functioning. JEL Classification: G20, G21, G28
    Keywords: bank regulation, systemically important banks, window dressing
    Date: 2019–07
  10. By: Bernd Hayo (Philipps-Universitaet Marburg); Kai Henseler (Philipps-Universitaet Marburg); Marc Steffen Rapp (Philipps-Universitaet Marburg)
    Abstract: We examine how the verbal complexity of ECB communications affects financial market trading based on high-frequency data from European stock index futures trading. Studying the 34 events between May 2009 and June 2017, during which the ECB Governing Council press conferences covered unconventional monetary policy measures, and using the Flesch-Kincaid Grade Level to measure the verbal complexity of introductory statements to the press conferences, we find that more complex communications are associated with a lower level of contemporaneous trading. Increasing complexity of introductory statements leads to a temporal shift of trading activity towards the subsequent Q&A session, which suggests that Q&A sessions facilitate market participants’ information processing.
    Keywords: ECB, central bank communication, textual analysis, linguistic complexity, readability, financial markets, European stock markets
    JEL: D83 E52 E58 G12 G14
    Date: 2019
  11. By: Elena Carletti; Roberto Marquez; Silvio Petriconi
    Abstract: We build a general equilibrium model of banks’ optimal capital structure, where bankruptcy is costly and investors have heterogenous endowments and incur a cost for participating in equity markets. We show that banks raise both deposits and equity, and that investors are willing to hold equity only if adequately compensated. We then introduce (binding) capital requirements and show that: (i) it distorts investment away from productive projects toward storage; or (ii) it widens the spread between the returns to equity and to deposits. These results hold also when we extend the model to incorporate various rationales justifying capital regulation.
    Keywords: limited market participation, bank capital structure, capital regulation, investor returns
    JEL: G21 G28
    Date: 2018
  12. By: Michael J. Lamla; Damjan Pfajfar; Lea Rendell
    Abstract: We explore the consequences of losing confidence in the price-stability objective of central banks by quantifying the inflation and deflationary biases in inflation expectations. In a model with an occasionally binding zero-lower-bound constraint, we show that both inflation bias and deflationary bias can exist as a steady-state outcome. We assess the predictions of this model using unique individual-level inflation expectations data across nine countries that allow for a direct identification of these biases. Both inflation and deflationary biases are present and sizable, but different across countries. Even among the euro-area countries, perceptions of the European Central Bank's objectives are very distinct.
    Keywords: inflation bias, deflationary bias, confidence in central banks, trust, effective lower bound, inflation expectations, microdata
    JEL: E31 E37 E58 D84
    Date: 2019–06
  13. By: MASUJIMA Yuki
    Abstract: This paper investigates what factors are the determinants of a safe haven currency's ability to appreciate during the risk-off episodes. I assess how the safe-haven status and related determinants of 14 currencies changed over time from 2002 until 2017, using a safe-haven index that shows the time-variant tendency of exchange rate movement in response to changes in market uncertainty, measured using the CBOE volatility index (VIX). The panel regression results suggest safe-haven determinants shifted from external sustainability factors (current account surplus) to market driven factors (carry trade opportunity and high liquidity) during and after the Global Financial Crisis. The results highlight the increasing effects that changes in monetary policy stance and market risk appetites have on a currency's safe-haven status. That said, in addition to affecting the exchange rate, the shift between monetary tightening and easing by the Federal Reserve and local central banks may also change the interaction between the appetite for market risk and a currency's safe-haven status.
    Date: 2019–07
  14. By: Georgios Georgiadis; Feng Zhu
    Abstract: We assess the empirical validity of the trilemma or impossible trinity in the 2000s for a large sample of advanced and emerging market economies. To do so, we estimate Taylor rule-type monetary policy reaction functions, relating the local policy rate to real-time forecasts of domestic fundamentals, global variables, as well as the base-country policy rate. In the regressions, we explore variations in the sensitivity of local to base-country policy rates across different degrees of exchange rate flexibility and capital controls. We find that the data are in general consistent with the predictions from the trilemma: both exchange rate flexibility and capital controls reduce the sensitivity of local to base-country policy rates. However, we also find evidence that is consistent with the notion that the financial channel of exchange rates highlighted in recent work reduces the extent to which local policymakers decide to exploit the monetary autonomy in principle granted by flexible exchange rates in specific circumstances: the sensitivity of local to base-country policy rates for an economy with a flexible exchange rate is stronger when it exhibits negative foreign currency exposures which stem from portfolio debt and bank liabilities on its external balance sheet and when base-country monetary policy is tightened. The intuition underlying this finding is that it may be optimal for local monetary policy to mimic the tightening of base-country monetary policy and thereby mute exchange rate variation because a depreciation of the local currency would raise the cost of servicing and rolling over foreign currency debt and bank loans, possibly up to a point at which financial stability is put at risk.
    Keywords: Trilemma, financial globalisation, monetary policy autonomy, spillovers
    JEL: F42 E52 C50
    Date: 2019–07
  15. By: Donato Masciandaro; Davide Romelli
    Abstract: This chapter reviews the evolution of the theory of monetary policy design since the 1980s, highlighting the emerging role of central banker psychology. Three subsequent stages are evident. First, the central bank was considered as an independent institution (modern economics). Second, central bankers were assumed to be delegated bureaucrats (advanced political economy). Third, a link with psychology was established (behavioural economics).
    JEL: E52 E58
    Date: 2019
  16. By: Zoe Venter
    Abstract: Financial instability and the subsequent credit crunches experienced by a number of countries following two decades of global structural reforms highlighted the importance of stabilizing credit supply and assigning a higher importance to financial stability. In this paper, I look at the independence of the Central Bank, the political environment and the impact of these factors on financial stability. I substantiate the literature review discussion with a brief empirical analysis of the effect of Central Bank independence on credit growth using an existing database created by Romelli (2018). The empirical results show that fluctuations in credit growth are larger for higher levels of Central Bank Independence and hence, in periods of financial instability or ultimately financial crises, Central Bank Independence would be reined back in an effort to reestablish financil stability.
    Keywords: Central Banks, Central BankIndependence, Financial Stability,Reform, Political Environment
    JEL: E58 F36 N14 N16
    Date: 2019–07
  17. By: Larsson, Bo (erfConsulting AB); Wijkander, Hans (Dept. of Economics, Stockholm University)
    Abstract: Effects from risk, bankruptcies, and capital regulation of banks is explored in a dynamic stochastic equilibrium model where banks have two controls, dividends and level of risktaking. Unregulated value-maximizing banks, balance current profit against cost of risk. Banks with capitalization below desired level chose a lower level of risk than well-capitalized banks, but their capital adequacy ratios are yet lower. Binding regulation reduces risk-taking and instantaneous risk of bankruptcy but in the process also reduce endogenous growth of bank capital. This leads to an increased risk of bankruptcy that stems from the longer time banks spend poorly capitalized after large negative shocks due to the capital regulation.
    Keywords: Banking; Dynamic Banking; Banking regulation; Capital adequacy; Dividends; Incentive structure
    JEL: C61 G21 G22
    Date: 2019–06–23
  18. By: Jean-Baptiste MICHAU (CREST; Ecole Polytechnique.)
    Abstract: What are the effects of helicopter drops of money under secular stagnation? This paper shows that, if the government cannot sustain a Ponzi debt scheme under full employment, then helicopter drops of money cannot transfer real wealth to households under secular stagnation. In that case, despite being in a permanent liquidity trap, a one-off helicopter drop triggers an upward jump in the price level, without any real effect on the economy. Conversely, if a Ponzi scheme can be sustained, then the helicopter drop can stimulate aggregate demand by raising household wealth. If the stagnation real interest rate is larger than the economic growth rate, the economy converges to full employment and a sustainable Ponzi scheme and, otherwise, it gradually reverts back to stagnation. Finally, continuous helicopter drops of money under stagnation must induce the economy to reach a full employment steady state, with or without a Ponzi scheme.
    Keywords: Helicopter drops of money, Liquidity trap, Ponzi scheme, Secular stagnation.
    JEL: E12 E31 E63 H63
    Date: 2019–06–01

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