nep-cba New Economics Papers
on Central Banking
Issue of 2019‒09‒09
28 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Alternatives to Inflation Targeting in Low Interest Rate Environments By Carl E. Walsh
  2. Facing the Quadrilemma: Taylor Rules, Intervention Policy and Capital Controls in Large Emerging Markets By Fernando Chertman; Michael Hutchison; David Zink
  3. Housing sector and optimal macroprudential policy in an estimated DSGE model for Luxembourg By Ibrahima Sangaré
  4. Monetary Policy Rules and Macroeconomic Stability By Jayawickrema, Vishuddhi
  5. Negative interest rates, excess liquidity and retail deposits: Banks’ reaction to unconventional monetary policy in the euro area By Selva Demiralp; Jens Eisenschmidt; Thomas Vlassopoulos
  6. Revisiting the fiscal theory of sovereign risk from a DSGE viewpoint By Okano Eiji; Kazuyuki Inagaki
  7. The Effects of Asset Purchases and Normalization of US Monetary Policy By Naoko Hara; Ryuzo Miyao; Tatsuyoshi Okimoto
  8. Is Inflation Fiscally Determined? By Bazzaoui, Lamia; Nagayasu, Jun
  9. Do reserve requirements reduce the risk of bank failure? By Glocker, Christian
  10. On the Effects of the ECB’s Funding Policies on Bank Lending and the Demand for the Euro as an International Reserve By Heather D. Gibson; Stephen G. Hall; Pavlos Petroulas; George S. Tavlas
  11. Stress Testing and Bank Lending By Shapiro, Joel; Zeng, Jing
  12. Exposure to Daily Price Changes and Inflation Expectations By Francesco D'Acunto; Ulrike M. Malmendier; Juan Ospina; Michael Weber
  13. Rational Expectations with Endogenous Information By Jonathan J Adams
  14. Shocking aspects of monetary policy on income inequality in the euro area By Jérôme Creel
  15. Uncertainty, Financial Markets, and Monetary Policy over the Last Century By Sangyup Choi; Chansik Yoon
  16. The macroeconomic impact of the euro By Akhmadieva, Veronika; Smith, Ron P
  17. Central bank digital currencies: The case of universal central bank reserves By Paolo Fegatelli
  18. Anchored Inflation Expectations By Eusepi, Stefano; Moench, Emanuel; Preston, Bruce; Viana de Carvalho, Carlos
  19. Expectations Anchoring Indexes for Brazil using Kalman Filter: exploring signals of inflation anchoring in the long term By Fernando Nascimento de Oliveira; Wagner Piazza Gaglianone
  20. Cryptocurrencies, Currency Competition, and the Impossible Trinity By Pierpaolo Benigno; Linda M. Schilling; Harald Uhlig
  21. China's Monetary Policy and the Loan Market: How Strong is the Credit Channel in China? By Max Breitenlechner; Riikka Nuutilainen
  22. An optimal early warning system for currency crises under model uncertainty By Mamdouh Abdelmoula M. Abdelsalama; Hany Abdel-Latif
  23. International Reserves, External Debt Maturity, and the Reinforcement Effect for Financial Stability By Xingwang Qian; Andreas Steiner
  24. Optimal Monetary and Fiscal Policy Rules, Welfare Gains and Exogenous Shocks in an Economy with Default Risk By Okano Eiji; Masataka Eguchi
  25. The risk-taking channel of international financial flows By Pietro Cova; Filippo Natoli
  26. Interest Rate Hysteresis in Macroeconomic Investment under Uncertainty By Belke, Ansgar H.; Göcke, Matthias
  27. Does Inflation Targeting Reduce the Dispersion of Price Setters’ Inflation Expectations? By Paulie, Charlotte
  28. Long-term inflation expectations and inflation dynamics By Thórarinn G. Pétursson

  1. By: Carl E. Walsh (Distinguished Professor of Economics, University of California, Santa Cruz (E-mail:
    Abstract: The challenges of a low interest rate, low inflation environment have led to calls to re-examine the basic framework of flexible inflation targeting (IT). Interest in alternatives such as price-level targeting (PLT) and average inflation targeting (AIT) arises from the way in which these policy regimes cause inflation expectations to work as automatic stabilizers, a factor that can be of major importance if the central bank is constrained at the ELB. I show that the performance of PLT deteriorates significantly relative to IT and AIT in the presence of wage rigidities, shocks to productivity, and deviations from rational expectations. A central bank able to credibly commit to the optimal policy consistent with PLT is likely to face a much higher probability of needing balance sheet policies to implement policy than would be the case under IT or AIT. These results suggest it is too early to count IT out in the competition over policy design.
    Keywords: Optimal monetary policy, Inflation targeting, Price-level targeting, Average inflation targeting
    JEL: E52 E58
    Date: 2019–08
  2. By: Fernando Chertman (University of California, Santa Cruz); Michael Hutchison (University of California, Santa Cruz); David Zink (University of California, Santa Cruz)
    Abstract: This paper investigates extended Taylor rules and foreign exchange intervention functions in large Emerging Markets (EM), measuring the extent to which policies are designed to stabilize output, inflation, exchange rates and accumulate international reserves. We focus on two large emerging markets--India and Brazil. We also consider the impact of greater capital account openness and which rules dominate when policy conflicts arise. We find that output stabilization is a dominant characteristic of interest rate policy in India, as is inflation targeting in Brazil. Both countries actively use intervention policy to achieve exchange rate stabilization and, at times, stabilizing reserves around a target level tied to observable economic fundamentals. Large unpredicted intervention purchases (sales) accommodate low (high) interest rates, suggesting that external operations are subordinate to domestic policy objectives. We extend the work to Chile and China for purposes of comparison. Chile’s policy functions are similar to Brazil, while China pursues policies that substantially diverge from other EMs.
    Date: 2019–08–10
  3. By: Ibrahima Sangaré
    Abstract: This study investigates the optimal macroprudential policies for Luxembourg using an estimated closed-economy DSGE model. The model features a monopolistically competitive banking sector, a collateral constraint and an explicit differentiation between the flow and the stock of household mortgage debt. Based on a welfare-oriented approach and in a context of easy monetary policy environment, we first find that the non-joint optimal loan-to-value (LTV) and risk weighted capital requirement (RW) ratios for Luxembourg seem to be 90% and 30%, respectively, while the joint optimal ratios are found to be 100% and 10% respectively. Our results from the combination of instruments suggest that the policy scenario that provides better stabilization effects on mortgage credits isn’t necessarily the one that is welfare improving. In other words, we find a complementarity between LTV and RW in terms of welfare, while their optimal combination diminishes the stabilization effects on mortgage debt and house prices. However, the time-varying and endogenous rules for LTV and RW improve the social welfare and better stabilizes mortgage loans and house prices compared to their static exogenous ratios. We further find that the optimal interactions between LTV and RW ratios in our modelling framework exhibit a convex shape. It should be recalled that the results are conditional on the model’s specific assumptions.
    Keywords: LTV, Risk weights, optimal macroprudential policy, combination of macroprudential instruments
    JEL: E32 E44 R38
    Date: 2019–07
  4. By: Jayawickrema, Vishuddhi
    Abstract: This paper attempts to characterize the monetary policy regimes in the United States and analyze their effects on macroeconomic stability. It does so by estimating Taylor-type forward-looking monetary policy reaction functions for the pre- and post-1979 periods, and simulating the resultant coefficients in a basic New Keynesian business cycle model. The feedback coefficient on inflation in the estimated policy reaction function is found to be less than unity for the 1960-1979 period, suggesting an accommodative monetary policy stance of the Federal Reserve. However, for the 1979-2017 period, the feedback coefficient on inflation is estimated to be substantially greater than unity, implying that the Federal Reserve adopted a proactive policy stance towards controlling inflation. It is also found that in recent times, the Federal reserve has shifted its focus from short one period ahead inflation targets to longer target horizons such as one year ahead inflation targets. Meanwhile, the model simulations show that the economy exhibits greater stability under a model with post-1979 calibration than a model with a combination of pre-1979 parameters and `sunspot' shocks.
    Keywords: Monetary Policy, Monetary Policy Rules, Taylor Rule, Macroeconomic Stability
    JEL: E32 E43 E52
    Date: 2019–01
  5. By: Selva Demiralp (Koç University); Jens Eisenschmidt (European Central Bank); Thomas Vlassopoulos (European Central Bank)
    Abstract: Negative interest rate policy (NIRP) is associated with a particular friction. The remuneration of banks´ retail deposits tends to be floored at zero, which limits the typical transmission of policy rate cuts to bank funding costs. We investigate whether this friction affects banks’ reactions under NIRP compared to a standard rate cut in the euro area. We argue that reliance on retail deposit funding and the level of excess liquidity holdings may increase banks’ responsiveness to NIRP. We find evidence that banks highly exposed to NIRP tend to grant more loans. This confirms studies pointing to higher risk taking by banks under NIRP and contrasts results that associate NIRP with a contraction in bank loans. Broader coverage of our loan data and the explicit consideration of banks’ excess liquidity holdings are likely reasons for this different result compared to some earlier literature. We are the first to document the importance of banks’ excess liquidity holdings for the effectiveness of NIRP, pointing to a strong complementarity of NIRP with central bank liquidity injections, e.g. via asset purchases.
    Keywords: Negative rates, bank balance sheets, monetary transmission mechanism
    JEL: E43 E52 G11 G21
    Date: 2019–09
  6. By: Okano Eiji (Nagoya City University); Kazuyuki Inagaki (Nanzan University)
    Abstract: We revisit Uribe’s[32]‘fiscal theory of sovereign risk,’ which suggests a trade-off between stabilizing inflation and suppressing default. Unlike Uribe[32], we develop a class of dynamic stochastic general equilibrium models in which the fiscal surplus is endogenous, but where the default mechanism follows Uribe[32] with nominal rigidities. We find that an optimal monetary and fiscal policy, in which both the nominal interest rate and the tax rate are policy instruments, not only stabilizes inflation and the output gap, but also default through stabilizing the fiscal surplus. Thus, there is not necessarily a trade-off between stabilizing inflation and suppressing default.
    Keywords: Sovereign Risk; Optimal Monetary Policy; Fiscal Theory of the Price Level
    JEL: E52 E60
    Date: 2019–01
  7. By: Naoko Hara (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Ryuzo Miyao (Professor, Faculty of Economics, University of Tokyo (E-mail:; Tatsuyoshi Okimoto (Associate Professor, Crawford School of Public Policy, Australian National University, and Visiting Fellow, Research Institute of Economy, Trade and Industry (RIETI) (E-mail: tatsuyoshi.
    Abstract: This paper examines changes in the effects of unconventional monetary policies in the US. To this end, we estimate a Markov-switching VAR model with absorbing regimes to capture possible structural changes. Our results detect regime changes around the beginning of 2011 and the middle of 2013. Before 2011, the US large-scale asset purchases (LSAPs) had relatively large impacts on the real economy and prices, but after the middle of 2013, their effects were weaker and less-persistent. In addition, after the middle of 2013, which includes the monetary policy normalization period, the asset purchase (or balance sheet) shocks had slightly weaker effects than during the early stage of the LSAPs but stronger effects than during the late stage of the LSAPs, while interest rate shocks had insignificant effects on the real economy and prices. Finally, our results suggest that the positive responses of durables and capital goods expenditures to interest rate shocks weakened the negative impacts of interest rate hikes after the middle of 2013 including the period of monetary policy normalization.
    Keywords: Quantitative easing, Unconventional monetary policy, LSAP, MSVAR
    JEL: C32 E21 E52
    Date: 2019–08
  8. By: Bazzaoui, Lamia; Nagayasu, Jun
    Abstract: This paper examines the relationship between fiscal variables and inflation for 46 countries from 1960–2017 using a linear identity that links inflation to fiscal and monetary variables and economic growth. The results indicate that inflation is affected by both monetary and fiscal policies. However, the relation between inflation and fiscal variables disappears when monetary policy is based on commitment strategies. We conclude that fiscal determinacy of inflation is only possible when central banks practice poorly structured discretion.
    Keywords: inflation, fiscal policy, monetary policy, public debt, panel VAR GMM
    JEL: E31 E43 E63 H63
    Date: 2019–08
  9. By: Glocker, Christian
    Abstract: There is an increasing literature proposing reserve requirements for financial stability. This study assesses their effects on the probability of bank failure and compares them to those of capital requirements. To this purpose a banking model is considered that is subject to legal reserve requirements. In general, higher reserve requirements promote risk-taking as either borrowers or banks have an incentive to choose riskier assets, so banks' probability of failure rises. Borrowers' moral hazard problem augments the adverse effects. They are mitigated when allowing for imperfectly correlated loan-default as higher interest revenues from non-defaulting loans curb losses from defaulting loans.
    Keywords: Reserve requirements, liquidity regulation, capital requirements, bank failure, default correlation
    JEL: E43 E58 G21 G28
    Date: 2019–08
  10. By: Heather D. Gibson (Bank of Greece); Stephen G. Hall (University of Leicester, Bank of Greece and University of Pretoria); Pavlos Petroulas (Bank of Greece); George S. Tavlas (Bank of Greece and University of Leicester)
    Abstract: The euro-area financial crisis that erupted in 2009 was marked by negative confidence effects that had both domestic and international ramifications. Domestically, bank lending declined sharply. Internationally, the demand for the euro as a reserve currency fell precipitously. We investigate the effects of ECB policies on banks’ lending, taking account of national and regional spillovers. We also assess the effects of ECB policies on euro reserve holdings. The results suggest that those policies were important for rebuilding confidence, thus supporting both bank lending and the use of the euro as a reserve asset.
    Keywords: euro area financial crisis, monetary policy operations, European banks, spatial panel model
    JEL: E3 G01 G14 G21
    Date: 2019–08–08
  11. By: Shapiro, Joel; Zeng, Jing
    Abstract: Bank stress tests are a major form of regulatory oversight. Banks respond to the toughness of the tests by changing their lending behavior. Regulators care about bank lending; therefore, banks' reactions to the tests affect the tests' design and create a feedback loop. We demonstrate that stress tests may be (1) soft, in order to encourage lending in the future, or (2) tough, in order to deter excessive risk-taking in the future. There may be multiple equilibria due to strategic complementarity. Regulators may strategically delay stress tests. We also analyze bottom-up stress tests and banking supervision exams.
    Keywords: bank lending; Bank Regulation; reputation; stress tests
    JEL: G21 G28
    Date: 2019–08
  12. By: Francesco D'Acunto; Ulrike M. Malmendier; Juan Ospina; Michael Weber
    Abstract: We show that, to form aggregate inflation expectations, consumers rely on the price changes they face in their daily lives while grocery shopping. Specifically, the frequency and size of price changes, rather than their expenditure share, matter for individuals’ inflation expectations. To document these facts, we collect novel micro data for a representative US sample that uniquely match individual expectations, detailed information about consumption bundles, and item-level prices. Our results suggest that the frequency and size of grocery-price changes to which consumers are personally exposed should be incorporated in models of expectations formation. Central banks' focus on core inflation - which excludes grocery prices - to design expectations-based policies might lead to systematic mistakes.
    Keywords: beliefs formation, rational inattention, realized inflation, transmission of monetary policy
    JEL: C90 D14 D84 E31 E52 G11
    Date: 2019
  13. By: Jonathan J Adams (Department of Economics, University of Florida)
    Abstract: This paper characterizes a general class of macroeconomic models with incomplete information, particularly when the information process includes endogenous variables. I derive conditions for existence and uniqueness of equilibrium, which apply even when the model contains endogenous state variables. I introduce an algorithm to solve the general model, which is easily applied whether the information process is exogenous or endogenous. As an application I consider a business cycle model where firms must make inferences about aggregate shocks through the movements of endogenous prices. Observed prices do not fully reveal the state of the economy, so monetary shocks can have real effects. In this model there is a role for policy: the central bank's money supply rule determines the size of the real effects of nominal shocks, by controlling how informative prices are about the aggregate state. The optimal policy targets acyclical inflation, which makes money neutral. Finally, I demonstrate an advantage of models with endogenous information: the noisy signals are driven by fundamental shocks, rather than ad hoc noise. These shocks are observable ex post, so data can discipline the information structure. Accordingly, I calibrate the model using US industry-level panel data.
    JEL: D84 E32 C62 C63
    Date: 2019–09
  14. By: Jérôme Creel (Observatoire français des conjonctures économiques)
    Abstract: This paper examines the distributional effects of monetary policy, either standard, nonstandard or both, on income inequality in 10 EA countries over the period 2000-2015. We use three different indicators of income inequality in a Panel VAR setting in order to estimate IRFs of inequality to a monetary policy shock. Results suggest that: (i) the distributional effects of ECB’s monetary policy have been modest and (ii) mainly driven in times of conventional monetary policy measures, especially in peripheral countries, while, overall, (iii) standard and non-standard monetary policies do not significantly differ in terms of impact on income inequality.terms of impact on income inequality.
    Keywords: Euro area; Monetary policy; Income distribution; Panel Var
    JEL: E62 E64 D63
    Date: 2019–09
  15. By: Sangyup Choi (Yonsei University); Chansik Yoon (Princeton University)
    Abstract: What has been the effect of uncertainty shocks in the U.S. economy over the last century? What are the historical roles of the financial channel and monetary policy channel in propagating uncertainty shocks? Our empirical strategies enable us to distinguish between the effects of uncertainty shocks on key macroeconomic and financial variables transmitted through each channel. A hundred years of data further allow us to answer these questions from a novel historical perspective. This paper finds robust evidence that financial conditions have played a crucial role in propagating uncertainty shocks over the last century, supporting many theoretical and empirical studies emphasizing the role of financial frictions in understanding uncertainty shocks. However, heightened uncertainty does not amplify the adverse effect of financial shocks, suggesting an asymmetric interaction between uncertainty and financial shocks. Interestingly, the stance of monetary policy seems to play only a minor role in propagating uncertainty shocks, which is in sharp contrast to the recent claim that binding zero-lower-bound amplifies the negative effect of uncertainty shocks. We argue that the contribution of constrained monetary policy to amplifying uncertainty shocks is largely masked by the joint concurrence of binding zero-lower-bound and tightened financial conditions.
    Keywords: uncertainty shocks; financial channel; counterfactual VARs; local projections; zero-lower- bound
    JEL: E31 E32 E44 G10
    Date: 2019–08–14
  16. By: Akhmadieva, Veronika (Birkbeck, University of London); Smith, Ron P (Birkbeck, University of London)
    Abstract: This paper examines whether the establishment of the euro caused structural breaks in the main macroeconomic relationships of member countries. It compares eight original members of the common currency with four European countries that did not join. The analysis constructs counterfactuals using both single equation models and a six equation vector autoregression with foreign exogenous variables, VARX*, explaining output, inflation, equity prices, exchange rates and short and long interest rates. It considers which equations changed the most and the most likely dates for any structural break.
    Keywords: euro, structural-breaks, GVAR
    JEL: C5 E5 F4
    Date: 2019–08
  17. By: Paolo Fegatelli
    Abstract: We analyse several motivations for the introduction of a widely accessible central bank digital currency (CBDC). If a central bank decided to offer a CBDC, its design would have to consider different areas of central bank activity, taking into account multiple policy principles, objectives and constraints. In addition, the introduction of a CBDC on a large scale may have a non-trivial impact on the architecture of the financial system. From this perspective, some common arguments in favour of CBDC may seem simplistic and the field of feasible options may be narrower than often believed. We reconsider Tobin’s idea to establish a system of universal access to central bank reserves, and clarify its feasibility and advantages as an account-based CBDC.
    Keywords: Central bank digital currency, universal central bank reserves, deposited currency accounts, cash, central bank, central bank policies, monetary policy, financial stability, payment systems, deposit insurance, bank deposits, inside money, collateral, virtual currencies
    JEL: E41 E42 E43 E51 E52 E58
    Date: 2019–07
  18. By: Eusepi, Stefano; Moench, Emanuel; Preston, Bruce; Viana de Carvalho, Carlos
    Abstract: Because of policy uncertainty long-run inflation beliefs are a state-contingent function of short-run inflation surprises. Expectations are well anchored only when the central bank is credible and long-run beliefs display small and declining sensitivity to short-run forecast errors. Nominal rigidities mean shifts in beliefs induce an endogenous inflation trend, with time-varying persistence and volatility. This feature of our theory of the nominal anchor distinguishes it from common explanations of low-frequency movements in inflation. The model, estimated using only US inflation and short-term forecasts from professional surveys, accurately predicts observed measures of long-term inflation expectations for the US and other countries, including several episodes of poorly anchored expectations.
    Keywords: Anchored expectations; Inflation expectations; survey data
    JEL: D83 D84 E32
    Date: 2019–07
  19. By: Fernando Nascimento de Oliveira; Wagner Piazza Gaglianone
    Abstract: Our objective in this paper is to build expectations anchoring indexes for inflation in Brazil that are fundamentally driven by the monetary authority’s capacity to anchor long-term inflation expectations vis-à-vis short-run inflation expectations. The expectations anchoring indexes are generated from a Kalman filter, based on a state-space model that also takes into account fiscal policy dynamics. The model’s signals are constructed using inflation expectations from the Focus survey of professional forecasters, conducted by the Central Bank of Brazil, and from the swap and federal government bond markets, which convey daily information of long-term inflation expectations. Although varying across specifications, the expectations anchoring indexes that we propose tend to display a downward trajectory, more clearly in 2009, and show a recovery starting in 2016 until the end of the sample (mid-2017).
    Date: 2019–08
  20. By: Pierpaolo Benigno; Linda M. Schilling; Harald Uhlig
    Abstract: We analyze a two-country economy with complete markets, featuring two national currencies as well as a global (crypto)currency. If the global currency is used in both countries, the national nominal interest rates must be equal and the exchange rate between the national currencies is a risk- adjusted martingale. We call this result Crypto-Enforced Monetary Policy Synchronization (CEMPS). Deviating from interest equality risks approaching the zero lower bound or the abandonment of the national currency. If the global currency is backed by interest-bearing assets, additional and tight restrictions on monetary policy arise. Thus, the classic Impossible Trinity becomes even less reconcilable.
    JEL: D53 E4 F31 G12
    Date: 2019–08
  21. By: Max Breitenlechner (University of Innsbruck); Riikka Nuutilainen (Bank of Finland)
    Abstract: We study the credit channel of Chinese monetary policy in a structural vector autoregressive framework. Using combinations of zero and sign restrictions, we identify monetary policy shocks linked to supply and demand responses in the loan market. Our results show that policy shocks coinciding with loan supply effects account for roughly 10 percent of output dynamics after two years, while loan demand effects represent up to 7 percent of output dynamics depending on the policy measure. The credit channel thus constitutes an important and economically relevant transmission channel for monetary policy in China. Monetary policy in China also accounts for a relatively high share of business cycle dynamics.
    Keywords: China, Monetary Policy, Transmission Effects, Structural Vector Autoregression, Zero and Sign Restrictions
    JEL: C32 E44 E52
    Date: 2019–08–22
  22. By: Mamdouh Abdelmoula M. Abdelsalama (Minufia University, Egypt); Hany Abdel-Latif (Swansea University, UK)
    Abstract: This paper assesses a number of early warning (EWS) models of financial crises with the aim of proposing an optimal model that can predict the incidence of a currency crisis in developing countries. For this purpose, we employ the dynamic model averaging (DMA) and equal weighting (EW) approaches to combine forecasts from individual models allowing for time varying weights. Taking Egypt as a case study and focusing only on currency crises, our findings show that combining forecasts (DMA- and EW-based EWS) models which account for model uncertainty perform better than other competing models in both in-sample and out-of-sample forecasts.
    Date: 2019–08–21
  23. By: Xingwang Qian (SUNY Buffalo State); Andreas Steiner (ifo Institute)
    Abstract: This paper studies how the maturity structure of external debt is affected by international reserves and how they reinforce financial stability through a more crisis-resilient maturity structure. We show in an illustrative theoretical model that reserves lengthen the maturity of external debt via a flattening of the yield curve. Using data of 66 emerging and developing countries and applying different econometric approaches, we find robust evidence that reserves increase the share of long-term (LT) relative to short-term (ST) external debt. Results hold for private and public external debt individually. Taking reserves and their effect on the debt maturity structure together, they reinforce financial stability.
    Keywords: International Reserves, Capital Inflows, Debt Maturity
    JEL: F3 F4
  24. By: Okano Eiji (Nagoya City University); Masataka Eguchi (Komazawa University)
    Abstract: We develop a class of dynamic stochastic general equilibrium models with nominal rigidities and we introduce default risk in the model. We find that if productivity changes are observed, policy authorities should be aware of default risk, although being aware of such risk is not very important following government expenditure changes. Welfare gains from awareness of default risk are nonnegligible if productivity changes, although welfare gains from awareness of default risk are tiny following government expenditure changes.
    Keywords: Sovereign Risk; Optimal Monetary Policy; Fiscal Theory of the Price Level
    JEL: E52 E60
    Date: 2019–07
  25. By: Pietro Cova (Bank of Italy); Filippo Natoli (Bank of Italy)
    Abstract: From the second half of the 1990s, the high saving propensity in emerging economies triggered massive inflows towards safe assets in the United States; then, from the early 2000s, global banks also increased investment in US markets targeting riskier securities. We investigate to what extent the global saving glut and the global banking glut have stimulated risk taking, and find significant effects on credit spreads, market volatility and bank leverage. In a VAR framework, we also detect linkages between foreign inflows, US household indebtedness and house prices, suggesting a substan- tial risk-taking channel. Our findings provide evidence of the autonomous role of foreign financial flows during the run-up to the global financial crisis.
    Keywords: saving glut, banking glut, capital flows, banking leverage, risk-taking channel
    JEL: F32 F33 F34
    Date: 2019–08–08
  26. By: Belke, Ansgar H. (University of Duisburg-Essen); Göcke, Matthias
    Abstract: The interest rate is generally considered as an important driver of macroeconomic investment. As an innovation, this paper derives the exact shape of the "hysteretic" impact of changes in the interest rate on macroeconomic investment under the scenarios of both certainty and uncertainty. We capture the direct interest rate-hysteresis on the investments and the capital stock and, explicitly, of stochastic changes on the interest rate-investment hysteresis. Starting with hysteresis effects on a microeconomic level of a single firm, we apply an explicit aggregation procedure to derive the interest rate hysteresis effects on a macroeconomic level. Based on our simple model we are able to obtain some conclusions about the efficacy of a central bank's interest rate policy, e.g. in times of low or even zero interest rates and high uncertainty, in terms of stimulating macroeconomic investment.
    Keywords: forward guidance, interest rate, investment, Mayergoyz-Preisach model, monetary policy, path dependence, non-ideal relay, sunk-cost hysteresis, uncertainty, zero lower bound
    JEL: C61 E22 E44
    Date: 2019–08
  27. By: Paulie, Charlotte (Uppsala University)
    Abstract: Using detailed Swedish micro data on prices and costs, this paper documents a decrease in the dispersion of changes in prices and markups following the introduction of an official inflation target of 2 percent. Using a structural model to decompose the change in the price-change distribution by potential explanatory factors, about 63 percent of the decrease in the price-change dispersion can be attributed to a decrease in the cross-sectional variance of inflation expectations. The lower dispersion of inflation expectations results in a lower markup dispersion and a welfare gain equivalent to a 0.79 percent increase in consumption.
    Keywords: Inflation targeting; price setting; misallocation; welfare
    JEL: D84 E52 L11
    Date: 2019–04–01
  28. By: Thórarinn G. Pétursson
    Abstract: After rising sharply following the Global Financial Crisis, inflation in Iceland has been low and stable in recent years despite a strong cyclical recovery. This not only reflects favourable external conditions but also coincides with a significant decline in long-term inflation expectations in financial markets. It is argued, however, that this market-based measure of inflation expectations actually underestimates the true decline in long-term inflation expectations of price setters. To extract this unobserved wedge between inflation expectations of price setters and financial agents, we estimate a time-varying parameter Phillips curve model for the inflation-targeting period since 2001, adjusting also for an unobserved risk premium in market-based inflation expectations. The empirical results suggest that the expectations wedge was significantly positive until early 2012, after which it starts to gradually decline towards zero. The true decline in long-term inflation expectations of actual price setters is therefore much steeper than is captured by the market-based measure and taking this into account results in a stable and plausible specification of the Phillips curve that can explain key features of the recent inflation developments in Iceland.
    JEL: E31 E32 E37 E52
    Date: 2019–08

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