nep-cba New Economics Papers
on Central Banking
Issue of 2019‒11‒18
forty-two papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Quantitative Easing and the Term Premium as a Monetary Policy Instrument By Etienne Vaccaro-Grange
  2. Learning and Misperception: Implications for Price-Level Targeting By Martin Bodenstein; James Hebden; Fabian Winkler
  3. China's Shadow Banking: Bank's Shadow and Traditional Shadow Banking By Guofeng Sun
  4. In the face of spillovers: prudential policies in emerging economies By Coman, Andra; Lloyd, Simon
  5. Non-standard monetary policy measures in the new normal By Anna Bartocci; Alessandro Notarpietro; Massimiliano Pisani
  6. Shifts in Monetary Policy and Exchange Rate Dynamics: Is Dornbusch's Overshooting Hypothesis Intact, After all? By Rüth, Sebastian K.
  7. Employment and the collateral channel of monetary policy By Bahaj, Saleem; Foulis, Angus; Pinter, Gabor; Surico, Paolo
  8. Money Neutrality, Monetary Aggregates and Machine Learning By Gogas, Periklis; Papadimitriou, Theophilos; Sofianos, Emmanouil
  9. Credit easing versus quantitative easing: evidence from corporate and government bond purchase programs By D’Amico, Stefania; Kaminska, Iryna
  10. A Theory of Intrinsic Inflation Persistence By Kurozumi, Takushi; Van Zandweghe, Willem
  11. Towards a new monetary theory of exchange rate determination By Cesa-Bianchi, Ambrogio; Kumhof, Michael; Sokol, Andrej; Thwaites, Gregory
  12. Exchange rate dynamics and monetary policy: Evidence from a non-linear DSGE-VAR approach By Huber, Florian; Rabithsc, Katrin
  13. Optimal timing of calling in large-denomination banknotes under natural rate uncertainty By Link, Thomas
  14. Unconventional monetary policy and corporate bond issuance By De Santis, Roberto A.; Zaghini, Andrea
  15. 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
  17. Monetary Dynamics in a Network Economy By Antoine Mandel; Vipin P. Veetil
  18. A structural model of interbank network formation and contagion By Coen, Patrick; Coen, Jamie
  19. External adjustment with a common currency: the case of the euro area By Alberto Fuertes
  20. Interest on Excess Reserves and U.S Commercial Bank Lending By Marcelo Rezende; Judit Temesvary; Rebecca Zarutskie
  21. Thinking Outside the Box: Do SPF Respondents Have Anchored Inflation Expectations? By Binder, Carola; Janson, Wesley; Verbrugge, Randal
  22. How Safe are Central Counterparties in Credit Default Swap Markets? By H Peyton Young; Mark Paddrik
  23. Household Debt and Aging in Japan By Charles Yuji Horioka; Yoko Niimi
  24. The Impact of EMU on European Transition Economies: Commitment, Institutional Capacity and the Monetary-Fiscal Mix By Begg, David
  25. Comparing Two Measures of Core Inflation: PCE Excluding Food & Energy vs. the Trimmed Mean PCE Index By Matteo Luciani; Riccardo Trezzi
  26. On the Role of Finance in Sraffa’s System By Dvoskin, Ariel; Feldman, Germán David
  27. Credit, capital and crises: a GDP-at-Risk approach By Aikman, David; Bridges, Jonathan; Hacioglu Hoke, Sinem; O’Neill, Cian; Raja, Akash
  28. The effects of climate change on a small open economy By George Economides; Anastasios Xepapadeas
  29. Prudential Regulation of Banks in Less Developed Economies By Murshed, S. Mansoob; Subagjo, Djono
  30. Supervisory governance, capture and non‑performing loans By Fraccaroli, Nicolò
  31. Anchored Inflation Expectations and the Flatter Phillips Curve By Jorgensen, Peter; Lansing, Kevin J.
  32. What measures of real economic activity slack are helpful for forecasting Russian inflation? By Ramis Khabibullin
  33. Trend Fundamentals and Exchange Rate Dynamics By Florian, Huber; Kaufmann, Daniel
  34. International digital currencies and their impact on monetary policy: An exploration of implications and vulnerability By Proettel, Thorsten
  35. Federal Funds Rate Control with Voluntary Reserve Targets By Garth Baughman; Francesca Carapella
  36. Market-implied systemic risk and shadow capital adequacy By Chatterjee, Somnath; Jobst, Andreas
  37. Low interest rates, bank's search-for-yield behavior and financial portfolio management By Lojak, Benjamin; Makarewicz, Tomasz; Proaño Acosta, Christian
  38. Central Bank Independence By Thomas I. Palley
  39. From the EMS to the EMU and... to China By Joseph Halevi
  40. EMU and the Developing countries By Cohen, Benjamin J.
  41. The Currency Composition of Foreign Exchange Reserves Retrospect and Prospect By Eichengreen, Barry; Mathieson, Donald J.
  42. Expectations about the Federal Funds Rate in the Long Run By Kasper Joergensen; Andrew C. Meldrum

  1. By: Etienne Vaccaro-Grange (Aix-Marseille Univ, CNRS, EHESS, Ecole Centrale, AMSE, Marseille, France.)
    Abstract: The transmission of Quantitative Easing to aggregate macroeconomic variables through the yield curve is disentangled in two yield channels: the term premium channel, captured by a term premium series, and the signaling channel, that corresponds to the interest rate expectations counterpart. Both yield components are extracted from a term structure model and plugged into a Structural VAR with Euro Area macroeconomic variables in which shocks are identified using sign restrictions. With this set-up, I show how the central bank can use the term premium as a single monetary policy instrument to foster output and prices. However, I also show that there has been a cost channel in the transmission of QE to inflation between 2015 and 2017. This cost channel provides a new explanation as to why inflation has been so muted during this period, despite the easing monetary environment. Finally, a policy rule for the term premium is estimated.
    Keywords: quantitative easing, shadow-rate term structure model, BVAR, sign restrictions
    JEL: C32 E43 E44 E52
    Date: 2019–11
  2. By: Martin Bodenstein; James Hebden; Fabian Winkler
    Abstract: Monetary policy strategies that target the price level have been advocated as a more effective way to provide economic stimulus in a deep recession when conventional monetary policy is limited by the zero lower bound on nominal interest rates. Yet, the effectiveness of these strategies depends on a central bank's ability to steer agents' expectations about the future path of the policy rate. We develop a flexible method of learning about the central bank's policy rule from observed interest rates that takes into account the limited informational content at the zero lower bound. When agents learn, switching from an inflation targeting to a price-level targeting strategy at the onset of a recession does not yield the desired stabilization benefits. These benefits only materialize after the policy rule has been in place for a sufficiently long time. Temporary price-level targeting strategies are likely to be much less effective than their permanent counterparts.
    Keywords: Zero lower bound ; Imperfect information ; Learning ; Price level targeting
    JEL: E31 E52
    Date: 2019–11–13
  3. By: Guofeng Sun
    Abstract: Banks' shadow, or money creation by banks beyond traditional loans, plays an important role in China's money-creation process, posing a number of challenges to monetary policy operations and financial risk management. This paper analyzes the money-creation mechanisms of China's shadow banking sector in detail, provides accurate measurements, investigates its effects on financial risk, and surveys recent regulation. To strengthen supervision, China's regulators should closely track the evolution of various shadow banking channels, both on- and off-balance sheet. Specific macroprudential regulation tools, such as asset reserves and risk reserves, should be applied separately to banks' shadow and traditional shadow banking.
    Keywords: banks' shadow, traditional shadow banking, credit money creation, bank accounting, regulation
    JEL: E44 E51 G28
    Date: 2019–11
  4. By: Coman, Andra (European Central Bank); Lloyd, Simon (Bank of England)
    Abstract: We examine whether emerging market prudential policies offset the macro-financial spillover effects of US monetary policy. We find that emerging markets with tighter overall prudential policy face significantly smaller, and less negative, spillovers to total credit from US monetary policy tightening shocks. Loan-to-value ratio limits and reserve requirements appear to be particularly effective prudential tools at mitigating the spillover effects of US monetary policy. Our findings indicate that prudential policies can dampen emerging markets’ exposure to US monetary policy and the associated global financial cycle, suggesting they may be a useful tool in the face of international macroeconomic policy trade-offs.
    Keywords: International spillovers; local projections; policy interactions; monetary policy; prudential policy
    JEL: E52 E58 E61 F44
    Date: 2019–09–27
  5. By: Anna Bartocci (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: We evaluate the macroeconomic effects of long-term sovereign bond purchases by the central bank in the ‘New Normal’, i.e. in an economy with a low equilibrium real interest rate and a high probability of hitting the zero lower bound (ZLB) on the short-term policy rate. Our analysis is based on the simulations of a dynamic general equilibrium model for the euro area. The main results are the following. First, long-term sovereign bond purchases reacting to a positive inflation gap help stabilize macroeconomic conditions when the monetary policy rate hits the ZLB. Second, these purchases are an effective stabilization tool following positive shocks to the sovereign term premium (financial shocks) and negative shocks to aggregate demand (real shocks). Third, purchases that also react to the long-term rates are effective in the case of recessionary financial shocks but not in the case of recessionary real shocks and fourth, to stabilize the effects of expansionary shocks, the central bank can increase the short-term monetary policy rate according to an ‘aggressive’ Taylor rule, instead of selling long-term sovereign bonds.
    Keywords: euro area, non-standard monetary policy, zero lower bound
    JEL: E31 E32 E58
    Date: 2019–11
  6. By: Rüth, Sebastian K.
    Abstract: How do nominal exchange rates adjust after surprise contractions in monetary policy? While the seminal contribution by Dornbusch provides concise predictions -exchange rates appreciate, i.e., overshoot on impact before depreciating gradually - empirical support for his hypothesis is at best mixed. I argue that the failure to discover overshooting may result from assumptions researchers have imposed to recover structural VARs. Specifically, simultaneous feedback effects between interest rates and exchange rates, which are inherently forward-looking variables, are often excluded or modeled alongside with strong restrictions. In this paper, I identify U.S. monetary policy shocks using surprises in Federal funds futures around policy announcements as external instruments, which recent literature has established to represent the appropriate laboratory in settings encompassing macroeconomic and financial variables. Resulting adjustments of the dollar, conditional on shifts in policy, generally align with Dornbusch's predictions during the post-Bretton-Woods era, including Volcker's tenure as Fed Chair.
    Keywords: Nominal exchange rate; monetary policy shock; external instrument; structural vector autoregression
    Date: 2019–11–13
  7. By: Bahaj, Saleem (Bank of England); Foulis, Angus (Bank of England); Pinter, Gabor (Bank of England); Surico, Paolo (London Business School)
    Abstract: This paper uses detailed firm-level data to show that monetary policy affects employment through housing collateral and corporate debt. Our research design exploits the fact that many small and medium-sized enterprises use their directors' homes as a key source of collateral for corporate loans, but directors typically live in a different region to their firm. This spatial separation of firms from their collateral allows us to distinguish the collateral channel from local demand effects. We find that younger and more levered firms with higher exposure to housing collateral fluctuations adjust employment the most following a change in monetary policy. The collateral channel explains a sizeable share of the aggregate employment response.
    Keywords: Firm heterogeneity; residential collateral; financial accelerator
    JEL: D22 E52 R30
    Date: 2019–09–20
  8. By: Gogas, Periklis (Democritus University of Thrace, Department of Economics); Papadimitriou, Theophilos (Democritus University of Thrace, Department of Economics); Sofianos, Emmanouil (Democritus University of Thrace, Department of Economics)
    Abstract: The issue of whether or not money affects real economic activity (money neutrality) has attracted significant empirical attention over the last five decades. If money is neutral even in the short-run, then monetary policy is ineffective and its role limited. If money matters, it will be able to forecast real economic activity. In this study, we test the traditional simple sum monetary aggregates that are commonly used by central banks all over the world and also the theoretically correct Divisia monetary aggregates proposed by the Barnett Critique (Chrystal and MacDonald, 1994; Belongia and Ireland, 2014), both in three levels of aggregation: M1, M2, and M3. We use them to directionally forecast the Eurocoin index: A monthly index that measures the growth rate of the euro area GDP. The data span from January 2001 to June 2018. The forecasting methodology we employ is support vector machines (SVM) from the area of machine learning. The empirical results show that: (a) The Divisia monetary aggregates outperform the simple sum ones and (b) both monetary aggregates can directionally forecast the Eurocoin index reaching the highest accuracy of 82.05% providing evidence against money neutrality even in the short term.
    Keywords: Eurocoin; simple sum; Divisia; SVM; machine learning; forecasting; money neutrality
    JEL: E00 E27 E42 E51 E58
    Date: 2019–07–05
  9. By: D’Amico, Stefania (Federal Reserve Bank of Chicago); Kaminska, Iryna (Bank of England)
    Abstract: Using security-level data, we analyse the effects of the Bank of England’s multiple rounds of gilt purchases (aka Quantitative Easing, QE) and its Corporate Bond Purchase Scheme (aka Credit Easing, CE) on corporate bond prices and issuance. This allows direct estimation of (i) QE’s cross-asset supply effects and (ii) the joint supply effects of QE and CE. We show that in the case of QE alone, the pass-through of the gilt supply shock to corporate bond prices is significant, is larger in the longer-run than at announcement, and is often limited to the default-free component of the corporate yield. In the case of the joint conduct of QE and CE, we find that the CE is more effective than QE in reducing credit spreads, especially for higher-rated bonds, and in stimulating corporate bond issuance, which responds quite rapidly to the corporate bond supply shock.
    Keywords: Quantitative easing; Corporate Bond Purchase Scheme; monetary transmission mechanism; corporate bonds
    JEL: E52 E58 E65 G12
    Date: 2019–09–20
  10. By: Kurozumi, Takushi (Bank of Japan); Van Zandweghe, Willem (Federal Reserve Bank of Cleveland)
    Abstract: We propose a novel theory of intrinsic inflation persistence by introducing trend inflation and variable elasticity of demand in a model with staggered price and wage setting. Under nonzero trend inflation, the variable elasticity generates intrinsic persistence in inflation through a measure of price dispersion stemming from staggered price setting. It also introduces intrinsic persistence in wage inflation under staggered wage setting, which affects price inflation. With the theory we show that inflation exhibits a persistent, hump-shaped response to a monetary policy shock. We also show that a credible disinflation leads to a gradual decline in inflation and a fall in output, and lower trend inflation reduces inflation persistence, as observed around the time of the Volcker disinflation.
    Keywords: Trend inflation; variable elasticity of demand; price dispersion; intrinsic inflation persistence; credible disinflation;
    JEL: E31 E52
    Date: 2019–08–29
  11. By: Cesa-Bianchi, Ambrogio (Bank of England and Centre for Macroeconomics); Kumhof, Michael (Bank of England, CEPR and Centre for Macroeconomics); Sokol, Andrej (European Central Bank, Bank of England and Centre for Macroeconomics); Thwaites, Gregory (Bank of England)
    Abstract: We study exchange rate determination in a 2-country model where domestic banks create each economy’s supply of domestic and foreign currency. The model combines the UIP-based and monetary theories of exchange rate determination, but the latter with a focus on private rather than public money creation. The model features an endogenous monetary spread or excess return in the UIP condition. This spread experiences sizeable changes when shocks affect the relative supplies (of bank loans) or demands (for bank deposits) of the two currencies. Under such shocks, monetary effects dominate traditional UIP effects in the determination of exchange rates and allocations, and this becomes stronger as domestic and foreign currencies become more imperfect substitutes. With these shocks, the model successfully addresses the UIP puzzle, and it is also consistent with the Meese-Rogoff and PPP puzzles.
    Keywords: Bank lending; money creation; money demand; endogenous money; uncovered interest parity; exchange rate determination; international capital flows; gross capital flows
    JEL: E44 E51 F41 F44
    Date: 2019–08–30
  12. By: Huber, Florian (University of Salzburg); Rabithsc, Katrin (WU Wien)
    Abstract: In this paper, we reconsider the question how monetary policy influences exchange rate dynamics. To this end, a vector autoregressive (VAR) model is combined with a two country dynamic stochastic general equilibrium (DSGE) model. Instead of focusing exclusively on how monetary policy shocks affect the level of exchange rates, we also analyze how they impact exchange rate volatility. Since exchange rate volatility is not observed, we estimate it alongside the remaining quantities in the model. Our findings can be summarized as follows. Contractionary monetary policy shocks lead to an appreciation of the home currency, with exchange rate responses in the short-run typically undershooting their long-run level of appreciation. They also lead to an increase in exchange rate volatility. Historical and forecast error variance decompositions indicate that monetary policy shocks explain an appreciable amount of exchange rate movements and the corresponding volatility.
    Keywords: Monetary policy; Exchange rate overshooting; stochastic volatility modeling; DSGE priors
    JEL: E43 E52 F31
    Date: 2019–10–22
  13. By: Link, Thomas
    Abstract: The elimination of large-denomination banknotes is one of several options to relax the effective-lower-bound constraint on nominal interest rates. We explore timing issues associated with the calling-in of large notes from a central banker's perspective and employ an optimal stopping model to show how the volatility and the expected path of the natural rate of interest determine an optimal timing strategy. Our model shows that such a strategy can involve a wait-and-see component analogously to an optimal exercise rule for a perpetual American option. In practice, a wait-and-see component might induce a central banker not to call in large notes until the natural rate has fallen to an exceptionally low level.
    Keywords: cashless economy,phase-out of paper currency,wait-and-see policy,optionvalue
    JEL: E42 E58
    Date: 2019
  14. By: De Santis, Roberto A.; Zaghini, Andrea
    Abstract: We assess the effect and the timing of the corporate arm of the ECB quantitative easing (CSPP) on corporate bond issuance. Because of several contemporaneous measures, to isolate the programme effects we rely on one key eligibility feature: the euro denomination of newly issued bonds. We find that the significant increase in bonds issuance by eligible firms is due to the CSPP and that this effect took at least six months to unfold. This result holds even when comparing firms with similar ratings, thus providing evidence that unconventional monetary policy can foster a financing diversification regardless of firms risk profile. JEL Classification: E52, G15, G32
    Keywords: corporate bond market, CSPP, quantitative easing
    Date: 2019–11
  15. 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
  16. By: Nadav Ben Zeev (BGU)
    Keywords: Prime adjustable rate mortgages; Mortgage default rates; Systematic monetary policy; Bayesian local projections
    JEL: E32 E52 E58
    Date: 2019
  17. By: Antoine Mandel (Centre d'Economie de la Sorbonne - Paris School of Economics;; Vipin P. Veetil (Department of Humanities and Social Sciences, Indian Institute of Technology Madras)
    Abstract: We develop a tractable model of out-of-equilibrium dynamics in a general equilibrium economy with cash-in-advance constraints. The dynamics emerge from local interactions between firms governed by the production network underlying the economy. We analytically characterise the influence of network structure on the propagation of monetary shocks. In the long run, the model converges to general equilibrium and the quantity theory of money holds. In the short run, monetary shocks propagate upstream via nominal demand changes and downstream via real supply changes. Lags in the evolution of supply and demand at the micro level can give rise to arbitrary dynamics of the distribution of prices. Our model explains the long standing Price Puzzle: a temporary rise in the price level in response to monetary contractions. The Price Puzzle emerges under two assumptions about downstream firms: they are disproportionally affected by monetary contractions and they account for a sufficiently small share of the wage bill. Empirical evidence supports the two assumptions for the US economy. Our model calibrated to the US economy using a data set of more than fifty thousand firms generates the empirically observed magnitude of the price level rise after monetary contractions
    Keywords: Price Puzzle; Production Network; Money; Monetary Non-Neutrality; Out-of-Equilibrium Dynamics
    JEL: C63 C67 D80 E31 E52
    Date: 2019–10
  18. By: Coen, Patrick (London School of Economics); Coen, Jamie (London School of Economics and Bank of England)
    Abstract: The interbank network, in which banks compete with each other to supply and demand differentiated financial products, fulfils an important function but may also result in risk propagation. We examine this trade-off by setting out a model in which banks form interbank network links endogenously, taking into account the effect of links on default risk. We estimate this model based on novel, granular data on aggregate exposures between banks. We find that the decentralised interbank market is not efficient: a social planner would be able to increase surplus on the interbank market by 13% without increasing mean bank default risk or decrease mean bank default risk by 4% without decreasing interbank surplus. We then propose two novel regulatory interventions (caps on aggregate exposures and pairwise capital requirements) that result in efficiency gains.
    Keywords: Contagion; systemic risk; interbank network; network formation
    JEL: G18 G28 L13 L51
    Date: 2019–10–11
  19. By: Alberto Fuertes (Banco de España)
    Abstract: This paper analyzes the behaviour of the external adjustment path for the four main economies in the euro area. I find a structural break in the behaviour of the net external position at the time of the introduction of the euro for France, Italy and Spain, pointing out that the inception of the common currency changed their external adjustment process. Germany does not show this structural break, being its external position more affected by other events such as the country reunification in 1989. I also find that France and Italy will adjust the net external position mainly through the valuation component, while Germany and Spain will restore their external balance mostly through the trade component. The common currency area could have exacerbated Germany’s net creditor position as the evolution of the euro has reacted to the external adjustment needs of debtor countries such as Italy and Spain.
    Keywords: external adjustment, exchange rate regime, structural breaks, valuation adjustment
    JEL: F31 F33
    Date: 2019–11
  20. By: Marcelo Rezende; Judit Temesvary; Rebecca Zarutskie
    Abstract: In this note, we empirically assess whether changes in the interest on excess reserves (IOER) rate and changes in the spread between the IOER rate and the effective federal funds rate (EFFR) have affected banks’ reserve holdings and lending, controlling for changes in the stance of monetary policy and other macroeconomic conditions.
    Date: 2019–10–18
  21. By: Binder, Carola (Haverford College); Janson, Wesley (Federal Reserve Bank of Cleveland); Verbrugge, Randal (Federal Reserve Bank of Cleveland)
    Abstract: Despite the stability of the median 10-year inflation expectations in the Survey of Professional Forecasters (SPF) near 2 percent, we show that not a single SPF respondent’s expectations have been anchored at the target since the Federal Open Market Committee’s (FOMC) enactment of an inflation target in January 2012, or even since 2015. However, we find significant evidence for “delayed anchoring,” or a move toward being anchored, particularly after the federal funds rate lifted off in December 2015.
    Keywords: inflation expectations; persistent disagreement; credibility; delayed anchoring;
    JEL: E31 E37 E52
    Date: 2019–08–20
  22. By: H Peyton Young; Mark Paddrik
    Abstract: We propose a general framework for estimating the vulnerability to default by a central counterparty (CCP) in the credit default swaps market. Unlike conventional stress testing approaches, which estimate the ability of a CCP to withstand nonpayment by its two largest counterparties, we study the direct and indirect effects of nonpayment by members and/or their clients through the full network of exposures. We illustrate the approach for the U.S. credit default swaps market under shocks that are similar in magnitude to the Federal Reserve’s stress tests. The analysis indicates that conventional stress testing approaches may underestimate the potential vulnerability of the main CCP for this market.
    Keywords: Credit default swaps, central counterparties, stress testing, systemic risk, financial networks
    JEL: D85 G01 G17 L14
    Date: 2019–11–04
  23. By: Charles Yuji Horioka; Yoko Niimi
    Abstract: In this paper, we analyze the borrowing behavior of Japanese households in comparison to the other Group of Seven (G7) countries and also broken down by the age group of the household head. We find that pre-retirement households (households with a head in the 50-59 age group) in Japan do not have inordinate amounts of debt and that their financial health is satisfactory. However, we also find that households with a head in the 30-39 age group have shown a sharp increase in debt holdings in recent years, due partly to the fact that tax breaks for housing purchase, reforms in the housing loan market since the early 2000s, and expansionary monetary policy enabled Japanese households to purchase housing at a younger age than they could previously. We therefore need to monitor the borrowing behavior of this cohort over time as the Bank of Japan normalizes its monetary policy, especially since households have become more vulnerable to rising interest rates as the share of households who have chosen variable-rate housing loans has increased in recent years.
    Date: 2019–11
  24. By: Begg, David
    Abstract: An interesting theory of transition must give a convincing account of structural adjustment and supply side improvement. In this paper, I discuss the incentives for government to undertake costly supply side improvement and how these relate to incentives governing the design of monetary and fiscal policy during transition. The government cares about deviations of inflation, output and government spending from their ideal levels, is subject to a budget constraint in which inflation yields some real revenue, and recognizes the distortionary effects of excess levels of taxation. Costly structural adjustment enhances future output by reducing supply side distortions.Within this framework, optimal policies are derived. For a given level of inherited structural capacity, optimal levels of inflation, output and government spending are derived. A poor structural inheritance forces high tax distortions, low output, and heavy reliance on the inflation tax. Hence there is a negative cross-country correlation of output and inflation, because of differences in structural inheritance, even though each country faces a vertical long run Phillips curve. Relative to the first best, failures of monetary precommitment lead to an inflation bias. Joining EMU may improve matters by solving this problem, but may induce two other difficulties: it may reduce the inflation tax too much, and it may lead to stabilization of the wrong shocks. It need not be welfare enhancing.The incentive for structural adjustment is then examined. Compared with the first best speed of adjustment, a failure of monetary discretion, by raising distortions, increases the marginal benefit of reform and induces more rapid adjustment. If transition economies willingly enter EMU, their distortions are reduced and in consequence they will reform more slowly. Since this seems at variance with current perceptions, the paper then introduces two further failures, namely in fiscal commitment and in commitment to reform itself. It is shown that these can interact to make complete stagnation of reform the optimal policy conditional on the failures remaining. In those circumstances, EMU membership, or even its prospect, may be a powerful force for speeding up the pace of reform in countries that otherwise would have stagnated.
    Keywords: International Development
  25. By: Matteo Luciani; Riccardo Trezzi
    Abstract: The goal of this note is to provide an assessment of two of the most commonly used indicators of core inflation: the PCE price index excluding food and energy (an exclusion index), and the Dallas Fed trimmed mean PCE price index (a central-tendency statistical measure).
    Date: 2019–08–02
  26. By: Dvoskin, Ariel (National University of San Martín); Feldman, Germán David (National University of San Martín)
    Abstract: We critically review the previous attempts to introduce money and finance into Sraffa’s price system, whose main difference is, we argue, their conception of the interest rate, either as an opportunity cost or as an effective cost of production. We examine the implications on three different grounds: (i) the formal consistency of the system; (ii) the possibilities to explicitly treat the financial industry as any other productive sector; and (iii) the validity of the so-called “monetary theory of distribution” (MTD). We then suggest a possible route, inspired by Schumpeter’s ideas on economic development, to introduce the banking sector through its role of granting credit to innovation. Unlike previous contributions, this reformulation allows us both to justify the basic nature of the financial sector and simultaneously preserve the validity of MTD.
    Keywords: Banking industry; Innovation; Monetary theory of distribution; Sraffa; Surplus approach.
    JEL: E11 E43 E52
    Date: 2019–10–16
  27. By: Aikman, David (Bank of England); Bridges, Jonathan (Bank of England); Hacioglu Hoke, Sinem (Bank of England and Data Analytics for Finance and Macro (KCL)); O’Neill, Cian (Bank of England); Raja, Akash (Bank of England)
    Abstract: How can macroeconomic tail risks originating from financial vulnerabilities be monitored systematically over time? This question lies at the heart of operationalising the macroprudential policy regimes that have developed around the world in response to the global financial crisis. Using quantile regressions applied to a panel dataset of 16 advanced economies, we examine how downside risk to growth over the medium term, GDP-at-Risk, is affected by a set of macroprudential indicators. We find that credit booms, property price booms and wide current account deficits each pose material downside risks to growth at horizons of three to five years. We find that such downside risks can be partiall y mitigated, however, by increasing the capitalisation of the banking system. We estimate that across our sample of countries, GDP-at-Risk, defined as the 5th quantile of the projected GDP growth distribution over three years, on average deteriorated by around 4.5 percentage points cumulatively in the run-up to the crisis. Our estimates suggest that an increase in bank capital equivalent to a countercyclical capital buffer rate of 2.5% (5%) would have been sufficient to mitigate up to 20% (40%) of this increase in medium-term macroeconomic tail risk.
    Keywords: Financial stability; GDP-at-Risk; macroprudential policy; quantile regressions; local projections
    JEL: G01 G18 G21
    Date: 2019–09–20
  28. By: George Economides (Athens University of Economics and Business, and CESifo); Anastasios Xepapadeas (Athens University of Economics and Business and University of Bologna)
    Abstract: We investigate the impact of climate change on the macroeconomic performance of a small open economy. The setup is a new Keynesian dynamic stochastic general equilibrium model of a small open economy without monetary policy independence in which a climate module that interacts with the economy has been incorporated. The model is solved numerically using common parameter values, fiscal data and projections about temperature growth from the Greek economy. Our results, suggest that climate change implies a significant output loss and a deterioration of competitiveness. Moreover, it seems that the loss of monetary policy independence is not a big loss, when we investigate the short- and long-term implications of climate change for a small open economy.
    Keywords: Climate change; monetary policy; new Keynesian models
    JEL: E5 E1
    Date: 2019–09
  29. By: Murshed, S. Mansoob; Subagjo, Djono
    Abstract: Beginning with an empirical analysis of banking crises using a logit econometric model covering a sample of developed and developing countries between 1980-97, the paper suggests that crises are more likely in years of low growth and high real interest rates. Private sector credit as a percentage of GDP, lagged credit growth and tight liquidity in the banking sector are also strongly related with banking crises. The results call for more robust financial regulation. The paper argues that less developed countries (LDCs) face inherent obstacles in setting up efficient regulation, and building up a sound-banking sector. These are related to the presence of multiple tasks and multiple principals, poor institutions, lack of economies of scales in banking sectors as well as regulatory supervision, and the lack of reputation. LDCs need a regulatory framework that rewards prudent risk taking, but punishes misconduct. This is likely to involve a combination of input based measures impacting on bankers' incentives, with a few direct controls on the output of the banking sector. The paper concludes with a list of policy options whose appropriateness is judged by the 'friendliness' with the circumstances in LDCs.
    Keywords: International Development
  30. By: Fraccaroli, Nicolò (Bank of England and University of Rome Tor Vergata)
    Abstract: Scholars have long believed the governance of banking supervision to affect financial stability. Although the literature has identified at length the pros and cons of having either a central bank or a separate agency responsible for microprudential banking supervision, the advantages of having this task shared by both institutions (shared supervision) have received considerably less attention. This paper fills this void by comparing the impact of three supervisory governance models — supervision by the central bank, by an agency or by both of them — on bank non‑performing loans. Using a new database on supervisory governance in 116 countries from 1970 to 2016, it finds that supervisory governance per se does not significantly affect non‑performing loans. However, it also finds that, where the risk of capture is high, shared supervision is associated with a significant reduction in non‑performing loans. This is in line with the supervisory capture theory, whereby it is more costly to capture two supervisors rather than one. Overall, these results provide new evidence in support of the relevance of supervisory governance in hampering supervisory capture from the banking sector.
    Keywords: Banking supervision; supervisory governance; supervisory capture; non-performing loans
    JEL: D73 E58 G18 G38 P16
    Date: 2019–09–06
  31. By: Jorgensen, Peter (University of California, Berkeley); Lansing, Kevin J. (Federal Reserve Bank of San Francisco)
    Abstract: Conventional versions of the Phillips curve cannot account for inflation dynamics during and after the U.S. Great Recession, leading many to conclude that the Phillips curve relationship has weakened or even disappeared. We show that if agents solve a signal extraction problem to disentangle temporary versus permanent shocks to inflation, then agents’ inflation expectations should have become more “anchored” over the Great Moderation period. An estimated New Keynesian Phillips curve that accounts for the increased anchoring of expected inflation exhibits a stable slope coefficient over the period 1960 to 2019. Out-of-sample forecasts show that this model can account for the “missing disinflation” during the U.S. Great Recession and the “missing inflation” during the subsequent recovery. We use a simple three-equation New Keynesian model to show that an increase in the Taylor rule coefficient on inflation (or the output gap) serves to endogenously anchor agents’ subjective inflation expectations and thereby “flatten” the reduced-form Phillips curve.
    JEL: E31 E37
    Date: 2019–11–06
  32. By: Ramis Khabibullin (Bank of Russia, Russian Federation)
    Abstract: This paper investigates inflation forecasting accuracy of several real activity slack measures for the Russian economy. Several Bayesian unobservable-components models using several real activity variables were considered. I show that real-activity slacks gain no improvement in Russian inflation forecasting. This is true for the monthly and for the quarterly data. The estimation was made in the period from the beginning of 2003 to the end of 2018 for monthly data and from the beginning of 1999 to the end of 2018 for the quarterly data. Moreover, their real-times estimates are unreliable in the sense of the magnitude of their revisions.
    Keywords: Phillips curve, factor model, unobserved components model, output gap, real activity slack, Bayesian estimation
    JEL: C32 C53 E31 E32 E37
    Date: 2019–10
  33. By: Florian, Huber (University of Salzburg); Kaufmann, Daniel (Université de Neuchâtel)
    Abstract: We estimate a multivariate unobserved components stochastic volatility model to explain the dynamics of a panel of six exchange rates against the US Dollar. The empirical model is based on the assumption that both countries’ monetary policy strategies may be well described by Taylor rules with a time-varying inflation target, a time-varying natural rate of unemployment, and interest rate smoothing. Compared to the existing literature, our model simultaneously provides estimates of the latent components included in a typical Taylor rule specification and the model-based real exchange rate. Our estimates closely track major movements along with important time series properties of real and nominal exchange rates across all currencies considered, outperforming a benchmark model that does not account for changes in trend inflation and trend unemployment. More precisely, the proposed approach improves upon competing models in tracking the actual evolution of the real exchange rate in terms of simple correlations while it appreciably improves upon simpler competitors in terms of matching the persistence of the real exchange rate.
    Keywords: Exchange rate models; trend inflation; natural rate of unemployment; Taylor rule; unobserved components stochastic volatility model
    JEL: E31 E52 F31 F41
    Date: 2019–10–22
  34. By: Proettel, Thorsten
    Abstract: The objective of this discussion paper is to explore the consequences for monetary policy from the establishment of an international digital currency modeled like Libra. For this purpose, a basic assessment of the behavior of economic agents is conducted and possible conflicts with monetary policy are analyzed. Furthermore, a simple approach is developed to estimate the nature and extent of vulnerability for 42 currencies. The results suggest that currencies from developing countries and from developed nations are vulnerable in different ways. In the end, a stronger convergence of central bank policies could result. Thus, the introduction of an international digital currency represents a turning point for monetary policy.
    Keywords: monetary policy,digital currency,blockchain,effective lower bound
    JEL: E42 E52 E58
    Date: 2019
  35. By: Garth Baughman; Francesca Carapella
    Abstract: This note describes a framework for implementing monetary policy, dubbed a voluntary reserve targets framework, that could reintroduce significant margins in the federal funds market, reviving the market no matter the aggregate quantity of reserves, while simultaneously limiting the volatility of rates.
    Date: 2019–08–26
  36. By: Chatterjee, Somnath (Bank of England); Jobst, Andreas (International Monetary Fund)
    Abstract: This paper presents a forward-looking approach to measure systemic solvency risk using contingent claims analysis (CCA) as a theoretical foundation for determining an institution’s default risk based on the uncertainty in its asset value relative to promised debt payments over time. Default risk can be quantified as market-implied expected losses calculated from integrating equity market and balance sheet information in a structural default risk model. The expected losses of multiple banks and their non-parametric dependence structure define a multivariate distribution that generates portfolio-based estimates of the joint default risk using the aggregation technique of the Systemic CCA framework (Jobst and Gray, 2013). This market-implied valuation approach (‘shadow capital adequacy’) endogenises bank solvency as a probabilistic concept based on the perceived default risk (in contrast to accounting-based prudential measures of capital adequacy). The presented model adds to the literature of analytical tools estimating market-implied systemic risk by augmenting the CCA approach with a jump diffusion process of asset changes to inform a more comprehensive and flexible assessment of common vulnerabilities to tail risks of the four largest UK commercial banks.
    Keywords: Systemic risk; contingent claims analysis; jump diffusion; CoVaR; systemic expected shortfall; conditional tail expectation; capital adequacy
    JEL: C61 C63 G01 G21 G28
    Date: 2019–09–16
  37. By: Lojak, Benjamin; Makarewicz, Tomasz; Proaño Acosta, Christian
    Abstract: We investigate the relationship between monetary policy and banks' risk-taking behavior. We study a general equilibrium model in which a risk averse bank credits firms and also manages a portfolio consisting of a risky and a risk-free asset. When a bank signs up credit contracts with firms, it takes into account their solvency and potential gains from outside investment strategies. We show that the bank's asset/liability and risk management depend on the prevailing policy rate. However, low policy rates incentivizes a bank to search-for-yield by re-allocating their asset portfolios towards more risky exposures ultimately leads to under-capitalized positions. This renders the financial sector more vulnerable.
    Date: 2019
  38. By: Thomas I. Palley
    Abstract: The case for central bank independence is built on an intellectual two-step. Step one argues there is a problem of inflation prone government. Step two argues independence is the solution to that problem. This paper challenges that case and shows it is based on false politics and economics. The paper argues central bank independence is a product of neoliberal economics and aims to institutionalize neoliberal interests. As regards economics, independence rests on a controversial construction of macroeconomics and also fails according to its own microeconomic logic. That failure applies to both goal independence and operational independence. It is a myth to think a government can set goals for the central bank and then leave it to the bank to impartially and neutrally operationalize those goals. Democratic countries may still decide to implement central bank independence, but that decision is a political one with non-neutral economic and political consequences. It is a grave misrepresentation to claim independence solves a fundamental public interest economic problem, and economists make themselves accomplices by claiming it does.
    Keywords: central bank independence, neoliberalism, class conflict, time consistency, operational independence, democracy
    JEL: E02 E42 E52 E58 E61 G18 G28
    Date: 2019
  39. By: Joseph Halevi (University College of Turin)
    Abstract: This essay deals with the EMS experience and its failure, with the Maastricht Treaty, and with the interregnum leading to the formation of the EMU in 1999. The paper highlights the position of German authorities, showing that they were quite lucid about the fundamental weaknesses inherent in a process that separated monetary from fiscal policies by giving priority to the centralization of the former. Instead of repeating the well known critiques leveled against the EMU '96 for which readers are referred to the unsurpassed treatment by Stiglitz, the essay highlights the splintering of Europe in the way in which it has unfolded during the 1990s and in the first decade of the present millennium. In particular the early economic and political origins of the terminal crisis of Italy are located between the late 1980s and the 1990s. France is shown to belong increasingly to the so-called European periphery by virtue of a weakening industrial structure and persistent balance of payments deficits. The paper argues that France regains its central role by political means and through its weight as an active nuclear military power centered on maintaining its imperial interests and posture especially in Africa. The first decade of the present millennium is portrayed as the period in which a distinct German economic area had been formed in the midst of Europe with a strong drive to the east with an increasingly powerful gravitational pull towards the People '92s Republic of China.
    Keywords: European Monetary System, Common Market, France, Germany, Italy, Netherlands, currency depreciation, European Monetary Union
    JEL: E02 F02 F5 N14 N24
    Date: 2019–09
  40. By: Cohen, Benjamin J.
    Abstract: The purpose of this paper is to explore economic and political implications of Europe's Economic and Monetary Union (EMU) for developing countries. In strictly economic terms, influences will be communicated through both trade and financial channels. Economies in the developing world will be affected by changes in European growth rates as well as by EMU's impact on transactions costs and enterprise competitiveness within Europe; they will also be impacted by changes in the structure and efficiency of Europe's capital markets. Modifications may be anticipated in borrowing and investment practices at the private level as well as in reserve and debt-management policies at the official level. In political terms, developing countries will be most directly influenced by the anticipated rivalry between Europe's new single currency, the euro, and the dollar, which will compel developing countries to reconsider their own national currency strategies. Three conclusions stand out. First, except for selected groups of countries with particularly close ties to the EU, most economic linkages appear marginal at best. It is much easier to enumerate possible channels of transmission than to find many that appear quantitatively significant. Second, among economic effects of EMU, financial channels seem to matter more than trade channels. And third, across the full range of possible linkages, the most lasting influences for developing countries may well turn out, notably, to be political rather than either trade or financial. Significant changes are likely in exchange-rate regimes in many parts of the developing world.
    Keywords: International Development
  41. By: Eichengreen, Barry; Mathieson, Donald J.
    Abstract: The management of international reserves remains one of the understudied aspects of the international monetary system. There are now a number of reasons why this should change. On the supply side of the market there is the advent of the euro, creating a full-fledged rival to the dollar for the first time in more than 50 years. The existence of this attractive alternative, it is said, will produce major shifts in the currency composition of international reserves, requiring large movements in the euro-dollar exchange rate to restore equilibrium to international financial markets. On the demand side there is the rush by industrial-country central banks out of gold and changes in the trade relations, capital account restrictions, and exchange rate regimes of developing countries, which may have important repercussions for the composition of their reserves. A number these issues have been addressed in the recent literature. But one of them-their impact on the currency composition of reserves-has not been systematically addressed. We therefore analyse recent trends in currency composition in this paper, with special attention to emerging markets, where the impact of changes in the international financial environment is especially far-reaching, and with special reference to the euro, perhaps the single most important event on the reserve-currency scene. Our single most important finding is the striking stability over time not just of the currency composition of reserves but also of the relationship between the demand for reserves denominated in different currencies and its principal determinants: trade flows, financial flows and currency pegs. This is not something that would have been predicted from recent contributions to the literature, which have forecast sharp shifts in the currency composition of central banks' holdings of foreign exchange. The message would seem to be that in this, as in other respects, the international monetary system is in a mode of gradual, continuous evolution, not of rapid, discontinuous change. For the same reasons that, say, the share of countries operating a particular exchange rate arrangement tends to evolve gradually (rather than to shift all at once in response to some grand scheme for a new Bretton Woods or a global system of target zones), the composition of reserves similarly appears to evolve only gradually, despite the existence of quite marked changes in the wider financial environment. If the right metaphor is punctuated equilibrium, then we would appear to be in one of those long periods between punctuation marks.
    Keywords: International Development
  42. By: Kasper Joergensen; Andrew C. Meldrum
    Abstract: To what extent does the persistent relatively low level of the federal funds rate reflect a decline in its long-run equilibrium? In this Note, we examine how views have evolved on that question among professional forecasters, Federal Open Market Committee (FOMC) participants, and investors in bond markets.
    Date: 2019–10–09

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