nep-cba New Economics Papers
on Central Banking
Issue of 2020‒02‒10
eighteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default) By Cristina Arellano; Yan Bai; Gabriel P. Mihalache
  2. Does Quantitative Easing Boost Bank Lending to the Real Economy or Cause Other Bank Asset Reallocation? The Case of the UK By Simone Giansante; Mahmoud Fatouh; Steven Ongena
  3. Monetary Policy Strategies for the Federal Reserve By Lars E.O. Svensson
  4. Monetary Policy Spillovers in Emerging Economies By Apostolos Serletis; Nahiyan Azad
  5. Banco de Portugal TARGET balance: evolution and main drivers By Rita Soares; Joana Sousa Leite; João Filipe; Nuno Nóbrega
  6. The Dynamics of U.S. REITs Returns to Uncertainty Shocks: A Proxy SVAR Approach By Oguzhan Cepni; Wiehan Dul; Rangan Gupta; Mark E. Wohar
  7. Worker Flows in Banking Regulation By Francesco Trebbi; David O. Lucca; Amit Seru
  8. Which Dealers Borrowed from the Fed’s Lender-of-Last-Resort Facilities? By Asani Sarkar; Viral V. Acharya; Warren B. Hrung; Michael J. Fleming
  9. Credit Spreads, Monetary Policy and the Price Puzzle By Benjamin Beckers
  10. Monetary Dynamics in a Network Economy By Antoine Mandel; Vipin Veetil
  11. Overcoming Borrowing Stigma: The Design of Lending-of-Last-Resort Policies By Zhang, Hanzhe; Hu, Yunzhi
  12. Private Money Production without Banks By Gary B. Gorton
  13. Banks, Politics and European Monetary Union By Martin Hellwig
  14. Follow That Money! How Global Banks Manage Liquidity Globally By Linda S. Goldberg; Nicola Cetorelli
  15. Unlocking the Treasury Market through TRACE By Liza Rodrigues; Or Shachar; Dobrislav Dobrev; Michiel De Pooter; Michael J. Fleming; Peter Johansson; Michael Puglia; Collin Jones; Frank M. Keane; Doug Brain
  16. Banking crisis prediction with differenced relative credit By Kauko, Karlo; Tölö, Eero
  17. Forward Guidance Under the Cost Channel By David Finck
  18. A Toolkit for Solving Models with a Lower Bound on Interest Rates of Stochastic Duration By Gauti Eggertsson; Sergey K. Egiev; Alessandro Lin; Josef Platzer; Luca Riva

  1. By: Cristina Arellano; Yan Bai; Gabriel P. Mihalache
    Abstract: This paper develops a New Keynesian model with sovereign default risk (NK-Default). We focus on the interaction between monetary policy, conducted according to an interest rate rule that targets inflation, and external defaultable debt issued by the government. Monetary policy and default risk interact since both affect domestic consumption, production, and inflation. We find that default risk amplifies monetary frictions and generates a tension for monetary policy, which increases the volatility of inflation and nominal rates. These monetary frictions in turn discipline sovereign borrowing, slowing down debt accumulation and lowering sovereign spreads. Our framework replicates the positive comovements of spreads with nominal domestic rates and inflation, a salient feature of emerging markets data, and can rationalize the experience of Brazil during the 2015 downturn, with high inflation, nominal rates, and spreads.
    JEL: E52 F34 F41
    Date: 2020–01
  2. By: Simone Giansante (University of Bath - School of Management); Mahmoud Fatouh (University of Essex; Bank of England); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR))
    Abstract: We investigate the impact of the Bank of England’s asset purchase program (APP) on the composition of assets of UK banks, and to the implications for the real economy, using a unique database on the program. The identification of banks that receives deposits (QE banks) injections by the program as well as the magnitude of these injections provides the ideal empirical design for a difference-in-difference matching exercise. We find no evidence that suggests QE boosted bank lending to the real economy. The overall reduction of retail lending was more pronounce for treated (QE) banks than for the control group. QE banks reallocated their assets towards lower risk weighted investments, such as government securities and reserves, as confirmed by the increased sensitivity of their equity returns on peripheral EU bond returns. Our findings suggest that risk weighted based capital constraints can limit the effectiveness of expansionary unconventional monetary policies and provide incentives on carry trade activities.
    Keywords: monetary policy, quantitative easing, bank lending
    JEL: E51 G21
    Date: 2019–09
  3. By: Lars E.O. Svensson
    Abstract: The general monetary policy strategy of “forecast targeting” allows the Federal Reserve to respond flexibly to all relevant information in achieving its dual mandate of maximum employment and price stability. In contrast, a simple “instrument” rule such as a Taylor-type rule restricts the Federal Reserve to only respond in a rigid way to the partial information of current inflation and output. Forecast targeting can be used for any of the more specific strategies of annual-inflation targeting, price-level targeting, temporary price-level targeting, average-inflation targeting, and nominal-GDP targeting. These specific strategies are examined and evaluated according to how well they may fulfill the dual mandate, considering the possibilities of a binding effective lower bound for the federal funds rate and a flatter Phillips curve. Nominal-GPD targeting means that GDP and the GDP deflator are considered perfect substitutes. It therefore does not treat maximum employment and price stability as separate and independent targets. In addition, data on GDP and the GDP deflator have longer reporting lags and are subject to substantial ex post revisions. The latter will require both retrospective and prospective revisions of the target path, with large communication difficulties. Average-inflation targeting has good prospects of handling the problems of a binding effective lower bound and a flatter Phillips curve. As a permanently applied strategy, it would also have good possibilities of becoming understood by and credible with markets and the general public.
    JEL: E52 E58
    Date: 2020–01
  4. By: Apostolos Serletis (University of Calgary); Nahiyan Azad (University of Calgary)
    Abstract: This paper explores for spillovers from monetary policy in the United States to a number of emerging market economies. We estimate the Elder and Serletis (2010) bivariate structural GARCH-in-Mean VAR in the U.S. monetary policy rate and the policy rate of each of six emerging economies that target the inflation rate — Brazil, Chile, Mexico, Romania, Serbia, and South Africa. We also estimate the same model in the U.S. monetary policy rate and the exchange rate (against the U.S. dollar) of each of six emerging economies that target the exchange rate — Bosnia and Herzegovina, Bulgaria, Comoros, Croatia, the Former Yugoslav Republic of Macedonia, and Montenegro. Our evidence suggests that positive (negative) U.S. monetary policy shocks tend to appreciate (depreciate) the currencies of the exchange rate targeting emerging economies, but have an ambiguous effect on the policy rates of the inflation-targeting emerging economies. Moreover, monetary policy uncertainty in the United States leads to an increase in policy rates in those emerging economies that target the inflation rate and to a depreciation of the currencies of those emerging economies that target the exchange rate.
    Date: 2019–09–13
  5. By: Rita Soares; Joana Sousa Leite; João Filipe; Nuno Nóbrega
    Abstract: Banco de Portugal TARGET balance, an accounting position representing a liability towards the European Central Bank arising from net cross-border payments in central bank money settled via the TARGET2 payment system, was the largest item on Banco de Portugal balance sheet by the end of 2018. In this paper, we depict the evolution and explain the main underlying drivers of Banco de Portugal TARGET liability since the beginning of Stage III of the EMU, following two perspectives, one based on Banco de Portugal balance sheet and other on the Portuguese Balance of Payments. We find that the evolution of Banco de Portugal TARGET liability is highly related with the volume of liquidity-providing monetary policy operations, although the underlying drivers evolved throughout the time: demand driven in 2011/2012 and supply driven from 2015 onwards. We find no time-invariant causal link between Banco de Portugal TARGET liability and neither financial market stress indicators nor the net financing needs of the Portuguese economy. We corroborate our findings empirically using simple OLS regressions.
    JEL: E42 E44 E52 E58
    Date: 2020
  6. By: Oguzhan Cepni (Central Bank of the Republic of Turkey, Anafartalar Mah. Istiklal Cad. No:10 06050 Ankara, Turkey); Wiehan Dul (Department of Economics, University of Pretoria, 0002, South Africa); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa); Mark E. Wohar (College of Business Administration, University of Nebraska at Omaha, 6708 Pine Street, Omaha, NE 68182, USA and School of Business and Economics, Loughborough University, Leicestershire, LE11 3TU, UK)
    Abstract: This paper investigates the impact of uncertainty shocks on REITs returns over a monthly period from 1972:01 to 2015:12, and sub-samples from 1972:01 to 2009:06, and 2009:07 to 2015:12, to accommodate for the possible effects of the Global Financial Crisis (GFC) and unconventional monetary policy decisions. We use the recently-proposed variations in the price of gold, around events associated with unexpected changes in uncertainty as an instrument to identify uncertainty shocks in a proxy Structural Vector Autoregressive (SVAR) model. Moreover, to control for news-related effects associated with these events, uncertainty and news shocks are jointly identified based on a set-identified proxy SVAR, as recently suggested in the VAR literature. Our results show that the uncertainty shock generates a larger negative impact on REITs returns over the post-GFC period to the extent that it also outweighs the impact of the otherwise dominant news (productivity) shocks. In addition, the impulse response dynamics related to the recursively identified uncertainty shock, as is standard in the literature, resembles the effects of a news shock, and somewhat contrary to intuition suggests that the impact of the uncertainty shock on REITs returns were higher during the pre-GFC era.
    Keywords: Connectedness, U.S. REITs, Proxy SVAR Model, Uncertainty, Monetary Policy Regimes
    JEL: C32 E52 R33
    Date: 2020–01
  7. By: Francesco Trebbi (Vancouver School of Economics; University of British Columbia; Harvard University; National Bureau of Economic Research; Graduate School of Business; Center for International Financial Analysis and Research (CIFAR)); David O. Lucca (Federal Reserve Bank); Amit Seru (Booth School of Business; National Bureau of Economic Research; Stanford University)
    Abstract: In the aftermath of the 2008 financial crisis, job transitions of personnel in banking supervision and regulation between the public and private sectors?often labeled the revolving door?have come under intense scrutiny and have been blamed by certain economists (Johnson and Kwak), legal scholars (John Coffee in the Financial Times), and policymakers (Dodd-Frank Act of 2010, Section 968) for distorting regulators? actions in favor of banks. However, other commentators have downplayed these distortions and presented a more benign viewpoint of these worker flows?as a means for regulatory agencies to attract higher-ability and skilled workers. Because data on job transitions in banking regulatory agencies are scarce, these discussions are mostly informed by anecdotes. Our recent paper brings more rigor to this debate by contributing a first set of stylized facts based on data related to incidence and drivers of worker flows in U.S. banking regulation. Our data show clear evidence of higher worker inflows to the regulatory sector during bad economic conditions. When we study worker flows as a function of an enforcement proxy, we find evidence to be inconsistent with the often-cited ?quid-pro-quo? hypothesis. We instead posit an alternative ?regulatory schooling? hypothesis that may better explain the empirical evidence.
    Keywords: worker flows; Banking regulation; revolving doors
    JEL: G3
  8. By: Asani Sarkar; Viral V. Acharya (Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); Kennesaw State University; London Business School; European Corporate Governance Institute; National Bureau of Economic Research; Reserve Bank of India; City University London); Warren B. Hrung; Michael J. Fleming
    Abstract: During the 2007-08 financial crisis, the Fed established lending facilities designed to improve market functioning by providing liquidity to nondepository financial institutions?the first lending targeted to this group since the 1930s. What was the financial condition of the dealers that borrowed from these facilities? Were they healthy institutions behaving opportunistically or were they genuinely distressed? In published research, we find that dealers in a weaker financial condition were more likely to participate than healthier ones and tended to borrow more. Our findings reinforce the importance of Bagehot?s principle that the lender-of-last resort should lend only against high-quality collateral and at a penalty rate so as to discourage unneeded or opportunistic borrowing.
    Keywords: stigma; insolvency; central banking; illiqudity; Lender of last resort; crises
    JEL: G1 G2 E5 H1
  9. By: Benjamin Beckers (Reserve Bank of Australia)
    Abstract: Identifying the causal effect of monetary policy on inflation remains a challenge. Researchers frequently find evidence of a 'price puzzle': increases in the policy rate are followed by higher rather than lower inflation. This can be explained by the forward-looking behaviour of the central bank. Inflation does not rise in response to an increase in the policy rate but, instead, the central bank raises its policy rate when it expects inflation to increase in the future. To identify the true causal effects of monetary policy on inflation, it is hence necessary to control for this systematic policy response to expected inflation. For Australia, however, the price puzzle has been found even when controlling for the cash rate's systematic response to the Reserve Bank's own inflation forecasts. I argue that this is due to an additional but omitted systematic response of the cash rate to credit market shocks. Easier credit market conditions lead to an economic expansion and higher inflation. Therefore, the Bank raises the cash rate – its policy rate – when credit spreads decline. However, the Bank's inflation forecasts do not fully capture the inflationary effect of easier credit conditions. As a result, cash rate changes are positively correlated with future inflation even when purging them of the cash rate's response to the Bank's inflation forecasts. Accordingly, I show that accounting for the cash rate's additional response to credit market conditions resolves the price puzzle. As expected, a higher cash rate reduces inflation and output growth, and raises the unemployment rate.
    Keywords: monetary policy; inflation; price puzzle; credit market shocks; credit spreads
    JEL: E31 E32 E43 E52
    Date: 2020–01
  10. By: Antoine Mandel (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, UP1 - Université Panthéon-Sorbonne, PSE - Paris School of Economics); Vipin Veetil (IIT Madras - 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.
    Abstract: Nous proposons un modèle de la dynamique hors-équilibre dans une économie en réseau où les agents sont soumis à des contraintes financières. Nous étudions la propagation des chocs de politique monétaire dans ce cadre. Nous démontrons notamment que le "price puzzle" émerge dans ce cadre du fait des délais dans la propagation des chocs.
    Keywords: Price Puzzle,Production Network,Money,Monetary Non-Neutrality,Out-Of-Equilibrium dynamics,Réseaux de production,dynamique hors-équilibre
    Date: 2019–10
  11. By: Zhang, Hanzhe (Michigan State University, Department of Economics); Hu, Yunzhi (Kenan-Flagler Business School, University of North Carolina, Chapel Hill, NC)
    Abstract: How should the government effectively provide liquidity to banks during periods of financial distress? During the 2008-2010 crisis, banks avoided borrowing from the Fed's long-standing discount window (DW), but actively borrowed and sometimes paid a higher interest in its special monetary program, the Term Auction Facility (TAF), although both programs had the same borrowing requirements. We use a dynamic adverse selection model with endogenous borrowing stigma costs to explain how the combination of the DW and TAF increased banks' borrowing and willingness to pay for loans from the Fed. Using micro-level data on DW borrowing and TAF bidding from 2007 to 2010, we confirm our theoretical predictions about the financial condition of banks in different facilities.
    Keywords: lending of last resort; discount window stigma; Term Auction Facility; adverse selection
    JEL: D44 E52 E58 G01
    Date: 2020–01–23
  12. By: Gary B. Gorton
    Abstract: I test the Dang, Gorton, and Holmström (2018) (DGH) theory that the optimal design of private money is debt backed by debt. I do this in the context of English inland bills of exchange (where all parties to the bill were in England), which were used as a medium of exchange during the Industrial Revolution in the north of England in the eighteenth and first half of the nineteenth centuries. These bills circulated via indorsements, committing each indorser’s personal wealth to back the bill. A sample of bills from the period 1762-1850 is studied to determine how frequently they changed hands (liquidity/velocity) and to determine how their credibility was established. Some bills were backed by banks and others by the joint liability of indorsers only. I test the DGH theory by asking: Were bank-backed bills more liquid than the joint liability-backed bills?
    JEL: E02 G21
    Date: 2020–01
  13. By: Martin Hellwig (Max Planck Institute for Research on Collective Goods)
    Abstract: This contribution to the panel on the future to EMU discusses the tensions that arise from the fact that banks are, on the one hand, an essential element of the monetary transmission mechanism and, on the other hand, an integral part of local, regional or national polities. Banking union can eliminate or at least reduce some of the procrastination that has allowed maintained bank weaknesses to persist and harmed the transmission of monetary policy but, whereas the SSM has been fairly successful, resolution is still not working properly and needs further reforms. At the same time, banking union suffers from the problem that interventions from Brussels or Frankfurt are seen as infringements of national sovereignty that lack political legitimacy. The conflict between supranational and national interests is ultimately irresolvable but, if EMU is to survive, measures must be taken to limit its impact.
    Keywords: Monetary union, central banking, politics of banks, banking union, bank resolution, bail-in.
    JEL: E42 E44 E51 G18 G28 G33
    Date: 2019–11
  14. By: Linda S. Goldberg; Nicola Cetorelli (Brown University; National Bureau of Economic Research; Research and Statistics Group; Federal Reserve Bank; Federal Reserve Bank of New York)
    Abstract: Banks increasingly move money around the world. Over the last thirty years, gross international claims of banks from all countries have grown ten-fold, reaching a peak of about $25 trillion in 2007 (see chart below). Such global banking flows have been much in the news recently, sometimes depicted as a key culprit of the transmission around the globe of the shocks following the bankruptcy of Lehman Brothers, and more recently the European sovereign debt crisis. The discourse in the regulatory arena seems to share this sentiment, with a bias towards curbing some of the global banking activity (for example, Bank for International Settlements, CGFS 2010, and the United Kingdom Independent Commission on Banking 2011). We acknowledge that global banking has contributed to the international propagation of shocks during the 2007 to 2009 crisis, as shown in a range of recent studies (for example, Acharya and Schnabl 2010, Cetorelli and Goldberg 2011, and 2012). However, we argue that there still are many unknowns regarding the intensity and the direction of global banking flows, as well as the consequences of these flows. There is a pressing need to refine our understanding of these dynamics, not just from a positive angle, but also to inform policy analysis. We take steps in this direction in some of our research, discussed in this blog post. We show that global banks manage liquidity on a global scale and that internal funding reallocations are bank and business-model specific. This centralized liquidity management is a feature of normal times, as well as a feature of market stress periods.
    Keywords: international banks; liquidity; Global banks
    JEL: F00 G2
  15. By: Liza Rodrigues; Or Shachar; Dobrislav Dobrev (United States; National Bureau of Economic Research); Michiel De Pooter; Michael J. Fleming; Peter Johansson; Michael Puglia; Collin Jones; Frank M. Keane; Doug Brain
    Abstract: The U.S. Treasury market is widely regarded as the deepest and most liquid securities market in the world, playing a critical role in the global economy and in the Federal Reserve?s implementation of monetary policy. Despite the Treasury market?s importance, the official sector has historically had limited access to information on cash market transactions. This data gap was most acutely demonstrated in the investigation of the October 15, 2014, flash event in the Treasury market, as highlighted in the Joint Staff Report (JSR). Following the JSR, steps were taken to improve regulators? access to information on Treasury market activity, as detailed in a previous Liberty Street Economics post, with Financial Industry Regulatory Authority (FINRA) members beginning to submit data on cash market transactions to FINRA?s Trade Reporting and Compliance Engine (TRACE) on July 10, 2017. This joint FEDS Note and Liberty Street Economics blog post from staff at the Board of Governors of the Federal Reserve System and Federal Reserve Bank of New York aims to share initial insights on the transactions data reported to TRACE, focusing on trading volumes in the market.
    Keywords: FINRA; trading volume; Treasury securities; TRACE
    JEL: G1
  16. By: Kauko, Karlo; Tölö, Eero
    Abstract: Indicators based on the ratio of credit to GDP have been found to be highly useful predictors of banking crises. We study the difference in this ratio as an early warning indicator. We test a large number of different versions of the differenced credit-to-GDP ratio with data on Euro area members. The optimal time interval of the difference is about two years. Using the moving average of GDP instead of the latest annual data has little impact on forecasting performance. The indicator is a particularly promising choice at relatively short forecasting horizons, such as two or three years.
    Keywords: banking crises,early warning indicators,differenced relative credit,credit intensity,countercyclical capital buffer
    JEL: G01 G17 G28
    Date: 2019
  17. By: David Finck (University of Giesssen)
    Abstract: A common finding in the literature is that forward guidance cannot be credible under discretionary policy as long as the zero lower bound is an one-off event. However, this is not the case when recurring episodes of zero interest rates are possible. In this paper, we contribute to this new result and assess the sustainability of forward guidance under the cost channel. We find that forward guidance can be sustainable under the cost channel. However, we show that it is less credible compared to a standard New Keynesian model. Our results show that this finding also depends on the strength of the cost channel. Furthermore, provide evidence that ignoring the presence of a cost channel can be costly in terms of steady-state consumption.
    Keywords: Forward Guidance, Sustainability, Cost Channel, Discretion
    JEL: E12 E43 E52 E58 E61
    Date: 2020
  18. By: Gauti Eggertsson; Sergey K. Egiev; Alessandro Lin; Josef Platzer; Luca Riva
    Abstract: This paper presents a toolkit to solve for equilibrium in economies with the effective lower bound (ELB) on the nominal interest rate in a computationally efficient way under a special assumption about the underlying shock process, a two-state Markov process with an absorbing state. We illustrate the algorithm in the canonical New Keynesian model, replicating the optimal monetary policy in Eggertsson and Woodford (2003), as well as showing how the toolkit can be used to analyze the medium scale DSGE model developed by the Federal Reserve Bank of New York. As an application, we show how well various policy rules perform relative to the optimal commitment equilibrium. A key conclusion is that previously suggested policy rules – such as price level targeting and nominal GDP targeting – do not perform well when there is a small drop in the price level, as observed during the Great Recession, because they do not imply sufficiently strong commitment to low future interest rates (”make-up strategy”). We propose two new policy rules, Cumulative Nominal GDP Targeting Rule and Symmetric Dual-Objective Targeting Rule that are more robust.
    Date: 2020

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