nep-cba New Economics Papers
on Central Banking
Issue of 2020‒04‒13
twenty-two papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Cross border flows, financial Intermediation and interactions of policy rules in a small open economy model By Ashima Goyal; Akhilesh K. Verma
  2. Monetary Policy in the 1990s: Bank of Japan's Views Summarized Based on the Archives and Other Materials By Masanao Itoh; Yasuko Morita; Mari Ohnuki
  3. Regime changes in Indias monetary policy and Tenures of RBI governors By Utso Pal Mustafi; Rajeswari Sengupta
  4. The Fed's enhanced swap lines and new interventions in the Treasury market By Richhild Moessner; William Anthony Allen
  5. Does Geographical Complexity of Colombian Financial Conglomerates Increase Banks’ Risk? The Role of Diversification, Regulatory Arbitrage and Funding Costs By Cardozo, Pamela; Morales-Acevedo, Paola; Murcia, Andrés; Pacheco, Beatriz
  6. Role of money in the monetary policy: A New Keynesian and new monetarist perspective By Masudul Hasan Adil; Neeraj R. Hatekar; Taniya Ghosh
  7. Macroprudential Policies and Current Account Balance By Ekinci, Mehmet Fatih
  8. Looking into the Rear-View Mirror: Lessons from Japan for the Eurozone and the U.S? By Pierre L. Siklos
  9. Liquidity Regulation and Bank Lending By Foly Ananou; Amine Tarazi; John O.S Wilson
  10. The Short-Run Impact of Interest Rates on Exchange Rates: Results for the Swiss franc Against the Euro and US Dollar from Daily Data 2001-2011 By Kugler, Peter
  11. Loan loss provisions under regulatory pressure: public versus private banks in Tunisia By FENDRI ZOUARI, Nawel; NEIFAR, MALIKA
  12. Welfare Implications of Bank Capital Requirements under Dynamic Default Decisions By Toshiaki Ogawa
  13. Monetary policy and regional inequality By Hauptmeier, Sebastian; Holm-Hadulla, Fédéric; Nikalexi, Katerina
  14. The Value of Opacity in a Banking Crisis By Haelim Anderson; Adam Copeland
  15. "A Simple Model of the Long-Term Interest Rate" By Tanweer Akram
  16. The market impact of systemic risk capital surcharges By Gündüz, Yalin
  17. How the Fed Managed the Treasury Yield Curve in the 1940s By Kenneth D. Garbade
  18. Monetary Policy,Markup Dispersion, and Aggregate TFP By Matthias Meier; Timo Reinelt
  19. Non-traditional Monetary Policy and the Future of the Financial Industries By Willem THORBECKE
  20. The Short-Run Impact of SNB Sight Deposits on Exchange Rates: Results from Weekly Data 2015 - 2018 By Kugler, Peter
  21. Shilnikov chaos, low interest rates, and new Keynesian macroeconomics By William A. Barnett; Giovanni Bella; Taniya Ghosh; Paolo Mattana; Beatrice Venturi
  22. Equilibrium real exchange rates and misalignments in large emerging markets: A Re-look through panel cointegrating estimation By Krittika Banerjee; Ashima Goyal

  1. By: Ashima Goyal (Indira Gandhi Institute of Development Research); Akhilesh K. Verma (Indira Gandhi Institute of Development Research)
    Abstract: We present a small open economy New Keynesian model with financial intermediation to investigate the interaction between monetary policy and macroprudential regulations. Our model economy attempts to capture the vulnerability of emerging market economies in the face of external and domestic shocks. We build a model that closely captures the dynamics of emerging market economies to show that interest rate policy rules alone may not be an effective instrument to stabilize the economy under negative shocks. Monetary policy implementation through augmented Taylor rule (ATR) is an inadequate tool to absorb negative shocks given its conflict between inflation and exchange rate objectives. We show that the use of macroprudential regulations (MaPs) with simple Taylor rule improves business cycle dynamics relative to ATR under domestic and external shocks. We present two kinds of MaP regulations to show that they effectively mitigate losses during economic downturns and reduce excessive risk-taking behavior during economic booms when used along with a simple monetary policy rule (MP). In addition, we also conduct welfare evaluation that supports complementarity between MP and MaPs under different shocks.
    Keywords: DSGE model, cross border flows, monetary policy macroprudential regulation
    JEL: E44 E52 E61 F42 G28
    Date: 2020–03
  2. By: Masanao Itoh (President, Otsuma Women's University (E-mail:; Yasuko Morita (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Mari Ohnuki (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: This monographic paper summarizes views held by the Bank of Japan (hereafter BOJ or the Bank) in the 1990s regarding economic and financial conditions as well as the conduct of monetary policy, based on materials compiled during the period mainly in its Archives. The following points were confirmed in writing this paper. First, throughout the 1990s, the Bank's thinking behind the conduct of monetary policy had shifted toward emphasizing the transparency of its policy management. The basic background to this seemed to be the growing importance of dialogue with market participants, reflecting a change in the target for money market operations from official discount rate changes to the guiding of money market rates. In addition, the fact that the revised Bank of Japan Act (hereafter the Bank of Japan Act of 1997) came into effect in April 1998 under the two principles of independence and transparency accelerated the trend of attaching importance to transparency. Second, on the back of the emphasis on transparency, the Bank enhanced its communication by increasing its releases in the second half of the 1990s, particularly after the enforcement of the Bank of Japan Act of 1997. Thus, the materials, especially those referred to in the latter half of this paper, consist mainly of the Bank's releases. And third, in the 1990s, the Bank faced a critical situation in which it needed to conduct monetary policy while paying due attention to the functioning of the financial system. Therefore, this paper includes numerous references to the issues regarding the financial system, mainly the disposal of nonperforming loans.
    Keywords: Monetary policy conduct, Disposal of nonperforming loans, Financial system crisis, Bank of Japan Act of 1997, Zero interest rate policy
    JEL: E52 E58 N15 N25
    Date: 2020–03
  3. By: Utso Pal Mustafi (Center for Monetary and Financial Studies (CEMFI), Madrid); Rajeswari Sengupta (Indira Gandhi Institute of Development Research)
    Abstract: In this paper, we estimate regime switches in Indian monetary policy during the period 1998-2017. Prior to the adoption of an inflation targeting rule in 2016, monetary policy in India was conducted in discretionary manner. The Reserve Bank of India followed a multiple indicator approach in which the policy rate was determined based on a multitude of macroeconomic indicators. Given the absence of any well defined framework, it is possible that monetary policy experienced multiple regime shifts as a consequence of overall macroeconomic developments as well as the discretionary setting of the policy rate by various RBI Governors. We apply a multivariate Markov-switching Vector Autoregression (MS-VAR) model to uncover the time variation in a system of variables related to monetary policy, as reflected through multiple regimes. We find that the optimal number of regimes during this period was three, with one of them being relatively less persistent. Among the other two, one regime corresponds closely to the tenure of Governor Jalan and sporadically appears during the tenure of Governor Reddy whereas the other regime overlaps with the time when Governor Rajan was in office. In contrast, Governor Subbarao's tenure does not correspond to any specific regime. We also characterise the regimes by the behaviour of specific macroeconomic variables.
    Keywords: Markov regime switches, Monetary policy, Inflation targeting, Reserve Bank of India, Discretionary monetary policy
    JEL: E4 E5 E6
    Date: 2020–03
  4. By: Richhild Moessner; William Anthony Allen
    Abstract: In March 2020, the Federal Reserve enhanced its existing swap lines with foreign central banks, and introduced additional temporary swap lines with other central banks, in order to support the smooth functioning of U.S. dollar funding markets during the coronavirus epidemic. The Federal Reserve also announced purchases of US Treasuries and agency mortgage bonds in order to support the smooth functioning of the Treasury and mortgage-backed securities market. We analyse the motivations for and the effects of these measures.
    Keywords: Central bank swap lines, government bonds
    JEL: E52 E58
    Date: 2020–03
  5. By: Cardozo, Pamela; Morales-Acevedo, Paola; Murcia, Andrés; Pacheco, Beatriz
    Abstract: During the last decade Colombian international financial conglomerates (IFC) expanded abroad, significantly increasing their geographical complexity. This paper analyzes the effect of this change in geographical complexity on the risk level of individual Colombian banks. We use monthly bank-level data on financial indicators and complexity measures for the period 2007- 2018. We use the Z-score as a measure of bank risk and the number of countries in which a Colombian IFC has foreign banks subsidiaries as a measure of geographical complexity. Our results suggest that complexity is associated with higher levels of individual bank risk, as a result of an expansion to countries with large GDP co-movements and lower regulatory qualities. In addition, we find that banks with access to international funding respond differently to monetary policy changes. In particular, during periods of domestic monetary policy tightening (loosening), individual banks of complex IFCs present higher (lower) levels of risk, suggesting that the monetary policy risk taking channel is affected by the level of geographical complexity.
    Keywords: Bank risk; Geographical complexity; Monetary policy
    JEL: E52 F65 G21 G28 G32
    Date: 2020–04
  6. By: Masudul Hasan Adil (Mumbai School of Economics and Public Policy, University of Mumbai); Neeraj R. Hatekar (Mumbai School of Economics and Public Policy, University of Mumbai); Taniya Ghosh (Indira Gandhi Institute of Development Research)
    Abstract: In the recent scenario, one of the most pertinent changes in monetary economics has been the virtual disappearance of what was once a dominant focus, the role of money in monetary policy, and in parallel, the disappearance of the LM curve. Economists used to think about issues of monetary policy with the help of the LM curve as being part of the analytical framework which captures the demand for money. However, the workhorse model of modern monetary theory and policy, the New Keynesian Dynamic Stochastic General Equilibrium framework only comprises of, a dynamic aggregate demand (or the dynamic IS) curve, an aggregate supply (or the New Keynesian Phillips) curve, and a monetary policy rule. The monetary policy rule is generally the Taylor rule that relates the nominal interest rate to the output gap and inflation gap, but typically not to either the quantity or the growth rate of money. This change in the modern monetary model reflects how the central banks make monetary policy now. The present study provides a detailed discussion on the role of money in monetary policy formulation, in the context of New Keynesian and New Monetarist perspective. The pros and cons of abandonment of money or the LM curve from monetary policy models have been discussed in detail.
    Keywords: Money, DSGE, New Keynesian, new monetarist, LM curve and Monetary policy
    JEL: E41 E43 E52 E58
    Date: 2020–01
  7. By: Ekinci, Mehmet Fatih
    Abstract: Macroprudential policies have become essential tools for the policy makers in order to maintain financial stability. Effectiveness of these policies has been studied by a growing literature with an emphasis on the impact of the policies on target variables such as credit growth and asset price appreciations. In this paper, we investigate the impact of macroprudential policies on the current account balance considering the link between external imbalances and financial stability. Building on a standard empirical current account model, we show that usage of an additional macroprudential instrument is associated with an improvement in the current account balance. Moreover, our results indicate that positive impact of macroprudential policy measures on the current account balance is stronger in the deficit countries compared to the surplus countries.
    Keywords: Global Imbalances, Current Account Balance, Macroprudential Policies and Panel Data.
    JEL: C33 E58 F32 G18 G28
    Date: 2020–04–05
  8. By: Pierre L. Siklos (Department of Economics, Wilfrid Laurier University and Balsillie School of International Affairs (E-mail:
    Abstract: Until recently, Japan has been treated as an outlier of sorts, apparently mired in slow growth and low to mildly negative inflation for over a decade. Monetary policy especially, but not alone, has received a healthy share of the blame for Japan's predicament. However, other major economies, notably the U.S. and the Eurozone, have since shown signs of what observers now call 'Japanification'. This paper revisits and reconsiders the narratives surrounding Japan's economic performance since the 1980s in relation to the experiences of the U.S. and the Eurozone. Although there are clearly important differences between these three economies, including important institutional and structural differences, there are also some striking parallels. Equally important, at least according to the metrics used in this study, is that the poor reputation of the Bank of Japan's monetary policy is underserved. To be sure, there were periods of excessive tightness in policy, but the same is true for the other two economies considered. Indeed, the BoJ has been more credible than the other two central banks considered most of the time over the past decade. Of course, important economic challenges remain but Japan is not an outlier. However, in the area of monetary policy, the current policy strategy may have put the 'cart before the horse'. Arguably, the largest risk is the loss of credibility unless all elements of the three 'arrows' of Abenomics have been aimed properly.
    Keywords: Bank of Japan, monetary policy regimes, deflation, central bank credibility
    JEL: E31 E32 E42 E44 E52 E58 C32 C34 C38
    Date: 2020–03
  9. By: Foly Ananou (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges); Amine Tarazi (LAPE - Laboratoire d'Analyse et de Prospective Economique - GIO - Gouvernance des Institutions et des Organisations - UNILIM - Université de Limoges); John O.S Wilson (Centre for Responsible Banking & Finance, University of St Andrews Gateway Building, St Andrews, Fife KY16 9RJ, UK)
    Abstract: Bank liquidity shortages during the global financial crisis of 2007-2009 led to the introduction of liquidity regulations, the impact of which has attracted the attention of academics and policymakers. In this paper, we investigate the impact of liquidity regulation on bank lending. As a setting, we use the Netherlands, where a Liquidity Balance Rule (LBR) was introduced in 2003. The LBR was imposed on Dutch banks only and did not apply to other banks operating elsewhere within the Eurozone. Using this differential regulatory treatment to overcome identification concerns, we investigate whether there is a causal link from liquidity regulation to the lending activities of banks. Using a difference-indifferences approach, we find that stricter liquidity requirements following the implementation of the LBR did not reduce lending. However, the LBR did lead Dutch banks to modify the structure of loan portfolios by increasing corporate lending and reducing mortgage lending. During this period Dutch banks experienced a significant increase in deposits and issued more equity. Overall, the findings of this study have relevance for policymakers tasked with monitoring the impact of post-crisis liquidity regulations on bank behavior.
    Keywords: Bank Lending,Basel III,Liquidity Regulation,Liquidity Balance Rule,Liquidity Coverage Ratio,Propensity Score Matching
    Date: 2020–03–24
  10. By: Kugler, Peter (University of Basel)
    Abstract: This paper provides an econometric analysis of the short-run impact of interest rates on the Swiss franc exchange rate covering the period January 2001 to June 2011 using daily data. Our model includes both the exchange rate of the Swiss franc against euro and dollar and uses the plausible assumption that foreign interest rates and the euro-dollar exchange rate are exogenous. In addition, we consider not only money market interest differentials, but also those for 2 and 10 year governments bonds. GMM estimation indicates that a one-percentage point increase in the 3-month Swiss franc Libor rate leads to a 3.7 % appreciation of the Swiss franc against euro and dollar. This result seems to be robust with respect to considering only increasing or decreasing interest rates and omitting data around SNB target band adjustments. Our findings appear reasonable and are between the extremely low and high estimates of the impact of Swiss interest rate changes on the exchange rate reported in the literature.
    Date: 2020–02–01
    Abstract: We study the effect of capital regulation on bank’s loan loss provisions. Using hand collected data on 13 Tunisian banks during the period 2006-2016, we show that Tunisian banks discretionnary decrease loan loss provisions under regulatory pressure. When studying private banks and public banks, we find that they don’t respond to the same capital regulatory constraints. Private banks discretionary reduce provisions in reaction to an increase in capital requirements when they are under pressure to meet regulatory eligible capital. However, the provisioning behavior of public banks is influenced by its regulatory capital position: they take lower loan loss provisions to enhance capital positions through the year and higher levels of loans loss provisions when coming into the year with stronger capital positions. Our analyses indicate that Tunisian banks use discretionary capital management to appear to be better capitalized but their overall ability to absorb loan losses is reduced. Regulators must be aware of this association and are requested to further strengthen regulation in loan classification and provisioning.
    Keywords: Tunisian banks, capital ratios, eligible capital, capital management, loan loss provisions, capital regulatory pressure, discretionary loan loss provisions, Panel Data
    JEL: C3 C33 G28 M41
    Date: 2020–03–12
  12. By: Toshiaki Ogawa (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: This paper studies capital requirements and their welfare implications in a dynamic general equilibrium model of banking. I embed two, less commonly considered but important, mechanisms. Firstly, banks choose entry and exit, which lets the number of banks change endogenously. Strengthening capital requirements reduces banks' franchise value and damages their liquidity providing function through the extensive margin. Secondly, since equity issuance is costly for banks, they precautionarily hold capital buffers against future liquidity shocks. This behavior makes present capital requirements only occasionally binding. My model shows that the optimal capital requirement would be lower than that in the literature because of the expanded negative effects of capital requirements. To maintain financial stability without damaging banks' liquidity provision, strengthening capital requirements needs to be accompanied by reducing the cost of equity issuance for banks.
    Keywords: Bank capital requirements, Occasionally binding constraints, Endogenous default, Entry and exit, General equilibrium model
    JEL: E00 G21 G28
    Date: 2020–03
  13. By: Hauptmeier, Sebastian; Holm-Hadulla, Fédéric; Nikalexi, Katerina
    Abstract: We study the impact of monetary policy on regional inequality using granular data on economic activity at the city- and county-level in Europe. We document pronounced heterogeneity in the regional patterns of monetary policy transmission. The output response to monetary policy shocks is stronger and more persistent in poorer regions, with the difference becoming particularly pronounced in the extreme tails of the distribution. Regions in the lower parts of the distribution exhibit hysteresis, consisting of long-lived adjustments in employment and labor productivity in response to the shocks. As a consequence, policy tightening aggravates regional inequality and policy easing mitigates it. JEL Classification: C32, E32, E52
    Keywords: local projections, monetary policy, quantile regressions, regional heterogeneity
    Date: 2020–03
  14. By: Haelim Anderson; Adam Copeland
    Abstract: During moments of heightened economic uncertainty, authorities often need to decide on how much information to disclose. For example, during crisis periods, we often observe regulators limiting access to bank‑level information with the goal of restoring the public's confidence in banks. Thus, information management often plays a central role in ending financial crises. Despite the perceived importance of managing information about individual banks during a financial crisis, we are not aware of any empirical work that quantifies the effect of such policies. In this blog post, we highlight results from our recent working paper, demonstrating that in a crisis, a policy of suppressing information about banks' balance sheets has a significant and positive effect on deposits.
    Keywords: Information management; Bank Opacity; Great Depression; Banking Crisis
    JEL: G1 G2 N0
    Date: 2020–04–02
  15. By: Tanweer Akram
    Abstract: This paper presents a simple model of the long-term interest rate. The model represents John Maynard Keynes’s conjecture that the central bank’s actions influence the long-term interest rate primarily through the short-term interest rate, while allowing for other important factors. It relies on the geometric Brownian motion to formally model Keynes’s conjecture. Geometric Brownian motion has been widely used in modeling interest rate dynamics in quantitative finance. However, it has not been used to represent Keynes’s conjecture. Empirical studies in support of the Keynesian perspective and the stylized facts on the dynamics of the long-term interest rate on government bonds suggest that interest rate models based on Keynes’s conjecture can be advantageous.
    Keywords: Long-Term Interest Rate; Bond Yields; Monetary Policy; Short-Term Interest Rate; John Maynard Keynes
    JEL: E12 E43 E50 E58 E60 G10 G12
  16. By: Gündüz, Yalin
    Abstract: This paper tests whether an increase or decrease of the capital surcharge for being a global systemically important bank (G-SIB) envisaged by regulators has an impact on the CDS prices of these banks. We find evidence that the CDS spreads of a G-SIB bank increase (decrease) after the announcement of a higher (lower) capital surcharge. However, this effect is temporary, as the mean CDS spreads revert to pre-announcement level, dropping sharply after the initial rise. Our analysis contributes to the debate on whether being designated as a G-SIB bank necessarily leads to implicit "too-big-to-fail" subsidies. The findings imply that the investors immediately update their beliefs on the systemic risk of the bank after the bucket reallocation announcement and temporarily demand more hedging against systemic risk.
    Keywords: Too-big-to-fail,CDS spreads,systemically important banks,G-SIBs,G-SIB capital surcharges
    JEL: G21 G28
    Date: 2020
  17. By: Kenneth D. Garbade
    Abstract: The coronavirus pandemic has prompted the Federal Reserve to pledge to purchase Treasury securities and agency mortgage-backed securities in the amount needed to support the smooth market functioning and effective transmission of monetary policy to the economy. But some market participants have questioned whether something more might not be required, including possibly some form of direct yield curve control. In the first half of the 1940s the Federal Open Market Committee (FOMC) sought to manage the level and shape of the Treasury yield curve. In this post, we examine what can be learned from the FOMC’s efforts of seventy-five years ago.
    Keywords: Math; Equation; Research
    JEL: G2
    Date: 2020–04–06
  18. By: Matthias Meier; Timo Reinelt
    Abstract: We document three new empirical facts: (i) monetary policy shocks increase the markup dispersion across firms, (ii) monetary policy shocks increase the relative markup of firms that adjust prices less frequently, and (iii) firms that adjust prices less frequently have higher markups. This is consistent with a New Keynesian model in which price rigidity is heterogeneous across firms. In the model, firms with stickier prices optimally set higher markups and their markups increase by more after monetary policy shocks. The consequent increase in markup dispersion explains why aggregate TFP declines after monetary policy shocks. In the calibrated model, monetary policy shocks explain substantial fluctuations in markup dispersion and aggregate productivity.
    Keywords: Monetary policy, markup dispersion, heterogeneous price rigidity, aggregate TFP
    Date: 2020–03
  19. By: Willem THORBECKE
    Abstract: This paper investigates how expansionary monetary policy after the Global Financial Crisis (GFC) has affected the U.S. banking sector. In response to the GFC the Federal Reserve first lowered the overnight federal funds rate from 5.25% in August 2007 to zero in December 2008. It then turned to quantitative easing, purchasing housing agency debt, mortgage-backed securities, and longer-term Treasury bonds to stimulate the economy. While these policies helped the overall economy to recover, they may have harmed the banking sector. Banks accept safe short-term deposits and transform these into risky longer-term loans. They make a profit on the difference between the interest rate they earn on longer-term assets and the rate they pay of short-term deposits (the net interest margin). Low short-term interest rates and compressed spreads between long- and short-term interest rates may impair bank profitability. Bernanke and Gertler (1995) have shown that reduced bank profitability can hinder their ability to extend loans. Bernanke (1993) noted that this is problematic because banks play a special role in channeling savings to promising borrowers. Financial markets are plagued by information imperfections. Savers release funds today for the promise of obtaining funds later. Whether they get repaid depends on the character of the borrower, the quality of the investment, the collateral that the borrower can provide, and other factors. The lender needs to consider these items and not just interest rates. Asymmetric information can thus hinder the flow of funds from savers to small businesses and other borrowers whose quality is hard to evaluate. Banks can bridge imperfect information problems because they have a comparative advantage because of: 1) economies of specialization, as lending officers gain expertise in a particular industry; 2) economies of scale, as it is cheaper for bank to evaluate a loan than for small savers to; and 3) economies of scope, as it is cheaper to provide lending services together with other services. This paper investigates how lower short-term rates and falls in the spread between long-and short-term rates affect bank profitability. To do this it investigates how these variables affect bank stock prices. Stock prices provide valuable information since they are the expected present value of future cash flows. The results indicate that falls in short rates and in the spread have caused large drops in bank stock returns after the GFC. Banks are also facing competitive pressures from Fin Tech firms and big technology firms. Their performance after the GFC has lagged other parts of the U.S. economy. They are thus vulnerable to negative shocks that could arise during a downturn or a crisis. The Fed should take account of the impact of their policies on the banking sector, since an interruption on the flow of credit through the financial system could prevent funds from going to the most promising firms. This misallocation of resources could then hinder long-term economic growth.
    Date: 2020–03
  20. By: Kugler, Peter (University of Basel)
    Abstract: This paper provides an econometric analysis of the short-run impact of SNB sight deposits mainly created by intervention on the Swiss franc exchange rate covering the period January 2015 to June 2018 using weekly data. Our model includes both the exchange rate of the Swiss franc against euro and dollar and uses the plausible assumption that foreign interest rates and the euro-dollar exchange rate are exogenous. Besides sight, deposits we include interest rate differentials for 2- and 10-year government bonds, and some exogenous exchange rate determinants. GMM estimation indicates that a one percent increase in the sight deposits leads leads to a 0.41 percent appreciation of the Swiss franc against euro and dollar.
    Date: 2020–02–01
  21. By: William A. Barnett (University of Kansas); Giovanni Bella (University of Cagliari); Taniya Ghosh (Indira Gandhi Institute of Development Research); Paolo Mattana (University of Cagliari); Beatrice Venturi (University of Cagliari)
    Abstract: The paper shows that in a New Keynesian (NK) model, an active interest rate feedback monetary policy, when combined with a Ricardian passive fiscal policy, a la Leeper-Woodford, may induce the onset of a Shilnikov chaotic attractor in the region of the parameter space where uniqueness of the equilibrium prevails locally. Implications, ranging from long-term unpredictability to global indeterminacy, are discussed in the paper. We find that throughout the attractor, the economy lingers in particular regions, within which the emerging aperiodic dynamics tend to evolve for a long time around lower-than-targeted inflation and nominal interest rates. This can be interpreted as a liquidity trap phenomenon, produced by the existence of a chaotic attractor, and not by the influence of an unintended steady state or the Central Bank's intentional choice of a steady state nominal interest rate at its lower bound. In addition, our finding of Shilnikov chaos can provide an alternative explanation for the controversial loanable funds over-saving theory, which seeks to explain why interest rates and, to a lesser extent inflation rates, have declined to current low levels, such that the real rate of interest is below the marginal product of capital. Paradoxically, an active interest rate feedback policy can cause nominal interest rates, inflation rates, and real interest rates unintentionally to drift downwards within a Shilnikov attractor set. Policy options to eliminate or control the chaotic dynamics are developed.
    Keywords: Shilnikov chaos criterion, global indeterminacy, long-term un-predictability, liquidity trap
    JEL: C61 C62 E12 E52 E63
    Date: 2020–01
  22. By: Krittika Banerjee (Indira Gandhi Institute of Development Research); Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: Equilibrium real exchange rates (ERERs) of a set of major emerging market economies (EMEs) are estimated in a panel cointegrating equation framework against trade weighted advanced economy (AE) currencies taking into account structural emerging market issues, and then used to derive misalignments of the RER. Since US as a dominant economy has considerable effect on EME monetary policy, we use weighted AE variables in order to avoid endogeneity when US data alone is used. We find robust support for the Balassa-Samuelson effect, whereby productivity appreciates RER. This is also seen to be a dominant factor, along with financial development. We find that dependency ratio appreciates ERER indicating excess demand possibly from increase in young dependent population, as well as future growth potential for these EMEs. Rise in fiscal expenditure and financial development, on average, have a depreciatory effect indicating improvements in long run supply conditions. Institutions are found to improve competitiveness in all EMEs in our sample, except Thailand. On average, Asian economies have more appreciated ERER indicating better fundamentals. Over 1995-2017 we find that EME RER followed a cyclical pattern closely linked to global events, with periods of appreciation followed by depreciation. Asian economies along with Brazil and Mexico can be grouped together in terms of RER movement. Russia and Turkey have edged on the side of under-valuation and followed a more random path. The absence of substantial prolonged under-valuation before the Global Financial Crisis implies it was not a sole cause of imbalances. Over-valuation indicates EMEs bore large post-crisis adjustment costs.
    Keywords: Real exchange rate, fundamentals, emerging markets, misalignments, global imbalances, adjustment costs
    JEL: C21 C22 C23 F31 F41 O5
    Date: 2020–01

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