nep-cba New Economics Papers
on Central Banking
Issue of 2020‒04‒27
twenty-one papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. How do monetary policy announcements affect inflation expectations? By Olsson, Kerstin
  2. Inflation and Exchange Rate Pass-Through By Jongrim Ha; M. Marc Stocker; Hakan Yilmazkuday
  3. Reviving the potency of monetary policy with recession insurance bonds By Julia Coronado; Simon Potter
  4. Macroprudential Ring-Fencing By Tomas Konecny; Lukas Pfeifer
  5. Forward-Looking Monetary Policy and the Transmission of Conventional Monetary Policy Shocks By Chunya Bu; John Rogers; Wenbin Wu
  6. The International Spillover Effects of US Monetary Policy Uncertainty By Lakdawala, Aeimit; Moreland, Timothy; Schaffer, Matthew
  7. Securing macroeconomic and monetary stability with a Federal Reserve–backed digital currency By Julia Coronado; Simon Potter
  8. News and Uncertainty about COVID-19: Survey Evidence and Short-Run Economic Impact By Alexander Dietrich; Keith Kuester; Gernot J. Muller; Raphael Schoenle
  9. Money demand stability, monetary overhang and inflation forecast in the CEE countries By Claudiu Tiberiu Albulescu; Dominique Pépin
  10. Banks to basics! Why banking regulation should focus on equity By Pierre Durand; Gaëtan Le Quang
  12. Capacity Reduction Policy Under the Interest Rate Peg in China By Bing Tong
  13. Understanding helicopter money By Delis, Manthos
  14. Central Bank Capital and Credibility: A Literature Survey By Atsushi Tanaka
  15. Overcoming Borrowing Stigma: The Design of Lending-of-Last-Resort Policies By Zhang, Hanzhe; Hu, Yunzhi
  16. A program for strengthening the Federal Reserve's ability to fight the next recession By David Reifschneider; David Wilcox
  17. Weighing up the Credit-to-GDP gap: A cautionary note By Oezer Karagedikli; Ole Rummel
  18. Monetary policy, investment and firm heterogeneity By Ferrando, Annalisa; Vermeulen, Philip; Durante, Elena
  19. Monetary policy transmission with downward interest rate rigidity By Grégory LEVIEUGE; Jean-Guillaume SAHUC
  20. How Does Supervision Affect Bank Performance during Downturns? By Uyanga Byambaa; Beverly Hirtle; Anna Kovner; Matthew Plosser
  21. A Tale of Two Major Postwar Business Cycle Episodes By Hashmat Khan; Louis Phaneuf; Jean-Gardy Victor

  1. By: Olsson, Kerstin (Department of Economics)
    Abstract: This paper examines the effects of policy rate announcements on households' inflation expectations over the time period 2003-2015. The effect is estimated using a two-stage least squares regression model. The announced changes are instrumented by a monetary policy surprise variable obtained from high-frequency swap trade data. The effect of an announced increase in the policy rate on inflation expectations is significant and positive. According to the New-Keynesian model, the effect of an exogenous monetary policy shock depends on the assumptions made on the persistence of the shock process in the model. Alternatively, the results may be interpreted as the policy announcement signalling the central bank's private information on the direction of future inflation. Given the sizeable weight of housing costs in the Swedish CPI basket, the results may also be interpreted as reflecting the direct effect of interest rates on the CPI. In this case, households internalize the effects of interest rates on CPI, when forming expectations about the future rate of inflation.
    Keywords: Monetary policy; Inflationary expectations; Instrumental Variables; Event studies
    JEL: C26 E31 E52 G14
    Date: 2020–04–18
  2. By: Jongrim Ha (World Bank); M. Marc Stocker (World Bank); Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: This paper investigates exchange rate pass-through into consumer prices by considering the nature of the shock triggering currency movements. By individually estimating structural factor-augmented vector autoregression models for 55 countries, monetary policy shocks are shown to be associated with higher exchange rate pass-through measures compared to other domestic shocks, while global shocks have widely different effects across countries. Pass-through measures tend to be lower in countries that combine flexible exchange rate regimes and credible inflation targets, where central bank independence can greatly facilitate the task of stabilizing inflation by using the exchange rate as a buffer against external shocks. It is implied that exchange rate pass-through should be investigated by considering the nature of the shock that triggers currency movements and country characteristics that affect the response of prices.
    Keywords: Inflation, Foreign Exchange, Monetary Policy, Exchange Rate Pass Through
    JEL: E31 E42 E52 F31
    Date: 2020–03
  3. By: Julia Coronado (Macropolicy Perspectives); Simon Potter (Peterson Institute for International Economics)
    Abstract: In the second part of their Policy Brief, Coronado and Potter discuss how the system of digital payment providers (DPPs) proposed in their first Policy Brief on this topic adds a new weapon to the monetary toolkit that could be implemented in a timely, effective, and inclusive manner. They describe how a digital currency backed by the Federal Reserve could augment automatic fiscal stabilizers and—more importantly—harness the power of “helicopter†money or quantitative easing directly to consumers in a disciplined manner. To implement QE directly to consumers, Coronado and Potter propose the creation of recession insurance bonds (RIBs)—zero-coupon bonds authorized by Congress and calibrated as a percentage of GDP sufficient to provide meaningful support in a downturn. Congress would create these contingent securities; Treasury would credit households’ digital accounts with them. The Fed could purchase them from households in a downturn after its policy rate hits zero. The Fed’s balance sheet would grow by the value of RIBs purchased; the initial matching liability would be deposits into the DPP system. The mechanism is easy for consumers to understand and could boost inflation expectations more than a debt-financed fiscal stimulus could.
    Date: 2020–04
  4. By: Tomas Konecny; Lukas Pfeifer
    Abstract: This paper focuses on ring-fencing in the specific context of macroprudential policy and its effects on financial integration in the EU over time. It views macroprudential ring-fencing as a restriction on the regulatory capital mobility of cross-border banking groups as a result of macroprudential measures. We find two main factors behind the observed heterogeneity of macroprudential policy with the potential for ring-fencing - credit risk materialisation and the share of foreign-owned banks' assets related to the gradual phase-in of capital reserves. The heterogeneity of risk weights should be partly limited by the new CRD V/CRR II regulatory package and other prudential backstops (such as the leverage ratio requirement and the output floor). On the other hand, the new regulatory package contains limits on structural reserves, which may lead to a situation where regulatory design precludes the application of macroprudential measures corresponding to the level of systemic risk.
    Keywords: Financial stability, macroprudential policy, ring-fencing
    JEL: E58 E61 G18
    Date: 2019–12
  5. By: Chunya Bu; John Rogers; Wenbin Wu
    Abstract: Standard structural VAR models and estimation using Romer and Romer (2004) monetary policy shocks show that, in samples after the 1980s, a contractionary conventional monetary policy shock generates smaller and sometimes perversely-signed impulse responses compared to earlier samples. Using insights from the central bank information effects literature, we show that the analyses producing these results suffer from an omitted variables problem related to forward-looking information emanating from Federal Reserve forecasts. Transmission of conventional monetary policy shocks takes on the standard signs, and is typically significant, once Fed forward-looking information is taken into account. This reconciliation does not follow from adding private sector forecasts to the estimation frameworks.
    Keywords: Information effect; Monetary policy; VARs
    Date: 2020–02–13
  6. By: Lakdawala, Aeimit (Michigan State University, Department of Economics); Moreland, Timothy (Michigan State University, Department of Economics); Schaffer, Matthew (UNC Greensboro)
    Abstract: An extensive literature studies the international transmission of US monetary policy surprises (shifts in expected path of the policy rate). In this paper we show that changes in uncertainty around the expected path constitute an important additional dimension of spillover effects to global bond yields. In advanced countries, it is the term premium component of yields that responds to uncertainty. We find that this can be explained by an international portfolio balance mechanism. In contrast, for emerging countries it is the expected component of yields that reacts to uncertainty. This can be rationalized from a flight to safety channel. We find heterogeneity in the country-level response to uncertainty only in emerging economies and it is driven by the degree of financial openness. Finally, equity markets in both advanced and emerging countries also respond to US monetary policy uncertainty, but only since the financial crisis.
    Keywords: monetary policy uncertainty; international spillover; international portfolio balance; flight to safety
    JEL: E43 E58 G12 G15
    Date: 2020–04–17
  7. By: Julia Coronado (Macropolicy Perspectives); Simon Potter (Peterson Institute for International Economics)
    Abstract: The US monetary system faces significant challenges from advances in technology and changes in the macroeconomy that, left unaddressed, will threaten the stability of the US economy and financial system. At the same time, low interest rates mean that central banks will not have the policy ammunition they had in the past during the next recession. The Federal Reserve needs new tools to meet its mandates of price stability and maximum employment. It also needs to preserve the safety and soundness of the financial system in a rapidly digitizing world. The authors propose a Fed-backed digital currency to solve both problems. Their proposal creates a regulated system of digital currency accounts for consumers managed by digital payment providers and fully backed by reserves at the Fed. The system would be limited in size, to preserve the functions and stability of the existing banking system. Fed backing would mean low capital requirements, which would in turn facilitate competition. Low fees and no minimum balance requirements in the new system would also help financial institutions reach the roughly 25 percent of the US population that is currently either unbanked or underbanked. Digital accounts for consumers could also provide a powerful new stabilization tool for both monetary and fiscal policies. For fiscal policy, it could facilitate new automatic stabilizers while also allowing the Fed to provide quantitative easing directly to consumers. This tool could be used in a timely manner with broad reach to all Americans.
    Date: 2020–03
  8. By: Alexander Dietrich; Keith Kuester; Gernot J. Muller; Raphael Schoenle
    Abstract: We survey households about their expectations of the economic fallout of the COVID-19 pandemic, in real time and at daily frequency. Our baseline question asks about the expected impact on output and inflation over a one-year horizon. Starting on March 10, the median response suggests that the expected output loss is still moderate. This changes over the course of three weeks: At the end of March, the expected loss amounts to some 15 percent. Meanwhile, the pandemic is expected to raise inflation considerably. The uncertainty about these effects is very large. In the second part of the paper we feed the survey data into a New Keynesian business cycle model. Because the economic costs of the pandemic have not fully materialized yet but are nonetheless (a) anticipated and (b) uncertain, private expenditure collapses, thereby amplifying and bringing forward in time the economic costs of the pandemic. The short-run economic impact of the pandemic depends critically on whether monetary policy accommodates the drop in the natural rate of interest or not.
    Keywords: corona; zero lower bound; uncertainty; news shocks; COVID-19; monetary policy; household expectations; natural rate; survey
    JEL: C83 E43 E52
    Date: 2020–04–09
  9. By: Claudiu Tiberiu Albulescu; Dominique Pépin (CRIEF - Centre de Recherche sur l'Intégration Economique et Financière - Université de Poitiers)
    Abstract: This paper first shows that the long-run money demand in Central and Eastern European (CEE) countries is better described by an open-economy model (OEM), which considers a currency substitution effect, than by a closed-economy model (CEM) used in several previous studies. Second, from the estimated models we derive two different measures of monetary overhang. Then we compare the ability of the OEM-based and the CEM-based measures of monetary overhang to predict inflation in the CEE countries, namely the Czech Republic, Hungary and Poland. While we cannot detect a significant difference of forecast accuracy between the two competing models, we show that the OEM-based forecast model that reveals a stable long-run money demand encompasses the CEM-based version for the CEE countries.
    Keywords: inflation forecasts,monetary overhang,money demand stability,CEE countries,currency substitution
    Date: 2018–12
  10. By: Pierre Durand; Gaëtan Le Quang
    Abstract: Banking regulation faces multiple challenges that call for rethinking the way it is designed in order to tackle the specific risks associated with banking activities. In this paper, we argue that regulators should focus on designing strong equity requirements instead of implementing several complex rules. Such a constraint in equity is however opposed by the banking industry because of its presumed adverse impact on banks' performance. Resorting to Random Forest regressions on a large dataset of banks balance sheet variables, we show that the ratio of equity over total assets has a clear positive effect on banks' performance, as measured by the return on assets. On the contrary, the impact of this ratio on the shareholder value, as measured by the return on equity, is most of the time weakly negative. Strong equity requirements do not, therefore, impede banks' performance but do reduce the shareholder value. This may be the reason why the banking industry so fiercely opposes strong equity requirements.
    Keywords: Banking regulation ; Capital requirements ; Basel III ; Random Forest Regression
    JEL: C44 G21 G28
    Date: 2020
  11. By: Nataliia Ostapenko
    Abstract: I propose a new approach to identifying exogenous monetary policy shocks that requires no priors on the underlying macroeconomic structure, nor any observation of monetary policy actions. My approach entails directly estimating the unexpected changes in the federal funds rate as those which cannot be predicted from the internal Federal Open Market Committee's (FOMC) discussions. I employ deep learning and basic machine learning regressors to predict the effective federal funds rate from the FOMC's discussions without imposing any time-series structure. The result of the standard three variable Structural Vector Autoregression (SVAR) with my new measure shows that economic activity and inflation decline in response to a monetary policy shock.
    Keywords: monetary policy, identification, shock, deep learning, FOMC, transcripts
    Date: 2020
  12. By: Bing Tong (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan)
    Abstract: Capacity reduction has been a recurrent theme in China’s economic policy. This paper proves in a New Keynesian model that the effects of the decapacity policy depend on its persistence and monetary policy regime (interest rate flexibility). Under an interest rate peg, a temporary policy is ineffective and even expansionary, whereas a permanent policy is effective due to a negative wealth effect. When the nominal interest rate is pegged, the real rate moves oppositely with inflation, which adds positive feedback to the economy. Thus the de-capacity policy has greater uncertainty under the interest rate peg. As a policy tool, it may easily deviate from its target and bring about excessive volatility. Last, long-run price stability and a gradually advanced de-capacity policy are helpful to the achievement of policy targets.
    Keywords: Chinese economy, Capacity reduction, De-capacity, New Keynesian Model, Supply shock, Interest rate peg
    JEL: E12 E31 E42 E43 E52 E61
    Date: 2020–04
  13. By: Delis, Manthos
    Abstract: What are the policy tools in times of economic crises? What are the tools that governments and central banks have against the coronavirus crisis? This article briefly explains how several types of monetary policy can currently work, placing an emphasis on a form of helicopter money directed to affected firms. The proposition is that this type of monetary policy should be avoided in general, but it might yield beneficial results in the current European economy.
    Keywords: Monetary policy; Helicopter money; Unconventional tools; Government debt
    JEL: E5 E50 G0 G01
    Date: 2020–04–07
  14. By: Atsushi Tanaka (School of Economics, Kwansei Gakuin University)
    Abstract: Research on central bank capital and credibility evolved from the interests of developing countries to those of developed countries after the global financial crisis of the late 2000s. There is growing concern about central bank balance sheets at exit from quantitative easing. This paper surveys the literature in such a context. It starts by citing early literature which suggests that a central bank with insufficient capital may be pressured to pursue an inflationary policy at a time of crisis that jeopardizes its credibility. A theoretical analysis of this problem is carried out by the use of the central bank budget constraints and its intertemporal variant, leading to discussions on the solvency of the central bank. Several central banks make fiscal transfers to the government, and their solvency situation is influenced by whether a central bank has fiscal transfers to and from the government.
    Keywords: central bank, solvency, financial strength, monetary policy, quantitative easing
    JEL: E52 E58
    Date: 2020–04
  15. By: Zhang, Hanzhe (Michigan State University, Department of Economics); Hu, Yunzhi (Kenan-Flagler Business School, University of North Carolina)
    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 participated in its special monetary program, the TermAuction Facility (TAF), although both programs had the same borrowing requirements. Us-ing an adverse selection model with endogenous borrowing decisions, we explain why two programs suffer from different stigma and how the introduction of TAF incentivized banks’ borrowing. Empirically, we combine several data sources to confirm the theoretical prediction that weaker banks borrowed relatively more from the DW.
    Keywords: lending of last resort; discount window stigma; Term Auction Facility; adverse selection
    JEL: D44 E52 E58 G01
    Date: 2020–04–19
  16. By: David Reifschneider (former Federal Reserve); David Wilcox (Peterson Institute for International Economics)
    Abstract: If the Federal Reserve does not decisively change the way it conducts monetary policy, it will probably not be capable of fighting recessions in the future as effectively as it fought them in the past. This reality helped motivate the Fed to undertake the policy framework review in which it is currently engaged. Researchers have suggested many steps the Fed could take to improve its recession-fighting ability; however, no consensus has emerged as to which of these steps would be both practical and maximally effective. This paper aims to fill that gap. It recommends that the Fed commit as soon as possible to a new approach for fighting recessions, involving two key elements. First, the Fed should commit that whenever it runs out of room to cut the federal funds rate further, it will leave the rate at its minimum level until the labor market recovers and inflation returns to 2 percent. Second, the Fed should commit that under the same circumstances, it will begin to purchase longer-term assets in volume and will continue such purchases until the labor market recovers. If the forces driving the next recession are not unusually severe, this framework might allow the Fed to be as effective at fighting that recession as it was in the past. If the next recession is more severe, however, the Fed will probably run out of ammunition even if it takes the two steps recommended here. Therefore, both monetary and fiscal policymakers should consider yet other steps they could take to enhance their ability to fight future recessions.
    Keywords: Monetary policy, Federal Reserve, framework review, effective lower bound
    JEL: E43 E44 E52 E58
    Date: 2020–03
  17. By: Oezer Karagedikli (South East Asian Central Banks (SEACEN)); Ole Rummel (South East Asian Central Banks (SEACEN))
    Abstract: It has been argued that credit-to-GDP gaps (credit gap) are useful early warning indicators for banking crises. In addition, the Basel Committee on Banking Supervision has also advocated using these gaps - estimated using a one-sided Hodrick-Prescott filter with a smoothing parameter of 400,000 - to inform policy on the appropriate counter-cyclical capital buffer. We use the weighted average representation of the same filter and show that it attaches high weights to observations from the past, including the distant past: up to 40 lags (10 years) of past data are used in the calculation of the one-sided trend/permanent component of the credit-to-GDP ratio. We show how past data that belongs to the ‘old-regime’ prior to the crises continue to influence the estimates of the trend for years to come. By using narrative evidence from a number of countries that experienced deep financial crises, we show that this leads to some undesirable influence on the trend estimates that is at odds with the post-crisis environment.
    JEL: J31 J64
    Date: 2020
  18. By: Ferrando, Annalisa; Vermeulen, Philip; Durante, Elena
    Abstract: This paper provides new evidence on the channels of monetary policy transmission combining 9 million observations on firm level investment and high-frequency identified monetary policy shocks. We show that the reaction of firms’ investment to a monetary policy shock is heterogeneous along dimensions that correspond to the two main channels of monetary policy transmission. First, we show that young firms are more sensitive to monetary policy shocks, supporting the existence of a credit channel of monetary policy. Second, we document large cross-sectional heterogeneity related to the industry the firm operates in. We find that firms producing durable goods react more than others, which is consistent with traditional interest rate channel effects of monetary policy. Third, we find that the effect of monetary policy shocks is longer lived for firms that are durable goods producers than for young firms indicating that demand effects last longer than credit effects. JEL Classification: E22, E52
    Keywords: investment, monetary policy shocks, monetary policy transmission
    Date: 2020–04
  19. By: Grégory LEVIEUGE; Jean-Guillaume SAHUC
    Date: 2020
  20. By: Uyanga Byambaa; Beverly Hirtle; Anna Kovner; Matthew Plosser
    Abstract: Supervision and regulation are critical tools for the promotion of stability and soundness in the financial sector. In a prior post, we discussed findings from our recent research paper which examines the impact of supervision on bank performance (see earlier post How Does Supervision Affect Banks?). As described in that post, we exploit new supervisory data and develop a novel strategy to estimate the impact of supervision on bank risk taking, earnings, and growth. We find that bank holding companies (BHCs or “banks”) that receive more supervisory attention have less risky loan portfolios, but do not have lower growth or profitability. In this post, we examine the benefits of supervision over time, and especially during banking industry downturns.
    Keywords: economic downturn; supervision; bank performance
    JEL: E5 G21 G28
    Date: 2020–04–08
  21. By: Hashmat Khan (Department of Economics, Carleton University); Louis Phaneuf (Université du Québec à Montréal); Jean-Gardy Victor (Université du Québec à Montréal)
    Abstract: We offer a tale of two major postwar business cycle episodes: the pre-1980s and the post-1982s prior to the Great Recession. We revisit the sources of business cycles and the reasons for the large variations in aggregate volatility from the first to the second episode. Using a medium-scale DSGE model where monetary policy potentially has cost-channel effects, we first show the Fed most likely targeted deviations of output growth from trend growth, not the output gap, for measure of economic activity. When estimating our model with a policy rule reacting to output growth with Bayesian techniques, we find the US economy was in a state of determinacy prior to 1980 and after 1982. Thus, aggregate instability before 1980 did not result from self-fulfilling changes in inflation expectations. Our evidence shows the Fed reacted more strongly to inflation after 1982. Based on sub-period estimates, we find that shocks to the marginal efficiency of investment largely drove the cyclical variance of output growth prior to 1980 (61%), while they have seen their importance falls dramatically after 1982 (19%). When looking at the sources of greater macroeconomic stability during the second episode, we find no strong support for the “good-luck hypothesis†. Change in nominal wage flexibility largely drove the decline in output growth volatility, while change in monetary policy was a key factor driving lower inflation variability.
    Keywords: Conventional Monetary Policy; Determinacy; Bayesian Estimation; Sources of Business Cycle; Changes in Aggregate Volatility
    JEL: E31 E32 E37
    Date: 2020–04–15

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