nep-cba New Economics Papers
on Central Banking
Issue of 2020‒08‒24
24 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Rethinking capital regulation: the case for a dividend prudential target By Muñoz, Manuel A.
  2. Who takes the ECB’s targeted funding? By Vergote, Olivier; Sugo, Tomohiro
  3. (Why) do central banks care about their profits? By Igor Goncharov; Vasso Ioannidou; Martin C. Schmalz
  4. RegGae: a toolkit for macroprudential policy with DSGEs By Eduardo C. Castro
  5. Stock market evidence on the international transmission channels of US monetary policy surprises By Tim D. Maurer; Thomas Nitschka
  6. Quantitative Easing and Financial Risk Taking: Evidence from Agency Mortgage REITs By W. Scott Frame; Eva Steiner
  7. New Financial Market Measures of the Neutral Real Rate and Inflation Expectations By Alex Aronovich; Andrew C. Meldrum
  8. Asymmetric behavior of exchange rate in Tunisia: a nonlinear approach By Boukraine, Wissem
  9. Wage inequality under inflation-targeting in South Africa By Serena Merrino
  10. Are monetary surprises effective? The view of professional forecasters in Israel By Alex Ilek
  11. Monetary Policy, Financial Constraints, and Redistribution By Christian Loenser; Andreas Schabert
  12. Shall we twist? By Sophie Altermatt; Simon Beyeler
  13. Reviving the Salter-Swan Small Open Economy Model By Stephanie Schmitt-Grohé; Martín Uribe
  14. Bank contagion in general equilibrium By Ferrari, Massimo Minesso
  15. Uncovered interest parity with foreign exchange interventions under exchange rate peg and inflation targeting: The case of Ukraine By Anton Grui
  16. The Economics of Helicopter Money By Pierpaolo Benigno; Salvatore Nisticò
  17. Drivers of European public debt management By Wolswijk, Guido
  18. What’s up with the Phillips Curve? By Del Negro, Marco; Lenza, Michele; Primiceri, Giorgio E.; Tambalotti, Andrea
  19. The Information Content of Capital Controls By Nie,Owen
  20. The need for monetary financing of corona budget deficits By De Grauwe, Paul
  21. The Political Economy of a Diverse Monetary Union By Enrico Perotti; Oscar Soons
  22. Liquidity Traps in a Monetary Union By Robert Kollmann
  23. Monetary Policy and Housing Loan Default By George Overton; Barbara Castillo Rico
  24. Asset Price Bubbles and Monetary Policy: Revisiting the Nexus at the Zero Lower Bound By Jacopo Bonchi

  1. By: Muñoz, Manuel A.
    Abstract: Recent empirical studies have documented two remarkable patterns shown by euro area banks in the aftermath of the Great Recession: (i) their tendency to boost capital ratios by shrinking assets (contraction of loans supply), and (ii) their reluctance to cut back on dividends (fall in retained earnings). First, I provide evidence of a potential link between these two trends. When shocks hit their profits, banks tend to adjust retained earnings to smooth dividends. This generates bank equity and credit supply volatility. Then I develop a DSGE model that incorporates this mechanism to study the transmission and effects of a novel macroprudential policy rule - that I shall call Dividend Prudential Target (DPT) - aimed at complementing existing capital regulation by tackling this issue. Welfare-maximizing DPTs are effective (more than the CCyB) in smoothing the financial and the business cycle (by means of less volatile retained earnings) and induce significant welfare gains associated to a Basel III-type of capital regulation through various channels. JEL Classification: E44, E61, G21, G28, G35
    Keywords: capital requirements, countercyclical capital buffer (CCyB), dividend restrictions, DSGE models, macroprudential policy
    Date: 2020–07
  2. By: Vergote, Olivier; Sugo, Tomohiro
    Abstract: This paper investigates motives of banks to borrow funds from the ECB through its first two series of targeted longer-term refinancing operations (TLTROs) allotted between September 2014 and March 2017. We quantify that the top-three parameters that determine banks’ take-up decisions are the price of the operation, the amount of eligible collateral of the bank, and the composition of that collateral. In particular, the opportunity for banks to transform their less liquid assets partly into liquid central bank reserves by pledging these assets as collateral with the central bank is a strong motive for take-up and suggests that accepting a broad set of collateral was important for the monetary easing provided by TLTROs. In addition, we find that the conditions attached to TLTRO participation and take-up played an important role in creating broad-based participation across banks of different financial strength and size. JEL Classification: C23, C24, E52, E58, G21
    Keywords: dynamic tobit panel, funding for lending, monetary policy operations, take-up behaviour, targeted longer-term refinancing operations
    Date: 2020–07
  3. By: Igor Goncharov (Lancaster University); Vasso Ioannidou (Lancaster University); Martin C. Schmalz (University of Oxford, CEPR, and ECGI)
    Abstract: We document that central banks are significantly more likely to report slightly positive profits than slightly negative profits, especially amid greater political pressure, the public’s receptiveness to more extreme political views, and when governors are reappointable. The propensity to report small profits over small losses is correlated with more lenient monetary policy and higher inflation. We conclude that profitability concerns, although absent from standard theory, are present and effective in practice. These findings inform a debate about the political economy of central banking, monetary stability, and the effectiveness of non-traditional central banking.
    Keywords: Central Banks, Profitability, Non-Traditional Central Banking, Monetary Stability
    JEL: E58
    Date: 2020–07
  4. By: Eduardo C. Castro
    Abstract: RegGae is a toolkit to adapt DSGE models for analyzing macroprudential policy. To be useful for macroprudential policy, a DSGE needs to have financial crises along the equilibrium path. RegGae embeds financial crises in DSGEs as regime switches, events that change the structural relationships in the economy. The solu-tion concept of RegGae is regime-wise linearization, a procedure that preserves the non-linearities of models of financial crises. The transition probabilities governing the switch are endogenous, conditional on the state variables. With the toolkit, DSGEs can be used to draw the distribution of variables in order to measure the expected welfare of macroprudential policy. This allows for calibrating macropru-dential tools to trade off mean and variance optimally. The toolkit unifies DSGE modeling with early warning (crisis prediction) methods. The endogeneity of the probability of regime switches reflects the fact that the probability of financial crises depends on the state of the economy while its timing cannot be forecasted. Because financial markets do not anticipate financial crises, RegGae assumes the typical per-fect foresight of the future sequence of regimes.
    Date: 2020–07
  5. By: Tim D. Maurer; Thomas Nitschka
    Abstract: We decompose unexpected movements in the stock market returns of 40 countries into different news components to assess why expansionary US monetary policy surprises are good news for stock markets. Our results suggest that prior to the zero lower bound (ZLB) period, federal funds rate surprises affect foreign stock markets mainly because such surprises are associated with news about future real interest rates. The effects of forward guidance surprises are negligible. At the ZLB, large-scale asset purchases (LSAP) reflect more than commitment to forward guidance. LSAP surprises constitute cash-flow news, while unanticipated forward guidance primarily reflects real interest rate news.
    Keywords: International spillovers, news, monetary policy, stock returns, vector autoregression
    JEL: E44 E52 F36 G15
    Date: 2020
  6. By: W. Scott Frame; Eva Steiner
    Abstract: An emerging literature documents a link between central bank quantitative easing (QE) and financial institution credit risk-taking. This paper tests the complementary hypothesis that QE may also affect financial risk-taking. We study Agency MREITs – levered shadow banks that invest in guaranteed U.S. Agency mortgage-backed securities (MBS) principally funded with repo debt. We show that Agency MREIT growth is inversely related to the Federal Reserve’s Agency MBS purchases, reflecting investor portfolio rebalancing. We also find that these institutions increased leverage during the later stages of QE, consistent with “reaching for yield” behavior. Agency MREITs seem to concurrently adjust their liquidity and interest rate risk profiles.
    Keywords: Quantitative Easing; Risk Taking; GSEs; Mortgages; Agency MBS
    JEL: E58 G21 G23 G28
    Date: 2020–06–30
  7. By: Alex Aronovich; Andrew C. Meldrum
    Abstract: Long-term U.S. interest rates have fallen substantially over the last two decades. The 5-to-10-year nominal forward interest rate implied by the prices of U.S. Treasury securities is now about 7 percentage points lower than it was at the start of the 1990s.
    Date: 2020–08–03
  8. By: Boukraine, Wissem
    Abstract: This paper employs the smooth transition autoregressive models (STAR) to analyze Tunisian exchange rate pass-through on quarterly data over the period 2011Q4 2019Q4. The non linearity tests suggest that the LSTAR specification describes better the behavior of exchange rate pass-through in Tunisia and our empirical results confirm its nonlinearity. We found evidence on high pass-through to inflation through external debt in both regimes.
    Keywords: Exchange rate pass-through, Regime Change, LSTAR, Tunisia
    JEL: C24 E31 F31 H60
    Date: 2020
  9. By: Serena Merrino
    Abstract: This paper aims at providing new evidence over the effect of conventional monetary policy shocks on wage inequality through the earnings heterogeneity channel under the inflation-targeting regime implemented in South Africa since 2000. The empirical contribution follows previous studies by implementing a multivariate time-series analysis and identifying the structural shocks in a vector error correction model. Impulse response functions show that the overall wage distribution worsens immediately after a positive shock to the prime rate.
    Keywords: Earnings, Earnings inequality, Inequality, Monetary policy, Distributions, vector error correction
    Date: 2020
  10. By: Alex Ilek (bank of Israel)
    Abstract: In this study we analyze the effect of the Bank of Israel (BOI) monetary surprises on inflation and the exchange rate, in the eyes of professional forecasters (PF) in Israel. We exploit a unique daily dataset in Israel containing various forecasts of the PF in sample from April 2001 to October 2016 and derive the monetary surprises of the BOI by exploiting the specific timing of expectations formation. We found that although the PF-perceived effect of monetary surprises on the exchange rate was stable over the past two decades, the pass-through from the exchange rate to inflation significantly declined after 2007, primarily due to a full dissociation of rent prices from the shekel-dollar exchange rate. We also provide indirect and partial evidence that the effect of the BOI monetary surprises on real activity did not change after 2007. That is, we didn't find evidence that the information channel introduced by Nakamura and Steinsson (2018) intensified in Israel despite a decline in natural rates worldwide and the establishment of a monetary committee at the BOI. We found, however, that after the establishment of the monetary committee there was a significant increase in interest-rate inertia. Finally, we found an asymmetric pattern of the PF's assessment of the CB interest rate after the global financial crisis. Following a positive surprise in the BOI interest rate, the PFs significantly updated upward their forecasts for the interest rate for the coming year. In contrast, when the monetary surprise was negative, the PFs barely updated downward their forecast for the interest rate.
    Date: 2020–07
  11. By: Christian Loenser (University of Cologne, Center for Macroeconomic Research); Andreas Schabert (University of Cologne, Center for Macroeconomic Research)
    Abstract: This paper examines how financial constraints affect redistribution via monetary policy. We explore a novel mechanism of monetary non-neutrality, which is based on debt limits imposed in nominal terms. Speci cally, when debt is constrained by current income, monetary policy can alter the real terms of borrowing. Changes in ination exert ambiguous effects, depending on the initial debt/wealth position and the willingness to borrow. We show analytically that borrowers can bene t from increased debt limits under lower inflation rates. This novel effect can dominate conventional debt deflation effects. We find that particularly less indebted borrowers as well as potential future borrowers gain and that aggregate welfare can be enhanced under a permanent reduction in inflation.
    Keywords: Monetary policy, redistribution, borrowing limits, non-state contingent nominal debt, heterogeneous agents
    JEL: D52 E44 E52
    Date: 2020–06
  12. By: Sophie Altermatt; Simon Beyeler
    Abstract: We study the implementation and effectiveness of Operation Twist, which represents the origin of today's unconventional monetary policy measures. Operation Twist serves as a perfect laboratory to assess the usefulness of such balance sheet policies because at that time interest rates were not at their lower bound and the economy was not in a historic turmoil. We assess the actions of the Fed and the Treasury under Operation Twist based on balance sheet data and evaluate the success of the operation using modern time series techniques. We find that the joint policy actions, despite being of rather moderate scale, were effective in compressing the long-short spreads of Treasury bond rates.
    Keywords: Operation Twist, monetary policy, interest rates, yield curve, time series
    JEL: C22 E43 E52 E63 E65
    Date: 2020
  13. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper provides microfoundations to the Salter-Swan policy framework, a graphical apparatus designed to ascertain the exchange-rate and fiscal stance of a policymaker with internal and external economic targets. The environment is an infinite-horizon small open economy producing tradable and nontradable goods that takes world prices and world interest rates as given and is populated by optimizing households and firms. The economy is subject to terms-of-trade and interest-rate shocks. The internal target of the government is the unemployment rate and the external target is the current account. Downward nominal wage rigidity and financial frictions serve as the rationale for meaningful policy intervention.
    JEL: F41
    Date: 2020–06
  14. By: Ferrari, Massimo Minesso
    Abstract: In this paper, I incorporate a complex network model into a state of the art stochastic general equilibrium framework with an active interbank market. Banks exchange funds one another generating a complex web of interbanking relations. With the tools of network analysis it is possible to study how contagion spreads between banks and what is the probability and size of a cascade (a sequence of defaults) generated by a single initial episode. Those variables are a key component to understand systemic risk and to assess the stability of the banking system. In extreme scenarios, the system may experience a phase transition when the consequences of one single initial shock affect the entire population. I show that the size and probability of a cascade evolve along the business cycle and how they respond to exogenous shocks. Financial shocks have a larger impact on contagion probability than real shocks that, however, are long lasting. Additionally I find that monetary policy faces a trade off between financial stability and macroeconomic stabilization. Government spending shocks, on the contrary, have smaller effects on both. JEL Classification: E44, E32, E52, E58, D85
    Keywords: contagion, DSGE, heterogenous agents, interbank market, network analysis
    Date: 2020–06
  15. By: Anton Grui (National Bank of Ukraine)
    Abstract: In this study, I modify the uncovered interest parity condition to account for foreign exchange interventions in the context of a small open economy. This is done in a framework of a semistructural New Keynesian model. I examine the case of Ukraine, which de facto transitioned to inflation targeting with a managed float in 2015 after a long period of pegged exchange rate. I simulate model-consistent foreign exchange interventions and use them to quantify the effectiveness of those actually observed. The proposed modification is relevant for inflation targeting regimes with foreign exchange interventions as an additional instrument and those in transition.
    Keywords: New Keynesian model, UIP, exchange rate, FX interventions
    JEL: E12 E17 E52 F31
    Date: 2020–08–18
  16. By: Pierpaolo Benigno (Department of Economics, University of Bern); Salvatore Nisticò (Department of Social Sciences and Economics, Sapienza University of Rome)
    Abstract: An economy plagued by a slump and in a liquidity trap has some options to exit the crisis. We discuss "helicopter money" and other equivalent policies that can reflate the economy and boost consumption. In the framework analysed - where lump-sum transfers may be the only effective fiscal response, like in the current pandemic crisis - the central bank, and only the central bank, is the rescuer of last resort of the economy. Fiscal policy is bounded by solvency constraints unless the central bank backs treasury's debt.
    Keywords: Helicopter money, ZLB, Pandemic Crisis
    JEL: E50
    Date: 2020–04
  17. By: Wolswijk, Guido
    Abstract: This study analyses the choice of government debt managers in the euro area between issuing short‐term or long‐term debt over the period 1992‐2017. Debt managers increased short‐term debt issuance in response to higher interest rate spreads and to rising government debt, notably in vulnerable, high‐debt countries. Thus, lower long-term rates as a result of ECB’s Quantitative Easing (QE) triggered debt managers to focus debt issuance on the long‐term end. Moreover, the usual increase in debt maturity when debt rises ceases to operate when QE is active, possibly because markets perceived it as a backstop to the government bond market. However, limited QE experience calls for caution in interpreting the results. JEL Classification: H63, G12
    Keywords: debt management, debt maturity, Quantitative Easing, reaction function
    Date: 2020–07
  18. By: Del Negro, Marco; Lenza, Michele; Primiceri, Giorgio E.; Tambalotti, Andrea
    Abstract: The business cycle is alive and well, and real variables respond to it more or less as they always did. Witness the Great Recession. Inflation, in contrast, has gone quiescent. This paper studies the sources of this disconnect using VARs and an estimated DSGE model. It finds that the disconnect is due primarily to the muted reaction of inflation to cost pressures, regardless of how they are measured—a flat aggregate supply curve. A shift in policy towards more forceful inflation stabilization also appears to have played some role by reducing the impact of demand shocks on the real economy. The evidence rules out stories centered around changes in the structure of the labor market or in how we should measure its tightness. JEL Classification: E31, E32, E37, E52
    Keywords: DSGE models, inflation, monetary policy trade-off, unemployment, VARs
    Date: 2020–07
  19. By: Nie,Owen
    Abstract: Capital controls, policy measures used by governments to regulate cross-country financial flows, have become standard policy options in many emerging market economies. This paper will focus on what capital controls reveal about the state of the economy and the implications of such revelation for policy efficacy. Using a small open economy model with a collateral constraint and overborrowing relative to the social optimum, this paper incorporates a representative agent's Bayesian updating of information in response to change in policy and show that the efficacy of capital controls to contain financial crises and improve welfare could be undermined if the agent rationally learns from policy. Empirically, this paper finds that capital controls convey important information market participants use to improve their understanding of fundamentals. This paper highlights the need for policymakers to consider the unintended consequences of information revelation in the design of capital flow management policies.
    Keywords: Macroeconomic Management,Banks&Banking Reform,Fiscal&Monetary Policy,Consumption,International Trade and Trade Rules
    Date: 2020–07–30
  20. By: De Grauwe, Paul
    Abstract: Sooner or later, the ECB must accept that monetary financing in support of deficit spending is a necessity not just for mitigating the coronavirus crisis, but also for averting a downward deflationary cycle that could pull the eurozone apart.
    Keywords: Covid-19; coronavirus
    JEL: J1 F3 G3
    Date: 2020–06–07
  21. By: Enrico Perotti (University of Amsterdam, CEPRand Tinbergen Institute); Oscar Soons (University of Amsterdam and Tinbergen Institute)
    Abstract: We analyze the political economy of monetary unification among countries with different quality of institutions. Countries with stronger institutions have lower public spending and better investment incentives, even under a stronger currency. Governments under weaker institutions spend more so must occasionally devalue. In a MU market prices and ows adjust quickly but institutional differences persist, so a diverse monetary union (DMU) has redistributive effects. The government in the weaker country expands spending, and investment may be reduced by the fiscal and common exchange rate effect. Strong country production benefits from the weaker currency but needs to offer fiscal support in a crisis. In equilibrium the required support is incentive compatible due to the devaluation gain. Some governments may join a DMU even if it depresses productive capacity to expand public spending. Even in a DMU beneficial for all countries, firms in weaker countries and savers in stronger countries may lose.
    Keywords: Monetary unions; institutional quality; fiscal union; political economy; fiscaltransfers
    JEL: O47 D72 F33 F45
    Date: 2020–06
  22. By: Robert Kollmann
    Abstract: The closed economy macro literature has shown that a liquidity trap can result from the self-fulfilling expectation that future inflation and output will be low (Benhabib et al. (2001)). This paper investigates expectations-driven liquidity traps in a two-country New Keynesian model of a monetary union. In the model here, country-specific productivity shocks induce synchronized responses of domestic and foreign output, while country-specific aggregate demand shocks trigger asymmetric domestic and foreign responses. A rise in government purchases in an individual country lowers GDP in the rest of the union. The result here cast doubt on the view that, in the current era of ultra-low interest rates, a rise in fiscal spending by Euro Area (EA) core countries would significantly boost GDP in the EA periphery (e.g. Blanchard et al. (2016)).
    Keywords: Zero lower bound; liquidity trap; monetary union; terms of trade; international fiscal spillovers; Euro Area
    JEL: E30 E40 F20 F30 F40
    Date: 2020–08
  23. By: George Overton; Barbara Castillo Rico
    Abstract: The most direct channel of transmission of monetary policy to households is the modification of ECB lending and deposit facilities rates. Outstanding borrowers with adjustable rate loans face affordability conditions changes with important consequences on their financial situation. In this paper, we study the impact of monetary policy changes on housing credit default over the period 2004-2015. We use an extensive panel of French housing loans to reconstruct amortization tables over the life of each loan and compute changes in quarterly payments due to monetary policy action, later using hazard models to map changes in interest rates to default. Importantly, our data set allows the assumption of the absence of strategic default our analysis, which isolates involuntary default in our estimates. First, we find that a 100 bp increase in quarterly payment induced by variations in the 3-month Euribor increases the probability of default by around 5\%. Second, we identify employment stability as a major insurance factor against rising policy rates during contractionary monetary policy action. Finally, we provide evidence about the existence of a self-selection of riskier borrower profiles into adjustable rate loans. The concern regarding payment size on adjustable-rate loans is of heightened importance in a monetary policy context characterized by uncertainty over the timing of a rate increase following a sustained period of low or negative rates.
    Keywords: Housing loans, Monetary policy, Default
    JEL: R30 H81 E52
    Date: 2020
  24. By: Jacopo Bonchi (Department of Social Sciences and Economics, Sapienza University of Rome)
    Abstract: Asset price bubbles are a major source of macroeconomic instability, but can they play a stabilizing role in a low interest rates environment? To answer this question, I study an economy in which the natural rate of interest declines permanently and a long-lasting zero lower bound (ZLB) episode makes risk-free interest rates persistently low. Asset price bubbles redistribute wealth across generations because of the life-cycle pattern of net worth. In this way, they increase the natural interest rate by serving as a store of value for older cohorts and as a collateral for the younger ones, and the central bank can escape from the ZLB with consequent output gains. Therefore, the redistribution of wealth/consumption across generations, which would be welfare-reducing in normal times, becomes welfare-enhancing. However, asset price bubbles affect mainly the natural interest rate through their role of collateral, and a leveraged bubble is the most detrimental for output when it crashes (Jordá et al., 2015).
    Keywords: Asset price bubbles; Natural interest rate; Zero lower bound
    JEL: E13 E44 E52
    Date: 2020–05

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