nep-cba New Economics Papers
on Central Banking
Issue of 2020‒08‒31
28 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. The interaction of monetary and financial tasks in different central bank structures By Houben, Aerdt; Kakes, Jan; Petersen, Annelie
  2. Measuring the Effectiveness of US Monetary Policy during the COVID-19 Recession By Martin Feldkircher; Florian Huber; Michael Pfarrhofer
  3. Leaning Against the Wind: A Cost-Benefit Analysis for an Integrated Policy Framework By Luis Brandao-Marques; R. G Gelos; Machiko Narita; Erlend Nier
  4. Liquidity, the Mundell-Tobin Effect, and the Friedman Rule By Lukas Altermatt; Christian Wipf
  5. A Quantitative Model for the Integrated Policy Framework By Tobias Adrian; Christopher J. Erceg; Jesper Lindé; Pawel Zabczyk; Jianping Zhou
  6. Banks, Money, and the Zero Lower Bound on Deposit Rates By Michael Kumhof; Xuan Wang
  7. Uncertain accommodative policies as tools for financial stability: recent developments By Ojo, Marianne; Roedl, Marianne
  8. Forward Guidance Matters: disentangling monetary policy shocks By Leonardo N. Ferreira
  9. The Impact of Quantitative Easing on Liquidity Creation By Supriya Kapoor; Oana Peia
  10. A Conceptual Model for the Integrated Policy Framework By Suman S Basu; Emine Boz; Gita Gopinath; Francisco Roch; Filiz D Unsal
  11. "Are We All MMTers Now? Not so Fast" By Yeva Nersisyan; L. Randall Wray
  12. The simpler the better: measuring financial conditions for monetary policy and financial stability By Bobasu, Alina; Venditti, Fabrizio; Arrigoni, Simone
  13. Banking Sector Performance During the COVID-19 Crisis By Demirguc-Kunt,Asli; Pedraza Morales,Alvaro Enrique; Ruiz Ortega,Claudia
  14. It is Only Natural: Europe’s Low Interest Rates By Marco Arena; Gabriel Di Bella; Alfredo Cuevas; Borja Gracia; Vina Nguyen; Alex Pienkowski
  15. A New Reserves Regime? COVID-19 and the Federal Reserve Balance Sheet By Gara Afonso; Marco Cipriani; Gabriele La Spada; Will Riordan
  16. The interbank market, Keynes’s degree of confidence and the link between banks’ liquidity and solvency By Konstantinos Loizos
  17. Drivers of consumer prices and exchange rates in small open economies By Corbo, Vesna; Di Casola, Paola
  18. CBDC: A systemic perspective By Bofinger, Peter; Haas, Thomas
  19. Sustainability and Solvency of Government Finances under the Euro: Illustrations and Policy Options By Heikki Oksanen
  20. How to Organize Research in Central Banks: The Czech National Bank's Experience By Simona Malovana
  21. Do We Really Know that U.S. Monetary Policy was Destabilizing in the 1970s? By Qazi Haque; Nicolas Groshenny; Mark Weder
  22. Short and long-run determinants of inflation in Tunisia By Boukraine, Wissem
  23. Global Banks’ Dollar Funding: A Source of Financial Vulnerability By Adolfo Barajas; Andrea Deghi; Claudio Raddatz; Dulani Seneviratne; Peichu Xie; Yizhi Xu
  24. Global Liquidity Traps By Kollmann, Robert
  25. Leverage Ratio Arbitrage All Over Again By Dong Beom Choi; Michael R. Holcomb; Donald P. Morgan
  26. Lower bound uncertainty and long-term interest rates By Christian Grisse
  27. Liquidity requirement and banks' lending By Okahara, Naoto
  28. The Advantages of an Independent Currency for Mitigating the Economic Impact of External Shocks Using the Example of the Coronavirus Pandemic: A Comparison of the Czech Republic and Slovakia By Miroslav Sevcik; Adela Zubikova; Pavel Smolak

  1. By: Houben, Aerdt; Kakes, Jan; Petersen, Annelie
    Abstract: This article describes how the institutional set-up of central bank tasls policies differs across Europe and discusses central bank involvement. In some jurisdictions (like Austria) the central bank continues to focus on its core monetary tasks, whereas in other jurisdictions (like the Netherlands) the central bank also plays a prominent role in non-monetary financial policy fields. The purpose of this article is to i) map out how traditional and new policy tools are organized across Europe, ii) discuss how these policy instruments interact, iii) review the pros and cons of central bank involvement, and iv) discuss how the organization of policies – particularly the role of the central bank – may be related to country-specific features (like the importance of large, systemic banks).
    Keywords: Central banks, monetary policy, lender of last resort, macroprudential policy, supervision, resolution
    JEL: E52 E58 G28 G38
    Date: 2020–08
  2. By: Martin Feldkircher; Florian Huber; Michael Pfarrhofer
    Abstract: The COVID-19 recession that started in March 2020 led to an unprecedented decline in economic activity across the globe. To fight this recession, policy makers in central banks engaged in expansionary monetary policy. This paper asks whether the measures adopted by the US Federal Reserve (Fed) have been effective in boosting real activity and calming financial markets. To measure these effects at high frequencies, we propose a novel mixed frequency vector autoregressive (MF-VAR) model. This model allows us to combine weekly and monthly information within an unified framework. Our model combines a set of macroeconomic aggregates such as industrial production, unemployment rates and inflation with high frequency information from financial markets such as stock prices, interest rate spreads and weekly information on the Feds balance sheet size. The latter set of high frequency time series is used to dynamically interpolate the monthly time series to obtain weekly macroeconomic measures. We use this setup to simulate counterfactuals in absence of monetary stimulus. The results show that the monetary expansion caused higher output growth and stock market returns, more favorable long-term financing conditions and a depreciation of the US dollar compared to a no-policy benchmark scenario.
    Date: 2020–07
  3. By: Luis Brandao-Marques; R. G Gelos; Machiko Narita; Erlend Nier
    Abstract: This paper takes a new approach to assess the costs and benefits of using different policy tools—macroprudential, monetary, foreign exchange interventions, and capital flow management—in response to changes in financial conditions. The approach evaluates net benefits of policies using quadratic loss functions, estimating policy effects on the full distribution of future output growth and inflation with quantile regressions. Tightening macroprudential policy dampens downside risks to growth stemming from loose financial conditions, and is beneficial in net terms. By contrast, tightening monetary policy entails net losses, calling for caution in the use of monetary policy to “lean against the wind.” These findings hold when policies are used in response to easing global financial conditions. Buying foreign-exchange or tightening capital controls has small net benefits.
    Date: 2020–07–07
  4. By: Lukas Altermatt; Christian Wipf
    Abstract: We investigate how the Mundell-Tobin effect, i.e., a positive relation between in flation and capital investment, changes the optimal monetary policy prescription in a framework that combines overlapping generations and new monetarist models. We find that the Friedman rule is optimal if and only if there is no Mundell-Tobin effect. A Mundell-Tobin effect is more likely to occur at the Friedman rule if capital is relatively liquid, and if the agents' risk aversion is relatively low. If the Friedman rule is not optimal, the optimal money growth rate lies between the Friedman rule and a constant money stock. We also show that it is more efficient to implement de flationary monetary policies by raising lump-sum taxes on old agents only.
    Keywords: New monetarism, overlapping generations, optimal monetary policy
    JEL: E4 E5
    Date: 2020–08
  5. By: Tobias Adrian; Christopher J. Erceg; Jesper Lindé; Pawel Zabczyk; Jianping Zhou
    Abstract: Many central banks have relied on a range of policy tools, including foreign exchange intervention (FXI) and capital flow management tools (CFMs), to mitigate the effects of volatile capital flows on their economies. We develop an empirically-oriented New Keynesian model to evaluate and quantify how using multiple policy tools can potentially improve monetary policy tradeoffs. Our model embeds nonlinear balance sheet channels and includes a range of empirically-relevant frictions. We show that FXI and CFMs may improve policy tradeoffs under certain conditions, especially for economies with less well-anchored inflation expectations, substantial foreign currency mismatch, and that are more vulnerable to shocks likely to induce capital outflows and exchange rate pressures.
    Date: 2020–07–07
  6. By: Michael Kumhof (Bank of England); Xuan Wang (Vrije Universiteit Amsterdam)
    Abstract: We develop a New Keynesian model where all payments between agents require bank deposits through deposits-in-advance constraints, bank deposits are created through disbursement of bank loans, and banks face a convex lending cost. At the zero lower bound on deposit rates (ZLBD), changes in policy rates affect activity through both real interest rates and banks’ net interest margins (NIM). At estimated credit supply elasticities, the Phillips curve is very flat at the ZLBD, because inflationary pressures increase NIM. This strongly increases credit and thereby output, but it dampens inflation by relaxing price setters’ credit rationing constraint. At the ZLBD, monetary policy has far larger effects on output relative to inflation, and Taylor rules stabilize output less effectively than rules that also respond to credit. For post-COVID-19 policy, this suggests urgency in returning inflation to targets, avoidance of negative policy rates, and a strong influence of credit conditions on rate setting.
    Keywords: Banks, money creation, inside money, money demand, deposits-in-advance, Phillips curve, zero lower bound, monetary policy rules, Taylor rules, post-COVID-19 reforms
    JEL: E41 E44 E51 G21
    Date: 2020–08–20
  7. By: Ojo, Marianne; Roedl, Marianne
    Abstract: The need to address issues pertaining to legal uncertainty, sound governance, public policy considerations – as well as forecasting techniques as a means of mitigating uncertainties in an environment where confidence the inflation target is low, are amongst some of the objectives which this paper aims to address. Innovative possibilities and opportunities of e digital currencies are then considered – particularly growing considerations of certain central banks to issue their own central bank digital currencies. Questions which still need to be addressed relating to the interest rates to be attached to such currencies and whether or not such interest rates should apply. Further considerations relate to whether the inflation targets should be raised. These innovative possibilities are considered – with further recommendations for research – before a conclusion is drawn. This paper constitutes a chapter to the volume “Rethinking Regulation and Monetary Policies”.
    Keywords: Leaning Against the Wind Policy; financial stability; monetary policies; interest rates; inflation targeting; stable coins; central banks; regulation; crypto assets
    JEL: E43 E44 F6 K20
    Date: 2020–08–04
  8. By: Leonardo N. Ferreira
    Abstract: Central banks have usually employed short-term rates as the main instrument of monetary policy. In the last decades, however, forward guidance has also become a central tool for monetary policy. In an innovative way this paper combines two sources of extraneous information –high frequency surprises and narrative evidence – with sign restrictions in a structural vector autoregressive (VAR) model to fully disentangle the effects of forward guidance shocks from the effects of conventional monetary policy shocks. Results show that conventional monetary policy has the expected effects even in a recent US sample, in contrast with the evidence reported by Barakchian and Crowe (2013) and Ramey (2016), and that forward guidance is an effective policy tool. In fact, it is at least as strong as conventional monetary policy.
    Date: 2020–08
  9. By: Supriya Kapoor; Oana Peia
    Abstract: We study the effects of the US Federal Reserve's large-scale asset purchase programs during 2008-2014 on bank liquidity creation. Banks create liquidity when they transform the liquid reserves resulted from quantitative easing into illiquid assets. As the composition of banks' loan portfolio affects the amount of liquidity it creates, the impact of quantitative easing on liquidity creation is not a priori clear. Using a difference-in-difference identification strategy, we find that banks that were more exposed to the policy increased lending relative to a control group. However, while the increase in lending was present across all three rounds of quantitative easing, we only find a strong effect on liquidity creation during the last round. This points to a weaker impact of quantitative easing on the real economy during the first two rounds, when affected banks transformed the reserves created through the asset purchase program into less illiquid assets, such as real estate mortgages.
    Keywords: Large-scale asset purchases; Quantitative easing; Liquidity creation; Bank lending
    JEL: E52 E58 G21
    Date: 2020–04
  10. By: Suman S Basu; Emine Boz; Gita Gopinath; Francisco Roch; Filiz D Unsal
    Abstract: In the Mundell-Fleming framework, standard monetary policy and exchange rate flexibility fully insulate economies from shocks. However, that framework abstracts from many real world imperfections, and countries often resort to unconventional policies to cope with shocks, such as COVID-19. This paper develops a model of optimal monetary policy, capital controls, foreign exchange intervention, and macroprudential policy. It incorporates many shocks and allows countries to differ across the currency of trade invoicing, degree of currency mismatches, tightness of external and domestic borrowing constraints, and depth of foreign exchange markets. The analysis maps these shocks and country characteristics to optimal policies, and yields several principles. If an additional instrument becomes available, it should not necessarily be deployed because it may not be the right tool to address the imperfection at hand. The use of a new instrument can lead to more or less use of others as instruments interact in non-trivial ways.
    Date: 2020–07–07
  11. By: Yeva Nersisyan; L. Randall Wray
    Abstract: As governments around the world explore ambitious approaches to fiscal and monetary policy in their responses to the COVID-19 crisis, Modern Money Theory (MMT) has been thrust into the spotlight once again. Unfortunately, many of those invoking the theory have misrepresented its central tenets, according Yeva Nersisyan and L. Randall Wray. MMT provides an analysis of fiscal and monetary policy applicable to national governments with sovereign, nonconvertible currencies. In the context of articulating the elements of that analysis, Nersisyan and Wray draw out one of the lessons to be learned from the pandemic and its policy responses: that the government’s ability to run deficits is not limited to times of crisis; that we must build up our supplies, infrastructure, and institutions in normal times, and not wait for the next crisis to live up to our means.
    Date: 2020–04
  12. By: Bobasu, Alina; Venditti, Fabrizio; Arrigoni, Simone
    Abstract: In this paper we assess the merits of financial condition indices constructed using simple averages versus a more sophisticated alternative that uses factor models with time varying parameters. Our analysis is based on data for 18 advanced and emerging economies at a monthly frequency covering about 70% of the world’s GDP. We use four criteria to assess the performance of these indicators, namely quantile regressions, Structural Vector Autoregressions, the ability of the indices to predict banking crises and their response to US monetary policy shocks. We find that averaging across the indicators of interest, using judgemental but intuitive weights, produces financial condition indices that are not inferior to, and actually perform better than, those constructed with more sophisticated statistical methods. JEL Classification: E32, E44, C11, C55
    Keywords: banking crises, financial conditions, quantile regressions, spillovers, SVARs
    Date: 2020–08
  13. By: Demirguc-Kunt,Asli; Pedraza Morales,Alvaro Enrique; Ruiz Ortega,Claudia
    Abstract: This paper analyzes bank stock prices around the world to assess the impact of the COVID-19 pandemic on the banking sector. Using a global database of policy responses during the crisis, the paper also examines the role of financial sector policy announcements on the performance of bank stocks. Overall, the results suggest that the crisis and the countercyclical lending role that banks are expected to play have put banking systems under significant stress, with bank stocks underperforming their domestic markets and other non-bank financial firms. The effectiveness of policy interventions has been mixed. Measures of liquidity support, borrower assistance, and monetary easing moderated the adverse impact of the crisis, but this is not true for all banks or in all circumstances. For example, borrower assistance and prudential measures exacerbated the stress for banks that are already undercapitalized and/or operate in countries with little fiscal space. These vulnerabilities will need to be carefully monitored as the pandemic continues to take a toll on the world?s economies.
    Keywords: Financial Sector Policy,Macroeconomic Management,International Trade and Trade Rules,Finance and Development,Banks&Banking Reform
    Date: 2020–08–14
  14. By: Marco Arena; Gabriel Di Bella; Alfredo Cuevas; Borja Gracia; Vina Nguyen; Alex Pienkowski
    Abstract: Estimates of the natural interest rate are often useful in the analysis of monetary and other macroeconomic policies. The topic gathered much attention following the great financial crisis and the Euro Area debt crisis due to the uncertainty regarding the timing of monetary policy normalization and the future path of interest rates. Using a sample of European countries (including several members of the Euro Area), this paper provides estimates of country-specific natural interest rates and some of their drivers between 2000 and 2019. In line with the literature, our findings suggest that natural interest rates declined during this period, and despite a rebound in the last few years of it, they have not recovered to their pre-crisis levels. The paper also discusses the implications of the decline in natural interest rates for monetary conditions and debt sustainability.
    Date: 2020–07–03
  15. By: Gara Afonso; Marco Cipriani; Gabriele La Spada; Will Riordan
    Abstract: Aggregate reserves declined from nearly $3 trillion in August 2014 to $1.4 trillion in mid-September 2019, as the Federal Reserve normalized its balance sheet. This decline came to a halt in September 2019 when the Federal Reserve responded to turmoil in short-term money markets, with reserves fluctuating around $1.6 trillion in the early months of 2020. Then, in response to the COVID-19 pandemic, the Federal Reserve dramatically expanded its balance sheet, both directly, through outright purchases and repurchase agreements, and indirectly, as a consequence of the facilities to support market functioning and the flow of credit to the real economy. In this post, we characterize the increase in reserves between March and June 2020, describing changes to the distribution and concentration of reserves.
    Keywords: reserves; COVID-19; branches; foreign banking organizations (FBOs); global systemically important banks (GSIBs)
    JEL: E5 I18
    Date: 2020–07–07
  16. By: Konstantinos Loizos (University of Athens (GR))
    Abstract: The link between banks’ liquidity and solvency is not adequately addressed in the literature, despite the central role of the interbank market in the spread of the recent crisis. This paper proposes a possible way by which the interbank rate and the required return on equity capital are determined, and are related to each other. Thereby, a link between liquidity and insolvency risk is derived on the grounds of Keynes's concept of ‘degree of confidence’ on held expectations about economic prospects. High degree of confidence and trust prevailing in the interbank market makes risk sharing possible at prices which render bank capital regulation ineffective in the rising phase of the cycle, and overly restricted in the downswing. Basel’s III higher capital, liquidity and leverage ratios might not be enough if measures, in the sense of Minsky’s Big Government-Big Bank, targeting overconfidence in booms and redressing the lack of confidence in the downturns are not taken into account.
    Keywords: Degree of confidence, Interbank market, Liquidity preference, Insolvency risk, Financial cycles
    JEL: E12 E32 G21
    Date: 2020–08
  17. By: Corbo, Vesna (Monetary Policy Department, Central Bank of Sweden); Di Casola, Paola (Monetary Policy Department, Central Bank of Sweden)
    Abstract: We study the fluctuations of exchange rates and consumer prices in two small open economies, Sweden and Canada, using a structural Bayesian VAR. Four domestic and two global shocks are identified through zero and sign restrictions. For both economies, we find that the main driver of consumer price inflation is the global demand shock. A negative global demand shock is not only deflationary for the small open economy, but also depreciates its currency. Hence, the observed exchange rate pass-through following this shock is of opposite sign to what is usually expected. Finally, exogenous shocks to the Exchange rate are less important drivers of exchange rate movements than in many other structural models.
    Keywords: Exchange rate pass-through; consumer prices; import prices; monetary policy; global shocks; SVAR
    JEL: E31 E52 F31 F41
    Date: 2020–03–01
  18. By: Bofinger, Peter; Haas, Thomas
    Abstract: In this study, we provide a systemic perspective on central bank digital currencies (CBDC). We separate existing proposals for CBDCs into the perspective of new payment objects, made available by central banks to a broader public, and new payment systems, operated by central banks. From a systemic perspective, CBDC proposals need to be examined to see how they would fit into the existing ecosystem of national, supra-regional, and international payment systems. To analyze the main implications of introducing CBDCs, we provide a price-theoretical banking model, which allows private non-banks to switch between holding bank deposits and CBDCs. In addition to the CBDC payment objects, we also present the option of a store-of-value CBDC. While most CBDC proposals incorporate new payment objects with new or existing payment systems, we discuss whether central banks could establish new payment systems without offering a new payment object.
    Keywords: central bank digital currency,central banks,payment systems
    JEL: E42 E52 E58 G21
    Date: 2020
  19. By: Heikki Oksanen
    Abstract: In this paper, sound public finances under the euro means sustainability in the long term instead of short- and medium-term fiscal discipline. The challenges to sustainability are identified for the four largest euro area member states, and several policy options for sustainability are illustrated with scenarios. Sustainability of the government finances is required for being solvent and having continuous access to credit at acceptable interest rates. Solvency in the long term is the key link between coherent fiscal and monetary policies. A main tool of the Eurosystem for setting an appropriate monetary stance is purchasing bonds issued by the solvent governments. It also must assess their solvency if it needs to act as the lender of last resort for a euro area government under liquidity shortage to prevent it from developing into a general financial crisis. Resolving the crisis caused by the Covid-19 pandemic requires confidence that the public finances will be steered towards sustainability and the Eurosystem can take its proper role as a central bank.
    Keywords: euro, fiscal policy, monetary policy
    JEL: E42 E62 E63 H10
    Date: 2020
  20. By: Simona Malovana
    Abstract: This paper describes the Czech National Bank's experience with the implementation of a new research model, which was motivated by a weakened link between research outputs and their application. The changes implemented in 2017 represented a next step in the evolution of the Czech National Bank's research process and have helped increase the relevance of research outputs and the flexibility of the whole process. The paper also summarizes the remaining challenges under the new research model and describes the implementation of project management in the financial research area.
    Keywords: Central banking, Czech National Bank, challenges, project management, research model
    JEL: A1 A3
    Date: 2020–07
  21. By: Qazi Haque (University of Western Australia and CAMA); Nicolas Groshenny (University of Adelaide and CAMA); Mark Weder (Department of Economics and Business Economics, Aarhus University and CAMA)
    Abstract: The paper re-examines whether the Federal Reserve’s monetary policy was a source of instability during the Great Inflation by estimating a sticky-price model with positive trend inflation, commodity price shocks and sluggish real wages. Our estimation provides empirical evidence for substantial wage rigidity and finds that the Federal Reserve responded aggressively to inflation but negligibly to the output gap. In the presence of non-trivial real imperfections and well-identified commodity price-shocks, U.S. data prefers a determinate version of the New Keynesian model: monetary policy-induced indeterminacy and sunspots were not causes of macroeconomic instability during the pre-Volcker era. However, had the Federal Reserve in the Seventies followed the policy rule of the Volcker-Greenspan-Bernanke period, inflation volatility would have been lower by one third.
    Keywords: Monetary policy, Trend inflation, Great Inflation, Cost-push shocks, Indeterminacy
    JEL: E32 E52 E58
    Date: 2020–08–14
  22. By: Boukraine, Wissem
    Abstract: The depreciation of the national currency, the higher wage costs passed on to prices and the growing external debt, has characterized the Tunisian economy for almost a decade. In this context we investigate its inflation dynamics to understand which variables affects it in the short and the long run. We apply the Autoregressive Distributed-lagged model over quarterly data from 2010 to 2019 alongside the bound testing approach. Our results suggest a significant impact of external debt and loans on inflation in the short and long run, while GDP growth affects inflation only in the long run.
    Keywords: Inflation, ARDL, Tunisia
    JEL: C01 E31
    Date: 2020
  23. By: Adolfo Barajas; Andrea Deghi; Claudio Raddatz; Dulani Seneviratne; Peichu Xie; Yizhi Xu
    Abstract: Leading up to the global financial crisis, US dollar activity by global banks headquartered outside the United States played a crucial role in transmitting shocks originating in funding markets. Although post-crisis regulation has improved banking systems’ resilience, US dollar funding remains a global vulnerability, as evidenced by strains that reemerged in March 2020 in the midst of the COVID-19 crisis. We show that shocks to US dollar funding costs lead to financial stress in the home economies of these global non-US banks, and to spillovers to borrowers, especially emerging economies. US dollar funding vulnerability amplifies these negative effects, while some policy-related factors act as mitigators, such as swap line arrangements between central banks and international reserve holdings. Thus, these vulnerabilities should be monitored and, to the extent possible, controlled.
    Date: 2020–07–03
  24. By: Kollmann, Robert
    Abstract: This paper studies fluctuations of interest rates, inflation and output in a two-country New Keynesian business cycle model with a zero lower bound (ZLB) constraint for nominal interest rates. The presence of the ZLB generates multiple equilibria driven by self-fulfilling changes in domestic and foreign inflation expectation. Each country randomly switches in and out of a liquidity trap. In a floating exchange rate regime, liquidity traps can either be synchronized or unsynchronized across countries. This is the case even if countries are perfectly financially integrated. By contrast, in a monetary union, self-fulfilling fluctuations in inflation expectations must be perfectly correlated across countries.
    Keywords: Zero lower bound, liquidity trap, global business cycles
    JEL: E3 E4 F2 F3 F4
    Date: 2020–04–15
  25. By: Dong Beom Choi; Michael R. Holcomb; Donald P. Morgan
    Abstract: Leverage limits as a form of capital regulation have a well-known, potential bug: If banks can’t lever returns as desired, they can boost returns on equity by shifting toward riskier, higher yielding assets. That reach for yield is the leverage rule “arbitrage.” But would banks do that? In a previous post, we discussed evidence from our working paper that banks did do just that in response to the new leverage rule that took effect in 2018. This post discusses new findings in our revised paper on when and how banks arbitraged.
    Keywords: leverage rule; reguatory arbitrage; risk; banks
    JEL: G21 E5 G28
    Date: 2020–06–30
  26. By: Christian Grisse
    Abstract: Nominal interest rates are constrained by an effective lower bound, but the level of the lower bound is uncertain. This paper uses a simple shadow rate term structure model to study how lower bound uncertainty affects long-term interest rates. The main result is that a decline in lower bound uncertainty, in the sense of a mean-preserving contraction of the lower bound distribution, is associated with a drop in expected future short rates. The effect on the variance of future short rates, and hence the term premium, is ambiguous. A calibration to Canadian data suggests that a decline in lower bound uncertainty is associated with a modest drop in long-term interest rates.
    Keywords: Monetary policy, negative interest rates, lower bound, uncertainty, term structure
    JEL: E43 E52
    Date: 2020
  27. By: Okahara, Naoto
    Abstract: This study proposes a model that describes banks' decisions about how much liquidity they hold and analyzes how liquidity regulations affect the amount of their lending. In literature, it is pointed out that banks are likely to hold ex-post excess liquidity under a liquidity regulation when some depositors make decisions based on the banks' soundness. This result implies that the regulation forces banks to suffer an unnecessary decrease of their lending, and thus, they would try to mitigate the loss by adjusting their portfolio. The aim of this study is to investigate whether banks' lending decreases or not when there exist multiple sets of assets that satisfy a liquidity regulation. In addition, we analyze two types of liquidity regulation; one focuses on banks' survivability, and the other focuses on continuity of their liquidity holding. The model shows that, even when there exist other ways to satisfy the regulations besides holding only reserves, banks still hold an ex-post excess amount of liquidity under either type of liquidity regulation. However, the model also shows that the amount of banks' lending varies according to how they satisfy the liquidity regulation and the probability that a severe reduction of lending happens depends partly on the regulation's type. These results implies that banks' decisions for mitigating losses caused by liquidity regulations lead to an undesired outcome, and thus, we consider more carefully banks' decisions under liquidity regulations.
    Keywords: Bank, Liquidity regulation, Excess liquidity
    JEL: E02 G21 G28
    Date: 2020–01–20
  28. By: Miroslav Sevcik (Faculty of Economics, University of Economics, Prague); Adela Zubikova (Faculty of Economics, University of Economics, Prague); Pavel Smolak (Faculty of Economics, University of Economics, Prague)
    Abstract: The content of the paper defines and characterizes five key arguments for why, given the absence of an optimal monetary area, it is advantageous for an economy to be able to dispose of its own currency during periods of crisis, such as the current coronavirus pandemic. The article bases its arguments on the optimal currency area theory and the Mundell-Fleming model. The analytical part of the article approaches the example of the Czech Republic and the Slovak Republic, a well-matched comparison given that they are both small open economies with a common history but also because they faced the coronavirus pandemic at the same time and were affected to a similar extent. Unlike its Czech neighbour, the Slovak Republic adopted a single currency, the Euro, in 2009 and therefore became a member of the eurozone. Therefore, the use of its own currency to mitigate the coronavirus pandemic effects can be approximated by comparing the two countries. The analysis in this article results in the identification of the following five arguments for the advantage of having an independent currency: 1) absence of an optimal monetary area in the eurozone, 2) an independent monetary policy, 3) foreign trade support, 4) mitigating the effects of the coronavirus pandemic on price level changes, 5) supporting domestic production and services. The coronavirus pandemic has deepened the already existing problems of the eurozone and has clearly demonstrated the benefits of maintaining an independent currency in the case of the Czech Republic.
    Keywords: Monetary union, Czech crown, Euro area, International trade, Czech Republic, Slovakia, COVID-19, pandemic crisis
    JEL: E42 E58 F40

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