nep-cba New Economics Papers
on Central Banking
Issue of 2020‒10‒05
eighteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Monetary Policy Surprises and Exchange Rate Behavior By Refet S. Gürkaynak; A. Hakan Kara; Burçin Kısacıkoğlu; Sang Seok Lee
  2. A Macro-Financial Perspective to Analyse Maturity Mismatch and Default By Xuan Wang
  3. How Robust Are Makeup Strategies to Key Alternative Assumptions? By James Hebden; Edward Herbst; Jenny Tang; Giorgio Topa; Fabian Winkler
  4. Monetary Momentum By Andreas Neuhierl; Michael Weber
  5. The Fed Takes on Corporate Credit Risk: An Analysis of the Efficacy of the SMCCF By Simon Gilchrist; Bin Wei; Vivian Z. Yue; Egon Zakrajšek
  6. Underlying Inflation: Its Measurement and Significance By Jeremy B. Rudd
  7. Banking euro area stress test model By Budnik, Katarzyna; Balatti, Mirco; Dimitrov, Ivan; Groß, Johannes; Kleemann, Michael; Reichenbachas, Tomas; Sanna, Francesco; Sarychev, Andrei; Siņenko, Nadežda; Volk, Matjaz
  8. Monetary policy and stock market valuation By Laine, Olli-Matti
  9. Financial Openness and Inflation: An Empirical Analysis By Alfred V. Guender; Hamish McHugh-Smith
  10. Average Inflation Targeting and Household Expectations By Olivier Coibion; Yuriy Gorodnichenko; Edward S. Knotek II; Raphael Schoenle
  11. After 25 Years as Faithful Members of the EU. Public Support for the Euro and Trust in the ECB in Austria, Finland and Sweden By Roth, Felix; Jonung, Lars
  12. Probing the mechanism: lending rate setting in a data-driven agent-based model By Papadopoulos, Georgios
  13. Regulatory stress tests and bank responses By Karel Janda; Oleg Kravtsov
  14. Capital Flows and the Stabilizing Role of Macroprudential Policies in CESEE By Markus Eller; Niko Hauzenberger; Florian Huber; Helene Schuberth; Lukas Vashold
  15. Uncertainty and monetary policy during extreme events By Giovanni Pellegrino; Efrem Castelnuovo; Giovanni Caggiano
  16. The Pricing of Bank Bonds, Sovereign Credit Risk and ECB's Asset Purchase Programmes By Ricardo Branco; João Pinto; Ricardo Ribeiro
  17. Exchange rate policy and external vulnerabilities in Sub-Saharan Africa: nominal, real or mixed targeting? By Fadia Al Hajj; Gilles Dufrénot; Benjamin Keddad
  18. Interest rate pegs and the reversal puzzle: On the role of anticipation By Gerke, Rafael; Giesen, Sebastian; Kienzler, Daniel

  1. By: Refet S. Gürkaynak; A. Hakan Kara; Burçin Kısacıkoğlu; Sang Seok Lee
    Abstract: Central banks unexpectedly tightening policy rates often observe the exchange value of their currency depreciate, rather than appreciate as predicted by standard models. We document this for Fed and ECB policy days using event-studies and ask whether an information effect, where the public attributes the policy surprise to an unobserved state of the economy that the central bank is signaling by its policy may explain the abnormality. It turns out that many informational assumptions make a standard two-country New Keynesian model match this behavior. To identify the particular mechanism, we condition on multiple asset prices in the event-study and model implications for these. We find that there is heterogeneity in this dimension in the event-study and no model with a single regime can match the evidence. Further, even after conditioning on possible information effects driving longer term interest rates, there appear to be other drivers of exchange rates. Our results show that existing models have a long way to go in reconciling event-study analysis with model-based mechanisms of asset pricing.
    JEL: E43 E44 E52 E58 G14
    Date: 2020–09
  2. By: Xuan Wang (Vrije Universiteit Amsterdam)
    Abstract: The Basel Committee proposed the Net Stable Funding Ratio (NSFR) to curb excessive maturity mismatch of the banking sector. However, it remains to be ascertained as to what are the financial and real effects of the NSFR on banks' credit quality, investment, and the pass-through of monetary policy. This paper develops a nominal dynamic general equilibrium featuring banks' maturity mismatch and the moral hazard due to costly monitoring. First, I show that a tightening of the NSFR to move loan maturity towards the long-run capital investment cycle would only increase real investment if it sufficiently improves banks' credit quality. Then in the numerical example calibrated with the US data, I show that such tightening of the NSFR can indeed increase real investment and also reduce the aggregate fluctuation of the economy. In the steady states, a 10% tightening in the NSFR can decrease net charge-offs of non-performing loans by about 0.06 pp annually, despite squeezing banks' interest margin. Moreover, the moral hazard stemming from banks' unobserved monitoring effort impairs the pass-through of monetary policy. However, a 10% tightening in the NSFR improves the pass-through of a 20-bp policy rate reduction by around 17% annually. Finally, the model simulates the stochastic dynamic equilibrium path to study the propagation of shocks, demonstrating that the NSFR complements monetary policy in reducing financial frictions.
    Keywords: Maturity mismatch, Net Stable Funding Ratio, default, banking, monetary policy, macro-prudential policy
    JEL: E44 E51 G18 G21
    Date: 2020–09–22
  3. By: James Hebden; Edward Herbst; Jenny Tang; Giorgio Topa; Fabian Winkler
    Abstract: We analyze the robustness of makeup strategies—policies that aim to offset, at least in part, past misses of inflation from its objective—to alternative modeling assumptions, with an emphasis on the role of inflation expectations. We survey empirical evidence on the behavior of shorter-run and long-run inflation expectations. Using simulations from the FRB/US macroeconomic model, we find that makeup strategies can moderately offset the real effects of adverse economic shocks, even when much of the public is uninformed about the monetary strategy. We also discuss the robustness of makeup strategies to alternative assumptions about the slope of the Phillips curve and the (mis)perception of economic slack.
    Keywords: Monetary policy; Effective lower bound; Expectations
    JEL: E47 E52
    Date: 2020–08–27
  4. By: Andreas Neuhierl (University of Notre Dame); Michael Weber (University of Chicago - Booth School of Business)
    Abstract: We document a large return drift around monetary policy announcements by the Federal Open Market Committee (FOMC). Stock returns start drifting up 25 days before expansionary monetary policy surprises, whereas they decrease before contractionary surprises. The cumulative return difference across expansionary and contractionary policy decisions amounts to 2.5% until the day of the policy decision and continues to increase to more than 4.5% 15 days after the meeting. The drift is more pronounced during periods of high uncertainty, it is a market-wide phenomenon, and it is present in all industries and many international equity markets. Standard returns factors and time-series momentum do not span the return drift around FOMC policy decisions. A simple trading strategy exploiting the drift around FOMC meetings increases Sharpe ratios relative to a buy-and-hold investment by a factor of 4. The cumulative returns before FOMC meetings significantly predict the subsequent policy surprise.
    Keywords: Return Drift, Monetary Policy, FOMC, Macro News
    JEL: E31 E43 E44 E52 E58 G12
    Date: 2020
  5. By: Simon Gilchrist; Bin Wei; Vivian Z. Yue; Egon Zakrajšek
    Abstract: We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the corporate bond market in the wake of the Covid-19 shock. The Fed announced the SMCCF on March 23 and expanded the program on April 9. Regression discontinuity estimates imply that these announcements reduced credit spreads on bonds eligible for purchase 70 basis points. We refine this analysis by constructing a sample of bonds—issued by the same set of companies—which differ in their SMCCF eligibility. A diff-in-diff analysis shows that both announcements had large effects on credit spreads, narrowing spreads 20 basis points on eligible bonds relative to their ineligible counterparts within the same set of issuers across the two announcement periods. The March 23 announcement also reduced bid-ask spreads ten basis points within ten days of the announcement. By lowering credit spreads and improving liquidity, the April 9 announcement had an especially pronounced effect on “fallen angels.” The actual purchases lowered credit spreads by an additional five basis points and bid-ask spreads by two basis points. These results confirm that the SMCCF made it easier for companies to borrow in the corporate bond market.
    JEL: E44 E58 G2
    Date: 2020–09
  6. By: Jeremy B. Rudd
    Abstract: Underlying inflation is the rate of inflation that would be expected to eventually prevail in the absence of economic slack, supply shocks, idiosyncratic relative price changes, or other disturbances. Underlying inflation is a useful benchmark for monetary policy in that it provides an idea of the rate of price change that would be expected to obtain under "normal" circumstances in an economy where the level of resource utilization is putting neither upward nor downward pressure on inflation.
    Date: 2020–09–18
  7. By: Budnik, Katarzyna; Balatti, Mirco; Dimitrov, Ivan; Groß, Johannes; Kleemann, Michael; Reichenbachas, Tomas; Sanna, Francesco; Sarychev, Andrei; Siņenko, Nadežda; Volk, Matjaz
    Abstract: The Banking Euro Area Stress Test (BEAST) is a large scale semi-structural model developed to assess the resilience of the euro area banking system from a macroprudential perspective. The model combines the dynamics of a high number of euro area banks with that of the euro area economies. It reflects banks’ heterogeneity by replicating the structure of their balance sheets and profit and loss accounts. In the model, banks adjust their assets, interest rates, and profit distribution in line with the economic conditions they face. Bank responses feed back to the macroeconomic environment affecting credit supply conditions. When applied to a stress test of the euro area banking system, the model reveals higher system-wide capital depletion than the analogous constant balance sheet exercise. JEL Classification: E37, E58, G21, G28
    Keywords: banking sector deleveraging, macroprudential policy, macro stress test, real economy-financial sector feedback loop
    Date: 2020–09
  8. By: Laine, Olli-Matti
    Abstract: This paper estimates the effect of the European Central Banks’s monetary policy on the term structure of expected stock market risk premia. Expected stock market premia are solved using analysts’ dividend forecasts, the Eurostoxx 50 stock index and Eurostoxx 50 dividend futures. Although risk-free rates have decreased after the global financial crisis, the results indicate that the expected average stock market return has remained quite stable at around 9 percent. This implies that the expected average stock market risk premium has increased since the financial crisis. The effect of monetary policy on expected premia is analysed using VAR models and local projection methods. According to the results, monetary policy easing raises the average expected premium. The effect is explained by a rise in long-horizon expected premia.
    JEL: E52 G12
    Date: 2020–09–18
  9. By: Alfred V. Guender (University of Canterbury); Hamish McHugh-Smith
    Abstract: Our empirical analysis reveals a strong systematic inverse link between financial openness and CPI inflation in over 100 countries, adding weight to the argument that inflation in financially open economies is lower. Trade openness in contrast bears no systematic relationship to inflation.
    Keywords: Financial Openness, Trade Openness, Inflation, Capital Controls
    JEL: E3 E5 F3
    Date: 2020–09–01
  10. By: Olivier Coibion; Yuriy Gorodnichenko; Edward S. Knotek II; Raphael Schoenle
    Abstract: Using a daily survey of U.S. households, we study how the Federal Reserve’s announcement of its new strategy of average inflation targeting affected households’ expectations. Starting with the day of the announcement, there is a very small uptick in the minority of households reporting that they had heard news about monetary policy relative to prior to the announcement, but this effect fades within a few days. Those hearing news about the announcement do not seem to have understood the announcement: they are no more likely to correctly identify the Fed’s new strategy than others, nor are their expectations different. When we provide randomly selected households with pertinent information about average inflation targeting, their expectations still do not change in a different way than when households are provided with information about traditional inflation targeting.
    JEL: E3 E4 E5
    Date: 2020–09
  11. By: Roth, Felix (Department of Economics, University of Hamburg); Jonung, Lars (Department of Economics, Lund University)
    Abstract: Austria, Finland and Sweden became members of the EU in 1995. This paper examines how support for the euro and trust in the European Central Bank (ECB) have evolved in these three countries since their introduction at the turn of the century. Support for the euro in the two euro-area members Austria and Finland has remained high and relatively stable since the physical introduction of the new currency nearly 20 years ago, while the euro crisis significantly reduced support for the euro in Sweden. Since the start of the crisis, trust in the ECB was strongly influenced by the pronounced increase in unemployment in the euro area, demonstrating that the ECB was held accountable for macroeconomic developments. Our results indicate that citizens in the EU, both within and outside the euro area, judge the euro and the ECB based on the economic performance of the euro area. Thus, the best way to foster support for the euro and trust in the ECB is to pursue policies aimed at achieving low unemployment and high growth.
    Keywords: euro; trust; ECB; EU; monetary union; Austria; Finland; Sweden
    JEL: E42 E52 E58 F33 F45
    Date: 2020–09–08
  12. By: Papadopoulos, Georgios
    Abstract: The mechanism underlying banks' interest rate setting behaviour is an important element in the study of economic systems with important policy implications associated with the potential of monetary and -recently- macroprudential policies to affect the real economy. In the agent-based modelling literature, lending rate setting has so far been modelled in an ad-hoc manner, based almost exclusively on theoretical grounds with the specifics usually chosen in an arbitrary fashion. This study tries to empirically identify the mechanism that approximates the observed patterns of consumer credit interest rates within a data-driven, agent-based model (ABM). The analysis suggests that there is heterogeneity across countries, both in terms of the rule itself as well as its specific parameters and that often a simple, borrower-risk only mechanism adequately approximates the historical series. More broadly, the validation exercise shows that the model is able to replicate the dynamics of several variables of interest, thus providing a way to bring ABMs "close to the data".
    Keywords: Agent-based modelling, Lending rate mechanism, Consumer credit, Model validation, Rule discovery
    JEL: C63 E21 E27 E43
    Date: 2020–09–04
  13. By: Karel Janda; Oleg Kravtsov
    Abstract: In this paper, we investigate how the regulatory stress test framework in the European Union affects banks’ investment decisions and portfolio choices. Using the causal inference and event study methodology, we document a substantial impact of EU-wide stress tests in 2011, 2014 and 2016 on the banks’ portfolio strategies. The banks subject to regulatory stress tests tend to structure their portfolios with lower risk assets that is reflected in a decline in risk-weighted assets as compared to the control group. At the same time, the dynamic of realized risk that is measured by the proportion of non-performing exposure in portfolios remains unaffected. The estimates based on two alternative subsamples indicate that the magnitude of such effect rise with the increase in the size of the bank´s assets.
    Keywords: regulatory stress test, capital regulation, heterogeneous treatment effect, event study, instrumental variable
    JEL: G20 G21 G28
    Date: 2020–08
  14. By: Markus Eller; Niko Hauzenberger; Florian Huber; Helene Schuberth; Lukas Vashold
    Abstract: In line with the recent policy discussion on the use of macroprudential measures to respond to cross-border risks arising from capital flows, this paper tries to quantify to what extent macroprudential policies (MPPs) have been able to stabilize capital flows in Central, Eastern and Southeastern Europe (CESEE) -- a region that experienced a substantial boom-bust cycle in capital flows amid the global financial crisis and where policymakers had been quite active in adopting MPPs already before that crisis. To study the dynamic responses of capital flows to MPP shocks, we propose a novel regime-switching factor-augmented vector autoregressive (FAVAR) model. It allows to capture potential structural breaks in the policy regime and to control -- besides domestic macroeconomic quantities -- for the impact of global factors such as the global financial cycle. Feeding into this model a novel intensity-adjusted macroprudential policy index, we find that tighter MPPs may be effective in containing domestic private sector credit growth and the volumes of gross capital inflows in a majority of the countries analyzed. However, they do not seem to generally shield CESEE countries from capital flow volatility.
    Date: 2020–09
  15. By: Giovanni Pellegrino; Efrem Castelnuovo; Giovanni Caggiano
    Abstract: How damaging are uncertainty shocks during extreme events such as the great recession and the Covid-19 outbreak? Can monetary policy limit output losses in such situations? We use a nonlinear VAR framework to document the large response of real activity to a financial uncertainty shock during the great recession. We replicate this evidence with an estimated DSGE framework featuring a concept of uncertainty comparable to that in our VAR. We employ the DSGE model to quantify the impact on real activity of an uncertainty shock under different Taylor rules estimated with normal times vs. great recession data (the latter associated with a stronger response to output). We find that the uncertainty shock-induced output loss experienced during the 2007-09 recession could have been twice as large if policymakers had not responded aggressively to the abrupt drop in output in 2008Q3. Finally, we use our estimated DSGE framework to simulate different paths of uncertainty associated to different hypothesis on the evolution of the coronavirus pandemic. We find that: i) Covid-19-induced uncertainty could lead to an output loss twice as large as that of the great recession; ii) aggressive monetary policy moves could reduce such loss by about 50%.
    Keywords: Uncertainty shock, nonlinear IVAR, nonlinear DSGE framework, minimum-distance estimation, great recession, Covid-19
    JEL: C22 E32 E52
    Date: 2020–09
  16. By: Ricardo Branco (Mazars Portugal and Universidade Católica Portuguesa, Católica Porto Business School); João Pinto (Universidade Católica Portuguesa, Católica Porto Business School and CEGE); Ricardo Ribeiro (Universidade Católica Portuguesa, Católica Porto Business School and CEGE)
    Abstract: The 2008 Global financial crisis and the subsequent European sovereign debt crisis deteriorated banks funding conditions and lead to a substitution effect among bond instruments. We examine the pricing of straight, covered and securitization bonds issued by European banks in the 2000-2016 period, with a particular focus on the effect of sovereign credit risk and ECB's asset purchase programmes on spreads. We nd that (i) straight, covered and securitization bonds are priced in segmented markets, (ii) the impact of common pricing determinants on spreads differ significantly between non-crisis and crisis periods, (iii) sovereign credit risk is an important determinant of banks' cost of funding, especially in crisis periods, (iv) ECB's asset purchase programmes exhibited mixed effectiveness in improving banks funding conditions, (v) contractual bond characteristics other than credit ratings, macroeconomic factors and bank characteristics are important determinants of spreads, and (vi) there is evidence of heterogeneity across countries.
    Keywords: Straight Bonds; Covered Bonds; Securitization Bonds; Bond Pricing; Sovereign Risk; Asset Purchase Programmes
    JEL: E52 G01 G12 G21 G32
    Date: 2020–01
  17. By: Fadia Al Hajj (College of Business Administration - GUST - Gulf University for Science and Technology); Gilles Dufrénot (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique, AMU - Aix Marseille Université); Benjamin Keddad (PSE - Paris School of Economics)
    Abstract: This paper discusses the theoretical choice of exchange rate regimes in Sub-Saharan African countries that are facing external vulnerabilities. To reduce instability, policymakers choose among promoting external competitiveness using a real anchor, lowering the burden of foreign debt using a nominal anchor or using a policy mix of both anchors. We observe that these countries tend to adopt mixed anchor policies. We solve a state space model to explain the determinants of and the strategy behind this policy. We find that the mixed targeting policy is a two-step strategy: First, monetary authorities choose the degree of nominal exchange rate flexibility according to the velocity of money, trade openness, foreign debt, degree of exchange rate pass-through and exchange rate target zone. Second, authorities seek to stabilize the real exchange rate depending on the degree of competition in the domestic goods market and the degree of foreign exchange intervention. We conclude with regime-switching estimations to provide empirical evidence of how these economic fundamentals influence exchange rate policy in Sub-Saharan Africa.
    Keywords: regime-switching model,external vulnerabilities,exchange rate policy,Sub-Saharan Africa
    Date: 2020
  18. By: Gerke, Rafael; Giesen, Sebastian; Kienzler, Daniel
    Abstract: We revisit the reversal puzzle: A counterintuitive contraction of inflation in response to an interest rate peg. We show that it is intimately related to the degree of agents' anticipation. If agents perfectly anticipate the peg, reversals occur depending on the duration of the peg. If they do not anticipate the peg, reversals are absent. In the case of imperfect anticipation, implemented by a Markov-switching framework, we measure the degree of anticipation by the frequency of the peg regime. Even if the frequency of the peg takes on a value twice as large as empirically observed, the reversal puzzle is absent.
    Keywords: Interest rate peg,Reversal puzzle,Regime-switching model
    JEL: E32 E52
    Date: 2020

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