nep-cba New Economics Papers
on Central Banking
Issue of 2020‒12‒14
twenty-one papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Asymmetric Monetary Policy Transmission in India:Does Financial Friction Matter? By Ranjan Kumar Mohanty; N R Bhanumurthy
  2. Communication, Information and Inflation Expectations By Fernando Borraz; Miguel Mello
  3. Institutions, Liquidity Preference, and Reserve Asset Holding in the Eurozone Core and Periphery Before and After Crises: Some Stylized Facts By Eichacker, Nina
  4. How the Federal Reserve's Central Bank Swap Lines Have Supported U.S. Corporate Borrowers in the Leveraged Loan Market By Annie McCrone; Ralf R. Meisenzahl; Friederike Niepmann; Tim Schmidt-Eisenlohr
  5. Complementaries and Tensions between Monetary and Macroprudential Policies in an Estimated DSGE Model (Application to Slovenia) By Lenarčič, Črt
  6. How do banking groups react to macroprudential policies? Cross-border spillover effects of higher capital buffers on lending, risk-taking and internal markets By Cappelletti, Giuseppe; Ponte Marques, Aurea; Salleo, Carmelo; Martín, Diego Vila
  7. On the Purchasing Power of Money in an Exchange Economy By Radwanski, Juliusz
  8. How New Fed Corporate Bond Programs Dampened the Financial Accelerator in the COVID-19 Recession By Michael D. Bordo; John V. Duca
  9. The Impact of Policy Interventions on Systemic Risk across Banks By Simona Nistor; Steven Ongena
  10. Financial stability policies and bank lending: quasi-experimental evidence from Federal Reserve interventions in 1920-21 By Rieder, Kilian
  11. Impulse response analysis in conditional quantile models with an application to monetary policy By Dong Jin Lee; Tae-Hwan Kim; Paul Mizen
  12. Preference Heterogeneity and Optimal Monetary Policy By Uras, Burak; van Buggenum, Hugo
  13. Fiscal policy and inflation expectations By Miguel Mello; Jorge Ponce
  14. Liquidity in resolution: comparing frameworks for liquidity provision across jurisdictions By Grund, Sebastian; Nomm, Nele; Walch, Florian
  15. 2020 US Neutral Rate Assessment By James Bootsma; Thomas J. Carter; Xin Scott Chen; Christopher Hajzler; Argyn Toktamyssov
  16. Interest rate pass-through and bank risk-taking under negative-rate policies with tiered remuneration of Central Bank Reserves By Christoph Basten; Mike Mariathasan
  17. Credit Risk and the Transmission of Interest Rate Shocks By Berardino Palazzo; Ram Yamarthy
  18. The natural rate of interest for an emerging economy: the case of Uruguay By Elizabeth Bucacos
  19. Asymmetric Shocks, Real Exchange Rate Distortions and Options for the Second Monetary Zone in West Africa By Chukwuma Agu; Uchenna Alexander Nnamani
  20. The Financial Accelerator in the Euro Area: New Evidence Using a Mixture VAR Model By Hamza Bennani; Matthias Neuenkirch
  21. Zombie lending: how many wondering souls are there? By Cecilia Dassatti; Francesc Rodriguez-Tous; Rodrigo Lluberas

  1. By: Ranjan Kumar Mohanty (Xavier Institute of Management, Bhubaneshwar(XIMB)); N R Bhanumurthy (BASE University)
    Abstract: In the context of adoption of flexible inflation targeting regime in India since 2016 and is about to be reviewed soon, it is necessary to understand the effectiveness of monetary transmission mechanism. The paper investigates if there are any asymmetries in the transmission during different regimes, and also verify the role of financial frictions in such asymmetries, if it exists. By using Markov-Switching Vector Autoregression (MS-VAR) models, our results suggest that there are asymmetries in the monetary transmission mechanism during highly volatile and low volatile regimes with respect to both output and inflation. It also finds that financial frictions do influence the extent of policy transmission process in India. From a policy perspective, while the Reserve Bank of India (RBI) may continue to target inflation especially during high volatile regimes, it could have output growth as an additional target especially during the low volatile regimes.
    Keywords: Monetary Transmission Mechanism, Financial Frictions, Bank Credit Channel, Interest Rate Channel, Markov-Switching Vector Autoregression (MS-VAR), India
    JEL: E52 E44 E58 C32
    Date: 2020–11
  2. By: Fernando Borraz (Banco Central del Uruguay); Miguel Mello (Banco Central del Uruguay)
    Abstract: We identify differences in the formation of inflationary expectations, credibility, and prediction errors, depending on the communication and in the level of information of price setters. Estimating dynamic panel data models we identify the relevance of being informed about the inflation target and, about the current inflation rate. We also find that the tone of the monetary policy communication reinforces the bias imposed on the monetary instrument. Through the interaction of information about inflation target and range, and the tone of monetary policy statements of the Central Bank, we conclude that partially informed agents form their expectations differently from non-informed ones, have lower prediction errors, and are more skeptical respect to the inflation target.
    Keywords: inflation, credibility, inflation target, communication, monetary policy
    JEL: E31 E52 E58
    Date: 2020
  3. By: Eichacker, Nina
    Abstract: The monetary integration of the Eurozone initially accommodated endogenous money creation across its members; however, liquidity crises that followed the Global Financial Crisis (GFC) revealed structural disparities in liquidity provision in response to funding crises. By refusing to act as a lender of last resort, the European Central Bank pushed governments across the Eurozone to guarantee domestic financial liabilities. The importance of repurchase agreements to fund Eurozone banking and the predominance of European government bonds in general collateral left peripheral governments vulnerable to decreased private demand for their debt, and financially constrained by private intermediaries’ refusal of peripheral sovereign bonds in general collateral. This constraint created accelerated the sovereign debt crises driving the Eurozone crisis. This paper analyzes Eurozone banks’, National Central Banks’, and governments’ balance sheets to show how they have internalized the lessons from the GFC. We find that these entities have returned to holding larger concentrations of reserve assets, a practice that some architects of the Eurozone had hoped monetary integration at the supranational level would end. As Eurozone governments consider how to respond to the Covid-19 pandemic, liquidity crunches that hurt financial and fiscal activity across the Eurozone remain a risk.
    Date: 2020–11–24
  4. By: Annie McCrone; Ralf R. Meisenzahl; Friederike Niepmann; Tim Schmidt-Eisenlohr
    Abstract: The cost of borrowing U.S. dollars through foreign exchange (FX) swap markets increased significantly in the beginning of the Covid-19 pandemic in February 2020, indicated by larger deviations from Covered Interest Rate Parity (CIP). CIP deviations narrowed again when the Federal Reserve expanded its swap lines to support U.S. dollar liquidity globally—by enhancing and extending its swap facility with foreign central banks and introducing the new temporary Foreign and International Monetary Authorities (FIMA) repurchase agreement facility.
    Date: 2020–11–12
  5. By: Lenarčič, Črt
    Abstract: Recent financial crisis has shown that the prior belief that the active monetary policy in pursuing price stability may not be sufficient enough to maintain financial stability as well as macroeconomic stability in an economy. Introducing a new economic policy, the macroprudential policy gave space to a complete new sphere of a�ecting an economy through a policy maker's perspective. Constructing a dynamic stochastic general equilibrium model, which incorporates a banking sector block, enables us to study the effects of financial frictions on the real economy. Taking the case of Slovenia, the simulation results show that taking into account the interplay between the monetary and macroprudential policies in a form of financial shocks matter in the economy.
    Keywords: monetary policy, macroprudential policy, DSGE model, banking sector
    JEL: E30 E32 E52
    Date: 2019–07
  6. By: Cappelletti, Giuseppe; Ponte Marques, Aurea; Salleo, Carmelo; Martín, Diego Vila
    Abstract: We study the impact of macroprudential capital buffers on banking groups' lending and risk-taking decisions, also investigating implications for internal capital markets. For identification, we exploit heterogeneity in buffers applied to other systemically important institutions, using information from three unique confidential datasets, including information on the EBA scoring process. This policy design induces a randomized experiment in the neighborhood of the threshold, which we use to identify the effect of higher capital requirements by comparing the change in the outcome for banks just above and below the cut-off, before and after the introduction of the buffer. The analysis is implemented relying on a fuzzy regression discontinuity and on a difference-in-differences matching design. We find that, when parent banks are constrained with higher buffers, subsidiaries deleverage lending and risk-taking towards non-financial corporations and marginally expanded lending towards households, with negative effects on protability. Also, we find that parents cut down on holdings of debt and equity issued by their subsidiaries. Our findings support the hypothesis that higher capital buffers have a positive disciplinary effect by reducing banks' risk-taking while having a (temporary) adverse impact on the real economy through a decrease in affiliated banks' lending activity. Therefore, to ensure the effectiveness of macroprudential policy, it is essential that policymakers assess their potential cross-border effects. JEL Classification: E44, E51, E58, G21, G28
    Keywords: capital buffers, Internal capital markets, lending, macroprudential policy, risk-taking
    Date: 2020–11
  7. By: Radwanski, Juliusz
    Abstract: A model is constructed in which completely unbacked fiat money, issued by generic supplier implementing realistically specified monetary policy designed to obey certain sufficient conditions, is endogenously accepted by rational individuals at uniquely determined price level. The model generalizes Lucas (1978) to an economy with frictions and specialization in production, without imposing the cash-in-advance constraint. The uniqueness of equilibrium is the consequence of complete characterization of both the environment, and the equilibrium concept. The results challenge the doctrine that equilibria of monetary economies are inherently indeterminate, and that money can become worthless only due to self-fulfilling expectations. The paper shows that monetary policy canonically features two dimensions, one of which corresponds to nominal interest rate, and the other to continuous helicopter drop of net worth, which in the model takes the form of universal basic income.
    Keywords: fiat money, monetary policy, Hahn problem, price level, inflation, sunspots, helicopter drop, universal basic income
    JEL: E10 E31 E41 E51 E52 E58 G12 G21
    Date: 2020–11–19
  8. By: Michael D. Bordo; John V. Duca
    Abstract: In the financial crisis and recession induced by the COVID-19 pandemic, many investment-grade firms became unable to borrow from securities markets. In response, the Fed not only reopened its commercial paper funding facility but also announced it would purchase newly issued and seasoned bonds of corporations rated as investment grade before the COVID pandemic. A careful splicing of different unemployment rate series enables us to assess the effectiveness of recent Fed interventions in these long-term debt markets over long sample periods, spanning the Great Depression, Great Recession and COVID Recession. Findings indicate that the announcement of forthcoming corporate bond backstop facilities had helped stop risk premia from rising further than they had by late-March 2020. In doing so, these Fed facilities have limited the role of external finance premia in amplifying the macroeconomic impact of the COVID pandemic. Nevertheless, the corporate bond programs blend the roles of the Federal Reserve in conducting monetary policy via its balance sheet, acting as a lender of last resort and pursuing credit policies.
    Keywords: financial crises; Federal Reserve; credit easing; lender of last resort; corporate bonds; corporate bond facility
    JEL: E51 G12
    Date: 2020–11–19
  9. By: Simona Nistor (Babes-Bolyai University - Department of Finance); Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR))
    Abstract: What is the impact of policy interventions on the systemic risk of banks? To answer this question, we analyze a comprehensive sample that combines bank-specific bailout events with balance sheets of key affected and non-affected European banks between 2008 and 2014. We find that guarantees reduce the systemic risk contribution made by small banks in the short run and by small or less liquid banks in the long run. Recapitalizations immediately decrease banks’ systemic importance, but the effect is also short-lived. Liquidity injections may even significantly increase systemic risk especially when administered to the less capitalized or highly profitable banks.
    Keywords: systemic risk, policy interventions, risk profile, Conditional Value at Risk, G-SIBs
    JEL: E58 G01 G21 G28 H81
    Date: 2020–12
  10. By: Rieder, Kilian
    Abstract: I estimate the comparative causal effects of monetary policy \leaning against the wind" (LAW) and macroprudential policy on bank-level lending and leverage by drawing on a single natural experiment. In 1920, when U.S. monetary policy was still decentralized, four Federal Reserve Banks implemented a conventional rate hike to address financial stability concerns. Another four Reserve Banks resorted to macroprudential policy with the same goal. Using sharp geographic regression discontinuities, I exploit the resulting policy borders with the remaining four Federal Reserve districts which did not change policy stance. Macroprudential policy caused both bank-level lending and leverage to fall significantly (by 11%-14%), whereas LAW had only weak and, in some areas, even perverse effects on these bank-level outcomes. I show that the macroprudential tool reined in over-extended banks more effectively than LAW because it allowed Federal Reserve Banks to use price discrimination when lending to highly leveraged counterparties. The perverse effects of the rate hike in some areas ensued because LAW lifted a pre-existing credit supply friction by incentivizing regulatory arbitrage. My results highlight the importance of context, design and financial infrastructure for the effectiveness of financial stability policies. JEL Classification: E44, E51, E52, E58, G21, N12, N22
    Keywords: bank lending, credit boom, Federal Reserve System, financial crisis, leaning against the wind, leverage, macroprudential policy, monetary policy, progressive discount rate, recession of 1920/1921
    Date: 2020–12
  11. By: Dong Jin Lee; Tae-Hwan Kim; Paul Mizen
    Abstract: This paper presents a new method to analyse the effect of shocks on time series using a quantile impulse response function (QIRF). While conventional impulse response analysis is restricted to evaluation using the conditional mean function, here, we propose an alternative impulse response analysis that traces the effect of economic shocks on the conditional quantile function. By changing the quantile index over the unit interval, it is possible to measure the effects of shocks on the entire conditional distribution of a variable of interest in our framework. Therefore, we can observe the complete distributional consequences of policy interventions, especially at the upper and lower tails of the distribution as well as the mean. Using the new approach, it becomes possible to evaluate two distinct features (called "distributional effects"): (i) a change in the dispersion of the conditional distribution of interest is changed after a shock, and (ii) a change in the degree of skewness of the conditional distribution caused by a policy intervention. None of these features can be observed in the conventional impulse response analysis exclusively based on the conditional mean function. In addition to proposing the QIRF, our second contribution is to present a new way to jointly estimate a system of multiple quantile functions. Our proposal system quantile estimator is obtained by extending the result of Jun and Pinkse (2009) to the time series context. We illustrate the QIFR on a VAR model in a manner similar to Romer and Romer (2004) in order to assess the impact of a monetary policy shock on the US economy.
    Keywords: quantile vector autoregression, monetary policy shock, quantile impulse response function, structural vector autoregression
    Date: 2020
  12. By: Uras, Burak (Tilburg University, School of Economics and Management); van Buggenum, Hugo (Tilburg University, School of Economics and Management)
    Date: 2020
  13. By: Miguel Mello (Banco Central del Uruguay); Jorge Ponce (Banco Central del Uruguay)
    Abstract: We find empirical evidence of a positive correlation between the budget deficit to GDP and inflation expectations of price setters in Uruguay. It implies an interdependence between fiscal and monetary policies: monetary policy faces more challenges to maintain inflation expectation anchored when the fiscal outcome worsen. The result is robust to considering other fiscal variables and to controlling for macroeconomic covariates. During the period under analysis, however, monetary policy has been effective to compensate the distortions introduced by fiscal policy on inflation expectations.
    Keywords: Inflation expectations, budget deficit, fiscal policy, monetary policy, Uruguay
    JEL: E52 E62 E63
    Date: 2020
  14. By: Grund, Sebastian; Nomm, Nele; Walch, Florian
    Abstract: As a response to the global financial crisis that started in 2008, many countries established dedicated resolution regimes that seek to limit the use of taxpayer money while maintaining the functions of failing banks that are critical for financial stability. This paper extends the existing research by zooming in on the specific topic of liquidity provision to banks in resolution. It examines the provision of liquidity in the United States, the United Kingdom, Japan, Canada and the banking union of the European Union (thereafter: the “banking union”). The paper observes the differences and commonalities of policy choices across jurisdictions with regard to both the relationship between private prefunding and temporary public liquidity provision and the roles of the public budget and the central bank. The comparison also reveals that the role of fiscal authorities is strong and that guarantees from a public budget are a common feature. The framework for the provision of liquidity in the banking union is not yet complete as the construction of a public sector backstop of sufficient size and speed is comparatively more complex in the banking union than in other jurisdictions. Therefore, the idea of establishing a European-level guarantee framework – which would allow access to Eurosystem liquidity for banks coming out of resolution with limited collateral – is being further investigated. JEL Classification: G01, G21, G28, G33, E58
    Keywords: banking union, European Central Bank, liquidity, resolution
    Date: 2020–12
  15. By: James Bootsma; Thomas J. Carter; Xin Scott Chen; Christopher Hajzler; Argyn Toktamyssov
    Abstract: This paper presents Bank of Canada staff’s current assessment of the US neutral rate, along with a newly developed set of models on which that assessment is based. The overall assessment is that the US neutral rate currently lies in a range of 1.75 to 2.75 percent. This represents a decline of 50 basis points relative to the range judged at the time of the Bank’s last neutral rate update in April 2019. Roughly half of this decline reflects an assessment of conditions prevailing in late 2019 and is thus unrelated to the COVID-19 pandemic. The other half reflects the balance of several key channels through which the COVID 19 shock is likely to influence US interest rates over the years ahead, including its impacts on potential output growth, inequality, demand for safe assets and the level of US government debt. Results from the new models specifically point to upward pressure from higher government debt being more than offset by downward pressure from lower potential output growth, higher inequality and heightened demand for safe assets.
    Keywords: Economic models; Interest rates; Monetary policy
    JEL: E40 E43 E50 E52 E58 F41
    Date: 2020–12
  16. By: Christoph Basten (University of Zurich; Swiss Finance Institute; CESifo); Mike Mariathasan (KU Leuven- Faculty of Economics & Business)
    Abstract: We identify the effects of negative interest rate policies on bank behavior using difference-in differences identification and data on all Swiss banks. First, we find that going negative can interrupt not only the pass-through from policy to deposit rates, but also that to mortgage rates. Second, banks’ ability to offset negative deposit margins with increased mortgage margins is shown to depend on market power. Third, imposing negative rates on all central bank reserves causes banks to replace one sixth with riskier assets, and cut another sixth without replacement, shortening their balance sheets. Together with increased mortgage margins and fee income, the asset replacement preserves profits, but increases financial stability risks. Fourth, mortgage margin increases, balance sheet contractions and risk increases differ from positive rate policy. Fifth, the interruption in pass-through and the risks to financial stability can be reduced by up to 90% through tiered remuneration, charging marginal reserves only.
    Keywords: negative interest rate policy, tiered remuneration, interest rate pass-through, credit risk, interest rate risk
    JEL: E43 E44 E52 E58 G20 G21
    Date: 2020–11
  17. By: Berardino Palazzo (Board of Governors of the Federal Reserve System); Ram Yamarthy (Office of Financial Research)
    Abstract: Using daily credit default swap (CDS) data going back to the early 2000s, we find a positive and significant relation between corporate credit risk and unexpected interest rate shocks around FOMC announcement days. Positive interest rate movements increase the expected loss component of CDS spreads as well as a risk premium component that captures compensation for default risk. Not all firms respond in the same manner. Consistent with recent evidence, we find that firm-level credit risk (as proxied by the CDS spread) is an important driver of the response to monetary policy shocks - both in credit and equity markets - and plays a more prominent role in determining monetary policy sensitivity than other common proxies of firm-level risk such as leverage and market size. A stylized corporate model of monetary policy, firm investment, and financing decisions rationalizes our findings.
    Keywords: credit risk, CDS, monetary policy, shock transmission, equity returns
    Date: 2020–12–03
  18. By: Elizabeth Bucacos (Banco Central del Uruguay)
    Abstract: Vast evidence indicates that the so-called natural rate of interest (NRI) has experienced a sustained fall in both advanced and emerging economies over the last 25 years. This situation threatens the central bank’s ability to guide relevant macroeconomic variables close to their welfare-maximizing path because the range of maneuver is reduced a great deal when interest rates descend to the zero lower bound. In this document, I provide an estimation of the natural interest rate for Uruguay, a small, open and dollarized emerging economy where the monetary policy instrument changes from interest rate to money aggregates in 2013, splitting the sample in two. The fundamentals-based model points a locus for the natural interest rate in the [0.98 2.06] range with 95 percent degree of certainty. This methodological approach is aimed at providing a novel framework for the Uruguayan case that allows to analyze the long-run fundamentals of the NIR and also to explain the reasons for short-run discrepancies between the real rate and its long-run equilibrium value. It is hoped that the fundamentals-based model adds to the myriad methods current in use at the Banco Central del Uruguay to estimate the NIR.
    Keywords: interest rate determination, monetary policy, Uruguay
    JEL: C10 E43 E52
    Date: 2020
  19. By: Chukwuma Agu; Uchenna Alexander Nnamani (University of Nigeria,)
    Abstract: The West African Monetary Zone (WAMZ) has continued to set targets of monetary integration for member states without success. With 2020 set as the new deadline for the attainment of monetary integration in the zone, it is not clear how the feasible this deadline is. It is clear that there are distortions that possibly affect not only the feasibility of enacting the union but also the potential outcome should the leaders decide to ram through the unification without due consideration to these factors. One such factor is exchange rate alignments. This study therefore investigates the presence of real exchange rate misalignments and the effects of such on the macroeconomic stabilities of the WAMZ countries. Due to paucity of data, the study captures only four of the six countries that make up WAMZ – Nigeria, Ghana, The Gambia, and Sierra Leone. It finds that there are misalignments of real exchange rates in all the four countries. These manifest mostly as real exchange rate (RER) overvaluation in two of the four countries, and as RER undervaluation in the other two countries. The RER misalignments and volatilities affect macroeconomic behaviours of the member countries in various ways and to varying degrees. We evaluate the diverse ways these misalignments affect macroeconomic policies and behaviour of the countries and their implications on the integration effort. The study concludes that efforts at stabilizing the macroeconomic fundamentals that determine RER in the WAMZ member states, beginning with monetary policy tools, will be important steps towards instituting a sustainable monetary union
    Date: 2019
  20. By: Hamza Bennani; Matthias Neuenkirch
    Abstract: We estimate a logit mixture vector autoregressive model describing monetary policy transmission in the euro area over the period 2003Q1-2019Q4 with a special emphasis on credit conditions. With the help of this model, monetary policy transmission can be described as mixture of two states (e.g., a normal state and a crisis state), using an underlying logit model determining the relative weight of these states over time. We show that shocks to the credit spread and shocks to credit standards directly lead to a reduction of real GDP growth, whereas shocks to the quantity of credit are less important in explaining growth fluctuations. Credit standards and the credit spread are also the key determinants of the underlying state of the economy in the logit submodel. Together with a more pronounced transmission of monetary policy shocks in the crisis state, this provides further evidence for a financial accelerator in the euro area. Finally, the detrimental effect of credit conditions is also reflected in the labor market.
    Keywords: Credit growth, credit spread, credit standards, euro area, financial accelerator, mixture VAR, monetary policy transmission
    JEL: E44 E52 E58 G21
    Date: 2020
  21. By: Cecilia Dassatti (Banco Central del Uruguay); Francesc Rodriguez-Tous (Cass Business School); Rodrigo Lluberas (Banco Central del Uruguay)
    Abstract: Banks' incentives to implement a policy of forbearance in order to avoid increasing their loan loss reserves leads to loan “evergreening”, through which a bank grants additional credit to a troubled firm. Exploiting granular data of all corporate loans from the Credit Registry in Uruguay, we identify banks' zombie lending strategies. While most papers on zombie lending focus on firms that display low levels of profitability, low productivity or that receive subsidized loans, we analyze zombie lending strategies by looking at changes in loans' repayment schedules granted by banks to firms. This allows us to actually observe the implementation of a zombie lending strategy, instead of inferring it through firms' balance-sheet indicators. After identifying and characterizing zombie lending, we study its effects on credit growth, finding a positive and statistically significant relationship between credit growth and zombie lending.
    Keywords: banks, credit, loan evergreening, regulatory arbitrage, zombie lending
    JEL: G21 G28 E44
    Date: 2020

This nep-cba issue is ©2020 by Sergey E. Pekarski. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.