nep-cba New Economics Papers
on Central Banking
Issue of 2020‒12‒21
24 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. How New Fed Corporate Bond Programs Dampened the Financial Accelerator in the Covid-19 Recession By Michael D. Bordo; John V. Duca
  2. Financial Markets and Dissent in the ECB’s Governing Council By Peter Tillmann
  3. Imperfect Credibility versus No Credibility of Optimal Monetary Policy By Jean-Bernard Chatelain; Kirsten Ralf
  4. Policy Maker's Credibility with Predetermined Instruments for Forward-Looking Targets By Jean-Bernard Chatelain; Kirsten Ralf
  5. Sudden Stops and Optimal Foreign Exchange Intervention By J. Scott Davis; Michael B. Devereux; Changhua Yu
  6. Does regulatory and supervisory independence affect financial stability? By Fraccaroli, Nicolò; Sowerbutts, Rhiannon; Whitworth, Andrew
  7. Financial technologies and the effectiveness of monetary policy transmission By Hasan, Iftekhar; Kwak, Boreum; Li, Xiang
  8. The 100% Reserve Reform: Calamity or Opportunity? By Pfister Christian
  9. Fiscal Stress and Monetary Policy Stance in Oil-Exporting Countries By Hao Jin; Chen Xiong
  10. We study the impact of monetary policy on the supply of bank credit when bank lending is denominated in foreign currencies. Accessing a comprehensive supervisory dataset from Hungary, we find that the supply of bank credit in a foreign currency is less sensitive to changes in domestic monetary conditions than the equivalent supply in the domestic currency. Changes in foreign monetary conditions similarly affect bank lending more in the foreign than in the domestic currency. Hence when banks lend in multiple currencies the domestic bank lending channel is weakened and international bank lending channels become operational. By Steven Ongena; Ibolya Schindele; Dzsamila Vonnák
  11. Collective Moral Hazard and the Interbank Market By ; Joseph E. Stiglitz
  12. Safe Payments By Jonathan Chiu; Mohammad Davoodalhosseini; Janet Hua Jiang; Yu Zhu
  13. Liquidity Risk at Large U.S. Banks By Laurence M. Ball
  14. The regulatory cycle in banking: what lessons from the U.S. experience? (from the Dodd-Frank Act to Covid-19) By Maurizio Trapanese
  15. Does Capital-Based Regulation Affect Bank Pricing Policy? By Dominika Ehrenbergerova; Martin Hodula; Zuzana Rakovska
  16. Information network modeling for U.S. banking systemic risk By Nicola, Giancarlo; Cerchiello, Paola; Aste, Tomaso
  17. Will the Secular Decline In Exchange Rate and Inflation Volatility Survive COVID-19? By Ethan Ilzetzki; Carmen M. Reinhart; Kenneth S. Rogoff
  18. Who cares about the Renminbi? By Shekhar Hari Kumar; Vimal Balasubramaniam; Ila Patnaik; Ajay Shah
  19. Monetary policy, firm exit and productivity By Hartwig, Benny; Lieberknecht, Philipp
  20. The In-house credit assessment system of Banca d'Italia By Filippo Giovannelli; Alessandra Iannamorelli; Aviram Levy; Marco Orlandi
  21. Dynamic Expectations Formation and U.S. Monetary Policy Regime Change By Xin Wei
  22. Could the 1933 Glass-Steagall Act have prevented the financial crisis? By Maxime Delabarre
  23. Foreign Currency Borrowing of Corporations as Carry Trades: Evidence from India By Viral V. Acharya; Siddharth Vij
  24. Effectiveness of Bailout Policies for Asset Bubbles in a Small Open Economy By Atsushi Motohashi

  1. 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 at spreads roughly 1 percentage point above non-recession averages. 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 the Covid Recession. Findings indicate that the announcement of forthcoming corporate bond backstop facilities have capped risk premia at levels 100 basis points above non-recession averages, akin to a “penalty rate” for lender of last resort interventions during financial crises. 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.
    JEL: E51 G12
    Date: 2020–11
  2. By: Peter Tillmann (Justus-Liebig-University Giessen)
    Abstract: The decision-making process in the ECB’s Governing Council remains opaque as the ECB, in contrast to many other central banks, does not publish the votes for or against a policy proposal. In this paper, we construct an index of dissent based on the ECB presidents’ answers to journalists’ questions during the press conference following each meeting. This narrative account of dissent suggests that dissenting votes are cast frequently. We show that dissent weakens the response of long-term interest rates to policy surprises and thus affects the monetary transmission mechanism. The yield response is significantly stronger under unanimity. This result becomes stronger if we exclude meetings with serial dissent or exclude the period of open-end Forward Guidance. Controlling for newspaper reporting about tensions in the Governing Council leaves the results unchanged.
    Keywords: event studies, monetary policy shock, monetary policy committee, disagreement
    JEL: E42 E43 E58
    Date: 2020
  3. By: Jean-Bernard Chatelain; Kirsten Ralf
    Abstract: A minimal central bank credibility, with a non-zero probability of not renegning his commitment ("quasi-commitment"), is a necessary condition for anchoring inflation expectations and stabilizing inflation dynamics. By contrast, a complete lack of credibility, with the certainty that the policy maker will renege his commitment ("optimal discretion"), leads to the local instability of inflation dynamics. In the textbook example of the new-Keynesian Phillips curve, the response of the policy instrument to inflation gaps for optimal policy under quasi-commitment has an opposite sign than in optimal discretion, which explains this bifurcation.
    Date: 2020–12
  4. By: Jean-Bernard Chatelain; Kirsten Ralf
    Abstract: The aim of the present paper is to provide criteria for a central bank of how to choose among different monetary-policy rules when caring about a number of policy targets such as the output gap and expected inflation. Special attention is given to the question if policy instruments are predetermined or only forward looking. Using the new-Keynesian Phillips curve with a cost-push-shock policy-transmission mechanism, the forward-looking case implies an extreme lack of robustness and of credibility of stabilization policy. The backward-looking case is such that the simple-rule parameters can be the solution of Ramsey optimal policy under limited commitment. As a consequence, we suggest to model explicitly the rational behavior of the policy maker with Ramsey optimal policy, rather than to use simple rules with an ambiguous assumption leading to policy advice that is neither robust nor credible.
    Date: 2020–12
  5. By: J. Scott Davis; Michael B. Devereux; Changhua Yu
    Abstract: This paper shows that foreign exchange intervention can be used to avoid a sudden stop in capital flows in a small open emerging market economy. The model is based around the concept of an under-borrowing equilibrium defined by Schmitt-Grohe and Uribe (2020). With a low elasticity of substitution between traded and non-traded goods, real exchange rate depreciation may generate a precipitous drop in aggregate demand and a tightening of borrowing constraints, leading to an equilibrium with an inefficiently low level of borrowing. The central bank can preempt this deleveraging cycle through foreign exchange intervention. Intervention is effective due to frictions in private international financial intermediation. Reserve accumulation has ex ante benefits by reducing the risk of a sudden stop, while intervention has ex-post benefits by limiting inefficient deleveraging. But intervention itself faces constraints. When the central bank’s stock of reserves is low, even foreign exchange intervention cannot prevent a sudden stop.
    JEL: E30 E50 F40
    Date: 2020–11
  6. By: Fraccaroli, Nicolò (W.R. Rhodes Center for International Economics and Finance at the Watson Institute for International and Public Affairs, Brown University); Sowerbutts, Rhiannon (Bank of England); Whitworth, Andrew (Bank of England)
    Abstract: Since the crisis financial regulators and supervisors have been given increased independence from political bodies. But there is no clear evidence of the benefits of these reforms on the stability of the banking sector. This paper fills that void, introducing a new dataset of reforms to regulatory and supervisory independence for 43 countries from 1999-2019. We combine this index with bank-level data to investigate the impact of reforms in independence on financial stability. We find that reforms that bring greater regulatory and supervisory independence are associated with lower non-performing loans in banks’ balance sheets. In addition, we provide evidence that these improvements do not come at the cost of bank efficiency and profitability. Overall, our results show that increasing the independence of regulators and supervisors is beneficial for financial stability.
    Keywords: Agency independence; financial stability; banking supervision; banking regulation; regulatory agencies
    JEL: E58 G28
    Date: 2020–11–27
  7. By: Hasan, Iftekhar; Kwak, Boreum; Li, Xiang
    Abstract: This study investigates whether and how financial technologies (FinTech) influencethe effectiveness of monetary policy transmission. We examine regional-level FinTech adoption and use an interacted panel vector autoregression model to explore how the effects of monetary policy shocks change with FinTech adoption. The re-sults indicate that FinTech adoption generally enhances monetary policy transmis-sion to real GDP, bank loans, and housing prices, while the evidence of transmission to consumer prices is mixed. A subcategorical analysis shows that the enhanced effectiveness is the most pronounced in the adoption of FinTech payment, compared to that of insurance and credit.
    Keywords: monetary policy,financial technology,interacted panel VAR
    JEL: C32 E52 G21 G23
    Date: 2020
  8. By: Pfister Christian
    Abstract: This paper considers the various 100% Reserve plans that have appeared since the interwar period and have since then been adapted. In all formulations of those schemes, Government liabilities (cash, central bank reserves and short-term Treasuries) back banks’ sight deposits. This organization contrasts with current so-called “fractional reserve banking”, in which, as a result of reserve requirements imposed by the central bank (Drumetz et al., 2015), reserves back only a small fraction of sight deposits. The paper briefly presents the six categories of plans. It then highlights their common features as well as their differences, showing that the differences are more numerous than the common features. The criticisms voiced against the different formulations of 100% Reserves are exposed, adding those of the author and distinguishing between the doubts expressed on the validity of the analysis on one hand, and some undesirable consequences of the reform on the other. In spite of these criticisms, it then shown that the 100% Reserve reform is becoming topical, with recent private sector, central banks and political initiatives that relate to it. Overall, the 100% Reserve reform does not appear as a meaningful opportunity to improve the functioning of banking systems. Furthermore, at least one of its variants could easily turn into a calamity. Fortunately, it is not that variant that is getting more topical.
    Keywords: 100% Reserve, Chicago Plan, deposited currency, full-reserve, limited purpose banking, narrow banking, sovereign money
    JEL: E42 E51 E52 E58
    Date: 2020
  9. By: Hao Jin (Wang Yanan Institute for Studies in Economics (WISE) and School of Economics, Xiamen University); Chen Xiong (Wang Yanan Institute for Studies in Economics (WISE) and School of Economics, Xiamen University)
    Abstract: We documented that for some oil-exporting countries, the correlation between exchange rates and oil prices is strongly negative during periods of significant oil price drop but is much weaker during other periods. To interpret this time-varying asymmetric correlation, we develop and estimate a Markov-switching small open economy New Keynesian model with oil income as a source of government revenue. In particular, we allow monetary and fiscal policy coefficients to switch across "active" and "passive" regimes. Using data on Russia, our result shows that the policy combinations fluctuate. We find that active monetary policy isolates the exchange rate from oil price variations but changes to passively tolerate depreciation and inflation to support government debt when oil price drops place fiscal policy in a state of stress. Counterfactual policy experiments suggest policy regime switching is crucial to account for the observed asymmetric impact of oil prices on the exchange rate and that the trans-mission channels of oil price shocks differ significantly across policy regimes.
    Keywords: Fiscal Policy; Monetary Policy; Exchange Rate; Oil Price
    JEL: E63 F41 Q43
    Date: 2020–06
  10. By: Steven Ongena (University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)); Ibolya Schindele (BI Norwegian Business School; Central Bank of Hungary); Dzsamila Vonnák (Hungarian Academy of Sciences (HAS) - Institute of Economics CERS-HAS (IEHAS))
    Keywords: bank balance-sheet channel, monetary policy, foreign currency lending
    JEL: E51 F3 G21
    Date: 2020–10
  11. By: ; Joseph E. Stiglitz
    Abstract: The concentration of risk within financial system is considered to be a source of systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions. We build a model of portfolio choice and endogenous contracts in which the government optimally intervenes during crises. By issuing financial claims to other institutions, relatively risky institutions endogenously become large and interconnected. This structure enables institutions to share the risk of systemic crisis in a privately optimal way, but channels funds to relatively risky investments and creates incentives even for smaller institutions to take excessive risks. Constrained efficiency can be implemented with macroprudential regulation designed to limit the interconnectedness of risky institutions.
    Keywords: Systemic risk; Systemically important financial institutions; Interbank markets; Financial crises; Bailouts; Macroprudential supervision
    JEL: E61 G01 G18 G21 G28
    Date: 2020–12–02
  12. By: Jonathan Chiu; Mohammad Davoodalhosseini; Janet Hua Jiang; Yu Zhu
    Abstract: We use a simple model to study whether private payment systems based on bank deposits can provide the optimal level of safety. In the model, bank deposits backed by projects are subject to default risk that can be mitigated by a depositor's ex ante and ex post monitoring. Safe payment instruments issued by a narrow bank can also be used as a back-up payment system when the risky bank fails. Private adoption of safe payment instruments is generally not socially optimal when buyers do not fully internalize the externalities of their adoption decision on sellers, or when the provision of deposit insurance distorts their adoption incentives. Using this framework, we discuss the optimal subsidy policy conditional on the level of deposit insurance.
    Keywords: Central bank research; Digital currencies and fintech; Financial institutions; Payment clearing and settlement systems
    JEL: E42 E50 G21
    Date: 2020–12
  13. By: Laurence M. Ball
    Abstract: This paper studies liquidity risk at the six largest U.S. banks. The starting point is the stress tests performed under the Liquidity Coverage Ratio (LCR) regulation, which compare a bank’s liquid assets to its loss of cash in a stress scenario that regulators say is based on the 2008 financial crisis. These tests find that all of the large banks could endure a liquidity crisis for 30 days without running out of cash. This paper argues, however, that some of the assumptions in the LCR stress scenario are not pessimistic enough to capture what could happen in a crisis like 2008. The paper then proposes changes in the dubious assumptions and performs revised stress tests. For 2019 Q4, the revised tests suggest it is unlikely that any of the six banks would survive a liquidity crisis for 30 days. This negative finding is most clear-cut for Goldman Sachs and Morgan Stanley.
    JEL: G21 G24 G28
    Date: 2020–11
  14. By: Maurizio Trapanese (Bank of Italy)
    Abstract: This paper analyses the interactions between financial regulation and crises with reference to the experience of the United States in the period after the global financial crisis up to the Covid-19 emergency. In the last few years, a new regulatory system for large banks has arisen in the U.S., reversing some elements of the Dodd-Frank Act and introducing deviations from the international rules. This approach is also confirmed by some of the measures adopted in response to Covid-19. If this trend were to spread to other jurisdictions, the globally harmonized approach to regulation could break down. In the current exceptional circumstances as well, the international standards must not be breached, as they provide the resilience needed to sustain lending to the economy, and to keep banks safe. With the memory of the global financial crisis fading and the long post-crisis economic expansion coming to an end, the pressures to dilute the G-20 rules could grow stronger. The importance of maintaining a consistent approach to banking regulation needs to be emphasized.
    Keywords: financial crises, international regulation
    JEL: F53 G01 G20
    Date: 2020–11
  15. By: Dominika Ehrenbergerova; Martin Hodula; Zuzana Rakovska
    Abstract: This paper tests whether a series of changes to capital requirements transmitted to a change to banks' pricing policy. We compile a rich bank-level supervisory dataset covering the banking sector in the Czech Republic over the period 2004-2019. We estimate that the changes to the overall capital requirements did not force banks to alter their pricing policy. The impact on bank interest margins and loan rates is found to lie in a narrow range around zero irrespective of loan category. Our estimates allow us to rule out effects even for less-capitalised banks and small banks. The results obtained contradict estimates from other studies reporting significant transmission of capital regulation to lending rates and interest margins. We therefore engage in a deeper discussion of why this might be the case. Our estimates may be used in the ongoing discussion of the benefits and costs of capital-based regulation in banking.
    Keywords: Bank pricing policy, capital requirements, interest margins, loan rates
    JEL: E58 G21 G28
    Date: 2020–11
  16. By: Nicola, Giancarlo; Cerchiello, Paola; Aste, Tomaso
    Abstract: In this work we investigate whether information theory measures like mutual information and transfer entropy, extracted from a bank network, Granger cause financial stress indexes like LIBOR-OIS (London Interbank Offered Rate-Overnight Index Swap) spread, STLFSI (St. Louis Fed Financial Stress Index) and USD/CHF (USA Dollar/Swiss Franc) exchange rate. The information theory measures are extracted from a Gaussian Graphical Model constructed from daily stock time series of the top 74 listed US banks. The graphical model is calculated with a recently developed algorithm (LoGo) which provides very fast inference model that allows us to update the graphical model each market day. We therefore can generate daily time series of mutual information and transfer entropy for each bank of the network. The Granger causality between the bank related measures and the financial stress indexes is investigated with both standard Granger-causality and Partial Granger-causality conditioned on control measures representative of the general economy conditions.
    Keywords: financial stress; granger causality; graphical models
    JEL: F3 G3
    Date: 2020–11–23
  17. By: Ethan Ilzetzki; Carmen M. Reinhart; Kenneth S. Rogoff
    Abstract: Over the 21st century, and especially since 2014, global exchange rate volatility has been trending downwards, notably among the core G3 currencies (dollar, euro and the yen), and to some extent the G4 (including China). This stability continued through the Covid-19 recession to date: unusual, as exchange volatility generally rises in US recessions. Compared to measures of stock price volatility, exchange rate volatility rivals the lows reached in the heyday of Bretton Woods I. This paper argues that the core driver is convergence in monetary policy, reflected in a sharp-reduction of inflation and short- and especially long-term interest rate differentials. This unprecedented stability, which partially extends to emerging markets, is strongly reinforced by expectations that the zero bound will be significantly binding for advanced economies for years to come. We consider various hypotheses and suggest that the shutdown of monetary volatility is the leading explanation. The concluding part of the paper cautions that systemic economic crises often produce major turning points, so a collapse of the Extended Bretton Woods II regime cannot be ruled out.
    JEL: E5 F3 F4 N2
    Date: 2020–11
  18. By: Shekhar Hari Kumar; Vimal Balasubramaniam; Ila Patnaik; Ajay Shah
    Abstract: Many researchers have examined the role of the Renminbi as an international currency, particularly after the Chinese authorities undertook policy initiatives for Renminbi internationalisation. We measure one aspect of Renminbi internationalisation: its role in de facto exchange rate arrangements as an anchor. We find that over 70 currencies have shown significant co-movements with the Renminbi over 2005-2017. Most of this global role is the response of some national currencies to unanticipated Renminbi depreciation. However, the contribution to explained variance by the Renminbi for detected currency-regime periods is very small, less than 2% on average, even in East Asian and Pacific-Rim countries who are known to closely track the Renminbi. This suggests that the Renminbi has thus far achieved a very small role in global exchange rate arrangements. Local currency co-movement with the Renminbi is strongest for countries with export exposure to China and Belt and Road initiative linkages. There is heterogeneity in this effect when conditioning on continent, exporter-type, net trade exposure and policy linkages like Belt and Road initiative suggesting multiple modes of future Renminbi internationalisation.
    JEL: F15 F31 F33 F36
    Date: 2020–12–10
  19. By: Hartwig, Benny; Lieberknecht, Philipp
    Abstract: We analyze the influence of monetary policy on firms' extensive margin and productivity. Our empirical evidence for the U.S. based on a macro-financial SVAR suggests that expansionary monetary policy shocks stimulate corporate profits, reduce firm exit and increase firm entry. In the medium run, exit overshoots the baseline. We rationalize these findings in a general equilibrium model featuring endogenous entry and exit. In the model, expansionary monetary policy shocks increase firm profits by stimulating aggregate demand and thereby allow less productive firms to remain in the market. As the monetary stimulus fades, these lessproductive firms become unprofitable such that exit overshoots. This exit channel of monetary policy implies a flatter aggregate supply curve and therefore amplifies output responses, but dampens inflationary effects.
    Keywords: firm exit,firm entry,extensive margin,corporate profits,monetarypolicy
    JEL: E24 E32 E52 E58 L11
    Date: 2020
  20. By: Filippo Giovannelli (Bank of Italy); Alessandra Iannamorelli (Bank of Italy); Aviram Levy (Bank of Italy); Marco Orlandi (Bank of Italy)
    Abstract: Banca d’Italia’s In-house Credit Assessment System (ICAS) is one of the sources for the valuation of collateral agreed upon within the Eurosystem’s monetary policy framework. It helps to provide liquidity to those Italian banks that cannot rely on an internal model (IRB). Its role has become all the more important in the aftermath of the financial crisis relating to the COVID-19 pandemic of 2020. The paper first outlines the Eurosystem’s collateral framework and describes Banca d’Italia’s ICAS in terms of architecture and governance. It then presents in detail the underlying statistical model, including the definition of default adopted, and the validation process for the statistical model and for the expert system. The paper concludes by providing data on the amount of collateral pledged with an ICAS rating and on the main features, including the probabilities of default, of the Italian non-financial companies rated by the system.
    Keywords: collateral framework, credit risk
    JEL: G32
    Date: 2020–11
  21. By: Xin Wei (Indiana University)
    Abstract: This essay studies the fundamental causes of the monetary policy regime switches within rational expectations models. I introduce a threshold-switching monetary policy process into the model that links the policy stance to the fundamental shocks by an autoregressive regime strength index. It creates an expectations feedback mechanism between private agents’ policy forecasts and future policy regime outcomes. As demonstrated in a novel threshold-switching Fisherian model, well management of the private sector’s expectations of policy regime change can have the same effect as actually switching the regime. Contrastingly, failure to do so leads to unfavorable outcomes of policy intention. Then, I embed the new mechanism into a New Keynesian model. Along the way, I also develop an efficient non-simulation based threshold-switching Kalman filter, in conjunction with a solution method that accounts for the endogeneity of switching regimes, to estimate the nonlinear New Keynesian model. My key empirical findings are threefold. First, non-policy shocks have been instrumental in driving U.S. monetary policy regime changes during the post-World War II period. Most notably, markup shock explains 65.6% of variations in the policy regimes. Second, absent from markup shocks, eight of the eleven less aggressive regimes would not have happened during this history. Finally, I conclude that linking the private sector’s dynamic expectations formation and the Fed’s dilemma of the dual mandate in the presence of adverse supply shocks is a promising path towards providing micro-foundations for monetary policy regime shifts.
    Keywords: expectations formation effects, monetary policy, regime switching, Bayesian analysis
    Date: 2020–08
  22. By: Maxime Delabarre (Sciences Po - Sciences Po)
    Abstract: This paper explores the common argument according to which the repeal of the Glass-Steagall Act was at the origin of the 2008 financial crisis. By arguing successively that the Act would not have covered the failing banks and that it would not have solved the "Too-big-to-fail" problem, this paper concludes by the negative. Had the Glass-Steagall act still been in place, the Global Financial crisis would not have been prevented. Mortgage policies, low capital requirements and Basel II seem to be more convincing alternatives.
    Keywords: Financial regulation,Glass-Steagall,Act Financial crisis,Financial conglomerates,Universal banking,Financial sector reform,Financial architecture,Financial stability
    Date: 2020–11–01
  23. By: Viral V. Acharya; Siddharth Vij
    Abstract: We establish that macroprudential policies limiting capital flows can curb risks arising from corporate foreign currency borrowing in emerging markets. Using detailed firm-level data from India, we show that propensity to issue foreign currency debt for the same firm is higher when the difference in short-term interest rates between India and the US is higher, i.e., when the dollar ‘carry trade’ is more profitable; this behavior is driven by the period after the global financial crisis. The positive relationship between issuance and the ‘carry trade’ breaks down once regulators institute more stringent interest-rate caps on foreign currency borrowing. Riskier borrowers such as importers and those with higher interest costs cut issuance most. Firm equity exposure to foreign exchange risk rose after issuance in favorable funding conditions and emerged as a source of external sector vulnerability during the ‘taper tantrum’ of 2013. Macroprudential policy action limiting capital flows is able to nullify this effect, such as during the market stress due to the COVID-19 pandemic.
    JEL: F31 F34 G15 G30
    Date: 2020–11
  24. By: Atsushi Motohashi (Kyoto University)
    Abstract: This study analyzes the effects of bailout policies on the growth rate and asset prices in a small open economy with asset bubbles. In our model, bubbles stimulate investment and economic activities (so-called “crowd-in effect” of bubbles). Thus, after bubble crushing occurs, recessions follow. Under this condition, we show that as long as bubbles persist, generous bailout policies raise the economic growth rate by enhancing the crowd-in effect. When bubbles burst, the bailout policy mitigates capital losses caused by the burst and accelerates economic growth and workers’ wages compared to the no-bailout case. Since the bailout policy has growth and recovery enhancing effects, a generous bailout policy is a desirable one for governments from the perspective of taxpayers’ welfare. It should be noted, however, that a U.S. monetary policy to reduce the interest rate enlarges the size of asset bubbles in a small open economy, and further reduction of the U.S. interest rate makes the size of asset bubbles too large to be sustainable without adequate policy intervention of the small open economy; the government needs to reduce the scale of bailouts to an appropriate level in response to the U.S. interest rate reduction.
    Keywords: Asset Bubbles; U.S. Interest Rate Policy; Economic Growth; Collapse of Asset Bubbles; Asset Prices; Bailout Policy
    JEL: E32 E44 E61 F43
    Date: 2020–12

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