nep-cba New Economics Papers
on Central Banking
Issue of 2021‒01‒18
twenty-two papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Central Bank Independence: Metrics and Empirics By Donato Masciandaro; Jacopo Magurno; Romano Tarsia
  2. The 'new normal' during normal times - liquidity regulation and conventional monetary policy By Sînziana Kroon; Clemens Bonner; Iman van Lelyveld; Jan Wrampelmeyer
  3. The Interplay between Monetary and Fiscal Policies in the EU By António Afonso; Alexandre Sousa
  4. Do FX Interventions Lead to Higher FX Debt? Evidence from Firm-Level Data By Minsuk Kim; Rui Mano; Mico Mrkaic
  5. Ramsey Optimal Policy in the New-Keynesian Model with Public Debt By Chatelain, Jean-Bernard; Ralf, Kirsten
  6. The impact of monetary policy on expectations along the yield curve By Böck, Maximilian; Feldkircher, Martin
  7. Short Rate Dynamics: A Fed Funds and SOFR perspective By Karol Gellert; Erik Schl\"ogl
  8. The international dimension of a fragile EMU By Ioannou Demosthenes; Pagliari Maria Sole; Stracca Livio
  9. On the Drivers of Inflation in Different Monetary Regimes By Daniel Garcés Díaz
  10. Should developed economies manage international capital flows? By Dennis Bonam; Gavin Goy; Emmanuel de Veirman
  11. Global Impacts of US Monetary Policy Uncertainty Shocks By Povilas Lastauskas; Anh Dinh Minh Nguyen
  12. Lending Relationships and Optimal Monetary Policy By Zachary Bethune; Guillaume Rocheteau; Russell Wong; Cathy Zhang
  13. The Role of Nonlinearity in Indeterminate Models: An Application to Expectations-Driven Liquidity Traps By Yoichiro Tamanyu
  14. India’s Inflation Process Before and After Flexible Inflation Targeting By Patrick Blagrave; Weicheng Lian
  15. Redistribution and the Monetary-Fiscal Policy Mix By Saroj Bhattarai; Jae Won Lee; Choongryul Yang
  16. International transmission of interest rates: the role of international reserves and sovereign debt By António Afonso; Florence Huart; João Tovar Jalles; Piotr Stanek
  17. Monetary and macroprudential policy complementarities: evidence from European credit registers By Altavilla, Carlo; Laeven, Luc; Peydró, José-Luis
  18. Government Bonds, Bank Liquidity and Non-Neutrality of Monetary Policy in the Steady By Wang, Tianxi
  19. Legal Aspects of Central Bank Digital Currency: Central Bank and Monetary Law Considerations By Wouter Bossu; Masaru Itatani; Catalina Margulis; Arthur D. P. Rossi; Hans Weenink; Akihiro Yoshinaga
  20. On the origin of systemic risk By Montagna, Mattia; Torri, Gabriele; Covi, Giovanni
  21. Bank liquidity, bank lending, and "bad bank" policies By Morrison, Alan D; Wang, Tianxi
  22. Liquidity Traps in a World Economy By Robert Kollmann

  1. By: Donato Masciandaro; Jacopo Magurno; Romano Tarsia
    Abstract: This paper reviews the evolution of the literature on Central Bank Independence (CBI) focusing on its metrics as well as on its empirical association with macroeconomic variables. Part One describes the evolution of the CBI indicators, while Part Two analyses the econometric studies devoted to shed light on the relationships between CBI and macroeconomic performances.
    Keywords: Monetary Policy, Central Bank Independence, Inflation, Growth, Sacrifice Ratio, Public Finance, Financial Stability
    JEL: E50 E52 E58
    Date: 2021
  2. By: Sînziana Kroon; Clemens Bonner; Iman van Lelyveld; Jan Wrampelmeyer
    Abstract: We analyze the impact of a requirement similar to the Basel III Liquidity Coverage Ratio (LCR) on conventional monetary policy implementation. Combining unique data sets of Dutch banks from 2002 to 2005, we find that the introduction of the LCR impacts banks' behaviour in open market operations. After the introduction of the LCR, banks bid for higher volumes and pay higher interest rates for central bank funds. In line with theory, banks reduce their reliance on overnight and short term unsecured funding. We do not observe a worsening of collateral quality pledged in open market operations. Thus, to correctly anticipate an open market operation's effect on interest rates, monetary policy requires central banks to consider not only the size of the operation, but also how it impacts banks' liquidity management and compliance with the LCR.
    Keywords: Liquidity regulation; monetary policy implementation; financial intermediation; banks; open market operations
    JEL: G18 G21 E42
    Date: 2021–01
  3. By: António Afonso; Alexandre Sousa
    Abstract: We study the interactions between monetary and fiscal policiesin the EU countries, for the period 1995-2019. Our results show notably that: i) the inflation rate has a relevantimpact over the central banks’ decision making; ii) the cyclically adjusted primary balance reacts positively to increases in the level of government debt; iii) monetary policy reaction functions do not seem to take into consideration the cyclically adjusted primary balance; iv) fiscal policy, via the cyclically adjusted primary balance, seem to be affected by the short-term interest rate in a negative way.The global economic and financial crisis impacted negatively both the short-term nominal interest rates and the cyclically adjusted primary balance, however with a higher degree in the euro area.
    Keywords: Monetary Policy, Fiscal Policy; Reaction Functions; Great Recession
    JEL: E52 E62 E63 E65 H62
    Date: 2020–12
  4. By: Minsuk Kim; Rui Mano; Mico Mrkaic
    Abstract: Central banks often buy or sell reserves-–-so called FX interventions (FXIs)---to dampen sharp exchange rate movements caused by volatile capital flows. At the same time, these interventions may entail unintended side effects. In this paper, we investigate whether FXIs incentivize firms to take on more unhedged FX debt, thereby increasing medium-term corporate vulnerabilities. Using a novel dataset with close to 5,000 nonfinancial firms across 19 emerging markets covering 2002--2017, we find that the firm-level share of FX debt rises following intensive use of FXIs, particularly for non-exporting firms in shallow financial markets with no FX debt to begin with. The magnitude of this effect is economically significant, with one standard deviation increase in FXI leading to an average 2 percentage points increase in the FX debt share. For reference, the median share of FX debt in the sample is zero.
    Keywords: Foreign exchange;Exchange rate arrangements;Exchange rates;Currencies;Exchange rate flexibility;WP,firm,balance sheet data,FX intervention
    Date: 2020–09–25
  5. By: Chatelain, Jean-Bernard; Ralf, Kirsten
    Abstract: In the discrete-time new-Keynesian model with public debt, Ramsey optimal policy eliminates the indeterminacy of simple-rules multiple equilibria between the fiscal theory of the price level versus new-Keynesian versus an unpleasant equilibrium. If public debt volatility is taken into account into the loss function, the interest rate responds to public debt besides inflation and output gap. Else, the Taylor rule is identical to Ramsey optimal policy when there is zero public debt. The optimal fiscal-rule parameter implies the local stability of public-debt dynamics ("passive" fiscal policy).
    Keywords: Fiscal theory of the Price Level, Ramsey Optimal Policy, New-Keynesian model, Fiscal Rule, Taylor Rule, Multiple Equilibria.
    JEL: C61 C62 E43 E52 E61 E62 E63
    Date: 2020–12–12
  6. By: Böck, Maximilian; Feldkircher, Martin
    Abstract: This article investigates how market participants adjust their expectations of interest rates at different maturities in response to a monetary policy and a central bank information shock for the US economy. The results show that market participants adjust their expectations faster to changes in interest rates compared to new releases of information by the central bank. This finding could imply that central bank information shocks are more opaque whereas a change in interest rates provides a stronger signal to the markets. Moreover, financial market agents respond with an initial underreaction to both shocks, potentially resembling inattention or overconfidence. Last, we find that the adjustment of expectations for yields with higher maturities takes considerably longer than for short-term yields. This finding is especially important for central banks since in the current low-interest rate environment monetary policy actions mainly consist of policies aimed at the long-end of the yield curve.
    Keywords: monetary policy, expectation formation, belief bias
    Date: 2020–12
  7. By: Karol Gellert; Erik Schl\"ogl
    Abstract: The Secured Overnight Funding Rate (SOFR) is becoming the main Risk-Free Rate benchmark in US dollars, thus interest rate term structure models need to be updated to reflect the key features exhibited by the dynamics of SOFR and the forward rates implied by SOFR futures. Historically, interest rate term structure modelling has been based on rates of substantially longer time to maturity than overnight, but with SOFR the overnight rate now is the primary market observable. This means that the empirical idiosyncrasies of the overnight rate cannot be ignored when constructing interest rate models in a SOFR-based world. As a rate reflecting transactions in the Treasury overnight repurchase market, the dynamics of SOFR are closely linked to the dynamics of the Effective Federal Funds Rate (EFFR), which is the interest rate most directly impacted by US monetary policy target rate decisions. Therefore, these rates feature jumps at known times (Federal Open Market Committee meeting dates), and market expectations of these jumps are reflected in prices for futures written on these rates. On the other hand, forward rates implied by Fed Funds and SOFR futures continue to evolve diffusively. The model presented in this paper reflects the key empirical features of SOFR dynamics and is calibrated to futures prices. In particular, the model reconciles diffusive forward rate dynamics with piecewise constant paths of the target short rate.
    Date: 2021–01
  8. By: Ioannou Demosthenes; Pagliari Maria Sole; Stracca Livio
    Abstract: This paper quantifies the economic influence that shocks to EMU cohesion, which in turn reflect the incomplete nature of the monetary union, have on the rest of the world, by disentangling euro area stress shocks and global risk aversion shocks on the basis of a combination of sign, magnitude and narrative restrictions in a daily Structural Vector Autoregression (VAR) model with financial variables. We find that the effects of euro area stress shocks are significant not only for the euro area but also for the rest of the world. Notably, an increase in euro area stress entails a slowdown of economic activity in the rest of the world, as well as a fall in imports/exports of both the euro area and the rest of the world. A decrease in euro area stress has somewhat more widespread beneficial effects on both economic performance and global trade activity.
    Keywords: Economic and Monetary Union, Bayesian SVAR, narrative sign restrictions, panel local projections
    JEL: C23 C32 F02 F33
    Date: 2020
  9. By: Daniel Garcés Díaz
    Abstract: This document proposes a general macroeconomic framework to analyze the behavior of inflation. This approach has two characteristics. The first is the distinction of monetary regimes based on the number of shocks that have a permanent effect on the price level. When all shocks have a permanent impact, the regime determines the inflation rate, as in inflation targeting. On the other hand, when there is only one shock with permanent effects, the regime determines the price level. An example of this is a regime with a fixed exchange rate. Even if there is no explicit target for the domestic price level, this becomes determined by the operation of a regime of this type. The second characteristic comes from the factors that Granger cause the rate of inflation or the price level. With this, a new perspective on four different historical cases emerges. One is the German hyperinflation; the second is that of the United States for a very long sample. For Brazil and Mexico, the analysis demonstrates that their inflationary processes' complexity arises from the regime changes they have gone through.
    JEL: C32 E41 E42 E52
    Date: 2020–12
  10. By: Dennis Bonam; Gavin Goy; Emmanuel de Veirman
    Abstract: At least since the euro area sovereign debt crisis, it is evident that country risk premium shocks have adverse economic effects, not only in emerging economies, but advanced economies as well. Using a Bayesian Panel Vector Autoregression model, we find that increases in the risk premium lower output under monetary union, yet not in countries with flexible exchange rates and independent monetary policies. We study the transmission mechanism in a two-country New Keynesian model and show that capital controls substantially attenuate the effects of risk premium shocks. However, the welfare gain of imposing capital controls hinges on the nature of the shock and the prevailing exchange rate regime.
    Keywords: Bayesian panel VAR; capital controls; exchange rate regime; welfare
    JEL: F32 F38 F41 F45
    Date: 2020–12
  11. By: Povilas Lastauskas (Bank of Lithuania & Vilnius University); Anh Dinh Minh Nguyen (Bank of Lithuania & Vilnius University)
    Abstract: We build a new empirical model to estimate the global impact of an increase in the volatility of US monetary policy shocks. Specifically, we admit time-varying variances of local structural shocks from a stochastic volatility specification. By allowing for rich dynamic interaction between the endogenous variables and timevarying volatility in the global setting, we find that US interest rate uncertainty not only drives local output and inflation volatility, but also causes declines in output, inflation, and the interest rate. Moreover, we document strong global impacts, making the world move in a very synchronous way. Crucially, spillback effects are found to be significant even for the US economy.
    Keywords: US Monetary Policy, Volatility Shocks, Uncertainty, Global Economy
    JEL: C32 C54 E52 E58 F44
    Date: 2020–12–30
  12. By: Zachary Bethune; Guillaume Rocheteau; Russell Wong; Cathy Zhang
    Abstract: We construct and calibrate a monetary model of corporate finance with endogenous formation of lending relationships. The equilibrium features money demands by firms that depend on their access to credit and a pecking order of financing means. We describe the mechanism through which monetary policy affects the creation of relationships and firms' incentives to use internal or external finance. We study optimal monetary policy following an unanticipated destruction of relationships under different commitment assumptions. The Ramsey solution uses forward guidance to expedite creation of new relationships by committing to raise the user cost of cash gradually above its long-run value. Absent commitment, the user cost is kept low, delaying recovery.
    Keywords: Credit relationships; banks; corporate finance; optimal monetary policy
    JEL: D83 E32 E51
    Date: 2020–09–25
  13. By: Yoichiro Tamanyu (Graduate School of Economics, Keio University)
    Abstract: This paper proposes a novel methodology to derive nonlinear solutions of an indeterminate DSGE model in which the decision rules are affected by sunspot shocks. We apply the method to an expectations-driven liquidity trap---a liquidity trap that arises because of the zero lower bound constraint on the nominal interest rate and the de-anchoring of economic agents' expectations---and find that the model dynamics exhibit significant nonlinearity. Such nonlinearity arises because the zero lower bound ceases to bind once the inflation rate rises because of a temporary increase in inflation expectations.
    Keywords: Indeterminacy, Nonlinearity, Sunspot, Expectations-Driven Liquidity Traps, Zero Lower Bound
    JEL: C62 C63 E31
    Date: 2020–11–28
  14. By: Patrick Blagrave; Weicheng Lian
    Abstract: We study the inflation process in India, focusing on the periods before and after the adoption of flexible inflation-forecast targeting (FIT) in India. Our analysis uses several approaches including standard Phillips curve estimation for headline and core inflation, an examination of the sensitivity of medium-term inflation expectations to inflation surprises, and the properties of convergence between headline and core inflation. Results indicate an important role for domestic factors in driving the inflation process, and there is evidence that expectations have become more anchored since 2015. This result could be attributable to FIT adoption, or to persistently low food prices which dominate the post-FIT-adoption period. The policy implications of these structural changes in the inflation process are investigated using a semi-structural model calibrated to the Indian economy.
    Keywords: Inflation;Food prices;Inflation targeting;Emerging and frontier financial markets;Import prices;India,WP,inflation expectation,headline inflation processes,food price inflation,core-inflation process,core-inflation determinant,headline inflation forecast
    Date: 2020–11–13
  15. By: Saroj Bhattarai; Jae Won Lee; Choongryul Yang
    Abstract: We show that the effectiveness of redistribution policy in stimulating the economy and improving welfare is directly tied to how much inflation it generates, which in turn hinges on monetary-fiscal adjustments that ultimately finance the transfers. We compare two distinct types of monetary-fiscal adjustments: In the monetary regime, the government eventually raises taxes to finance transfers while in the fiscal regime, inflation rises, effectively imposing inflation taxes on public debt holders. We show analytically in a simple model how the fiscal regime generates larger and more persistent inflation than the monetary regime. In a quantitative application, we use a two-sector, two-agent New Keynesian model, situate the model economy in a Covid-19 recession, and quantify the effects of the transfer components of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. We find that the transfer multipliers are significantly larger under the fiscal regime—which results in a milder contraction—than under the monetary regime, primarily because inflationary pressures of this regime counteract the deflationary forces during the recession. Moreover, redistribution produces a Pareto improvement under the fiscal regime.
    Keywords: household heterogeneity, redistribution, monetary-fiscal policy mix, transfer multiplier, welfare evaluation, Covid-19, CARES Act
    JEL: E53 E62 E63
    Date: 2020
  16. By: António Afonso; Florence Huart; João Tovar Jalles; Piotr Stanek
    Abstract: We analyse the international transmission of interest rates by focusing onthe role of the accumulation of international reserves and on the financing of sovereign debt. An increase in foreign exchange reserves is expected to moderate the influence of U.S. interest rates.However,a high level of government debt raises the sovereign risk premium. Moreover, an increase in the stock ofgovernment debt denominated in foreign currency may increasethe expected rate of depreciation of the domestic currency. We explain the theoretical mechanisms in a model, which describes the money market equilibrium in an economy with capital account openness. Then, we test the predictions of the model for a panel of advanced and developing economies over the period 1970-2018. Our main findings are: i) significant spillovers from the U.S. interest rates to other countries, mostly for Advanced Economies; ii) a dampening effect of the share of external liabilities in the domestic currency, clearly a determinant of risk premium; iii)a negative effect of international reserves on interest rates, as expected; iv) higher reserves decrease risk premia, for long-term interest rates; v)the significanceof spilloversfades once the sovereign debtreaches100% of GDPin developed countries.
    Keywords: interest rates, international reserves, government debt, spillover effects, monetary policy, fiscal policy, panel analysis
    JEL: C23 E43 E63 F31 F34 G15 H60
    Date: 2021–01
  17. By: Altavilla, Carlo; Laeven, Luc; Peydró, José-Luis
    Abstract: We document that there are strong complementarities between monetary policy and macroprudential policy in shaping the evolution of bank credit. We use a unique loan-level dataset comprising multiple credit registers from several European countries and different types of loans, including corporate loans, mortgages and consumer credit. We merge this rich information with borrower and bank-level characteristics and with indicators summarising macroprudential and monetary policy actions. We find that monetary policy easing increases both bank lending and lending to riskier borrowers, especially when there is a more accommodative macroprudential environment. These effects are stronger for less capitalised banks. Results apply to both household and firm lending, but they are stronger for consumer and corporate loans than for mortgages. Finally, for firms, the overall increase in bank lending induced by an accommodative policy mix is stronger for more (ex ante) productive firms than firms with high ex ante credit risk, except for banks with low capital. JEL Classification: E51, E52, E58, G21, G28
    Keywords: corporate and household credit, euro area, macroprudential policy, monetary policy
    Date: 2020–12
  18. By: Wang, Tianxi
    Abstract: This paper studies non-neutrality of monetary policy in a model where fiat money is used by banks to meet liquidity demand and a government bond to collateralize reserve borrowing. It finds that if some banks are liquidity constrained, any monetary policy that alters the bond-to-fiat money ratio moves the interbank rate and is non-neutral in the steady state. Moreover, the effect for liquidity un-constrained banks is the opposite of that for the maximally constrained. Lastly, if the expansion of digital ways of payment eliminates depositor withdrawals, fiat money will stop circulation and a bullion standard will probably return.
    Date: 2021–01–12
  19. By: Wouter Bossu; Masaru Itatani; Catalina Margulis; Arthur D. P. Rossi; Hans Weenink; Akihiro Yoshinaga
    Abstract: This paper analyzes the legal foundations of central bank digital currency (CBDC) under central bank and monetary law. Absent strong legal foundations, the issuance of CBDC poses legal, financial and reputational risks for central banks. While the appropriate design of the legal framework will up to a degree depend on the design features of the CBDC, some general conclusions can be made. First, most central bank laws do not currently authorize the issuance of CBDC to the general public. Second, from a monetary law perspective, it is not evident that “currency” status can be attributed to CBDC. While the central bank law issue can be solved through rather straithforward law reform, the monetary law issue poses fundmental legal policy challenges.
    Keywords: Central Bank digital currencies;Currencies;Central bank legislation;Legal support in revenue administration;Payment systems;Central Bank Digital Currency,CBDC,Blockchain,Cryptocurrency,Crypto assets,WP,central bank law,monetary unit,book money,digital currency,law reform,token-based CBDC
    Date: 2020–11–20
  20. By: Montagna, Mattia; Torri, Gabriele; Covi, Giovanni
    Abstract: Systemic risk in the banking sector is usually associated with long periods of economic downturn and very large social costs. On one hand, shocks coming from correlated exposures towards the real economy may induce correlation in banks' default probabilities thereby increasing the likelihood for systemic-tail events like the 2008 Great Financial Crisis. On the other hand, financial contagion also plays an important role in generating large-scale market failures, amplifying the initial shocks coming from the real economy. To study the sources of these rare phenomena, we propose a new definition of systemic risk (i.e. the probability of a large number of banks going into distress simultaneously) and thus we develop a multilayer microstructural model to study empirically the determinants of systemic risk. The model is then calibrated on the most comprehensive granular dataset for the euro area banking sector, capturing roughly 96% or EUR 23.2 trillion of euro area banks' total assets over the period 2014-2018. The output of the model decompose and quantify the sources of systemic risk showing that correlated economic shocks, financial contagion mechanisms, and their interaction are the main sources of systemic events. The results obtained with the simulation engine resemble common market-based systemic risk indicators and empirically corroborate findings from existing literature. This framework gives regulators and central bankers a tool to study systemic risk and its developments, pointing out that systemic events and banks’ idiosyncratic defaults have different drivers, hence implying different policy responses. JEL Classification: D85, G17, G33, L14
    Keywords: financial contagion, microstructural models, systemic risk
    Date: 2020–12
  21. By: Morrison, Alan D; Wang, Tianxi
    Abstract: Why are bank deposits demandable when they are also negotiable? We present a General Equilibrium model in which demandable debt exposes banks to liquidity risk so that they can signal their types and ensure that their liabilities can circulate as a means of payment. Banks can manage their liquidity risk by altering their deposit rate and their lending scale. When banks are transparent, so that depositors have homogenous information about their assets, they use only the former tool: their lending scale is effcient, and they do not experience liquidity crisis. When banks are opaque, so that depositors receive private signals of their quality, they ineffciently shrink the scale of their lending. A bank's stock of liquid assets affects its capacity for risk taking. A "bad bank" policy can resolve liquidity crises by reducing the opacity of the bank's assets.
    Keywords: Liquidity crises, demandable deposits, negotiable deposits, bad bank policies
    Date: 2021–01–12
  22. By: Robert Kollmann
    Abstract: This paper studies a New Keynesian model of a two-country world with a zero lower bound (ZLB) constraint for nominal interest rates. A floating exchange rate regime is assumed. The presence of the ZLB generates multiple equilibria. The two countries can experience recurrent liquidity traps induced by the self-fulfilling expectation that future inflation will be low. These "expectations-driven" liquidity traps can be synchronized or unsynchronized across countries. In an expectations-driven liquidity trap, the domestic and international transmission of persistent shocks to productivity and government purchases differs markedly from shock transmission in a "fundamentals-driven" liquidity trap.
    Keywords: Zero lower bound, expectations-driven and fundamentals-driven liquidity traps, domestic and international shock transmission, terms of trade, exchange rate, net exports
    Date: 2021–01

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