nep-cba New Economics Papers
on Central Banking
Issue of 2021‒02‒08
24 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Central bank credibility, long-term yields and the effects of monetary integration By Marcin Kolasa; Dominik Supera
  2. Pandemic recession, helicopter money and central banking: Venice, 1630 By Goodhart, C. A. E.; Masciandaro, Donato; Ugolini, Stefano
  3. On the Use of Current or Forward-Looking Data in Monetary Policy: A Behavioural Macroeconomic Approach By Paul De Grauwe; Yuemei Ji
  4. Economic uncertainty, macroprudential policies and bank risk: Evidence from emerging Asian economies By Jeon, Bang; Yao, Yao; Chen, Minghua; Wu, Ji
  5. Are large national debt and ultra-low inflation harmful? —— S-shape Phillips curve: the inflation-unemployment relationship of a low profit rate model By Yang, Jinrui
  6. The Distortionary Effects of Central Bank Direct Lending on Firm Quality Dynamics By Li, Wenhao; Li, Ye
  7. Multilateral Divisia monetary aggregates for the Euro Area By Barnett, William; Gaekwad, Neepa
  8. Macroeconomic Consequences of Foreign Exchange Futures Market for Inflation Targeting Economies By Syarifuddin, Ferry
  9. Implications of Banking Regulations on Online Payment Failures By Chawla, Aditi; Manjhi, Ganesh; Bhattacharya, Gaurav
  10. One size fits some: analysing profitability, capital and liquidity constraints of custodian banks through the lens of the SREP methodology By Coste, Charles-Enguerrand; Tcheng, Céline; Vansieleghem, Ingmar
  11. Monetary Policy and Racial Inequality By Alina K. Bartscher; Moritz Kuhn; Moritz Schularick; Paul Wachtel
  12. Financial structure, capital openness and financial crisis By Zhai, Weiyang
  13. The Fed's Discount Window in "Normal" Times By Huberto M. Ennis; Elizabeth C. Klee
  14. Liquidity Premium, Credit Costs, and Optimal Monetary Policy By Lee, Sukjoon
  15. Unequal Unemployment Effects of COVID-19 and Monetary Policy across U.S. States By Hakan Yilmazkuday
  16. The Supply-Side Effects of Monetary Policy By David Baqaee; Emmanuel Farhi; Kunal Sangani
  17. Estimating the Effects of Demographics on Interest Rates: A Robust Bayesian Perspective By Paul Ho
  18. Leaning against the bubble. Can theoretical models match the empirical evidence? By Ciccarone, Giuseppe; Giuli, Francesco; Marchetti, Enrico; Tancioni, Massimiliano
  19. Managing Stablecoins: Optimal Strategies, Regulation, and Transaction Data as Productive Capital By Li, Ye; Mayer, Simon
  20. Deposit Insurance, Moral Hazard and Bank Risk By Alexei Karas; William Pyle; Koen Schoors
  21. Issuance and valuation of corporate bonds with quantitative easing By Pegoraro, Stefano; Montagna, Mattia
  22. The Story of the Real Exchange Rate By Oleg Itskhoki
  23. Dynamic Banking and the Value of Deposits By Bolton, Patrick; Li, Ye; Wang, Neng; Yang, Jinqiang
  24. Diagnosis of systemic risk and contagion across financial sectors By Sayuj Choudhari; Richard Licheng Zhu

  1. By: Marcin Kolasa; Dominik Supera
    Abstract: Forming a monetary union implies equalization of short-term interest rates across the member states as monetary policy is delegated to a common central bank, but also leads to integration of risk-free bond markets. In this paper we develop a quantitative open economy model where long-term bond yields matter for real allocations. We next use the model to shed light on the macroeconomic effects of convergence in bond prices within a currency union. Our focus is on a small open economy, where the pre-accession level of interest rates is high due to floating exchange rate and relatively low central bank focus on stabilizing inflation. We find that, from the perspective of social welfare in the country adopting a common currency, the benefits associated with lower long-term yields can outweigh the costs related to a loss of monetary independence.
    Keywords: monetary integration, bond yields, central bank credibility
    JEL: E30 E43 E44 E52 F45
    Date: 2021–01
  2. By: Goodhart, C. A. E.; Masciandaro, Donato; Ugolini, Stefano
    Abstract: This paper analyses the monetary policy that the Most Serene Republic of Venice implemented in the years of calamities using a modern equivalent of helicopter money, precisely an extraordinary money issuing, coupled with capital losses for the issuer. We consider the 1629 famine and the 1630-1631 plague as a negative macroeconomic shock that the incumbent government addressed using fiscal monetization. Consolidating the balance sheets of the Mint and of the Giro Bank, and having heterogenous citizens - inequality matters - we show that the Republic implemented what was, in effect, helicopter money driven by political economy reasons, in order to avoid popular riots.
    Keywords: central banking; helicopter money; monetary policy; pandemic; Venice 1630
    JEL: D70 E50 E60 N10 N20
    Date: 2021–01
  3. By: Paul De Grauwe; Yuemei Ji
    Abstract: We analyse the use of current and forward-looking data in the setting of monetary policy (Taylor rule). We answer the question of whether the use of forward-looking data is to be preferred over the use of current data. We use a behavioural macroeconomic model that generates periods of tranquillity alternating with crisis periods characterized by fat tails in the distribution of output gap. We find that the answer to our question depends on the nature of the monetary policy regime. In general, in a strict inflation targeting regime the use of forward-looking data leads to a lower quality of monetary policymaking than in a dual mandate monetary policy regime. Finally, nowcasting tends to improve the quality of monetary policy especially in a strict inflation targeting regime.
    Keywords: Taylor rule, behavioural macroeconomics, animal spirits, strict inflation targeting, dual mandate, nowcasting
    Date: 2021
  4. By: Jeon, Bang (School of Economics); Yao, Yao (Research Institute of Economics and Management); Chen, Minghua (Research Institute of Economics and Management); Wu, Ji (Research Institute of Economics and Management)
    Abstract: This paper examines the impact of macroprudential policies on bank risk under economic uncertainty in emerging Asian economies. By using bank-level panel data for selected emerging Asian economies during the period 2000-2016, we present consistent evidence that bank risk increases with economic uncertainty, while macroprudential measures play an ameliorative role to the uncertainty-induced bank risk. We confirm that these findings are robust against a series of alternative measures of economic uncertainty and bank risk, and alternative econometric tools to address possible endogeneity concerns.
    Keywords: Economic uncertainty; bank risk; macroprudential policy; emerging Asia
    JEL: G15 G21
    Date: 2021–01–16
  5. By: Yang, Jinrui
    Abstract: This paper, through a neo-Kaleckian model of a closed industrialized economy, shows a large scale of national debt and an ultra-low inflation rate are not dangerous but necessary if the profit rate of capitalists is low. The S-shape Phillips curve in the static analyses (in the long-run perspective then) shows, when inflation rate is low (which is called semi-classical situation), unemployment rate increases with inflation rate. In the semi-classical situation, the ratio of national debt to GDP decreases with inflation rate while deficit ratio increases with inflation rate. The dynamic analyses show, if the government can fix inflation rate on a target level, an industrialized economy can be dynamically stable.
    Keywords: employment, inflation, deficit, national debt, profit rate
    JEL: E11 E12 E24 E31 H6
    Date: 2020–12–31
  6. By: Li, Wenhao (U of Southern California); Li, Ye (Ohio State U)
    Abstract: Bypassing the banking systems, central banks around the world lent to nonfinancial firms on an unprecedented scale during the Covid-19 crisis. Effective and necessary as it is, direct lending is subject to credit mispricing given central banks' lack of information on individual borrowers. Our dynamic model characterizes a downward bias in firm quality distribution that is self-perpetuating: Direct lending in the current crisis necessitates a greater scale of interventions in future crises, which in turn cause more severe distortion of firm quality distribution. Such effects are amplified by firms' forward-looking investment decisions in normal times. Low-quality firms overinvest to take advantage of underpriced central bank credit in future crises while, on a relative basis, high-quality firms underinvest. The distortionary effects can be mitigated by central banks' use of market information, collaboration and regulation of informed banks, and coordination of direct lending and conventional monetary policy.
    JEL: E5 G0
    Date: 2020–11
  7. By: Barnett, William; Gaekwad, Neepa
    Abstract: In light of the “two-pillar strategy” of the European Central Bank, good measures of aggregated money across countries in the Euro area are policy relevant. The objective of this paper is to focus on the multilateral Divisia monetary aggregates for the Euro area to produce a theoretically consistent measure of monetary services for the Euro area monetary union. Based on theory developed in Barnett (2007), the multilateral Divisia monetary aggregates for 17 Euro area countries are found to provide a better signal of recession, when compared to the corresponding simple sum monetary aggregates.
    Keywords: Divisia index, European Union, European Monetary Union, Monetary aggregation.
    JEL: C43 C82 E51 E52 F33
    Date: 2021–01
  8. By: Syarifuddin, Ferry
    Abstract: Although the discussion on foreign exchange (FX) futures market has drawn significant concern in the economic literature, this paper is the first attempt to address how the FX futures market impacts macroeconomic conditions with the inflation targeting regime. We use a dataset comprising of four emerging market countries with inflation targeting regime and active FX futures market, namely Brazil, Mexico, Turkey, and India, from January 2015 to December 2018. By utilizing Bayesian Panel Vector Autoregressions, we find that the FX futures rate shocks significantly affect the macroeconomic environment and monetary policy due to the strong relationship between the spot and futures market. We also find the initial indication of the market squeezing mechanism in the FX futures market. However, it occurs only in a small magnitude and a short period and thus, the spot exchange rate, inflation rate, and economic growth would not fluctuate abnormally. Our findings are robust for the various robustness checks.
    Keywords: Foreign Exchange Futures Market, Inflation Targeting Framework, Macroeconomy, Emerging Economies
    JEL: E52 E58 G23
    Date: 2020–12
  9. By: Chawla, Aditi; Manjhi, Ganesh; Bhattacharya, Gaurav
    Abstract: This paper explores the `latent economy' of online transaction failure that prevails in the digital payment system. A two-variant model of profit, with a different cost function in each variant, has been proposed to examine the profit of commercial banks. The model considers that when an online transaction fails, banks use the money held in the Unified Payment System to earn revenue in the form of interest income by investing the same. The theoretical exposition of the model has been corroborated by simulation by assuming feasible parametric restrictions and exogenous values. The paper finds that commercial banks make profit by using the held amount at the existing cost. As the proportion of the held money used by the banks increases, their profits increase and the commercial banks incur losses when an `alternative cost' with stricter penalties is imposed.
    Keywords: Digital Payments, Transaction Failure, UPI Payment Failure
    JEL: E58 G18 G28 L51
    Date: 2021–01–16
  10. By: Coste, Charles-Enguerrand; Tcheng, Céline; Vansieleghem, Ingmar
    Abstract: Custodians play a key but discrete role in the global financial market infrastructure. In Europe, they are licensed as “credit institutions ”, a legal requirement for European deposit-taking institutions, and therefore they face the same prudential requirements as “traditional” banks. However, their business model and risk profile are different from those of traditional banks since the core of their activity does not encompass balance sheet transformation and the associated risks. JEL Classification: G15, G21, G28, L22
    Keywords: bank, credit institution, custodian, prudential supervision
    Date: 2021–01
  11. By: Alina K. Bartscher (Department of Economics, University of Bonn); Moritz Kuhn (Department of Economics, University of Bonn; CEPR and IZA); Moritz Schularick (Federal Reserve Bank of New York; and Department of Economics, University of Bonn; and CEPR); Paul Wachtel (Department of Economics, New York University Stern School of Business)
    Abstract: This paper aims at an improved understanding of the relationship between monetary policy and racial inequality. We investigate the distributional effects of monetary policy in a unified framework, linking monetary policy shocks both to earnings and wealth differentials between black and white households. Specifically, we show that, although a more accommodative monetary policy increases employment of black households more than white households, the overall effects are small. At the same time, an accommodative monetary policy shock exacerbates the wealth difference between black and white households, because black households own less financial assets that appreciate in value. Over multi-year time horizons, the employment effects are substantially smaller than the countervailing portfolio effects. We conclude that there is little reason to think that accommodative monetary policy plays a significant role in reducing racial inequities in the way often discussed. On the contrary, it may well accentuate inequalities for extended periods.
    Keywords: monetary policy, racial inequality, income distribution, wealth distribution, wealth effects
    JEL: E40 E52 J15
    Date: 2021–01
  12. By: Zhai, Weiyang
    Abstract: This paper examines how the financial structure and capital openness of a country have affected the likelihood of financial crisis over the past two decades. By applying a panel probit estimation to a sample of 38 countries, we find the following. 1) An economy with a more market-based financial structure is less likely to experience a currency crisis. 2) More capital openness is associated with a lower probability of a currency crisis. 3) Countries with a more market-based financial structure are also less likely to experience a currency crisis if that structure is coupled with a more open capital account. 4) Unlike what is found for currency crises, neither financial structure nor capital openness has any effect on banking crises.
    Keywords: financial structure; capital openness; currency crisis; banking crisis
    JEL: G01 G15 G28
    Date: 2020–12–29
  13. By: Huberto M. Ennis; Elizabeth C. Klee
    Abstract: We study new transaction-level data of discount window borrowing in the U.S. from 2010–17, merged with quarterly data on bank financial conditions (balance sheet and revenue). The objective is to improve our understanding of the reasons why banks use the discount window during periods outside financial crises. We also provide a model of the decision of banks to borrow at the window, which is helpful for interpreting the data. We find that decisions to gain access and to borrow at the discount window are meaningfully correlated with some relevant characteristics of banks and the composition of their balance sheets. Banks choose simultaneously to obtain access to the discount window and hold more cash-like liquidity as a proportion of assets. Yet, conditional on access, larger and less liquid banks tend to borrow more from the discount window. In general, our findings suggest that banks could, in principle, adapt their operations to modulate, and possibly reduce, their use of the discount window in "normal" times.
    Keywords: Discount window; Financial crises; Borrowing
    Date: 2021–01–13
  14. By: Lee, Sukjoon
    Abstract: I study how monetary policy affects firms' external financing decisions. More precisely, I study the transmission mechanism of monetary policy to credit costs in a general equilibrium macroeconomic model where firms issue corporate bonds or obtain bank loans, and corporate bonds are not just stores of value but also serve a liquidity role. The model shows that an increase in the nominal policy rate can lower the borrowing cost in the corporate bond market, while increasing that in the bank loan market, and I provide empirical evidence that supports this result. The model also predicts that a higher nominal policy rate induces firms to substitute corporate bonds for bank loans, which is supported by the existing empirical evidence. In the model, the Friedman rule is suboptimal so that keeping the cost of holding liquidity at a positive level is socially optimal. The optimal policy rate is an increasing function of the degree of corporate bond liquidity.
    Keywords: Corporate Finance; Credit Cost; Bank Loan; Corporate Bond; Liquidity Premium; Monetary Policy
    JEL: E43 E44 E51 E52 G12 G21
    Date: 2020–11–15
  15. By: Hakan Yilmazkuday (Department of Economics, Florida International University)
    Abstract: This paper shows that daily Google trends can be used as an alternative to conventional U.S. data (with alternative frequencies) on unemployment, interest rates, inflation and coronavirus disease 2019 (COVID-19). This information is used to investigate the effects of COVID-19 and the corresponding monetary policy on the U.S. unemployment, both nationally and across U.S. states, by using a structural vector autoregression model. Historical decomposition analyses show that the U.S. unemployment is mostly explained by COVID-19, whereas the contribution of monetary policy is almost none. An investigation based on the U.S. states further suggests that COVID-19 and the corresponding monetary policy conducted based on nationwide economic developments have resulted in unequal changes in state-level unemployment rates, suggesting evidence for distributive effects of national monetary policy.
    Keywords: COVID-19, Coronavirus, Google Trends, Monetary Policy
    JEL: J63 F66 I10
    Date: 2021–01
  16. By: David Baqaee; Emmanuel Farhi; Kunal Sangani
    Abstract: We propose a supply-side channel for the transmission of monetary policy. We study an economy with heterogeneous firms, sticky prices, and endogenous markups. We show that if, as is consistent with the empirical evidence, bigger firms have higher markups and lower pass-throughs than smaller firms, then a monetary easing endogenously increases aggregate TFP and improves allocative efficiency. This endogenous positive “supply shock” amplifies the effects of the positive “demand shock” on output and employment. The result is a flattening of the Phillips curve. This effect is distinct from another mechanism discussed at length in the real rigidities literature: a monetary easing leads to a reduction in desired markups because of strategic complementarities in pricing. We calibrate the model to match firm-level pass-throughs and find that the misallocation channel of monetary policy is quantitatively important, flattening the Phillips curve by about 70% compared to a model with no supply-side effects. We derive a tractable four-equation dynamic model and show that monetary easing generates a procyclical hump-shaped response in aggregate TFP and countercyclical dispersion in firm-level TFPR. The improvements in allocative efficiency amplify both the impact and persistence of interest rate shocks on output.
    JEL: E0 E12 E24 E3 E4 E5 L11 O4
    Date: 2021–01
  17. By: Paul Ho
    Abstract: There are a vast range of estimates for the effect of demographics on interest rates. I show that these magnitudes are not well-identified without data on capital and life-cycle consumption. However, these data are often omitted. Using nonparametric prior sensitivity analysis for an overlapping generations model estimated through Bayesian methods, I show that without these data, small changes in the prior for the discount rate, intertemporal elasticity of substitution, and capital depreciation rate can shift the posterior quantiles for the effects of demographics by up to 1.5 percentage points. Data on the capital-output ratio and life-cycle consumption tighten identification.
    Keywords: Interest rates; Bayesian methods; Discount rates
    Date: 2020–10–07
  18. By: Ciccarone, Giuseppe; Giuli, Francesco; Marchetti, Enrico; Tancioni, Massimiliano
    Abstract: By estimating a Markov-switching model, we provide new evidence on the nonlinear effects of monetary policy shocks on asset prices and on their bubble component. We show that regime-dependence is mainly driven by the states affecting the interest rate equation. We also show that, following a positive interest rate shock, an OLG model of asset price bubbles with credit frictions and sticky prices may predict an increase in the real rate, a recession/deflation and an increase in the bubble value. This result, which is new to the theoretical literature, matches both the previously existing and our empirical evidence.
    Keywords: Asset price bubbles; monetary policy; overlapping generations models.
    JEL: E13 E32 E44 E52 G12
    Date: 2020–12–08
  19. By: Li, Ye (Ohio State U); Mayer, Simon (Erasmus U Rotterdam)
    Abstract: In a dynamic model of stablecoins, we show that even with over-collateralization, a pledge of one-to-one convertibility to a reference currency is not sustainable in a stochastic environment. The distribution of states is bimodal--a fixed exchange rate can persist, but debasement happens with a positive probability and recovery is slow. When negative shocks drain the reserves that back stablecoins, debasement allows the issuer to share risk with users. Collateral requirements cannot eliminate debasement, because risk sharing is ex-post efficient under any threat of costly liquidation, whether it is due to reserve depletion or violation of regulation. Optimal stablecoin management requires a combination of strategies commonly observed in practice, such as open market operations, transaction fees or subsidies, re-pegging, and issuance and repurchase of "secondary units" that function as stablecoin issuers' equity. The implementation varies with user-network effects and is guided by Tobin's q of transaction data as productive capital.
    JEL: E41 E42 E51 E52 F31 G12 G18 G21 G31 G32 G35 L14 L86
    Date: 2020–12
  20. By: Alexei Karas; William Pyle; Koen Schoors
    Abstract: Using evidence from Russia, we explore the effect of the introduction of deposit insurance on bank risk. Drawing on variation in the ratio of firm deposits to total household and firm deposits before the announcement of deposit insurance, so as to capture the magnitude of the decrease in market discipline after the introduction of deposit insurance, we demonstrate that larger declines in market discipline generate larger increases in traditional measures of risk. These results hold in a difference-in-difference setting in which private domestic banks serve as the treatment group and state and foreign-owned banks, whose deposit insurance regime does not change, serve as a control group.
    Keywords: deposit insurance, market discipline, moral hazard, risk taking, banks, Russia
    JEL: G21 G28 P34
    Date: 2021
  21. By: Pegoraro, Stefano; Montagna, Mattia
    Abstract: After the announcement of the European Central Bank’s corporate quantitative easing program, non-financial corporations timed the bond market by shifting their issuance toward bonds eligible for the program. However, issuers of eligible bonds did not increase total issuance compared to other issuers; nor did they experience different economic outcomes. Instead, the announcement produced substantial spillover effects on risk premia. Credit risk premia declined, both in the corporate bond market and in the default swap market, whereas the valuation of eligible bonds did not change relative to comparable ineligible bonds. Firms took advantage of reduced risk premia by issuing riskier bond types. Using a novel and comprehensive dataset of corporate bonds in the euro area, we document how firms substituted across bond characteristics, and we find evidence of their intention to time the market. Our model indicates corporate market timing is instrumental in allowing quantitative easing to produce spillover effects. JEL Classification: G32, G12, E52, E58, E44
    Keywords: corporate bonds, CSPP, market timing, quantitative easing, risk premia
    Date: 2021–01
  22. By: Oleg Itskhoki
    Abstract: The real exchange rate (RER) measures relative price levels across countries, capturing deviations from purchasing power parity (PPP). RER is a key variable in international macroeconomic models as it is central to equilibrium conditions in both goods and asset markets. It is also one of the most starkly-behaved variables empirically, tightly co-moving with the nominal exchange rate and virtually uncorrelated with most other macroeconomic variables, nominal or real. This survey lays out an equilibrium framework of RER determination, focusing separately on each building block and discussing corresponding empirical evidence. We emphasize home bias and incomplete pass-through into prices with expenditure switching and goods market clearing, imperfect international risk sharing, country budget constraint and monetary policy regime. We show that RER is inherently a general-equilibrium variable, which depends on the full model structure and policy regime, and therefore partial theories like PPP are insufficient to explain it. We also discuss issues of stationarity and predictability of exchange rates.
    JEL: E31 F31 F41 G15
    Date: 2020–12
  23. By: Bolton, Patrick (Columbia U and Imperial College London); Li, Ye (Ohio State U); Wang, Neng (Columbia U); Yang, Jinqiang (Shanghai U of Finance and Economics)
    Abstract: We propose a dynamic theory of banking where the role of deposits is akin to that of productive capital in the classical Q-theory of investment for non-financial firms. As a key source of leverage, deposits create value for well-capitalized banks. However, unlike productive capital of nonfinancial firms that typically has a positive marginal q, the deposit q can turn negative for undercapitalized banks. Demand deposit accounts commit banks to allow holders to withdraw or deposit funds at will, so banks cannot perfectly control leverage. Therefore, for banks with insufficient capital to buffer risk, deposit inflow destroys value through the uncertainty it brings in future leverage. This intertemporal channel complements the focus of static models on value destruction of deposit outflow and bank run. Our model predictions on bank valuation and dynamic asset-liability management are broadly consistent with the evidence. Moreover, our model lends itself to a re-evaluation of the costs and benefits of leverage regulation, offers alternative perspectives on banking in a low interest rate environment, and reveals new aspects of deposit market power that has unique implications on bank franchise value.
    JEL: E4 E5 G21 G3
    Date: 2020–12
  24. By: Sayuj Choudhari; Richard Licheng Zhu
    Abstract: In normal times, it is assumed that financial institutions operating in non-overlapping sectors have complementary and distinct outcomes, typically reflected in mostly uncorrelated outcomes and asset returns. Such is the reasoning behind common "free lunches" to be had in investing, like diversifying assets across equity and bond sectors. Unfortunately, the recurrence of crises like the Great Financial Crisis of 2007-2008 demonstrate that such convenient assumptions often break down, with dramatic consequences for all financial actors. In hindsight, the emergence of systemic risk (as exemplified by failure in one part of a system spreading to ostensibly unrelated parts of the system) has been explained by narratives such as deregulation and leverage. But can we diagnose and quantify the ongoing emergence of systemic risk in financial systems? In this study, we focus on two previously-documented measures of systemic risk that require only easily available time series data (eg monthly asset returns): cross-correlation and principal component analysis. We apply these tests to daily and monthly returns on hedge fund indexes and broad-based market indexes, and discuss their results. We hope that a frank discussion of these simple, non-parametric measures can help inform legislators, lawmakers, and financial actors of potential crises looming on the horizon.
    Date: 2021–01

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