nep-cba New Economics Papers
on Central Banking
Issue of 2021‒03‒08
twenty-six papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. The New Monetary Policy Revolution: Advice and Dissent By Philip Turner
  2. The ECB monetary policy response to the Covid-19 crisis By Pablo Aguilar; Óscar Arce; Samuel Hurtado; Jaime Martínez-Martín; Galo Nuño; Carlos Thomas
  3. The more the merrier? Evidence from the global financial crisis on the value of multiple requirements in bank regulation By Buckmann, Marcus; Gallego Marquez, Paula; Gimpelewicz, Mariana; Kapadia, Sujit; Rismanchi, Katie
  4. Talking in a language that everyone can understand? Transparency of speeches by the ECB Executive Board By Glas, Alexander; Müller, Lena
  5. Euro area house price fluctuations and unconventional monetary policy surprises By Hülsewig, Oliver; Rottmann, Horst
  6. How persistent is inflation in Kazakhstan? A fractionally integrated approach By Alisher Tolepbergen
  7. Monetary policy shocks and inflation inequality By Christoph Lauper; Giacomo Mangiante
  8. Central bank currency swap lines By Enrique Esteban García-Escudero; Elisa J. Sánchez Pérez
  9. How to issue a central bank digital currency By David Chaum; Christian Grothoff; Thomas Moser
  10. Learning, expectations and monetary policy By Pablo Garcia
  11. Evolving United States Stock Market Volatility: The Role of Conventional and Unconventional Monetary Policies By Vasilios Plakandaras; Rangan Gupta; Mehmet Balcilar; Qiang Ji
  12. COVID-19 Crisis: Lessons Learned for Future Policy Research By Jean-Sébastien Fontaine; Corey Garriott; Jesse Johal; Jessica Lee; Andreas Uthemann
  13. A note of caution on quantifying banks' recapitalization effects By Schmidt, Kirsten; Noth, Felix; Tonzer, Lena
  14. Solvency distress contagion risk: network structure, bank heterogeneity and systemic resilience By Abduraimova, Kumushoy; Nahai-Williamson, Paul
  15. Three green financial policies to address climate risks By Francesco Lamperti; Valentina Bosetti; Andrea Roventini; Massimo Tavoni; Tania Treibich
  16. Optimal policy with occasionally binding constraints: piecewise linear solution methods By Harrison, Richard; Waldron, Matt
  17. The Japanese banks in the lasting low-, zero- and negative-interest rate environment By Schnabl, Gunther; Murai, Taiki
  18. The role of labor market structure and shocks for monetary policy in Kazakhstan By Alisher Tolepbergen
  19. Unconventional monetary policy and corporate bond issuance By De Santis, Roberto A.; Zaghini, Andrea
  20. Deposit Insurance and Depositor Behavior: Evidence from Colombia By Nicolás de Roux; Nicola Limodio
  21. Is inflation targeting a strategy past its sell-by date? By Alberto Locarno; Alessandra Locarno
  22. ECB-Global 2.0: a global macroeconomic model with dominant-currency pricing, tariffs and trade diversion By Georgiadis, Georgios; Hildebrand, Sebastian; Ricci, Martino; Schumann, Ben; van Roye, Björn
  23. Thoughts on the design of a European Recovery Fund By Óscar Arce; Iván Kataryniuk; Paloma Marín; Javier J. Pérez
  24. On the origin of systemic risk By Montagna, Mattia; Torri, Gabriele; Covi, Giovanni
  25. Too-big-to-fail Reforms and Systemic Risk By Kakuho Furukawa; Hibiki Ichiue; Yugo Kimura; Noriyuki Shiraki
  26. Macroprudential policy interactions in a sectoral DSGE model with staggered interest rates By Hinterschweiger, Marc; Khairnar, Kunal; Ozden, Tolga; Stratton, Tom

  1. By: Philip Turner
    Abstract: Central banks have undertaken a revolution in monetary policy. They reluctantly abandoned conventional wisdom designed to keep them out of political trouble. This paper looks at this revolution through the lens of the divergent perspectives of the IMF and the BIS. The Jeremiahs predicted this revolution would fail to reduce unemployment and lead only to financial ruin. The Jeremiahs were proved wrong on both counts. Radical whatever-it-takes monetary expansion rescued a depressed world economy. Regulatory reform kept financial risks in check. Because central banks now have two distinct monetary policy instruments - their balance sheet as well as the policy interest rate - monetary policy may have financial stability as an objective in addition to its traditional macroeconomic one. The questions for 2021 and beyond are two. The first is: if the mix of large balance sheets, a sudden jump in government debt and yet-to-be-determined regulatory failures creates new financial stability or macroeconomic risks, what should central banks do? The second is: will governments let them?
    Keywords: Monetary policy, financial stability, financial crisis, fiscal dominance, QE, lender of last resort, macroprudential policy, central banks, Fed, ECB, Bank of England, Bank of Japan, Basel Committee, BIS, CGFS, FSB, IEO, IMF
    JEL: E52 E58 G18
    Date: 2021–02
  2. By: Pablo Aguilar (Banco de España); Óscar Arce (Banco de España); Samuel Hurtado (Banco de España); Jaime Martínez-Martín (Banco de España); Galo Nuño (Banco de España); Carlos Thomas (Banco de España)
    Abstract: The ECB has responded forcefully to the challenges posed by the COVID-19 crisis for the euro area economy. This paper reviews the different monetary policy measures adopted by the ECB since the COVID-19 outbreak and explains their rationale. It also looks at several analyses of the impact of some of the main measures on both the Spanish economy and that of the euro area as a whole.
    Keywords: European Central Bank, asset purchases, refinancing operations
    JEL: E44 E52 E58
    Date: 2020–10
  3. By: Buckmann, Marcus (Bank of England); Gallego Marquez, Paula (Bank of England); Gimpelewicz, Mariana (Bank of England); Kapadia, Sujit (European Central Bank); Rismanchi, Katie (Bank of England)
    Abstract: This paper assesses the value of multiple requirements in bank regulation using a novel empirical rule‑based methodology. Exploiting a dataset of capital and liquidity ratios for a sample of global banks in 2005 and 2006, we apply simple threshold-based rules to assess how different regulations individually and in combination might have identified banks that subsequently failed during the global financial crisis. Our results generally support the case for a small portfolio of different regulatory metrics. Under the objective of correctly identifying a high proportion of banks which subsequently failed, we find that a portfolio of a leverage ratio, a risk-weighted capital ratio, and a net stable funding ratio yields fewer false alarms than any of these metrics individually – and at less stringent calibrations of each individual regulatory metric. We also discuss how these results apply in different robustness exercises, including out-of-sample evaluations. Finally, we consider the potential role of market-based measures of bank capitalisation, showing that they provide complementary value to their accounting-based counterparts.
    Keywords: Banking regulation; Basel III; bank failure; global financial crisis; marketbased metrics; regulatory complexity
    JEL: G01 G18 G21 G28
    Date: 2021–01–29
  4. By: Glas, Alexander; Müller, Lena
    Abstract: Using novel data on speeches held by members of the European Central Bank's Executive Board, we investigate whether monetary policy transparency has increased over time. With respect to the general public as the target audience, our findings suggest that the European Central Bank successfully improved the frequency and clarity of information provision since its inception. The increase in transparency is gradual, rather than being induced by changes in the Executive Board's composition or major economic events such as the Great Recession. However, the clarity of speeches in recent years is still fairly low. Moreover, our findings indicate that clarity decreased under Christine Lagarde's presidency following the outbreak of the Coronavirus pandemic. We conclude that while the European Central Bank was able to increase transparency over time, further improvements in clarity are required to make monetary policy truly accessible to the broad public.
    Keywords: Central Bank Communication,Monetary Policy Transparency,Clarity,Readability
    JEL: E52 E58
    Date: 2021
  5. By: Hülsewig, Oliver; Rottmann, Horst
    Abstract: This paper examines the reaction of house prices in a panel of euro area countries to monetary policy surprises over the period 2010-2019. UsingJordà's (2005) local projection method, we find that house prices rise in response to expansionary monetary policy shocks that can be related to unconventional monetary policy measures. Thus, monetary policy should take into account the risk of house price fluctuations when implementing new large scale policy interventions.
    Keywords: House price fluctuations,unconventional monetary policy,local projection method
    JEL: E52 E58 E32 G21
    Date: 2021
  6. By: Alisher Tolepbergen (NAC Analytica, Nazarbayev University)
    Abstract: The paper analyzes persistence properties of monthly inflation and its components in Kazakhstan using fractionally integrated approach for the period between February 2001 and June 2020. The results suggest the presence of long memory behavior in inflation series. General inflation, food inflation, and non-food inflation experience a break in late 2015 when the National Bank of Kazakhstan announced a shift in the monetary policy regime. The evidence for the effect of the policy change on inflation persistence is mixed. Non-food inflation is fractionally cointegrated with the nominal depreciation rate. Finally, the estimation of persistence parameter is sensitive to the choice of data frequency.
    Keywords: Inflation; persistence; fractional integration
    JEL: C22 E31
    Date: 2020–09
  7. By: Christoph Lauper; Giacomo Mangiante
    Abstract: We evaluate household-level inflation rates since 1980, for which we compute various dispersion measures, and we assess their reaction to monetary policy shocks. We find that (i) contractionary monetary policy significantly and persistently decreases inflation dispersion in the economy, and that (ii) different demographic groups are heterogeneously affected by monetary policy. Due to different consumption bundles, lower-income households experience higher average inflation, which at the same time is decreasing more after a contractionary monetary policy shock, leading to an overall convergence of inflation rates between income groups. Finally, these results imply that (iii) consumption and income inequality are significantly different when controlling for different inflation rates.
    Keywords: monetary policy, inflation inequality, redistributional effects
    JEL: E31 E52
    Date: 2021–01
  8. By: Enrique Esteban García-Escudero (Banco de España); Elisa J. Sánchez Pérez (Banco de España)
    Abstract: As the US dollar plays a pivotal role in international trade and financial markets, non-US banks’ reliance on short-term wholesale funding markets (such as repo, commercial paper, certificate of deposit and swap markets) to finance their dollar assets makes them especially vulnerable to shocks in these markets, such as those arising from the global financial and COVID-19 crises. The crisis management mechanisms in place before the global financial crisis (the International Monetary Fund and international reserves) were overwhelmed by it. Only the rapid deployment of an international currency swap network, as a result of policy cooperation between the main global central banks, allowed equilibrium between dollar supply and demand to be restored and the severest consequences of the market strains for non-US banks to be avoided.
    Keywords: central bank swap lines, IMF, International Monetary System, dollar funding, non-US banks, global financial crisis, COVID-19 crisis, cross-currency basis, international lender of last resort
    JEL: E41 E51 E58 F34
    Date: 2020–09
  9. By: David Chaum; Christian Grothoff; Thomas Moser
    Abstract: With the emergence of Bitcoin and recently proposed stablecoins from BigTechs, such as Diem (formerly Libra), central banks face growing competition from private actors offering their own digital alternative to physical cash. We do not address the normative question whether a central bank should issue a central bank digital currency (CBDC) or not. Instead, we contribute to the current research debate by showing how a central bank could do so, if desired. We propose a token-based system without distributed ledger technology and show how earlier-deployed, software-only electronic cash can be improved upon to preserve transaction privacy, meet regulatory requirements in a compelling way, and offer a level of quantum-resistant protection against systemic privacy risk. Neither monetary policy nor financial stability would be materially affected because a CBDC with this design would replicate physical cash rather than bank deposits.
    Keywords: Digital currencies, central bank, CBDC, blind signatures, stablecoins
    JEL: E42 E51 E52 E58 G2
    Date: 2021
  10. By: Pablo Garcia
    Abstract: I present a New Keynesian model in which the central bank’s anti-inflationary preferences change over time. Agents do not observe the current monetary regime, but rationally learn about it using Bayes theorem. The model provides a structural interpretation for the contractionary effects of monetary policy uncertainty shocks as recently documented in the empirical literature. In addition, the model shows that learning reduces the effects of monetary policy on the economy by softening the link between fundamentals and equilibrium prices and allocations.
    Keywords: C11, D83, E52
    JEL: C11 D83 E52
    Date: 2021–02
  11. By: Vasilios Plakandaras (Department of Economics, Democritus University of Thrace, Komotini, 69100, Greece); Rangan Gupta (Department of Economics, University of Pretoria, Private Bag X20, Hatfield, 0028, South Africa); Mehmet Balcilar (Eastern Mediterranean University, Famagusta, via Mersin 10, Northern Cyprus, Turkey); Qiang Ji (Institutes of Science and Development, Chinese Academy of Sciences, Beijing, China; School of Public Policy and Management, University of Chinese Academy of Sciences, Beijing, China)
    Abstract: Despite the econometric advances of the last 30 years, the effects of monetary policy stance during the boom and busts of the stock market are not clearly defined. In this paper, we use a structural heterogenous vector autoregressive (SHVAR) model with identified structural breaks to analyze the impact of both conventional and unconventional monetary policies on the U.S. stock market volatility. We find that contractionary monetary policy enhances stock market volatility, but the importance of monetary policy shocks in explaining volatility evolves across different regimes and is relative to supply shocks (and shocks to volatility itself). In comparison to business cycle fluctuations, monetary policy shocks explain a greater fraction of the variance of stock market volatility at shorter horizons, as in medium to longer horizons. Our basic findings of a positive impact of monetary policy on equity market volatility (being relatively stronger during calmer stock markets periods) is also corroborated by analyses conducted at the daily frequency based on an augmented heterogenous autoregressive model of realized volatility (HAR-RV) and a multivariate k-th order nonparametric causality-in-quantiles framework, respectively. Our results have important implications both for investors and policymakers.
    Keywords: Stock Market Volatility, Conventional and Unconventional Monetary Policies, Structural Breaks, Structural Heterogenous Vector Autoregressive Model, Multivariate Nonparametric higher-Order Causality-in-Quantiles Test, Intraday Data
    JEL: C22 C32 E32 E52 G10
    Date: 2021–02
  12. By: Jean-Sébastien Fontaine; Corey Garriott; Jesse Johal; Jessica Lee; Andreas Uthemann
    Abstract: Fixed-income markets were disrupted at the beginning of the COVID-19 crisis. We document the sources of this disruption in Canada. As whole industries temporarily shut down, businesses and households ran down their savings or needed credit to survive income losses. As volatility increased, portfolio managers sold securities to manage their leveraged exposures or meet actual and anticipated margin calls and redemption requests. In financial markets, a substantial part of the demand for money came from asset managers. When the dealer arms of commercial banks approached their internal risk limits, the demand for money outpaced their willingness to deal or lend against securities, and trading costs rose in core and peripheral funding markets. The unprecedented scale of interventions by the Bank of Canada and other central banks raises questions that we pose for future policy research. Can central banks’ policies and crisis interventions in financial markets better reflect the growing role that asset managers play in the financial system? And can the structure of financial markets be made less reliant on the capacity of banks to supply money?
    Keywords: Coronavirus disease (COVID-19); Financial markets; Monetary policy
    JEL: D47 E41 E5 G01 G14 G20 G21 G23
  13. By: Schmidt, Kirsten; Noth, Felix; Tonzer, Lena
    Abstract: Unconventional monetary policy measures like asset purchase programs aim to reduce certain securities' yield and alter financial institutions' investment behavior. These measures increase the institutions' market value of securities and add to their equity positions. We show that the extent of this recapitalization effect crucially depends on the securities' accounting and valuation methods, country-level regulation, and maturity structure. We argue that future research needs to consider these factors when quantifying banks' recapitalization effects and consequent changes in banks' lending decisions to the real sector.
    Keywords: Unconventional monetary policy,security valuation,capital regulation
    JEL: G21 G28 E52 E58
    Date: 2021
  14. By: Abduraimova, Kumushoy (Imperial College Business School); Nahai-Williamson, Paul (Bank of England)
    Abstract: We systematically analyse how network structure and bank characteristics affect solvency distress contagion risk in interbank networks. As interbank networks become more connected and more regular in structure, the contagion risk of system-wide shocks and individual bank defaults initially increases and then decreases, all else being equal. The low density heterogeneous network structures that typify real interbank networks are particularly prone to solvency distress contagion risk, when banks are similar in balance sheet size and capitalisation. However, when networks are calibrated to UK data, the higher capitalisation of large, highly-connected banks relative to their interbank exposures significantly increases the resilience of the system and reduces the importance of network structure. These findings reinforce the importance and effectiveness of imposing higher capital buffers on systemically important banks and of policies that limit interbank exposures. We also demonstrate that for real-world interbank networks, simple network metrics other than individual bank connectedness do not provide robust indicators for monitoring solvency contagion risk, suggesting that policymakers should continue efforts to model these risks explicitly rather than rely on simple aggregate indicators.
    Keywords: Financial networks; systemic risk; financial contagion; banking policy
    JEL: C54 D85 G01 G21 G28
    Date: 2021–02–26
  15. By: Francesco Lamperti; Valentina Bosetti; Andrea Roventini; Massimo Tavoni; Tania Treibich
    Abstract: Which policies can increase the resilience of the financial system to climate risks? Recent evidence on the significant impacts of climate change and natural disasters on firms, banks and other financial institutions call for a prompt policy response. In this paper, we employ a macro-financial agent- based model to study the interaction between climate change, credit and economic dynamics and test a mix of policy interventions. We first show that financial constraints exacerbate the impact of climate shocks on the economy while, at the same time, climate damages to firms make the banking sector more prone to crises. We find that credit provision can both increase firms' productivity and their financial fragility, with such a trade-off being exacerbated by the effects of climate change. We then test a set of 'green' finance policies addressing these risks, while fostering climate change mitigation: i) green Basel-type capital requirements, ii) green public guarantees to credit, and iii) carbon-risk adjustment in credit ratings. All the three policies reduce carbon emissions and the resulting climate impacts, though moderately. However, their effects on financial and real dynamics is not straightforwardly positive. Some combinations of policies fuel credit booms, exacerbating financial instability and increasing public debt. We show that the combination of all three policies leads to a virtuous cycle of (mild) emission reductions, stable financial sector and high economic growth. Additional tools would be needed to fully adapt to climate change. Hence, our results point to the need to complement financial policies cooling down climate-related risks with mitigation policies curbing emissions from real economic activities.
    Keywords: Climate change; endogenous growth; financial stability; macroprudential policy; agent-based model.
    Date: 2021–02–21
  16. By: Harrison, Richard (Bank of England); Waldron, Matt (Bank of England)
    Abstract: This paper develops a piecewise linear toolkit for optimal policy analysis of linear rational expectations models, subject to occasionally binding constraints on (multiple) policy instruments and other variables. Optimal policy minimises a quadratic loss function under either commitment or discretion. The toolkit accounts for the presence of ‘anticipated disturbances’ to the model equations, allowing optimal policy analysis around scenarios or forecasts that are not produced using the model itself (for example, judgement-based forecasts such as those often produced by central banks). The flexibility and applicability of the toolkit to very large models is demonstrated in a variety of applications, including optimal policy experiments using a version of the Federal Reserve Board’s FRB/US model.
    Keywords: Optimal policy; commitment; discretion; occasionally binding constraints
    JEL: C61 C63 E61
    Date: 2021–02–26
  17. By: Schnabl, Gunther; Murai, Taiki
    Abstract: The bursting of the Japanese bubble economy in the early 1990s put the stage for a lasting lowzero-, and negative-interest rate environment, which fundamentally changed the business environment for the Japanese commercial banks. On the income side, with interest margins becoming increasingly depressed, net interest revenues declined, which forced the banks to expand revenues from fees and commissions. The banks had to cut costs by reducing the number of employees, closing branches and merging into larger banks. The gradual concentration process has most recently cumulated in the relaxation of the monopoly law. With the capital allocation function of banks being undermined, the Japanese economy has become zombified, suffering from anemic growth.
    Keywords: Japan,Bank of Japan,monetary policy,banks,interest margin,financial repression,concentration,regional banks
    JEL: E50 E52 G21
    Date: 2020
  18. By: Alisher Tolepbergen (NAC Analytica, Nazarbayev University)
    Abstract: In this paper we study the role of labor market structure and shocks for monetary policy in Kazakhstan employing a New Keynesian model with labor market rigidities. First, we examine to what extent more flexible labor market affects the transmission of monetary policy in the calibrated version of the model. The results show that more flexible wage-setting process improves the transmission mechanism. A monetary policy shock translates faster to inflation. Further, we find that the relevance of other features of labor market for the transmission of monetary policy shocks is limited. Second, we estimate the model using Bayesian techniques to identify labor market shocks that are important for monetary policy making. The estimation results suggest that shocks to the bargaining power of workers explain most of output and inflation fluctuations and thus should be closely monitored by the central bank.
    Keywords: DSGE; labor market; wage rigidity; Bayesian estimation
    JEL: E32 E52 J64 C11
    Date: 2020–12
  19. By: De Santis, Roberto A.; Zaghini, Andrea
    Abstract: We assess the effect and the timing of the corporate arm of the ECB quantitative easing (CSPP) on corporate bond issuance. Because of several contemporaneous mea- sures, to isolate the programme effects we rely on one key eligibility feature: the euro denomination of newly issued bonds. We find that the significant increase in bonds issuance by eligible firms is due to the CSPP and that this effect took at least six months to unfold. This result holds even when comparing firms with similar ratings, thus providing evidence that unconventional monetary policy can foster a financing diversification regardless of firms' risk profile. We also highlight the impact of the programme on the real economic activity. The evidence suggests that while all firms increased investment in capital expenditures and intangible assets, the CSPP induced eligible firms to invest in marketable and equity securities, to repurchase their own stocks, to hold cash and to carry out short-term investment.
    Keywords: quantitative easing,CSPP,corporate bond market
    JEL: E52 G15 G32
    Date: 2021
  20. By: Nicolás de Roux; Nicola Limodio
    Abstract: We exploit a large and unexpected increase in the Colombian insurance threshold to investigate how depositors respond to higher deposit insurance. Monthly depositor-level records from a major bank show that the level and growth rate of deposits rise with higher coverage. Individuals who were fully and nearly-fully insured before the policy drive this increment. A survey of bank customers indicates that higher deposits were replenished by lowering cash and other assets. We estimate an elasticity of deposit growth to deposit insurance of 0.4%, and fi nd a similar fi gure in the United States by leveraging the 2008 increase in deposit insurance.
    Keywords: Banking, Financial Regulation, Household Saving.
    JEL: G21 G28 G51
    Date: 2021–02–17
  21. By: Alberto Locarno (Bank of Italy); Alessandra Locarno (Libera Universita Internazionale degli Studi Sociali "Guido Carli")
    Abstract: In this paper we compare alternative monetary policy strategies to assess which one is best suited (1) to reduce output and inflation volatility and at the same time (2) minimise the frequency and costs of ZLB episodes. We consider only targeting rules, i.e. rules that minimise the loss function assigned by the Government to the monetary policymaker, who is assumed to set the policy rate under discretion. We run a horse race among eight different strategies. Our analysis confirms the theoretical findings by Svensson (1999) and Vestin (2006) that price-level targeting can guarantee a better performance than inflation targeting in terms of both of the criteria described above. These findings are valid regardless of whether interest-rate variability is included in the loss function or not and are robust to changes in model parameters. Nominal GDP-level targeting also performs well: though it is not uniformly superior to inflation targeting or average inflation targeting, it succeeds in ensuring better outcomes over a large range of model parameters and social preferences.
    Keywords: E ective lower bound, infl ation targeting, price-level targeting
    JEL: E31 E37 E52 E58
    Date: 2021–02
  22. By: Georgiadis, Georgios; Hildebrand, Sebastian; Ricci, Martino; Schumann, Ben; van Roye, Björn
    Abstract: In a highly interlinked global economy a key question is how foreign shocks transmit to the domestic economy, how domestic shocks affect the rest of the world, and how policy actions mitigate or amplify spillovers. For policy analysis in such a context global multi-country macroeconomic models that allow a structural interpretation are needed. In this paper we present a revised version of ECB-Global, the European Central Bank's global macroeconomic model. ECB-Global 2.0 is a semi-structural, global multi-country model with rich channels of international shock propagation through trade, oil prices and global financial markets for the euro area, the US, Japan, the UK, China, oil-exporting economies, Emerging Asia, and a rest-of-the-world block. Relative to the original version of model, ECB-Global 2.0 features dominant-currency pricing, tariffs and trade diversion. We illustrate the usefulness of ECB-Global exploring scenarios motivated by recent trade tensions between China and the US. JEL Classification: C51, E30, E50
    Keywords: macro-modelling, multi-country models, spillovers
    Date: 2021–03
  23. By: Óscar Arce (Banco de España); Iván Kataryniuk (Banco de España); Paloma Marín (Banco de España); Javier J. Pérez (Banco de España)
    Abstract: The European Union (EU) requires swift, lasting and sufficient action to combat the health and economic crisis triggered by COVID-19. The ECB and EU Council’s responses have been effective in mitigating the short-term impact of the crisis and reducing the risks of it becoming protracted by enabling the Member States (MSs) to mobilise a significant volume of funds. Nevertheless, the scale of the crisis has underlined the absence of key shared economic policy instruments. This article analyses the conditions required for an effective European response to the crisis and its possible consequences in the future. First, the article outlines the basic features which should underpin a recovery strategy based on providing a joint response to common structural challenges (the fight against climate change, digitalisation, higher investment in public health and disease prevention, and a restructuring of broad areas of the productive system) with fresh funds and a renewed reform drive. Second, a design proposal for a “Recovery Fund” is set out. Funds will be mobilised with the twofold objective of maintaining suitable financing conditions for MSs’ sovereign debt (which requires giving the Fund the capacity to purchase government debt securities for an extended period of time) and boosting the financing of specific structural projects aligned with the strategic needs of the EU as a whole. This instrument must be efficient (governed by the principle of a suitable and proportionate use of public funds), show solidarity (by making its funds particularly available to those who most need them), be balanced (by eliminating permanent transfer risks resulting from the opportunistic behaviour of Member States) and have conditions attached to ensure that the funds are used to advance the objectives of the recovery strategy. Insofar as its creation is tied to a medium and long-term European strategy, the Fund’s effectiveness should be geared to covering a very extensive time frame, potentially laying the foundations for a permanent structure. And it should be backed by the EU budget, duly strengthened by additional funds from the MSs and receipts from the future introduction of new EU-wide taxes.
    Keywords: Recovery Fund, sovereign debt, European economic governance, European Union, fiscal policy
    JEL: E02 E62 F55
    Date: 2020–05
  24. By: Montagna, Mattia (European Central Bank); Torri, Gabriele (University of Bergamo); Covi, Giovanni (Bank of England)
    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 (ie 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 €23.2 trillion of euro-area banks’ total assets over the period 2014–2018. The outputs 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.
    Keywords: Systemic risk; financial contagion; microstructural models
    JEL: D85 G17 G33 L14
    Date: 2021–01–29
  25. By: Kakuho Furukawa (Bank of Japan); Hibiki Ichiue (Bank of Japan); Yugo Kimura (Bank of Japan); Noriyuki Shiraki (Bank of Japan)
    Abstract: We examine the effects of too-big-to-fail reforms using ĢCoVaR and SRISK. Developments in these market-based systemic risk measures suggest that the reforms have led to a larger decline in the systemic risk contribution of global systemically important banks (G-SIBs) than of other banks. The systemic risk measures also suggest that the larger the systemic risk associated with a G-SIB, the more the reforms have led to a decline in its systemic risk. These findings are consistent with the objectives of the reforms and are validated by statistical analyses, including quantile panel regressions. We also highlight the importance of using data for a subset of financial institutions to adjust for the increase in data coverage when using popular estimates of SRISK. Furthermore, SRISK may overestimate systemic risk in recent years by ignoring the role of total loss absorbing capacity (TLAC)-eligible bonds.
    Keywords: Too Big to Fail, Systemic Risk, Financial Regulations, CoVaR, SRISK
    JEL: G21 G23 G28
  26. By: Hinterschweiger, Marc (Bank of England); Khairnar, Kunal (Toulouse School of Economics); Ozden, Tolga (University of Amsterdam); Stratton, Tom (Bank of England)
    Abstract: We develop a two-sector DSGE model with a detailed banking sector along the lines of Clerc et al (2015) to assess the impact of macroprudential tools (minimum, countercyclical and sectoral capital requirements, as well as a loan-to-value limit) on key macroeconomic and financial variables. The banking sector features residential mortgages and corporate lending subject to staggered interest rates à la Calvo (1983), which is motivated by the sluggish movement of lending rates due to fixed interest rate loan contracts. Other distortions in the model include limited liability, bankruptcy costs and penalty costs for deviations from regulatory capital. We estimate the model using Bayesian methods based on quarterly UK data over 1998 Q1–2016 Q2. Our contributions are threefold. We show that: (i) co-ordination of macroprudential tools may have a welfare-improving effect, (ii) macroprudential tools would have improved some macroeconomic indicators but, within our model, not have prevented the Global Financial Crisis, (iii) staggered interest rates may alter the transmission of macroprudential tools that work through interest rates.
    Keywords: Sectoral DSGE model; macroprudential policy; interest rate stickiness
    JEL: E32 E58 G18 G21
    Date: 2021–01–22

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