nep-cba New Economics Papers
on Central Banking
Issue of 2021‒07‒26
24 papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Debt Management in a World of Fiscal Dominance By Boris Chafwehé; Charles de Beauffort; Rigas Oikonomou
  2. Sequencing Extended Monetary Policies at the Effective Lower Bound By Yang Zhang; Lena Suchanek; Jonathan Swarbrick; Joel Wagner; Tudor Schlanger
  3. Supplementary Paper Series for the "Assessment" (3): Inflation-Overshooting Commitment:An Analysis Using a Macroeconomic Model By Takuji Kawamoto; Jouchi Nakajima; Tomoaki Mikami
  4. The fuel of unparalleled recovery: Monetary policy in South Africa between 1925 and 1936 By Swanepoel, Christie; Fliers, Philip
  5. Monetary Policy Risk: Rules vs. Discretion By David Backus; Mikhail Chernov; Stanley E. Zin; Irina Zviadadze
  6. Sectoral shocks and monetary policy in the United Kingdom By Dixon, Huw; Franklin, Jeremy; Millard, Stephen
  7. Tracking ECB's communication: Perspectives and Implications for Financial Markets By FORTES, Roberta; Le Guenedal, Theo
  8. "Multifactor Keynesian Models of the Long-Term Interest Rate" By Tanweer Akram
  9. Oligopoly Banking, Risky Investment, and Monetary Policy By Altermatt, Lukas; Wang, Zijian
  10. Hierarchical contagions in the interdependent financial network By William A. Barnett; Xue Wang; Hai-Chuan Xu; Wei-Xing Zhou
  11. Impulse-Based Computation of Policy Counterfactuals By James Hebden; Fabian Winkler
  12. Foreign Exchange Intervention, Capital Flows, and Liability Dollarization By Paul Castillo; Juan Pablo Medina
  13. Incentive compatible relationship between the ERM II and close cooperation in the Banking Union: the cases of Bulgaria and Croatia By María J. Nieto; Dalvinder Singh
  14. Un-used Bank Capital Buffers and Credit Supply Shocks at SMEs during the Pandemic By Jose M. Berrospide; Arun Gupta; Matthew P. Seay
  15. What are the main differences between the practice of supervising large banks in the UK and in the euro area, and what are the main risks of regulatory divergence? By Haselmann, Rainer; Tröger, Tobias
  16. Sowing the Seeds of Financial Crises: Endogenous Asset Creation and Adverse Selection By Nicolas Caramp
  17. Money Aggregates, Debt, Pent-Up Demand, and Inflation: Evidence from WWII By Federico S. Mandelman
  18. Bail-in and Bank Funding Costs By Vittoria Cerasi; Paola Galfrascoli
  19. Capital ratios and banking crises in the European Union By Raphaël Cardot-Martin; Fabien Labondance; Catherine Refait-Alexandre
  20. Interest rate skewness and biased beliefs By Bauer, Michael; Chernov, Mikhail
  21. The eurozone: what is to be done? By Minford, Patrick; Ou, Zhirong; Wickens, Michael; Zhu, Zheyi
  22. Bitcoin, Currencies, and Bubbles By Nassim Nicholas Taleb
  23. Capital Requirements and Claims Recovery: A New Perspective on Solvency Regulation By Cosimo Munari; Lutz Wilhelmy; Stefan Weber
  24. Inside the black box: tools for understanding cash circulation By Luca Baldo; Elisa Bonifacio; Marco Brandi; Michelina Lo Russo; Gianluca Maddaloni; Andrea Nobili; Giorgia Rocco; Gabriele Sene; Massimo Valentini

  1. By: Boris Chafwehé (European Commission - JRC); Charles de Beauffort (Université Catholique de Louvain); Rigas Oikonomou (Université Catholique de Louvain)
    Abstract: We study the impact of debt maturity management in an economy where monetary policy is 'passive' and subservient to fiscal policy. We setup a tractable model, to characterize analytically the dynamics of inflation, as well as other macroeconomic variables, showing their dependence on the monetary policy rule and on the maturity of debt. Debt maturity becomes a key variable when the monetary authority reacts to inflation and the appropriate maturity of debt can restore the efficacy of monetary policy in controlling inflation. This requires debt management to focus on issuing long bonds. Moreover, we propose a novel framework of Ramsey optimal coordinated debt and monetary policies, to derive analytically the interest rate rule followed by the monetary authority as a function of debt maturity. The optimal policy model leads to the same prescription, long-term debt financing enables to stabilize inflation. Lastly, the relevance of debt maturity in reducing inflation variability is also confirmed in a medium scale DSGE model estimated with US data.
    Keywords: Passive Monetary Policy, Government Debt Management, Fiscal and Monetary Policy Interactions, Bayesian estimation, Ramsey policy.
    JEL: E31 E52 E58 E62 C11
    Date: 2021–07
  2. By: Yang Zhang; Lena Suchanek; Jonathan Swarbrick; Joel Wagner; Tudor Schlanger
    Abstract: In response to the global COVID-19 pandemic, the Bank of Canada aggressively lowered its policy interest rate and provided additional easing using forward guidance and quantitative easing. In this analysis, we use simulations in the Bank of Canada’s projection model—the Terms-of-Trade Economic Model—to consider a suite of extended monetary policies (EMPs) to support the economy following the COVID-19 crisis. We focus on the implementation sequencing of three EMP options when the policy rate is at the effective lower bound: credit easing, forward guidance and quantitative easing. We find that the policy mix that delivers the best outcome for the Canadian economy calls for immediately implementing forward guidance and quantitative easing, followed by credit easing when containment measures are lifted. Furthermore, going “full scale” and implementing all available EMP options effectively helps stabilizing the economy because each of these tools reinforces the others. We also quantify the fiscal response needed to offset the gap in gross domestic product created by the effective lower bound, given operational limitations in scaling up EMPs.
    Keywords: Coronavirus disease (COVID-19); Monetary policy; Monetary policy transmission
    JEL: E58
    Date: 2021–07
  3. By: Takuji Kawamoto (Bank of Japan); Jouchi Nakajima (Bank of Japan); Tomoaki Mikami (Bank of Japan)
    Abstract: In its "Inflation-Overshooting Commitment," the Bank of Japan commits to continuing to expand the monetary base until the year-on-year rate of increase in the CPI exceeds the price stability target of 2 percent and stays above the target in a stable manner. Through the commitment, the Bank of Japan is implementing a so-called "makeup strategy," which aims to offset a part of past inflation misses from the target by allowing actual inflation to overshoot the target for some time and thereby stabilizing average inflation over the business cycle. Existing studies have shown that such makeup strategies are actually effective for the U.S. economy. This paper examines the effectiveness of the makeup strategy for Japan's economy, where inflation expectations formation is known to be largely adaptive. Specifically, we build a small-scale macroeconomic model for Japan's economy and conduct simulation analysis to study the implications of adopting the makeup strategy for early achievement of the inflation target as well as the incurring social welfare costs. Simulation results show that when the inflation rate has been below the target, it is effective to stabilize average inflation by offsetting the past inflation misses over some makeup windows. In addition, the results suggest that when the natural rate of interest is lower, the optimal makeup window becomes longer.
    Keywords: Monetary Policy; Inflation-overshooting commitment; Makeup strategy; Average inflation targeting; Stochastic simulation
    JEL: C53 E31 E47 E52 E58
    Date: 2021–07–13
  4. By: Swanepoel, Christie; Fliers, Philip
    Abstract: The newly established South African Reserve Bank (SARB) was tasked to protect the currency by navigating the interwar gold standard, and, from March 1933, maintaining parity with the Pound Sterling. We find that South Africa's exit from gold secured an unparalleled and rapid recovery from the Great Depression. South Africa's exit was accompanied by an inextricable link of the SARB's policy rate to the interest rate set by the Bank of England (BoE). This sacrifice of independent monetary policy allowed the SARB to fix the country's exchange rate without impeding the flow of gold to London. The SARB fuelled the economy by reducing its policy rates and accumulating gold. Had South Africa not devalued, the country would have suffered a severe depression and persistent deflation. An alternative to the devaluation, was for the SARB to pursue a cheap money strategy. By setting interest rates historically low, we find that South Africa could have achieved higher levels of economic growth, at the cost of higher inflation. Ultimately, South Africa's unparalleled recovery can be ascribed to the devaluation, however the change in the SARB monetary policy and the bank's control over the gold markets were of paramount importance.
    Keywords: monetary policy management,interwar gold standard,South Africa
    JEL: N14 N20 E42 E52 E58 F33
    Date: 2021
  5. By: David Backus; Mikhail Chernov; Stanley E. Zin; Irina Zviadadze
    Abstract: Long-run asset-pricing restrictions in a macro term-structure model identify discretionary monetary policy separately from a policy rule. We find that policy discretion is an important contributor to aggregate risk. In addition, discretionary easing coincides with good news about the macroeconomy in the form of lower inflation, higher output growth, and lower risk premiums on short-term nominal bonds. However, it also coincides with bad news about long-term financial conditions in the form of higher risk premiums on long-term nominal bonds. Shocks to the rule correlate with changes in the yield curve’s level. Shocks to discretion correlate with changes in its slope.
    JEL: E43 E52 G12
    Date: 2021–07
  6. By: Dixon, Huw (Cardiff Business School); Franklin, Jeremy (Bank of England); Millard, Stephen (Bank of England, Centre for Macroeconomics and Durham University Business School.)
    Abstract: In this paper, we examine the extent to which monetary policy should respond to movements in sectoral inflation rates. To do this we construct a Generalised Taylor model that takes specific account of the sectoral make-up of the consumer price index (CPI). We calibrate the model for each sector using the UK CPI microdata. We find that a policy rule that allows for different responses to inflation in different sectors outperforms a rule which just targets aggregate CPI, as does a rule that responds only to non food and energy inflation. However, we find that the optimal sectoral rule only leads to a small absolute improvement in terms of extra consumption.
    Keywords: CPI inflation, Sectoral inflation rates, Generalised Taylor economy, Financial Intermediation
    JEL: E17 E31 E52
    Date: 2021–05
  7. By: FORTES, Roberta; Le Guenedal, Theo
    Abstract: This article assesses the communication of the European Central Bank (ECB) using Natural Language Processing (NLP) techniques. We show the evolution of discourse over time and capture the main themes of interest for the central bank that go beyond its traditional mandate of maintaining price stability, enlightening main concerns and themes of discussion among board members. We also built sentiment signals compatible with any form of language, both formal and informal, an important step as the ECB aims to enhance communication with non-expert audiences. In a second step, we measure the impact of the ECB's communication on the EUR/USD exchange rate. We found that our quantitative series, both topics and sentiment, improve financial-linked models consistently in all periods analyzed (2.5\% on average). Meaningful signals comprise a broad range of subjects and vary in time. This suggests that overall ECB's talk matters for asset prices, including themes not directly related to monetary policy. This result is particularly important in a context in which the ECB, as well as other major central banks, are moving towards integrating issues closer to the society into their scope of action, implying that subjects, which were considered peripheral, may become central. This emphasizes the importance for markets to effectively track central banks' communication to improve investment processes.
    Keywords: Quantitative trading, Central Bank, Fixed Income,Exchange Rates, Text mining, NLP, Euro
    JEL: C38 C63 E44 F3 F31 G12
    Date: 2020–12
  8. By: Tanweer Akram
    Abstract: This paper presents multifactor Keynesian models of the long-term interest rate. In recent years there have been a proliferation of empirical studies based on the Keynesian approach to interest rate modeling. However, standard multifactor models of the long-term interest rate in quantitative finance have not been yet incorporated Keynes's insights about interest rate dynamics. Keynes's insights about the influence of the current short-term interest rate are introduced in two different multifactor models of the long-term interest rate to illustrate how the long-term interest rate relates to the short-term interest rate, the central bank’s policy rate, inflation expectations, the central bank’s inflation target, volatility in financial markets, and Wiener processes.
    Keywords: Long-Term Interest Rate; Government Bond Yields; Monetary Policy; Short-Term Interest Rate; Inflation; Inflation Target; John Maynard Keynes
    JEL: E12 E43 E50 E58 E60 G10 G12 G41
    Date: 2021–07
  9. By: Altermatt, Lukas; Wang, Zijian
    Abstract: Oligopolistic competition in the banking sector and risk in the real economy are important characteristics of developed economies, but have so far mostly been abstracted from in monetary economics. We build a dynamic general equilibrium model of monetary policy transmission that incorporates both of these features and document that including them leads to important insights in our understanding of the transmission mechanism. Various equilibrium cases can occur, and policies have differing effects in these cases. We calibrate the model to the U.S. economy in 2016-2019 in order to study how changes in the degree of banking competition or the policy rate would have affected equilibrium outcomes. We find that doubling banking competition would have increased welfare by 1.02\%, but at the cost of increasing the probability of bank default from 0.02\% to 0.44\%. We further find that the policy rate was set optimally to minimize the probability of bank default, but that a decrease in the policy rate by 1pp would have increased welfare by 0.40\%. We also show that bank profits are increasing in the policy rate, in particular when interest rates are low. Thus, a 1pp reduction in the policy rate would have reduced profits per bank by 35.5\% in our calibrated economy. Finally, we document that monetary policy pass-through is incomplete under imperfect competition in the banking sector, as a change in the policy rate by 1pp leads to a change of only 0.92pp in the loan rate, while pass-through to the deposit rate is nearly complete for rate increases, but almost zero for rate reductions due to the zero-lower bound.
    Keywords: Oligopoly competition, Risky investment, Monetary policy, Financial intermediation
    Date: 2021–07–13
  10. By: William A. Barnett; Xue Wang; Hai-Chuan Xu; Wei-Xing Zhou
    Abstract: We model hierarchical cascades of failures among banks linked through an interdependent network. The interaction among banks include not only direct cross-holding, but also indirect dependency by holding mutual assets outside the banking system. Using data extracted from the European Banking Authority, we present the interdependency network composed of 48 banks and 21 asset classes. Since interbank exposures are not public, we first reconstruct the asset/liability cross-holding network using the aggregated claims. For the robustness, we employ three reconstruction methods, called $\textit{Anan}$, $\textit{Ha\l{}a}$ and $\textit{Maxe}$. Then we combine the external portfolio holdings of each bank to compute the interdependency matrix. The interdependency network is much denser than the direct cross-holding network, showing the complex latent interaction among banks. Finally, we perform macroprudential stress tests for the European banking system, using the adverse scenario in EBA stress test as the initial shock. For different reconstructed networks, we illustrate the hierarchical cascades and show that the failure hierarchies are roughly the same except for a few banks, reflecting the overlapping portfolio holding accounts for the majority of defaults. Understanding the interdependency network and the hierarchy of the cascades should help to improve policy intervention and implement rescue strategy.
    Date: 2021–06
  11. By: James Hebden; Fabian Winkler
    Abstract: We propose an efficient procedure to solve for policy counterfactuals in linear models with occasionally binding constraints. The procedure does not require knowledge of the structural or reduced-form equations of the model, its state variables, or its shock processes. Forecasts of the variables entering the policy problem, and impulse response functions of these variables to anticipated policy shocks under an arbitrary policy, constitute sufficient information to construct valid counterfactuals. We show how to compute solutions for instrument rules and optimal discretionary and commitment policies with multiple policy instruments, and discuss various extensions including imperfect information, asymmetric objectives, and limited commitment. Our procedure facilitates the comparison of the effects of policy regimes across models. As an application, we compute counterfactual paths of the US economy around 2015 for several monetary policy regimes.
    Keywords: Computation; DSGE; Occasionally Binding Constraints; Optimal Policy; Commitment; Discretion
    JEL: C61 C63 E52
    Date: 2021–07–15
  12. By: Paul Castillo (Central Bank of Peru); Juan Pablo Medina (Universidad Adolfo Ibanez, Chile)
    Abstract: This paper investigates the relevance of foreign exchange intervention in dealing with the global financial cycle in emerging economies. We show in a VAR analysis that a shock to global capital flows has a sizable effect on economic activity, and this effect is amplified in emerging economies with liability dollarization. However, countries that systematically rely on sterilized foreign exchange intervention display lower output and real exchange rate volatility in response to global capital flows shocks. We then develop a small open economy model with liability dollarization and balance sheets effects calibrated to an emerging economy. The model is consistent with the empirical evidence. Model simulations show that liability dollarization amplifies the effects of the global financial cycle and that foreign exchange intervention can reduce macroeconomic volatility and improve welfare. These results point to the importance of foreign exchange reserves in insulating emerging economies from shocks to global capital flows.
    Keywords: Foreign Exchange Intervention; Global Financial Cycle; Liability Dollarization; Balance Sheet Effects; Emerging Economies
    JEL: E58 F31 F41
    Date: 2021–06–25
  13. By: María J. Nieto (Banco de España); Dalvinder Singh (University of Warwick)
    Abstract: The goal of expanding participation in the European Banking Union was to allow the “outs” to enter into close cooperation, but it did not include the simultaneous joining of the Exchange Rate Mechanism (ERM II). Focusing on the cases of Bulgaria and Croatia, this paper attempts to respond to various questions. What is the rationale behind the double requirement of having simultaneously to apply to become a member of the ERM II and to prepare to become a member of the Banking Union via the rule-based “close-cooperation” coordination mechanism between the EU non-euro-area national competent authorities (NCAs) and the European Central Bank (ECB)? Does the integration of close-cooperation countries’ banking systems with the euro-area banking systems support the decision to join the ERM II and “opting in” to the Single Supervisory Mechanism (SSM)? What are the advantages of preparing to become a full member of the euro area and the SSM? It is evident from the research undertaken in this paper that there are clear benefits of close cooperation for these member states whose domestic currencies are already linked to the euro, in view of the dominant position eurozone banks have in their respective domestic markets. It is more difficult for a national central bank or NCA to exercise discretion in implementing ECB decisions once it is committed to the path leading to full European Monetary Union (EMU) membership. Hence the commitment to join the EMU minimises the authority risk for the ECB as well as for the Single Resolution Board, as safeguards become non-significant and termination is not an issue. The uncertainty about the functioning and durability of the close-cooperation arrangement is largely removed.
    Keywords: Banking Union, close cooperation, ERM II
    JEL: E02 E44 F15 G15 G21 H12 K23
    Date: 2021–07
  14. By: Jose M. Berrospide; Arun Gupta; Matthew P. Seay
    Abstract: Did banks curb lending to creditworthy small and mid-sized enterprises (SME) during the COVID-19 pandemic? Sitting on top of minimum capital requirements, regulatory capital buffers introduced after the 2008 global financial crisis (GFC) are costly regions of “rainy day†equity capital designed to absorb losses and provide lending capacity in a downturn. Using a novel set of confidential loan level data that includes private SME firms, we show that “buffer-constrained†banks (those entering the pandemic with capital ratios close to this regulatory buffer region) reduced loan commitments to SME firms by an average of 1.4 percent more (quarterly) and were 4 percent more likely to end pre-existing lending relationships during the pandemic as compared to “buffer-unconstrained†banks (those entering the pandemic with capital ratios far from the regulatory capital buffer region). We further find heterogenous effects across firms, as buffer-constrained banks disproportionately curtailed credit to three types of borrowers: (1) private, bank-dependent SME firms, (2) firms whose lending relationships were relatively young, and (3) firms whose pre-pandemic credit lines contractually matured at the start of the pandemic (and thus were up for renegotiation). While the post-2008 period saw the rise of banking system capital to historically high levels, these capital buffers went effectively unused during the pandemic. To the best of our knowledge, our study is the first to: (1) empirically test the usability of these Basel III regulatory buffers in a downturn, and (2) contribute a bank capital-based transmission channel to the literature studying the effects of the pandemic on SME firms.
    Keywords: Financial institutions; Capital regulation; Procyclicality; COVID-19
    JEL: G20 G21 G28
    Date: 2021–07–15
  15. By: Haselmann, Rainer; Tröger, Tobias
    Abstract: This in-depth analysis provides evidence on differences in the practice of supervising large banks in the UK and in the euro area. It identifies the diverging institutional architecture (partially supranationalised vs. national oversight) as a pivotal determinant for a higher effectiveness of supervisory decision making in the UK. The ECB is likely to take a more stringent stance in prudential supervision than UK authorities. The setting of risk weights and the design of macroprudential stress test scenarios document this hypothesis. This document was provided by the Economic Governance Support Unit at the request of the ECON Committee.
    Keywords: Bank Supervision,Economic Governance,Banking Union,Brexit
    Date: 2021
  16. By: Nicolas Caramp (Department of Economics, University of California Davis)
    Abstract: What sows the seeds of financial crises, and what policies can help avoid them? I model the interaction between the ex-ante production of assets and ex-post adverse selection in financial markets. Positive shocks that increase market prices exacerbate the production of low-quality assets and can increase the likelihood of a financial market collapse. The interest rate and the liquidity premium are endogenous and depend on the functioning of financial markets as well as the total supply of assets (private and public). Optimal policy balances the economy’s liq- uidity needs ex-post with the production incentives ex-ante, and it can be implemented with three instruments: government bonds, asset purchase programs, and transaction taxes. Pub- lic liquidity improves incentives but implies a higher deadweight loss than private market interventions. Optimal policy does not rule out private market collapses but mitigates the fluctuations in the total liquidity.
    JEL: E44 G01 G12 D82
    Date: 2021–07–15
  17. By: Federico S. Mandelman
    Abstract: The COVID-19 pandemic produced a massive decline in U.S. consumption in 2020 and swift fiscal and monetary responses. After growing at a rather steady 5 percent rate for decades, the money supply (M2) increased 25 percent over the past year alongside unprecedented fiscal support, raising some inflationary concerns. Concurrent with the reopening of the economy as vaccines roll out, this article derives some lessons from the U.S. experience during and after WWII. The debt-to-GDP ratio increased from 40 percent to 110 percent because of the war effort. Most of it was financed by Fed debt purchases, through a de facto yield curve control that held down short- and long-term interest rates. The money supply doubled in size, but inflation was muted during the conflict as private consumption demand was severely restrained. Private consumption was suppressed, as factories were fully devoted to the rearmament effort, food was rationed, and construction was practically prohibited. Households’ saving boomed as a result. After the war, swift pent-up consumption demand culminated in a short-lived spike in inflation from 2 percent to 20 percent in 1946–47, which quickly returned to 2 percent in 1949. Contractionary monetary and fiscal policies, along well-anchored low inflation expectations inherited from the Great Depression, appeared to have contributed to rapid disinflation. I also discuss the experiences of Japan and Europe in recent decades.
    Keywords: Money aggregates; inflation; World War II; pent-up demand; COVID-19
    JEL: E19 I19
    Date: 2021–05–17
  18. By: Vittoria Cerasi; Paola Galfrascoli
    Abstract: We empirically evaluate the impact of the new resolution policy, the so-called Bank Recovery and Resolution Directive (BRRD) enacted in 2016, on the cost of funding for EU banks. We first measure the change in the spreads of credit default swaps on subordinated and senior bonds issued by EU banks around the period when the policy became effective and provide evidence of a greater increase in the risk premia of more junior bail-in-able bonds than for senior bonds. We then investigate the reasons for the different intensities by which this policy has affected the banks in our sample. We uncover specific characteristics of banks and macroeconomic factors to explain this heterogeneity. Banks with more problematic loans, that are less capitalized, and that are headquartered in countries with a higher risk premium on sovereign debt have experienced a greater rise in the cost of their funds; conversely, larger banks with a greater proportion of domestic over total subsidiaries were less affected. Moreover, we show that the low-interest-rate environment has increased the riskiness of all the banks in our sample. Overall, our paper provides evidence that market discipline has been reinforced by the adoption of the BRRD.
    Keywords: Bank resolution; Credit Default Swaps; Market discipline.
    JEL: G28 G21 G14
    Date: 2021–07
  19. By: Raphaël Cardot-Martin (CRESE EA3190, Univ. Bourgogne Franche-Comté, F-25000 Besançon, France); Fabien Labondance (CRESE EA3190, Univ. Bourgogne Franche-Comté, F-25000 Besançon, France); Catherine Refait-Alexandre (CRESE EA3190, Univ. Bourgogne Franche-Comté, F-25000 Besançon, France)
    Abstract: We assess if capital ratios reduced the occurrence of banking crises in the European Union from 1998 to 2017. We use a Probit model and estimate the effect of two measures: the bank capital to total assets ratio and the bank regulatory capital to Risk Weighted Assets (RWA). We found that both measures affect negatively the probability of crisis. This result is robust to the exclusion of outliers, to the inclusion of various control variables for banking, financial and macroeconomic risks. Finally, we show that while the bank regulatory capital to RWA has always a negative effect on the probability of crisis, the bank capital to total assets ratio is only significant above a threshold, estimated between 10% and 12%.
    Keywords: Unconventional measures, retail interest rate, Heterogeneous panel
    JEL: G21 E44
    Date: 2021–07
  20. By: Bauer, Michael; Chernov, Mikhail
    Abstract: Conditional yield skewness is an important summary statistic of the state of the economy. It exhibits pronounced variation over the business cycle and with the stance of monetary policy, and a tight relationship with the slope of the yield curve. Most importantly, variation in yield skewness has substantial forecasting power for future bond excess returns, high-frequency interest rate changes around FOMC announcements, and consensus survey forecast errors for the ten-year Treasury yield. The COVID pandemic did not disrupt these relations: historically high skewness correctly anticipated the run-up in long-term Treasury yields starting in late 2020. The connection between skewness, survey forecast errors, excess returns, and departures of yields from normality is consistent with a theoretical framework where one of the agents has biased beliefs.
    Keywords: bond markets,yield curve,skewness,biased beliefs,monetary policy
    JEL: E43 E44 E52 G12
    Date: 2021
  21. By: Minford, Patrick (Cardiff Business School); Ou, Zhirong (Cardiff Business School); Wickens, Michael (Cardiff Business School); Zhu, Zheyi (Cardiff Business School)
    Abstract: We construct a macro DSGE model of the eurozone and its two main regions, the North and the South, with the aim of matching the macro facts of these economies by indirect inference and using the resulting empirically-based model to assess possible new policy regimes. The model we have found to fit the facts suggests that substantial gains in macro stability and consumer welfare are possible if the fiscal authority in each region is given the freedom to respond to its own economic situation. Further gains could come with the restoration of monetary independence to the two regions, in effect creating a second 'southern euro' bloc.
    Keywords: eurozone; macro stability; fiscal policy; monetary independence
    JEL: E32 E52 E62 F41
    Date: 2021–06
  22. By: Nassim Nicholas Taleb
    Abstract: We apply quantitative finance methods and economic arguments to cryptocurrencies in general and bitcoin in particular -- as there are about $10,000$ cryptocurrencies, we focus (unless otherwise specified) on the most discussed crypto of those that claim to hew to the original protocol (Nakamoto, 2009) and the one with, by far, the largest market capitalization. In its current version, in spite of the hype, bitcoin failed to satisfy the notion of "currency without government" (it proved to not even be a currency at all), can be neither a short nor long term store of value (its expected value is no higher than $0$), cannot operate as a reliable inflation hedge, and, worst of all, does not constitute, not even remotely, a safe haven for one's investments, a shield against government tyranny, nor a tail protection vehicle for catastrophic episodes. Furthermore, there appears to be an underlying conflation between the success of a payment mechanism (as a decentralized mode of exchange), which so far has failed, and the speculative variations in the price of a zero-sum asset with massive negative externalities. Going through monetary history, we also show how a true numeraire must be one of minimum variance with respect to an arbitrary basket of goods and services, how gold and silver lost their inflation hedge status during the Hunt brothers squeeze in the late 1970s and what would be required from a true inflation hedged store of value.
    Date: 2021–06
  23. By: Cosimo Munari; Lutz Wilhelmy; Stefan Weber
    Abstract: Protection of creditors is a key objective of financial regulation. Where the protection needs are high, i.e., in banking and insurance, regulatory solvency requirements are an instrument to prevent that creditors incur losses on their claims. The current regulatory requirements based on Value at Risk and Average Value at Risk limit the probability of default of financial institutions, but they fail to control the size of recovery on creditors' claims in the case of default. We resolve this failure by developing a novel risk measure, Recovery Value at Risk. Our conceptual approach can flexibly be extended and allows the construction of general recovery risk measures for various risk management purposes. By design, these risk measures control recovery on creditors' claims and integrate the protection needs of creditors into the incentive structure of the management. We provide detailed case studies and applications: We analyze how recovery risk measures react to the joint distributions of assets and liabilities on firms' balance sheets and compare the corresponding capital requirements with the current regulatory benchmarks based on Value at Risk and Average Value at Risk. We discuss how to calibrate recovery risk measures to historic regulatory standards. Finally, we show that recovery risk measures can be applied to performance-based management of business divisions of firms and that they allow for a tractable characterization of optimal tradeoffs between risk and return in the context of investment management.
    Date: 2021–07
  24. By: Luca Baldo (Bank of Italy); Elisa Bonifacio (Bank of Italy); Marco Brandi (Bank of Italy); Michelina Lo Russo (Bank of Italy); Gianluca Maddaloni (Bank of Italy); Andrea Nobili (Bank of Italy); Giorgia Rocco (Bank of Italy); Gabriele Sene (Bank of Italy); Massimo Valentini (Bank of Italy)
    Abstract: In this study, we assess the main drivers of banknote circulation in Italy over the last decades by using a number of econometric tools proposed in the literature. We explore the role played by the banknote flows from abroad, changes in the institutional framework and disentangle domestic demand for transaction purposes from other components, including liquidity hoarding. We find that changes in legal limits on cash payment and money holdings for precautionary reasons explain the bulk of cash dynamics. Moreover, the share of transaction demand declined over time becoming of second-order. Finally, we find that, during the pandemic from Covid-19, the exceptional raise in cash circulation was mostly the result of an increase in precautionary demand due to both economic uncertainty and restrictions to mobility that resulted into a marked decline of lodgments to the central bank.
    Keywords: cash circulation, cash, payment habits, Covid-19 pandemic
    JEL: E41 E42 G2
    Date: 2021–07

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