nep-cba New Economics Papers
on Central Banking
Issue of 2021‒10‒11
fourteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Reserve tiering and the interbank market By Lucas Marc Fuhrer; Matthias Jüttner; Jan Wrampelmeyer; Matthias Zwicker
  2. Central bank communication with non-experts: a road to nowhere? By Ehrmann, Michael; Wabitsch, Alena
  3. Monetary Policy in a Low Interest Rate Environment: Reversal Rate and Risk-Taking By Heider, Florian; Leonello, Agnese
  4. The Global Financial Cycle By Silvia Miranda-Agrippino; Hélène Rey
  5. What lowered inflation in India: Monetary policy or commodity prices? By Pulapre Balakrishnan; M Parameswaran
  6. Nobody’s child: the Bank of Greece in the interwar years By Andreas Kakridis
  7. Has the Comprehensive Assessment made the European financial system more resilient? By Calo, Silvia; Gregori, Wildmer Daniel; Petracco Giudici, Marco; Rancan, Michela
  8. The Root Cause of Sovereign Default By Harashima, Taiji
  9. Banks' risk-taking within a banking union By Farnè, Matteo; Vouldis, Angelos
  10. The Currency Board Debate of the 1940s-1960s By Thakkar, Parth
  11. What Quantity of Reserves Is Sufficient? By Adam Copeland; Darrell Duffie; Yilin Yang
  12. Do liquidity limits amplify money market fund redemptions during the COVID crisis? By Dunne, Peter G.; Giuliana, Raffaele
  13. Measuring Market Expectations By Christiane Baumeister
  14. Liquidity Stress Testing in Asset Management -- Part 3. Managing the Asset-Liability Liquidity Risk By Thierry Roncalli

  1. By: Lucas Marc Fuhrer; Matthias Jüttner; Jan Wrampelmeyer; Matthias Zwicker
    Abstract: Since the financial crisis, major central banks have introduced negative interest rates with the help of tiered reserve remuneration. We theoretically and empirically investigate monetary policy implementation via reserve tiering using a unique bank-level dataset from Switzerland. We find that reserve tiering can successfully be used to steer short-term interest rates. Furthermore, reserve tiering helps maintain sufficient activity in the interbank market, which is key for financial stability and reliable interest rate benchmarks. Due to frictions such as collateral constraints, trading costs, and window dressing around regulatory reporting dates, not only the aggregate level of reserves but also the reserve distribution matters for monetary policy implementation.
    Keywords: Interbank market, reserve tiering, negative rates, monetary policy
    JEL: E43 E58 G12 G21
    Date: 2021–09–27
  2. By: Ehrmann, Michael; Wabitsch, Alena
    Abstract: Central banks have intensified their communication with non-experts – an endeavour which some have argued is bound to fail. This paper studies English and German Twitter traffic about the ECB to understand whether its communication is received by non-experts and how it affects their views. It shows that Twitter traffic is responsive to ECB communication, also for non-experts. For several ECB communication events, Twitter constitutes primarily a channel to relay information: tweets become more factual and the views expressed more moderate and homogeneous. Other communication events, such as former President Draghi’s “Whatever it takes” statement, trigger persistent traffic and a divergence in views. Also, ECB-related tweets are more likely to get retweeted or liked if they express stronger or more subjective views. Thus, Twitter also serves as a platform for controversial discussions. The findings suggest that central banks manage to reach non-experts, i.e. their communication is not a road to nowhere. JEL Classification: E52, E58
    Keywords: central bank communication, monetary policy, non-experts, social media
    Date: 2021–10
  3. By: Heider, Florian; Leonello, Agnese
    Abstract: This paper develops a simple analytical framework to study the impact of central bank policy-rate changes on banks’ credit supply and risk-taking incentives. Unobservable expost bank monitoring of loans creates an external-financing constraint, which determines bank leverage. Unobservable, costly ex-ante screening of borrowers determines the level of bank risk-taking. More risk-taking tightens the external-financing constraint. The policy rate affects the external-financing constraint because it affects both the return on outside investors’ alternative investments and loan rates. In a low rate environment, a policy-rate cut reduces bank funding costs less because of a zero lower bound (ZLB) on retail deposit rates. Bank risk-taking is a necessary but not sufficient for a policy-rate cut to become contractionary ("reversal"). Reversal can occur even though banks’ net-interest margins increase. Credit market competition plays an important role for the interplay of monetary policy and financing stability. When banks have market power, a policy-rate cut can increase lending and still lead to risk-taking. We use our analytical framework to discuss the literature on how monetary policy affects the credit supply of banks, with special emphasis on low and negative rates. JEL Classification: E44, E52, E58, G20, G21
    Keywords: bank lending, deposits, equity multiplier, zero-lower bound
    Date: 2021–10
  4. By: Silvia Miranda-Agrippino; Hélène Rey
    Abstract: We review the literature on the empirical characteristics of the global financial cycle and associated stylized facts on international capital flows, asset prices, risk aversion and liquidity in the financial system. We analyse the co-movements of global factors in asset prices and capital flows with commodity prices, international trade and world output as well as the sensitivity of different parts of the world to the Global Financial Cycle. We present evidence of the causal effects of the monetary policies of the US Federal Reserve, the European Central Bank and of the People's Bank of China on the Global Financial Cycle. We then assess whether the 2008 financial crisis has altered the transmission channels of monetary policies on the Global Financial Cycle. Finally, we discuss the theoretical modelling of the Global Financial Cycle and avenues for future research.
    JEL: E5 F3
    Date: 2021–10
  5. By: Pulapre Balakrishnan (Ashoka University); M Parameswaran (Centre for Developing Studies)
    Abstract: India has seen lower inflation by historical standards, for the past five years. This has been attributed by some observers to the adoption of inflation targeting by the country’s central bank, the Reserve Bank of India. In particular, it has been asserted that the taming of inflation reflects the anchoring of expectations of it through inflation targeting. We evaluate these claims. Our estimates indicate that there is no basis to the claim that inflation has been lowered due to the anchoring of expectations. On the other hand, we are able to fully account for the trajectory of inflation in India in terms of an explanation of inflation other than the one on which inflation targeting is premised.
    Keywords: Inflation targeting, Inflation models, Monetary policy, India, Structuralist macroeconomics
    Date: 2021–10
  6. By: Andreas Kakridis (Bank of Greece and Ionian University)
    Abstract: Neither history nor economic historians have been kind to Greece’s central bank in the interwar years. Born at the behest of the League of Nations to help the country secure a new international loan, the Bank of Greece was treated with a mixture of suspicion and hostility. The onset of the Great Depression pitted its statutory objective to defend the exchange rate against the incentive to reflate the domestic economy. Its policy response has generally been criticized as either ineffectual or detrimental: the Bank is accused of having pursued an unduly orthodox and restrictive policy, both during but also after the country’s exit from the gold exchange standard, some going as far as to argue that the 1932 devaluation failed to produce genuine recovery. Relying primarily on archival material, this paper combines qualitative and quantitative sources to revisit the Bank of Greece’s birth and operation during the Great Depression. In doing so, it hopes to put Greece on the map of international comparisons of the Great Depression and debates on the role of the League of Nations, the effectiveness of money doctoring and foreign policy interventions more generally. What is more, the paper seeks to revise several aspects of the conventional narrative surrounding the Bank’s role. First, it argues that monetary policy was neither as ineffective nor as restrictive as critics suggest; this was largely thanks to a continued trickle of foreign lending, but also to the Bank’s own decision to sterilize foreign exchange outflows, thus breaking the ‘rules of the game’. Second, it revisits Greece’s attempt to cling to gold after sterling’s devaluation, a decision routinely denounced as a critical policy mistake. Last but not least, it challenges the notion that Greece constitutes an exception to the rule that wants countries who shed their ‘golden fetters’ recovering faster.
    Keywords: central bank; Greece;gold standard; Great Depression; League of Nations
    JEL: E58 E65 N14 N24
    Date: 2021–07
  7. By: Calo, Silvia (Central Bank of Ireland); Gregori, Wildmer Daniel (European Commission); Petracco Giudici, Marco (European Commission); Rancan, Michela (Marche Polytechnic University)
    Abstract: What has been the impact of the Comprehensive Assessment (CA) carried out by the ECB on banks' resilience? Implementing a difference-indifference approach, we analyse a non-risk based measure defined as the ratio of Tier 1 capital over total assets of European banks’ balance sheets during the years 2007-2018. This wide time span, compared to previous literature, allows a better analysis of CA's medium-term effects. We find that banks under the CA have a higher ratio, suggesting that the CA has contributed to foster banks' resilience. Importantly, this seems to have been achieved by banks increasing their capitalization level without shrinking their assets. In addition, this impact appears to be driven by banks located in countries where the regulatory environment and property rights are relatively less strong.
    Keywords: Comprehensive assessment, European banks, Financial stability, Regulation
    JEL: G21 G28
    Date: 2021–08
  8. By: Harashima, Taiji
    Abstract: Sovereign defaults have occurred more frequently in emerging countries and accompany significant currency depreciation and high inflation. The standard model of sovereign default cannot necessarily explain these facts sufficiently. In this paper, I examine the root cause of sovereign default on the basis of a model of inflation that is built on a micro-foundation of government behavior and conclude that the root cause of sovereign default is an insufficiently independent central bank. Without a sufficiently independent central bank, the government inevitably borrows money excessively, and as a result, inflation and currency depreciation accelerate. This situation will frustrate and anger the population, and the government may then declare a sovereign default in an attempt to place the blame on foreign lenders, at least temporarily.
    Keywords: Central bank; Exchange rate; Government bond; Inflation; International debt; Sovereign default
    JEL: E58 F31 F34 F53 H63
    Date: 2021–10–05
  9. By: Farnè, Matteo; Vouldis, Angelos
    Abstract: We study the relationship between banks’ size and risk-taking in the context of supranational banking supervision. Consistently with theoretical work on banking unions and in contrast to analyses emphasising incentives underpinned by the too-big-to-fail effect, we find an inverse relationship between banks’ size and non-performing loan growth for a sample of European banks. Evidence is provided that the mechanism operates through the enhanced organisational efficiency of the supranational set-up rather than incentives alignment among the supervisors and the banks. JEL Classification: F33, G21, G28, G32, C20
    Keywords: banking union, euro area, non-performing loans, supervision, too-big-to-fail
    Date: 2021–10
  10. By: Thakkar, Parth (The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise)
    Abstract: The late 1940s to the 1960s featured a sustained debate about currency boards in underdeveloped (or, in today’s parlance, developing) economies and their desirability compared to the alternative of central banking. Critics of currency boards found fault with them for the foregone cost of their “idle reserves,” their implied deflationary bias, their lack of discretionary monetary policy, and their lack of a lender of last resort, among other things. Defenders of the currency board system argued that the criticisms were either incorrect or irrelevant. After carefully reviewing the debate, I opine on it, coming down mainly on the side of the defenders of currency boards.
    Keywords: Currency board; debate
    JEL: B27 E59 F33 N10
    Date: 2021–10
  11. By: Adam Copeland; Darrell Duffie; Yilin Yang
    Abstract: A concern of the Federal Reserve is how to manage its balance sheet and whether, over the long run, the balance sheet should be small or large. In this post, we highlight results from a recent paper in which we show how, even during a period of “ample” reserves, the Fed’s management of its balance sheet had material impacts on funding markets and especially the repo market. We argue that the Fed’s “balance-sheet normalization” from March 2017 to September 2019—under which aggregate reserves declined by more than $950 billion—combined with post-crisis liquidity regulations, stressed the intraday management of reserves of large bank holding companies that are active in wholesale funding markets resulting in higher repo rates and spikes in such.
    Keywords: repo rates; reserves; Treasuries; Treasurys; payments; central bank balance sheet
    JEL: G1 E58
    Date: 2021–09–29
  12. By: Dunne, Peter G.; Giuliana, Raffaele
    Abstract: Regulation of Money Market Funds (MMFs) in the EU requires some categories of MMFs to consider applying liquidity management tools if they breach a minimum ‘weekly’ liquidity requirement. Anticipation of the application of such tools is a plausible amplifier of run risks. Using a larger European dataset than previously studied, we assess whether proximity to liquidity thresholds explains differences in redemptions both at the start of the COVID-19 crisis and in the following months. We assess this effect for MMFs subject to and exempt from the liquidity regulation. The evidence shows that outflows can be robustly associated with proximity to minimum liquidity requirements in the peak of the crisis for funds required to consider suspending redemptions if breaches occur. In the post-crisis phase the redemption-liquidity relationship does not appear to be specifically related to mandated consideration of the suspension of redemptions. The evidence supports consideration of countercyclical liquidity requirements or buffers that are more usable in times of stress. JEL Classification: G01, G15, G23, G28, G18, G20, F30
    Keywords: liquidity limits, money market funds
    Date: 2021–10
  13. By: Christiane Baumeister (University of Notre Dame; University of Pretoria; NBER; CEPR)
    Abstract: Asset prices are a valuable source of information about financial market participants' expectations about key macroeconomic variables. However, the presence of time-varying risk premia requires an adjustment of market prices to obtain the market's rational assessment of future price and policy developments. This paper reviews empirical approaches for recovering market-based expectations. It starts by laying out the two canonical modeling frameworks that form the backbone for estimating risk premia and highlights the proliferation of risk pricing factors that result in a wide range of different asset-price-based expectation measures. It then describes a key methodological innovation to evaluate the empirical plausibility of risk premium estimates and to identify the most accurate market-based expectation measure. The usefulness of this general approach is illustrated for price expectations in the global oil market. Then, the paper provides an overview of the body of empirical evidence for monetary policy and inflation expectations with a special emphasis on market-specific characteristics that complicate the quest for the best possible market-based expectation measure. Finally, it discusses a number of economic applications where market expectations play a key role for evaluating economic models, guiding policy analysis, and deriving shock measures.
    Keywords: futures markets, risk premia, monetary policy, commodities, market expectations, financial markets, asset pricing, return regressions, affine term structure models, risk adjustment, model uncertainty, forecasting, expectational shocks
    JEL: C52 E31 E43 E52 G14 Q43
    Date: 2021–09
  14. By: Thierry Roncalli
    Abstract: This article is part of a comprehensive research project on liquidity risk in asset management, which can be divided into three dimensions. The first dimension covers the modeling of the liability liquidity risk (or funding liquidity), the second dimension is dedicated to the modeling of the asset liquidity risk (or market liquidity), whereas the third dimension considers the management of the asset-liability liquidity risk (or asset-liability matching). The purpose of this research is to propose a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers. In this third and last research paper focused on managing the asset-liability liquidity risk, we explore the ALM tools that can be put in place to control the liquidity gap. These ALM tools can be split into three categories: measurement tools, management tools and monitoring tools. In terms of measurement tools, we focus on the computation of the redemption coverage ratio (RCR), which is the central instrument of liquidity stress testing programs. We also study the redemption liquidation policy and the different implementation methodologies, and we show how reverse stress testing can be developed. In terms of liquidity management tools, we study the calibration of liquidity buffers, the pros and cons of special arrangements (redemption suspensions, gates, side pockets and in-kind redemptions) and the effectiveness of swing pricing. In terms of liquidity monitoring tools, we compare the macro- and micro-approaches of liquidity monitoring in order to identify the transmission channels of liquidity risk.
    Date: 2021–10

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