nep-cba New Economics Papers
on Central Banking
Issue of 2021‒12‒13
twenty papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Monetary Policy Spillover to Small Open Economies: Is the Transmission Different under Low Interest Rates? By Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; Yaz Terajima
  2. U.S. monetary and fiscal policy regime changes and their interactions By Chang, Yoosoon; Kwak, Boreum; Qiu, Shi
  3. Monetary policy shocks and inflation inequality By Christoph Lauper; Giacomo Mangiante
  4. Determinants of European Banks’ Default Risk By Nicolas Soenen; Rudi Vander Vennet
  5. Optimal Monetary Policy in a Small Open Economy with Non-tradable Goods By Jia, Pengfei
  6. On the stance of macroprudential policy By Cecchetti, Stephen G.; Suarez, Javier
  7. The Demand for Money, Near-Money, and Treasury Bonds By Krishnamurthy, Arvind; Li, Wenhao
  8. Does public debt granger-cause inflation? A multivariate analysis By Saungweme, Talknice; Odhiambo, Nicholas M
  9. Central bank's stabilization and communication policies when firms have motivated overconfidence in their own information accuracy or processing. By Camille Cornand; Rodolphe Dos Santos Ferreira
  10. Financial Instability and Banking Crises in a small open economy By Grytten, Ola Honningdal
  11. ECB Consumer Expectations Survey: an overview and first evaluation By Bańnkowska, Katarzyna; Borlescu, Ana Maria; Charalambakis, Evangelos; Da Silva, António Dias; Di Laurea, Davide; Dossche, Maarten; Georgarakos, Dimitris; Honkkila, Juha; Kennedy, Neale; Kenny, Geoff; Kolndrekaj, Aleksandra; Meyer, Justus; Rusinova, Desislava; Teppa, Federica; Törmälehto, Veli-Matti
  12. Robust Optimal Macroprudential Policy By Mr. Francisco Roch; Giselle Montamat
  13. Zero Lower Bound on Inflation Expectations By Gorodnichenko, Yuriy; Sergeyev, Dmitriy
  14. Young Firms and Monetary Policy Transmission By Thomas McGregor
  15. Central Bank Digital Currency: functional scope, pricing and controls By Bindseil, Ulrich; Panetta, Fabio; Terol, Ignacio
  16. The Countercyclical Capital Buffer and International Bank Lending: Evidence from Canada By David Chen; Christian Friedrich
  17. Public debt and inflation dynamics: Empirical evidence from Zimbabwe By Saungweme, Talknice; Odhiambo, Nicholas M
  18. Inflation Narratives By Peter Andre; Ingar Haaland; Christopher Roth; Johannes Wohlfart
  19. Leakages from Macroprudential Regulations: The Case of Household-Specific Tools and Corporate Credit By Lucyna Gornicka; Peichu Xie
  20. Reserves Were Not So Ample after All By Copeland, Adam; Duffie, Darrell; Yang, Yilin (David)

  1. By: Jin Cao; Valeriya Dinger; Tomás Gómez; Zuzana Gric; Martin Hodula; Alejandro Jara; Ragnar Juelsrud; Karolis Liaudinskas; Simona Malovaná; Yaz Terajima
    Abstract: We explore the impact of low and negative monetary policy rates in core world economies on bank lending in four small open economies—Canada, Chile, the Czech Republic and Norway—using confidential bank-level data. Our results show that the impact on lending in these small open economies depends on the interest rate level in the core. When interest rates are high, monetary policy cuts in core economies can reduce credit supply in small open economies. In contrast, when interest rates in core economies are low, further expansionary monetary policy increases lending in small open economies, consistent with an international bank lending channel. These results have important policy implications, suggesting that central banks in small open economies should watch for the impact of potential regime switches in core economies’ monetary policy when rates shift to and from the very low end of the distribution.
    Keywords: Financial institutions; Monetary policy transmission; International topics
    JEL: E43 E58 F34 F42 G28
    Date: 2021–11
  2. By: Chang, Yoosoon; Kwak, Boreum; Qiu, Shi
    Abstract: We investigate U.S. monetary and fiscal policy interactions in a regime-switching model of monetary and fiscal policy rules where policy mixes are determined by a latent bivariate autoregressive process consisting of monetary and fiscal policy regime factors, each determining a respective policy regime. Both policy regime factors receive feedback from past policy disturbances, and interact contemporaneously and dynamically to determine policy regimes. We find strong feedback and dynamic interaction between monetary and fiscal authorities. The most salient features of these interactions are that past monetary policy disturbance strongly influences both monetary and fiscal policy regimes, and that monetary authority responds to past fiscal policy regime. We also find substantial evidence that the U.S. monetary and fiscal authorities have been interacting: central bank responds less aggressively to inflation when fiscal authority puts less attention on debt stabilisation, and vice versa.
    Keywords: monetary and fiscal policy rules,endogenous regime switching,joint estimation,policy interactions,feedback channels
    JEL: C13 C32 E52 E63
    Date: 2021
  3. 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, middle-income households experience higher median inflation rates, which at the same time are more reactive to a contractionary monetary policy shock, leading to an overall convergence of inflation rates between income groups. These results imply that (iii) the impact of monetary policy shocks on expenditure inequality is significantly more muted once we control for differences in individual inflation rates.
    Keywords: monetary policy, inflation inequality, redistributional effects
    JEL: E31 E52
    Date: 2021–11
  4. By: Nicolas Soenen; Rudi Vander Vennet (-)
    Abstract: Using bank CDS spreads, we examine three types of determinants of Euro Area bank default risk in the period 2008-2019: bank characteristics related to new regulation, the bank-sovereign nexus and the monetary policy stance. We find that Basel 3 regulation improves the banks’ risk profile since higher capital ratios and more stable deposit funding contribute significantly to lower CDS spreads. We confirm the persistence of the bank-sovereign interconnectedness and find that sovereign default risk is transmitted to bank risk with an amplification factor. The ECB monetary policy stance is neutral with respect to bank risk, hence we find no evidence of perceived excessive risk-taking behavior.
    Keywords: bank default risk, CDS spreads, monetary policy, sovereign risk
    JEL: G21 G32 E52
    Date: 2021–11
  5. By: Jia, Pengfei
    Abstract: This paper studies optimal monetary policy in a small open economy DSGE model with non-tradable goods and sticky prices. The introduction of non-traded goods is shown to have important implications for the transmission of shocks and monetary policy arrangements. First, the results show that positive technology shocks need not lead to deflation. In response to technology shocks, real exchange rates and the terms of trade depreciate. The relative price of tradable to non-tradable goods may increase or decrease, depending on the shocks. Second, based on welfare analysis, this paper evaluates the performance of different interest rate rules. The results show that if monetary policy is not very aggressive, the Taylor-type interest rate policy that targets CPI inflation performs the best. However, as monetary policy becomes relatively aggressive, the policy that targets domestic inflation is shown to yield the highest level of welfare. Third, this paper studies the Ramsey policy and optimal allocations. The results indicate that the Ramsey optimal policy stabilizes the inflation rates in both production sectors, while allowing for volatilities in CPI inflation, real exchange rates, the terms of trade, and the relative price of tradable goods. This suggests that the interest rate rules targeting CPI inflation or exchange rates are suboptimal. The results also show that in response to sector specific shocks, the Ramsey planner only cares about the inflation rate in the sector where the shock originates.
    Keywords: Optimal monetary policy; Small open economy; Non-tradable goods, Business cycles; Exchange rates
    JEL: E31 E32 E52 F31 F41
    Date: 2021–11–23
  6. By: Cecchetti, Stephen G.; Suarez, Javier
    Abstract: In this report we outline how a formulating normative measure of macroprudential policy stance requires a framework containing objectives, tools and transmission mechanisms. To complement the currently prevailing narrative approach, we apply lessons from the monetary policy to macroprudential policy. We begin with by proposing that the ultimate objective of macroprudential policy is to minimise the frequency and severity of economic losses arising from severe financial distress and then integrate the concept of growth-at-risk into the framework. Implementation of our framework for the evaluation of the macroprudential policy stance faces a series of challenges, including availability of the appropriate data, that policymakers generally have multiple objectives and tools, and the uncertain responses of economic agents to macroprudential policy actions.
    Date: 2021–12
  7. By: Krishnamurthy, Arvind (Stanford Graduate School of Business and NBER); Li, Wenhao (Stanford Graduate School of Business and NBER)
    Abstract: Bank-created money, shadow-bank money, and Treasury bonds all satisfy investor’s demand for a liquid transaction medium and safe store of value. We measure the quantity of these three forms of liquidity and their corresponding liquidity premium over a sample from 1926 to 2016. We empirically examine the links between these different assets, estimating the extent to which they are substitutes, and the amount of liquidity per-unit-of-asset delivered by each asset. We construct a new broad monetary aggregate based on our analysis and show that it helps resolves the money-demand instability and missing-money puzzles of the monetary economics literature. Our empirical results inform models of the monetary transmission mechanism running through shifts in asset supplies, such as quantitative easing policies. Our results on the substitutability of bank and shadow-bank money also inform analyses of the coexistence of the shadow-banking and regulated banking system.
    JEL: E41 E44 E63 G12
    Date: 2021–08
  8. By: Saungweme, Talknice; Odhiambo, Nicholas M
    Abstract: The optimal balance between fiscal and monetary policy in achieving price stability has been contestedin literature. In the main, however, it is widely recognised that whether public debts are financed in amonetary way or otherwise, the choice of policy action affects the effectiveness of monetary policy inensuring price stability. This study contributes to the debate by testing the dynamic causal relationshipbetween public debt and inflation in Tanzania covering the period 1970-2020. The study applies theautoregressive distributed lag (ARDL) bounds testing technique to cointegration and the ECM-basedGranger-causality test to explore this relationship. In order to address the omission-of-variable bias,which has been the major methodological deficiency detected in some previous studies, two monetaryvariables, namely money supply and interest rate, were added as intermittent variables alongside publicdebt and inflation. The findings from this study show that there is a consistent long-run cointegratingrelationship between public debt, inflation, money supply and interest rate in Tanzania. However, theresults fail to find evidence of causality between public debt and inflation in Tanzania, irrespective ofwhether the causality is estimated in the short run or in the long run. The findings of this study,therefore, show that Tanzania?s current debt is not inflationary; hence, policymakers may continue topursue the desirable fiscal policies necessary for the country?s long-term optimal growth path.
    Keywords: Public debt, inflation, ARDL, Granger-causality, Tanzania
    Date: 2021–11
  9. By: Camille Cornand; Rodolphe Dos Santos Ferreira
    Abstract: Using a simple microfounded macroeconomic model with price making firms and a central bank maximizing the welfare of a representative household, it is shown that the presence of firms' motivated beliefs has stark consequences for the conduct of optimal communication and stabilization policies. Under pure communication (resp. communication and stabilization policies), motivated beliefs about own private information (resp. own ability to process information) reverse the bang-bang solution of transparency (resp. opacity with full stabilization) found in the literature under objective beliefs and lead to intermediate levels of communication (and stabilization).
    Keywords: motivated beliefs, public and private information (accuracy), overconfidence, communication policy, stabilization policy.
    JEL: D83 D84 E52 E58
    Date: 2021
  10. By: Grytten, Ola Honningdal (Dept. of Economics, Norwegian School of Economics and Business Administration)
    Abstract: The present paper seeks to investigate the importance of financial instability during four banking crises, with focus on the small open economy of Norway. The crises elaborated on are the Post First world war crisis of the early 1920s, the mid 1920s Monetary crisis, the Great Depression of the 1930s and the Scandinavian banking crisis of 1987-1993. <p> The paper firstly offers a brief description of the financial instability hypothesis as applied by Minsky, Kindleberger, and in a new explicit dynamic financial crisis model. Financial instability creation basically happens in times of overheating, overspending and over lending, i.e., during significant booms, and have devastating effects after markets have turned into a state of crises. <p> Thereafter, the paper tests the validity of the financial instability hypothesis by using a quantitative structural time series model. The test reveals upheaval of financial and macroeconomic indicators prior to the crises, making the economy overheat and create asset bubbles due to huge growth in debt. These conditions caused the following banking crises. <p> Finally, the four crises are discussed qualitatively. The conclusion is that significant increase in money supply and debt caused overheating, asset bubbles and finally financial and banking crises which spread to the real economy.
    Keywords: Financial crises; banking crises; financial stability; macroeconomic; economic history; monetary expansion
    JEL: E44 E51 E52 F34 G15 N24
    Date: 2021–11–11
  11. By: Bańnkowska, Katarzyna; Borlescu, Ana Maria; Charalambakis, Evangelos; Da Silva, António Dias; Di Laurea, Davide; Dossche, Maarten; Georgarakos, Dimitris; Honkkila, Juha; Kennedy, Neale; Kenny, Geoff; Kolndrekaj, Aleksandra; Meyer, Justus; Rusinova, Desislava; Teppa, Federica; Törmälehto, Veli-Matti
    Abstract: The Consumer Expectations Survey (CES) is an important new tool for analysing euro area household economic behaviour and expectations. This new survey covers a range of important topical areas including consumption and income, inflation and gross domestic product (GDP) growth, the labour market, housing market activity and house prices, and consumer finance and credit access. The CES, which was launched as a pilot in January 2020, is a mixed frequency modular survey, which is conducted online. The survey structure and centralised data collection ensures the collection of harmonised quantitative and qualitative euro area information in a timely manner that facilitates direct cross-country comparisons. During the pilot phase, it was conducted for the six largest euro area countries and contained 10,000 individual respondents. In the context of the coronavirus (COVID-19) pandemic, the CES has been used to gather useful information on the impact of the crisis on the household sector and the effectiveness of policy measures to mitigate the effects of the pandemic. The CES also collects information on the public’s overall trust in the ECB, their knowledge about its objectives and the channels through which they learn about its monetary policy and other central bank-related topics. This paper describes the key features of this new ECB survey – including its statistical properties – and offers a first evaluation of the results from the pilot phase. It also identifies a number of areas where the survey can be usefully developed further. Overall, the experience with the CES has been very positive, and the pilot survey is considered to have achieved its main objectives. JEL Classification: C42, D12, D14, E21, E24, E31
    Keywords: consumer behaviour, euro area, expectations, household surveys, micro data set
    Date: 2021–12
  12. By: Mr. Francisco Roch; Giselle Montamat
    Abstract: We consider how fear of model misspecification on the part of the planner and/or the households affects welfare gains from optimal macroprudential taxes in an economy with occasionally binding collateral constraints as in Bianchi (2011). On the one hand, there exist welfare gains from internalizing how borrowing decisions in good times affect the value of collateral during a crisis. On the other hand, interventions by a robust planner that has in mind a model far from the true underlying distribution of shocks, can result in negligible welfare gains, or even losses. This is because a policy that is robust to misspecification, as in Hansen and Sargent (2011), is optimal under a "worst-case'' scenario but not under alternative distributions of the state. A robust planner introduces taxes that are 5 percentage points higher but does not achieve a significant increase in welfare gains compared to a non-robust planner when the true underlying model is not the worst-case. If households also make choices that are robust to model misspecification, the gains are significantly reduced and a highly-robust planner "underborrows" and induces welfare losses. If, however, the worst-case scenario is indeed realized, then welfare gains are the largest possible.
    Keywords: Robustness; Model Uncertainty; Macroprudential Policy; Sudden Stops.
    Date: 2021–02–26
  13. By: Gorodnichenko, Yuriy (University of California, Berkeley); Sergeyev, Dmitriy (Bocconi University)
    Abstract: We document a new fact: in U.S., European and Japanese surveys, households do not expect deflation, even in environments where persistent deflation is a strong possibil- ity. This fact stands in contrast to the standard macroeconomic models with rational expectations. We extend a standard New Keynesian model with a zero-lower bound on inflation expectations. Unconventional monetary policies, such as forward guid- ance, are weaker. In liquidity traps, the government spending output multiplier is finite, and adverse aggregate supply shocks are not expansionary. The possibility of confidence-driven liquidity traps is attenuated.
    Keywords: inflation expectations, non-rational beliefs, survey data
    JEL: E5 E7 G4
    Date: 2021–11
  14. By: Thomas McGregor
    Abstract: We investigate the role of business dynamism in the transmission of monetary policy by exploitingthe variation in firm demographics across U.S. states. Using local projections, we find that a larger fraction of young firms significantly mutes the effects of monetary policy on the labor market and personal income over the medium term. The firm entry rate and the employment share of young firms are key factors underpinning these results, which are robust to a battery of robustness tests. We develop a heterogeneous-firm model with age-dependent financial frictions that rationalizes the empirical evidence.
    Keywords: firm demographics; business dynamism; monetary policy; local projections; U.S. states.; U.S. states; monetary policy shock; entry rate; population demographics; policy function; startup firm; exit rate; firm productivity; growth rate; Employment; Wages; Personal income; Credit ratings; Global
    Date: 2021–03–05
  15. By: Bindseil, Ulrich; Panetta, Fabio; Terol, Ignacio
    Abstract: Even before their deployment in major economies, one of the concerns that has been voiced about central bank digital currency (CBDC) is that it might be too successful and lead to bank disintermediation, which could intensify further in the case of a banking crisis. Some also argue that CBDC might crowd out private payment solutions beyond what would be desirable from the perspective of the comparative advantages of private and public sector money. This paper discusses success factors for CBDC and how to avoid the risk of crowding out. After examining ways to prevent excessive use as a store of value, the study emphasises the importance of the functional scope of CBDC for the payment functions of money. The paper also recalls the risks that use could be too low if functional scope, convenience or reachability are unattractive for users. Finding an adequate functional scope – neither too broad to crowd out private sector solutions, nor too narrow to be of limited use – is challenging in an industry with network effects, like payments. The role of the incentives offered to private sector service providers involved in distributing, using and processing CBDC (banks, wallet providers, merchants, payment processors, acquirers, etc.) is discussed, including fees and compensation. JEL Classification: E3, E5, G1
    Keywords: central bank digital currency, cross-border payments, financial stability, means of payment, payment solution, store of value
    Date: 2021–12
  16. By: David Chen; Christian Friedrich
    Abstract: We examine the impact of the recently introduced Basel III countercyclical capital buffer (CCyB) on foreign lending activities of Canadian banks. Using panel data for the six largest Canadian banks and their foreign activities in up to 94 countries, we explore the variation in CCyB rates across countries to overcome the identification challenge associated with limited time-series evidence on the use of the CCyB in individual jurisdictions. Our main sample focuses on the period from 2013Q2 to 2019Q3, when CCyB rates experienced a prolonged tightening cycle. We show that in response to a 1-percentage-point tightening announcement in a foreign CCyB, the growth rate of cross-border lending between Canadian banks’ head offices and borrowers in CCyB-implementing countries decreases by between 12 and 17 percentage points. Most importantly, due to the CCyB’s unique reciprocity rule, which also subjects foreign banks to domestic regulation, the direction of this effect differs from that of other forms of foreign capital regulation that have been previously examined in the literature. When investigating the underlying transmission channels of a CCyB change, we find that, in particular, large banks are more able than small banks to shield their cross-border lending against the impact of foreign CCyB changes. Finally, when focusing on the loosening cycle in CCyB rates that emerged in early 2020, we show that our findings on the differential effects for large and small banks also carry over to the COVID-19 episode—a time when various jurisdictions rapidly released their CCyBs to stabilize their banks’ lending activities.
    Keywords: Credit risk management; Financial institutions; Financial stability; Financial system regulation and policies; International topics
    JEL: E32 F21 F32 G28
    Date: 2021–11
  17. By: Saungweme, Talknice; Odhiambo, Nicholas M
    Abstract: The study seeks to empirically test the hypothesis that public debt has a significant influenceon inflation in Zimbabwe, covering the period 1980-2020. The study was motivated by recenttrends in public debt and domestic inflation in Zimbabwe, and the need to guide debt-inflationrelated policy. These latest trends have started to ring alarming bells, which raises questionson the effectiveness of fiscal and monetary policies in bringing macroeconomic stability in thecountry. Applying the Autoregressive Distributed Lag (ARDL) bounds testing procedure tocointegration and an error correction mechanism (ECM), expanded by incorporatingstructural breaks, the study finds evidence in support of positive and significant impact ofpublic debt on inflation dynamics in Zimbabwe, particularly in the long run. Based on thefindings, public debt dynamics matter for inflation process in Zimbabwe. That is, fiscal policycan be considered to be an important determinant of the effectiveness of monetary policy inZimbabwe. Therefore, the government should be mindful of increases in public debt as this was found to be inflationary.
    Keywords: ARDL, inflation, public debt, Zimbabwe
    Date: 2021–11
  18. By: Peter Andre (University of Bonn); Ingar Haaland (University of Bergen and CESifo); Christopher Roth (University of Cologne); Johannes Wohlfart (Department of Economics and CEBI, University of Copenhagen)
    Abstract: We survey retail investors at an online bank to study beliefs about the autocorrelation of aggregate stock returns, and how these beliefs shape investment decisions measured in administrative account data. Individuals' beliefs exhibit substantial heterogeneity and predict trading responses to market movements. We inform a random half of our respondents that historically the autocorrelation of aggregate returns was close to zero, which persistently changes their beliefs. Among those initially believing in mean reversion, treated respondents buy significantly less equity during the COVID-19 crash four months later. Our results highlight how heterogeneity in subjective models causally drives trade in asset markets.
    Keywords: Narratives, Inflation, Beliefs, Macroeconomics, Fiscal Policy, Monetary Policy
    JEL: D83 D84 E31 E52 E71
    Date: 2021–11–25
  19. By: Lucyna Gornicka; Peichu Xie
    Abstract: Sector-specific macroprudential regulations increase the riskiness of credit to other sectors. Using firm-level data, this paper computed the measures of the riskiness of corporate credit allocation for 29 advanced and emerging economies. Consistently across these measures, the paper finds that during credit expansions, an unexpected tightening of household-specific macroprudential tools is followed by a rise in riskier corporate lending. Quantitatively, such unexpected tightening during a period of rapid credit growth increases the riskiness of corporate credit by around 10 percent of the historical standard deviation. This result supports early policy interventions when credit vulnerabilities are still low, since sectoral leakages will be less important at this stage. Further evidence from bank lending standards surveys suggests that the leakage effects are stronger for larger firms compared to SMEs, consistent with recent evidence on the use of personal real estate as loan collateral by small firms.
    Keywords: standards survey; credit vulnerability; leakage effect; credit riskiness; bond credit ratio ma; Credit; Macroprudential policy; Bank credit; Macroprudential policy instruments; Corporate sector; Global
    Date: 2021–04–29
  20. By: Copeland, Adam (FRBNY); Duffie, Darrell (Stanford GSB); Yang, Yilin (David) (Stanford GSB)
    Abstract: The Federal Reserve’s “balance-sheet normalization,†which reduced aggregate reserves between 2017 and September 2019, increased repo rate distortions, the severity of rate spikes, and intraday payment timing stresses, culminating with a significant disruption in Treasury repo markets in mid-September 2019. We show that repo rates rose above efficient-market levels when the total reserve balances held at the Federal Reserve by the largest repo-active bank holding companies declined and that repo rate spikes are strongly associated with delayed intraday payments of reserves to these large bank holding companies. Intraday payment timing stresses are magnified by early-morning settlement of Treasury security issuances. Substantially higher aggregate levels of reserves than existed in the period leading up to September 2019 would likely have eliminated most or all of these payment timing stresses and repo rate spikes.
    JEL: D47 D82 G14
    Date: 2021–07

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