nep-cba New Economics Papers
on Central Banking
Issue of 2022‒01‒17
twenty-two papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Revisiting monetary policy objectives and strategies: international experience and challenges from the ELB By Martina Cecioni; Adriana Grasso; Alessandro Notarpietro
  2. Monetary Policy and Endogenous Financial Crises By Collard, Fabrice; Boissay, Frédéric; Galì, Jordi; Manea, Cristina
  3. Is the Taylor Rule Still an Adequate Representation of Monetary Policy in Macroeconomic Models? By James Dean; Scott Schuh
  4. Is the Word of a Gentleman as Good as His Tweet? Policy communications of the Bank of England By Michael J. Lamla; Dmitri V. Vinogradov
  5. The signalling channel of negative interest rates By Oliver de Groot; Alexander Haas
  6. Bank risk-taking and impaired monetarypolicy transmission By Koenig, Philipp J.; Schliephake, Eva
  7. Debating Central Bank Mandates By Adam Tooze
  8. Corporate legacy debt, inflation, and the efficacy of monetary policy By Goodhart, C. A. E.; Peiris, M. U.; Tsomocos, Dimitrios P; Wang, Xuan
  9. Monetary policy and Bitcoin By Karau, Sören
  10. Words Speak as Loudly as Actions: Central Bank Communication and the Response of Equity Prices to Macroeconomic Announcements By Benjamin Gardner; Chiara Scotti; Clara Vega
  11. The Hidden Heterogeneity of Inflation and Interest Rate Expectations: The Role of Preferences By Lena Dräger; Michael J. Lamla; Damjan Pfajfar
  12. Dominant Currency Paradigm: A Review By Gita Gopinath; Oleg Itskhoki
  13. Revisiting the link between systemic risk and competition based on network theory and interbank exposures By Enrique Bátiz-Zuk; José Luis Lara Sánchez
  14. News-Driven International Credit Cycles By Galip Kemal Ozhan
  15. CREWS: a CAMELS-based early warning system of systemic risk in the banking sector By Jorge E. Galán
  16. Best Before? Expiring Central Bank Digital Currency and Loss Recovery By Charles M. Kahn; Maarten van Oordt; Yu Zhu
  17. Predicting the Demand for Central Bank Digital Currency: A Structural Analysis with Survey Data By Jiaqi Li
  18. Regulating Credit Booms from Micro and Macro Perspectives By Ogawa, Toshiaki
  19. Savings, efficiency and the nature of bank runs By Leonello, Agnese; Mendicino, Caterina; Panetti, Ettore; Porcellacchia, Davide
  20. Inflation Targeting and Private Domestic Investment in Developing Countries By Bao-We-Wal Bambe
  21. Financial Market Turbulence and Macro-Financial Developments in Ireland: a Mixed Data Sampling (MIDAS) Approach By Parla, Fabio

  1. By: Martina Cecioni (Bank of Italy); Adriana Grasso (ECB); Alessandro Notarpietro (Bank of Italy; Bank of Italy)
    Abstract: We review the experience of central banks in 12 advanced economies in formulating their price stability objectives during the last 20 years. All central banks under review target a small and positive inflation rate (typically 2%). In most cases, they set a point target, in some a range or a point with bands around it. Range and bands are more common among small open economies. We also conduct a model-based analysis of the macroeconomic performance of different monetary policy strategies when the policy rate is constrained by the effective lower bound (ELB). Under standard inflation targeting, inflation remains, on average, below target (disinflationary bias). ELB incidence and duration are higher the lower the target. A point inflation target performs better than a range, especially if compared to an asymmetric one with the focal point close to the ceiling. Makeup strategies (price level targeting and average inflation targeting) and asymmetric inflation targeting strategies, in which the central bank’s reaction to below-target inflation is stronger compared with the case of above-target inflation, reduce the disinflationary effects of the ELB and have better macroeconomic stabilization properties compared with standard inflation targeting.
    Keywords: central banking, monetary policy rules, effective lower bound
    JEL: E31 E32 E52 E58
    Date: 2021–12
  2. By: Collard, Fabrice; Boissay, Frédéric; Galì, Jordi; Manea, Cristina
    Abstract: We study whether a central bank should deviate from its objective of price stability to promote financial stability. We tackle this question within a textbook New Keynesian model augmented with capital accumulation and microfounded endogenous financial crises. We compare several interest rate rules, under which the central bank responds more or less forcefully to inflation and aggregate output. Our main findings are threefold. First, monetary policy affects the probability of a crisis both in the short run (through aggregate demand) and in the medium run (through savings and capital accumulation). Second, a central bank can both reduce the probability of a crisis and increase welfare by departing from strict inflation targeting and responding systematically to fluctuations in output. Third, financial crises may occur after a long period of unexpectedly loose monetary policy as the central bank abruptly reverses course.
    Keywords: Financial crisis ; monetary policy
    Date: 2021–12–20
  3. By: James Dean (West Virginia University, Department of Economics); Scott Schuh (West Virginia University, Department of Economics)
    Abstract: A Taylor Rule remains the consensus monetary policy specification in macroeconomic models despite unconventional monetary policies (UMP) and the policy rate stuck near zero in 2009-2015. We extend the literature by testing for structural breaks in benchmark macro models at 2007:Q3 that might reflect UMP. Significant breaks occurred altering model shocks, dynamics, and output gaps. The “shadow†funds rate proxies for UMP but has little effect on results. Deducing cause(s) of structural breaks is challenging due to changes in non-policy structure that may be unrelated to UMP and to the omission of UMP from the benchmark models.
    Keywords: Taylor Rule, Structural Break, Macroeconomic Models, Unconventional Monetary Policy
    JEL: E43 E52 E58 E12 E13 E65 E61 C50 C32
    Date: 2021–12
  4. By: Michael J. Lamla (Leuphana University Lüneburg and ETH Zürich, KOF Swiss Economic Institute); Dmitri V. Vinogradov (University of Glasgow and National Research University Higher School of Economics)
    Abstract: Policy announcements by central banks affect financial markets, but their effect on consumer beliefs is limited. This paper studies the implications of using different communication channels: established media outlets versus social media. Information on the news sources comes from our original consumer surveys administered just before and right after policy announcement events, enabling a causal inference on the announce- ment effect. We focus on the Bank of England, the first central bank to actively adopt accessible language, simplified messages and new forms of communication via its Twitter account. Based on about 10 000 individual consumer responses in 2018-2019, overall we find no statistically significant effect of announcements on perceptions or expectations, yet respondents who receive news have better perceptions and expectations than those who don't. Policy announcement events trigger an increase in the share of consumers who receive monetary policy news, the share of informed consumers is higher among Twitter users, suggesting potential benefits from Twitter communication with the public. However, Twitter users tend to overestimate inflation and interest rates, make a greater expectations/perception error. In addition they report higher confidence in their estimates. In terms of expectations quality, spreading the word of the Central bank via conventional mass media appears to be more effective than tweets.
    Keywords: perceptions, expectations, central bank communication, consumer, Twitter
    JEL: E52 E58
    Date: 2021–05
  5. By: Oliver de Groot; Alexander Haas
    Abstract: Negative interest rates remain a controversial policy for central banks. We study a novel signalling channel and ask under what conditions negative rates should exist in an optimal policymaker’s toolkit. We prove two necessary conditions for the opti mality of negative rates: a time-consistent policy setting and a preference for policy smoothing. These conditions allow negative rates to signal policy easing, even with deposit rates constrained at zero. In an estimated model, the signalling channel dominates the costly interest margin channel. However, the effectiveness of negative rates depends sensitively on the degree of policy inertia, level of reserves, and ZLB duration.
    Keywords: Monetary policy, Taylor rule, Forward guidance, Liquidity trap
    Date: 2021–12–16
  6. By: Koenig, Philipp J.; Schliephake, Eva
    Abstract: We consider a standard banking model with agency frictions to simultaneously studythe weakening and reversal of monetary transmission and banks' risk-taking in alow-interest environment. Both, weaker monetary transmission and higher risk-taking arise because lower policy rates impair banks' net worth. The pass-throughto deposit rates, the level of excess reserves and the extent of the agency problembetween banks and depositors are crucial determinants of monetary transmission.If the deposit pass-through is sufficiently impaired, a reversal rate exists. For policyrates below the reversal rate further interest rate reductions lead to a disproportionalincrease in risk-taking and a contraction in loan supply.
    Keywords: Monetary policy,Bank lending,Risk-taking channel,Reversal rate
    JEL: G21 E44 E52
    Date: 2021
  7. By: Adam Tooze (Columbia University)
    Abstract: Central banks are in the crosshairs of public debate about economic policy. Every minute of every day, interest rate decisions are debated and weighed in financial markets. The risks of inflation are assessed. Trillions of dollars hinge on correctly interpreting the next move by key central bankers. Central bank appointments are avidly discussed. Public campaigns are waged for and against particular candidates. This makes guardians of central bank independence nervous. Too much public scrutiny might put that independence at risk. But it should not be surprising that people want to debate the role of central banks. It is not because they are failing. It is because they have such massive effects. Furthermore, what is provocative is not just the scale of their interventions but the things that they are doing. Their role has visibly shifted. It is hard to claim that the status quo is set in tablets of stone, when the actual experience of recent decades is that what central banks do is very much a response to circumstances. Why then should we not go back to basics and ask fundamental questions about their mandate and their role?
    Keywords: Central banks, new mandates, ECB, Fed
    JEL: E5 E58
    Date: 2021–12
  8. By: Goodhart, C. A. E.; Peiris, M. U.; Tsomocos, Dimitrios P; Wang, Xuan
    Abstract: The COVID-19 pandemic has coincided with a rapid increase in indebtedness. Although the rise in public debt and its policy implications have received much attention recently, the rise in corporate debt has received less so. We argue that high levels of corporate debt may impede the transmission mechanism of monetary policy and make it less effective in controlling inflation. In an environment with working capital financing requirements, when firms’ indebtedness is sufficiently high, the income effect of higher nominal interest rates offsets or even dominates its usual negative substitution effect on aggregate demand and is quantitatively important. This mechanism is independent of standard financial and nominal frictions and enhances the trade-off between inflation and output stabilisation.
    Keywords: coronavirus; covid-19
    JEL: E31 E44 E52 G33
    Date: 2021–12–10
  9. By: Karau, Sören
    Abstract: Bitcoin was conceptualized in response to perceived shortcomings in the monetary and financialsystem, not only related to large financial institutions but also to discretionary decision makingin monetary policy. Using high-frequency data and a weekly proxy VAR model, I study theimpact of monetary policy on Bitcoin. The paper shows that monetary shocks have sizableeffects on Bitcoin prices, but that these differ in sign: a disinflationary monetary tightening bythe ECB lowers valuations - consistent with the notion of Bitcoin as a digital gold -, whereasa Fed tightening increases Bitcoin prices. I document similar differences with respect to cen-tral bank information shocks and explore potential explanations by studying various aspects ofthe Bitcoin ecosystem. Exploiting both differences in Bitcoin valuations across currencies andblockchain transaction data, the paper shows that the increased demand for Bitcoin following aUS monetary tightening is primarily driven by emerging markets. I argue that this likely reflectsthe technological and institutional particularities of Bitcoin that make it sought after as globaldigital cashwhen international economic and financial conditions deteriorate.
    Keywords: Bitcoin,Blockchain,Monetary policy,Proxy VAR
    JEL: E42 G32 L14 O16
    Date: 2021
  10. By: Benjamin Gardner; Chiara Scotti; Clara Vega
    Abstract: While the literature has already widely documented the effects of macroeconomic news announcements on asset prices, as well as their asymmetric impact during good and bad times, we focus on the reaction to news based on the description of the state of the economy as painted by the Federal Open Market Committee (FOMC) statements. We develop a novel FOMC sentiment index using textual analysis techniques, and find that news has a bigger (smaller) effect on equity prices during bad (good) times as described by the FOMC sentiment index. Our analysis suggests that the FOMC sentiment index offers a reading on current and future macroeconomic conditions that will affect the probability of a change in interest rates, and the reaction of equity prices to news depends on the FOMC sentiment index which is one of the best predictors of this probability.
    Keywords: Monetary policy; Public information; Probability of a recession; Price discovery
    JEL: C53 D83 E27 E37 E44 E47 E50 G10
    Date: 2021–11–18
  11. By: Lena Dräger (Leibniz University Hannover.); Michael J. Lamla (Leuphana University of Lüneburg and ETH Zurich, KOF Swiss Economic Institute); Damjan Pfajfar (Board of Governors of the Federal Reserve System)
    Abstract: Using a new consumer survey dataset, we study the role of macroeconomic preferences for expectations and economic decisions. While household expectations are inversely related to preferences, households with the same ination expectations can di_erently assess whether the level of expected ination and of nominal interest rates is appropriate or too high/too low. This `hidden heterogeneity' in expectations is correlated with sociodemographic characteristics and a_ects current and planned spending via the intertemporal elasticity of substitution. We also show that the variation in preferences can be explained with risk preferences. Overall, this adds a new dimension to the de_nition of anchored expectations.
    Keywords: Macroeconomic expectations, monetary policy perceptions, ination and interestrate preferences, risk preferences, survey microdata
    JEL: E31 E52 E58 D84
    Date: 2021–05
  12. By: Gita Gopinath; Oleg Itskhoki
    Abstract: A handful of currencies, especially the US dollar, play a dominant role in international trade. We survey the active theoretical and empirical literature that documents patterns of currency use in global trade, the implications of dominant currencies for international transmission of shocks, exchange rate pass-through, expenditure switching, and optimal monetary policy. We describe advances in the endogenous currency choice literature including conditions for the emergence and persistence of dominant currency equilibria.
    JEL: F30 F40
    Date: 2021–12
  13. By: Enrique Bátiz-Zuk; José Luis Lara Sánchez
    Abstract: This paper examines the link between bank competition measures and risk indicators using quarterly interbank exposures data for all banks in Mexico during 2008Q1-2019Q1. The classical literature focuses on disentangling the link between competition and individual bank solvency risk. In this paper, we take one step forward in analyzing the relationship between competition and systemic risk. We use counterfactual bank-level contagion risk indicators as a proxy of systemic risk to assess their relationship with traditional competition measures. Our main finding indicates a negative relationship between the bank-level Lerner index and systemic risk. This means that an increase in competition is associated with an increase in systemic risk. Additionally, we find that the implementation of regulatory reform during the period studied does not affect this relationship.
    JEL: C23 D40 G21 G28 L14 L16 L22
    Date: 2021–12
  14. By: Galip Kemal Ozhan
    Abstract: How does news about future economic fundamentals affect within-country and cross-country credit allocation? How effective is unconventional policy when financial crises are driven by unfulfilled favorable news? I study these questions by employing a two-sector, two-country macroeconomic model with a financial sector in which financial crises are associated with occasionally binding leverage constraints. In response to positive news on the valuation of non-traded sector capital that turns out to be incorrect at a later date, the model captures the patterns of financial flows and current account dynamics in Spain between 2000-2010, including the changes in the sectoral allocation of bank credit and movements in cross-country borrowing during the boom and the bust. When there are unconventional policies by a common authority in response to unfulfilled favorable news, liquidity injections perform better in ameliorating the downturn than direct assets purchases from the non-traded sector.
    Keywords: Central bank research; Digital currencies and fintech
    JEL: E44 F32 F41 G15 G21
    Date: 2021–12
  15. By: Jorge E. Galán (Banco de España)
    Abstract: This document proposes an aggregate early-warning indicator of systemic risk in the banking sector. The indicator is derived from a logistic model based on the variables in the CAMELS rating system, originally developed for the US, and complemented with macroeconomic aggregate variables. The model is applied to the Spanish banking sector using bank-level data for a complete financial cycle, from 1999 to 2021. The performance of the model is assessed not only during the last global financial crisis and the subsequent sovereign crisis, but also during the recent Covid-19 shock. The proposed indicator has a macroprudential orientation, which differs from most of previous studies predicting individual bank defaults. The indicator is found to provide accurate early-warning signals of systemic risk in the banking sector within a two-year horizon. In this context, the indicator provides mid-term signals of systemic risk that complement those derived from macrofinancial indicators and from measures of the materialization of risk.
    Keywords: banks, defaults, early-warning performance, macroprudential policy, systemic risk
    JEL: C25 E32 E58 G01 G21
    Date: 2021–11
  16. By: Charles M. Kahn; Maarten van Oordt; Yu Zhu
    Abstract: An important feature of physical cash payments is resilience, due to their indifference to power outages or network coverage. Many central banks are exploring issuing digital cash substitutes with similar online payment functionality. Such substitutes could incorporate novel features, making them more desirable than physical cash. This paper considers introducing an expiry date for online digital currency balances to automate personal loss recovery. We show that this functionality could substantially increase consumer demand for digital cash, with the time to expiration playing an important role. Having more information available to the central bank improves accuracy of loss recovery but may decrease welfare.
    Keywords: Digital currencies and fintech
    JEL: E42
    Date: 2021–12
  17. By: Jiaqi Li
    Abstract: This paper predicts households’ demand for central bank digital currency (CBDC) with different design attributes by applying a structural demand model to a unique Canadian survey dataset. CBDC and its close alternatives, cash and demand deposits, are viewed as product bundles of different attributes. I estimate households’ preferences towards these attributes from how they allocate their liquid assets between cash and demand deposits. The estimated preferences are used to predict the demand for CBDC with a set of design attributes and quantify the impacts of CBDC design choices on CBDC demand. Under a baseline design for CBDC, the aggregate CBDC holdings out of households’ liquid assets could range from 4 to 52%, depending on whether households would perceive CBDC to be closer to cash or deposits. I find that important design attributes include budgeting usefulness, anonymity, bundling of bank services, and rate of return.
    Keywords: Central bank research; Digital currencies and fintech
    JEL: E58
    Date: 2021–12
  18. By: Ogawa, Toshiaki
    Abstract: This study examines how micro- and macro-prudential policies work and interact with each other over the credit cycles using a dynamic general equilibrium model of financial intermediaries. Micro-prudential policies restrict the excess risk-taking of individual institutions, while taking real interest rates (prices) as given. By contrast, macro prudential policies control the aggregate credit supplied (equilibrium outcome) by internalizing prices or the general equilibrium effect. The proposed model indicates that: (i) micro-prudential policy alone cannot completely remove inefficient credit cycles; (ii) when macro-prudential policy is conducted jointly with the micro-prudential one, policymakers can improve banks' credit quality and remove inefficient credit cycles completely without sacrificing the total credit supply; and (iii) the contributions of micro and macro-prudential policies to the improvement in social welfare are roughly comparable.
    Keywords: Micro-prudential policy; Macro-prudential policy; Moral hazard problem; General equilibrium; Inefficient credit cycles
    JEL: E0 E44 G01 G21 G28
    Date: 2022–01–05
  19. By: Leonello, Agnese; Mendicino, Caterina; Panetti, Ettore; Porcellacchia, Davide
    Abstract: Does the level of deposits matter for bank fragility and efficiency? In a banking model with endogenous bank runs and a consumption-saving decision, we show that the level of deposits has opposite effects on bank fragility depending on the nature of bank runs. In an economy with panic-driven runs, higher deposits make banks less fragile, while the opposite is true when runs are only driven by fundamentals. The effect of deposits is not internalized by depositors. A saving externality arises, leading to excessive fragility and insufficient liquidity provision. The economy features under-saving when runs are panic driven, and over-saving when fundamental driven. JEL Classification: G01, G21, G28
    Keywords: endogenous bank runs, fundamental runs, liquidity provision, panic runs, saving externality
    Date: 2022–01
  20. By: Bao-We-Wal Bambe (CERDI - Centre d'Études et de Recherches sur le Développement International - CNRS - Centre National de la Recherche Scientifique - UCA - Université Clermont Auvergne)
    Abstract: This paper analyses the effect of inflation targeting on private domestic investment in developing countries. Using the propensity scores matching method, which allows addressing the self-selection bias in the policy adoption, I find that inflation targeting has increased private domestic investment from 2.05 to 2.53 percentage points in targeting countries compared to nontargeting countries. The estimated coefficients are economically meaningful and robust to a battery of econometric tests and alternative specifications. Finally, I highlight several heterogeneities in the effect of inflation targeting, depending on various factors.
    Keywords: E51,E52,E58,590,E62,E220,Inflation targeting,Private domestic investment,Developing countries,Propensity score matching
    Date: 2021–12–14
  21. By: Parla, Fabio (Central Bank of Ireland)
    Abstract: In this paper, we construct a weekly measure of systemic stress across a range of indicators for Irish financial markets, covering money, sovereign bonds, equity, banking and foreign exchange markets by using a time-varying correlation-based approach. We compare the ability of the resulting index to capture known financial market stress events in Ireland with existing alternative measures. Furthermore, we use the indicator as a proxy of financial distress to assess the high-frequency propagation mechanism of financial markets shocks to the macroeconomy. Given that macroeconomic variables are sampled at a monthly frequency, the temporal transmission of shocks is carried through a structural Bayesian mixed-frequency Vector Autoregressive model. We find evidence of a moderate temporal aggregation bias due to aggregating weekly observations of the financial stress indicator to a monthly frequency. In particular, the results suggest that the response of the macroeconomic variables depends on the timing of the shocks within the month.
    Keywords: Financial stress index, macro-financial linkages, Mixed-Frequency VAR, MIDAS
    JEL: C32 E44 G10
    Date: 2021–09
  22. By: Christian Aubin (CRIEF - Centre de Recherche sur l'Intégration Economique et Financière - Université de Poitiers)
    Abstract: This paper reconsiders the Fisherian equation of exchange by explicitly distinguishing two types of transactions associated with industrial circulation, on the one hand, and financial circulation, on the other. In this context, a formal link can be established between the financialization of the economy and the downward trend in the income velocity of money during the last decades.
    Abstract: Ce papier reconsidère l'équation fisherienne des échanges en distinguant explicitement deux types de transactions associées, d'une part, à une circulation industrielle et, d'autre part, à une circulation financière. Dans ce cadre, un lien peut être établi entre la financiarisation de l'économie et la baisse tendancielle de la vitesse-revenu de circulation de la monnaie des dernières décennies.
    Keywords: money,quantity theory of money,equation of exchange,velocity of money,financialization,monetary policy
    Date: 2021–12–19

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