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on Central Banking |
| By: | Frederic Boissay; Fabrice Collard; Jordi Galí; Cristina Manea |
| 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. |
| JEL: | E32 E44 E52 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:29602&r= |
| By: | Sushant Acharya; Keshav Dogra; Sanjay Singh |
| Abstract: | We formalize the idea that the financial sector can be a source of non-fundamental risk. Households’ desire to hedge against price volatility can generate price volatility in equilibrium, even absent fundamental risk. Fearing that asset prices may fall, risk-averse households demand safe assets from leveraged intermediaries, whose issuance of safe assets exposes the economy to self-fulfilling fire sales. Policy can eliminate non-fundamental risk by (i) increasing the supply of publicly backed safe assets, through issuing government debt or bailing out intermediaries, or (ii) reducing the demand for safe assets, through social insurance or by acting as a market maker of last resort. |
| Keywords: | Business fluctuations and cycles; Inflation and prices; Monetary policy |
| JEL: | D52 D84 E62 G12 |
| Date: | 2022–01 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:22-4&r= |
| By: | Wenting Song; Samuel Stern |
| Abstract: | This paper provides direct evidence of the importance of firm attention to macro-economic dynamics. We construct a text-based measure of firm attention to macro-economic news and document firm attention that is polarized and countercyclical. Differences in attention lead to asymmetric responses to monetary policy: expansionary monetary shocks raise market values of attentive firms more than those of inattentive firms, and contractionary shocks lower values of attentive firms by less. We use the measure to calibrate a quantitative model of rationally inattentive firms with hetero-geneous costs of information. Less attentive firms adjust prices slowly in response to monetary innovations, which yields non-neutrality. As average attention varies over the business cycle, so does the efficacy of monetary policy. |
| Keywords: | Business fluctuations and cycles; Inflation and prices, Monetary policy |
| JEL: | D83 E44 E52 |
| Date: | 2022–01 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:22-3&r= |
| By: | Li, Boyao |
| Abstract: | I develop a banking model to examine the effects of government expenditures on the credit and money supply under Basel III regulations. Purchases of goods and services from real firms or transfer payments to households as conventional government expenditures (CGEs) inject reserves into banks. Purchases of equity from banks as unconventional government expenditures (UGEs) inject equity into banks. Three Basel III regulations are examined: the capital adequacy ratio, liquidity coverage ratio, and net stable funding ratio. My results demonstrate that the CGE or UGE causes multiplier effects on the credit supply. The multiplier greater (less) than one means that banks amplify (contract) the government expenditure. Multiplier effects on the money supply in response to the CGE or UGE are also presented. My paper sheds considerable light on how government expenditure and bank regulation simultaneously affect the credit and money supply. |
| Keywords: | Bank credit supply; Government expenditure; Basel III; Multiplier effect; Balance sheet |
| JEL: | E51 E61 E62 G21 G28 |
| Date: | 2021–12–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:111311&r= |
| By: | Mitali Das; Gita Gopinath; Ṣebnem Kalemli-Özcan |
| Abstract: | We show that “preemptive” capital flow management measures (CFM) can reduce emerging markets and developing countries’ (EMDE) external finance premia during risk-off shocks, especially for vulnerable countries. Using a panel dataset of 56 EMDEs during 1996–2020 at monthly frequency, we document that countries with preemptive policies in place during the five year window before risk-off shocks experienced relatively lower external finance premia and exchange rate volatility during the shock compared to countries which did not have such pre-emptive policies in place. We use the episodes of Taper Tantrum and COVID-19 as risk-off shocks. Our identification relies on a difference-in-differences methodology with country fixed effects where preemptive policies are ex-ante by construction and cannot be put in place as a response to the shock ex-post. We control the effects of other policies, such as monetary policy, foreign exchange interventions (FXI), easing of inflow CFMs and tightening of outflow CFMs that are used in response to the risk-off shocks. By reducing the impact of risk-off shocks on countries’ funding costs and exchange rate volatility, preemptive policies enable countries’ continued access to international capital markets during troubled times. |
| JEL: | F3 F31 F41 F44 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:29615&r= |
| By: | Laurence M. Ball; Daniel Leigh; Prachi Mishra; Antonio Spilimbergo |
| Abstract: | Large price changes in industries affected by the COVID-19 pandemic have caused erratic fluctuations in the U.S. headline inflation rate. This paper compares alternative approaches to filtering out the transitory effects of these industry price changes and measuring the underlying or core level of inflation over 2020-2021. The Federal Reserve’s preferred measure of core, the inflation rate excluding food and energy prices, has performed poorly: over most of 2020-21, it is almost as volatile as headline inflation. Measures of core that exclude a fixed set of additional industries, such as the Atlanta Fed’s sticky-price inflation rate, have been less volatile, but the least volatile have been measures that filter out large price changes in any industry, such as the Cleveland Fed’s median inflation rate and the Dallas Fed’s trimmed mean inflation rate. These core measures have followed smooth paths, drifting down when the economy was weak in 2020 and then rising as the economy has rebounded. |
| JEL: | E31 E58 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:29609&r= |
| By: | Katsafados, Apostolos; Anastasiou, Dimitris |
| Abstract: | The purpose of this study is twofold. First, to construct short-term prediction models for bank deposit flows in the Euro area peripheral countries, employing machine learning techniques. Second, to examine whether textual features enhance the predictive ability of our models. We find that Random Forest models including both textual features and macroeconomic variables outperform those that include only macro factors or textual features. Monetary policy authorities or macroprudential regulators could adopt our approach to timely predict potential excessive bank deposit outflows and assess the resilience of the whole banking sector in the Euro area peripheral countries. |
| Keywords: | Bank deposit flows; European banks; textual analysis; short-term prediction; machine learning |
| JEL: | C0 C22 C5 C51 C54 E44 E47 G10 |
| Date: | 2022–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:111418&r= |
| By: | Richhild Moessner |
| Abstract: | We study the effects of professionals’ survey-based inflation expectations on inflation for a large number of 36 OECD economies, using dynamic cross-country panel estimation of New-Keynesian Phillips curves. We find that inflation expectations have a significantly positive effect on inflation. We also find that the effect of inflation expectations on inflation is larger when inflation is higher. This suggests that second-round effects via the effects of higher inflation expectations on inflation are more relevant in a high-inflation environment. |
| Keywords: | inflation, inflation expectations, Phillips curve |
| JEL: | E52 E58 |
| Date: | 2021 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_9467&r= |
| By: | Igor Livshits; Youngmin Park |
| Abstract: | This paper offers a simple theory of inefficiently lax financial regulation arising as an outcome of a democratic political process. Lax financial regulation encourages some banks to issue risky residential mortgages. In the event of an adverse aggregate housing shock, these banks fail. When banks do not fully internalize the losses from such failure (due to limited liability), they offer mortgages at less than actuarially fair interest rates. This opens the door to homeownership for young, low net-worth individuals. In turn, the additional demand from these new homebuyers drives up house prices. This leads to a non-trivial distribution of gains and losses from lax regulation among households. On the one hand, renters and individuals with large non-housing wealth suffer from the fragility of the banking system. On the other hand, some young, low net-worth households are able to get a mortgage and buy a house, and current (old) homeowners benefit from the increase in the price of their houses. When these latter two groups, who benefit from the lax regulation, constitute a majority of the voting population, then regulatory failure can be an outcome of the democratic political process. |
| Date: | 2022–01–10 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:93611&r= |
| By: | Olivier Jeanne |
| Abstract: | This paper presents a tractable model of a global economy in which countries can use a broad range of policy instruments---the nominal interest rate, taxes on imports and exports, taxes on capital flows or foreign exchange interventions. Low demand may lead to unemployment because of downward nominal wage stickiness. Markov perfect equilibria with and without international cooperation are characterized in closed form. The welfare costs of trade and currency wars crucially depend on the state of global demand and on the policy instruments that are used by national policymakers. Countries have more incentives to deviate from free trade when global demand is low. Trade wars lower employment if they involve tariffs on imports but raise employment if they involve export subsidies. Tariff wars can lead to self-fulfilling global liquidity traps. |
| JEL: | F16 F31 F33 F38 F40 F42 |
| Date: | 2021–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:29603&r= |
| By: | Florian Exler; Igor Livshits; James MacGee; Michele Tertilt |
| Abstract: | Do cognitive biases call for regulation to limit the use of credit? We incorporate over-optimistic and rational borrowers into an incomplete markets model with consumer bankruptcy. Over-optimists face worse income risk but incorrectly believe they are rational. Thus, both types behave identically. Lenders price loans forming beliefs—type scores—about borrower types. This gives rise to a tractable theory of type scoring. As lenders cannot screen types, borrowers are partially pooled. Over-optimists face cross subsidized interest rates but make financial mistakes: borrowing too much and defaulting too late. The induced welfare losses outweigh gains from cross subsidization. We calibrate the model to the U.S. and quantitatively evaluate policies to address these frictions: financial literacy education, reducing default cost, increasing borrowing costs, and debt limits. While some policies lower debt and filings, only financial literacy education eliminates over borrowing and improves welfare. Score-dependent borrowing limits can reduce financial mistakes but lower welfare. |
| Keywords: | Consumer Credit; Over-Optimism; Financial Mistakes; Bankruptcy; Default; Financial Literacy; Financial Regulation; Type Score; Cross-Subsidization |
| JEL: | E21 E49 G18 K35 |
| Date: | 2021–12–07 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedpwp:93457&r= |