nep-cba New Economics Papers
on Central Banking
Issue of 2022‒04‒11
twenty-one papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Household Heterogeneity and the Performance of Monetary Policy Frameworks By Edouard Djeutem; Mario He; Abeer Reza; Yang Zhang
  2. The Central Bank Strikes Back! Credibility of Monetary Policy under Fiscal Influence By Antoine Camous; Dmitry Matveev
  3. Quantitative forward guidance through interest rate projections By Boris Hofmann; Dora Xia
  4. How Does Monetary Policy Affect Prices of Corporate Loans? By Seung Kwak
  5. Optimal Monetary Policy with r* By Roberto M. Billi; Jordi Galí; Anton Nakov
  6. Monetary policy trade-offs at the zero lower bound By Stefano Eusepi; Christopher G. Gibbs; Bruce Preston
  7. Monetary policy in South Africa, 2007-21 By Patrick Honohan; Athanasios Orphanides
  8. Central bank digital currency with heterogeneous bank deposits By Remo Nyffenegger
  9. Monetary Policy and the Run Risk of Loan Funds By Nicola Cetorelli; Gabriele La Spada; João A. C. Santos
  10. Federal Reserve Structure and Economic Ideas By Michael D. Bordo; Edward Simpson Prescott
  11. Central Bank Digital Currency in a Developing Economy: A Dynamic Stochastic General Equilibrium Analysis By Rivera Moreno, Pablo Nebbi; Triana Montaño, Karol Lorena
  12. Unconventional Monetary Policy in the Euro Area. Impacts on Loans, Employment, and Investment By António Afonso; Francisco Gomes Pereira
  13. Central Bank Liquidity Facilities and Market Making By David Cimon; Adrian Walton
  14. Stablecoins and Central Bank Digital Currencies: Policy and Regulatory Challenges By Barry Eichengreen; Ganesh Viswanath-Natraj
  15. Optimal Liquidity Control and Systemic Risk in an Interbank Network with Liquidity Shocks and Regime-dependent Interconnectedness By Chotipong Charoensom; Thaisiri Watewai
  16. From low to high inflation: Implications for emerging market and developing economies By Jongrim Ha; M. Ayhan Kose; Franziska Ohnsorge
  17. Causal effects of the Fed's large-scale asset purchases on firms' capital structure By Nocera, A.; Pesaran, M. H.
  18. Inflation Levels and (In)Attention By Anat Bracha; Jenny Tang
  19. Calibrating the countercyclical capital buffer for Italy By Pierluigi Bologna; Maddalena Galardo
  20. A New Approach to Assess Inflation Expectations Anchoring Using Strategic Surveys By Olivier Armantier; Argia M. Sbordone; Giorgio Topa; Wilbert Van der Klaauw; John C. Williams
  21. Asia Digital Common Currency as a Global (International) Currency By Wataru Takahashi; Taiji Inui

  1. By: Edouard Djeutem; Mario He; Abeer Reza; Yang Zhang
    Abstract: We compare the performance of alternative monetary policy frameworks (inflation targeting, average inflation targeting, price level targeting and nominal GDP level targeting) in a tractable HANK model where incomplete financial markets and idiosyncratic earnings risk introduce precautionary savings and consumption inequality. Financial market incompleteness generates an additional source of societal welfare loss due to cyclical fluctuations in inequality on top of those from inflation and output volatility. We find that history-dependent policies are preferred in this framework. However, if central banks put a high weight on curbing inequality, AIT and IT can be preferred over PLT.
    Keywords: Monetary policy framework; Monetary policy transmission; Monetary policy and uncertainty; Economic models
    JEL: D31 D52 E21 E31 E58
    Date: 2022–03
  2. By: Antoine Camous; Dmitry Matveev
    Abstract: How should independent central banks react if pressured by fiscal policymakers? We study an environment with strategic monetary-fiscal interactions where the central bank has a limited degree of commitment to follow policies over time and the fiscal authority has none. We contrast the implications of two monetary frameworks: one where the central bank follows a standard rule aiming exclusively at price stability against the other, where monetary policy additionally leans against fiscal influence. The latter rule improves economic outcomes by providing appropriate incentives to the fiscal authority. More importantly, the additional fiscal conditionality can enhance the credibility of the central bank to achieve price stability. We emphasize how the level and structure of government debt emerge as key factors affecting the credibility of monetary policy with fiscal conditionality.
    Keywords: Credibility; Fiscal policy; Monetary policy
    JEL: E02 E52 E58 E61 E62
    Date: 2022–03
  3. By: Boris Hofmann; Dora Xia
    Abstract: We assess quantitative forward guidance through interest rate projections along four key dimensions: (i) predictability, (ii) credibility, (iii) redundancy and (iv) consistency. Based on data for the Reserve Bank of New Zealand, the Norges Bank, the Sveriges Riksbank and the Federal Reserve, we find that the interest rate projections released by these four central banks are predictable and credible, but in limited ways. Market expectations of the future path of interest rates predict changes in the central bank projection path, but far from fully. Central bank paths' credibility is limited as markets adjust to path surprises, but far from a one-to-one basis. Both predictability and credibility decrease with the projection horizon. We further find that central bank interest rate projections are not redundant as they impact market expectations also when controlling for the effects of central bank macro projections that are released in parallel. Finally, the interest rate projections are consistent with the macro projections as they are empirically linked by a stabilising Taylor rule.
    Keywords: forward guidance, interest rate projections, central bank communication.
    JEL: E52 E58
    Date: 2022–03
  4. By: Seung Kwak
    Abstract: We study the impact of unanticipated monetary policy news around FOMC announcements on secondary market corporate loan spreads. We find that the reaction of loan spreads to monetary policy news is weaker than that of bond spreads: following an unanticipated monetary policy tightening (easing) shock, loan spreads do not increase (decrease) as much as bond spreads do. Decomposition of the spreads into compensations for expected defaults and risk premiums shows that differential reactions of loan and bond risk premiums are the main driver of the differential spread reactions. We further find that the weaker loan spread reactions to monetary policy shocks are more pronounced for riskier loans. Lastly, reactions of primary market loan spreads to monetary policy shocks are also muted. These findings highlight heterogeneous impacts of monetary policy across different types of corporate credit markets, possibly reflecting heterogeneous investor demand responses to monetary policy in those markets.
    Keywords: Corporate bonds; Monetary policy; Corporate loans
    JEL: E52 G12 G23
    Date: 2022–02–25
  5. By: Roberto M. Billi; Jordi Galí; Anton Nakov
    Abstract: We study the optimal monetary policy problem in a New Keynesian economy with a zero lower bound (ZLB) on the nominal interest rate, and in which the steady state natural rate (r*) is negative. We show that the optimal policy aims to approach gradually a steady state with positive average inflation. Around that steady state, inflation and output fluctuate optimally in response to shocks to the natural rate. The central bank can implement that optimal outcome by means of an appropriate state-contingent rule, even though in equilibrium the nominal rate remains at zero most (or all) of the time. In order to establish that result, we derive sufficient conditions for local determinacy in a more general model with endogenous regime switches.
    Keywords: zero lower bound, New Keynesian model, decline in r*, equilibrium determinacy, regime switching models, secular stagnation
    JEL: E32 E52
    Date: 2022–03
  6. By: Stefano Eusepi; Christopher G. Gibbs; Bruce Preston
    Abstract: We study zero interest-rate policy in response to a large negative demand shock when long-run inflation expectations can fall over time. Because falling expectations make monetary policy less effective by raising real interest rates, the optimal forward guidance policy makes large front-loaded promises to stabilize expectations. Policy is too stimulatory in the event of transitory shocks, but provides insurance against persistent shocks. Optimal policy is well-approximated by a constant calendar-based forward guidance, independent of the shock’s realized persistence. This insurance principle qualitatively and quantitatively distinguishes our paper from other recent research on bounded rationality and the forward guidance puzzle.
    Keywords: Optimal Monetary Policy, Learning Dynamics, Expectations Stabilization, Forward Guidance
    JEL: E32 D83 D84
    Date: 2022–03
  7. By: Patrick Honohan; Athanasios Orphanides
    Abstract: This paper reviews South Africa's monetary policy since 2007 and makes recommendations towards improving the inflation-targeting framework currently in place. Following a surge in inflation into double digits in 2007/08, the South African Reserve Bank managed to guide inflation in line with the 3-6 per cent target band. Estimates of South Africa's potential output underwent successive downward revisions. The resulting output gap misperceptions contributed to the tendency of inflation to be closer to the upper edge of the band in the 2010s.
    Keywords: Monetary policy, Inflation targeting, Output gap, South Africa
    Date: 2022
  8. By: Remo Nyffenegger
    Abstract: This paper analyses the effects of an introduction of a retail central bank digital currency (CBDC) on bank intermediation in a general equilibrium model with heterogeneous bank deposits and an imperfectly competitive loan market. I find that the impacts of a CBDC strongly differ depending on whether it is used as a medium of exchange or as a saving vehicle. A calibration of the model to the US economy from 1987-2006 shows that if a CBDC is only used as a medium of exchange, a 10% increase in the fraction of people who hold central bank money as a medium of exchange decreases bank lending only by 0.2%. The effect is four times stronger if CBDC is only used as a saving vehicle.
    Keywords: Central bank digital currency, bank lending, new monetarism, overlapping generations
    JEL: E42 E50 E58
    Date: 2022–03
  9. By: Nicola Cetorelli; Gabriele La Spada; João A. C. Santos
    Abstract: Loan funds are open-end mutual funds holding predominantly corporate leveraged loans. We document empirically that loan funds are significantly more susceptible to run risk than any other category of debt funds, including corporate bond funds. Most importantly, we establish a link between loan funds’ flows and monetary policy, based on the institutional characteristics of their portfolio holdings. We find robust evidence indicating a pro-cyclical relationship between monetary policy and loan-fund flows. This relationship, however, is asymmetric: weaker for policy-rate increases and stronger for policy-rate decreases. Finally, the effect of monetary policy shocks on loan-fund flows also depends on the level of market short-term rates, suggesting that it is not only the direction of the monetary policy change that matters, but also the level of the policy rate at the time of the change. Our results thus identify a novel channel of monetary policy transmission affecting a critical segment of the credit sector, represented by leveraged lending.
    Keywords: mutual funds; monetary policy; leverage lending
    JEL: G23 E52 G28
    Date: 2022–03–01
  10. By: Michael D. Bordo; Edward Simpson Prescott
    Abstract: This essay was written in memory of Marvin Goodfriend for a Federal Reserve Bank of Richmond book called Essays in Honor of Marvin Goodfriend: Economist and Central Banker. We discuss his Carnegie-Rochester conference paper titled "The Role of a Regional Bank in a System of Central Banks." In that paper, Marvin argued that the Federal Reserve's decentralized structure allowed for competing ideas about monetary and banking policy to develop with the central bank. In our essay, we describe how Marvin demonstrated this argument during his long career at the Federal Reserve Bank of Richmond. We also describe the institutional developments that led to this competition, including reforms that Chairman William McChesney Martin made to the operation of the Federal Open Market Committee in the 1950s and the introduction of monetary policy ideas such as monetarism and rational expectations by the Reserve Banks.
    Keywords: Federal Reserve structure; monetary policy; governance; Marvin Goodfriend
    JEL: B0 E58 G28 H1
    Date: 2022–01–21
  11. By: Rivera Moreno, Pablo Nebbi; Triana Montaño, Karol Lorena
    Abstract: Central Bank Digital Currency (CBDC) has been in the center of discussion of many monetary policy research agendas. We explore how the business cycle behavior of a developing economy is affected by the introduction of this type of money as a second monetary policy tool. We emphasize on the characteristic dual formal and informal labor markets that are present in most developing economies, given its relevance on explaining the business cycle dynamics. Our main contribution is the building of a model that encompasses such characteristics and features the relevance of monetary balances to macroeconomic fluctuations. We find that CBDC has the ability to improve the monetary policy effectiveness, and the response of relevant variables may be amplified or dampened, depending on the nature of the shock. Also the magnitude of the new dynamics introduced by CBDC are also profoundly dependant on its structural parameters. The main transmission mechanisms that are affected by CBDC are the dynamics of distortions generated by transaction costs.
    Date: 2022–04
  12. By: António Afonso; Francisco Gomes Pereira
    Abstract: Using a difference-in-differences identification strategy on a micro panel at the bank and firm level, we study the transmission effectiveness of ECB’s large-scale asset purchasing programs programs (i.e. APP and PEPP) in the Euro area. Our findings show: first, balance sheet composition of banks is an important determinant of monetary policy transmission. We tested this hypothesis by showing that banks more exposed to government debt securities had higher loan growth than less exposed banks after the APP announcement. By extension, this could lead to heterogeneous economic impacts depending on the geographical location of exposed banks. For the PEPP, contrary to the APP, we did not find a portfolio-rebalancing channel for banks that were more exposed to government debt securities. Second, using balance sheet data on corporates, we verify that firms that borrowed more increased employment and fixed capital investment, albeit to a lesser degree than before the APP announcement. Furthermore, our sample shows that corporations in countries with banks more exposed to government debt securities had higher borrowing growth and fixed capital growth versus countries with less exposed banks.
    Keywords: unconventional monetary policy, difference-in-differences, euro area, employment, investment.
    JEL: C23 D22 E52 E58 G11 G20
    Date: 2022–03
  13. By: David Cimon; Adrian Walton
    Abstract: In the onset of the COVID-19 crisis, central banks purchased large volumes of assets in an effort to keep markets operational. We model one such central bank, which purchases assets from dealers to alleviate balance sheet constraints. Asset purchases can prevent market breakdown, improve price efficiency and reduce dealer risk positions. A central bank that purchases assets at their expected value is able to achieve market outcomes as if dealers were unconstrained. Absent other concerns, central banks can maximize welfare by purchasing assets at a premium, though they may create market distortions. Alternatively, central banks who bear costs associated with large interventions may only be willing to purchase assets at a discount. In the absence of leverage constraints, lending programs are as effective as asset purchases; when leverage constraints are present, lending programs lose effectiveness.
    Keywords: Coronavirus disease (COVID-19); Economic models; Financial institutions; Financial markets; Market structure and pricing
    JEL: G10 G20 L10
    Date: 2022–03
  14. By: Barry Eichengreen; Ganesh Viswanath-Natraj
    Abstract: Stablecoins and central bank digital currencies are on the horizon in Asia, and in some cases have already arrived. This paper provides new analysis and a critique of the use case for both forms of digital currency. It provides time-varying estimates of devaluation risk for the leading stablecoin, Tether, using data from the futures market. It describes the formidable obstacles to widespread use of central bank digital currencies in cross-border transactions, the context in which their utility is arguably greatest. The bottom line is that significant uncertainties continue to dog the region's digital currency initiatives.
    Date: 2022–02
  15. By: Chotipong Charoensom; Thaisiri Watewai
    Abstract: We propose a novel interbank network model in which banks face systemic liquidity shocks, fight-to-quality liquidity flows, and collapses of the interbank network during crises, and study their impacts on the optimal liquidity control and the systemic risk of the interbank network. We find that banks respond to negative shocks by holding positive precautionary liquidity, but once the shock size is sufficiently large, the benefit of precautionary liquidity reduces, and banks lower their precautionary liquidity. Lending (borrowing) banks also hold positive (negative) interbank liquidity provision. Banks hold more provision for more interconnected networks, but when the network is too interconnected, it is too costly to hold large provision, causing banks to lower the provision. On the contrary, a higher degree of the fight-to-quality effect tends to make banks act more aggressively on both precautionary liquidity and interbank provision. As a result, the systemic risk tends to increase in the size of the negative shock, but is quite insensitive to the degree of the fight-to-quality effect. Our analysis shows that the systemic risk increases if the interbank market collapses or becomes too interconnected during crises. Rewards and penalties from regulators can help reduce the systemic risk, but they come with a cost and have different implications on the banks' optimal policies.
    Keywords: Liquidity shock; Interbank Interconnectedness; Fight-to-quality; Systemic risk; Precautionary liquidity; Interbank liquidity provision; Regime switching; Stochastic control
    Date: 2022–03
  16. By: Jongrim Ha; M. Ayhan Kose; Franziska Ohnsorge
    Abstract: Recent energy and food price surges, in the wake of Russia’s invasion of Ukraine, have exacerbated inflation pressures that are unusually high by the standards of the past two decades. High and rising inflation has prompted many emerging market and developing economy (EMDE) central banks and some advanced-economy central banks to increase interest rates. Inflation is expected to ease back towards targets over the medium-term as recent shocks unwind, but the 1970s experience is a reminder of the material risks to this outlook. As inflation remains elevated, the risk is growing that, to bring inflation back to target, advanced economies need to undertake a much more forceful monetary policy response than currently anticipated. If this risk materializes, it would imply additional increases in borrowing costs for EMDEs, which are already struggling to cope with elevated inflation at home before the recovery from the pandemic is complete. EMDEs need to focus on calibrating their policies with macroeconomic stability in mind, communicating their plans clearly, and preserving and building their credibility.
    Keywords: Global Inflation, Commodity Price, War in Ukraine, Global Recession, Great Inflation, Monetary Policy Tightening
    JEL: E31 E32 E37 Q43
    Date: 2022–04
  17. By: Nocera, A.; Pesaran, M. H.
    Abstract: This paper investigates the short- and long-term impacts of the Federal Reserve’s large-scale asset purchases (LSAPs) on the capital structure of U.S. non-financial firms. To isolate the effects of LSAPs from the impact of concurrent macroeconomic conditions, we exploit cross-industry variations in the ability of firms therein to raise external funds without exhausting their debt capacity. We show that firms’ responses to LSAPs strongly depend on the financing decisions of other peers in the same industry. The higher the proportion of firms without high debt burdens in an industry, the stronger the response of firms within the industry to the Fed’s asset purchases. Overall, our results show that LSAPs facilitated firms’ access to debt financing and that the impacts of LSAPs on firms’ capital structure are likely to be long-lasting.
    Keywords: Capital structure, identification, interactive effects, leverage, quantitative easing, unconventional monetary policy
    JEL: G32 E44 E52 E58
    Date: 2022–04–05
  18. By: Anat Bracha; Jenny Tang
    Abstract: Inflation expectations are key determinants of economic activity and are central to the current policy debate about whether inflation expectations will remain anchored in the face of recent pandemic-related increases in inflation. This paper explores evidence of inattention by constructing two different measures of consumers’ inattention and documents greater inattention when inflation is low. This suggests that there is indeed a risk of an acceleration in the increases in inflation expectations if actual inflation remains high.
    Keywords: inattention; inflation expectations; expectation anchoring
    JEL: D80 E31 E70
    Date: 2022–01–01
  19. By: Pierluigi Bologna (Bank of Italy); Maddalena Galardo (Bank of Italy)
    Abstract: While the setting of the countercyclical capital buffer (CCyB) is not an automatic decision, insights from indicators, such as the credit-to-GDP gap, are a starting point to inform the policy decision. This paper identifies an optimal rule to map the credit-to-GDP gap adjusted to the guide to set the CCyB. We follow two alternative procedures. First, we apply the criteria suggested by the Basel Committee on Banking Supervision, (BCBS), obtaining 3 percentage points of the adjusted gap as the activation threshold and 8 percentage points as the maximum. Then we depart from the BCBS approach by proposing a procedure based on the maximization of the area under the receiver operating characteristic curve (AUROC), which suggests 1 and 9 percentage points as the minimum and maximum thresholds, respectively. We also explore whether the CCyB, had it been in place, would have mitigated the repercussions of the Great Financial Crisis for the Italian banking system. Based on a stylized exercise, the full release of the CCyB at the outbreak of the crisis would have freed around 40 billion of capital, a value close to the total amount of banks' credit provisions during the three following years.
    Keywords: macroprudential policy, CCyB, buffer calibration, credit cycle
    JEL: E32 G21 G28
    Date: 2022–03
  20. By: Olivier Armantier; Argia M. Sbordone; Giorgio Topa; Wilbert Van der Klaauw; John C. Williams
    Abstract: We propose a new approach to assessing the anchoring of inflation expectations using “strategic surveys.” Namely, we measure households’ revisions in long-run inflation expectations after they are presented with different economic scenarios. A key advantage of this approach is that it provides a causal interpretation in terms of how inflation events affect long-run inflation expectations. We implement the method in the summer of 2019 and the spring-summer of 2021 when the anchoring of long-run inflation expectations was in question. We find that the risk of unanchoring of expectations was reasonably low in both periods, and that long-run inflation expectations were essentially as well anchored in August 2021 as in July 2019, before the COVID-19 pandemic.
    Keywords: inflation; expectations; anchoring; strategic surveys
    JEL: D12 D84 E31 E52
    Date: 2022–02–01
  21. By: Wataru Takahashi (Faculty of Economics, Osaka University of Economics and Research Fellow, Research Institute for Economics and Business Administration, Kobe University, JAPAN); Taiji Inui (Japan International Cooperation Agency and Asia Development Bank (ADB), JAPAN)
    Abstract: This paper proposes “Asia Digital Common Currency (ADCC)” aiming at fostering Asian financial markets. We are proposing to issue a digital common currency controlled and managed under multilateral governance framework. As a result, the international currency, which should be an international public good, will be governed by a multilateral system. Under our proposed ADCC, each member country can carry out monetary policy independently. It also has a mechanism to maintain currency sovereignty in digital era. In addition, ADCC will contribute to the development of financial market infrastructures in Asia. It will foster the bond markets and standardize the Asian financial system. Asia lags behind Europe in monetary integration, but historically had experiences in common currency circulation. ADCC is an idea that should be thoroughly considered in order to develop the Asian and Japanese economies in the digital age.
    Keywords: Digital currency; Common currency; International currency as an international public good; Currency sovereignty (Münzhoheit); Anonymity; Independence of monetary policy
    JEL: E42 F33 F36
    Date: 2022–03

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