nep-cba New Economics Papers
on Central Banking
Issue of 2022‒04‒25
nineteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Disinflation Costs and Macroprudential Policies: Real and Welfare Effects By Busato, Francesco; Ferrara, Maria; Varlese, Monica
  2. A Note on Temporary Supply Shocks with Aggregate Demand Inertia By Ricardo J. Caballero; Alp Simsek
  3. Uncertainty and Monetary Policy Experimentation: Empirical Challenges and Insights from Academic Literature By Matteo Cacciatore; Dmitry Matveev; Rodrigo Sekkel
  4. Consumption Heterogeneity and Monetary Policy in an Open Economy By Sihao Chen; Michael B. Devereux; Kang Shi; Jenny Xu
  5. Foreign Currency Debt and Exchange Rate Pass-Through By Anna Burova; Konstantin Egorov; Dmitry Mukhin
  6. Optimal timing of policy interventions in troubled banks By König, Philipp Johann; Mayer, Paul; Pothier, David
  7. Collective Moral Hazard and the Interbank Market By Levent Altinoglu; Joseph E. Stiglitz
  8. What Do the Data Tell Us About Inflation Expectations? By Francesco D’Acunto; Ulrike Malmendier; Michael Weber
  9. Supply or Demand? Policy Makers' Confusion in the Presence of Hysteresis By Antonio Fatás; Sanjay R. Singh
  10. Monetary Policy and Economic Growth in a Schumpeterian Model with Incumbents and Entrants By Lu, You-Xun; Chen, Shi-kuan; Lai, Ching-chong
  11. FinTech Lending, Social Networks and the Transmission of Monetary Policy By Xiaoqing Zhou
  12. Cybersecurity and financial stability By Anand, Kartik; Duley, Chanelle; Gai, Prasanna
  13. Evaluating the Effectiveness of Early Warning Indicators: An Application of Receiver Operating Characteristic Curve Approach to Panel Data By Yildirim, Yusuf; Sanyal, Anirban
  14. The bond market impact of the South African Reserve Bank bond purchase programme By Roy Havemann; Henk Janse van Vuuren; Daan Steenkamp; Rossouw van Jaarsveld
  15. Macroprudential Policy Efficiency: Assessment for the Uncollateralized Consumer Loans in Russia By Irina Kozlovtceva; Henry Penikas; Ekaterina Petreneva; Yulia Ushakova
  16. Flexible inflation targeting: Concepts and application in India By Ashima Goyal
  17. Exploring correlations between aggregate demand and supply shocks in India By Ashima Goyal; Sritama Ray
  18. Saved by the bell? Equity market responses to surprise Covid-19 lockdowns and central bank interventions By Aakriti Mathur; Rajeswari Sengupta; Bhanu Pratap
  19. Existence and uniqueness of solutions to dynamic models with occasionally binding constraints By Holden, Tom D.

  1. By: Busato, Francesco; Ferrara, Maria; Varlese, Monica
    Abstract: This paper investigates the costs of disinflation in an otherwise standard DSGE model with borrowing constraints and credit frictions, augmented with macroprudential authority. Analyzing the real and welfare effects of a permanent change in the inflation rate, we study the role of macroprudential policy and its interaction with monetary policy in ensuring financial stability. Results show that when macroprudential authority intervenes actively in order to improve financial stability, disinflation costs are limited. As for the welfare effects, disinflation is welfare improving for savers but welfare costly for borrowers and banks.
    Keywords: Disinflation, Macroprudential policy, Loan-to-value ratio, Monetary policy, Sacrifice ratio, Welfare effects
    JEL: D60 E44 E58
    Date: 2022–02–28
  2. By: Ricardo J. Caballero; Alp Simsek
    Abstract: We study optimal monetary policy during temporary supply contractions when aggregate demand has inertia and expansionary policy is constrained. In this environment, it is optimal to run the economy hot until supply recovers. Positive output gaps in the low-supply phase lessen the negative output gaps expected to emerge once supply recovers. However, the policy does not remain loose throughout the low-supply phase: The central bank undoes the initial interest rate cuts once aggregate demand gains momentum. If inflation also has inertia, the central bank still overheats the economy during the low-supply phase but gradually cools it down over time.
    JEL: E21 E32 E43 E44 E52 G12
    Date: 2022–03
  3. By: Matteo Cacciatore; Dmitry Matveev; Rodrigo Sekkel
    Abstract: Central banks face considerable uncertainty when conducting monetary policy. Some of the reasons for this include limitations of economic data, the unobservability of key macroeconomic variables such as potential output, structural changes to the economy and disagreements over the correct model for the transmission of monetary policy. At the same time, monetary policy is affected by uncertainty from various sources, including lack of or imperfect observation of economic variables, structural economic changes and possible misspecifications using models. We draw from the academic literature to review some of the key sources of this uncertainty and their implications for the conduct of monetary policy. First, we discuss evidence on release lags and revisions to economic data. We also highlight uncertainty around measuring unobservable variables such as the output gap and the natural rate of unemployment. The strength of a trade-off between these measures of economic slack and inflation—a cornerstone of monetary policy—is itself subject to continuous reassessment. Second, the literature finds that different sources of uncertainty may make the optimal conduct of monetary policy either more or less responsive to economic shocks. Additionally, the benefits of tackling uncertainty by engaging in purposeful monetary policy experimentation are typically small but may become more significant during major structural change or following unprecedented shocks.
    Keywords: Central bank research; Monetary policy and uncertainty; Potential output
    JEL: E3 E5
    Date: 2022–04
  4. By: Sihao Chen; Michael B. Devereux; Kang Shi; Jenny Xu
    Abstract: We explore how consumption heterogeneity affects the international transmission mechanism of monetary shocks and the choice of optimal monetary policy in an open economy. Incorporating two types of agents (Ricardian versus Keynesian) into a standard open economy macro model, we find that there are sizeable ranges of household heterogeneity in which monetary policy become ineffective, but this depends sensitively on the interaction of aggregate demand and relative price effects. We derive the global optimal monetary policy with household heterogeneity under alternative pricing regimes. PPI targeting is still the optimal monetary policy under PCP and can restore the economy to the efficient equilibrium. Under LCP, however, the presence of consumption heterogeneity and currency misalignment implies that CPI inflation targeting is no longer optimal in most cases. Finally, we show that when fiscal instruments such as an import tax and export subsidy are introduced, both currency misalignment and consumption heterogeneity can be eliminated, and even under LCP, PPI targeting is the optimal monetary rule.
    JEL: F3 F4
    Date: 2022–03
  5. By: Anna Burova (Bank of Russia, Russian Federation); Konstantin Egorov (New Economic School); Dmitry Mukhin (London School of Economics)
    Abstract: This paper studies both theoretically and empirically the firm’s choice of currency for its debt. We use a parsimonious model with financial frictions to derive an intuitive sufficient statistic for the share of foreign-currency debt in firm’s liabilities and demonstrate its robustness in several extensions. Due to the risk management considerations, firms are more likely to borrow in dollars when the pass-through of the exchange rate into their profits is higher. We leverage this insight empirically using the micro-level data on loans issued by Russian banks to local firms as well as the data on firms’ balance sheets and cash flows. The data strongly supports the predictions of the model indicating that firms with profits more stable in dollars are more likely to borrow in foreign currency than firms with profits stable in local currency. These results extend to a choice between the euro and the dollar and survive after controlling for firms’ size and export status. Note that our results describe efficiency at the firm level, and they do not have direct implications for macroprudential policy as foreign currency debt may also affect exchange rate volatility, inflation and output.
    Keywords: currency choice, invoicing currency, borrowing currency, dollar in global economy, bank loans, exporter status, optimal debt composition
    JEL: D22 F31 F34 G11 G21 G32
    Date: 2022–02
  6. By: König, Philipp Johann; Mayer, Paul; Pothier, David
    Abstract: We analyze the problem of a policy authority (PA) that must decide when to resolve a troubled bank whose underlying solvency is uncertain. Delaying resolution increases the chance that information arrives that reveals the bank's true solvency state. However, delaying resolution also gives uninsured creditors the opportunity to withdraw, which raises the cost of bailing out insured depositors. The optimal resolution date trades off these costs with the option value of making a more efficient resolution decision following the arrival of information. Providing the bank with liquidity support buys the PA time to wait for information, but increases the PA's losses if the bank is insolvent. The PA may therefore optimally choose to delay the provision of liquidity support in order to minimize its losses.
    Keywords: Bank Resolution,Lender of Last Resort,Banking Crises
    JEL: G01 G21 G28
    Date: 2022
  7. By: Levent Altinoglu; Joseph E. Stiglitz
    Abstract: The concentration of risk within the financial system leads to systemic instability. We propose a theory to explain the structure of the financial system and show how it alters the risk taking incentives of financial institutions when the government optimally intervenes during crises. By issuing interbank claims, risky institutions endogenously become too interconnected to fail. This concentrated structure enables institutions to share the risk of systemic crises in a privately optimal way, but leads to excessive risk taking even by peripheral institutions. Interconnectedness and excessive risk taking reinforce one another. Macroprudential regulation which limits the interconnectedness of risky institutions improves welfare.
    JEL: E44 E61 G01 G18 G28
    Date: 2022–02
  8. By: Francesco D’Acunto; Ulrike Malmendier; Michael Weber
    Abstract: Inflation expectations are central to economics because they affect the effectiveness of fiscal and monetary policy as well as realized inflation. We survey the recent literature with a focus on the inflation expectations of households. We first review standard data sources and discuss their advantages and disadvantages. We then document that household inflation expectations are biased upwards, dispersed across individuals, and volatile in the time series. We also provide evidence of systematic differences by gender, income, education, and race. Turning to the underlying expectations formation process, we highlight the role of individuals' exposure to price signals in their daily lives, such as price changes in groceries, the role of lifetime experiences, and the role of cognition. We then discuss the literature that links inflation expectations to economic decisions at the individual level, including consumption-savings and financial decisions. We conclude with an outlook for future research.
    JEL: C90 D14 D84 E31 E52 E71 G11 G51 G53
    Date: 2022–03
  9. By: Antonio Fatás; Sanjay R. Singh (Department of Economics, University of California Davis)
    Abstract: Policy makers need to separate between temporary demand-driven shocks and permanent shocks in order to design optimal aggregate demand policies. In this paper we study the case of a central bank that ignores the presence of hysteresis when identifying shocks. By assuming that all low-frequency output fluctuations are driven by permanent technology shocks, monetary policy is not aggressive enough in response to demand shocks. In addition, we show that errors in assessing the state of the economy can be self-perpetuating if seen through the lens of the mistaken views of the policy maker. We show that a central bank that mistakes a demand shock for a supply shock, will produce permanent effects on output through their suboptimal policies. Ex-post, the central bank will see an economy that resembles what they had forecast when designing their policies. The shock is indeed persistent and this persistence validates their assumption that the shock was a supply-driven one. The interaction between forecasts, policies and hysteresis creates the dynamics of self-perpetuating errors that is the focus of this paper.
    Keywords: business cycles, hysteresis, Potential Output, Stabilization Policy
    JEL: E32 E60 O4
    Date: 2022–04–19
  10. By: Lu, You-Xun; Chen, Shi-kuan; Lai, Ching-chong
    Abstract: An important aspect of economic growth is the interaction between incumbents and new firms. In this study, we develop a monetary Schumpeterian model with an endogenous market structure (EMS) and two types of quality improvements (the own-product improvements of incumbents and creative destruction of entrants) to analyze the effects of monetary policy. The key finding of our analysis is that an increase in the nominal interest rate importantly affects the composition of innovation that drives economic growth, stimulating the incumbents’ own-product improvements and reducing the entrants’ creative destruction. Therefore, the growth effect of monetary policy is ambiguous, and depends on the relative magnitudes of the incumbents’ and entrants’ contributions to R&D and growth. Finally, we provide a quantitative analysis of the growth and welfare effects of monetary policy and consider an extension of the benchmark model with an elastic labor supply and a CIA constraint on consumption.
    Keywords: innovation, monetary policy, economic growth, endogenous market structure
    JEL: E41 O31 O41
    Date: 2022–01–18
  11. By: Xiaoqing Zhou
    Abstract: One of the main channels through which monetary policy stimulus affects the real economy is mortgage borrowing. This channel, however, is weakened by frictions in the mortgage market. The rapid growth of financial technology-based (FinTech) lending tends to ease these frictions, given the higher quality services provided under this new lending model. This paper establishes that the role of FinTech lending in the monetary policy transmission is further amplified by consumers’ social networks. I provide empirical evidence for this network effect using county-level data and novel identification strategies. A 1 pp increase in the FinTech market share in a county’s socially connected markets raises the county’s FinTech market share by 0.23-0.26 pps. Moreover, I find that in counties where FinTech market penetration is high, the pass-through of market interest rates to borrowers is more complete. To quantify the role of FinTech lending and its network propagation in the transmission of monetary policy shocks, I build a multi-region heterogeneous-agent model with social learning that embodies key features of FinTech lending. The model shows that the responses of consumption and refinancing to a monetary stimulus are 13% higher in the presence of FinTech lending. Almost half of this improvement is accounted for by FinTech propagation through social networks.
    Keywords: FinTech; social networks; mortgage; monetary policy; regional transmission
    JEL: E21 E44 E52 G21 G23
    Date: 2022–03–25
  12. By: Anand, Kartik; Duley, Chanelle; Gai, Prasanna
    Abstract: Cyber attacks can impair banks operations and precipitate bank runs. When digital infrastructure is shared, banks defend themselves by investing in cybersecurity but can free-ride on the security measures of others. Ex ante free-riding by banks interacts with the ex post coordination frictions underpinning bank runs. While the temptation to free-ride induces underinvestment in cybersecurity, the prospect of a run encourages greater investment. System-wide cybersecurity is suboptimal and sensitive to rollover risk and bank heterogeneity. Regulatory measures, including negligence rules, liquidity regulation and cyber hygiene notices, facilitate constrained efficient cybersecurity investment. We suggest testable hypotheses to inform empirical work in this area.
    Keywords: cyber attacks,bank runs,global games,weaker-link public goods
    JEL: G01 G21 G28 H41
    Date: 2022
  13. By: Yildirim, Yusuf; Sanyal, Anirban
    Abstract: Early warning indicators (EWIs) of banking crises should ideally be judged on how well they function in relation to the choice issue faced by macroprudential policymakers. Several practical features of this challenge are translated into statistical evaluation criteria, including difficulties measuring the costs and advantages of various policy interventions, as well as requirements for the timeliness and stability of EWIs. We analyze the balance panel of possible EWIs for six countries that have experienced currency crisis and banking crisis in recent times. Using possible early warning indicators, we evaluate the suitability of these EWIs in view of their predictive power and stability of signals. The paper observes that credit disbursements to non-financial sectors and central government provides stable signal about systemic risks. Further debt service ratio, inter bank rates and total reserves are also found to be useful in predicting these crisis. Lastly, the paper observes that linear combination of these indicators improves the predictive power of EWIs further.
    Keywords: EWIs,ROC,area under the curve,shrinkage
    JEL: G01 C40 G21
    Date: 2022
  14. By: Roy Havemann; Henk Janse van Vuuren; Daan Steenkamp; Rossouw van Jaarsveld
    Abstract: We use a unique dataset comprising over a million trades and quotes to assess the impact of the unexpected announcement of a bond purchase programme by the South African Reserve Bank on intraday market liquidity, yields and pricing volatility. Our dataset details the timing and order details of individual bonds purchased by the South African Reserve Bank during the COVID-19 pandemic, as well as data from over a million other fixed-coupon bond trades and intraday quotes. We find that the programme was successful at shoring up market confidence and addressing dislocation in the government bond market. We show that bond spreads fell both on announcement and after purchases themselves. Bond pricing adjusted slowly, with effects typically strengthening over the course of the trading day. We find that announcement effects dominated the impact of purchases themselves. Lastly, our intraday dataset enables assessment of the spillovers of central bank announcements in major economies and we show that the Federal Reserve played an important role in stabilising South Africa’s bond market, helping to support the actions of SARB.
    Keywords: bond purchase programme, liquidity, yield curve
    JEL: C5 E43 E58 G12 G14
    Date: 2022–03
  15. By: Irina Kozlovtceva (Bank of Russia, Russian Federation); Henry Penikas (Bank of Russia, Russian Federation); Ekaterina Petreneva (Bank of Russia, Russian Federation); Yulia Ushakova (Bank of Russia, Russian Federation)
    Abstract: We use the Russian banks’ 2015-2019 data to evaluate the effectiveness of the macro- prudential measures in curbing the booming consumer lending segment. We find that the measures are successful in reducing the overall loan portfolio riskiness and in capital cushion accumulation by banks. In the short-run of up to 1-2 quarters after the measure announcement date banks tend to reduce both the new loan volumes and the average consumer loan portfolio growth rate. Such reduction is more typical with the smallest market players. However, in the longer time horizon up to a year from the measure application date we observe the increase in the average credit growth rates. Such findings correspond to the experience of the emerging markets of Argentine, Colombia, Thailand. In general, we consider that the observed credit growth after the measure implementation is smaller than it could have been without the measures in place. We also expect that the observed lending growth rate brings less financial instability risks and it reflects the potential for the natural loan extension in Russia.
    Keywords: financial stability, risk-weight, consumer loan, macroprudential
    JEL: G21 G28 G32
    Date: 2020–11
  16. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: The paper examines considerations that arise in adapting IT to emerging markets (EMs). These include the necessity of flexibility, the working of the expectations channel, the dominance of supply shocks, fiscal-monetary coordination, forecasting issues and guidance of thin markets. Implementation of inflation targeting in India has matured from a strict form that imposed a large output sacrifice, towards flexibility with better forecasting that kept inflation in the tolerance band, contributed to good growth recoveries as well as improved financial parameters in the first two years of the pandemic.
    Keywords: Flexible inflation targeting, concepts, India, market imperfections, anchoring
    JEL: E52 E63 E65
    Date: 2022–03
  17. By: Ashima Goyal (Indira Gandhi Institute of Development Research); Sritama Ray (Indira Gandhi Institute of Development Research)
    Abstract: We explore the relative contributions of demand and supply shocks on inflation and output in India when correlation is allowed between shocks. Our SVAR model is estimated with quarterly GDP, WPI and CPI data covering the period between 1997Q2 and 2020Q1. The Keynesian case is of demand leading to a shift in supply as firms with excess capacity respond, while the case of supply affecting demand could be due to policy reactions to supply shocks. We estimate the correlations and slopes under different identifying assumptions. We find a positive correlation between shocks in all cases. Overall, a Horizontal Supply Curve (HSC) identification is supported, an asymmetry expected for a populous emerging market in transition. The short-run output cost of disinflationary policy is, therefore, large. Moreover, a policy demand contraction following a negative supply shock turns out to have perverse effects when the HSC holds, further aggravated when headline CPI is the target variable. This was the Indian experience of slowdown and inflation persistence after 2011 following demand tightening under food price shocks. Policy should ideally sustain demand, which can induce output expansion, and moderate the impact of shocks making the impact of demand and supply shocks more even. India's inflation targeting framework can therefore work better by aiding supply side improvements and anchoring inflation expectations.
    Keywords: Correlated demand and supply shocks, asymmetry, monetary policy, horizontal and vertical supply curves, India, structural VAR
    JEL: C51 C52 E52 E58
    Date: 2022–03
  18. By: Aakriti Mathur (The Graduate Institute of International and Development Studies); Rajeswari Sengupta (Indira Gandhi Institute of Development Research); Bhanu Pratap (Reserve Bank of India)
    Abstract: Negative equity market reactions at the onset of the Covid-19 crisis raised concerns about the vulnerabilities in non-financial firms, requiring swift actions by central banks to prevent system-wide stresses. We investigate the Indian context, where the announcement of a surprise, nationwide lockdown in March 2020, was followed by the announcement of an unanticipated policy package by the central bank a few days later. Using natural language processing on quarterly earnings call reports, we construct a firm-specific measure of concern about the pandemic for a set of Indian non-financial firms. We find that firms that were exposed to the pandemic in early 2020 had worse stock market performance when the lockdown was announced. These results are explained by the implications of pandemic-related uncertainty for the future cash flows of these firms. The central bank's policy package seemed to have reversed the impact of the lockdown announcement in the short-term.
    Keywords: Covid-19, event study, earnings calls, firm performance, uncertainty, central bank policies
    JEL: G14 G18 G32 E58 L25 D8
    Date: 2022–03
  19. By: Holden, Tom D.
    Abstract: Occasionally binding constraints (OBCs) like the zero lower bound (ZLB) can lead to multiple equilibria, and so to belief-driven recessions. To aid in finding policies that avoid this, we derive existence and uniqueness conditions for otherwise linear models with OBCs. Our main result gives necessary and sufficient conditions for such models to have a unique ('determinate') perfect foresight solution returning to a given steady state, for any initial condition. While standard New Keynesian models have multiple perfect-foresight paths eventually escaping the ZLB, price level targeting restores uniqueness. We also derive equilibrium existence conditions under rational expectations for arbitrary non-linear models.
    Keywords: occasionally binding constraints,zero lower bound,determinacy,existence,uniqueness,price level targeting
    JEL: C62 E3 E4 E5
    Date: 2022

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