nep-cba New Economics Papers
on Central Banking
Issue of 2022‒05‒02
seventeen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Nonbank Finance and Monetary Policy Transmission in Asia By Beirne, John; Renzhi, Nuobu; Volz, Ulrich
  2. Optimal Monetary Policy Rules in the Fiscal Theory of the Price Level By Boris Chafwehé; Charles de Beauffort; Rigas Oikonomou
  3. Credible Forward Guidance By Taisuke Nakata; Takeki Sunakawa
  4. Estimating Treatment Effects of Monetary Policies and Macro-prudential Policies: From the Perspectives of Macro-economic Policy Evaluation By Zeqin Liu; Zongwu Cai; Ying Fang
  5. Monetary Policy in a Model of Growth By Albert Queraltó
  6. A benefit of monetary policy response to inequality By Kengo NUTAHARA
  7. The Problems of Inflation Targeting Originate in the Monetary Theory of Knut Wicksell By Jonung, Lars
  8. Independently green? An integrated strategy for a transformative ECB By Klüh, Ulrich; Urban, Janina
  9. Monetary Policy and Asset Price Overshooting: A Rationale for the Wall/Main Street Disconnect By Ricardo J. Caballero; Alp Simsek
  10. Monetary policy and the racial wage gap By Edmond Berisha; Ram Sewak Dubey; Eric Olson
  11. Political Shocks and Inflation Expectations: Evidence from the 2022 Russian Invasion of Ukraine By Lena Dräger; Klaus Gründler; Niklas Potrafke
  12. Hysteresis, endogenous growth, and monetary policy By Sebastián Amador
  13. The case for a cautiously optimistic outlook for US inflation By David Reifschneider; David Wilcox
  14. The Incredible Taylor Principle By Pablo Andrés Neumeyer; Juan Pablo Nicolini
  15. From Low to High Inflation: Implications for Emerging Market and Developing Economies By Ha, Jongrim; Kose, Ayhan M.; Ohnsorge, Franziska
  16. Fintech, Cryptocurrencies, and CBDC: Financial Structural Transformation in China” By Franklin Allen; Xian Gu; Julapa Jagtiani
  17. Application of Quantum Computers in Foreign Exchange Reserves Management By Martin Vesel\'y

  1. By: Beirne, John (Asian Development Bank Institute); Renzhi, Nuobu (Asian Development Bank Institute); Volz, Ulrich (Asian Development Bank Institute)
    Abstract: Focusing on Asian economies over the period 2006 to 2019, we find that while nonbank finance appears to complement rather than substitute credit provision by the traditional banking sector, weaker regulatory quality is an important driving factor. Moreover, while we find that central bank policy rates countercyclically affect credit provision by nonbanks, impulse responses to monetary policy shocks with and without nonbank finance indicate that the effectiveness of monetary policy as a transmission channel to GDP growth, inflation, house prices, and traditional bank credit is weakened in the presence of nonbank finance. Our paper has implications for monetary policy implementation, potentially incorporating nonbanks into central bank operations and liquidity provision, as well as for financial supervisors in mitigating regulatory arbitrage.
    Keywords: nonbank finance; fintech; monetary policy; Asia
    JEL: E44 E50 G20
    Date: 2022–01
  2. By: Boris Chafwehé (Joint Research Centre, European Commission); Charles de Beauffort (National Bank of Belgium); Rigas Oikonomou (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: In the fiscal theory of the price level, inflation and debt dynamics are determined jointly. We derive optimal monetary policy rules that can approximate the Ramsey outcome in this environment. When the government issues a portfolio of bonds of different maturities and buys it back every period the optimal interest rate response to inflation is a simple, transparent function of the average debt maturity. This policy exploits the maturity structure to minimize the intertemporal variability of inflation in response to fiscal shocks. We then turn to the more realistic scenario of a government that does not repurchase and reissue debt in every period. In the case where debt is only long term, the optimal policy equilibrium features oscillations in inflation and simple interest rate rules may lead to explosive inflation dynamics. Issuing both short and long bonds rules out oscillations and implies that simple inflation targeting rules can approximate the Ramsey outcome. Under no repurchases a flat maturity structure of debt is optimal to reduce inflation variability.
    Keywords: Fiscal Theory, Optimal Interest Rates, Government Debt Maturity, Ramsey policy
    JEL: E31 E52 E58 E62 C11
    Date: 2022–03–28
  3. By: Taisuke Nakata (Associate Professor, Faculty of Economics, University of Tokyo (E-mail:; Takeki Sunakawa (Associate Professor, Faculty of Economics, Hitotsubashi University (E-mail:
    Abstract: How can the central bank credibly implement a "lower-for- longer" strategy? To answer this question, we analyze a series of optimal sustainable policy problems-indexed by the duration of reputational loss- in a sticky-price model with an effective lower bound (ELB) constraint on nominal interest rates. We find that, even without an explicit commitment technology, the central bank can still credibly keep the policy rate at the ELB for an extended period-though not as extended as under the optimal commitment policy-and meaningfully mitigate the adverse effects of the ELB constraint on economic activity.
    Keywords: Average Inflation Targeting, Effective Lower Bound, Forward Guidance, Sustainable Plan, Time-Consistency
    JEL: E32 E52 E61 E62 E63
    Date: 2022–04
  4. By: Zeqin Liu (School of Statistics, Shanxi University of Finance and Economics, Taiyuan, Shanxi 030006, China); Zongwu Cai (Department of Economics, The University of Kansas, Lawrence, KS 66045, USA); Ying Fang (The Wang Yanan Institute for Studies in Economics, Xiamen University, Xiamen, Fujian 361005, China and Department of Statistics & Data Science, School of Economics, Xiamen University, Xiamen, Fujian 361005, China)
    Abstract: Since the global financial crisis in 2008, an increasing number of economists, central banks and regulators across the world has realized the occurrence of fundamental changes in the dynamics of the economy. The breakout of the global financial crisis highlights the importance of financial shocks. Aiming to maintaining financial stability, Bank for International Settlements (BIS) initialized macro-prudential policies in the early of 2009. China, as one of important countries pioneering the practice of macro-prudential policies, adopted a so called two-pillar regulatory framework of monetary policies and macro-prudential policies to safeguard the macroeconomic and financial stability. However, due to the coincidence of policy targets and the interdependence in transmission mechanisms between monetary policies and macro-prudential policies, the practice of the two-pillar regulatory framework raises some important coordination issues (Beau et al. 2012). The aim of this paper is to discuss theoretically the coordination mechanisms between monetary policies and macro-prudential policies, and then evaluate empirically the effects of the practice of the two-pillar regulatory framework on policy targets, such as economic growth, inflation, and financial stability in China. One of main contributions of this paper is to estimate the causal effects of China’s two-pillar regulatory framework from 2007 to 2017 by adopting new macroeconomic policy evaluation methods proposed by Angrist and Kuersteiner (2011) and Angrist et al. (2018). Compared to mainstream methods such as dynamic stochastic general equilibrium (DSGE) models, the macroeconomic policy evaluation methods based on Rubin’s causal model alleviate the risk of model misspecification by avoiding to specify how an economy works and how outcome variables are determined. Moreover, the concept of dynamic treatment effect developed in the framework of macroeconomic policy evaluation coincides with the nonlinear impulse function induced by structural models. In other words, the new method can complement the DSGE models by providing parallel estimates insensitive with structural model setup. Another major contribution of this paper is to extend the existing macroeconomic policy evaluation methods by adopting statistical learning methods to estimating policy propensity score functions using macroeconomic big data and proposing a new test statistic for testing the conditional unconfoundedness assumption. It is well known that a major challenge in empirical macroeconomic research is how to capture exogenous policy shocks to identify causal effects. We address this issue in two aspects. First, in order to fully use all information available at the current period, we propose to model policy-making process based on macroeconomic big data and adopt statistical learning methods to solve the high dimensional problem. Moreover, we propose a new statistic to test the exogeneity of the residuals estimated from the policy propensity scores using macroeconomic big data, which is a conditional unconfoundedness in the context of time series data. The latter actually provides a testable method of evaluating the validity of the use of the macroeconomic policy evaluation method. Finally, our empirical findings can be summarized as follows. First, when macro-prudential policies remaining neutral, monetary policies can effectively manage the aggregate demand and fulfill the output target by adjusting money supply and credit growth,while the transmission channel through interest rates does not work effectively. Second, when monetary policies remaining neutral, macro-prudential policies can maintain financial stability as expected, and at the same time, there are little effects on real economy targets. Last, when monetary policies and macro-prudential policies are jointly implemented, a same direction policy combination can further strengthen the effect on the output target and accelerate the process towards the target. However, the same direction combination has no significant exaggerating impact on financial stability variables. In addition, we find that the same direction combination may cause counteracting effects on some target outcome variables, such as the growth rate of capital adequacy ratio and the risk-weighted asset ratio. We ascribe the counteracting effect to the argument that the same direction policy combination weakens the negative correlations between monetary policies and banks’ risk-taking level.
    Keywords: Monetary Policy; Macro-prudential Policy; Two-pillar Regulatory Framework; Macro-economic Policy Evaluation
    JEL: E60 E50 G28
    Date: 2022–04
  5. By: Albert Queraltó
    Abstract: Empirical evidence suggests that recessions have long-run effects on the economy's productive capacity. Recent literature embeds endogenous growth mechanisms within business cycle models to account for these "scarring" effects. The optimal conduct of monetary policy in these settings, however, remains largely unexplored. This paper augments the standard sticky-price New Keynesian (NK) to allow for endogenous dynamics in aggregate productivity. The model has a representation similar to the two-equation NK model, with an additional condition linking productivity growth to current and expected future output gaps. Absent state contingency in the subsidies that correct the externalities associated with productivity growth, optimal monetary policy sets inflation above target whenever the subsidies fall short of the externalities. In the recovery from a spell at the ZLB, the optimal discretionary policy sets inflation temporarily above target, helping mitigate the long-run damage. Following a cost-push shock that creates inflationary pressure, the central bank tolerates a larger rise in inflation than in a model with exogenous productivity. The gains from commitment include the central bank's ability to make credible promises about future output gaps in a way that allows it to manipulate current productivity growth.
    Keywords: Business cycles; Growth; Optimal monetary policy; Hysteresis; Scarring
    JEL: E32 E43 E52 E58 O31 O42
    Date: 2022–04–01
  6. By: Kengo NUTAHARA
    Abstract: The main objective of this paper is to investigate a monetary policy response to inequality in a Two-Agent New Keynesian (TANK) model with hand-to-mouth households. I derive the analytical condition for equilibrium determinacy and show that a monetary policy response to inequality is helpful in achieving equilibrium de terminacy. On the other hand, the impulse responses to structural shocks show that a monetary policy response to inequality does not necessarily reduce the volatilities of both inflation and output although it mitigates the volatility of inequality.
    Keywords: Inequality; monetary policy; TANK; hand-to-mouth; equilibrium in determinacy JEL classifications: E25; E31; E32; E52; E58
    Date: 2022–04
  7. By: Jonung, Lars (Department of Economics, Lund University)
    Abstract: The theoretical foundation of inflation targeting was laid out by the Swedish economist Knut Wicksell (1851-1926) in his groundbreaking treatise, Interest and Prices, published originally in German in 1898. Here he proposed price stability as the rule for monetary policy. Today, inflation targeting is considered the best-practice approach to monetary policy across the world. It has contributed to stable and low consumer price inflation since the 1990s in many countries. However, inflation targeting has recently been the subject of several objections. Most prominently, the focus on consumer price stability has fostered financial instability, as reflected in the global financial crisis of 2008-09. In addition, the sharp rise in asset prices has led to growing wealth inequality. <p> Why have these problems emerged? This paper provides an answer by comparing Wicksell’s theory of price level determination in a pure credit economy, the “cumulative process”, to the neo-Wicksellian world of today, characterized by inconvertible fiat money, floating exchange rates, advanced financial systems, unregulated interest rates and well-developed asset markets. In this way, it becomes apparent that the neglect of asset markets and asset prices is the source of the flaws of the present Wicksellian regime of unlimited finance. The shortcomings of the neo-Wicksellian approach can be remedied while remaining within a Wicksellian framework. The key is to combine the nominal anchor of price stability with a reformed financial system that maintains credit stability. The paper uses empirical evidence from Sweden and the United States.
    Keywords: Inflation targeting; price level targeting; natural rate; Knut Wicksell; Milton Friedman; financial crises; credit; asset inflation; central banking
    JEL: B10 B22 E10 E31 E40 E50 G01 G20
    Date: 2022–04–11
  8. By: Klüh, Ulrich; Urban, Janina
    Abstract: What should be the role of the ECB in tackling the socio-ecological challenges related to planetary boundaries, such as climate change and loss of biodiversity? A clear answer to this question is still lacking, in spite of the strategy review of 2021. Regretfully, this review has not received the scrutiny it deserves, as the pandemic and the war in Ukraine have taken center stage. Taking these recent developments into account, we provide a critique of the new strategy. We argue that it lacks transformativity, as it subsumes climate change under the policy objective of price stability, assumes that transformations can be mastered within the structures of the past, and refrains from questioning the current institutional set up. In its main part, the paper discusses the historical relevance of what we believe is the main reason for these deficits: The fear that taking up the real issues (such as independence and accountability) would make the ECB a political football in times of rising inflation. Taking these fears seriously, we show that the institutionalization of central banking has always reflected the transformative dynamics of their time. Consequently, if planetary boundaries represent a transformative challenge, they will radically change the ECB, too. Moreover, we provide evidence that central banks' historical transformations have always reflected their peculiar position as mediators between the financial and the political realm. We argue that, at the current juncture, transforming central banking implies moving away from finance and towards politics. This involves risks. However, we argue that the historical experience offers few reasons to fear a closer integration of central banking into the public sphere, as long as the latter is dominated by democratic politics. Consequently, if one comes to the conclusion that the ECB's current corset is too narrow, it can and should be augmented. While we do not offer a blueprint for such augmentation, we conclude our analysis by sketching elements of a sustainable strategy for a transformative ECB.
    Keywords: Monetary Policy,Sustainability,Green Deal,Climate Policy,Central Bank Independence,Central Bank Accountability
    JEL: B15 B25 B26 B52 E02 E58 N2
    Date: 2022
  9. By: Ricardo J. Caballero; Alp Simsek
    Abstract: We analyze optimal monetary policy and its implications for asset prices, when aggregate demand has inertia and responds to asset prices with a lag. If there is a negative output gap, the central bank optimally overshoots aggregate asset prices (asset prices are initially pushed above their steady-state levels consistent with current potential output). Overshooting leads to a temporary disconnect between the performance of financial markets and the real economy, but it accelerates the recovery. When there is a lower-bound constraint on the discount rate, overshooting becomes a concave and non-monotonic function of the output gap: the asset price boost is low for a deeply negative initial output gap, grows as the output gap improves over a range, and shrinks toward zero as the output gap improves further. This pattern also implies that good macroeconomic news is better news for asset prices when the output gap is more negative. Finally, we document that during the Covid-19 recovery, the policy-induced overshooting was large−sufficient to explain the high levels of stock and house prices in 2021.
    Keywords: monetary policy, aggregate demand inertia, lags, output gap, recovery, asset prices, overshooting, Wall/Main Street disconnect, Covid-19, interest rate lower bound, macroeconomic news, market bond portfolio, QE/LSAPs
    JEL: E21 E32 E43 E44 E52 G12
    Date: 2022
  10. By: Edmond Berisha; Ram Sewak Dubey; Eric Olson
    Abstract: This paper aims to clarify the relationship between monetary policy shocks and wage inequality. We emphasize the relevance of within and between wage group inequalities in explaining total wage inequality in the United States. Relying on the quarterly data for the period 2000-2020, our analysis shows that racial disparities explain 12\% of observed total wage inequality. Subsequently, we examine the role of monetary policy in wage inequality. We do not find compelling evidence that shows that monetary policy plays a role in exacerbating the racial wage gap. However, there is evidence that accommodative monetary policy plays a role in magnifying between group wage inequalities but the impact occurs after 2008.
    Date: 2022–03
  11. By: Lena Dräger; Klaus Gründler; Niklas Potrafke
    Abstract: How do global political shocks influence individuals’ expectations about economic outcomes? We run a unique survey on inflation expectations among 145 tenured economics professors in Germany and exploit the 2022 Russian invasion in Ukraine as a natural experiment to identify the effect of a global political shock on expectations about national inflation rates. We find that the Russian invasion increased short-run inflation expectations for 2022 by 0.75 percentage points. Treatment effects are smaller regarding mid-term expectations for 2023 (0.47 percentage points) and are close to zero for longer periods. Text analysis of open questions shows that experts increase their inflation expectations because they expect supply-side effects to become increasingly important after the invasion. Moreover, experts in the treatment group are less likely to favour an immediate reaction of monetary policy to the increased inflation, which gives further evidence of the shock being interpreted primarily as a supply-side shock.
    Keywords: inflation expectations, belief formation, natural experiment, 2022 Russian invasion of Ukraine, survey, economic experts
    JEL: E31 E71 D74 D84
    Date: 2022
  12. By: Sebastián Amador (Department of Economics, University of California Davis)
    Abstract: I provide evidence of substantial hysteresis (i.e., a situation in which temporary shocks have long-run effects) from monetary shocks on two sources of endogenous growth; human capital and technological adoption. This contribution is the first to test for the presence of this phenomenon in direct measures of the supply-side potential of economies, instead of indirect measures, e.g., TFP. To estimate the effects of exogenous monetary policy shocks, I improve on the the trilemma identification by incorporating a mean-unbiased instrumental variable estimator. Results show substantial hysteresis in both human capital and technological adoption. Importantly, these are found to be asymmetric, as only contractionary shocks result in long lasting responses. I evaluate the aggregate importance of monetary hysteresis with a growth accounting exercise. Across the 17 countries in sample, the accumulated average cost of monetary hysteresis ranges between 1.2 and 9.6% of TFP, for human capital and the adoption of electricity, respectively.
    Keywords: hysteresis, money non-neutrality, endogenous growth
    JEL: E01 E30 E32 E44 E47 E51 F33 F42 F44
    Date: 2022–04–20
  13. By: David Reifschneider (former Federal Reserve); David Wilcox (Peterson Institute for International Economics)
    Abstract: The Federal Reserve and most other analysts failed to anticipate the surge in inflation in 2021. Considerable debate now surrounds the question of whether the Fed is too sanguine in anticipating that too-high inflation will mostly take care of itself over the next few years, even as the unemployment rate remains low and monetary policy remains accommodative. This Policy Brief concludes that although the Federal Open Market Committee (FOMC) was too optimistic in the projections it issued in December 2021, the broad contour of its baseline inflation outlook for 2022 and beyond remains sensible. The authors find the 2021 surge in inflation resulted mainly from COVID-19-related sectoral developments rather than the classic situation of aggregate demand outstripping the overall economy's long-run productive potential. The statistical analysis in this Policy Brief was conducted before Russia invaded Ukraine. As a result of the war, the inflation situation will probably get worse before it gets better, and could do so in dramatic manner if Russian energy exports are banned altogether. Nonetheless, if the key considerations identified in this Policy Brief remain in place, and if monetary policymakers respond to evolving circumstances in a sensible manner, the inflation picture should look considerably better in the next one to three years.
    Date: 2022–03
  14. By: Pablo Andrés Neumeyer; Juan Pablo Nicolini
    Abstract: This note addresses the role of the Taylor principle to solve the indeterminacy of equilibria in economies in which the monetary authority follows an interest rate rule. We first study the role of imposing two additional ad-hoc restrictions on the definition of equilibrium. Imposing the equilibrium to be locally unique never delivers a unique outcome. Imposing the equilibrium to be bounded, renders the outcome unique only if the inflation target is the Friedman rule. Second, we show that the Taylor principle is strongly time inconsistent - in a sense we make very precise - and that policies that implement the Friedman rule are the only sustainable policies.
    Keywords: Taylor principle; Uniqueness of equilibrium; Time consistency
    JEL: E40 E50
    Date: 2022–01–28
  15. By: Ha, Jongrim; Kose, Ayhan M.; Ohnsorge, Franziska
    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: 2022–03–29
  16. By: Franklin Allen; Xian Gu; Julapa Jagtiani
    Abstract: Fintech and decentralized finance have penetrated all areas of the financial system and have improved financial inclusion in the last decade. In this paper, we review the recent literature on fintech, cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs). There are important implications from the rise of fintech and the introduction of stablecoins and CBDCs in recent years. We provide an overview of China’s experience in fintech, focusing on payments, digital banking, fintech lending, and the recent progress on its CBDC pilots (e-CNY). We also discuss important considerations in designing effective cryptocurrency regulations. Cryptocurrency regulations could promote growth of innovations through enhanced public confidence in this market. The e-CNY could become mainstream in the global market through effective regulations, which provide incentives and protection to market participants. A key factor to success for digital currencies has been their widespread adoption. If the Chinese e-CNY were to become a mainstream currency, the introduction of CBDC could potentially offer solutions to existing problems inherent in traditional financial systems.
    Keywords: fintech; cryptocurrency regulations; stablecoins; CBDCs; e-CNY; China
    JEL: G21 G28 G18 L21
    Date: 2022–04–11
  17. By: Martin Vesel\'y
    Abstract: The main purpose of this article is to evaluate possible applications of quantum computers in foreign exchange reserves management. The capabilities of quantum computers are demonstrated by means of risk measurement using the quantum Monte Carlo method and portfolio optimization using a linear equations system solver (the Harrow-Hassidim-Lloyd algorithm) and quadratic unconstrained binary optimization (the quantum approximate optimization algorithm). All demonstrations are carried out on the cloud-based IBM Quantum(TM) platform. Despite the fact that real-world applications are impossible under the current state of development of quantum computers, it is proven that in principle it will be possible to apply such computers in FX reserves management in the future. In addition, the article serves as an introduction to quantum computing for the staff of central banks and financial market supervisory authorities.
    Date: 2022–03

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