nep-cba New Economics Papers
on Central Banking
Issue of 2022‒05‒30
twelve papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Addressing systemic risk in Europe during Covid-19: The role of regulation and the policy mix By Dotta, Vitor
  2. House price dynamics, optimal LTV limits and the liquidity trap By Ferrero, Andrea; Harrison, Richard; Nelson, Benjamin
  3. Monetary Policy Transmission and Policy Coordination in China By Miss Sonali Das; Wenting Song
  4. Resilience of bank liquidity ratios in the presence of a central bank digital currency By Alissa Gorelova; Bena Lands; Maria teNyenhuis
  5. Managing Expectations in the New Keynesian Model By Robert G. King; Yang K. Lu
  6. Money, Exchange Rate and Export Quality By Ganguly, Shrimoyee; Acharyya, Rajat
  7. Shocks to Inflation Expectations By Jonathan J. Adams; Mr. Philip Barrett
  8. Interest rate shocks, competition and bank liquidity creation By Kick, Thomas
  9. COVID-19, policy interventions, credit vulnerabilities and financial (in)stability By Kimundi, Gillian
  10. The U.S. Economic Dynamics and Inflation Persistence: a Regime-Switching Perspective By Elton Beqiraj; Giuseppe Ciccarone; Giovanni Di Bartolomeo
  11. Trust and monetary policy By Paul De Grauwe; Yuemei Ji
  12. Instinctive versus reflective trust in the European Central Bank By Angino, Siria; Secola, Stefania

  1. By: Dotta, Vitor
    Abstract: This work examines the impacts which the Covid-19 pandemic brought to the stability of the European financial sector. Lockdowns, businesses unable to operate and uncertainty about how the pandemic would evolve fueled a sharp recession. From the lessons learned in the global financial crises and the Eurozone debt crises, there's an increasing role of macroprudential policies, especially the regiments of the Basel III framework and the monetary policy toolkit. Alongside macroprudential regulation, the European Central Bank provided substantial monetary policy easing, for instance the release of capital buffers and other capital requirements, expanding the TLTRO III and Pandemic Emergency Program which facilitated monetary policy transmission. Authorities also deployed strong fiscal policies which encompassed from tax holidays to direct transfers to households and firms. The combination of fiscal, monetary, and regulatory policy was unprecedented and helped the economy during the shutdown moments. As a result, indicators of systemic risks in the banking sector during the pandemic remained relatively stable.
    Keywords: Systemic Risk,Covid-19 pandemic,banks,banking sector,Europe,Policy Mix,Monetary and Fiscal policy
    JEL: G21 G28 G38 E58 E62 E63
    Date: 2022
  2. By: Ferrero, Andrea (University of Oxford); Harrison, Richard (Bank of England); Nelson, Benjamin (RCM)
    Abstract: The global financial crisis prompted the rapid development of macro-prudential frameworks and an increased reliance on borrower-based policy tools, which influence the demand for credit. This paper studies the optimal design of one such tool, a loan-to-value (LTV) limit, and its implications for monetary policy in a model with nominal rigidities and financial frictions. The welfare-based loss function features a role for macro-prudential policy to enhance risk-sharing. Optimal LTV limits are strongly countercyclical. In a house price boom-bust episode, the active use of LTV limits alleviates debt-deleveraging dynamics and prevents the economy from falling into a liquidity trap.
    Keywords: Monetary and macro-prudential policy; financial crisis; zero lower bound
    JEL: E52 E58 G01 G28
    Date: 2022–03–25
  3. By: Miss Sonali Das; Wenting Song
    Abstract: We study the transmission of conventional monetary policy in China, focusing on the interaction between monetary and fiscal policy given the unique institutional set-up for macroeconomic policy making. Our results suggest some progress but also continued difficulties in the transmission of monetary policy. Similar to recent studies, we find evidence of monetary policy pass-through to interest rates. However, the impact of monetary policy measures that are not coordinated with fiscal policy is significantly weaker than that of coordinated measures. This suggests the need for further improvements to the interest-rate based framework.
    Keywords: monetary policy, monetary fiscal coordination, textual analysis, China; monetary policy transmission; monetary policy measure; monetary policy pass-through; pass-through to interest rates; monetary policy shock; fiscal policy measure; Yield curve; Central bank policy rate; Monetary policy instruments; Deposit rates
    Date: 2022–04–29
  4. By: Alissa Gorelova; Bena Lands; Maria teNyenhuis
    Abstract: Could Canadian banks continue to meet their regulatory liquidity requirements after the introduction of a cash-like retail central bank digital currency (CBDC)? We conduct a hypothetical exercise to estimate how a CBDC could affect bank liquidity by increasing the run-off rates of transactional retail deposits under four increasingly severe scenarios.
    Keywords: Central bank research; Digital currencies and fintech; Econometric and statistical methods; Financial institutions; Financial stability
    JEL: E4 G2 G21 O3 O33
    Date: 2022–05
  5. By: Robert G. King (Boston University and NBER); Yang K. Lu (Department of Economics, The Hong Kong University of Science and Technology)
    Abstract: We study the optimal monetary policy in a setting where the private sector is forward-looking and learning about the type of central bank in place. We consider two types of central bank, one patient type that can commit and one opportunistic type that is myopic and cannot commit. Being able to commit or not, the central bank in place chooses inflation policies optimally, taking into account the learning and rational expectation of the private sector. We show that the equilibrium can be obtained as a solution to a recursive optimization of the committed type in which the actions of the opportunistic type are subject to an incentive compatibility constraint. The numerical solution to a calibrated model reveals that the committed central bank with good initial reputation adopts policies similar to the standard solution under full commitment, whereas the committed central bank with poor initial reputation aims at building reputation with anti-inflation policies that involve real costs. If the opportunistic central bank with good initial reputation is in place, there will be lengthy real stimulations with gradually rising actual and expected inflation, followed by stagflation when the history of positive inflation surprises depletes the central bank's reputation.
    Keywords: time inconsistency, reputation game, optimal monetary policy, forwardlooking expectations
    JEL: E52 D82 D83
    Date: 2020–06
  6. By: Ganguly, Shrimoyee; Acharyya, Rajat
    Abstract: This paper theoretically examines the effect of an expansionary monetary policy on export quality and its ramifications on the aggregate employment of the unskilled workers in a competitive general equilibrium framework of a small open economy. This issue assumes relevance since monetary policies are often pursued by the central bank of an economy to manage exchange rate fluctuations under a managed float regime, which may have adverse consequences for export-quality choices and thereby for export growth given the growing preference of buyers in richer nations for higher qualities of goods they consume. Under optimal allocation of wealth over a portfolio of cash, domestic assets and foreign assets, we show that an increase in the domestic money supply affects the choice of export-quality primarily in two ways. One is through larger investment, capital formation and consequent endowment effect; the other is through changes in the nominal exchange rate. Under less price-elastic demand for a non-traded good, the export quality is upgraded when higher quality varieties of the export good are relatively capital intensive. On the other hand, though the expansionary monetary policy may raise the aggregate employment of unskilled workers due to its endowment effect, may lower it through changes in the quality of the export good. The overall effect is thus ambiguous. A larger initial size of bequests has a similar effect.
    Keywords: Monetary Policy, Export Quality, Exchange rate, Unemployment, Portfolio choice
    JEL: E24 E5 F11
    Date: 2022–04–29
  7. By: Jonathan J. Adams; Mr. Philip Barrett
    Abstract: The consensus among central bankers is that higher inflation expectations can drive up inflation today, requiring tighter policy. We assess this by devising a novel method for identifying shocks to inflation expectations, estimating a semi-structural VAR where an expectation shock is identified as that which causes measured expectations to diverge from rationality. Using data for the United States, we find that a positive inflation expectations shock is deflationary and contractionary: inflation, output, and interest rates all fall. These results are inconsistent with the standard New Keynesian model, which predicts inflation and interest rate hikes. We discuss possible resolutions to this new puzzle.
    Keywords: Inflation, Sentiments, Expectations, Monetary Policy
    Date: 2022–04–29
  8. By: Kick, Thomas
    Abstract: We study the effects of interest rate shocks (IRS) on banks' liquidity creation. A unique supervisory data set from the Deutsche Bundesbank allows identifying banks' liquidity creation for the real economy and the effects of banking market competition. Here, we employ a novel approach to account for IRS that are both unexpected and effective for a bank's business model. We find that higher individual pricing power in the market lowers banks' liquidity creation, which is in line with theory that monopolistic firms undersupply the market when utilizing their high pricing power in the bank competition-liquidity creation nexus. While positive IRS per se lead to an increase in bank liquidity creation, we find that a high bank-individual pricing power curbs this impact on liquidity creation significantly. Moreover, we show that monetary policy was most effective during the global financial crisis and for well-capitalized banks, whereas periods of low interest rates are characterized by the persistent increase in liability-side liquidity creation.
    Keywords: bank liquidity creation,unexpected monetary policy,low interest rate environment,financial crisis,financial markets regulation,banking market competition,dynamic GMM
    JEL: G21 G28 G30 C23
    Date: 2022
  9. By: Kimundi, Gillian
    Abstract: At the 2014 Michel Camdessus Inaugural Central Banking Lecture (IMF), Janet Yellen posed the following question, "...How should monetary and other policymakers balance macroprudential approaches ... in the pursuit of financial stability?" This conversation has become more critical following the effects of COVID-19 on economic and financial indicators globally. Using sector-level measures of financial stability, this study seeks to investigate the effect of monetary and fiscal policy interventions on the stability of the banking sector and determine the role (if any) played by the credit environment on financial stability's response to policy interventions. A Bayesian Threshold VAR model is estimated using quarterly data from (Q1) 2005 to June (Q2) 2021, where the Threshold variable is the Credit to GDP Gap, used to define high vs low credit environments. Facilitating the analysis and discussion using expansionary policy interventions implemented during the COVID-19 period (CBR reduction, lower reserves, higher fiscal spending and tax reliefs), the results indicate that the expansionary policy stances have clear implications on financial stability aggregates capturing credit risk (NPL Ratios) and liquidity risk (depository moments). Secondly, policy effects on financial stability indicators vary depending on the credit environment they are implemented in. More of the indicators respond poorly to expansionary fiscal and monetary policy action in a high credit environment. Based on this response, it is arguable that this credit cycle presents a vulnerability to the sector, rather than evidence of financial deepening. The results also point out a critical aspect relating to the choice of monetary policy action. Lower reserves are followed by more negative responses in financial stability aggregates in both credit environments, especially those related to credit risk. Policy recommendations following these results are also discussed.
    Date: 2022
  10. By: Elton Beqiraj; Giuseppe Ciccarone; Giovanni Di Bartolomeo
    Abstract: This paper revisits the US business cycle accounting for exogenous switches in the inflation intrinsic persistence formalized as changes in the hazard functions. After controlling for Phillips curves shifts, we identify two monetary regimes, leading to a different interpretation from that generally proposed. The Fed operates according to the Brainard Principle by gradually reacting to observed shocks and deviating only episodically to a more active regime. Quantitatively, the main drivers of the business cycle are structural changes in price settings and stochastic volatilities. We also find that structural changes in price and wage adjustments play opposite roles in the Great Inflation. In general, shifts in the Phillips curves are central for correctly understanding the Fed behavior and the business cycle dynamics.
    Keywords: duration-dependent wage adjustments; intrinsic inflation persistence; DSGE models; hybrid Phillips curves; Markow-switching
    JEL: E42 E52 E58
    Date: 2022–04
  11. By: Paul De Grauwe; Yuemei Ji
    Abstract: We analyze how trust affects the transmission of negative demand and supply shocks. We define trust to have two dimensions: there is trust in the central bank’s inflation target and trust in the future of economic activity. We use a behavioural macroeconomic model that is characterized by the fact that individuals lack the cognitive ability to understand the underlying model and to know the distribution of the shocks that hit the economy. We find, first, that when large negative demand shocks occur the subsequent trajectories taken by output gap and inflation typically coalesce around a good and a bad trajectory. Second, these good and bad trajectories are correlated with movements in trust. In the bad trajectories trust collapses, in the good trajectories it is not affected. This feature is stronger when a negative supply shock occurs than in the case of a negative demand shock. Third, initial conditions (history) matters. Unfavorable initial conditions drive the economy into a bad trajectory, favorable initial conditions produce good trajectories.
    Date: 2022–05
  12. By: Angino, Siria; Secola, Stefania
    Abstract: Political science research has established that trust in institutions, including central banks, is shaped by socio-economic and demographic factors, as well as by the assessment of institutional features and by slow-moving components such as culture. However, the role of cognitive processes has largely been neglected, especially in the analysis of central bank trust. In this paper we aim to address this gap focusing on the case of the European Central Bank (ECB). We introduce the concepts of “instinctive trust”, which captures an on-the-spot judgement on the institution’s trustworthiness, and of “reflective trust”, which refers to a more pondered opinion on the matter. Using a survey experiment, we find that deeper consideration about the ECB promotes less trust in the institution compared to an on-the-spot judgement. This result is mainly driven by women, and in particular by those who say they possess a low understanding of the central bank’s policies. JEL Classification: C83, D83, E58, Z13
    Keywords: central bank, Institutional trust, survey experiment
    Date: 2022–05

This nep-cba issue is ©2022 by Sergey E. Pekarski. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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