nep-cba New Economics Papers
on Central Banking
Issue of 2022‒07‒18
twenty-one papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. When Could Macroprudential and Monetary Policies Be in Conflict? By Jose Garcia Revelo; Grégory Levieuge
  2. ECB monetary policy and commodity prices By Shahriyar Aliev; Evžen Kočenda
  3. It takes two: Fiscal and monetary policy in Mexico By Ana Aguilar; Carlos Cantú; Claudia Ramírez
  4. Inflation Past, Present and Future: Fiscal Shocks, Fed Response, and Fiscal Limits By John H. Cochrane
  5. Liquidity coverage ratios and monetary policy credit in the time of Corona By Gocheva, Viktoriya; Mudde, Yvo; Tapking, Jens
  6. The limited power of monetary policy in a pandemic By Antoine Lepetit; Cristina Fuentes-Albero
  7. Escaping Secular Stagnation with Unconventional Monetary Policy By Luba Petersen; Ryan Rholes
  8. Elusive Unpleasantness By Carlos Goncalves; Mauro Rodrigues, Fernando Genta
  9. A Monetary Policy Asset Pricing Model By Ricardo J. Caballero; Alp Simsek
  10. Monetary Policy and Lending Interest Rates: evidence from Mexico By Pablo Cotler; Rodrigo Carrillo
  11. Natural Disasters and Financial Stress: Can Macroprudential Regulation Tame Green Swans? By Avril Pauline; Levieuge Grégory; Turcu Camelia
  12. Monetary Policy and Bubbles in G7 Economies: Evidence from a Panel VAR Approach By Petre Caraiani; Rangan Gupta; Jacobus Nel; Joshua Nielsen
  13. State-dependent Central Bank Communication with Heterogeneous Beliefs By Herbert Sylvérie
  14. International Inflation and Trade Linkages in Brazil under Inflation Targeting By Guilherme Spinato Morlin
  15. European Stabilization Policy After the Covid-19 Pandemic: More Flexible Integration or More Federalism? By Andersson, Fredrik N. G.; Jonung, Lars
  16. Macroprudential Policy and Aggregate Demand By Andre Teixeira; Zoe Venter
  17. International monetary policy and cryptocurrency markets: dynamic and spillover effects By Elsayed, Ahmed H.; Sousa, Ricardo M.
  18. Trend inflation and an empirical test of real rigidities By Marenčák, Michal
  19. Carry Trade and Negative Policy Rates in Switzerland : Low-lying fog or storm ? By Bruno Thiago Tomio; Guillaume Vallet
  20. Endogenous Liquidity and Capital Reallocation By Wei Cui; Randall Wright; Yu Zhu
  21. Comparing Past and Present Inflation By Marijn A. Bolhuis; Judd N. L. Cramer; Lawrence H. Summers

  1. By: Jose Garcia Revelo; Grégory Levieuge
    Abstract: This paper aims to provide a comprehensive analysis of the potential conflicts between macroprudential and monetary policies within a DGSE model with financial frictions. The identification of conflicts is conditional on different types of shocks, policy instruments, and policy objectives. We first find that conflicts are not systematic but are fairly frequent, especially in the case of supply-side and widespread shocks such as investment efficiency and bank capital shocks. Second, monetary policy and countercyclical capital requirements generate conflicts in many circumstances. By affecting interest rates, they both “get in all the cracks”, albeit with their respective targets generally moving in opposite directions. Nonetheless, monetary policy could reduce its adverse financial side effects by responding strongly to the output gap. Third, countercyclical loan-to-value caps, as sector-specific instruments, cause fewer conflicts. Thus, they can be more easily implemented without concerns about generating spillovers, whereas smooth coordination is required between state-contingent capital requirements and monetary policy.
    Keywords: Macroprudential Policy, Loan-to-Value, Countercyclical Buffer, Monetary Policy, Conflicts, DSGE Model
    JEL: E44 E58 E61
    Date: 2022
  2. By: Shahriyar Aliev; Evžen Kočenda
    Abstract: We assess the impact of ECB monetary policy on global aggregate and sectoral commodity prices over 2001-2019. We employ a SVAR model and separately assess periods before and after the global financial crisis. Our key results indicate that contractionary monetary policy shocks have positive effects on commodity prices during both conventional and unconventional monetary policy periods, indicating the effectiveness of unconventional monetary policy tools. The largest impact is documented on fuel and food commodities. Our results also suggest that the effect of ECB monetary policy on commodity prices transmits through the exchange rate channel, which influences European market demand.
    Keywords: European Central Bank, commodity prices, short-term interest rates, M2 stock, monetary aggregate, unconventional monetary policy, Structural Vector Autoregressive model, exchange rates
    JEL: C54 E43 E58 F31 G15 Q02
    Date: 2022–06–21
  3. By: Ana Aguilar; Carlos Cantú; Claudia Ramírez
    Abstract: We model the interaction between fiscal and monetary policy and qualify their effects in a semi-structural small open economy model calibrated for Mexico. In our model, fiscal and monetary policy follow rules tied to specific targets. We estimate how fiscal policy, through deficits and public debt accumulation, and monetary policy, through the interest rate, directly affect the economy. We study the nature of the feedback between policy decisions and examine their indirect effects through the sovereign risk channel. We find that the response of monetary policy to stabilise the economy after a shock depends on how strict is the fiscal rule. A loose fiscal stance pushes a tighter monetary policy stance. Instead, the economy recovers faster when monetary and fiscal policy complement each other.
    Keywords: monetary policy, fiscal policy, sovereign risk premium, policy rules
    JEL: E52 E58 H5 H63
    Date: 2022–05
  4. By: John H. Cochrane
    Abstract: Our current inflation stemmed from a fiscal shock. The Fed is slow to react. Why? Will the Fed's slow reaction spur more inflation? I write a simple model that encompasses the Fed's mild projections and its slow reaction, and traditional views that inflation will surge without swift rate rises. The key question is whether expectations are forward looking or backward looking. If expectations are forward looking, the Fed is right, and inflation will eventually fade without a period of high real interest rates. Price stickiness means inflation will persist past an initial shock. To reduce inflation, fiscal and monetary policy must be coordinated. Without fiscal contraction, an unpleasant arithmetic holds: The Fed can reduce inflation now, but only by increasing inflation later. If the Fed wishes to lower inflation durably via interest rate rises, those must come with fiscal support to pay higher costs on the debt and a windfall to bondholders. Coordinated fiscal, monetary and microeconomic reforms can, and have, swiftly eliminated inflation without the major recession of the early 1980s. Nonetheless, in the very long run, the central bank controls the price level.
    JEL: E31 E52 E58 E63 E65
    Date: 2022–05
  5. By: Gocheva, Viktoriya; Mudde, Yvo; Tapking, Jens
    Abstract: When a bank receives credit from the central bank, its Liquidity Coverage Ratio (LCR) changes. In most cases, the LCR increases. We investigate how this LCR boost from central bank credit affects banks’ behaviour, looking at the euro area during the Corona year 2020. Our theoretical and empirical analyses suggest that banks that get strong LCR boosts from central bank credit tend to take actions that reduce their LCRs. In this sense, banks consume their LCR boosts. In terms of policy conclusions, our analysis suggests that central bank credit operations can provide strong incentives for banks to take actions that reduce their LCRs. Such actions, which could include the provision of additional credit and a shortening of the maturity structure of the liabilities of the banks, plausibly have an impact on the real economy. As such, our analysis reveals what may be called a “LCR channel” of monetary policy transmission. JEL Classification: E52, E58, G28
    Keywords: central bank credit operations, Corona pandemic, Liquidity Coverage Ratio, monetary policy transmission
    Date: 2022–06
  6. By: Antoine Lepetit; Cristina Fuentes-Albero
    Abstract: We embed an extension of the canonical epidemiology model in a New Keynesian model and analyze the role of monetary policy as a virus spreads and triggers a sizable recession. In our framework, consumption is less sensitive to real interest changes in a pandemic than in normal times because individuals have to balance the benefits of taking advantage of intertemporal substitution opportunities with the risk of becoming sick. Accommodative monetary policies such as forward guidance result in large increases in inflation but have only limited effects on real economic activity as long as the risk of infection is large. The optimal design of monetary policy hinges on how other tools used to limit virus spread, such as lockdowns, are deployed. If the lockdown policy is conducted optimally, monetary policy should focus on keeping inflation on target. However, if the lockdown policy is not optimal, the central bank faces a trade-off between its objective of stabilizing inflation and the necessity to minimize the inefficiencies associated with virus spread.
    Keywords: COVID-19, SIR macro model, statedependent effects of monetary policy, forward guidance, monetary policy trade-offs, optimal monetary policy
    JEL: E5 E1 E11
    Date: 2022–05
  7. By: Luba Petersen; Ryan Rholes
    Abstract: We design a new experimental framework to study policy interventions to combat secular stagnations and liquidity traps in an overlapping-generations environment where participants form expectations and make real economic decisions. We observe that participants can learn to coordinate on high inflation full-employment equilibria. Permanent deleveraging shocks induce pessimistic, backward-looking expectations and considerable consumption heterogeneity as the economies experience persistent deflation. We explore the ability of unconventional monetary policy to lead economies out of deflationary traps. Permanently increasing the central bank's inflation target is insufficient to generate inflationary expectations due to low central bank credibility. Negative interest rates stimulate spending and generate the necessary inflation for the economies to escape the zero lower bound. Negative interest rates are more potent than raising the inflation target at shifting consumption to the present.
    JEL: C92 E03 E52 E70
    Date: 2022–06
  8. By: Carlos Goncalves; Mauro Rodrigues, Fernando Genta
    Abstract: As first argued in Sargent and Wallace (1981), under certain conditions a tighter monetary policy today might give rise to higher expected inflation if the public perceives that the worsened debt dynamics could end up in debt monetization. This channel is arguably stronger in countries featuring high debt and interest rates, along with weaker economic institutions. Brazil is a large emerging economy that fits the profile. Yet, using a high-frequency identification strategy, we show that higher interest rates lead to unequivocally lower inflation expectations (and local currency appreciation) around Brazil’s Central Bank monetary policy meetings.
    Keywords: monetary policy; inflation expectations; Brazil
    JEL: E52 E31 E43
    Date: 2022–06–24
  9. By: Ricardo J. Caballero; Alp Simsek
    Abstract: We propose a model where monetary policy is the key determinant of aggregate asset prices (financial conditions). Spending decisions are made by a group of agents ("households") that respond to aggregate asset prices, but with noise, delays, and inertia. Asset pricing is determined by a different group of forward-looking agents ("the market"). The central bank ("the Fed") targets asset prices to close the output gap. Our model explains several facts, including why the Fed stabilizes asset price fluctuations driven by financial market shocks ("the Fed put/call"), but destabilizes asset prices in response to aggregate demand or supply shocks that induce macroeconomic imbalances (as in the late stages of the Covid-19 recovery). Although the Fed targets asset prices, it "cooperates" with the market to achieve its desired asset price. When the market and the Fed have different beliefs, the market perceives monetary policy "mistakes" that influence the policy rate the Fed needs to set. These perceived "mistakes" induce a policy risk premium and may generate a "behind the curve" phenomenon.
    JEL: E32 E43 E44 E52 G12
    Date: 2022–06
  10. By: Pablo Cotler (Department of Economics - Universidad Iberoamericana Ciudad de Mexico); Rodrigo Carrillo (Department of Economics, Universidad Iberoamericana Ciudad de Mexico)
    Abstract: Whenever the Central Bank modifies its interest rate, it is generally thought that all lending interest rates for new loans will follow. Perhaps for this reason, it is seldom analyzed whether changes in the monetary stance have a similar effect on borrowers’ expenditure across the entire income distribution. In this paper we examine this hypothesis by looking at what happened in the personal and payroll loan markets when the Central Bank of Mexico varied its reference rate during the period 2011-2019. Since it is possible that banks may have pricing policies that may differ according to the loan size, our pass-through estimations are done at an aggregate and disaggregate level. Using an autoregressive model with distributed lags that incorporates asymmetric effects, we find two major results. First, changes in the reference rate do not imply that lending rates will move in the same direction. Typically, the pass-through is either zero or negative. Thus, the interest rate channel arising from the markets for personal and payroll loans may not be helpful to reduce the inflation rate. Second, estimations using aggregate data may be misleading since they do not necessarily reflect what happens within loans of different sizes. Finally, the exclusion of control variables may bias the results. However, it also has consequences, one of them being that asymmetric pricing may no longer detected.
    JEL: E43 E52 G21
    Date: 2022–06–21
  11. By: Avril Pauline; Levieuge Grégory; Turcu Camelia
    Abstract: We empirically investigate the impact of natural disasters on the external finance premium (EFP), conditional on the stringency of macroprudential regulation. The intensity of natural disasters is measured through an original set of geophysical indicators for a sample of 88 countries over the period 1996-2016. Using local projections, we show that, following storms, the EFP significantly rises (drops) when macroprudential regulation is lax (stringent). This suggests that regulated financial systems could foster favorable financing conditions to replace destroyed capital with more productive capital. Macroprudential stringency seems less crucial in the case of floods, which are more predictable and thus may prompt self-discipline.
    Keywords: Financial Stress, External Finance Premium, Macroprudential Policy, Natural Disasters, Local Projections
    JEL: E43 E5 Q54 C23
    Date: 2022
  12. By: Petre Caraiani (Institute for Economic Forecasting, Romanian Academy, Romania); Rangan Gupta (Department of Economics, University of Pretoria, Private Bag X20, Hatfield 0028, South Africa); Jacobus Nel (Department of Statistics, University of Florida, 230 Newell Drive, Gainesville, FL, 32601, USA); Joshua Nielsen (Boulder Investment Technologies, LLC, 1942 Broadway Suite 314C, Boulder, CO, 80302, USA)
    Abstract: We use the LPPLS Multi-Scale Confidence Indicator approach to detect both positive and negative bubbles at short-, medium- and long-run for the stock markets of the G7 countries. We were able to detect major crashes and rallies in the seven stock markets over the monthly period of 1973:02 to 2020:09. We also observed similar timing of strong (positive and negative) LPPLS indicator values across the G7 countries, suggesting synchronized extreme movements in these stock markets. Given this, to obtain an overall picture of the G7, we used a panel VAR model to analyze the impact of monetary policy shocks on the six indicators of bubbles. We found that monetary policy not only impact the bubble indicators, but also responds to them, with the nature of the underlying responses contingent on whether bubbles are positive or negative in nature, as well as the time-scale we are analyzing. In light of these findings, our results have serious implications for monetary authorities of these developed markets. But in general, we can conclude that central banks of the G7 can indeed ``lean against the wind", and they have also been doing so under both conventional and unconventional monetary policy periods.
    Keywords: Multi-Scale Bubbles, Panel VAR, Monetary Policy, G7 Countries
    JEL: C22 C32 E52 G15
    Date: 2022–06
  13. By: Herbert Sylvérie
    Abstract: This paper studies how state-contingent central bank communication can improve welfare when externalities are at play. In the model, a central banker (CB) wants to influence the private sector beliefs, which are heterogeneous, to generate an upward bias in their action. The CB can engender such welfare-improving bias by providing public information, choosing a signalling strategy that is a function of fundamentals. To study this optimal communication strategy, I introduce heterogeneous priors in an otherwise standard Bayesian persuasion model à la Gentzkow and Kamenica (2011) and characterize the dependence of optimal disclosure on the heterogeneity of beliefs. I show that heterogeneity matters in two ways: (i) it is optimal to send moderating signals, which implies sending signals with positive error probabilities in both states, and constitutes a non-trivial departure from the homogeneous beliefs case; (ii) higher dispersion in beliefs leads the monetary authority to send signals with lower error probabilities. I apply my framework to a central bank communication problem in which the policy maker communicates about aggregate conditions to influence firms' investment decisions in presence of investment externalities. I empirically validate the model's predictions by showing that the FOMC unemployment rate forecasts are systematically biased in opposite directions in recessions and expansions. Also in line with the model's predictions, the forecast biases are decreasing in the degree of private sector disagreement for each state.
    Keywords: Central Bank Communication, Bayesian Persuasion, Expectations, Forecasts
    JEL: E52 E58 D83
    Date: 2022
  14. By: Guilherme Spinato Morlin
    Abstract: We assess the connection between global and domestic inflation in Brazil during the period from 1999 to 2020. Input-output linkages have been shown to be an important cause of inflation synchronization of inflation for advanced and emerging economies. International cost shocks are less studied in the case of Brazil. We therefore estimate a Structural VAR model with an index for producer prices (PPI) of Brazilian trade partners, in addition to the other relevant determinants of inflation. Estimates show a positive effect of the Foreign PPI on Brazilian Consumer Price Index, constituting a relevant explanation for domestic inflation in Brazil during the period 1999-2020. Impulse Response functions show that the Exchange Rate is the main determinant of domestic CPI in Brazil. The results are in line with the literature’s empirical findings showing the overall relevance of international variables in the explanation of inflation. Overall, our results reveal the dominance of shocks related to the external sector (Exchange Rate, Foreign PPI, and Commodity Prices) over domestic shocks (GDP and Interest Rate) to explain inflation in Brazil. The importance of international shocks and of Foreign PPI in particular has important implications for monetary policy. International shocks are not affected by the policy rate pegged by the Central Bank of Brazil. However, the impact of these shocks on Brazilian prices also depend on the exchange rate. Therefore, our results seem to confirm that the inflation targeting regime relied mainly on the exchange rate effect of interest rate increases. Finally, this paper provides an additional variable explaining the effect of external shocks on domestic inflation in Brazil.
    Keywords: inflation, monetary policy, global inflation, exchange rate.
    JEL: E31 E52 F41 O54
    Date: 2022
  15. By: Andersson, Fredrik N. G. (Department of Economics, Lund University); Jonung, Lars (Department of Economics, Lund University)
    Abstract: Crises are a major driving force behind cooperation in the European Union. This holds also for monetary and fiscal policy. During severe crises, cooperation has been enlarged and intensified. The recent covid-19 pandemic is a clear example of this pattern. The pandemic has had huge impact on the conduct of stabilization policies in the EU. Public debt has grown rapidly in many EU member states. The ECB has carried out a highly expansionary monetary policy. In this paper, we discuss the implications for the EU of a move towards increased fiscal federalism following the pandemic. First, the role of crises as a driver of political change is analysed. Next, we examine in greater detail, the effect of crises on the design of stabilisation policies in the EU since the introduction of the euro, the common currency. Finally, we discuss the significance of the recent pandemic-induced steps towards increased federalism for the EU. We raise the question as to whether this is a desirable path for the future of European cooperation.
    Keywords: Monetary policy; fiscal policy; fiscal rules; stabilization policy; European Union; ECB; crises
    JEL: E60 F42 H60
    Date: 2022–06–21
  16. By: Andre Teixeira (Universidade de Lisboa); Zoe Venter (Universidade Catolica Portuguesa)
    Abstract: This paper assesses the impact of macroprudential policy (MaPP) on aggregate demand in the EU between 2000-2019. Using a difference-in-differences approach, we find that MaPP reduces household consumption and increases firm investment. These effects are relatively mild in the short run but become more pronounced in the long run. Our findings point to a weaker macroeconomic impact than suggested in previous studies.
    Keywords: macroprudential policy; aggregate demand; difference-in-difference approach
    JEL: E
    Date: 2022
  17. By: Elsayed, Ahmed H.; Sousa, Ricardo M.
    Abstract: Using daily data over the period August 5, 2013–September 27, 2019, this study investigates the dynamic spillovers between international monetary policies across four major economies (i.e. Eurozone, Japan, UK and US) and three key cryptocurrencies (i.e. Bitcoin, Litecoin and Ripple). In doing so, we apply a Time-Varying Parameter Vector Auto-Regression (TVP-VAR) model, a dynamic connectedness approach and network analysis. The empirical results indicate that cryptocurrency returns and monetary policy spillovers were particularly large when shadow policy rates became negative, moderated during the Fed's ‘tapering process’, and sharpened again more recently as cryptocurrency buoyancy returned. Gross directional spillovers suggest that shadow policy rates have more ‘to give than to receive’, while those from and to cryptocurrency returns are naturally volatile. There is also strong interconnectedness between monetary policy in either the US or the Eurozone and the UK, and between Bitcoin and Litecoin. However, the spillovers across monetary policy and cryptocurrencies tend to be muted. Finally, spillovers were only slightly larger during the Fed's ‘unconventional’ policy compared to the ‘standard’ era, but their composition qualitatively changed over time.
    Keywords: cryptocurrency; interconnectedness; international transmission; Monetary policy; spillovers; time-variation
    JEL: F3 G3
    Date: 2022–05–16
  18. By: Marenčák, Michal
    Abstract: Positive trend inflation resolves the observational equivalence of various sources of real rigidities which are first-order equivalent under zero trend inflation. This paper builds on this observation to assess the empirical performance of three widely used types of real rigidities — firm-specific capital, firm-specific wages and a kinked-demand curve — in matching the U.S. inflation dynamics. Firm-specific wages outperform the kinked-demand curve and firm-specific capital in terms of empirical fit. We document that positive trend inflation might reduce the ability of firm-specific factors to prolong the real affects of monetary disturbances.
    Keywords: trend inflation, real rigidity, Calvo pricing, price dispersion, monetary policy, inflation persistence
    Date: 2022–05
  19. By: Bruno Thiago Tomio (CREG - Centre de recherche en économie de Grenoble - UGA - Université Grenoble Alpes); Guillaume Vallet (CREG - Centre de recherche en économie de Grenoble - UGA - Université Grenoble Alpes)
    Abstract: This article uses data from hedge funds to investigate the behavior of the Swiss franc carry trade in the period of negative interest rate policy in Switzerland. In an effort to disentangle the funding currency and safe haven effects embedded in the Swiss carry trade activity with four target currencies (U.S. dollar, euro, Japanese yen, and British pound), we estimate structural vector autoregressive models with financial variables. Along with evidence for the funding currency and safe haven effects, results also show that: (i) the uncovered interest rate parity is violated for the U.S. dollar, euro and Japanese yen models, (ii) hedge funds are able to move asset prices, and (iii) an increased systemic risk is linked to a higher Swiss franc carry trade activity.
    Keywords: Carry trade,Negative interest rate policy,Market volatility,Swiss franc,SVAR model
    Date: 2021–10–28
  20. By: Wei Cui; Randall Wright; Yu Zhu
    Abstract: We study economies where firms acquire capital in primary markets then retrade it in secondary markets after information on idiosyncratic productivity arrives. Our secondary markets incorporate bilateral trade with search, bargaining and liquidity frictions. We distinguish between full and partial sales (one firm gets all or some of the other’s capital). Both exhibit interesting long- and short-run patterns in data that the model can match. Depending on monetary and credit conditions, more partial sales occur when liquidity is tight. Quantitatively, we find significant steady-state and business-cycle implications. We also investigate the impact of search, taxation and persistence in firm-specific shocks.
    Keywords: Business fluctuations and cycles; Monetary policy
    Date: 2022–06
  21. By: Marijn A. Bolhuis; Judd N. L. Cramer; Lawrence H. Summers
    Abstract: There have been important methodological changes in the Consumer Price Index (CPI) over time. These distort comparisons of inflation from different periods, which have become more prevalent as inflation has risen to 40-year highs. To better contextualize the current run-up in inflation, this paper constructs new historical series for CPI headline and core inflation that are more consistent with current practices and expenditure shares for the post-war period. Using these series, we find that current inflation levels are much closer to past inflation peaks than the official series would suggest. In particular, the rate of core CPI disinflation caused by Volcker-era policies is significantly lower when measured using today’s treatment of housing: only 5 percentage points of decline instead of 11 percentage points in the official CPI statistics. To return to 2 percent core CPI inflation today will thus require nearly the same amount of disinflation as achieved under Chairman Volcker.
    JEL: C43 E21 E31 E37
    Date: 2022–06

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