nep-cba New Economics Papers
on Central Banking
Issue of 2022‒09‒05
eighteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Debt sustainability and monetary policy: the case of ECB asset purchases By Enrique Alberola-Ila; Gong Cheng; Andrea Consiglio; Stavros A. Zenios
  2. Fiscal deficits and inflation risks: the role of fiscal and monetary policy regimes By Ryan Niladri Banerjee; Valerie Boctor; Aaron Mehrotra; Fabrizio Zampolli
  3. Capital flows and monetary policy trade-offs in emerging market economies By Paolo Cavallino; Boris Hofmann
  4. Quarterly Projection Model for Vietnam: A Hybrid Approach for Monetary Policy Implementation By Mr. Natan P. Epstein; Lucyna Gornicka; Karel Musil; Valeriu Nalban; Nga Ha
  5. Inflation target credibility in times of high inflation By Coleman, Winnie; Nautz, Dieter
  6. Shadow Rate Models and Monetary Policy By Ethan Struby; Michael F. Connolly
  7. Labor Market Shocks and Monetary Policy By Serdar Birinci; Fatih Karahan; Yusuf Mercan; Kurt See
  8. Individual Trend Inflation By Toshitaka Sekine; Frank Packer; Shunichi Yoneyama
  9. Optimal deficit‑spending in a liquidity trap with long‑term government debt By Charles de Beauffort
  10. FTPL and the Maturity Structure of Government Debt in the New Keynesian Model By Max Ole Liemen; Olaf Posch
  11. The Labor Earnings Gap, Heterogeneous Wage Phillips Curves, and Monetary Policy By Mario Giarda
  12. The macroeconomic effects of Basel III regulations with endogenous credit and money creation By Li, Boyao
  13. Bank of Japan's ETF purchase program and equity risk premium: a CAPM interpretation By Mitsuru Katagiri; Koji Takahashi; Junnosuke Shino
  14. Should Bank Stress Tests Be Fair? By Paul Glasserman; Mike Li
  15. Monetary Policy Under Labor Market Power By Miss Anke Weber; Rui Mano; Mr. Yannick Timmer; Anastasia Burya
  16. Connectedness of money market instruments: A time-varying vector autoregression approach By Lilian Muchimba
  17. Introducing New Forms of Digital Money: Evidence from the Laboratory By Gabriele Camera
  18. Forecasting euro area inflation using a huge panel of survey expectations By Florian Huber; Luca Onorante; Michael Pfarrhofer

  1. By: Enrique Alberola-Ila; Gong Cheng; Andrea Consiglio; Stavros A. Zenios
    Abstract: We incorporate monetary policy into a model of stochastic debt sustainability analysis and evaluate the impact of unconventional policies on sovereign debt dynamics. The model optimizes debt financing to trade off financing cost with refinancing risk. We show that the ECB pandemic emergency-purchase programme (PEPP) substantially improves debt sustainability for euro area sovereigns with a high debt stock. Without PEPP, debt would be on an increasing (unsustainable) trajectory with high probability, while, with asset purchases, it is sustainable and the debt ratio is expected to return to pre-pandemic levels by about 2030. The improvement in debt dynamics extends beyond the PEPP and is larger for more gradual unwinding of the Central Bank balance sheet. Optimal financing under PEPP induces an extension of maturities reducing the risk without increasing costs. The analysis also shows that inflation surprises have relatively little impact on debt dynamics, with the direction and magnitude of the effect depending on the monetary policy response.
    Date: 2022–07
  2. By: Ryan Niladri Banerjee; Valerie Boctor; Aaron Mehrotra; Fabrizio Zampolli
    Abstract: Using data from a panel of advanced economies over four decades, we show that the inflationary effect of fiscal deficits crucially depends on the prevailing fiscal-monetary policy regime. Under fiscal dominance, defined as a regime in which the government does not adjust the primary balance to stabilise debt and the central bank is less independent or puts less emphasis on price stability, the average effect on inflation of higher deficits is found to be up to five times larger than under monetary dominance. Under fiscal dominance, higher deficits also increase the dispersion of possible future inflationary outcomes, especially the probability of high inflation. Based on forecasts from our model, the high inflation experienced by many countries during the recovery from the Covid-19 pandemic appears more consistent with a regime of fiscal dominance than monetary dominance.
    Keywords: fiscal deficit, inflation, fiscal policy regime, monetary policy regime, monetary policy independence
    JEL: E31 E52 E62 E63
    Date: 2022–07
  3. By: Paolo Cavallino; Boris Hofmann
    Abstract: We lay out a small open economy model incorporating key features of EME economic and financial structure: high exchange rate pass-through to import prices, low pass-through to export prices and shallow domestic financial markets giving rise to occasionally binding leverage constraints. As a consequence of the latter, a sudden stop with large capital outflows can give rise to a financial crisis. In the sudden stop, the central bank faces an intratemporal trade-off as output declines while inflation rises. In normal times, there is an intertemporal trade-off as the risk of a future sudden stop forces the central bank to factor financial stability considerations into its policy conduct. The optimal monetary policy leans against capital flows and domestic leverage. Macroprudential, capital flow management and central bank balance sheet policies can help to mitigate both intra- and intertemporal trade-offs. Fiscal policy also plays a key role. A higher level of public debt and a weaker fiscal policy imply greater leverage and hence greater tail risk for the economy.
    Keywords: capital flows, monetary policy trade-offs, emerging market economies
    JEL: E5 F3 F4
    Date: 2022–07
  4. By: Mr. Natan P. Epstein; Lucyna Gornicka; Karel Musil; Valeriu Nalban; Nga Ha
    Abstract: We present a newly developed Quarterly Projection Model (QPM) for Vietnam. This QPM represents an extended version of the canonical New Keynesian semi-structural model, accounting for Vietnam-specific factors, including a hybrid monetary policy framework. The model incorporates the array of policy instruments, specifically interest rates, indicative nominal credit growth guidance, and exchange rate interventions, that the authorities employ to meet the primary objective of price stability. The calibrated model embeds a theoretically consistent monetary transmission mechanism and demonstrates robust in-sample forecasting accuracy, both of which are important prerequisites for the richer analysis and forecast-based narratives that support a forward-looking monetary policy regime.
    Keywords: Vietnam; Forecasting and Policy Analysis; Quarterly Projection Model; Monetary Policy; Transmission Mechanism; sample forecasting accuracy; impulse response; projection model; monetary policy implementation; forward-looking monetary policy regime; Inflation; Nominal effective exchange rate; Exchange rates; Exchange rate adjustments; Real exchange rates; Global
    Date: 2022–06–24
  5. By: Coleman, Winnie; Nautz, Dieter
    Abstract: We use a representative online survey to investigate the inflation expectations of German consumers and the credibility of the ECB's inflation target during the recent high inflation period. We find that credibility has trended downwards since summer 2021, reaching an all-time low in April 2022. The high correlation between inflation expectations and the actual rate of inflation strongly indicate that inflation expectations have been de-anchored from the inflation target. With increasing inflation, German consumers are more convinced that - in contrast to the ECB's inflation target - inflation will be well above 2% over the medium term.
    Keywords: Credibility of Inflation Targets,Household Inflation Expectations,Expectation Formation
    JEL: C83 E31 E52 E58
    Date: 2022
  6. By: Ethan Struby (Carleton College); Michael F. Connolly (Colgate University and Boston College)
    Abstract: We examine the channels and efficacy of monetary policy at the zero lower bound (ZLB) through the lens of shadow rate models. We compare estimates across models with various factor structures and different assumptions about interest rate forecasts. We confirm that calendar-based forward guidance discretely shifted the implied duration of the ZLB and that large scale asset purchases (LSAPs) primarily lowered term premia. However, we find that the real effects of monetary policy are more muted relative to prior estimates: a 1 standard deviation fall in the shadow rate causes a peak decline in the unemployment rate of 0.003-0.01%.
    JEL: E43 E44 E52 G12
    Date: 2022–08
  7. By: Serdar Birinci; Fatih Karahan; Yusuf Mercan; Kurt See
    Abstract: We develop a heterogeneous-agent New Keynesian model featuring a frictional labor market with on-the-job search to quantitatively study the role of worker flows in inflation dynamics and monetary policy. Motivated by our empirical finding that the historical negative correlation between the unemployment rate and the employer-to-employer (EE) transition rate up to the Great Recession disappeared during the recovery, we use the model to quantify the effect of EE transitions on inflation in this period. We find that the four-quarter inflation rate would have been 0.6 percentage points higher between 2016 and 2019 if the EE rate increased commensurately with the decline in unemployment. We then decompose the channels through which a change in EE transitions affects inflation. We show that an increase in the EE rate leads to an increase in the real marginal cost, but the direct effect is partially mitigated by the equilibrium decline in market tightness through aggregate demand that exerts downward pressure on the marginal cost. Finally, we study the normative implications of job mobility for monetary policy responding to inflation and labor market variables according to a Taylor rule, and find that the welfare cost of ignoring the EE rate in setting the nominal interest rate is 0.2 percent in additional lifetime consumption.
    Keywords: job mobility; monetary policy; Heterogeneous-agent New Keynesian (HANK) model; job search
    JEL: E12 E24 E52 J31 J62 J64
    Date: 2022–08
  8. By: Toshitaka Sekine (Hitotsubashi University and CAMA); Frank Packer (Bank for International Settlements); Shunichi Yoneyama (Bank of Japan)
    Abstract: This paper extends the recent approaches to estimate trend inflation from the survey responses of individual forecasters. It relies on a noisy information model to estimate the trend inflation of individual forecasters. Applying the model to the recent Japanese data, it reveals that the added noise term plays a crucial role and there exists considerable heterogeneity among individual trend inflation forecasts that drives the dynamics of the mean trend inflation forecasts. Divergences in forecasts as well as moves in estimates of trend inflation are largely driven by a identifiable group of forecasters who see less noise in the inflationary process, expect the impact of transitory inflationary shocks to wane more quickly, and are more flexible in adjusting their forecasts of trend inflation in response to new information.
    Keywords: inflation forecast, disagreement, unobserved components model, noisy information, inflation target, quantitative and qualitative monetary easing, Bank of Japan
    JEL: E31 E52 E58
    Date: 2022–08
  9. By: Charles de Beauffort (Economics and Research Department, NBB)
    Abstract: When the government issues long-term bonds, the optimal time-consistent fiscal and monetary policy is to consolidate debt in a liquidity trap by increasing taxes and by taming public spending. This prescription is at odds with large deficit-spending undertaken in the US during previous liquidity trap episodes. In this article, I show that accumulating debt turns optimal with long-term bonds and flexible wages if labor taxes are kept constant or if monetary policy is conducted non optimally. Moreover, even when labor taxes fluctuate and policy is fully coordinated, optimal deficit-spending in a liquidity trap emerges in a medium-scale model with sticky wages and rule-of-thumb consumers. In this case, debt consolidation occurs only after the nominal interest rate has lifted-off the zero lower bound, in accordance with conventional wisdom that a government should fix the roof while the sun is shining.
    Keywords: : Optimal Time-Consistent PolicyDistortionary TaxationLiquidity TrapFiscal and Monetary PolicySticky WagesRule-of-Thumb Consumers.
    JEL: E43 E52 E62 E63
    Date: 2022–07
  10. By: Max Ole Liemen; Olaf Posch
    Abstract: In this paper, we revisit the fiscal theory of the price level (FTPL) within the New Keynesian (NK) model. We show in which cases the average maturity of government debt matters for the transmission of policy shocks. The central task of this paper is to shed light on the theoretical predictions of the maturity structure on macro dynamics with an emphasis on model-implied expectations. In particular, we address the transmission channels of monetary and fiscal policy shocks on the interest rate and inflation dynamics. Our results illustrate the role of the maturity of existing debt in the wake of skyrocketing debt-to-GDP ratios and increasing government expenditures. We highlight our results by quantifying the effects of the large-scale US fiscal packages (CARES) and predict a surge in inflation if the deficits are not sufficiently backed by future surpluses.
    Keywords: NK models, FTPL, government debt, maturity structure, CARES
    JEL: E32 E12 C61
    Date: 2022
  11. By: Mario Giarda
    Abstract: We study the role of household heterogeneity in skills over the business cycle in the U.S. We document that the ratio of labor income of skilled to unskilled workers (the earnings gap) is coun-tercyclical and increases in response to contractionary monetary policy. This result is due to the higher rigidity in unskilled workers’ wages and gross substitution between skills in production. We find that in a calibrated New Keynesian model, when the earnings gap is countercyclical and un-skilled workers are more financially constrained, the impact of monetary policy shocks can be twice as strong as with homogeneous wage rigidities.
    Date: 2021–12
  12. By: Li, Boyao
    Abstract: When banks create credit and money endogenously, how do Basel III regulations affect the macroeconomy? This study develops a simple monetary circuit model based on the stock-flow consistent framework. It analytically solves for the equilibrium where banks comply with the capital adequacy ratio or net stable funding ratio. The growth rates can decompose into the money creation processes. The primary component is lending, which depends on bank spreads (or profitability) and regulatory rules. Moreover, this study reveals a channel through which credit and money creation affect economic growth. Debt ratios of firms are related to their animal spirits and the economy’s growth rates, and this relationship implies conditions for firms using debt and going bankrupt. Finally, results reveal that regulations can transfer risk from banks to firms. These findings shed new light on banks’ macroeconomic roles and the effects of bank regulations.
    Keywords: Money creation; Basel III; Economic growth; Leverage; Banking macroeconomics
    JEL: E12 E51 G28
    Date: 2022–07–15
  13. By: Mitsuru Katagiri; Koji Takahashi; Junnosuke Shino
    Abstract: In this paper, we investigate the effects of the Bank of Japan's (BOJ) exchange-traded fund (ETF) purchase program on equity risk premia. We first construct a unique panel dataset for the amount of individual stock that the BOJ has indirectly purchased in the program. Then, utilizing the cross-sectional and time-series variations in purchases associated with the BOJ's policy changes, the empirical analysis reveals that: (i) the BOJ's ETF purchases instantaneously support stock prices on the days of purchases, and (ii) the instantaneous positive effects on stock prices, combined with the countercyclical nature of the BOJ's purchases, have decreased the market beta and coskewness of Japanese stocks, thus leading to an economically significant decline in risk premia.
    Keywords: large-scale asset purchases (LSAP), ETF purchase program, capital asset pricing model (CAPM), Bank of Japan
    JEL: E58 G12 G14
    Date: 2022–07
  14. By: Paul Glasserman; Mike Li
    Abstract: Regulatory stress tests have become the primary tool for setting capital requirements at the largest U.S. banks. The Federal Reserve uses confidential models to evaluate bank-specific outcomes for bank-specific portfolios in shared stress scenarios. As a matter of policy, the same models are used for all banks, despite considerable heterogeneity across institutions; individual banks have contended that some models are not suited to their businesses. Motivated by this debate, we ask, what is a fair aggregation of individually tailored models into a common model? We argue that simply pooling data across banks treats banks equally but is subject to two deficiencies: it may distort the impact of legitimate portfolio features, and it is vulnerable to implicit misdirection of legitimate information to infer bank identity. We compare various notions of regression fairness to address these deficiencies, considering both forecast accuracy and equal treatment. In the setting of linear models, we argue for estimating and then discarding centered bank fixed effects as preferable to simply ignoring differences across banks. We present evidence that the overall impact can be material. We also discuss extensions to nonlinear models.
    Date: 2022–07
  15. By: Miss Anke Weber; Rui Mano; Mr. Yannick Timmer; Anastasia Burya
    Abstract: Using the near universe of online vacancy postings in the U.S., we study the interaction between labor market power and monetary policy. We show empirically that labor market power amplifies the labor demand effects of monetary policy, while not disproportionately affecting wage growth. A search and matching model in which firms can attract workers by either offering higher wages or posting more vacancies can rationalize these findings. We also find that vacancy postings that do not require a college degree or technology skills are more responsive to monetary policy, especially when firms have labor market power. Our results help explain the “wageless” recovery after the 2008 financial crisis and the flattening of the wage Phillips curve, especially for the low-skilled, who saw stagnant wages but a robust decline in unemployment.
    Keywords: Labor market power; Monetary Policy; Vacancies; Wages; vacancy posting; wage Phillips curve; technology skill; monetary policy shock; Labor markets; Labor demand; Labor share; Unemployment rate; Global
    Date: 2022–07–01
  16. By: Lilian Muchimba (University of Portsmouth)
    Abstract: The heightened volatility of LIBOR rates relative to other money market funding rates following the 2012 manipulation scandal and the 2007/2008 global financial crisis led to financial regulators’ recommendation to transit to more robust rates. During this period, uncertainty and heightened credit risks led to the drying up of liquidity in underlying money markets, especially for the longer-dated money market instruments. The need to shift to alternative rates was reinforced during the covid-19 crisis in March 2020 when the LIBOR rates’ vulnerability to short-term liquidity, and therefore volatility was amplified. This paradigm shift has economic and financial consequences. While connectedness studies exist for various financial markets and/or instruments, studies on money markets are limited. This is despite the uniqueness of money markets. This study fills the gap by investigating the volatility connectedness of overnight index swaps, LIBOR rates, and foreign exchange swaps using the time-varying vector autoregressive model. Specifically, the study measures the extent and dynamic connectedness of three major currencies (EUR, GBP, and JPY) in three maturity categories (1-month, 3-month and 6-month), for the period 2007-2020. The findings show that the connectedness of instruments is time-varying, event dependent for these currencies, with a high integration during crisis periods. However, the integration reduces when markets are calm. Notably, the bi-directional volatility connectedness of instruments varies across currencies. This is not surprising considering the domestic institutional and monetary policy specificities affecting these currencies.
    Keywords: LIBOR; foreign exchange swaps; overnight index swaps; volatility connectedness; monetary transmission mechanism
    JEL: E43 E52 G15 F3 C5
    Date: 2022–08–12
  17. By: Gabriele Camera (Economic Science Institute, Chapman University)
    Abstract: Central banks may soon issue currencies that are entirely digital (CBDCs) and possibly interest-bearing. A strategic analytical framework is used to investigate this innovation in the laboratory, contrasting a traditional “plain†tokens baseline to treatments with “sophisticated†interest-bearing tokens. In the experiment, this theoretically beneficial innovation precluded the emergence of a stable monetary system, reducing trade and welfare. Similar problems emerged when sophisticated tokens complemented or replaced plain tokens. This evidence underscores the advantages of combining theoretical with experimental investigation to provide insights for payments systems innovation and policy design.
    Keywords: digital currency, endogenous institutions, repeated games, CBDC
    JEL: C70 C90
    Date: 2022
  18. By: Florian Huber; Luca Onorante; Michael Pfarrhofer
    Abstract: In this paper, we forecast euro area inflation and its main components using an econometric model which exploits a massive number of time series on survey expectations for the European Commission's Business and Consumer Survey. To make estimation of such a huge model tractable, we use recent advances in computational statistics to carry out posterior simulation and inference. Our findings suggest that the inclusion of a wide range of firms and consumers' opinions about future economic developments offers useful information to forecast prices and assess tail risks to inflation. These predictive improvements do not only arise from surveys related to expected inflation but also from other questions related to the general economic environment. Finally, we find that firms' expectations about the future seem to have more predictive content than consumer expectations.
    Date: 2022–07

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