nep-cba New Economics Papers
on Central Banking
Issue of 2022‒11‒07
eleven papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Optimal fiscal policy and the Fiscal Theory of the Price Level By Guillermo Santos
  2. How do banks manage liquidity? Evidence from the ECB’s tiering experiment By Baldo, Luca; Heider, Florian; Hoffmann, Peter; Sigaux, Jean-David; Vergote, Olivier
  3. Greening capital requirements By Dafermos, Yannis; van Lerven, Frank; Nikolaidi, Maria
  4. Consumer savings behaviour at low and negative interest rates By Felici, Marco; Kenny, Geoff; Friz, Roberta
  5. Zero-Knowledge Optimal Monetary Policy under Stochastic Dominance By David Cerezo S\'anchez
  6. Politicians, bankers and the Great Depression: The Spanish banking crisis of 1931 By Jorge-Sotelo, Enrique
  7. Optimal fiscal and monetary policy with preference over safe assets By Guillermo Santos
  8. The Real Effects of Debt Covenants: Evidence from Australia By Kim Nguyen
  9. ECB Significant-Bank Risk Profile and COVID-19 Crisis Containment By Bozena Gulija; Costanza Russo; Dalvinder Singh
  10. LOLR policies, banks' borrowing capacities and funding structures By Corradin, Stefano; Sundaresan, Suresh
  11. The scarring effects of deep contractions By David Aikman; Mathias Drehmann; Mikael Juselius; Xiaochuan Xing

  1. By: Guillermo Santos (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: This paper studies optimal fiscal policy in the context of a DSGE model in which the optimizing government can issue nominal non-contingent debt and is subject to an independent monetary policy setting the nominal interest rate according to an inflation targeting rule. The fiscal authority can stabilize the economy having several tools at its disposal, including government consumption, public investment and distortionary taxes. We focus on the case where the monetary authority sets the nominal interest rate to respond weakly to inflation, the so called passive money regime Leeper (1991). We compare the outcome of optimal fiscal policy in that case with the polar opposite, when the monetary authority aggressively responds to inflation. It is well known that in standard DGSE models (without an optimizing government and when fiscal policy follows ad hoc rules) switching from an active to a passive monetary regime, brings about a considerable increase in macroeconomic volatility, mainly due to inflation fluctuations reflect debt sustainability. We ask whether optimal fiscal policy would choose to set fiscal variables irresponsibly when inflation fiscal debt in the passive money case. We find that the answer is no. The differences in the optimal policy allocation under active/passive monetary policies are small when the fundamental disturbances that hit the economy are standard demand shocks. We show that this result holds both under full commitment and in the case where time-consistent policy cannot commit to the future path of its fiscal variables. In both cases changing the monetary regime from active to passive only has a small effect on equilibrium outcomes.
    Keywords: passive monetary policy, optimal fiscal policy, time-consistent equilibrium, public investment
    JEL: E31 E52 E62 H21 H54
    Date: 2022–10–12
  2. By: Baldo, Luca; Heider, Florian; Hoffmann, Peter; Sigaux, Jean-David; Vergote, Olivier
    Abstract: We study how banks manage their liquidity among the various assets at their disposal. We exploit the introduction of the ECB’s two-tier system which heterogeneously reduced the cost of additional reserves holdings. We find that the treated banks increase reserve holdings by borrowing on the interbank market, decreasing lending to affiliates of the same group, and selling marketable securities. We also find that banks have a preference for a stable portfolio composition of liquid assets over time. Our results imply that frictions in one market for liquidity can spill over to several markets. JEL Classification: G21, G11, E52
    Keywords: bank liquidity, central bank reserves, government bonds, monetary policy implementation, money markets
    Date: 2022–09
  3. By: Dafermos, Yannis; van Lerven, Frank; Nikolaidi, Maria
    Abstract: Capital requirements play a central role in financial regulation and have significant implications for financial stability and credit allocation. However, in their existing form, they fail to capture environment-related financial risks and act as a barrier to the transition to an environmentally sustainable economy. This paper considers how capital requirements can become green and explores how green differentiated capital requirements (GDCRs) can be incorporated into financial regulation frameworks.
    JEL: F3 G3
    Date: 2022–10–07
  4. By: Felici, Marco; Kenny, Geoff; Friz, Roberta
    Abstract: We study interest rates transmission to savings at low and negative rates. Exploiting cohorts of consumers from a data-rich multi-country survey, we show how the strength of interest rate transmission to savings varies with the level of nominal interest rates. This response is positive when interest rates are high but declines steadily at lower levels. At very low levels, there is evidence that the savings response may even reverse sign. Such a “savings’ reversal” is consistent with the behavioural evidence on money illusion as well as with a negative signalling effect from policy announcements in a liquidity trap and may weaken the direct stimulatory effects from very low and negative rates. Consistent with this, the reversal appears to be causally related to central bank information shocks and concentrated among older consumers and consumers with lower educational attainment. JEL Classification: D12, D84, E21, E31, E52
    Keywords: consumer survey, euro area, liquidity trap, nominal interest rates, savings
    Date: 2022–09
  5. By: David Cerezo S\'anchez
    Abstract: Optimal simple rules for the monetary policy of the first stochastically dominant crypto-currency are derived in a Dynamic Stochastic General Equilibrium (DSGE) model, in order to provide optimal responses to changes in inflation, output, and other sources of uncertainty. The optimal monetary policy stochastically dominates all the previous crypto-currencies, thus the efficient portfolio is to go long on the stochastically dominant crypto-currency: a strategy-proof arbitrage featuring a higher Omega ratio with higher expected returns, inducing an investment-efficient Nash equilibrium over the crypto-market. Zero-knowledge proofs of the monetary policy are committed on the blockchain: an implementation is provided.
    Date: 2022–10
  6. By: Jorge-Sotelo, Enrique
    Abstract: This paper contributes to the literature on moral hazard, lending of last resort and the political origins of banking crises. Drawing on newly accessed quantitative and qualitative archival sources the paper documents how a bank - Banco de Cataluña - formed a coalition with the Dictatorship of Primo de Rivera (1923-30) in order to depart from the framework of "constructive ambiguity" that characterized central bank lending of last resort in Spain. As a result, the bank developed a uniquely risky portfolio and incurred in insider lending to internationally exposed firms at the onset of the Great Depression. The fall of the Dictatorship and democratic transition, the collapse of international trade, and global deflation during 1929-31 made fragilities emerge causing the bank to fail.
    Keywords: moral hazard,lender of last resort,Great Depression
    JEL: N24 E58 G01
    Date: 2022
  7. By: Guillermo Santos (UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: This paper investigates optimal fiscal and monetary policy in a New-Keynesian model with preferences over safe assets (POSA). Relative to a model with standard preferences, a Ramsey planner facing POSA uses inflation more actively to absorb the effects of fiscal and demand shocks despite inflation being costly. The optimal response of inflation to the shocks thus departs from the traditional prescription observed in standard New-keynesian models with sticky prices in which inflation volatility is near zero. Moreover, under POSA taxes are not as smooth as under standard preferences and are more frontloaded, an outcome that brings the model closer to optimal policy under flexible prices. With POSA, debt issuance depresses the liquidity premium, reducing revenues collected by the government and tightening the budget constraint. Therefore the planner is much less willing to issue debt in response to (say) a fiscal shock, which explains the excess tax volatility observed. These results do not dramatically change when private capital is introduced to the economy, the planner stills finds optimal to use inflation to absorb the shocks. Moreover in spite of the fact that debt issuance is lower private investment is still crowded out under POSA due to the higher distortionary taxes. Finally, the planner faced with POSA outperforms the New-Keynesian planner (with standard preferences) in terms of stabilizing the economy to a negative demand disturbance, but underperforms in terms of managing the government spending shock. The negative demand shock increases the demand for government debt and relaxes the tradeoff facing the planner. The opposite holds in the case of a spending shock.
    Keywords: optimal fiscal and monetary policy, bonds in the utility function, distortionary taxes, liquidity premium
    JEL: E31 E52 E62 H21
    Date: 2022–10–12
  8. By: Kim Nguyen (Reserve Bank of Australia)
    Abstract: I study how the use and structure of debt covenants affect real business activity and pass-through of monetary policy using a newly constructed dataset of corporate debt covenants in Australia. I find that exposure to debt covenants disciplines firms' investment and staff expenses even in the absence of covenant breaches. In addition, covenants with interest coverage limits appear to amplify the transmission of monetary policy shocks while other types of covenants appear to mitigate transmission. As such, the shift from interest coverage limits to other types of covenants that appears to have occurred since the late 2000s may have lowered the responsiveness of investment to monetary policy, and in turn accounted for some of the surprising weakness in non-mining investment over the past decade.
    Keywords: debt covenants; financing friction; investment; employment; monetary policy
    JEL: G1 E2 E5
    Date: 2022–10
  9. By: Bozena Gulija; Costanza Russo (Queen Mary University of London); Dalvinder Singh (University of Warwick)
    Abstract: The COVID-19 pandemic has caused an unprecedented degree of public and private intervention to avert a social, economic and financial crisis. EU member states, and especially participating member states of the European Banking Union (EBU), introduced a broad set of measures, including public guarantees, moratoria and amendments to the European Commission State Aid framework, to contain the negative effects of the pandemic on the economy. The EU suspended its fiscal rules and the European Central Bank increased its monetary operations. The paper uses an empirical analysis to review the impact of public support on the Single Supervisory Mechanism (SSM) banks and the acutely exposed participating EBU member states because of their significant increase in government debt levels. We argue that the containment of the crisis creates a major uncertainty, namely a possible insolvency lag once the benefits of the public support subside and insolvencies start to materialise. This uncertainty is associated with non-financial corporates, the safety and soundness of the SSM significant banks and sovereign debt sustainability, forming a new 'doom loop'. We suggest the design of a 'transition phase' as a mechanism of accountability to improve the understanding of those uncertainties to ensure financial stability.
    Keywords: deposit insurance, bank resolution
    JEL: G21 G33
    Date: 2022–07
  10. By: Corradin, Stefano; Sundaresan, Suresh
    Abstract: We investigate banks' benefits and costs of having access to LOLR. Integrating novel data sets we estimate the borrowing capacities of euro area banks at the ECB. Controlling for ratings, we find that banks with more fragile funding are likely to borrow more from the ECB during the great financial and euro area sovereign debt crises. We develop a dynamic model of a bank and calibrate it to our empirical estimates. A bank with access to LOLR has higher equity value and makes larger investments in new loans, but it is more leveraged, pays more dividends and issues less equity. JEL Classification: G2, E5, E58
    Keywords: borrowing capacity, collateral, haircut, liquidity, LOLR
    Date: 2022–10
  11. By: David Aikman; Mathias Drehmann; Mikael Juselius; Xiaochuan Xing
    Abstract: We find that deep contractions have highly persistent scarring effects, depressing the level of GDP at least a decade hence. Drawing on a panel of 24 advanced and emerging economies from 1970 to the present, we show that these effects are nonlinear and asymmetric: there is no such persistence following less severe contractions or large expansions. While scarring after financial crises is well known, it also occurred after the deep contractions of the 1970s and 1980s that followed energy price shocks and restrictive monetary policy to combat high inflation. These results are very robust and have important implications for policy making and macro modelling.
    Keywords: Hysteresis, nonlinearity, financial crises, monetary policy, oil shocks.
    JEL: E32 E37 G01
    Date: 2022–10

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