nep-cba New Economics Papers
on Central Banking
Issue of 2022‒12‒05
eleven papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. The Eurozone as an Inflation Target Zone By Pompeo Della Posta; Roberto Tamborini
  2. Monetary Policy when Export Revenues Drop By Drago Bergholt; Øistein Røisland; Tommy Sveen; Ragnar Torvik
  3. The Taylor Rule and its Aftermath: Elements for an Interpretation along Classical-Keynesian lines By Levrero, Enrico Sergio
  4. Just Do IT? An Assessment of Inflation Targeting in a Global Comparative Case Study By Roberto Duncan; Enrique Martinez-Garcia; Patricia Toledo
  5. Risk sharing and monetary policy transmission By Hauptmeier, Sebastian; Holm-Hadulla, Fédéric; Renault, Théodore
  6. The Welfare Effects of Bank Liquidity and Capital Requirements By Skander J. Van den Heuvel
  7. Demand Segmentation in the Federal Funds Market By Manjola Tase
  8. Climate Change and the Role of Regulatory Capital: A Stylized Framework for Policy Assessment By Michael Holscher; David Ignell; Morgan Lewis; Kevin J. Stiroh
  9. How Do Deposit Rates Respond to Monetary Policy? By Alena Kang-Landsberg; Matthew Plosser
  10. Government in the Money View: Sovereign Debt, Liquidity Preference, and the Fiscal-Monetary Nexus By Eichacker, Nina
  11. What drives inflation? Disentangling demand and supply factors By Sandra Eickmeier; Boris Hofmann

  1. By: Pompeo Della Posta; Roberto Tamborini
    Abstract: In the revised monetary policy strategy of the European Central Bank (ECB), “price stability is best maintained by aiming for two per cent inflation over the medium term”, with “symmetric commitment” to this target. “Symmetry means that the Governing Council considers negative and positive deviations from this target as equally undesirable”. In this article, we therefore analyse this policy strategy through a model of inflation target zone, with a central value and symmetric upper and lower bounds on inflation, within which the central bank may decide not to intervene, provided inflation is expected to fluctuate around the central value. We show that the policy benefits guaranteed by a target zone can be dissipated if market agents are uncertain about its width.
    Keywords: European Central Bank, monetary policy strategy, inflation target zones
    JEL: E31 E42
    Date: 2022
  2. By: Drago Bergholt; Øistein Røisland; Tommy Sveen; Ragnar Torvik
    Abstract: We study how monetary policy should respond to shocks which permanently alter the steady state structure of the economy. In such a case monetary policy affects not only the short run misallocations due to nominal rigidities, but also relative prices which stimulate reallocation of capital. We consider a permanent and negative shock to export revenues that requires a larger traded sector and a smaller non-traded sector in the new steady state. This reallocation calls for a change in relative prices during the transition, but may also lead to a period of high unemployment. We show how an appropriate monetary policy could mitigate the welfare costs of the transition by allowing the exchange rate to depreciate, and thereby allowing inflation to increase in the short run. Traditional monetary policy regimes, such as inflation targeting or a fixed exchange rate, would imply high unemployment and inefficiently slow transition. Stabilizing nominal wage growth, in contrast, would be close to the welfare-optimal monetary policy.
    Keywords: Structural Change, Dutch Disease, Monetary Policy
    Date: 2022–11
  3. By: Levrero, Enrico Sergio (Roma Tre University)
    Abstract: The aim of this paper is to assess to what extent the Taylor rule can be considered an appropriate representation of the tendency of central banks to react to price inflation. After an overview of the origin and use of the Taylor rule, the paper stresses some difficulties in its implementation according to the modern theory of central banking and the limits of its interpretation by the New Consensus models. Finally, an alternative interpretation of this rule along Classical-Keynesian lines is advanced. In this context, it has to be interpreted, as it is in actual fact, as a flexible and non-mechanical benchmark for monetary policies which are seen to affect income distribution between wages and profits.
    Keywords: Monetary policy; Taylor rule; Cost-push inflation
    JEL: E11 E12 E52 E58
    Date: 2022–10–31
  4. By: Roberto Duncan; Enrique Martinez-Garcia; Patricia Toledo
    Abstract: This paper proposes new measures of the effectiveness of inflation targeting (IT) and evaluates its main drivers in a (large) sample of advanced economies (AEs) and emerging market and developing economies (EMDEs). Using synthetic control methods, we find that IT has heterogeneous effects on inflation across countries. The gains shifting the level of inflation (generally downwards) are modest and smaller in AEs than are those in EMDEs. All such gains are statistically significant in one out of three economies approximately. Second, statistically significant differences in keeping inflation close to target under IT (compared with estimated counterfactuals) can be detected more broadly in nearly half of the economies. Third, IT can be a source of economic resilience that helped cushion inflation fluctuations during the 2007-09 Global Financial Crisis with statistically significant gains mostly found among EMDEs (in two out of three of these economies). Finally, we find that IT effectiveness—measured by the dynamic treatment effect and the absolute deviations of both observed and synthetic inflation from target—is significantly correlated with indices of exchange rate stability and monetary policy independence, especially among EMDEs.
    Keywords: Inflation targeting; Monetary policy; Inflation; synthetic control method
    JEL: C33 E31 E42 E52 E58 E61 N10
    Date: 2022–11–05
  5. By: Hauptmeier, Sebastian; Holm-Hadulla, Fédéric; Renault, Théodore
    Abstract: Using regionally disaggregated data on economic activity, we show that risk sharing plays a key role in shaping the real effects of monetary policy. With weak risk sharing, monetary policy shocks trigger a strong and durable response in output. With strong risk sharing, the response is attenuated, and output reverts to its initial level over the medium term. The attenuating impact of risk sharing via credit and factor markets concentrates over a two-year horizon, whereas fiscal risk sharing operates over longer horizons. Fiscal risk sharing especially benefits poorer regions by shielding them against persistent output contractions after tightening shocks. JEL Classification: C32, E32, E52
    Keywords: local projections, monetary policy, quantile regressions, regional heterogeneity, risk sharing
    Date: 2022–11
  6. By: Skander J. Van den Heuvel
    Abstract: The stringency of bank liquidity and capital requirements should depend on their social costs and benefits. This paper investigates their welfare effects and quantifies their welfare costs using sufficient statistics. The special role of banks as liquidity providers is embedded in an otherwise standard general equilibrium growth model. Capital and liquidity requirements mitigate moral hazard from deposit insurance, which, if unchecked, can lead to excessive credit and liquidity risk at banks. However, these regulations are also costly because they reduce the ability of banks to create net liquidity and can distort investment. Equilibrium asset returns reveal the strength of demand for liquidity, yielding two simple sufficient statistics that express the welfare cost of each requirement as a function of observable variables only. Based on U.S. data, the welfare cost of a 10 percent liquidity requirement is equivalent to a permanent loss in consumption of about 0.02%, a modest impact. Even using a conservative estimate, the cost of a similarly-sized increase in the capital requirement is roughly ten times as large. Even so, optimal policy relies on both requirements, as the financial stability benefits of capital requirements are found to be broader.
    Keywords: Capital requirements; Convenience yields; Banking; Welfare; Liquidity requirements; Sufficient statistics
    JEL: G28 G21 E44
    Date: 2022–11–04
  7. By: Manjola Tase
    Abstract: This paper outlines a model of demand segmentation in the federal funds market with two types of borrowers - the "interest on reserves (IOR) arbitrage'' type and the "regulatory'' type - which have different reservation prices and cannot always be separated. When fed funds trade above IOR, the "regulatory" type is revealed and consequently pays an interest rate closer to its real reservation price, pushing the fed funds rate further up. When fed funds trade below IOR, a decrease in the fed funds rate encourages entry in the market for IOR arbitrage purposes thus counteracting the downward pressure on the fed funds rate. We use probit regression models and daily data for the period April 2018 to February 2020 to provide empirical support for this model. We find the following: 1) When fed funds trade above IOR, there is, on average, a 10 percentage points increase in the probability that the fed funds rate increases the following period. Furthermore, analysis using confidential bank-level data shows that this increase in the probability is higher for banks that report their liquidity profile daily and that were present all trading days during this period. 2) When the fed funds trade below IOR, the probability of a decrease in the fed funds rate decreases with the widening of the spread between the fed funds rate and IOR.
    Keywords: Fed funds; Demand segmentation; Repo; Monetary policy
    JEL: E49 E52 G28
    Date: 2022–11–04
  8. By: Michael Holscher; David Ignell; Morgan Lewis; Kevin J. Stiroh
    Abstract: This paper presents a stylized framework to assess conceptually how the financial risks of climate change could interact with a regulatory capital regime. We summarize core features of a capital regime such as expected and unexpected losses, regulatory ratios and risk-weighted assets, and minimum requirements and buffers, and then consider where climate-related risk drivers may be relevant. We show that when considering policy implications, it is critically important to be precise about how climate change may impact the loss-generating process for banks and to be clear about the specific policy objective. While climate change could potentially impact the regulatory capital regime in several ways, an internally coherent approach requires a strong link between specific assumptions and beliefs about how these financial risks may manifest as bank losses and what objectives regulators are pursuing. We conclude by identifying several potential research opportunities to better understand these complex issues and inform policy development.
    Keywords: Climate change; Regulatory capital
    JEL: G21 G28
    Date: 2022–10–18
  9. By: Alena Kang-Landsberg; Matthew Plosser
    Abstract: When the Federal Open Market Committee (FOMC) wants to raise the target range for the fed funds rate, it raises the interest on reserve balances (IORB) paid to banks, the primary credit rate offered to banks, and the award rate paid to participants that invest in the overnight reverse repo (ON RRP) market to keep the fed funds rate within the target range (see prior Liberty Street Economics posts on this topic). When these rates change, market participants respond by adjusting the valuation of financial products, of which a significant category is deposits. Understanding how deposit terms adapt to changes in policy rates is important to understanding the impact of monetary policy more broadly. In this post, we evaluate the pass through of the fed funds rate to deposit rates (that is, deposit betas) over the past several interest rate cycles and discuss factors that affect deposit rates.
    Keywords: deposits; beta; fed funds; monetary policy
    JEL: G2 E5
    Date: 2022–11–21
  10. By: Eichacker, Nina
    Abstract: In times of financial crisis, we expect monetary authorities to provide liquidity support to banks at risk of failure. However, governments often provide monetary support to banks at risk of failure through guarantees and direct lending to financial institutions, often in tandem with monetary authorities. At the same time, governments may require liquidity support in moments of crisis, when cyclical deficits rise, and bond market activity constrains access to funding. This paper introduces governments’ activity into both the Post-Keynesian theory of endogenous money as well as Mehrling’s ‘Money View’ of the economy. It demonstrates how government activity becomes more important during periods of heightened liquidity preference through its support of financial institutions, while governments may simultaneously become more vulnerable to private bondholders increased liquidity preference. Some governments are likely to face greater obstacles in providing liquidity and accessing funding in times of economic uncertainty, while others may find their ability to provide liquidity is bolstered by popular perceptions of their credit worthiness. Recent experiences during the Global Financial Crisis, the Eurozone Crisis, and the COVID-19 Crisis illustrate the importance of understanding the monetary and financial factors that may constrain governments’ abilities to fund deficits, especially given the importance of fiscal expenditure as a stabilizing economic force, or as a potential driver of economic development.
    Date: 2022–09–19
  11. By: Sandra Eickmeier; Boris Hofmann
    Abstract: e estimate indicators of aggregate demand and supply conditions based on a structural factor model using a large number of inflation and real activity measures for the United States. We identify demand and supply factors by imposing theoretically motivated sign restrictions on factor loadings. The results provide a narrative of the evolution of the stance of demand and supply over the past five decades. The most recent factor estimates indicate that the inflation surge since mid-2021 has been driven by a combination of extraordinarily expansionary demand conditions and tight supply conditions. We obtain similar results for the euro area, but with a somewhat greater role for tight supply consistent with the greater exposure of the euro area to recent adverse global energy price shocks. We further find that tighter monetary policy and financial conditions dampen both demand and supply conditions.
    Keywords: inflation, aggregate demand and supply, factor model, sign restrictions, monetary policy.
    JEL: E3 E5 E6 C3
    Date: 2022–11

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