nep-cba New Economics Papers
on Central Banking
Issue of 2023‒03‒27
eighteen papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. Breaking Monetary Policy News: The Role of Mass Media Coverage of ECB Announcements for Public Inflation Expectations By Patrick Hirsch; Lars P. Feld; Ekkehard A. Köhler
  2. Loose Monetary Policy and Financial Instability By Maximilian Grimm; Òscar Jordà; Moritz Schularick; Alan M. Taylor
  3. Do firm expectations respond to Monetary Policy announcements? By Federico Di Pace; Giacomo Mangiante; Riccardo Masolo
  4. On the Effectiveness of Foreign Exchange Reserves During the 2021-22 U.S. Monetary Tightening Cycle By Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin
  5. Heterogeneity and the Equitable Rate of Interest. By Riccardo Masolo
  6. Optimal Monetary Policy with Heterogeneous Agents: Discretion, Commitment, and Timeless Policy By Eduardo Dávila; Andreas Schaab
  7. Asymmetries in Federal Reserve Objectives By Narayana R. Kocherlakota
  8. Monetary Policy, Digital Assets, and DeFi Activity By Antzelos Kyriazis; Iason Ofeidis; Georgios Palaiokrassas; Leandros Tassiulas
  9. Effects of Sustainable Monetary and Fiscal Policy on FDI Inflows to EMDE Countries By Bruno Pires Tiberto; Helder Ferreira de Mendonça
  10. Bounded Rational Expectation: How It Can Affect the Effectiveness of Monetary Rules in the Open Economy By Dong, Xue; Minford, Patrick; Meenagh, David; Yang, Xiaoliang
  11. The Global Dollar Cycle By Maurice Obstfeld; Haonan Zhou
  12. Econometric assessment of the monetary policy shocks in Morocco: Evidence from a Bayesian Factor-Augmented VAR By Marouane Daoui
  13. What Will Be the Impact of Fintech on the Payment System? A Perspective from Money Creation By Hajime Tomura
  14. Expectation Shocks and Business Cycles By Sonan Memon
  15. Cryptocurrencies: Review of Economics and Policy By Sonan Memon
  16. Financial Development and Minimum Capital Requirements in Macroeconomic Analysis By Miho Sunaga
  17. Reevaluating the Taylor Rule with Machine Learning By Alper Deniz Karakas
  18. Dollarization as an Effective Commitment Device: The Case of Argentina By Emilio Ocampo

  1. By: Patrick Hirsch; Lars P. Feld; Ekkehard A. Köhler
    Abstract: Using the variation in national television news of four major member states in the Eurozone, we find causal effects of coverage of high-frequency identified monetary policy announcements on households’ inflation expectations in an event study and a generalized Difference-in-Differences approach with stacked data. If a monetary policy decision receives news coverage, the adaptation of inflation expectations is stronger than without coverage. Second, we find that coverage of ‘delphic’ monetary policy announcements, which are primarily informational in nature, leads to an inverse adjustment, i.e., expansionary shocks lead to households lowering their inflation expectations, as opposed to coverage of a textbook, ‘odyssean’, monetary policy shock.
    Keywords: inflation expectations, media coverage, transmission of monetary policy, quasi-experimental evidence
    JEL: E31 E52 E58 C83 D84
    Date: 2023
  2. By: Maximilian Grimm; Òscar Jordà; Moritz Schularick; Alan M. Taylor
    Abstract: Do periods of persistently loose monetary policy increase financial fragility and the likelihood of a financial crisis? This is a central question for policymakers, yet the literature does not provide systematic empirical evidence about this link at the aggregate level. In this paper we fill this gap by analyzing long-run historical data. We find that when the stance of monetary policy is accommodative over an extended period, the likelihood of financial turmoil down the road increases considerably. We investigate the causal pathways that lead to this result and argue that credit creation and asset price overheating are important intermediating channels.
    JEL: E43 E44 E52 E58 G01 G21 N10
    Date: 2023–02
  3. By: Federico Di Pace; Giacomo Mangiante; Riccardo Masolo (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore)
    Abstract: We study whether firms’ expectations react to the Bank of England’s monetary policy announcements by comparing the responses to the Decision Maker Panel (DMP) survey filed immediately before and after a Monetary Policy Committee (MPC) meeting. On the one hand, we find that firms’ expectations and uncertainty about their own business for the most part do not respond to high-frequency monetary policy surprises. On the other hand, announced changes in the monetary policy rate induce firms to revise their price expectations, with rate hikes resulting in a reduction in price expectations and the uncertainty surrounding them.
    Keywords: Central bank communication, firm expectations, high-frequency identification, survey data.
    JEL: D84 E52 E58
    Date: 2023–02
  4. By: Rashad Ahmed; Joshua Aizenman; Jamel Saadaoui; Gazi Salah Uddin
    Abstract: This paper examines the role of foreign exchange (FX) reserves and other fundamental factors in explaining cross-country differences in foreign currency depreciation observed over the 2021-22 Federal Reserve monetary policy tightening cycle that led to a sharp appreciation of the US dollar. Using a broad cross-section of over 50 countries, we document that an additional 10 percentage points of FX reserves/GDP held ex-ante was associated with 1.5 to 2 percent less exchange rate depreciation. We also find that higher ex-ante policy rates were associated with less depreciation, especially among financially open economies. Taken together, these results support the buffering role of FX reserves and their potential to promote monetary policy independence in the presence of global spillovers.
    JEL: F32 F40 F68
    Date: 2023–02
  5. By: Riccardo Masolo (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore)
    Abstract: The equitable rate of interest represents a benchmark to evaluate the cross-sectional effects of monetary policy. I define it as the real rate of interest that minimizes the welfare losses associated to cross-sectional heterogeneity, under flexible prices. In a large class of models, it can be expressed as the payoff of a suitably chosen portfolio. In a Two-Agent New Keynesian model the deviations of the optimal policy prescription, relative to a Representative-Agent benchmark, can be traced back to the equitable rate gap: the difference between prevailing real rates and the equitable rate. This parallels the way in which the natural rate is the reference stick to evaluate the stance of monetary policy with regards to aggregate stabilization. Indeed, the difference between the natural rate and the equitable rate marks the tradeoff between aggregate and cross-sectional stabilization, faced by a welfare-maximizing policymaker.
    Keywords: Monetary Policy, Heterogeneous Agents, Optimal Policy.
    JEL: E31 E52
    Date: 2023–02
  6. By: Eduardo Dávila; Andreas Schaab
    Abstract: This paper characterizes optimal monetary policy in a canonical heterogeneous-agent New Keynesian (HANK) model with wage rigidity. Under discretion, a utilitarian planner faces the incentive to redistribute towards indebted, high marginal utility households, which is a new source of inflationary bias. With commitment, i) zero inflation is the optimal long-run policy, ii) time-consistent policy requires both inflation and distributional penalties, and iii) the planner trades off aggregate stabilization against distributional considerations, so Divine Coincidence fails. We compute optimal stabilization policy in response to productivity, demand, and cost-push shocks using sequence-space methods, which we extend to Ramsey problems and welfare analysis.
    JEL: E52 E61
    Date: 2023–02
  7. By: Narayana R. Kocherlakota
    Abstract: This paper uses evidence from the Federal Open Market Committee’s Summary of Economic Projections to show that US monetary policymakers have objectives over unemployment and inflation outcomes that are not well-approximated through a conventional quadratic loss function. Rather, policymakers derive material costs (benefits) from overshooting (undershooting) their long-run inflation and unemployment goals. The trade-off between the resultant downward tilts in unemployment and inflation played a key role in shaping the evolution of monetary policy choices since the Great Recession.
    JEL: E52 E58
    Date: 2023–03
  8. By: Antzelos Kyriazis; Iason Ofeidis; Georgios Palaiokrassas; Leandros Tassiulas
    Abstract: This paper studies the effects of unexpected changes in US monetary policy on digital asset returns. We use event study regressions and find that monetary policy surprises negatively affect BTC and ETH, the two largest digital assets, but do not significantly affect the rest of the market. Second, we use high-frequency price data to examine the effect of the FOMC statements release and Minutes release on the prices of the assets with the higher collateral usage on the Ethereum Blockchain Decentralized Finance (DeFi) ecosystem. The FOMC statement release strongly affects the volatility of digital asset returns, while the effect of the Minutes release is weaker. The volatility effect strengthened after December 2021, when the Federal Reserve changed its policy to fight inflation. We also show that some borrowing interest rates in the Ethereum DeFi ecosystem are affected positively by unexpected changes in monetary policy. In contrast, the debt outstanding and the total value locked are negatively affected. Finally, we utilize a local Ethereum Blockchain node to record the activity history of primary DeFi functions, such as depositing, borrowing, and liquidating, and study how these are influenced by the FOMC announcements over time.
    Date: 2023–02
  9. By: Bruno Pires Tiberto; Helder Ferreira de Mendonça
    Abstract: Emerging Market and Developing Economies (EMDE) countries are the leading destinations of Foreign Direct Investment (FDI). We investigate whether sustainable monetary and fiscal policy through indicators that reflect the expectations concerning the central bank’s commitment to a target and the sustainability of government finance affects FDI inflows. Based on a large sample of 75 EMDE countries from 1990 to 2019, we provide empirical evidence through panel data analysis that sustainable macroeconomic policies are an essential driver of FDI inflows. The findings show EMDE countries should increase the central bank credibility, decrease the fiscal imbalance, and adopt inflation targeting to enhance FDI inflows.
    Date: 2023–02
  10. By: Dong, Xue (Zhejiang University of Finance and Economics, China); Minford, Patrick (Cardiff Business School); Meenagh, David (Cardiff Business School); Yang, Xiaoliang (Cardiff Business School)
    Abstract: Since the channel for agents’ expectations matters for the effectiveness of monetary policies, it is crucial for policy-makers to assess the degree to which economic agents are boundedly rational and understand how the bounded rationality affects the monetary rules in stabilising the economy. We investigate the empirical evidence for the bounded rationality in a small open economy model of the UK, and compare the results with those for the conventional rational expectations model. Overall, comparing the estimated models favours the bounded rationality framework. The results show that bounded rationality model helps to explain the hump-shaped dynamics of real exchange rate following monetary shocks, while the rational expectations model cannot. Also, we find that the exchange rate channel in the bounded rationality enlarges the effects of foreign mark-up shock, policymakers should send stronger signals over its target to the economics agents to combat the inflation. So the bounded rationality that can be found in the data still leaves scope for the forward guidance channel to work strongly enough to be exploited by policymakers.
    Keywords: bounded rationality, monetary policy, small open economy, exchange rate channel
    JEL: E52 E70 F41 C51 F31
    Date: 2023–02
  11. By: Maurice Obstfeld; Haonan Zhou
    Abstract: The U.S. dollar’s nominal effective exchange rate closely tracks global financial conditions, which themselves show a cyclical pattern. Over that cycle, world asset prices, leverage, and capital flows move in concert with global growth, especially influencing the fortunes of emerging and developing economies (EMDEs). This paper documents that dollar appreciation shocks predict economic downturns in EMDEs and highlights policies countries could implement to dampen the effects of dollar fluctuations. Dollar appreciation shocks themselves are highly correlated not just with tighter U.S. monetary policies, but also with measures of U.S. domestic and international dollar funding stress that themselves reflect global investors’ risk appetite. After the initial market panic and upward dollar spike at the start of the COVID-19 pandemic, the dollar fell as global financial conditions eased; but the higher inflation that followed has induced central banks everywhere to tighten monetary policies more recently. The dollar has strengthened considerably since mid-2021 and a contractionary phase of the global financial cycle is now under way. Owing to increases in public- and business-sector debts during the pandemic, a strong dollar, higher interest rates, and slower economic growth will be challenging for EMDEs.
    JEL: E58 F31 F41 F44 O11
    Date: 2023–03
  12. By: Marouane Daoui
    Abstract: The analysis of the effects of monetary policy shocks using the common econometric models (such as VAR or SVAR) poses several empirical anomalies. However, it is known that in these econometric models the use of a large amount of information is accompanied by dimensionality problems. In this context, the approach in terms of FAVAR (Factor Augmented VAR) models tries to solve this problem. Moreover, the information contained in the factors is important for the correct identification of monetary policy shocks and it helps to correct the empirical anomalies usually encountered in empirical work. Following Bernanke, Boivin and Eliasz (2005) procedure, we will use the FAVAR model to analyze the impact of monetary policy shocks on the Moroccan economy. The model used allows us to obtain impulse response functions for all indicators in the macroeconomic dataset used (117 quarterly frequency series from 1985: Q1 to 2018: Q4) to have a more realistic and complete representation of the impact of monetary policy shocks in Morocco.
    Date: 2023–02
  13. By: Hajime Tomura (Waseda University)
    Abstract: The efficiency of thecurrentpayment systemrestsnot only onengineering technology but also on the legal tender and central bank system enacted by each country’s law.This essay compares the current paymentsystem with an alternative payment system that uses electronic records, such as cryptocurrencies and security tokens, assubstitutesfor conventionalcurrencies. The alternative payment system has an advantage in designing the integration of electronic payments into non-bank businesses from scratch without being bound by the technical specifications of existing bank deposit account systems. On the other hand, it cannot benefit from the supply of legal tender issued bythe central bank. Given this disadvantage, this essay argues that electronic records such as cryptocurrencies and security tokens will not substitute conventional currencies aspontaneously. Rather than changing the internal structure of the banking system, fintech will facilitate connections between bank deposit account systems and non-banking systems. Given this outlook, this essay predicts that central-bank digital currency (CBDC) will be a kind of enabler service if implemented in acountry with a developed banking system.
    Keywords: paymentsystems, security tokens, cryptocurrencies, electronic money, legal tender, central-bank digital currency.
    Date: 2022–10
  14. By: Sonan Memon (Pakistan Institute of Development Economics)
    Abstract: I study a smorgasbord of different expectation shocks in two kinds of macroeconomic models. As a baseline, I use a simple aggregate demand and supply framework with adaptive expectations. I present impulse response results for exogenous, temporary expectation shocks lasting for one period only or four periods, expectation shock with output gap-centered Taylor rule as opposed to inflation targeting and permanent exogenous shocks (long-run shock) to expectations. Later, I extend my results using a New Keynesian model, allowing for a richer analysis. In this New Keynesian setting, I study the impact of anticipated and unanticipated preference shocks with backward- and forward-looking expectations. My results indicate the centrality of the expectation formation process in driving the shock reactions and propagation 1. Policymakers in Pakistan should design policies which manoeuvre market sentiments more effectively through press releases and frequent information sharing with the market to make business cycle fluctuations more docile.
    Keywords: AD and AS Model, Expectation Shocks in New Keynesian Models, Monetary Policy and Inflation Expectations, Permanent and Sequence of Temporary Expectation Shocks, Smorgasbord of Inflation Expectation Shocks, Temporary
    JEL: D84 E00 E12 E30 E32 E40 E50 E52 E70 E71
    Date: 2023
  15. By: Sonan Memon (Pakistan Institute of Development Economics)
    Abstract: In this review paper, I begin by discussing crypto’s market penetration, legal status, and economic opportunities for Pakistan. I mainly focus on the economics of digital “currencies”. Key questions include how does crypto “currency” compare with traditional fiat currencies as a substitute? Which economic problems does it currently solve or have the potential to solve (e.g. lowers verification and networking costs)? What are its economic limitations (e.g. high energy costs, speculative bubbles, prohibitive costs of maintaining incentive compatibility and the blockchain trilemma)? How does the widespread adoption of digital currencies change the monetary and fiscal policy paradigm? Which set of regulations are needed from policymakers to address crypto’s adverse effects, such as accommodating illicit activities and threatening consumer protection? In the appendix, I also summarise the design features of the technology that underlies cryptocurrencies.
    Keywords: Cryptocurrencies: Bitcoin, Ethereum, Tether etc, Blockchain Technology, Economics of Cryptocurrencies, Implications for Fiscal and Monetary Policy, Regulation of Crypto Market,
    JEL: E00 E31 E40 E41 E42 E43 E44 E50 E58 E62 F33
    Date: 2022
  16. By: Miho Sunaga
    Abstract: We develop a macroeconomic model with a moral hazard problem between financial intermediaries and households, which causes inefficient resource allocation, to make us reconsider the financial regulation according to financial development, and individual and aggregate economic activities in the short and long runs. First, we show that in an economy where financial market has not developed, raising minimum capital requirements improves resource allocation and welfare in the long run, while it reduces welfare in an economy where financial market has developed. Second, our study reveals that an economy with a minimum capital adequacy ratio of 8% has a larger drop in aggregate net worth, consumption, and output when a negative capital quality shock occurs. However, during the financial crisis, the economy recovers faster than an economy with a higher minimum capital ratio (about 10%).These results indicate that tighter bank requirements temporally mitigate crises in economies with a developed financial market; however, they do not promote their activity in the long run.
    Date: 2023–02
  17. By: Alper Deniz Karakas
    Abstract: This paper aims to reevaluate the Taylor Rule, through a linear and a nonlinear method, such that its estimated federal funds rates match those actually previously implemented by the Federal Reserve Bank. In the linear method, this paper uses an OLS regression model to find more accurate coefficients within the same Taylor Rule equation in which the dependent variable is the federal funds rate, and the independent variables are the inflation rate, the inflation gap, and the output gap. The intercept in the OLS regression model would capture the constant equilibrium target real interest rate set at 2. The linear OLS method suggests that the Taylor Rule overestimates the output gap and standalone inflation rate's coefficients for the Taylor Rule. The coefficients this paper suggests are shown in equation (2). In the nonlinear method, this paper uses a machine learning system in which the two inputs are the inflation rate and the output gap and the output is the federal funds rate. This system utilizes gradient descent error minimization to create a model that minimizes the error between the estimated federal funds rate and the actual previously implemented federal funds rate. Since the machine learning system allows the model to capture the more realistic nonlinear relationship between the variables, it significantly increases the estimation accuracy as a result. The actual and estimated federal funds rates are almost identical besides three recessions caused by bubble bursts, which the paper addresses in the concluding remarks. Overall, the first method provides theoretical insight while the second suggests a model with improved applicability.
    Date: 2023–02
  18. By: Emilio Ocampo
    Abstract: One of the main arguments to justify dollarization in an emerging market economy is to eliminate high, persistent, and volatile inflation. To achieve this objective swiftly it must generate sufficient credibility, which in turn depends critically on whether its expected probability of reversal is low. Argentina once again faces this predicament. Because of acute institutional anomie, which makes non-contingent rules under domestic jurisdiction easily reversible, even the best-intentioned policymakers cannot generate sufficient credibility. The country remains trapped in stop-go cycle of reforms that accelerates its economic decline. The root of the problem can be traced back to populism, which heightened time-inconsistency and then destroyed the formal and informal mechanisms that could have helped moderate it. With acute institutional anomie, an effective commitment device requires surrendering discretion in monetary affairs to a foreign jurisdiction. Dollarization could fulfill such role. The evidence suggests that, in the long-run, the strongest insurance against reversal is the support of the electorate. However, in the short-run, the institutional design of dollarization is critical.
    Keywords: Foreign Exchange Rate Regimes, Dollarization, Monetary Policy, Time Inconsistency, Anomie, Argentina.
    JEL: B2 B17 B3 B22 B27 F31 F32 O24
    Date: 2023–02

This nep-cba issue is ©2023 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.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.