nep-cba New Economics Papers
on Central Banking
Issue of 2023‒05‒08
nine papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. A Theory of Fear of Floating By Javier Bianchi; Louphou Coulibaly
  2. Calibrating Macroprudential Policies in Europe Amid Rising Housing Market Vulnerability By Ms. Laura Valderrama
  3. Banking on Uninsured Deposits By Itamar Drechsler; Alexi Savov; Philipp Schnabl; Olivier Wang
  4. Identifying and assessing systemic risks in Ireland: a review of the Central Bank’s toolkit By Hallissey, Niamh; Killeen, Neill; Wosser, Michael
  5. Disinflation and the Stock Market: Third World Lessons for First World Monetary Policy By Anusha Chari; Peter Blair Henry
  6. Narrative-Driven Fluctuations in Sentiment: Evidence Linking Traditional and Social Media By Alistair Macaulay; Wenting Song
  7. Global Risk, Non-Bank Financial Intermediation, and Emerging Market Vulnerabilities By Anusha Chari
  8. A monetary-fiscal theory of sudden inflations By Marco Bassetto; David S. Miller
  9. Fallacy of floating? Reconsidering the ability of flexible exchange rates to offset terms-of-trade volatility in developing countries By Ioana Octavia Popescu

  1. By: Javier Bianchi; Louphou Coulibaly
    Abstract: Many central banks whose exchange rate regimes are classified as flexible are reluctant to let the exchange rate fluctuate. This phenomenon is known as “fear of floating”. We present a simple theory in which fear of floating emerges as an optimal policy outcome. The key feature of the model is an occasionally binding borrowing constraint linked to the exchange rate that introduces a feedback loop between aggregate demand and credit conditions. Contrary to the Mundellian paradigm, we show that a depreciation can be contractionary, and letting the exchange rate float can expose the economy to self-fulfilling crises.
    Keywords: Self-fulfilling financial crises; Exchange rates
    JEL: E52 F45 F41 G01 F36 F33 E44 F34
    Date: 2023–02–03
  2. By: Ms. Laura Valderrama
    Abstract: Housing market developments are in the spotlight in Europe. Over-stretched valuations amid tightening financial conditions and a cost-of-living crisis have increased risks of a sustained downturn and exposed challenging trade-offs for macroprudential policy between ensuring financial system resilience and smoothing the macro-financial cycle. Against this backdrop, this paper provides detailed considerations regarding how to (re)set macroprudential policy tools in response to housing-related systemic risk in Europe, providing design solutions to avoid unintended consequences during a tightening phase, and navigating the trade-offs between managing the build-up of vulnerabilities and the macro-financial cycle in a downturn. It also proposes a novel framework to measure the effectiveness of tools and avoid overlaps by quantifying the risks addressed by different macroprudential instruments. Finally, it introduces a taxonomy allowing to assess a country’s macroprudential stance and whether adjustments to current policy settings are warranted—such as the relaxation of capital-based tools and possibly some borrower-based measures in the event of a more severe downturn.
    Keywords: Housing markets; household vulnerability; income distribution; economic cycle; financial stability; macroprudential policy.
    Date: 2023–03–24
  3. By: Itamar Drechsler; Alexi Savov; Philipp Schnabl; Olivier Wang
    Abstract: Motivated by the regional bank crisis of 2023, we model the impact of interest rates on the liquidity risk of banks. Prior work shows that banks hedge the interest rate risk of their assets with their deposit franchise: when interest rates rise, the value of the assets falls but the value of the deposit franchise rises. Yet the deposit franchise is only valuable if depositors remain in the bank. This creates run incentives for uninsured depositors. We show that a run equilibrium is absent at low interest rates but appears when rates rise because the deposit franchise comes to dominate the value of the bank. The liquidity risk of the bank thus increases with interest rates. We provide a formula for the bank’s optimal risk management policy. The bank should act as if its deposit rate is more sensitive to market rates than it really is, i.e., as if its “deposit beta” is higher. This leads the bank to shrink the duration of its assets. Shortening duration has a downside, however: it exposes the bank to insolvency if interest rates fall. The bank thus faces a dilemma: it cannot simultaneously hedge its interest rate risk and liquidity risk exposures. The dilemma disappears only if uninsured deposits do not contribute to the deposit franchise (if they have a deposit beta of one). The recent growth of low-beta uninsured checking and savings accounts thus poses stability risks to banks. The risks increase with interest rates and are amplified by other exposures such as credit risk. We show how they can be addressed with an optimal capital requirement that rises with interest rates.
    JEL: E52 G12 G21
    Date: 2023–04
  4. By: Hallissey, Niamh (Central Bank of Ireland); Killeen, Neill (Central Bank of Ireland); Wosser, Michael (Central Bank of Ireland)
    Abstract: This Note describes the Central Bank of Ireland’s overall approach and toolkit for assessing systemic risks in Ireland. The aim of systemic risk assessments is to identify and measure the potential for negative macro-financial outcomes (“tail risks”) to occur in the future. Evaluating the nature and magnitude of risks facing the financial system in a forward-looking, systematic manner is an important input to the setting of macroprudential policy. There are four main elements to the risk identification and assessment framework including (i) the monitoring of selected indicators, (ii) the development of analytical tools and modelling approaches, (iii) qualitative tools such as the use of surveys and engagement with stakeholders and (iv) targeted deep dives on specific topics to complement regular analysis. The risk assessment draws on these different elements to inform judgements on key risks facing the financial system in Ireland.
    Date: 2022–11
  5. By: Anusha Chari; Peter Blair Henry
    Abstract: When policymakers implement a disinflation program directed at high inflation, the real dollar value of their country’s stock market index experiences a cumulative abnormal 12-month return of 48 percent in anticipation of the event. In contrast, the average cumulative abnormal 12-month return associated with disinflations directed at moderate inflation is negative 18 percent. The 66-percentage point difference between cumulative abnormal returns, along with descriptive evidence and case studies, suggests that unlike the swift eradication of past high inflations documented by Sargent (1982), the US will not experience a quick, low-cost transition from moderate inflation to the Fed’s two-percent target.
    JEL: E44 E52 E65
    Date: 2023–04
  6. By: Alistair Macaulay; Wenting Song
    Abstract: This paper studies the role of narratives for macroeconomic fluctuations. We micro-found narratives as directed acyclic graphs and show how exposure to different narratives can affect expectations in an otherwise standard macroeconomic model. We capture such competing narratives in news media’s reports on a US yield curve inversion by using techniques in natural language processing. Linking these media narratives to social media data, we show that exposure to a recessionary narrative is associated with a more pessimistic sentiment, while exposure to a nonrecessionary narrative implies no such change in sentiment. In a model with financial frictions, narrative-driven beliefs create a trade-off for quantitative easing: extended periods of quantitative easing make narrative-driven waves of pessimism more frequent, but smaller in magnitude.
    Keywords: Financial markets; Inflation and prices; Monetary policy
    JEL: D84 E32 E43 E44 E5 G1
    Date: 2023–04
  7. By: Anusha Chari
    Abstract: Over the last two decades, the unprecedented increase in non-bank financial intermediation, particularly open-end mutual funds and ETFs, accounts for nearly half of the external financing flows to emerging markets exceeding cross-border lending by global banks. Evidence suggests that investment fund flows enhance risk-sharing across borders and provide emerging markets access to more diverse forms of financing. However, a growing body of evidence also indicates that investment funds are inherently more vulnerable to liquidity and redemption risks during periods of global financial market stress, increasing the volatility of capital flows to emerging markets. Benchmark-driven investments, namely passive funds, appear particularly sensitive to global risk shocks such as tightening US dollar funding conditions relative to their active fund counterparts. The procyclicality of investment fund flows to emerging markets during times of global stress poses financial stability concerns with implications for the role of macroprudential policy.
    JEL: F21 F32 F36 F65 G11 G15 G23
    Date: 2023–04
  8. By: Marco Bassetto (Institute for Fiscal Studies); David S. Miller (Federal Reserve Board)
    Date: 2022–12–20
  9. By: Ioana Octavia Popescu
    Abstract: This paper questions the traditionally accepted superiority of flexible exchange rate regimes in o↵setting commodity price fluctuations. Employing an updated measure of the commodity terms-of-trade, a comparison of exchange rate regime classifications and more recent data than much of literature supporting this assertion, I find little evidence that flexible regimes deliver better outcomes in this regard. Although previous results are reproducible with the use of a certain terms-of-trade measure, their significance dissipates when employing an arguably more comprehensive measure. The results are similarly sensitive to the use of an alternative exchange rate regime classification. Notably, any significance found with either measure vanishes in the period after 2004, potentially indicative of a structural break in the transmission of terms-of-trade improvements to economic growth. In light of these findings, I suggest that, with updated measures and awareness of a potential structural break in hand, it may be time to re-evaluate the way in which terms-of-trade shocks have been understood to transmit in developing economies and what kind of exchange rate regime is best suited to this transmission mechanism.
    Date: 2023

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