nep-cba New Economics Papers
on Central Banking
Issue of 2023‒08‒28
eighteen papers chosen by
Sergey E. Pekarski, Higher School of Economics

  1. Monetary policy shocks and firms’ bank loan expectations By Ferrando, Annalisa; Grazzini, Caterina Forti
  2. Optimal Monetary Policy with r* By Roberto M. Billi; Jordi Galí; Anton Nakov
  3. Intervening against the Fed By Rodnyansky, A.; Timmer, Y.; Yago, N.
  4. The ECB Strategy Review - Implications for the Space of Monetary Policy By Lucian Briciu; Stefan Hohberger; Luca Onorante; Beatrice Pataracchia; Marco Ratto; Lukas Vogel
  5. Monetary Transmission through Bank Securities Portfolios By John Krainer; Pascal Paul
  6. Information and the Formation of Inflation Expectations by Firms: Evidence from a Survey of Israeli Firms By Yuriy Gorodnichenko; Rafi Melnick; Ari Kutai
  7. The Impact of Monetary Policy on the U.S. Stock Market since the Pandemic By Willem THORBECKE
  8. Bank credit, inflation, and default risks over an infinite horizon By Goodhart, Charles A.E.; Tsomocos, Dimitrios P.; Wang, Xuan
  9. Shared Problem, Shared Solution: Benefits from Fiscal-Monetary Interactions in the Euro Area By Robert C. M. Beyer; Rupa Duttagupta; Alexandra Fotiou; Ms. Keiko Honjo; Mr. Mark A Horton; Zoltan Jakab; Vina Nguyen; Mr. Rafael A Portillo; Jesper Lindé; Mrs. Nujin Suphaphiphat; Mr. Li Zeng
  10. Kicking the Can Down the Road: Government Interventions in the European Banking Sector By Viral V. Acharya; Lea Borchert; Maximilian Jager; Sascha Steffen
  11. Quantifying financial stability trade-offs for monetary policy: a quantile VAR approach By Chavleishvili, Sulkhan; Kremer, Manfred; Lund-Thomsen, Frederik
  12. Interest Rate Pass-Through in Nigeria By Oyadeyi, Olajide
  13. The Fiscal Effects of Terms-of-Trade-Driven Inflation By Gergö Motyovszki
  14. Unmet Payment Needs and a Central Bank Digital Currency By Christopher Henry; Walter Engert; Alexandra Sutton-Lalani; Sebastian Hernandez; Darcey McVanel; Kim Huynh
  15. Fiscal Dominance, Monetary Policy and Exchange Rates: Lessons from Early-Modern Venice By Donato Masciandaro; Davide Romelli; Stefano Ugolini
  16. It takes a panel to predict the future: What the stock market says about future economic growth in Canada By Greg Adams; Jean-Sébastien Fontaine
  17. On the Origins of the Federal Reserve System and Its Structure By Owen F. Humpage
  18. Dollar Rivals By Jeffrey A. Frankel

  1. By: Ferrando, Annalisa; Grazzini, Caterina Forti
    Abstract: We provide new evidence on how ECB’s monetary policy decisions affect firms’ bank loan expectations in the euro area. We use firm-level data derived from the ECB Survey on the Access to Finance of Enterprises for the period 2009 to 2022 and identify the impact of monetary policy by comparing the responses of firms interviewed shortly before and after monetary policy shocks. Our results are as follows. First, we find that firms’ bank loan expectations react to monetary policy, with a contractionary shock leading to a downward revision of expectations. Second, we show that firms’ response depends on the size and the sign of the shock, with only large and contractionary shocks having a significant negative effect on expectations. Third, we observe that the different components of central bank communication (i.e. the pure monetary policy shock and the central bank information shock) have different impacts on firms’ beliefs. Fourth, we find that conventional and unconventional QE shocks have opposite effects on expectations, with the impact of QE policies mainly being driven by the central bank information component of the related announcements. Finally, we document that the response to monetary policy differs along firms’ structural characteristics. JEL Classification: C83, D22, D84, E58
    Keywords: firms’ expectations, monetary policy, survey data
    Date: 2023–08
  2. By: Roberto M. Billi; Jordi Galí; Anton Nakov
    Abstract: We study the optimal monetary policy problem in a New Keynesian economy with a zero lower bound (ZLB) on the nominal interest rate, when the steady state natural rate (r*) becomes permanently negative. We show that the optimal policy aims to approach gradually a new steady state with positive average inflation. Around that steady state, the optimal policy implies well defined (second-best) paths for inflation and output in response to shocks to the natural rate. Under plausible calibrations, the optimal policy implies that the nominal rate remains at its ZLB most of the time. Despite the latter feature, the central bank can implement the optimal outcome as a unique equilibrium by means of an appropriate nonlinear interest rate rule. In order to establish that result, we derive sufficient conditions for local determinacy in a general model with endogenous regime switches.
    JEL: E32 E5
    Date: 2023–07
  3. By: Rodnyansky, A.; Timmer, Y.; Yago, N.
    Abstract: This paper studies the spillovers of US monetary policy and the mitigating role of foreign exchange interventions (FXI) by combining deviations from a daily FXI policy rule with high frequency US monetary policy shocks, daily exchange rates, and firm-level stock prices, as well as firm-level balance sheet variables across multiple countries. We first present evidence that without interventions contractionary US monetary policy shocks spill over through a balance sheet channel: foreign exchange rates depreciate and stock prices fall, driven by those firms with US dollar debt. However, when countries counter-intervene, the spillover of US monetary policy tightening is muted. FXIs entirely offset the depreciation of the domestic exchange rate and the reduction in stock price for firms with US dollar debt, suggesting that “intervening against the Fed" protects economies from the adverse spillover of US monetary policy tightening through the balance sheet channel of exchange rates.
    Keywords: Foreign Exchange Intervention, Monetary Policy Spillovers, Balance Sheet Channel, Exchange Rates, Dollar Debt
    JEL: E44 E52 F31 F32 F41
    Date: 2023–08–07
  4. By: Lucian Briciu; Stefan Hohberger; Luca Onorante; Beatrice Pataracchia; Marco Ratto; Lukas Vogel
    Abstract: This paper investigates two important elements of the ECB’s 2021 monetary policy strategy review in an estimated structural open-economy macro model of the euro area: (a) explicit symmetry of the 2% inflation target, which can be expected to lower the risk of hitting the effective lower bound (ELB) on short-term interest rates by raising average inflation towards the target, and (b) commitment to forceful or persistent monetary accommodation in a low interest rate environment, here interpreted as low-for-longer response in the recovery from the ELB. We simulate the model with draws from the estimated distribution of shocks. Both elements increase average inflation and reduce the average output gap. Stabilisation gains are modest in quantitative terms, however, for the given illustrative policy rules, and they are more pronounced when the economy operates at the ELB. Important in the current context, the low-for-longer policy in the model does not jeopardise inflation stabilisation in the event of (inflationary) negative supply shocks at the exit from the ELB. With private sector ‘myopia’ instead of fully rational expectations, the low-for-longer rule still yields stabilisation gains at the ELB, but they shrink in quantitative terms.
    JEL: E30 E52 E58
    Date: 2023–07
  5. By: John Krainer; Pascal Paul
    Abstract: We study the transmission of monetary policy through bank securities portfolios for the United States using granular supervisory data on bank securities, hedging positions, and corporate credit. We find that banks that experienced larger market value losses on their securities during the monetary tightening cycle in 2022 extended relatively less credit to firms. Such a spillover effect was stronger for (i) available-for sale securities, (ii) unhedged securities, (iii) low-capitalized banks, and (iv) banks that have to include unrealized gains and losses on their available-for-sale securities in their regulatory capital. Our findings provide evidence for a forceful transmission channel of monetary policy that is shaped by the regulatory framework of the banking system.
    Keywords: banks; firms; securities; monetary policy
    JEL: E32 E43 E44 E51 E52 E60 G21 G32
    Date: 2023–07–26
  6. By: Yuriy Gorodnichenko; Rafi Melnick; Ari Kutai
    Abstract: This study analyzes how firms form their inflation expectations during a regime change in monetary policy and a transition to a low-inflation environment. Using the Bank of Israel survey of firms, we document the basic properties of firms’ inflation expectations and examine how Israeli firms update their inflation expectations after receiving new information about inflation or monetary policy. We find that even after successful de-dollarization and disinflation a positive inflation surprise leads to a sizable upward adjustment in inflation expectations for the next year and quarter. A surprise hike in the monetary interest rate leads to a downward adjustment in inflation expectations.
    JEL: D22 E31 E5
    Date: 2023–07
  7. By: Willem THORBECKE
    Abstract: Inflation in 2021 and 2022 grew much faster than the Federal Reserve expected. The Fed downplayed inflation in 2021 and then increased the federal funds rate by 500 basis points between March 2022 and May 2023. This paper investigates how this unprecedented tightening impacted the stock market. To do so it estimates a fully specified multi-factor model that measures the exposure of 53 assets to Bauer and Swanson (2022) monetary policy surprises over the 1988 to 2019 period. It then uses the monetary policy betas to gauge investors’ beliefs about monetary policy between 2020 and 2023. The results indicate that changing perceptions about monetary policy multiplied uncertainty and stock market volatility.
    Date: 2023–07
  8. By: Goodhart, Charles A.E.; Tsomocos, Dimitrios P.; Wang, Xuan
    Abstract: The financial intermediation wedge of the banking sector used to co-move positively with the federal funds rate, but the post-GFC era saw a disconnect between them. We develop a flexible price dynamic general equilibrium with banks’ liquidity creation to offer an explanation. In a corridor system, the financial wedge and policy rate are shown to co-move, and the pass-through of monetary policy onto both inflation and output obtains. However, the post-GFC floor system obviates the need for the financial wedge to cover the cost of obtaining reserves, so the wedge and the policy rate indeed disconnect in equilibrium; furthermore, we show that the disconnect obstructs monetary expansions from generating inflation. In this environment, tightening bank capital requirement leads to disinflationary pressure. Money-financed fiscal expansions that subsidise non-bank sectors’ borrowing costs improve output and reduce default risks but increase inflation. The model uses banks’ liquidity creation via credit extension to provide a rationale for both the pre-pandemic disinflation and the post-pandemic inflation. The results hold both on the dynamic paths and in the steady state, and the role of money enlarges the Taylor rule determinacy region.
    Keywords: corporate default; financial intermediation wedge; inside money deposits; liquidity creation; long-run non-neutrality; money-financing; reserve management
    JEL: F3 G3 J1
    Date: 2023–08–01
  9. By: Robert C. M. Beyer; Rupa Duttagupta; Alexandra Fotiou; Ms. Keiko Honjo; Mr. Mark A Horton; Zoltan Jakab; Vina Nguyen; Mr. Rafael A Portillo; Jesper Lindé; Mrs. Nujin Suphaphiphat; Mr. Li Zeng
    Abstract: This paper employs two established macroeconomic models to show that fiscal policy in the euro area can help monetary policy in reducing inflation. Specifically, a fiscal consolidation of 1 percent of GDP for two years and 0.5 percent in the third year across the euro area would ease the policy interest rate by 30-50 basis points relative to the baseline scenario, while lowering inflation. It would also put the public debt-to-GDP ratio on a downward path, with the output costs reversing after the second year. Additionally, a stronger fiscal contribution to the policy mix could mitigate financial fragmentation risks. In the current context of elevated inflation in all euro area economies, the findings suggest two key takeaways: first, synchronized fiscal and monetary policies offer gains even when monetary policy is unconstrained and, second, sharing the burden of lowering inflation through fiscal consolidation among euro area members is beneficial for union-wide inflation reduction, improving debt sustainability and inducing a lower policy rate path.
    Keywords: Policy mix; monetary policy; fiscal policy; policy coordination
    Date: 2023–07–21
  10. By: Viral V. Acharya; Lea Borchert; Maximilian Jager; Sascha Steffen
    Abstract: We analyze the determinants and the long-run consequences of government interventions in the eurozone banking sector during the 2008/09 financial crisis. Using a novel and comprehensive dataset, we document that fiscally constrained governments “kicked the can down the road” by providing banks with guarantees instead of full-fledged recapitalizations. We adopt an econometric approach that addresses the endogeneity associated with governmental bailout decisions in identifying their consequences. We find that forbearance caused undercapitalized banks to shift their assets from loans to risky sovereign debt and engage in zombie lending, resulting in weaker credit supply, elevated risk in the banking sector, and, eventually, greater reliance on liquidity support from the European Central Bank.
    Keywords: forbearance; evergreening; zombie lending; sovereign debt crisis; bank recapitalization; fiscal constraints; political economy
    JEL: E44 G21 G28 G32 G34
    Date: 2023–08
  11. By: Chavleishvili, Sulkhan; Kremer, Manfred; Lund-Thomsen, Frederik
    Abstract: We propose a novel empirical approach to inform monetary policymakers about the potential effects of policy action when facing trade-offs between financial and macroeconomic stability. We estimate a quantile vector autoregression (QVAR) for the euro area covering the real economy, monetary policy and measures of ex ante and ex post systemic risk representing financial stability. Policy implications are derived from scenario analyses where the associated costs and benefits are functions of the projected paths of the potentially asymmetric distributions of inflation and economic growth, allowing us to take a risk management perspective. One exercise considers the intertemporal financial stability trade-off in the context of the global financial crisis, where we find ex post evidence in favour of monetary policy leaning against the financial cycle. Another exercise considers the short-term financial stability trade-off when deciding the appropriate speed of monetary policy tightening to combat inflationary pressures in a fragile financial environment. JEL Classification: C32, E37, E44, E52, G01
    Keywords: growth-at-risk, Policy trade-offs, quantile regression, systemic risk
    Date: 2023–07
  12. By: Oyadeyi, Olajide
    Abstract: This paper examined interest rate pass-through in Nigeria using monthly data from 2006 to 2020. It focused on the pass-through process from the policy rate to the money market and retail rates and from the pass-through of the money market rates to the retail rates. The results showed that there was an incomplete short-run pass-through with a higher degree from the policy rate to the money market rate, while the pass-through process over-shoot in the long run. However, this pass-through was found to be very weak and incomplete from the policy rate to the retail rates and from the money market rates to the retail rates. The mean adjustment lags suggested that it takes a quicker period for policy rate changes to fully reflect on the money market and retail segment of the market. Finally, the deposit rates were found to respond more significantly, albeit slowly, to changes in the policy and interbank rates compared to the lending rates. In essence, we recommend that the monetary authorities critically appraise the size of interest rate pass-through to the retail and money market rates in light of the heterogeneous response from the policy rate to the retail and money market rates.
    Keywords: Interest Rate Pass-Through; Monetary Policy Rate; Lending Rates, Deposit Rates and; Interbank Rates
    JEL: E4 E42 E43 E51 E52 E58
    Date: 2022–04–18
  13. By: Gergö Motyovszki
    Abstract: This paper looks at whether the recent sharp spike in inflation can be beneficial for public debt sustainability by eroding the real value of nominal debt. Simulations with the European Commission’s QUEST model suggest that if the source of inflation is an adverse terms-of-trade shock, then it leads to a rising public debt-to-GDP ratio. In this case, the debt-reducing effect of higher inflation is outweighed by the adverse effects of slower real growth, a declining primary budget balance, and higher interest rates as an active monetary policy tightens to fight inflationary pressures. The results are highly policy-dependent: shorter consolidated debt maturity (brought about by past QE programs) would speed up the rise in interest expenditures, while a more accommodative monetary policy would delay them, also supporting nominal growth. The reaction of the primary fiscal balance (via automatic stabilisers, inflation indexation and debt-stabilisation rules) also matters. However, the baseline result that the debt-to-GDP ratio rises in response to an adverse terms-oftrade shock is fairly robust across all but the most extreme alternative policy scenarios
    JEL: E52 E62 E63 F41 F44 H62 H63
    Date: 2023–07
  14. By: Christopher Henry; Walter Engert; Alexandra Sutton-Lalani; Sebastian Hernandez; Darcey McVanel; Kim Huynh
    Abstract: We discuss the payment habits of Canadians both in the current payment environment and in a hypothetical cashless environment. We also consider whether a central bank digital currency (CBDC) would address unmet payment needs in a cashless society. Most adult Canadians do not experience gaps in their access to a range of payment methods, and this would probably continue to be the case in a cashless environment. Some people could, however, face difficulties making payments if merchants no longer generally accepted cash as a method of payment. For a payment-oriented CBDC to successfully address unmet payment needs, the main consumer groups—who already have access to a range of payment options—would have to widely adopt the CBDC and use it at scale. This is necessary to encourage widespread merchant acceptance of CBDC, which would, in turn, encourage further consumer adoption and use. However, most consumers face few payment gaps or frictions and therefore might have relatively weak incentives to adopt and—especially—to use CBDC at scale. If that were the case, widespread merchant acceptance also would be unlikely. This suggests that addressing unmet payment needs for a minority of consumers by issuing a CBDC could be challenging under the conditions explored in this paper. The minority of consumers with unmet payment needs will only be able to benefit from a CBDC if the majority of consumers experience material benefits and therefore drive its use.
    Keywords: Bank notes; Central bank research; Digital currencies and fintech; Financial services
    JEL: C C9 E E4 O O54
    Date: 2023–08
  15. By: Donato Masciandaro; Davide Romelli; Stefano Ugolini
    Abstract: The impact of fiscal dominance on exchange rates has been relatively overlooked by the literature. We focus on an early unique experiment of freely floating State-issued money, implemented in Venice from 1619 to 1666. Building on a new hand-collected database from a previously unused archival source, we show that despite the Venetian government’s reputation for fiscal prudence, the external value of the ducat was highly sensitive, and increasingly so, to episodes of automatic government deficit monetization through the Banco del Giro during the shocks of 1630 (outbreak of the bubonic plague) and 1648-50 (escalation of the Cretan War).
    JEL: F31 E63 N33 N43
    Date: 2023
  16. By: Greg Adams; Jean-Sébastien Fontaine
    Abstract: Throughout 2022, the Canadian economy faced persistently high inflation. The Bank of Canada responded forcefully by increasing the target rate by 425 basis points between March 2022 and January 2023. These increases led investors to expect slower economic growth in Canada, and these expectations are evident in the drop in earnings forecasts for companies whose stocks are traded on the TSX. This provided policy-makers with an early sign that higher interest rates would be effective and slow economic growth because these forecasts fell more for companies that are more sensitive to interest rates.
    Keywords: Asset pricing; Financial markets; Monetary policy transmission
    JEL: E47 E52
    Date: 2023–07
  17. By: Owen F. Humpage
    Abstract: The creation of the Federal Reserve System ultimately stemmed from fundamental changes in the banking industry that heightened the risks associated with shifts in the public’s liquidity preferences and that created an atmosphere of distrust between the small, traditional, country banks and the large, transforming, Wall Street banks. The severity of the Panic of 1907 became the proximate factor in the Federal Reserve’s formation. The panic, which the New York Clearing House’s slow, discriminative, and insufficient response characterized, gave credence to concerns of growing financial risks and invigorated calls for reform. The Federal Reserve’s unique structure reflects compromises reached in attempts to dampen the risks in the banking industry while easing the distrust and fears of dominance among its various stakeholders.
    Keywords: Inelastic/Elastic Currency; New York Clearing House; Reserve pyramiding; Panic of 1907; Aldrich Plan; Federal Reserve Act; Reserve Bank Organization Committee
    JEL: E58 N20
    Date: 2023–08–02
  18. By: Jeffrey A. Frankel
    Abstract: Written on the 50th anniversary of floating exchange rates, this paper deals with possible alternatives to a unipolar dollar-based system. It considers (1) measures of international currency use; (2) potential challengers to the dollar; (3) network externalities; and (4) the plausibility of gold and digital currencies, as alternatives to regular currencies. On the one hand, network externalities operate in favor of the status quo: the dollar as the single leading international currency. On the other hand, the danger of abuse of exorbitant privilege – for example, by debasing the currency or repeated use of sanctions – operates in favor of challengers. A good guess is that the dollar will continue to lose market share slowly to others, but will remain in the lead.
    JEL: F33
    Date: 2023–07

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