nep-cba New Economics Papers
on Central Banking
Issue of 2023‒10‒30
29 papers chosen by
Sergey E. Pekarski, Higher School of Economics

  1. The forward guidance trap By Orphanides, Athanasios
  2. Monetary targeting revisited By Kern, Florian; Sigl-Glöckner, Philippa; Krahé, Max
  3. Is "Inflation First" Really "Rentiers First"? The Taylor Rule and Rentier Income in Industrialized Countries By Mario Seccareccia; Guillermo Matamoros
  4. Measuring the Effects of Unconventional Monetary Policy Tools under Adaptive Learning By Cole, Stephen J.; Huh, Sungjun;
  5. Climate-conscious monetary policy By Nakov, Anton; Thomas, Carlos
  6. Central bank communication by ??? The economics of public policy leaks By Ehrmann, Michael; Gnan, Phillipp; Rieder, Kilian
  7. Optimal monetary policy in an estimated SIR model By Benmir, Ghassane; Jaccard, Ivan; Vermandel, Gauthier
  8. Living Up to Expectations: Central Bank Credibility, the Effectiveness of Forward Guidance and Inflation Dynamics Post-Global Financial Crisis By Stephen J. Cole; Enrique Martinez-Garcia; Eric Sims
  9. Does Monetary Policy Shape the Path to Carbon Neutrality? By Döttling, Robin; Lam, Adrian
  10. Estimating the Appropriate Quantity of Settlement Balances in a Floor System By Narayan Bulusu; Matthew McNeely; Kaetlynd McRae; Jonathan Witmer
  11. Monetary transmission in Iceland - Evidence from a structural VAR model By Thorarinn G. Petursson
  12. Robust monetary policy under shock uncertainty By Mario Carceller del Arco; Jan Willem van den End
  13. Who’s Borrowing and Lending in the Fed Funds Market Today? By Gara Afonso; Gonzalo Cisternas; Brian Gowen; Jason Miu; Josh Younger
  14. Macroprudential Policies and Capital Controls Over Financial Cycles By Maria Arakelyan; Adam Gersl; Mr. Martin Schindler
  15. Quantitative Easing and the Functioning of the Gilts Repo Market By Mahmoud Fatouh; Simone Giansante; Steven Ongena
  16. The Central Bank's Dilemma: Look Through Supply Shocks or Control Inflation Expectations? By Paul Beaudry; Thomas J. Carter; Amartya Lahiri
  17. U.S. Monetary Policy Shocks and Bank Lending in Latin America: Evidence of an International Bank Lending Channel By Giraldo, Carlos; Giraldo, Iader; Gomez-Gonzalez, Jose E.; Uribe, Jorge M.
  18. U.S. Interest Rates and Emerging Market Currencies: Taking Stock 10 Years After the Taper Tantrum By Nira Harikrishnan; Benjamin Silk; Emre Yoldas
  19. Labor Market Discrimination and the Racial Unemployment Gap: Can Monetary Policy Make a Difference? By Isabel Cairó; Avi Lipton
  20. The pass-through of market interest rates to bank interest rates By Sergio Mayordomo; Irene Roibás
  21. Interest rates, not the money supply: Towards a non-monetarist interpretation of the TFEU By Orphal, Philipp; Kern, Florian; Krahé, Max
  22. Enough liquidity with enough capital - And vice versa? By Gersbach, Hans; Haller, Hans; Zelzner, Sebastian
  23. From Linear to Nonlinear: Rethinking Inflation Dynamics in the Calvo Pricing Mechanism By Ales Marsal; Katrin Rabitsch; Lorant Kaszab
  24. Climate Risk and Bank Capital Structure By Bakkar, Yassine
  25. China's macroeconomic policies and spillover effects By Niemeläinen, Julia
  26. A Blueprint for the Fourth Generation of Bank of Canada Projection and Policy Analysis Models By Donald Coletti
  27. Redefining Financial Inclusion for a Digital Age: Implications for a Central Bank Digital Currency By Alexandra Sutton-Lalani; Sebastian Hernandez; John Miedema; Jiamin Dai; Badr Omrane
  28. Sovereign spreads, central bank collateral frameworks, and periphery premia in the Eurozone By Schuster, Florian
  29. Less-Cash or More-Cash? Determinants and Trends of Currency in Circulation in a Panel of 17 Economies By Kumar Chandrakamal Pramod Kumar

  1. By: Orphanides, Athanasios
    Abstract: This paper examines the policy experience of the Fed, ECB and BOJ during and after the Covid-19 pandemic and draws lessons for monetary policy strategy and its communication. All three central banks provided appropriate accommodation during the pandemic but two failed to unwind this accommodation in a timely manner. The Fed and ECB guided real interest rates to inappropriately negative levels as the economy recovered from the pandemic, fueling high inflation. The policy error can be traced to decisions regarding forward guidance on policy rates that delayed lift-off while the two central banks continued to expand their balance sheets. The Fed and the ECB fell into the forward guidance trap. This could have been avoided if policy were guided by a forwardlooking rule that properly adjusted the nominal interest rate with the evolution of the inflation outlook.
    Keywords: Monetary policy strategy, forward guidance, policy rules
    JEL: E52 E58 E61
    Date: 2023
  2. By: Kern, Florian; Sigl-Glöckner, Philippa; Krahé, Max
    Abstract: Central banks define a monetary policy strategy in which they set out the instruments they use to achieve their monetary policy objectives as well as the incoming data they take into account when using these instruments. Independent central banks in particular are expected to provide a detailed and comprehensible explanation of their monetary policy strategy, since the absence of direct democratic legitimation comes along with particular accountability requirements. Since the end of the Bretton Woods system, both the Federal Reserve Bank (Fed) and the Deutsche Bundesbank, and later the European Central Bank (ECB), have made significant changes to their monetary policy strategy. In the 1970s, both the Bundesbank and the Fed pursued, at least officially, a monetary targeting strategy. We explain the analytical fallacies that underlay this strategy and the ideological assumptions that paved its way into practice. It is still unclear why a framework that is incoherent even at the theoretical level has been upheld for so long. It is conceivable that path dependency and a negative error culture played a role. Accordingly, we propose an evaluation of monetary policy strategy and its changes since 1973 with the aim of identifying and remedying relevant institutional weaknesses. The evaluation should also aim at clarifying whether monetary targeting resulted in institutional choices that continue to prevent monetary policy from achieving the Union's stated objectives in an optimal manner to this day. Considering that the quantity theory of money underlying monetary targeting is also propagated by supporters of cryptocurrencies, who use it specifically to attack the legitimacy of central banks, a reappraisal of the theory should also help to strengthen trust in central banks and reduce the damage caused by cryptocurrencies.
    Date: 2022
  3. By: Mario Seccareccia (University of Ottawa); Guillermo Matamoros (University of Ottawa)
    Abstract: The Taylor rule has returned as a significant policy guide amid increasingly overt political pressures for its official (and not just its implicit) adoption at the US Fed as inflation fears have come to dominate monetary policy actions both in the US and internationally in recent times. Our paper analyzes the effect of monetary policy on the functional distribution of income by reconstructing how the post-1970s "inflation first" policy commitments of central banks came to be crystallized in the Taylor rule. While there are differences among the various specifications of this "rule", the Taylor relation is merely an offshoot of what can be described generically as the family of Wicksellian reaction functions whose implications support rentier income over time. Because of the internal logic of the Taylor rule, this has led to different interpretations such as, for example, the more Keynesian Yellen rule, which depart from the strict sense of the Taylor rule. The paper also interprets the Taylor Rule in light of Wicksell's formulation and analyzes the potential consequence of the differences. In contrast to the strict Wicksell rule of "proportional" adjustment, our econometric findings suggest evidence that central banks adjust "over-proportionally" the benchmark money interest rate in the presence of changes in the inflation rate for the complete "inflation first" era since the 1970s until the COVID-19 crisis. They thereby strongly favored rentier incomes in their reaction functions, with the possible exception of the post-financial crisis period. To limit the pro-rentier consequences of such inflation-targeting regimes, it is important that policymakers mandate multiple objectives for central banks, as exemplified in the current US Fed's dual mandate.
    Keywords: Central bank reaction functions, income distribution, monetary policy, Taylor rule, Wicksell rule
    JEL: E12 E52 E58
    Date: 2023–07–10
  4. By: Cole, Stephen J.; Huh, Sungjun; (Department of Economics Marquette University; Department of Economics Marquette University)
    Abstract: We compare the economic effects of forward guidance and quantitative easing utilizing the four-equation New Keynesian model of Sims, Wu, and Zhang (2023) with agents forming expectations via an adaptive learning rule. The results indicate forward guidance can have a greater influence on macroeconomic variables compared to quantitative easing, suggesting that forward guidance may have contributed to the high inflation rate after the COVID-19 related recession. Adaptive learning agents estimate a higher effect of forward guidance on the economy leading to a greater impact on expectations, and thus, contemporaneous inflation. However, the performance gap between forward guidance and quantitative easing can change. If quantitative easing includes anticipated shocks, more households finance consumption through long-term borrowing, and the central bank provides a greater percentage of liquidity in the long-term borrowing market, the performance of quantitative easing can increase, and at times, outperform forward guidance.
    Keywords: unconvetional monetary policy, QE, LSAP, forward guidance, adaptive learning
    JEL: E32 E52 E58 D83
    Date: 2023–10
  5. By: Nakov, Anton; Thomas, Carlos
    Abstract: We study the implications of climate change and the associated mitigation measures for optimal monetary policy in a canonical New Keynesian model with climate externalities. Provided they are set at their socially optimal level, carbon taxes pose no trade-offs for monetary policy: it is both feasible and optimal to fully stabilize inflation and the welfare-relevant output gap. More realistically, if carbon taxes are initially suboptimal, trade-offs arise between core and climate goals. These trade-offs however are resolved overwhelmingly in favor of price stability, even in scenarios of decades-long transition to optimal carbon taxation. This reflects the untargeted, inefficient nature of (conventional) monetary policy as a climate instrument. In a model extension with financial frictions and central bank purchases of corporate bonds, we show that green tilting of purchases is optimal and accelerates the green transition. However, its effect on CO2 emissions and global temperatures is limited by the small size of eligible bonds’ spreads. JEL Classification: E31, E32, Q54, Q58
    Keywords: climate change externalities, green QE, Pigouvian carbon taxes, Ramsey optimal monetary policy
    Date: 2023–09
  6. By: Ehrmann, Michael; Gnan, Phillipp; Rieder, Kilian
    Abstract: Leaks of confidential information emanating from public institutions have been the focus of a long-standing line of research. Yet, their determinants as well as their potential impact on public views and on policy effectiveness remain elusive. To address this gap, we study leaks from central banks because their effects are instantaneously reflected in financial markets. Based on a novel database of anonymous monetary policy leaks in the euro area as reported by newswires, we provide evidence that many of these leaks are likely placed by individual insiders with minority opinions. While we find that leaks have large effects on markets and weaken official policy announcements, our results also suggest that leaks do not lock in decision-makers, and that attributed communication can mitigate some of their effects. JEL Classification: D83, E52, E58, G14, H83
    Keywords: central bank communication, European Central Bank, leaks, media, monetary policy
    Date: 2023–09
  7. By: Benmir, Ghassane; Jaccard, Ivan; Vermandel, Gauthier
    Abstract: This paper studies the design of Ramsey optimal monetary policy in a Health New Keynesian (HeNK) model with Susceptible, Infected and Recovered (SIR) agents. The nonlinear model is estimated with maximum likelihood techniques on Euro Area data. Our objective is to deconstruct the mechanism by which contagion risk affects the conduct of monetary policy. If monetary policy is the only game in town, we find that the optimal policy features significant deviations from price stability to mitigate the effect of the pandemic. The best outcome is obtained when the optimal Ramsey policy is combined with a lockdown strategy of medium intensity. In this case, monetary policy can concentrate on its price stabilization objective. JEL Classification: E52, E32
    Keywords: Covid-19, HeNK, macroeconomic trade-offs, nonlinear inference, Tin-bergen principle
    Date: 2023–09
  8. By: Stephen J. Cole; Enrique Martinez-Garcia; Eric Sims
    Abstract: This paper studies the effectiveness of forward guidance when central banks have imperfect credibility. Exploiting unique survey-based measures of expected inflation, output growth and interest rates, we estimate a small-scale New Keynesian model for the United States and other G7 countries plus Spain allowing for deviations from full information rational expectations. In our model, the key parameter that aggregates heterogeneous expectations captures the central bank's credibility and affects the overall effectiveness of forward guidance. We find that the central banks of the U.S., the U.K., Germany and other major advanced economies have similar levels of credibility (albeit far from full credibility); however, Japan's central bank credibility is much lower. For each country, our measure of credibility has declined over time, making forward guidance less effective. In a counterfactual analysis, we document that inflation would have been significantly higher, and the zero lower bound on short-term interest rates much less of an issue, in the wake of the Global Financial Crisis had the public perceived central bank forward guidance statements to be perfectly credible. Moreover, inflation would have declined more, and somewhat faster, with perfect credibility in the wake of the inflation surge post-COVID-19.
    Keywords: forward guidance; central bank credibility; heterogeneous expectations
    JEL: D84 E30 E52 E58 E60 P52
    Date: 2023–09–29
  9. By: Döttling, Robin; Lam, Adrian (University of Pittsburgh)
    Abstract: This paper empirically examines the interaction between monetary policy and carbon transition risk. Using an event study design, we find that the stock prices of firms with higher carbon emissions are more responsive to monetary policy shocks identified from high-frequency movements in Fed Funds futures around Federal Open Market Committee (FOMC) announcements. Cross-sectional tests reveal that this effect is driven by firms that are more capital intensive, with lower ESG ratings, with greater climate risk exposures, or without climate abatement plans. Using instrumental-variable local projections, we find that high-emission firms reduce emissions relative to low-emission firms, but slow down these efforts when monetary policy is restrictive. Taken together, our results indicate that monetary policy shapes the path to carbon neutrality irrespective of whether central banks embrace a climate target.
    Date: 2023–09–24
  10. By: Narayan Bulusu; Matthew McNeely; Kaetlynd McRae; Jonathan Witmer
    Abstract: In April 2022, the Bank of Canada announced that it would continue to use a floor system to implement monetary policy by providing a sufficiently large quantity of settlement balances to enable the overnight repo rate to trade at close to the deposit rate. In contrast, the Bank’s guiding principles of prudence, transparency and neutrality, which govern the management of its balance sheet, favour maintaining settlement balances as low as possible. In this context, this paper describes two complementary approaches to estimating the appropriate quantity of settlement balances needed to effectively maintain a floor system. The first is a regression-based analysis to estimate the quantity required to maintain the overnight repo rate close to the Bank’s policy interest rate (which is equal to the deposit rate in a floor system). The second is an analysis of operational considerations in implementing a floor system in Canada. Both approaches highlight that considerable uncertainty exists in determining the demand for settlement balances. Such uncertainty emphasizes the need for the Bank to monitor money market conditions as it continues to normalize its balance sheet after undertaking quantitative easing operations related to the COVID-19 pandemic.
    Keywords: Financial institutions; Financial markets; Financial system regulation and policies; Monetary policy implementation; Payment clearing and settlement systems
    JEL: E41 E42 E52 E58 G21 G28
    Date: 2023–10
  11. By: Thorarinn G. Petursson
    Abstract: This paper analysis the transmission mechanism of monetary policy in Iceland using three alternative identification schemes in a structural VAR setting. Consistent with the international literature, we find that an unexpected monetary policy tightening leads to a temporary but sizable contraction in output, a sustained appreciation of the nominal exchange rate, and a more sluggish and persistent decline in inflation. Three other structural shocks are also identified. All have plausible economic interpretation and can explain the bulk of the variation in output and inflation over our sample period. By comparison, the contribution from monetary policy shocks is relatively modest, especially to output fluctuations. Historical decomposition shows, however, that monetary policy played an important role during the disinflation of the second half of the 2010s and in offsetting a large negative demand shock following the global pandemic at the start of this decade. However, the historical decomposition also suggests that the withdrawal of the post-Covid monetary easing was too slow, thus contributing to rising inflation by the end of the sample period.
    JEL: C32 E52 F41
    Date: 2023–09
  12. By: Mario Carceller del Arco; Jan Willem van den End
    Abstract: We assess the robustness of monetary policy under shock uncertainty based on a novel empirical method. Shock uncertainty arises from the inability to observe the output gap in real time, by which the contribution of supply and demand shocks to inflation is unknown. We apply our method in a medium-scale Dynamic Stochastic General Equilibrium (DSGE) model to the recent inflation surge in the US. We find that robust monetary policy aimed at limiting extreme welfare losses under shock uncertainty should neither be too strong nor too mild, given the probability that supply shocks are a dominant driver of economic fluctuations. An overly strong response to inflation in supply driven scenarios is associated with large tail losses due to adverse output dynamics.
    Keywords: Monetary policy; Inflation; Policy-making under risk and uncertainty
    JEL: E52 E58 D81
    Date: 2023–10
  13. By: Gara Afonso; Gonzalo Cisternas; Brian Gowen; Jason Miu; Josh Younger
    Abstract: The Federal Open Market Committee (FOMC) communicates the stance of monetary policy through a target range for the federal funds rate, which is the rate set in the market for uncollateralized short-term lending and borrowing of central bank reserves in the U.S. Since the global financial crisis, the market for federal funds has changed markedly. In this post, we take a closer look at who is currently trading in the federal funds market, as well as the reasons for their participation.
    Keywords: fed funds; reserves; Interbank market; monetary policy; Federal Open Market Committee (FOMC)
    JEL: E5 G1 G2
    Date: 2023–10–10
  14. By: Maria Arakelyan; Adam Gersl; Mr. Martin Schindler
    Abstract: In this paper we assess the effectiveness of macroprudential policies and capital controls in supporting financial stability. We construct a large and granular dataset on prudential and capital flow management measures covering 53 countries during 1996-2016. Conditional on a credit boom, we study the impact of these policy measures on the probability of the credit boom ending in a bust. Our analysis suggests that macroprudential tools are effective from this perspective. If credit booms are accompanied by capital flow surges, in addition to macroprudential tools, capital controls on money market instruments including cross-border interbank lending tend to contribute to reducing the likelihood of a credit bust.
    Keywords: Macroprudential measures; capital controls; financial stability; credit cycles; capital control measure; credit bust; Net policy tightening; credit growth; boom episode; Credit booms; Macroprudential policy; Macroprudential policy instruments; Capital inflows; Global
    Date: 2023–08–25
  15. By: Mahmoud Fatouh (University of Essex; Bank of England); Simone Giansante (University of Palermo); Steven Ongena (University of Zurich; Swiss Finance Institute; KU Leuven; NTNU Business School; Centre for Economic Policy Research (CEPR))
    Abstract: We assess the impact of quantitative easing (QE) on the provisioning of liquidity and the pricing in the UK gilt repo market. We compare the behaviour of banks that received reserves injections via QE operations to other similar banks in terms of the amounts lent and pricing. We also investigate whether leverage ratio capital requirements affected the amounts of liquidity supplied by broker-dealers and the spreads they charged. We find that QE interventions can improve liquidity provision, and that their size determines how this is attained. QE can also reduce the cost of borrowing in the repo market, unless it was associated with spikes in demand for liquidity. Our findings further indicate that the leverage ratio supports the provision of liquidity during stress, as it prompts banks to become less leveraged. However, the larger capital charge repo transactions attract under the leverage ratio requirement is reflected in their spreads.
    Keywords: Monetary policy, quantitative easing, gilt repo market, leverage ratio
    JEL: G10 G21 G23
    Date: 2023–09
  16. By: Paul Beaudry; Thomas J. Carter; Amartya Lahiri
    Abstract: When countries are hit by supply shocks, central banks often face the dilemma of either looking through such shocks or reacting to them to ensure that inflation expectations remain anchored. In this paper, we propose a tractable framework to capture this dilemma and explore optimal policy under a range of assumptions on how expectations are formed, including a form of bounded rationality involving level-k thinking (LKT). Despite modelling LKT in a way that nests both adaptive and rational expectations as special cases, we show that the optimal policy under LKT is qualitatively different and involves abrupt pivots in the policy stance. In particular, it is optimal for the central bank to initially look through supply shocks until a threshold is reached, then pivot discontinuously to a more hawkish anti-inflationary stance. We find that such pivots can, if optimally executed, be compatible with soft landings in the sense that most (or even all) of the reduction in inflation occurs through re-anchoring of expectations rather than economic slack. We also discuss risks and why policy errors in terms of tightening too late or too slowly can be especially costly in such an environment.
    JEL: E40 E50
    Date: 2023–09
  17. By: Giraldo, Carlos (Latin American Reserve Fund); Giraldo, Iader (Latin American Reserve Fund); Gomez-Gonzalez, Jose E. (City University of New York – Lehman College); Uribe, Jorge M. (Universitat Oberta de Catalunya)
    Abstract: We examine the impact of U.S. monetary policy shocks on bank lending in five major Latin American countries where large U.S. banks have limited presence. Our analysis covers annual balance sheet data from 2000 to 2021 for all banks in these nations, utilizing a recently developed measure of U.S. monetary policy shocks by Bu et al. (2021). Our findings reveal the existence of an international bank lending channel, with a one-percentage-point increase in the Fed funds rate resulting in an average 80.6 basis-point reduction in domestic bank loan growth in these countries. Liquidity and solvency emerge as crucial factors driving variations in lending behavior among Latin American banks, with banks exhibiting stronger liquidity and solvency profiles experiencing higher loan supply growth rates. This international bank lending channel persists even in countries with minimal U.S. bank presence, leading to constrained cross-border lending activities.
    Keywords: International bank lending channel; U.S. monetary policy shocks; loan growth; Latin America;
    JEL: E51 E52 E59 G21
    Date: 2023–10–04
  18. By: Nira Harikrishnan; Benjamin Silk; Emre Yoldas
    Abstract: In 2013, a shift in expectations of market participants for the timing of the tapering of the Federal Reserve's asset purchases, and its ramifications for normalization of U.S. monetary policy, led to sharp increases in longer-term U.S. Treasury yields and volatility in broader financial markets. The episode came to be known as the "taper tantrum" because the strong market reaction came in response to Federal Reserve communications that were largely consistent with market analysts' expectations.
    Date: 2023–10–04
  19. By: Isabel Cairó; Avi Lipton
    Abstract: Black workers experience a higher unemployment rate, as well as more volatile employment dynamics, than white workers, and the racial unemployment rate gap is largely unexplained by observable characteristics. We develop a New Keynesian model with search and matching frictions in the labor market, endogenous separations, and employer discrimination against Black workers to explain these outcomes. The model is consistent with key features of the aggregate economy and is able to explain key labor market disparities across racial groups. We then use this model to assess the effects of the Federal Reserve’s new monetary policy framework---interest rates respond to shortfalls of employment from its maximum level rather than deviations---on racial inequality in the labor market. We find that shifting from a Deviations interest rate rule to a Shortfalls rule reduces the racial unemployment rate gap and the model-based measures of labor market discrimination but increases the average inflation rate. From a welfare perspective, we find that the Shortfalls approach does not do much to reduce racial inequality in our model economy.
    Keywords: Unemployment; Monetary policy; Racial inequality; Discrimination
    JEL: E24 E52 J15 J70
    Date: 2023–10–03
  20. By: Sergio Mayordomo (BANCO DE ESPAÑA); Irene Roibás (BANCO DE ESPAÑA)
    Abstract: The pass-through of market interest rates to the financial conditions of households and firms is an essential element in the monetary policy transmission mechanism. In this paper, we analyse how this transmission is playing out in the current hiking cycle in the euro area and in Spain, as compared to previous cycles. We find that the pass-through to the interest rates on retail time deposits is slower than in previous hiking cycles in both jurisdictions. Moreover, a slower pass-through is also observed for mortgages in Spain. We then show there is significant heterogeneity in this pass-through across euro area countries, especially for mortgages and retail time deposits. This heterogeneity is driven by both bank and country characteristics. More specifically, in the case of deposits, we find that almost half of the difference between the remuneration of retail time deposits in Spain and the euro area is driven by differences across banking sectors in the need to raise funds through deposits to supply credit.
    Keywords: monetary policy, interest rate pass-through, bank lending channel, loans, retail deposits, heterogeneity.
    JEL: E43 E47 E50 E51 E52 E58 E59 E65 G17 G21
    Date: 2023–10
  21. By: Orphal, Philipp; Kern, Florian; Krahé, Max
    Abstract: In this paper, we show that the case law on the legality of bond purchases by Eurosystem central banks is partly based on the economic theory of monetarism and, in particular, on a 1981 paper by Thomas Sargent and Neil Wallace ("Some Unpleasant Monetarist Arithmetic"). However, monetarism, already controversial in the 1970s and 1980s, is now recognised as false. The assumptions on which Sargent and Wallace based their argument were already partially inaccurate at the time; today, it is generally accepted that these assumptions do not hold in reality.2 This intellectual progress should be taken into account in ongoing interpretation of the European treaties and the European legal framework. Building on this observation, in this paper we develop an updated, "non-monetarist" interpretation of Article 123 TFEU. This interpretation deviates from the standards developed in previous case law in three ways: First, the prohibition under which the European System of Central Banks may not purchase government bonds on the secondary markets under conditions which would, in practice, have an effect equivalent to that of a direct purchase of government bonds ("prohibition of transactions with equivalent effect") should be given up on. Second, the restriction that secondary market purchases must not weaken incentives (judicially speaking, the "impetus") towards "sound fiscal policy" ("prohibition on circumvention") should be replaced. Instead of this restriction, the proper limiting principle is that secondary market purchases must pursue the objective of price stability and, if possible without compromising the first objective, support the general economic policies in the European Union. Within the purposes of Article 123 TFEU, sound public finances are only a means for achieving price stability. The focus of the interpretation should therefore be the pursuit of price stability. The general economic policy goal of sound public finances is the subject of other rules. Third, and on a related point, the Federal Constitutional Court of Germany (BverfG) should no longer ground the protection of the Bundestag's budgetary right in Article 123 TFEU. The increasingly detailed measures and prohibitions built on an extensive reading of this article are detrimental to monetary policy and thus to price stability. This does not mean that the Federal Constitutional Court should give up on protecting the Bundestag's budgetary sovereignty. Instead, the protection of the Bundestag's budgetary right should be carried out under the legal benchmarks actually created for this purpose: Articles 121, 125 and 126 TFEU.
    Date: 2023
  22. By: Gersbach, Hans; Haller, Hans; Zelzner, Sebastian
    Abstract: We study the interplay of capital and liquidity regulation in a general equilibrium setting by focusing on future funding risks. The model consists of a banking sector with long-term illiquid investment opportunities that need to be financed by short-term debt and by issuing equity. Reliance on refinancing long-term investment in the middle of the life-time is risky, since the next generation of potential short-term debt holders may not be willing to provide funding when the return prospects on the long-term investment turn out to be bad. For moderate return risk, equilibria with and without bank default coexist, and bank default is a self-fulfilling prophecy. Capital and liquidity regulation can prevent bank default and may implement the first-best. Yet the former is more powerful in ruling out undesirable equilibria and thus dominates liquidity regulation. Adding liquidity regulation to optimal capital regulation is redundant.
    Keywords: financial intermediation, funding risk, bank default, banking regulation, liquidity requirements, capital requirements
    JEL: G21 G33 G38
    Date: 2023
  23. By: Ales Marsal (National Bank of Slovakia); Katrin Rabitsch (Department of Economics, Vienna University of Economics and Business); Lorant Kaszab (Magyar Nemzeti Bank)
    Abstract: Modern macroeconomics is increasingly leaning towards nonlinear solution methods. Our paper addresses the importance of nonlinearities in price setting. We demonstrate how nonlinearity in endogenous price adjustments, due to misalignments in relative prices, can trigger a price dispersion inflation spiral. This phenomenon yields globally unstable dynamics, even in instances where the model is locally stable around the non-stochastic steady state. We introduce the concept of the stability region as a nonlinear counterpart to the determinacy region. Our findings indicate that in a nonlinear world, the Taylor principle alone does not guarantee inflation stability and stable macroeconomic model moments. This new understanding not only challenges the conventional wisdom on inflation stabilization but also underscores the urgency for recalibrating monetary policy strategies in response to these dynamics.
    Keywords: Determinacy, stability, price dispersion, monetary policy, nonlinear solution methods, macro-finance
    JEL: E13 E31 E43 E44
    Date: 2023–09
  24. By: Bakkar, Yassine
    Abstract: We study the role of climate risk exposure in the dynamic behavior of banks' regulatory capital adjustment using a large European sample from 39 countries during the 2006-2021 period. We find that banks facing high exposure to climate risk opt for higher target (regulatory) capital adequacy ratio and make faster adjustment to their optimal capital structure, especially if they are more exposed to carbon pollution. Such banks boost their adjustment during the post Paris Agreement period. These banks move to their target capital adequacy ratio by mainly adjusting their risk-weighted assets or by reallocating them more promptly than other peers, but without necessarily altering assets, particularly, lending. This paper lends support to the importance of the climate change-related risks into prudential supervision to protect the financial system's resilience and contributes to the debate on climate-related capital requirements.
    Keywords: Dynamic capital structure, Speed of adjustment, Climate change, Paris Agreement, Balance sheet composition
    JEL: G21 G28 Q53 Q54
    Date: 2023
  25. By: Niemeläinen, Julia
    Abstract: This paper provides a brief overview of China's capital controls, external asset holdings and the real interest rate, and analyzes the quantitative effects of China's macroeconomic policies between 2000 and 2015, including capital controls, interest rate policy, exchange rate policy and fiscal policy, on the dynamics of China's trade balance vis-a-vis the United States and the world real interest rate. In my analysis, I take into account the demographic differences between the countries, which affect the external imbalances directly and indirectly by affecting the transmission of the macroeconomic policies. Capital controls in China remain stringent even though they have somewhat eased in 2010s, and its gross external asset holdings differ from its peer countries both in terms of the largest functional categories and by type of investment. The average interest rate spread with the US has narrowed down. According to my analysis, the macroeconomic policies overall, and mainly the undervaluation of the real exchange rate, have had a positive impact on China's trade balance. The impact of the macroeconomic policies on the real interest rate has been positive, countering the negative trend induced by demographic factors.
    Keywords: capital controls, capital flows, China
    JEL: F21 F41 F42 G28
    Date: 2023
  26. By: Donald Coletti
    Abstract: This paper outlines a strategic plan for the development of the fourth generation of Bank of Canada projection and policy analysis models. The plan features a new Canadian workhorse macroeconomic model as well as a suite of alternative models to better support a risk management approach to monetary policy. This new generation of models seeks to improve our understanding of inflation dynamics, the supply side of the economy and the underlying risks faced by policy-makers coming from uncertainty about how the economy functions. New approaches for dealing with idiosyncratic trends in the data and for leveraging the power of large data sets will be employed.
    Keywords: Economic models; Inflation and prices; Labour markets; Monetary policy and uncertainty
    JEL: C50 C51 C52 C53 C54 C55
    Date: 2023–10
  27. By: Alexandra Sutton-Lalani; Sebastian Hernandez; John Miedema; Jiamin Dai; Badr Omrane
    Abstract: Digitalization—the use of data, digital platforms and advanced analytics—has quickly become widespread in today’s society. This has introduced new opportunities, but it has also created new barriers and exacerbated existing inequities. This is likewise true in the realm of payments, where issues around financial inclusion, digital inclusion and accessibility compound the challenges for users. Our work expands on that of Henry et al. (2023). We base our research on two key premises. First, we apply the social model of disability to the Canadian payments landscape to identify opportunities to remove barriers that marginalize or hinder people. Second, we investigate beyond the standard economic measures and aggregate statistics related to these topics to build a nuanced understanding of the challenges inherent in the current system. Our findings highlight important areas of research and design consideration for new digital payment products and services, specifically for central banks contemplating the introduction of a central bank digital currency. We identify barriers that rural populations, Indigenous communities, Canadians with low incomes and persons with disabilities face in using financial products. We also note a deficiency in the current research and payment offerings for those with cognitive accessibility challenges. With these findings, we aim to build awareness of the inequities and challenges present in the current payments system and motivate existing financial technology providers to move toward offering more-inclusive products and services.
    Keywords: Bank notes; Central bank research; Digital currencies and fintech; Digitalization; Financial services
    JEL: A14 E42 E50 I31 O33 O51
    Date: 2023–10
  28. By: Schuster, Florian
    Abstract: This paper studies the emergence of sovereign bond yield spreads in the Eurozone prior to the financial crisis. While spreads were close to zero in European government debt markets until the mid-2000s, they have persistently widened since then in many member states. We employ a difference-in-differences approach to analyze this phenomenon. We find that the Eurosystem's move from unconditional to conditional collateral eligibility of sovereign bonds, as part of the 2005 Single List reform, was the institutional change triggering the emergence of sovereign spreads in the Euro Area. Conditional eligibility becomes effective predominantly through a periphery premium: higher yields have been demanded from countries whose business cycles deviate most from the average Eurozone cycle. In contrast, spreads did not arise in response to adverse macroeconomic and fiscal fundamentals.
    Date: 2023
  29. By: Kumar Chandrakamal Pramod Kumar (Institute of Economic Studies, Charles University, Prague, Czech Republic)
    Abstract: Digital payments are growing rapidly, and the use of cash seems to be declining, at least in advanced economies in Europe and the U.S. However, the literature on payment systems provides an interesting perspective- cash, or currency, when measured as a percentage of the gross domestic product, has not been falling as clearly as might be intuited. Contrarily, many economies face an increase in currency in circulation rates. This paper discusses this topic in literature and explores the determinants of currency in circulation in a panel of 17 countries between 2001-2022 and whether determinants from prior literature are also significant across a group of heterogeneous countries. Interest rates are found to affect the demand for cash significantly and negatively, while tax revenues have a significantly positive impact. Some measures of financial development are also considered but are found to not have any strong explanatory power. Country fixed effects regression analysis suggests that determining what type of economies may have higher or lower currency in circulation is a complex matter requiring more detailed investigation.
    Keywords: Currency in circulation, Monetary demand, Panel data, Fixed-effects regression, Interest rates, tax revenue
    JEL: E12 E41 E50 E51
    Date: 2023–10

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