nep-cba New Economics Papers
on Central Banking
Issue of 2023‒11‒13
twenty-two papers chosen by
Sergey E. Pekarski, Higher School of Economics

  1. Empirical Analysis of the Impact of Legal Tender Digital Currency on Monetary Policy -Based on China's Data By Ruimin Song; TIntian Zhao; Chunhui Zhou
  2. Central Bank Communication with the General Public By Dräger, Lena
  3. Mr Putin and the chronicle of a normalisation foretold By Chadha, Jagjit S.
  4. On the Negatives of Negative Interest Rates By Aleksander Berentsen; Romina Ruprecht; Hugo van Buggenum
  5. Consumers’ Macroeconomic Expectations By Dräger, Lena; Lamla, Michael J.
  6. Flexible Inflation Targeting and Macroeconomic Performance: Evidence from ASEAN By Nuwat Nookhwun; Rawipha Waiyawatjakorn
  7. Evaluating Policy Institutions -150 Years of US Monetary Policy- By Régis Barnichon; Geert Mesters
  8. Application of Artificial Intelligence for Monetary Policy-Making By Mariam Dundua; Otar Gorgodze
  9. Climate Risk, Bank Lending and Monetary Policy By Carlo Altavilla; Marco Pagano; Miguel Boucinha; Andrea Polo
  10. A journal ranking based on central bank citations By Raphael Auer; Giulio Cornelli; Christian Zimmermann
  11. Who takes the cake? The heterogeneous effect of ECB accommodative monetary policy across income classes By Natalia Martín Fuentes; Elena Bárcena Martín; Salvador Pérez Moreno
  12. Firm Balance Sheet Liquidity, Monetary Policy Shocks, and Investment Dynamics By Priit Jeenas
  13. CIP deviations: The role of U.S. banks’ liquidity and regulations By Bazán, Walter; Ortiz, Marco; Terrones, Marco; Winkelried, Diego
  14. The liquidity state-dependence of monetary policy transmission By Guimaraes, Rodrigo; Pinter, Gabor; Wijnandts, Jean-Charles
  15. An evaluation of the Bank of England’s ILTR operations: comparing the product-mix auction to alternatives By Giese, Julia; Grace, Charlotte
  16. Leverage Ratio, Risk-Based Capital Requirements, and Risk-taking in the UK By Mahmoud Fatouh; Simone Giansante; Steven Ongena
  17. Identification and Inference under Narrative Restrictions By Raffaella Giacomini; Toru Kitagawa; Matthew Read
  18. Quantitative Easing in the Euro Area: Implications for Income and Wealth Inequality By Dusan Stojanovic
  19. Ring-fencing in financial networks By Bardoscia, Marco; Ka-Kay Pang, Raymond
  20. The Chicago Fed DSGE Model: Version 2 By Jeffrey R. Campbell; Filippo Ferroni; Jonas D. M. Fisher; Leonardo Melosi
  21. A new economic and financial theory of money By Michael E. Glinsky; Sharon Sievert
  22. Machine learning for economics research: when, what and how By Ajit Desai

  1. By: Ruimin Song; TIntian Zhao; Chunhui Zhou
    Abstract: This paper takes the development of China's Central bank digital currencies as a perspective, theoretically analyses the impact mechanism of the issuance and circulation of Central bank digital currencies on China's monetary policy and various variables of the money multiplier; at the same time, it selects the quarterly data from 2010 to 2022, and examines the impact of the Central bank digital currencies on the money supply multiplier through the establishment of the VECM model. The research results show that: the issuance of China's Central bank digital currencies will have an impact on the effectiveness of monetary policy and intermediary indicators; and have a certain positive impact on the narrow money multiplier and broad money multiplier. Based on theoretical analyses and empirical tests, this paper proposes that China should explore a more effective monetary policy in the context of Central bank digital currencies in the future on the premise of steadily promoting the development of Central bank digital currencies.
    Date: 2023–10
  2. By: Dräger, Lena
    Abstract: This paper surveys the literature on the role and effects of central bank communication with the general public, particularly regarding the formation of macroeconomic expectations. It starts by giving a brief overview of the recent “communication revolution†in central bank communication. The challenges for central bank communication with the public are outlined by surveying the evidence about low average knowledge on inflation and monetary policy in the population. Next, I evaluate the effects of direct communication, distinguishing between challenges to getting the attention of the public and effects of information on the public’s inflation expectations once attention is gained. Finally, I review the role of the media as transmitter of central bank communication to the public.
    Keywords: Central bank communication, consumers, households, literature survey, RCT studies.
    JEL: E52 E58 D84
    Date: 2023–10
  3. By: Chadha, Jagjit S.
    Abstract: Major central banks have been caught in a low interest rate trap for over a decade. The temporary response to the financial crisis of 2008-9 has become something of a regime. The Federal Reserve, for example, attempted to ease quantitative easing in 2013 but this stalled following the “taper tantrum” and commenced a normalisation in the Federal Funds rate from 2015 but during Covid major central banks around the world rapidly returned policy rates to around zero. Low policy rates have been the response to tighter credit conditions, excessive global savings, low levels of investment and fiscal consolidation. But they have also played a role in propelling asset price growth and increasing levels of indebtedness. The accommodative stance in monetary policy, as well as the impetus from previous monetary and fiscal interventions seem like to have stoked inflation to a higher level that might otherwise have been the case following the shock of a war on the European continent. But may also have finally secured a normalisation in policy rates.
    Keywords: monetary policy; Ukraine war; normalisation; liquidity trap
    JEL: E43 E58 E61
    Date: 2023–09–08
  4. By: Aleksander Berentsen; Romina Ruprecht; Hugo van Buggenum
    Abstract: Major central banks remunerate reserves at negative rates (NIR). To study thelong-run effects of NIR, we focus on the role of reserves as intertemporal stores of value that are used to settle interbank liabilities. We construct a dynamic general equilibrium model with commercial banks holding reserves and funding investments with retail deposits. In the long run, NIR distorts investment decisions, lowers welfare, depresses output, and reduces bank profitability. The type of distortion depends on the transmission of NIR to retail deposits. The availability of cash explains the asymmetric effects of policy-rate changes in negative vs positive territory.
    Keywords: Monetary policy; Interest rates; Money market; Negative interest rate
    JEL: E40 E42 E43 E50 E58
    Date: 2023–09–29
  5. By: Dräger, Lena; Lamla, Michael J.
    Abstract: After the financial crisis of 2008, central banks around the world have increased their communication efforts to reach consumers, with the aim of both guiding and anchoring their inflation expectations. For the expectations channel of monetary policy to work as intended, central banks need a thorough understanding of the formation process of expectations by the general public and of the relationship between expectations and economic choices. This warrants reliable and detailed data on consumers’ expectations of macroeconomic variables such as inflation or interest rates. We thus survey the available survey data and issues regarding the measurement of macroeconomic expectations. Furthermore, we discuss the research frontier on important aspects of the expectations channel: We evaluate the evidence on whether expectations are formed consistently with standard macroeconomic relationships, discuss the insights with respect to the anchoring of inflation expectations, explore the role of narratives and preferences and lastly, we survey the research on causal effects of central bank communication on expectations and economic choices.
    Keywords: Consumers’ macroeconomic expectations, central bank communication, survey data
    JEL: E52 E30 D84 C83
    Date: 2023–10
  6. By: Nuwat Nookhwun; Rawipha Waiyawatjakorn
    Abstract: The experience of flexible inflation targeting in ASEAN-5 has been favorable. This paper shows improvements in macroeconomic outcomes consistent with the framework’s mandated objectives: lower levels and volatility of inflation, more stable economic growth and a well-functioned financial system. ASEAN-5 economies can cope well with a se- quence of past shocks and crises, although the marginal contribution of the inflation targeting framework itself is still not clear-cut. Over the past 20 years, policy frameworks of ASEAN-5, similar to other emerging market economies, have continuously evolved to incorporate various policy tools, which include foreign exchange intervention, macropru- dential policy and capital flow measures. This reflects challenges emanated from capital flow volatility and domestic financial imbalances. A multitude of policy tools are ar- guably one of the key factors contributing to the sound macroeconomic outcome during the post-targeting periods.
    Keywords: flexible inflation targeting; monetary policy; ASEAN; financial stability; integrated policy
    JEL: E52 E58 D78
    Date: 2023–10
  7. By: Régis Barnichon; Geert Mesters
    Abstract: How should we evaluate and compare the performances of policy institutions? We propose to evaluate institutions based on their reaction function, i.e., on how well they reacted to the different shocks that hit the economy. We show that reaction function evaluation is possible with only two sufficient statistics (i) the impulse responses of the policy objectives to non-policy shocks, which capture what an institution did on average to counteract these shocks, and (ii) the impulse responses of the policy objectives to policy shocks, which capture what an institution could have done to counteract the shocks. A regression of (i) on (ii) —a regression in impulse response space— allows to compute the distance to the optimal reaction function, and thereby evaluate and rank institutions. We use our methodology to evaluate US monetary policy; from the Gold standard period, the early Fed years and the Great Depression, to the post World War II period, and the post-Volcker regime. We find no material improvement in the reaction function over the first 100 years, and it is only in the last 30 years that we estimate large and uniform improvements in the conduct of monetary policy.
    Keywords: optimal policy, reaction function, structural shocks, impulse responses, monetary history
    JEL: C14 C32 E32 E52 N10
    Date: 2023–10
  8. By: Mariam Dundua (Financial and Supervisory Technology Development Department, National Bank of Georgia); Otar Gorgodze (Head of Financial and Supervisory Technologies Department, National Bank of Georgia)
    Abstract: The recent advances in Artificial Intelligence (AI), in particular, the development of reinforcement learning (RL) methods, are specifically suited for application to complex economic problems. We formulate a new approach looking for optimal monetary policy rules using RL. Analysis of AI generated monetary policy rules indicates that optimal policy rules exhibit significant nonlinearities. This could explain why simple monetary rules based on traditional linear modeling toolkits lack the robustness needed for practical application. The generated transition equations analysis allows us to estimate the neutral policy rate, which came out to be 6.5 percent. We discuss the potential combination of the method with state-of-the-art FinTech developments in digital finance like DeFi and CBDC and the feasibility of MonetaryTech approach to monetary policy.
    Keywords: Artificial Intelligence; Reinforcement Learning; Monetary policy
    JEL: C60 C61 C63 E17 C45 E52
    Date: 2022–11
  9. By: Carlo Altavilla (European Central Bank, CSEF and CEPR.); Marco Pagano (University of Naples Federico II, CSEF, EIEF, and CEPR.); Miguel Boucinha (European Central Bank); Andrea Polo (Luiss University, EIEF, CEPR and ECGI.)
    Abstract: Combining euro-area credit register and carbon emission data, we provide evidence of a climate risk-taking channel in banks’ lending policies. Banks charge higher interest rates to firms featuring greater carbon emissions, and lower rates to firms committing to lower emissions, controlling for their probability of default. Both effects are larger for banks committed to decarbonization. Consistently with the risk-taking channel of monetary policy, tighter policy induces banks to increase both credit risk premia and carbon emission premia, and reduce lending to high emission firms more than to low emission ones. While restrictive monetary policy increases the cost of credit and reduces lending to all firms, its contractionary effect is milder for firms with low emissions and those that commit to decarbonization.
    Keywords: climate risk, carbon emissions, interest rate, lending, monetary policy.
    JEL: E52 G21 Q52 Q53 Q54 Q58
    Date: 2023–10–18
  10. By: Raphael Auer; Giulio Cornelli; Christian Zimmermann
    Abstract: We present a ranking of journals geared toward measuring the policy relevance of research. We compute simple impact factors that count only citations made in central bank publications, such as their working paper series. Whereas this ranking confirms the policy relevance of the major general interest journals in the field of economics, the major finance journals fare less favourably. Journals specialising in monetary economics, international economics and financial intermediation feature highly, but surprisingly not those specialising in econometrics. The ranking is topped by the Brookings Papers on Economic Activity, followed by the Quarterly Journal of Economics and the Journal of Monetary Economics, the American Economic Journal: Macroeconomics, and the Journal of Political Economy.
    Keywords: central banks; citations; academic journals; ranking
    JEL: A11 E50 E58
    Date: 2023–10
  11. By: Natalia Martín Fuentes (University of Málaga); Elena Bárcena Martín (University of Málaga); Salvador Pérez Moreno (University of Málaga)
    Abstract: This work provides evidence on the heterogeneous effects of ECB’s monetary policy across income classes in the euro area. In particular, this investigation focuses on the macroeconomic channel and analyses how expansionary monetary policy affects income inequality through the labour market, that is, by stimulating economic activity which ultimately affects income classes differently. Based on European Union Statistics on Income and Living Conditions (EU-SILC) data, we compute specific labour market metrics for each income class (lower, lower-middle, upper-middle, and upper) for the countries that originated the Economic and Monetary Union (EMU-11). Covering the period between 2006Q1 and 2019Q4, we estimate a series of country-specific structural Vector Autoregressive (SVAR) models to analyse the impact of an unexpected decline in the euro area shadow rate. As a robustness check, we estimate local projections models using exogenous monetary policy surprises. The results suggest that past monetary easing shocks helped decrease unemployment rates for lower- and middle-income class households, to a larger extent for the former. This differential impact across income classes is accounted for a substantially stronger improvement in job finding rates for those located at the bottom of the income distribution. In contrast, job separation rates have been homogeneously affected across the distribution. Conversely, the employment status of those located at the rightmost side of the income distribution seems to have been less elastic to monetary policy shocks. The analysis identifies a positive impact of expansionary monetary policy on real labour income. Overall, our results suggest that expansionary monetary policy has helped decrease labour income inequality.
    Keywords: Monetary policy, income inequality, income class, structural vector autoregressions (SVARs), local projections, euro area.
    JEL: C11 D31 E52
  12. By: Priit Jeenas
    Abstract: I study the role of firms' balance sheet liquidity in the transmission of monetary policy to investment. In response to monetary contractions, U.S. firms with fewer liquid asset holdings reduce investment relatively more. This can be explained by their higher likelihood to issue debt and the implied exposure to borrowing cost fluctuations. I rationalize these results using a heterogeneous firm macroeconomic model with financial constraints, debt issuance costs, and differential returns on cash and borrowing. Compared to a framework which ignores liquidity considerations, monetary transmission to aggregate investment is slightly dampened and depends on liquid asset portfolios beyond net worth.
    Keywords: monetary policy, investment, financial frictions, firm heterogeneity
    Date: 2023–10
  13. By: Bazán, Walter; Ortiz, Marco; Terrones, Marco; Winkelried, Diego
    Abstract: This paper inquires how private bank regulation and liquidity in the US are related to the deviations from the covered interest parity (CIP) condition. We find evidence that bank liquidity effects on CIP deviations partially offset those resulting from regulatory changes in a sample of 11 OECD countries over the 2001-2019 period. This finding supports an old conjecture that changes in private banks' liquidity and regulation could significantly affect the wedge between liquid US dollars and illiquid foreign exchange forward contracts in international financial markets. Interestingly, the effects of liquidity on CIP deviations become more important when the impact of bank regulation intensifies, reflecting the presence of interaction effects.
    Keywords: Cross-currency bases; covered interest rate parity; bank regulation; liquidity
    JEL: E44 F31 G14 G15 O24
    Date: 2023–09–15
  14. By: Guimaraes, Rodrigo (Bank of England); Pinter, Gabor (Bank of England); Wijnandts, Jean-Charles (Bank of England)
    Abstract: The large reactions of long-term government bond yields to monetary policy shocks occur during periods of higher market liquidity, and there is very little reaction during periods of lower liquidity. This newly documented liquidity state-dependence persistently affects real yields, term premia as well as long-term mortgage rates. Balance sheet constraints on both hedge funds and dealers contribute to the liquidity state-dependence. Conditioning on market liquidity yields stronger state-dependence than simply conditioning on macroeconomic indicators. Our results underscore the importance of market functioning, and the financial health of key intermediaries that support it, for implementing stabilisation policies.
    Keywords: Monetary Policy Shocks; Market Liquidity; Real Term Premium; Intermediary Asset Pricing.
    JEL: E40 E50 G12 G23
    Date: 2023–10–19
  15. By: Giese, Julia (Bank of England); Grace, Charlotte (Nuffield College, University of Oxford)
    Abstract: We compare the product-mix auction (PMA) – the mechanism used by the Bank of England (BoE) for its Indexed Long-Term Repo (ILTR) operations – to simpler alternative auction designs, namely a pair of separate simultaneous auctions, and a ‘reference price auction’. Using data from the auctions held in June 2010 to January 2014, we find that the PMA increased welfare (defined by the difference between the spreads that financial institutions were willing to pay and the spreads that the BoE was willing to accept) by approximately 50%, or 2 basis points per loan, relative to these alternatives. We would expect larger welfare gains in a less stable period than the period studied, and simulations confirm this. Broader benefits of the auctions of reducing systemic risk, while mitigating moral hazard, informing the BoE about stress in the market, and communicating the ‘correct’ price to the market, are taken into account in our approach, to the extent that the BoE’s supply curve internalises some of these externalities. We also find that the PMA always gave the BoE more (or occasionally the same) surplus and revenue relative to if one of the alternative designs had been used. However, the effect of the PMA on aggregate bidder surplus was ambiguous. The latter result may be a property of the period studied, and of the fact that there were only two sets of eligible collateral in this period.
    Keywords: Product mix auction; auction design; central bank liquidity provision
    JEL: D44 E58
    Date: 2023–10–19
  16. By: Mahmoud Fatouh (Bank of England and University of Essex); Simone Giansante (University of Palermo); Steven Ongena (University of Zurich; Swiss Finance Institute; KU Leuven; NTNU Business School; CEPR)
    Abstract: We assess the impact of the leverage ratio capital requirements on the risk-taking behaviour of banks both theoretically and empirically. We use a difference-in-differences (DiD) setup to compare the behaviour of UK banks subject to the leverage ratio requirements (LR banks) to otherwise similar banks (non-LR banks). Conceptually, introducing binding leverage ratio requirements into a regulatory framework with risk-based capital requirements induces banks to re-optimise, shifting from safer to riskier assets (higher asset risk). Yet, this shift would not be one-for-one due to risk weight differences, meaning the shift would be associated with a lower level of leverage (lower insolvency-risk). The interaction of these two changes determines the impact on the aggregate level of risk. Empirically, we show that LR banks did not increase asset risk, and slightly reduced leverage levels, compared to the control group after the introduction of leverage ratio in the UK. As expected, these two changes lead to a lower aggregate level of risk. Our results show that credit default swap spreads on the 5-year subordinated debt of LR banks fell relative to non-LR banks post leverage ratio introduction.
    Keywords: Capital regulation; Risk-taking; Leverage ratio; risk-based requirements
    JEL: G01 G21 G28
    Date: 2023–10
  17. By: Raffaella Giacomini (University College London); Toru Kitagawa (Brown University); Matthew Read (Reserve Bank of Australia)
    Abstract: We consider structural vector autoregressions subject to narrative restrictions, which are inequalities involving structural shocks in specific time periods (e.g. shock signs in given quarters). Narrative restrictions are used widely in the empirical literature. However, under these restrictions, there are no formal results on identification or the properties of frequentist approaches to inference, and existing Bayesian methods can be sensitive to prior choice. We provide formal results on identification, propose a computationally tractable robust Bayesian method that eliminates prior sensitivity, and show that it is asymptotically valid from a frequentist perspective. Using our method, we find that inferences about the output effects of US monetary policy obtained under restrictions related to the Volker episode are sensitive to prior choice. Under a richer set of restrictions, there is robust evidence that output falls following a positive monetary policy shock.
    Keywords: frequentist coverage; global identification; identified set; robustness
    JEL: C32 E52
    Date: 2023–10
  18. By: Dusan Stojanovic
    Abstract: This study examines how and to what extent quantitative easing of the ECB affects household income and wealth inequality in the euro area. Previous theoretical models have investigated the dynamics of inequality measures through differential access of households to financial/capital market (the portfolio rebalancing channel), neglecting the labor market differential (the earnings heterogeneity channel). Although the portfolio rebalancing channel may provide insight into wealth inequality and non-labor income inequality, this is not the case with labor (and thus total) income inequality. To be in line with the empirical evidence on labor income inequality, this study also considers segmented labor market on the basis of capital-skill complementarity in production and asymmetric real wage rigidities. When only financial market segmentation is considered, the quantitative results indicate a drop in total income inequality that is diminished over time, while wealth inequality experiences a rise that gradually becomes weaker. The introduction of the segmented labor market significantly mitigates the observed drop in total income inequality, while a rise in wealth inequality is largely amplified. Given the possible broadening of the ECB’s mandate towards distributional issues in the future, the analysis of segmented labor and financial markets can be more beneficial to the ECB as it provides a clearer picture of the inequality effects.
    Keywords: quantitative easing, capital-skill complementarity, asymmetric real wage rigidity, skill premium, portfolio rebalancing channel, earnings heterogeneity channel
    JEL: E21 E22 E44 E52 E58
    Date: 2023–08
  19. By: Bardoscia, Marco (Bank of England); Ka-Kay Pang, Raymond (London School of Economics and Political Sciences)
    Abstract: Ring-fencing is a reform of the UK banking system that requires large banks to separate their retail services from other activities of the group, such as investment banking. We consider a network of bilateral exposures between banks in which financial contagion can spread because banks incorporate the creditworthiness of their counterparties into the valuation of their assets. Ring-fencing acts as an exogenous shock that impacts the creditworthiness of banks through leverage, depending on how assets are allocated between ring-fenced and non-ring-fenced entities. We find conditions on this allocation that leads to safer ring-fenced entities and less safe non-ring-fenced entities when compared with their groups prior to the implementation of ring-fencing. We also show that ring-fencing can make both the equity of individual banking groups and the aggregate equity of the banking system decrease. When this happens, ring-fenced entities are safer than their groups prior to ring-fencing.
    Keywords: Ring-fencing; financial networks; systemic risk
    JEL: G21 G28
    Date: 2023–10–19
  20. By: Jeffrey R. Campbell; Filippo Ferroni; Jonas D. M. Fisher; Leonardo Melosi
    Abstract: The Chicago Fed dynamic stochastic general equilibrium (DSGE) model is used for policy analysis and forecasting at the Federal Reserve Bank of Chicago. This guide describes its specification, estimation, dynamic characteristics, and how it is used to forecast the U.S. economy. In many respects the model resembles other medium-scale New Keynesian frameworks, but there are several features which distinguish it: the monetary policy rule includes anticipated future deviations, productivity is driven by both neutral and investment specific technical change, multiple price and wage indices identify price and wage inflation, the data are measured in a model consistent way, and market-expected interest rates are used to measure the expected path of the federal funds rate that is taken into account by the model’s agents when they make their decisions. The model also incorporates a new method introduced by Ferroni, Fisher, and Melosi (2023) to address the unusual Covid pandemic macroeconomic dynamics.
    Keywords: New Keynesian model; DSGE models; covid-19; Pandemic; Survey of Professional Forecasters; Business cycles; Forecasting; Policy analysis
    JEL: E1 E2 E3 E4 E5
    Date: 2023–09–26
  21. By: Michael E. Glinsky; Sharon Sievert
    Abstract: This paper fundamentally reformulates economic and financial theory to include electronic currencies. The valuation of the electronic currencies will be based on macroeconomic theory and the fundamental equation of monetary policy, not the microeconomic theory of discounted cash flows. The view of electronic currency as a transactional equity associated with tangible assets of a sub-economy will be developed, in contrast to the view of stock as an equity associated mostly with intangible assets of a sub-economy. The view will be developed of the electronic currency management firm as an entity responsible for coordinated monetary (electronic currency supply and value stabilization) and fiscal (investment and operational) policies of a substantial (for liquidity of the electronic currency) sub-economy. The risk model used in the valuations and the decision-making will not be the ubiquitous, yet inappropriate, exponential risk model that leads to discount rates, but will be multi time scale models that capture the true risk. The decision-making will be approached from the perspective of true systems control based on a system response function given by the multi scale risk model and system controllers that utilize the Deep Reinforcement Learning, Generative Pretrained Transformers, and other methods of Artificial Intelligence (DRL/GPT/AI). Finally, the sub-economy will be viewed as a nonlinear complex physical system with both stable equilibriums that are associated with short-term exploitation, and unstable equilibriums that need to be stabilized with active nonlinear control based on the multi scale system response functions and DRL/GPT/AI.
    Date: 2023–10
  22. By: Ajit Desai
    Abstract: This article reviews selected papers that use machine learning for economics research and policy analysis. Our review highlights when machine learning is used in economics, the commonly preferred models and how those models are used.
    Keywords: Central bank research; Econometric and statistical methods; Economic models
    JEL: A1 A10 B2 B23 C4 C45 C5 C55
    Date: 2023–10

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