nep-cba New Economics Papers
on Central Banking
Issue of 2024‒02‒05
twenty-one papers chosen by
Sergey E. Pekarski, Higher School of Economics

  1. Central Bank Crisis Interventions: A Review of the Recent Literature on Potential Costs By Patrick Aldridge; David Cimon; Rishi Vala
  2. Insurance corporations’ balance sheets, financial stability and monetary policy By Kaufmann, Christoph; Leyva, Jaime; Storz, Manuela
  3. Finding new objectives, seeking new instruments By Cobham, David
  4. Leaning against persistent financial cycles with occasional crises By Yasin Mimir
  5. Distributional Effects of Monetary Policy Shocks on Wage and Hours Worked: Evidence from the Czech Labor Market By Monika Junicke; Jakub Mateju; Haroon Mumtaz; Angeliki Theophilopoulou
  6. Foreign Exchange Interventions in the New-Keynesian Model: Transmission, Policy, and Welfare By Yossi Yakhin
  7. The inverted yield curve in a 3-equation model By Michl, Thomas R.; Davis, Leila
  8. Monetary-fiscal policy interactions when price stability occasionally takes a back seat By Schmidt, Sebastian
  9. Fear (no more) of Floating: Asset Purchases and Exchange Rate Dynamics By Yasin Mimir
  10. The Effects of Communicating Inflation Uncertainty on Household Expectations Metropolitan Areas By Olena Kostyshyna; Luba Petersen
  11. Making It Real: Bringing Research Models into Central Bank Projections By Marc-André Gosselin; Sharon Kozicki
  12. Unintended consequences of QE: Real estate prices and financial stability By Berg, Tobias; Haselmann, Rainer; Kick, Thomas; Schreiber, Sebastian
  13. Monetary Policy and Racial Inequality in Housing Markets: A Study of 140 US Metropolitan Areas By Qi Li; Xu Zhang
  14. Market-Based Estimates of the Natural Real Rate: Evidence from Latin American Bond Markets By Luis Ceballos; Jens H. E. Christensen; Damian Romero
  15. International reserves, currency depreciation and public debt: new evidence of buffer effects in Africa. By Issiaka Coulibaly; Blaise Gnimassoun; Hamza Mighri; Jamel Saadaoui
  16. Global Risk Factors and Their Impacts on Interest Rates and Exchange Rates: Evidence from ASEAN+4 economies By OGAWA Eiji; LUO Pengfei
  17. Supporting the Transition to Net-Zero Emissions: The Evolving Role of Central Banks By Karen McGuinness
  18. Perceived versus Calibrated Income Risks in Heterogeneous-Agent Consumption Models By Tao Wang
  19. Collateral pledgeability and asset manager portfolio choices during redemption waves By Thiago Fauvrelle; Mathias Skrutkowski
  20. Can monetary and fiscal policy account for South Africas economic stagnation By Tumisang Loate; Nicola Viegi
  21. Modelling Risk-Weighted Assets: Looking Beyond Stress Tests By Josef Sveda; Jiri Panos; Vojtech Siuda

  1. By: Patrick Aldridge; David Cimon; Rishi Vala
    Abstract: Central banks may engage in large-scale lending and asset purchases to stabilize financial markets and implement monetary policy during crises. The ability of these actions to restore financial market functioning is well documented; however, they come with costs. We provide a literature review of the costs associated with these central bank actions, without commenting on the net benefits they provide. We find support for the premise that crisis actions may negatively impact market liquidity, distort asset prices, create conflicts between monetary and financial stability objectives and increase rent seeking and unproductive uses of the liquidity provided by the central bank. We discuss measures that may mitigate the negative impacts of crisis actions.
    Keywords: Central bank research; Financial institutions; Financial markets; Financial stability, Lender of last resort
    JEL: E5 E58 G10 G20
    Date: 2023–12
  2. By: Kaufmann, Christoph; Leyva, Jaime; Storz, Manuela
    Abstract: The euro area insurance sector and its relevance for real economy financing have grown significantly over the last two decades. This paper analyses the effects of monetary policy on the size and composition of insurers’ balance sheets, as well as the implications of these effects for financial stability. We find that changes in monetary policy have a significant impact on both sector size and risk-taking. Insurers’ balance sheets grow materially after a monetary loosening, implying an increase of the sector’s financial intermediation capacity and an active transmission of monetary policy through the insurance sector. We also find evidence of portfolio re-balancing consistent with the risk-taking channel of monetary policy. After a monetary loosening, insurers increase credit, liquidity and duration risk-taking in their asset portfolios. Our results suggest that extended periods of low interest rates lead to rising financial stability risks among non-bank financial intermediaries. JEL Classification: E52, G11, G22, G23
    Keywords: monetary policy transmission, non-bank financial intermediation, portfolio re-balancing, risk-taking
    Date: 2024–01
  3. By: Cobham, David
    Abstract: This short paper use the perspective of the assignment problem to examine the evolution of the workings of monetary policy and the Monetary Policy Committee (MPC) of the Bank of England over its first 25 years. It outlines how the Bank, and the MPC, came across additional possible objectives and searched for additional possible instruments. It then argues the need for some recasting of the role of the MPC and the way in which it operates.
    Keywords: assignment problem, monetary policy, inflation targeting, inflation, economic growth
    JEL: E42 E52 E58 F33
    Date: 2024
  4. By: Yasin Mimir
    Abstract: We study conditions under which a leaning against the wind (LAW)-type monetary policy is advisable to address risks to financial stability. We do so within a regime-switching dynamic stochastic general equilibrium (DSGE) model with endogenous crises and persistent financial cycles based on partly backward-looking house price beliefs. Under empirically plausible financial cycles, LAW increases inflation volatility because it amplifies the effects of supply shocks on inflation. It also leads to a lower average inflation, resulting in more frequent episodes of a binding lower bound on interest rates. LAW is advisable only if (i) the central bank puts more weight on output stability or (ii) financial cycles are less persistent than observed.
    Keywords: leaning against the wind, monetary policy, financial cycle, regime-switching DSGE
    JEL: E52 E58 G01
    Date: 2023–04–04
  5. By: Monika Junicke; Jakub Mateju; Haroon Mumtaz; Angeliki Theophilopoulou
    Abstract: We investigate the heterogeneity in the effects of monetary policy shocks on the distribution of wages and hours worked, using unique contract-level data from the Czech labor market and identifying monetary policy shocks using a narrative approach based on market surprises in interest rate futures. The results suggest that low-wage groups are hit more profoundly by monetary policy shocks than high-wage groups, and the effect of restrictive shocks is stronger in the manufacturing sector than in any other. Exploring other dimensions of the data offers insights into the heterogeneity of the the impact of monetary policy on different demographic groups. We show that low-educated and also young workers are more affected by restrictive monetary policy shocks due to their higher shares in low-wage groups.
    Keywords: Heterogeneity, monetary policy, shock identification, wage inequality
    JEL: C32 E24 E52 J31
    Date: 2023–12
  6. By: Yossi Yakhin (Bank of Israel)
    Abstract: The paper introduces foreign exchange interventions (FXIs) to an otherwise standard new-Keynesian small open economy model. The paper studies the transmission mechanism of FXIs, solves for the optimal policy, suggests an implementable policy rule, and evaluates the welfare implications of different policies. Relying on the portfolio balance channel, a purchase of foreign reserves crowds out private holdings of foreign assets, thereby raising the UIP premium and the effective real return domestic agents face. As a result, a purchase of foreign reserves contracts domestic demand. At the same time, it depreciates the value of the domestic currency, which raises the price of foreign goods relative to domestic goods, thereby expanding foreign demand for home exports and contracting domestic imports. The effect on production depends on the wealth effect on labor supply. Optimal FXIs completely insulate the economy from the effect of financial shocks, such as capital flows and risk premium shocks. A policy rule that aims at stabilizing the UIP premium brings the economy close to its optimal allocation, regardless of the source of the shocks. The paper discusses the conditions under which strict targeting of the UIP premium is optimal. Calibrating the model to the Israeli economy, lifetime welfare gains from following optimal FXI policy, relative to maintaining a fixed level of foreign reserves, amount to 2.4% of annual steady state consumption. The results are robust to a variety of microstructures of the financial sector suggested in recent literature.
    Keywords: Foreign Exchange Interventions, UIP Premium, Monetary Policy, Open Economy Macroeconomics
    JEL: E44 E52 E58 F30 F31 F40 F41 G10 G15
    Date: 2024–01
  7. By: Michl, Thomas R. (Department of Economics, Colgate University); Davis, Leila (Department of Economics, University of Massachusetts Boston)
    Abstract: The power of an inverted yield curve to predict recessions is widely discussed in the financial press, yet most undergraduate textbooks provide little discussion of this stylized fact. This paper fills this gap by extending a 3-equation textbook model to include an accessible treatment of a term structure of interest rates formed by the one-period policy rate and a two-period rate that obeys the Fisher Equation. The Phillips curve features partially anchored adaptive expectations, while financial markets and the central bank have perfect foresight. Using this framework, we show that raising the policy rate in response to an inflation shock inverts the yield curve. Whether this inversion foreshadows a recession, however, depends on the bank’s monetary policy rule, which we illustrate using numerical examples. In particular, we show that, with anchoring and an output-gap averse central bank, inflation can stabilize and the yield curve can invert without an ensuing recession.
    JEL: A22 E31 E43 E44 E52
    Date: 2024–01–23
  8. By: Schmidt, Sebastian
    Abstract: What are the macroeconomic consequences of a government that is limited in its willingness or ability to raise primary surpluses, and a central bank that accommodates its interest-rate policy to the fiscal conditions? I address this question in a dynamic stochastic sticky-price model with endogenous shifts between an “orthodox” and a “fiscally-dominant” policy regime. The risk of future regime shifts has encompassing effects on equilibrium. Inflation is systematically higher than it would be if fiscal policy always adjusted its primary surplus sufficiently and monetary policy was solely concerned with price stability. This inflation bias is increasing in the real value of government debt. Regime-switching probabilities are not invariant to policy. The central bank can attenuate the risk of a shift to the fiscally-dominant regime by raising the real interest rate sufficiently moderately when inflation increases. Lower fiscal dominance risk, in turn, mitigates the inflation bias. JEL Classification: E31, E52, E62, E63
    Keywords: endogenous regime shifts, fiscal dominance, fiscal policy, inflation bias, monetary policy
    Date: 2024–01
  9. By: Yasin Mimir
    Abstract: We provide a theory on currency dynamics, capital flows and conditions for emerging market economy central bank asset purchases to leave room for manoeuvre for conventional monetary policy. Local-currency asset purchases ease financial conditions and boost banks’ foreign borrowing capacity. Therefore, they curb the financial amplification of government bond sell-off shocks by mitigating private sector capital outflows and the accompanying exchange rate depreciation. The resulting limited rise in inflation reduces the pro-cyclicality of conventional monetary policy. Our framework sheds light on stable exchange rate dynamics observed after the unprecedented asset purchase announcements in emerging-market economies during the COVID-19 crisis.
    Keywords: Asset purchases, exchange rate, conventional monetary policy
    JEL: E62 E63 G21
    Date: 2023–05–26
  10. By: Olena Kostyshyna; Luba Petersen
    Abstract: This paper examines the value of direct communication to households about inflation and the uncertainty around inflation statistics. All types of information about inflation are effective at immediately managing inflation expectations, with information about outlooks being more effective and more relevant than that about recent inflation and Bank targets. We observe no downside to communicating about inflation with uncertainty on two measures: the level of expected inflation and uncertainty about it. On a third measure—probabilistic inflation expectations—we observe positive effects: they become more centered around the communicated ranges. However, communication with uncertainty weakens the link between expected inflation and spending plans, a key channel in the transmission of monetary policy. Communicating precise inflation outlooks can lengthen the effects of these communications on households.
    Keywords: Central Bank Research; Credibility; Inflation and prices; Inflation targets; Monetary policy and uncertainty; Monetary policy communications
    JEL: C93 D84 E59 E7
    Date: 2023–12
  11. By: Marc-André Gosselin; Sharon Kozicki
    Abstract: This paper aims to bridge the gap between models in research and models used to support policy decisions in central banks. Models used in central bank projection environments overlap with research models and benefit from lessons learned in research, but they differ from research models in important ways. For example, to deal with real-world macroeconomic projection issues, central bank models may have a broader scope. To inform policy decision-making, models generally need both a theoretical basis and an ability to “fit” the data. For repeated projection exercises, forecasters need models that can be adapted to deal with data flows, including historical revisions. And, to provide valuable advice, forecasters must incorporate judgement into their projections to address issues outside the scope of the model. If all these challenges are met, then central bank models and projections will also inform the economic narrative that helps the public understand the policy decisions. In this context, this paper is organized around four main themes: 1) model requirements for central bank purposes; 2) overview of the Bank of Canada’s main policy models—ToTEM and LENS; 3) challenges in meeting those modelling requirements; and 4) practical approaches to addressing some challenges under time constraints. The paper concludes with a description of how lessons learned from research and practice set the stage for the Bank’s future modelling agenda, as discussed in Coletti (2023).
    Keywords: Economic models; Monetary policy
    JEL: C32 C51 E37 E47 E52
    Date: 2023–12
  12. By: Berg, Tobias; Haselmann, Rainer; Kick, Thomas; Schreiber, Sebastian
    Abstract: We investigate how unconventional monetary policy, via central banks' purchases of corporate bonds, unfolds in credit-saturated markets. While this policy results in a loosening of credit market conditions as intended by policymakers, we report two unintended side effects. First, the policy impacts the allocation of credit among industries. Affected banks reallocate loans from investment-grade firms active on bond markets almost entirely to real estate asset managers. Other industries do not obtain more loans, particularly real estate developers and construction firms. We document an increase in real estate prices due to this policy, which fuels real estate overvaluation. Second, more loan write-offs arise from lending to these firms, and banks are not compensated for this risk by higher interest rates. We document a drop in bank profitability and, at the same time, a higher reliance on real estate collateral. Our findings suggest that central banks' quantitative easing has substantial adverse effects in credit-saturated economies.
    Date: 2023
  13. By: Qi Li; Xu Zhang
    Abstract: This paper investigates the differential impact of monetary policy on homeownership and housing returns among Black, Hispanic and White households. Using data on 13 million repeat sales from 1993 to 2020, we construct and analyze race-specific entries and exits of homeownership and housing returns for 140 metropolitan areas in the United States. Our findings reveal significant heterogeneity: for minority households, one unit of monetary tightening leads to a 15% lower housing return and a 31% lower entry into homeownership than White households. This heterogeneity primarily stems from the less favorable labor market responses of minority groups to contractionary monetary policy. These findings emphasize the unintended consequences of monetary policy on racial inequality in the housing market.
    Keywords: Monetary policy; Housing; Central bank research
    JEL: E52 E40 R00
    Date: 2023–12
  14. By: Luis Ceballos; Jens H. E. Christensen; Damian Romero
    Abstract: We provide market-based estimates of the natural real rate, that is, the steady-state short-term real interest rate, for Brazil, Chile, and Mexico. Our approach uses a dynamic term structure finance model estimated directly on the prices of individual inflation indexed bonds with adjustments for bond-specific liquidity and real term premia. First, we find that inflation-indexed bond liquidity premia in all three countries are sizable with significant variation. Second, we find large differences in their estimated equilibrium real rates: Brazil’s is large and volatile, Mexico’s is stable but elevated, while Chile’s is low and has fallen persistently. Although uncertain, our estimates could have important implications for the conduct of monetary policy in these three countries.
    Keywords: affine arbitrage-free models; financial markets; frictions; monetary policy; rstar
    JEL: C32 E43 E52 G12
    Date: 2023–12–21
  15. By: Issiaka Coulibaly; Blaise Gnimassoun; Hamza Mighri; Jamel Saadaoui
    Abstract: The paper adds to the literature on the issue of public debt in African economies, by investigating the role foreign exchange reserves play in improving the level of indebtedness and as buffer of the negative effect of exchange rate depreciation while considering the exchange rate policy. Our results show a direct link between the level of foreign currency reserves and that of external debt in Africa. Particularly, we demonstrate that higher foreign currency reserves tend to decrease the public debt stock to GDP. This effect is even more significant when countries go through high exchange rate depreciation episodes (10% or higher). This impact, however, is not homogenous among country groups, as only countries with a floating exchange regime tend to benefit from this buffer effect compared to anchored regimes. In a time where most African economies face severe exchange rate depreciation episodes following the U.S. monetary tightening policy, central bankers and policy makers need to consider a plethora of policy issues including interventions in the FX market to mitigate depreciations and maintain a sustainable public debt stock.
    Keywords: Exchange Rate, International Reserves, Buffer Effect, Public Debt.
    JEL: F3 F31 F32 F34 H6
    Date: 2023
  16. By: OGAWA Eiji; LUO Pengfei
    Abstract: The international finance trilemma represents the trade-off among exchange rate stability, monetary policy autonomy and free capital flows, resulting in varied reactions to global risk factors among Asian economies. This study explores how various monetary policy objectives shape the diverse responses of Asian interest rates and exchange rates to global risk factors. Using the Structural Vector Autoregressive Model with Exogenous Variables (SVARX), we analyze the impulse responses of short-term interest rates and exchange rates to global risk factors, including the US monetary policy changes, global economic policy and financial risks, and oil prices. The main findings are as follows: first, we found that most of the Asian monetary authorities except Japan mirror the US monetary policy changes, demonstrating that a key policy objective is to stabilize their cross-border capital flows and exchange rates. The magnitude of mirroring depends on countries’ exchange rate regimes. Furthermore, although global economic policy and financial risks trigger the depreciation of most of the Asian exchange rates, their influence on Asian short-term interest rates is relatively smaller, showing the limited influence of global risk appetite on monetary policy objectives. Last, we found the opposite responses of Asian interest rates and exchange rates to oil prices, showing the diverse economic effects of oil prices on oil export and import countries.
    Date: 2024–01
  17. By: Karen McGuinness
    Abstract: While climate change was largely tackled by government policies in the past, central banks are increasingly grappling with the risks climate change poses. They are evaluating their operational policies to reflect these risks and the transition to a net-zero economy. This paper explores the trade-offs and considerations central banks face.
    Keywords: Central bank research; Climate change; Financial markets
    JEL: D53 E58 E63 G32 Q Q54
    Date: 2023–12
  18. By: Tao Wang
    Abstract: Models of microeconomic consumption (including those used in heterogeneous-agent macroeconomic models) typically calibrate the size of income risk to match panel data on household income dynamics. But, for several reasons, what is measured as risk from such data may not correspond to the risk perceived by the agent. This paper instead uses data from the Federal Reserve Bank of New York’s Survey of Consumer Expectations to directly calibrate perceived income risks. One of several examples of the implications of heterogeneity in perceived income risks is increased wealth inequality stemming from differential precautionary saving motives. I also explore the implications of the fact that the perceived risk is lower than the calibrated level of risk either because of unobserved heterogeneity by researchers or because of overconfidence by the agents.
    Keywords: Monetary policy; Monetary Policy and Uncertainty; Business Fluctuations and Cycles
    JEL: D14 E21 E71 G51
    Date: 2023–12
  19. By: Thiago Fauvrelle; Mathias Skrutkowski
    Abstract: This paper studies whether Eurosystem collateral eligibility played a role in the portfolio choices of euro area asset managers during the “dash-for-cash” episode of 2020. We find that asset managers reduced their allocation to ECB-eligible corporate bonds, selling them in order to finance redemptions, while simultaneously increasing their cash holdings. These findings add nuance to previous studies of liquidity strains and price dislocations in the corporate bond market during the onset of the Covid-19 pandemic, indicating a greater willingness of dealers to increase their inventories of corporate bonds pledgeable with the ECB. Analysing the price impact of these portfolio choices, we also find evidence pointing to price pressure for both ECB-eligible and ineligible corporate bonds. Bonds that were held to a larger extent by investment funds in our sample experienced higher price pressure, although the impact was lower for ECB-eligible bonds. We also discuss broader implications for the related policy debate about how central banks could mitigate similar types of liquidity shocks.
    Keywords: Investment funds, dash-for-cash, corporate bonds, Eurosystem collateral eligibility
    JEL: G11 G23
    Date: 2023–12–12
  20. By: Tumisang Loate; Nicola Viegi
    Abstract: This paper examines the interaction between macroeconomic variables and the fiscal and monetary policy mix between 2012 and 2019, a period characterised by increases in public debt and the sovereign risk premium, and low economic growth. Using a large Bayesian vector autoregression, we find that monetary and fiscal policy fail to account for the observed lower real gross domestic product between 2012 and 2019. Based on the historical relationship between monetary and fiscal policy in South Africa, the results indicate that we should have observed much higher growth, especially during the 20152019 period. In addition, we find little evidence that low growth during the period can be explained by the much-criticised anti-growth monetary policy.
    Date: 2024–01–19
  21. By: Josef Sveda; Jiri Panos; Vojtech Siuda
    Abstract: We propose an improved methodology for modelling potential scenario paths of banks' risk-weighted assets, which drive the denominator of capital adequacy ratios. Our approach centres on modelling the internal risk structure of bank portfolios and thus aims to provide more accurate estimations than the common portfolio level approaches used in top-down stress testing frameworks. This should reduce the likelihood of significant misestimation of risk-weighted assets, which can lead to unjustifiably high or low solvency measures and induce false perceptions about banks' financial health. The proposed methodology is easy to replicate and suitable for various applications, including stress testing and calibration of macroprudential tools. After the methodology is introduced, we show how our proposed approach compares favourably to the methods typically used. Subsequently, we use our approach to estimate the potential increase in risk weights due to a cyclical deterioration in credit parameters and the corresponding setup of the countercyclical capital buffer for the Czech banking sector. Finally, an illustrative, hands-on example is provided in the Appendix.
    Keywords: Countercyclical capital buffer, credit portfolio structure, risk weighted exposure, stress-testing
    JEL: E58 G21 G28 G29
    Date: 2023–12

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