nep-cba New Economics Papers
on Central Banking
Issue of 2024‒03‒11
sixteen papers chosen by
Sergey E. Pekarski, Higher School of Economics

  1. The lending implications of banks holding excess capital By Neryvia Pillay; Konstantin Makrelov
  2. Optimal Monetary Policy, Tariff Shocks and Exporter Dynamics By Masashige Hamano; Francesco Pappadà; Maria Teresa Punzi
  3. The Role of International Financial Integration in Monetary Policy Transmission By Jing Cynthia Wu; Yinxi Xie; Ji Zhang
  4. Artificial intelligence in central banking: benefits and risks of AI for central banks By Ozili, Peterson K
  5. Smooth Regulatory Intervention By Schilling, Linda
  6. Uncertainty and the Federal Reserve’s Balance Sheet Monetary Policy. By Valentina Colombo; Alessia Paccagnini
  7. The Housing Supply Channel of Monetary Policy By Bruno Albuquerque; Martin Iseringhausen; Frederic Opitz
  8. The transmission of bank liquidity shocks: Evidence from the Eurosystem collateral framework By Hüttl, Pia; Kaldorf, Matthias
  9. Managing the transition to central bank digital currency By Assenmacher, Katrin; Ferrari Minesso, Massimo; Mehl, Arnaud; Pagliari, Maria Sole
  10. The post-pandemic inflation debate: a critical review By Diogo Martins
  11. Decomposing systemic risk measures by bank business model in Luxembourg By Xisong Jin
  12. U.S. Inflation Expectations During the Pandemic By Euihyun Bae; Andrew Hodge; Miss Anke Weber
  13. The Federal Reserve’s responses to the post-Covid period of high inflation By Jane E. Ihrig; Christopher J. Waller
  14. Repo, Sponsored Repo and Macro-prudential Regulation By Miguel Fernandes; Mario Pascoa
  15. Insurers’ M&A in the United States during the 1990-2022 period: Is the Fed monetary policy a causal factor By Dionne, Georges; Fenou, Akouété; Mnasri, Mohamed
  16. The Italian Banking System During the 1907 Financial Crisis and the Role of the Bank of Italy By Francesco Vercelli

  1. By: Neryvia Pillay; Konstantin Makrelov
    Abstract: Banks hold capital above microprudential and macroprudential regulatory requirements for a variety of reasons, including as a risk mitigation measure. In this study, we assess how decisions around the size of excess capital as well as monetary and financial stability actions impact sectoral lending in South Africa. Using a unique set of micro data for the South African banking sector for the period 2008 to 2020, provided by South Africas Prudential Authority, our analysis controls for bank characteristics such as bank size, profitability and liquidity. Our results suggest that banks decisions around holding additional capital affect their lending. As expected, monetary policy actions have a strong impact on bank lending and so do regulatory changes to bank capital requirements. These impacts tend to be smaller for larger banks, in line with results published in the global literature. Our results highlight the difficulties of thinking about policy in a Tinbergen rule type of world. Fiscal, microprudential, macroprudential and monetary policy actions can affect price and financial stability goals through their impact on credit extension. When policies work at cross purposes, they can easily undermine each others goals.
    Date: 2024–01–16
  2. By: Masashige Hamano (Waseda University); Francesco Pappadà (Ca’ Foscari University of Venice and Paris School of Economics); Maria Teresa Punzi (Sim Kee Boon Institute, Singapore Management University)
    Abstract: In this paper, we explore the response of optimal monetary policy to uncoordinated trade policies (foreign tariff shocks). We first provide a simple model of open economy with heterogeneous firms and derive a closed-form solution for the optimal monetary policy response to tariff shocks in presence of nominal rigidities. We show that optimal monetary policy is expansionary following foreign tariff hikes. Under nominal rigidities, uncertainty about foreign tariff hikes induces sluggish adjustments in the labor market reallocation between exporters and domestic firms, leading to an incentive for monetary authority to intervene and mitigate the impact of tariff shocks. In an extended model, we then show the response of our economy to a tariff shock under the Ramsey monetary policy, a Taylor Rule and a fixed exchange rate regime. Finally, we provide empirical evidence for the response of domestic monetary policy to foreign tariff shocks using data on Global Antidumping from the US.
    Keywords: Optimal Monetary Policy; Tariff Shocks; Exporter Dynamics
    JEL: E3 E6 Q54 R1
    Date: 2023–12
  3. By: Jing Cynthia Wu; Yinxi Xie; Ji Zhang
    Abstract: Motivated by empirical evidence, we propose an open-economy New Keynesian model with financial integration that allows financial intermediaries to hold foreign long-term bonds. We find financial integration features an amplification for a domestic monetary policy shock and a negative spillover for a foreign shock. These results hold for conventional and unconventional monetary policies. Among various aspects of financial integration, the bond duration plays a major role, and our results cannot be replicated by a standard model of perfect risk sharing between households. Finally, we observe an important interaction between financial integration and trade openness, and demonstrate trade alone does not have an economically meaningful impact on monetary policy transmission.
    JEL: E40 E5 F30
    Date: 2024–02
  4. By: Ozili, Peterson K
    Abstract: Artificial intelligence (AI) is a topic of interest in the finance literature. However, its role and implications for central banks have not received much attention in the literature. Using discourse analysis method, this article identifies the benefits and risks of artificial intelligence in central banking. The benefits of artificial intelligence for central banks are that deploying artificial intelligence systems will encourage central banks to develop information technology (IT) and data science capabilities, it will assist central banks in detecting financial stability risks, it will aid the search for granular micro economic/non-economic data from the internet so that the data can support central banks in making policy decisions, it enables the use of AI-generated synthetic data, and it enables task automation in central banking operations. However, the use of artificial intelligence in central banking poses some risks which include data privacy risk, the risk that using synthetic data could lead to false positives, high risk of embedded bias, difficulty of central banks to explain AI-based policy decisions, and cybersecurity risk. The article also offers some considerations for responsible use of artificial intelligence in central banking.
    Keywords: central bank, artificial intelligence, financial stability, responsible AI, artificial intelligence model.
    JEL: E51 E52 E58
    Date: 2024
  5. By: Schilling, Linda
    Abstract: Policy makers have developed different forms of policy intervention for stopping, or preventing runs on financial firms. This paper provides a general framework to characterize the types of policy intervention that indeed lower the run-propensity of investors versus those that cause adverse investor behavior, which increases the run-propensity. I employ a general global game to analyze and compare a large set of regulatory policies. I show that common policies such as Emergency Liquidity Assistance, and redemption (withdrawal) fees either exhibit features that lower firm stability ex ante, or have offsetting features rendering the policy ineffective.
    Keywords: financial regulation, bank runs, global games, policy effectiveness, bank resolution, withdrawal fees, emergency liquidity assistance, lender of last resort policies, money market mutual fund gates, suspension of convertibility
    JEL: D81 D82 G21 G28 G33 G38
    Date: 2024–02–03
  6. By: Valentina Colombo (Università Cattolica del Sacro Cuore; Dipartimento di Economia e Finanza, Università Cattolica del Sacro Cuore); Alessia Paccagnini
    Abstract: This study assesses the impact of financial uncertainty shocks in the US and explores the influence of monetary policy. Using a nonlinear Vector Autoregressive model, incorporating short-term interest rates and the Federal Reserve’s balance sheet policy, we find that the reaction of the monetary policy is asymmetric across the business cycle. The state-dependent responses in consumption and investment significantly influence GDP fluctuations. A counterfactual analysis reveals that balance sheet-related monetary policy helps reduce both the duration and severity of the recessionary impacts caused by these shocks.
    Keywords: Uncertainty, Smooth Transition VAR, Nonlinearities, Monetary Policy.
    JEL: C50 E32 E52
    Date: 2024–02
  7. By: Bruno Albuquerque; Martin Iseringhausen; Frederic Opitz
    Abstract: We study the role of regional housing markets in the transmission of US monetary policy. Using a FAVAR model over 1999q1–2019q4, we find sizeable heterogeneity in the responses of US states to a contractionary monetary policy shock. Part of this regional variation is due to differences in housing supply elasticities, household debt overhang, and housing wealth (volatility). Our analysis indicates that house prices and consumption respond more in supply-inelastic states and in states with large household debt imbalances, where negative housing wealth effects bite more strongly and borrowing constraints become more binding. Moreover, financial stability risks increase sharply in these areas as mortgage delinquencies and foreclosures surge, worsening banks’ balance sheets. Finally, monetary policy may have a stronger effect on housing tenure decisions in supply-inelastic states, where the homeownership rate and price-to-rent ratios decline by more. Our findings stress the importance of regional housing supply conditions in assessing the macrofinancial effects of rising interest rates.
    Keywords: Credit conditions; FAVAR; house prices; monetary policy; regional data; supply elasticities
    Date: 2024–02–02
  8. By: Hüttl, Pia; Kaldorf, Matthias
    Abstract: How does a shock to the liquidity of bank assets affect credit supply, cross-border lending, and real activity at the firm level? We exploit that, in 2007, the European Central Bank replaced national collateral frameworks by a single list. This collateral framework shock added loans to non-domestic euro area firms to the pool of eligible assets. Using loan level data, we show that banks holding a large share of newly eligible cross-border loans increase loan supply by 14% and reduce spreads by 16 basis points, compared to banks with smaller holdings of such loans. The additional credit is mainly extended to (previously eligible) domestic borrowers, suggesting only a limited cross-border effect of the collateral framework shock. However, the shock had real effects: firms highly exposed to affected banks increase their total debt, employment, and investment.
    Keywords: Bank Liquidity Shocks, Bank Lending Channel, Financial Integration, Real Effects, Eligibility Premia
    JEL: E44 E58 G21
    Date: 2024
  9. By: Assenmacher, Katrin; Ferrari Minesso, Massimo; Mehl, Arnaud; Pagliari, Maria Sole
    Abstract: We develop a two-country DSGE model with financial frictions to study the transition from a steady-state without CBDC to one in which the home country issues a CBDC. The CBDC provides households with a liquid, convenient and storage-cost free means of payments which reduces the market power of banks on deposits. In the steady-state CBDC unambiguously improves welfare without disintermediating the banking sector. But macroeconomic volatility in the transition period to the new steady-state increases for plausible values of the latter. Demand for CBDC and money overshoot, thereby crowding out bank deposits and leading to initial declines in investment, consumption and output. We use non-linear solution methods with occasionally binding constraints to explore how alternative policies reduce volatility in the transition, contrasting the effects of restrictions on non-residents, binding caps, tiered remuneration and central bank asset purchases. Binding caps reduce disintermediation and output losses in the transition most effectively, with an optimal level of around 40% of steady-state CBDC demand. JEL Classification: E50, E58, F30, F41
    Keywords: central bank digital currency, occasionally binding constraints, open-economy DSGE models, steadystate transition
    Date: 2024–02
  10. By: Diogo Martins
    Abstract: This article provides a critical review of the post-pandemic inflation debate. The first part structures the debate through the classification of the arguments into two broad categories (the neoclassical view and the critical political economy view) along with several subcategories. The classification is informed by the positions assumed by debate participants regarding the origin and propagation mechanisms of inflation, together with the economic policy solutions advanced to face the current inflationary episode. The second part is focused on showing that the hegemony of contractionary monetary policy as a policy response to address contemporary inflation is based on weak foundations, whose theoretical and empirical arguments have been consistently and convincingly disputed in critical political economy circles over the last decades.
    Keywords: Inflation; pandemic; critical political economy; neoclassical economics; central banks; monetary policy.
    JEL: E12 E31 E32 E52 E61 E64
    Date: 2024–01
  11. By: Xisong Jin
    Abstract: This paper introduces a forward-looking bank-level stress testing framework for a large-scale system to assess three forms of banking system vulnerability– bank capital fragility, bank capital adequacy and bank solvency. Results for Luxembourg are provided with a decomposition by bank business model and domicile type. The paper goes on to assess how these systemic risk indicators are linked to macroeconomic variables, and investigates their predictive power for Luxembourg’s nominal GDP growth one year ahead. Several important findings are documented over 2003Q2 to 2023Q3. First, the systemic risk indicators responded to the main stock market crashes in a timely manner. However, contributions from different bank business models and domicile types varied over time. Second, association with key macroeconomic variables (interest rates, liquidity flow, euro area consumer confidence and business climate) depended on the different characteristics of systemic risk across bank business models. Third, the systemic risk indicators contributed to explaining nominal GDP growth one year ahead. However, the systemic risk component associated with search-for-yield behavior and fee & commission generating activities could also explain nominal GDP growth, suggesting that if banks became more dependent on these income sources, they could create financial stability issues in the long run. Overall, the framework provides a useful monitoring toolkit that tracks changes in forward-looking systemic risk and risk spillovers in the Luxembourg banking sector.
    Keywords: Financial stability, systemic risk, macro-prudential policy, dynamic dependence, banking business model, financial stress index, coronavirus COVID-19, macro-financial linkages.
    JEL: C1 E5 F3 G1
    Date: 2024–02
  12. By: Euihyun Bae; Andrew Hodge; Miss Anke Weber
    Abstract: This paper studies how and why inflation expectations have changed since the emergence of Covid-19. Using micro-level data from the University of Michigan Survey of Consumers, we show that the distribution of consumer expectations at one-year and five-ten year horizons has widened since the surge of inflation during 2021, along with the mean. Persistently high and heterogeneous expectations of consumers with less education and lower income are mainly responsible. A simple model of adaptive learning is able to mimic the change in inflation expectations over time for different demographic groups. The inflation expectations of low income and female consumers are consistent with using less complex forecasting models and are more backward-looking. A medium-scale DSGE model with adaptive learning, estimated during 1965-2022, has a time-varying solution that produces lower forecast errors for inflation than a variant with rational expectations. The estimated model interprets the surge of inflation in 2021 mainly as the result of a price markup shock, which is more persistent and requires a larger and more persistent monetary policy response than under rational expectations.
    Keywords: Inflation Expectations; Learning; Forecasting
    Date: 2024–02–09
  13. By: Jane E. Ihrig; Christopher J. Waller
    Abstract: In the face of the COVID-19 pandemic in March 2020, the Federal Reserve committed to using its full range of tools to support the U.S. economy. Over the next year and a half, with progress on vaccinations and strong policy support, indicators of economic activity and employment strengthened while inflation moved higher. Faced with a tight labor market and elevated inflation, the Federal Open Market Committee (FOMC) began a process of unwinding the very accommodative stance of monetary policy and moving to a restrictive policy stance to address inflation pressures. Here we review the sequence of actions taken by the Committee between late 2020 and mid-2023 as well as discuss some issues it contemplated along the way; the table provides a chronological list of key events over this period.
    Date: 2024–02–14
  14. By: Miguel Fernandes (University of Surrey); Mario Pascoa (University of Surrey)
    Abstract: The repo market played an important role in the 2007-2008 crisis and its aftermath. The “run on repo†started in 2007 when cash lenders withdrew their repo funding due to concerns over securitized mortgages as collateral and haircuts rose dramatically as described in Gorton and Metrick (2012). The combination of very large, unprecedented haircuts with declining asset values, helped fuel the insolvency problems in the banking sector, which would eventually lead to massive bailouts throughout 2008 and the bankruptcy of some major banks. In the following years, the repo market recovered most of its influence and size, but the Basel III regulations that were imposed to prevent future banking crises and limit leverage would create new frictions in the repo market. The “leverage ratio†in particular has perverse effect on the repo markets. The “leverage ratio†demands that banks hold Tier 1 capital as a percentage of their total assets.
    Date: 2024–02
  15. By: Dionne, Georges (HEC Montreal, Canada Research Chair in Risk Management); Fenou, Akouété (HEC Montreal, Canada Research Chair in Risk Management); Mnasri, Mohamed (HEC Montreal, Canada Research Chair in Risk Management)
    Abstract: We investigate the causes of the gap in mergers and acquisitions (M&A) between life and nonlife insurers in the US from 1990 to 2022. Our DID analysis indicates a parallel trend between M&As in the life insurance and nonlife insurance sectors from 1990 to 2012, and a significant difference after 2012. There was a shock in the life insurance market that resulted in a reduction in M&As after 2012. Variable annuity sales in the life insurance sector declined after 2012. We find evidence that low interest rates observed during the implementation of the quantitative easing policy of the Fed from 2008 to 2012 caused the difference in M&As in the life sector after 2012.
    Keywords: Merger and acquisition; life insurance; nonlife insurance; US insurance market; DID methodology; quantitative easing policy; life insurance annuity; variable annuity
    JEL: C21 D40 D80 G14 G22 G34
    Date: 2024–02–21
  16. By: Francesco Vercelli (Bank of Italy)
    Abstract: This paper examines the Italian banking system during the 1907 financial crisis, from start to finish. Using bank balance sheet data from the Historical Archive of Credit in Italy, we analyse the developments of the banking system in the run-up to the crisis. We show that the four Italian mixed banks, which registered a rapid growth at the beginning of the 20th century, were little engaged in the traditional activity of bill discounting and largely involved in ‘repurchase agreements’ on stocks and in correspondent current accounts. Because of this business model, the mixed banks – and in particular the Società Bancaria Italiana – turned out to be fragile when the international crisis hit the country. Then we analyse the complex interactions between the major financial institutions and the government in order to face the crisis. We focus on the role of the Bank of Italy, which acted as a modern central bank for the first time since its creation.
    Keywords: financial crisis, history of banking
    JEL: C81 G21 N23 N24
    Date: 2022–06

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