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on Central Banking |
| By: | Mr. Philip Barrett; Josef Platzer |
| Abstract: | Activity and inflation responded slowly to the Federal Reserve’s rate hikes in 2022. Was this because the transmission of monetary policy had changed? Or did other shocks offset tighter policy? We use pre-pandemic data to estimate a VAR with monetary policy shocks identified from high-frequency data, and use it as a filter to back out the sequence of monetary policy shocks consistent with data since 2022. We compare these implied shocks to the actual shocks and find the difference statistically significant during February-July 2022. These differences imply that monetary transmission was around 25 percent weaker than normal. Our method accounts for other shocks; allowing them to change to match the post-COVID covariance of the data produces similar results but in a shorter period. We decompose changes in the uncertainty of our estimate and find that colinearity of shocks is generally more important than uncertainty over model parameters. We extend our analysis to central bank information shocks and find Federal Reserve communication was less powerful than usual during 2021. |
| Keywords: | Monetary Policy; Semi-structural Identification; VAR; Filtering |
| Date: | 2024–06–21 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/129 |
| By: | Michael T. Kiley |
| Abstract: | Activity shortfalls are more costly than strong activity. I consider optimal monetary policy under discretion with an asymmetric (activity shortfalls) loss function. The model satisfies the natural rate hypothesis. The asymmetric loss function and resulting optimal monetary policy exacerbates shortfalls in activity. The additional frequency of activity shortfalls arises from the adjustment of expectations implied by the natural rate hypothesis. The shortfalls asymmetry leads to an inflationary bias, similar to results in the time-consistency literature. Mandating a central bank objective with greater symmetry than the social loss function improves outcomes. Greater symmetry lowers the magnitude of activity shortfalls. Greater symmetry also reduces inflation bias. The model also implies that an optimal monetary policy does not accommodate fluctuations from aggregate demand shocks, as is standard in such models. As a result, the analysis implies that monetary accommodation of strength in economic activity likely requires justifications other than asymmetric costs of shortfalls. |
| Keywords: | Monetary Policy; Rules; Discretion; Symmetric loss function; Asymmetric loss function |
| JEL: | E52 E58 E37 |
| Date: | 2024–05–28 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-32 |
| By: | Michaelis, Henrike |
| Abstract: | This paper uses a time-varying vector autoregressive (VAR) model for the euro area to explore the changes in the interest rate pass-through to bank retail rates following conventional and unconventional monetary policy shocks. The median estimate of the impulse responses shows a considerably higher pass-through during crisis periods, especially the financial crisis and the coronavirus pandemic. From mid-2013 to 2015-16, the monetary policy pass-through to the bank lending rate becomes slightly stronger. In the remainder of 2016, the pass-through weakens. From then until the end of 2019, it hovers at a lower level. However, the credible intervals reveal a large uncertainty concerning the pass-through over the entire sample. Therefore, a constant and complete pass-through is clearly within the realms of possibility. Since the standard deviation of monetary policy shocks grows substantially since the onset of unconventional measures in 2011, changes in bank retail rates seem to be driven mainly by such shocks in this period. |
| Keywords: | Euro area, interest rate pass-through, time-varying vector autoregressive model, sign restrictions |
| JEL: | C11 E40 E43 E52 G21 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bubdps:299243 |
| By: | Emina Milišić (Central Bank of Bosnia and Herzegovina); Emina Žunić Dželihodžić (Central Bank of Bosnia and Herzegovina) |
| Abstract: | This paper examines the pass-through of European Central Bank (ECB) monetary policy to deposit rates in Bosnia and Herzegovina (B&H). We use aggregate and bank-level data to study interest rate pass-through by bank size and ownership for the period 2012-2023. In extensions, we also study pass-through by counterparty and maturity of deposit contracts. Our results suggest that average pass-through is slow and incomplete. We document that pass-through is faster and more complete for banks which are small and foreign-owned, as compared to banks which are large (and foreign-owned), or banks which are small and domestic. This finding suggests that pass-through depends both on domestic market power of banks as well as their access to foreign money markets. |
| Keywords: | monetary policy; transmission mechanism; deposit rates; currency board |
| JEL: | E42 E52 E58 E60 |
| Date: | 2024–07–04 |
| URL: | https://d.repec.org/n?u=RePEc:gii:giihei:heidwp10-2024 |
| By: | Paul Castillo; Mr. Ruy Lama; Juan Pablo Medina |
| Abstract: | Financial dollarization is considered a source of macroeconomic instability in many emerging economies. Dollarization constrains the ability of central banks to stimulate output during economic downturns. In contrast to the conventional monetary transmission mechanism, a monetary policy loosening in a dollarized economy leads to a currency depreciation, adverse balance sheet effects, and a contraction in investment and output growth. In this paper we evaluate the role of foreign exchange reserves in facilitating macroeconomic stabilization in a financially dollarized economy. We first show empirically that foreign exchange intervention in response to capital outflows can largely reduce the volatility of output and the real exchange rate in dollarized economies. We then develop a small open economy model with foreign currency debt and balance sheets effects. Our quantitative model shows that an active foreign exchange intervention policy is sufficient for offsetting the output volatility associated with financial dollarization. These results can explain the prevalence of low macroeconomic volatility in some dollarized economies (Christiano et al., 2021) and they highlight the role of foreign exchange reserves in reducing the welfare costs of dollarization. |
| Keywords: | Foreign Exchange Intervention; Global Financial Cycle; Financial Dollarization; Balance Sheet Effects; Emerging Economies. |
| Date: | 2024–06–21 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/127 |
| By: | Mervyn A. King |
| Abstract: | Inflation targets were introduced well ahead of the development of the theory of inflation targeting. The practice was successful because it comprised a new set of procedures and institutions for setting monetary policy in a transparent and accountable fashion – “constrained discretion”; the later theory was less useful because it purported to be a theory of the determination of the price level. But inflation targeting does not constitute a new theory of the monetary transmission mechanism. The belief that it does led to the replacement of Milton Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon” by the new dictum that “inflation is always and everywhere a transitory phenomenon”. This had unfortunate consequences during the recent inflation. The paper concludes with a discussion of the challenges facing inflation targets in the future. |
| JEL: | E42 E43 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32594 |
| By: | Kimundi, Gillian |
| Abstract: | Capital is central to efficient intermediation and is a core indication of the financial health of a bank. Recent shifts in monetary policy, economic shocks and contextspecific events in interbank liquidity flow in Kenya call for a revisit of banks' response through the lens of their capitalization. Using data from 27 banks between 2001 and 2021, this study first reveals that there is heterogeneity in how banks respond to policy, economic and market shifts, and that capital plays a key role in maintaining (and in some cases amplifying) balance sheet activity and cushioning operating profitability. Small, lesser-capitalized banks are more sensitive to monetary policy and shifts in interbank market liquidity, whereas large, higher-capitalized banks are more sensitive to GDP shocks. Collectively, the role of capital depends on the nature of the shock, the size of the bank and the sub-period studied. The study concludes with relevant policy and bank-level implications from these findings. |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:kbawps:297990 |
| By: | Michael T. Kiley |
| Abstract: | I assess monetary policy strategies to foster price stability and labor market strength. The assessment incorporates a range of challenges, including uncertainty regarding the equilibrium real interest rate, mismeasurement of economic potential, and balancing the costs and benefits associated with employment shortfalls and labor market strength. I find that the ELB remains a significant constraint, hindering achievement of the inflation objective and worsening employment shortfalls. Symmetric policy reaction functions mitigate the most adverse effects of employment shortfalls by contributing to economic stability. Make-up strategies address ELB risks. These strategies call for policy to accommodate some period of inflation above its long-run objective following an ELB episode. I also consider an asymmetric shortfalls approach to policy. This approach provides accommodation in response to weak activity while foregoing tightening in response to strong activity. While the approach can, in principle, address ELB risks by raising inflation, it performs poorly. The shortfalls approach exacerbates economic volatility, worsens employment shortfalls, and creates excess inflationary pressures. Mismeasurement is not sufficient to limit the importance of strong responses to measured slack. Overall, monetary policy can promote price stability and labor market strength by focusing on economic stability, with a strategy targeted to address ELB risks. |
| Keywords: | Monetary policy; Rules and discretion; Effective lower bound; Symmetric loss function; Asymmetric loss function |
| JEL: | E52 E58 E37 |
| Date: | 2024–05–28 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-33 |
| By: | Ndwiga, David |
| Abstract: | Using a Panel VAR model and annual bank level data for the period 2008-2022, this study investigated banks risk taking behaviour amid monetary policy tightening considering the role of banks' non-interest-bearing deposits and equity levels. Estimation results found monetary policy tightening and equity levels reduces the bank risk taking behavior thus evidence of monetary policy risk-taking transmission channel. However, the contrary was reported with regard to bank liability: - non - interest bearing deposit "pseudo assets". However, interaction between policy rate, equity and "pseudo assets" was found to increase bank risk appetite significantly. This study is important since under the risk-taking channel view, a change in the policy rate is immediately transmitted to money-market instruments of different maturity and to other short-term rates, such as interbank deposits and this quickly affects the interest rates that banks charge their customers for variable-rate loans, including overdrafts. |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:kbawps:297987 |
| By: | Khalil, Makram; Lewis, Vivien |
| Abstract: | Price setting has become more flexible following a string of large adverse shocks (Covid-19, the Ukraine War). We argue that a shift to a high-uncertainty regime incentivizes firms to invest in their ability to adjust prices. We formalize this idea in a general equilibrium model with endogenous price flexibility and entry-exit. Faced with higher productivity uncertainty, firms set prices more flexibly. This improves their resilience, reducing exit and output losses in response to negative supply shocks. Uncertainty regarding monetary policy has similar effects. We show that higher monetary policy uncertainty can be welfare-improving when productivity shocks are large. |
| Keywords: | entry, exit, price flexibility, supply shocks, uncertainty |
| JEL: | E22 E31 E32 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bubdps:299235 |
| By: | William F. Diamond; Tim Landvoigt; Germán Sánchez Sánchez |
| Abstract: | We analyze the impact of fiscal and monetary stimulus in an economy with mortgage debt, where inflation redistributes from savers to borrowers. We show theoretically that fiscal transfers without future tax increases cause a surge in inflation, increasing consumption demand and house prices. The power of fiscal stimulus grows when borrowers are more indebted. We then show quantitatively that transfers followed by easy monetary policy cause a surge in inflation which helps explain features of the post-Covid boom, including a boom in output and house prices. This boom comes with a longer-term contraction, since redistribution reduces borrower labor supply. |
| JEL: | E44 E52 E63 G51 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32573 |
| By: | R\"udiger Frey; Theresa Traxler |
| Abstract: | We study the impact of regulatory capital constraints on fire sales and financial stability in a large banking system using a mean field game model. In our model banks adjust their holdings of a risky asset via trading strategies with finite trading rate in order to maximize expected profits. Moreover, a bank is liquidated if it violates a stylized regulatory capital constraint. We assume that the drift of the asset value is affected by the average change in the position of the banks in the system. This creates strategic interaction between the trading behavior of banks and thus leads to a game. The equilibria of this game are characterized by a system of coupled PDEs. We solve this system explicitly for a test case without regulatory constraints and numerically for the regulated case. We find that capital constraints can lead to a systemic crisis where a substantial proportion of the banking system defaults simultaneously. Moreover, we discuss proposals from the literature on macroprudential regulation. In particular, we show that in our setup a systemic crisis does not arise if the banking system is sufficiently well capitalized or if improved mechanisms for the resolution of banks violating the risk capital constraints are in place. |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2406.17528 |
| By: | Fueki, Takuji; Hürtgen, Patrick; Walker, Todd B. |
| Abstract: | Financial institutions, especially in Europe, hold a disproportionate amount of domestic sovereign debt. We examine the extent to which this home bias leads to capital misallocation in a real business cycle model with imperfect information and fiscal stress. We assume banks can hold sovereign debt according to a zero-risk weight policy and contrast this scenario to one in which banks weight the sovereign debt according to default probabilities. Banks are assumed to miscalculate the probability of a disaster state due to moral hazard and imperfect monitoring. This distortion pushes the economy away from the first-best allocation. We show that the zero risk weight policy exacerbates these distortions while a non-zero risk-weight improves allocations. The welfare costs associated with zero-risk weight policies are large. Households are willing to give up 3.2 percent of their consumption to move to the first-best allocation, whereas in the economy with non-zero risk-weights households are willing to give up only 1.2 percent of their consumption to move to the first-best allocation. |
| Keywords: | Zero-Risk Weight, Fiscal Limit, Macroprudential Regulation, Sovereign-Bank Nexus, Fiscal Stress |
| JEL: | E61 E62 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bubdps:299238 |
| By: | Panagiotis Bouras; Joaquín Saldain; Xing Guo; Thomas Michael Pugh; Maria teNyenhuis |
| Abstract: | We assess how much the recent rate-hike cycle has and will affect mortgage borrowers' consumption through its impacts on mortgage payments. Our analysis provides insights into the effects of changes in monetary policy on the consumption of mortgage borrowers. |
| Keywords: | Interest rates; Monetary policy; Recent economic and financial developments |
| JEL: | D1 D13 E2 E21 G5 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocsan:24-14 |
| By: | Victor Musa; Bertrand Gilles Umba; Lewis Mambo; Jonas Kibala; Josephine Mushiya; Yannick Luvezo; Jules Nsunda; Grégoire Lumbala; Yves Siasi; Serge Mfumukanda; Lubaki Ange; Kabata Olivier; Luc Shindano; Dyna Heng; Diego Rodriguez Guzman; Barna Szabo |
| Abstract: | The paper introduces a semi-structural Quarterly Projection Model (QPM) tailored for the Democratic Republic of the Congo (DRC), highlighting its resource richness and high degree of dollarization. We provide an overview of the model's specifications to elucidate key features of the DRC economy and present its properties, evaluating its alignment with DRC data and assessing its goodness of fit. Additionally, the paper demonstrates the QPM's practical application through a counterfactual scenario, comparing policy recommendations with the actual policy responses of the Central Bank of the Republic of Congo to observed exchange rate and inflation pressures in 2023. Beyond the QPM, the paper showcases supplementary tools that enhance its utility for generating medium-term forecasts and developiong narratives in support of monetary policymaking. Specifically, we introduce the Nowcasting and Near-Term Forecast models, designed to assess the economy in real-time and predict short-term inflationary trends. |
| Keywords: | Resource-rich; Dollarization; Monetary policy; Inflation; Exchange Rate Policies |
| Date: | 2024–06–21 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/126 |
| By: | Lahcen Bounader; Mr. Selim A Elekdag |
| Abstract: | We develop a model with diagnostic expectations (DE) and a financial accelerator (FA) that generates mutually reinforcing shock amplification, especially in the case of demand shocks. However, supply shocks can be dampened via a debt deflation channel, which is strengthened amid DE. Importantly, the model results in a worsening of the inflation-output volatility trade-off confronting policymakers. In contrast to most of the literature—which argues against targeting the level of asset prices—our financial accelerator model with DE suggests that targeting house price growth may result in welfare gains. |
| Keywords: | Financial Accelerator; Diagnostic Expectations; Optimal monetary policy; Instrument rules |
| Date: | 2024–06–28 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2024/132 |
| By: | Annie Soyean Lee; Charles Engel |
| Abstract: | Empirical work finds that flows of investments from the U.S. and other high income countries to emerging markets increase during times of quantitative easing by the U.S. Federal Reserve, and the reverse movement occurs under quantitative tightening. We offer new evidence to confirm these findings, and then propose a theory based on the liquidity of U.S. government liabilities held by the public. We hypothesize that QE, by increasing liquidity, offers greater flexibility for investors that might be concerned their funds will be tied up when shocks to income or investment opportunities arise. With the assurance that some of their portfolio can be readily sold in liquid markets, rich country investors are more willing to increase investments in illiquid loans to emerging markets. The effect of increasing the liquidity of U.S. government liabilities on investments in EMs may even be stronger during times of greater uncertainty. |
| JEL: | E5 F30 F40 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32572 |
| By: | Klaus Adam; Henning Weber |
| Abstract: | We review the academic literature investigating the economic determinants of the welfare optimal inflation target. We start with a bird’s-eye review of the academic literature covering the past 60 years. Up to the year 2010, the academic literature recommended optimal inflation targets that are either negative or zero. The subsequent literature incorporated new economic features and can rationalize also positive inflation targets. In our review, we discuss these features, especially the role of (i) productivity and unaccounted quality progress, (ii) the lowerbound constraint on nominal rates, (iii) nominal wage rigidity, and (iv) product turnover and product aggregation. In a final setup, we provide suggestions for further research on the topic. |
| Keywords: | optimal inflation, Ramsey policy, optimal rules, lower-bound constraint, wage rigidity, relative price trends |
| JEL: | E31 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:bon:boncrc:crctr224_2024_572 |
| By: | Fares Bounajm; Jean Garry Junior Roc; Yang Zhang |
| Abstract: | We explore the drivers of the surge in inflation in Canada during the COVID-19 pandemic. This work is part of a joint effort by 11 central banks using the model developed by Bernanke and Blanchard (2023) to identify similarities and differences across economies. |
| Keywords: | Economic models; Inflation and prices; Labour markets |
| JEL: | E2 E24 E3 E31 E37 E5 E52 E6 |
| Date: | 2024–06 |
| URL: | https://d.repec.org/n?u=RePEc:bca:bocsan:24-13 |
| By: | Bulat Gafarov; Madina Karamysheva; Andrey Polbin; Anton Skrobotov |
| Abstract: | We propose a novel approach to identification in structural vector autoregressions (SVARs) that uses external instruments for heteroscedasticiy of a structural shock of interest. This approach does not require lead/lag exogeneity for identification, does not require heteroskedasticity to be persistent, and facilitates interpretation of the structural shocks. To implement this identification approach in applications, we develop a new method for simultaneous inference of structural impulse responses and other parameters, employing a dependent wild-bootstrap of local projection estimators. This method is robust to an arbitrary number of unit roots and cointegration relationships, time-varying local means and drifts, and conditional heteroskedasticity of unknown form and can be used with other identification schemes, including Cholesky and the conventional external IV. We show how to construct pointwise and simultaneous confidence bounds for structural impulse responses and how to compute smoothed local projections with the corresponding confidence bounds. Using simulated data from a standard log-linearized DSGE model, we show that the method can reliably recover the true impulse responses in realistic datasets. As an empirical application, we adopt the proposed method in order to identify monetary policy shock using the dates of FOMC meetings in a standard six-variable VAR. The robustness of our identification and inference methods allows us to construct an instrumental variable for monetary policy shock that dates back to 1965. The resulting impulse response functions for all variables align with the classical Cholesky identification scheme and are different from the narrative sign restricted Bayesian VAR estimates. In particular, the response to inflation manifests a price puzzle that is indicative of the cost channel of the interest rates. |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2407.03265 |