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on Central Banking |
| By: | Christopher J. Gust; J. David López-Salido |
| Abstract: | Central banks operate in a world in which there is substantial uncertainty regarding the transmission of its actions to the economy because of uncertainty regarding the formation of private-sector expectations. We model private sector expectations using a finite horizon planning framework: Households and firms have limited foresight when deciding spending, saving, and pricing decisions. In this setting, contrary to standard New Keynesian (NK) models, we show that "an inflation scares problem" for the central bank can arise where agents' longer-run inflation expectations deviate persistently from a central bank's inflation target. We formally characterize optimal time-consistent monetary policy when there is uncertainty about the planning horizons of private sector agents and a risk of inflation scares. We show how risk management considerations modify the optimal leaning-against-the-wind principle in the NK literature with a novel, additional preemptive motive to avert inflation scares. We quantify the importance of such risk management considerations during the recent post-pandemic inflation surge. |
| Keywords: | Finite horizon planning; Optimal time-consistent policy under uncertainty; Leaning against the wind; Attenuation principle |
| JEL: | C11 E52 E70 |
| Date: | 2024–08–02 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2024-59 |
| By: | Holtemöller, Oliver; Sardone, Alessandro |
| Abstract: | In this paper, we discuss how environmental damage and emission reduction policies affect the conduct of monetary policy in a two-sector (clean and dirty) dynamic stochastic general equilibrium model. In particular, we examine the optimal response of the interest rate to changes in sectoral inflation due to standard supply shocks, conditional on a given environmental policy. We then compare the performance of a nonstandard monetary rule with sectoral inflation targets to that of a standard Taylor rule. Our main results are as follows: first, the optimal monetary policy is affected by the existence of environmental policy (carbon taxation), as this introduces a distortion in the relative price level between the clean and dirty sectors. Second, compared with a standard Taylor rule targeting aggregate inflation, a monetary policy rule with asymmetric responses to sector-specific inflation allows for reduced volatility in the inflation gap, output gap, and emissions. Third, a nonstandard monetary policy rule allows for a higher level of welfare, so the two goals of welfare maximization and emission minimization can be aligned. |
| Keywords: | climate change, environmental policy, inflation, macroeconomic stabilization, monetary policy |
| JEL: | E32 E52 E58 Q54 Q58 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:iwhdps:301153 |
| By: | Juan R. Hernández (Division of Economics, CIDE); Mateo Hoyos (Division of Economics, CIDE); Daniel Ventosa-Santaulària (Division of Economics, CIDE) |
| Abstract: | In this paper, we examine the impact of global uncertainty on the effectiveness of monetary policy in reducing inflation in emerging market economies (EMEs). Specifically, we explore the repercussions of: (i) global financial stress; (ii) disruptions in the global supply chain; (iii) heightened levels of global geopolitical uncertainty; and (iv) anomalies attributed to climate change. Our main contribution is to demonstrate that monetary policy in EMEs is effective, albeit to a lesser extent, in reducing inflation when uncertainty is heightened due to global factors. We also find that, among the shocks we study, disruptions in the global supply chain affect the most the policy trans- mission mechanisms. To identify the monetary policy shocks, we use a trilemmabased instrument exploiting surprises in the federal funds rate, and cross section variation in capital account openness of each EME. Our results un derscore the complexities inherent in navigating monetary policy within an uncertain global outlook for EMES. |
| Keywords: | Inflation, Monetary Policy, Emerging Market Economies, Financial Volatility, Global Supply Chain, Policy Uncertainty, Climate Change |
| JEL: | C23 C26 C54 E31 E52 F41 |
| Date: | 2024–07 |
| URL: | https://d.repec.org/n?u=RePEc:emc:wpaper:dte634 |
| By: | Charles Engel; Steve P.Y. Wu |
| Abstract: | Exchange-rate models fit very well for the U.S. dollar in the 21st century. A “standard” model that includes real interest rates and a measure of expected inflation for the U.S. and the foreign country, the U.S. comprehensive trade balance, and measures of global risk and liquidity demand is well-supported in the data for the U.S. against other G10 currencies. The monetary and non-monetary variables play equally important roles in explaining exchange rate movements. In the 1970s – early 1990s, the fit of the model was poor but the fit (as measured by t- and F-statistics, and R-squareds) has increased almost monotonically to the present day. We make the case that it is better monetary policy (inflation targeting) that has led to the improvement, as the scope for self-fulfilling expectations has disappeared. We provide a variety of evidence that links changes in monetary policy to the performance of the exchange-rate model. |
| JEL: | F31 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32808 |
| By: | Kanngiesser, Derrick (Bank of England); Willems, Tim (Bank of England) |
| Abstract: | We propose a systematic approach for central banks to leverage past forecasts (and associated errors) with the aim of learning more about the structure and functioning of the underlying economy. Applying this method to forecasts made by the Bank of England’s Monetary Policy Committee since 2011, we find that its forecasts have tended to underestimate pass‑through from wage growth, whilst also featuring a Phillips curve that is too flat. Regarding the effects of monetary policy, our results point to transmission via inflation expectations possibly having played a bigger role than attributed to it in the forecast. We also provide a more classical evaluation of forecast errors – finding inflation forecasts to have been unbiased. At the same time, however, inflation forecasts tend to be less accurate than those for real GDP growth, unemployment, and wage growth. This seems attributable to greater inherent uncertainties in the inflation process. |
| Keywords: | Forecasting; forecast error analysis; monetary policy |
| JEL: | E32 E47 E62 |
| Date: | 2024–08–06 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:1078 |
| By: | Dr. Gabriel Züllig; Valentin Grob |
| Abstract: | We investigate how the level of corporate leverage affects firms' investment response to monetary policy shocks. Based on novel aggregate time series estimates, leverage acts amplifying, whereas in the cross section of firms, higher leverage predicts a muted response to monetary policy. We use a heterogeneous firm model to show that in general equilibrium, both empirical findings can be true at the same time: When the average firm has lower leverage and therefore reduces its investment demand more strongly after a contractionary shock, the price of capital declines sharply, which incentivizes all firms regardless of their leverage to invest relatively more, muting the aggregate decline of investment. We provide empirical evidence supporting this hypothesis. Overall, if there are general equilibrium adjustments to shocks, effects estimated by exploiting cross-sectional heterogeneity in micro data can differ substantially from the macroeconomic elasticities, in our example even in terms of their sign. |
| Keywords: | Firm heterogeneity, State dependence, Financial frictions, General equilibrium |
| JEL: | D22 E32 E44 E52 |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:snb:snbwpa:2024-08 |
| By: | Babette Jansen (University of Antwerp); Roland Winkler (Friedrich Schiller University Jena, and University of Antwerp) |
| Abstract: | We consider a two-agent New Keynesian model with savers and hand-to-mouth households with quasi-separable utility functions as introduced by Bilbiie (2020a). This framework allows for separate parameterization of consumption-hours complementarity and income effects on labor supply. We examine how variations in the size of income effects, the degree of non-separability between consumption and hours worked, and the share of hand-to-mouth households impact aggregate dynamics and determinacy properties of interest rate rules. Complementarity between consumption and hours worked and small income effects can reverse the Taylor principle and result in expansionary monetary contractions. |
| Keywords: | Heterogeneity, Monetary policy, Nonseparable preferences, Real indeterminacy, Taylor principle, TANK |
| JEL: | E32 E52 E58 E44 E24 |
| Date: | 2024–08–23 |
| URL: | https://d.repec.org/n?u=RePEc:jrp:jrpwrp:2024-006 |
| By: | Hassan Afrouzi; Saroj Bhattarai; Edson Wu |
| Abstract: | We provide theory and evidence that relative price shocks can cause aggregate inflation and act as aggregate supply shocks. Empirically, we show that exogenous positive energy price shocks have a positive impact not only on headline but also on U.S. core inflation while depressing U.S. real activity. In a two-sector monetary model with upstream and downstream sectors and heterogeneous price stickiness, we analytically characterize how upstream shocks propagate to prices. Using panel IV local projections, we show that the responsiveness of sectoral PCE prices to energy price shocks is in line with model predictions. Motivated by post-COVID inflation in the U.S., a model experiment shows that a one-time relative price shock generates persistent movements in headline and core inflation similar to those observed in the data, even in the absence of aggregate slack. The model also emphasizes that monetary policy stance plays an important role in propagation of such shocks. |
| JEL: | C67 E32 E52 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32816 |
| By: | Julian Ashwin; Paul Beaudry; Martin Ellison |
| Abstract: | Neural networks offer a promising tool for the analysis of nonlinear economies. In this paper, we derive conditions for the global stability of nonlinear rational expectations equilibria under neural network learning. We demonstrate the applicability of the conditions in analytical and numerical examples where the nonlinearity is caused by monetary policy targeting a range, rather than a specific value, of inflation. If shock persistence is high or there is inertia in the structure of the economy, then the only rational expectations equilibria that are learnable may involve inflation spending long periods outside its target range. Neural network learning is also useful for solving and selecting between multiple equilibria and steady states in other settings, such as when there is a zero lower bound on the nominal interest rate. |
| JEL: | C45 E19 E47 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32807 |
| By: | Woo Jin Choi (University of Seoul); Ju Hyun Pyun (Korea University); Youngjin Yun (Inha University) |
| Abstract: | A central bank's accumulation of foreign reserves can reallocate domestic savings and influence investments across different firms. Leveraging institutional features in Korea and connecting firms to their lending banks for the 2004-2019, we examine how reserve accumulation and sterilization impact credit allocation within the banking system and firm investment. We track the bonds issued by the central bank to sterilize/fund reserve purchases. Different banks take varying amounts of sterilization bonds, and those more responsive adjust their loan supply to firms. As a result, firms heavily dependent on these banks for credit decrease investment during reserve accumulation. |
| Keywords: | international reserves, sterilized intervention, firm investment, bank balance sheet |
| JEL: | C23 E22 E58 F21 F31 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:inh:wpaper:2024-6 |
| By: | Carlos Alberto Durigan Junior; Mauro De Mesquita Spinola; Rodrigo Franco Gon\c{c}alves; Fernando Jos\'e Barbin Laurindo |
| Abstract: | Central Bank Digital Currency (CBDC) can be defined as a virtual currency based on node network and digital encryption algorithm issued by a country which has a legal credit protection. CBDCs are supported by Distributed Ledger Technologies (DLTs), and they may allow a universal means of payments for the digital era. There are many ways to proceed, they all require central banks to develop technological expertise. Considering these points, it is important to understand the new IT governance in the financial markets due to CBDC and digital economy. Information Technology is an essential driver that will allow the new financial industry design. This paper has the objective to answer two questions through an updated Systematic Literature Review (SLR). The first question is What IT resources and tools have been considered or applied to set the governance of CBDC adoption? The second; Identify IT governance models in the financial market due to CBDC adoption. Bank for International Settlements (BIS) publications, Scopus and Web of Science were considered as sources of studies. After the strings and including criteria were applied, fourteen papers were analyzed. This paper finds many IT resources used in the CBDC adoption and some preliminary IT design related to the IT governance of CBDC, in the results and discussion section the findings are more detailed. Finally, limitations and future work are considered. Keywords: Blockchain, Central Bank Digital Currency (CBDC), Digital Economy, Distributed Ledger Technology (DLT), Information Technology (IT), IT governance. |
| Date: | 2024–05 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2407.07898 |
| By: | Enrique G. Mendoza; Vincenzo Quadrini |
| Abstract: | Research has shown that the unilateral accumulation of international reserves by a country can improve its own macro-financial stability. However, we show that when many countries accumulate reserves, the induced general equilibrium effects weaken financial and macroeconomic stability, especially for countries that do not accumulate reserves. The issuance of public debt by advanced economies has the opposite effect. We derive these results from a two-region model where private defaultable debt has a productive use. Quantitative counterfactuals show that the surge in reserves (public debt) contributed to reduce (increase) world interest rates but also to increase (reduce) private leverage. This in turn increased (decreased) volatility in both emerging and advanced economies. |
| JEL: | F31 F41 F62 F65 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:32810 |
| By: | Lloyd, Simon (Bank of England); Manuel, Ed (London School of Economics) |
| Abstract: | A common approach to estimating causal effects in macroeconomics involves constructing orthogonalised ‘shocks’ then integrating them into local projections or vector autoregressions. For a general set of estimators, we show that this two-step ‘shock-first’ approach can be problematic for identification and inference relative to a one-step procedure which simply adds appropriate controls directly in the outcome regression. We show this analytically by comparing one and two-step estimators without assumptions on underlying data-generating processes. In simple ordinary least squares (OLS) settings, the two approaches yield identical coefficients, but two-step inference is unnecessarily conservative. More generally, one and two-step estimates can differ due to omitted-variable bias in the latter when additional controls are included in the second stage or when employing non-OLS estimators. In monetary-policy applications controlling for central-bank information, one-step estimates indicate that the (dis)inflationary consequences of US monetary policy are more robust than previously realised, not subject to a ‘price puzzle’. |
| Keywords: | Identification; instrumental variables; local projections; omitted-variable bias; vector autoregressions |
| JEL: | C22 C26 C32 C36 E50 E60 |
| Date: | 2024–08–06 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:1079 |
| By: | Jaromir Baxa; Tomas Sestorad |
| Abstract: | This paper proposes a novel approach to decompose the Economic Policy Uncertainty indices of European countries into the common and country-specific components using the time-varying total connectedness. Then, by employing a Bayesian panel VAR model, we assess how common and country-specific uncertainty shocks influence economic activity, prices, and monetary policy, with the shocks identified using zero and sign restrictions. Our results reveal that only common shocks have significant effects on all macroeconomic variables. This result is robust across alternative samples and structural identifications. Therefore, our findings imply that policymakers should focus on uncertainty shocks that are synchronized across countries. |
| Keywords: | Common uncertainty, economic policy uncertainty, panel VAR, spillovers |
| JEL: | C32 F42 F45 |
| Date: | 2024–08 |
| URL: | https://d.repec.org/n?u=RePEc:cnb:wpaper:2024/9 |