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on Central Banking |
| By: | Mr. Luis Ignacio Jácome; Mr. Nicolas E Magud; Samuel Pienknagura; Martin Uribe |
| Abstract: | As inflation targeting (IT) turns 35, it has become a key institutional monetary framework by central banks. Yet, this paper shows that stark differences exist among inflation targeting countries in the conduct of monetary policy. Behind such heterogeneity, the legacy of a high inflation history appears as a preponderant factor. We propose a model that diverges from existing IT workhorse models by adding path-dependence (to a forward-looking model) and potentially imperfect central bank credibility. We show that achieving low inflation (hitting the target) requires more aggressive monetary policy, and is costlier from an output point of view, when individuals’ past inflationary experiences shape their inflation expectation formation. In turn, we provide empirical evidence of the need for these two theoretical additions. Countries that experienced a high level of inflation before adopting the IT regime tend to respond more aggressively to deviations of inflation expectations from the central bank’s target. We also point to the existence of a credibility puzzle, whereby the strength of a central bank’s monetary policy response to deviations from the inflation target remains broadly unchanged even as central banks gain credibility over time. Put differently, a country’s inflationary past casts a long and persistent shadow on central banks. |
| Keywords: | Inflation Targeting; Central Banking; Past Inflation |
| Date: | 2025–04–11 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/079 |
| By: | Michael T. Kiley; Frederic S. Mishkin |
| Abstract: | Since the initial launch of inflation targeting in the early 1990s in New Zealand and a few other countries, inflation targeting has become the predominant monetary policy strategy in large advanced and emerging market economies. Inflation targeting has been remarkably successful in anchoring inflation, likely owing to core elements of the framework across central banks. Its reaction process, which adjusts the monetary policy stance to ensure the return of inflation to target, allows it to flexibly incorporate a wide range of factors while limiting the discretionary biases that can contribute to excessive inflation. The emphasis on communications about the inflation outlook promotes transparency and accountability. As a result, inflation targeting central banks have, on balance, managed well the large shocks associated with the Global Financial Crisis and COVID. Even so, there are numerous challenges discussed in this paper that are associated with calibration and communications of forward guidance, quantitative easing/tightening, and financial stability. |
| Keywords: | Inflation targeting; Monetary policy; Central banking; Financial stability |
| JEL: | E52 E58 |
| Date: | 2025–03–31 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2025-25 |
| By: | Edward Nelson |
| Abstract: | This paper examines the revival in the analysis of monetary policy rules that took place during the 1990s. The focus is on the role that John Taylor played in this revival. It is argued that Taylor’s role—most notably through his advancing the Taylor rule, developed in 1992−1993 and increasingly permeating discussions in research and policy circles over the subsequent several years—is usefully viewed as one of building bridges. In particular, Taylor created links between a monetary policy rules tradition closely associated with Milton Friedman and an interest-rate setting tradition long associated with central banks. The rules tradition had looked unfavorably on interest-rate setting, while the central bank tradition was unfavorably disposed toward policy rules. The Taylor rule helped create a compromise between the traditions, while also advancing an interest-rate reaction function that helped create a revival during the 1990s of economic research on monetary policy rules. |
| Keywords: | Taylor rule; Interest rate rules |
| JEL: | E52 E58 |
| Date: | 2025–03–28 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfe:2025-23 |
| By: | Hess, Simon |
| Abstract: | This paper studies the effects of introducing a Central Bank Digital Currency (CBDC) on economic output, bank intermediation and financial stability in a closed economy using an Agent-based Stock Flow Consistent (AB-SFC) Model. Thereby a digital bank run is simulated across various economic environments with different monetary policy and bank bankruptcy regimes. According to the model, non-remunerated CBDC issued in a positive-interest environment with a corridor system may increase GDP through increased seigniorage income and government spending. Also bank funding becomes more expensive since bank deposit stickiness is prevented. Non-remunerated CBDC issued in a zero-interest environment has no impact since there is no distributional effect of the interest payments. In a floor-system where the interest rate on CBDC matches the policy rate, CBDC also counteracts deposit stickiness and redistributes bank profits from shareholders to depositors. Thereby CBDC improves the transmission of the policy rate to households and firms. The bank bankruptcy regime also affects the outcome. While CBDC makes no difference in a bailout regime it does in a bail-in regime where it decreases inequality and distributes bank rescue costs evenly among households and firms, potentially enhancing financial stability. Introducing CBDC within a deposit insurance system postpones bank rescue payments, which creates an additional dynamic in GDP. |
| Keywords: | central bank digital currency, agent-based model, bank run, bailout, bail-in, financial stability |
| JEL: | E42 E58 G21 G23 G28 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:roswps:171 |
| By: | Kolasa, Marcin (International Monetary Fund); Laséen, Stefan (Monetary Policy Department, Central Bank of Sweden); Lindé, Jesper (Sveriges Riksbank and International Monetary Fund) |
| Abstract: | This paper provides a comprehensive assessment of the macroeconomic and fiscal impact of unconventional monetary tools in small open economies. Using a DSGE model, we show that the exchange rate plays a critical role to amplify the favourable impact of unconventional monetary policy while it attenuates the effectiveness of conventional fiscal policy to jointly boost output and inflation. We then use the model as a laboratory to do a case study of the Swedish Riksbank asset purchases and negative policy rates 2015-2019. We find that the Riksbank unconventional policy measures provided meaningful macroeconomic stimulus to economic activity and inflation, with the dual benefit of reducing overall government debt by about 5 percent of GDP. If conventional fiscal policy had been used to provide a commensurate output boost, inflation would have risen notably less, and the fiscal cost would have amounted to a deterioration of the government debt position with nearly 5 percent of GDP. |
| Keywords: | Monetary Policy; Asset Purchases; Quantitative Easing; Negative Interest Rate Policy; Fiscal Policy |
| JEL: | D44 E52 E58 E63 |
| Date: | 2025–04–01 |
| URL: | https://d.repec.org/n?u=RePEc:hhs:rbnkwp:0450 |
| By: | De Grauwe, Paul; Foresti, Pasquale |
| Abstract: | We study the role of agents’ limited cognitive capabilities, combined with fiscal and monetary policies, in the generation of a deflationary trap. In order to do so, we employ a heterogeneous expectations New Keynesian model in which the agents’ forecasts are based on simple heuristics. Thanks to a learning mechanism, the model is able to generate endogenous changes in agents’ beliefs that we prove to have a crucial role in the characterization of a deflationary trap. We show that the probability of hitting the zero lower bound on the interest rate, and potentially entering a deflationary trap, is not only affected by the inflation target set by the central bank. This probability is also influenced by the governments’ focus on public debt stabilization and by the agents’ memory and willingness to learn. We also show that the impact of these factors is very significant for inflation targets in the range 0–3%, while an inflation target of 4% isolates the system from the zero lower bound problem. |
| Keywords: | agents’ beliefs; deflationary trap; monetary–fiscal policy; zero lower bound |
| JEL: | E52 E61 F33 F36 |
| Date: | 2025–04–09 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:127946 |
| By: | Uluc Aysun (Department of Economics, College of Business Administration, University of Central Florida); Sewon Hur (Federal Reserve Bank of Dallas); Zeynep Yom (Department of Economics, Villanova School of Business, Villanova University) |
| Abstract: | We build and embed an endogenous growth mechanism into an otherwise standard New Keynesian DSGE model to investigate the transmission of monetary policy. Endogenous growth is determined by the R&D expenditures of monopolistically competitive firms and monetary policy, through its effects on these expenditures, can have supply-side effects in addition to its usual demand-side effects. After solving the model and estimating it with a Bayesian methodology, we find that R&D activity amplifies the responses to monetary policy shocks. An empirical investigation that uses firm-level COMPUSTAT data supports this result. Specifically, we find that monetary policy transmission operates more strongly through R&D intensive firms. |
| Keywords: | R&D, endogenous growth, DSGE, monetary policy, COMPUSTAT |
| JEL: | E24 E32 O30 O33 |
| Date: | 2025–05 |
| URL: | https://d.repec.org/n?u=RePEc:vil:papers:61 |
| By: | Jesper Lindé; Marcin Kolasa; Stefan Laseen |
| Abstract: | This paper provides a comprehensive assessment of the macroeconomic and fiscal impact of unconventional monetary tools in small open economies. Using a DSGE model, we show that the exchange rate plays a critical role to amplify the favourable impact of unconventional monetary policy while it attenuates the effectiveness of conventional fiscal policy to jointly boost output and inflation. We then use the model as a laboratory to do a case study of the Swedish Riksbank asset purchases and negative policy rates 2015-2019. We find that the Riksbank unconventional policy measures provided meaningful macroeconomic stimulus to economic activity and inflation, with the dual benefit of reducing overall government debt by about 5 percent of GDP. If conventional fiscal policy had been used to provide a commensurate output boost, inflation would have risen notably less, and the fiscal cost would have amounted to a deterioration of the government debt position with nearly 8 percent of GDP. |
| Keywords: | Monetary Policy; Asset Purchases; Quantitative Easing; Negative Interest Rate Policy; Fiscal Policy |
| Date: | 2025–04–04 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/066 |
| By: | Damjan Pfajfar; Fabian Winkler |
| Abstract: | We document novel facts about US household preferences over inflation and monetary policy tradeoffs. Many households were attentive to news about monetary policy and to interest rates in 2023. The median household perceives the Federal Reserve's inflation objective to be 3 percent, but would prefer it to be lower. Quantifying the tradeoff between inflation and unemployment, we find an average acceptable sacrifice ratio of 0.6, implying that households are likely to find disinflation costly. Average preferences are well represented by a non-linear loss function with near equal weights on inflation and unemployment. These preferences also exhibit sizable demographic heterogeneity. |
| Keywords: | household survey; attention; inflation target; sacrifice ratio; dual mandate |
| JEL: | D12 E52 E58 |
| Date: | 2025–04–24 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedcwq:99898 |
| By: | Eiji Fujii; Xingwang Qian |
| Abstract: | This paper investigates the cyclicality of international reserves and their role in macroeconomic stabilization. We challenge two widely held assumptions: (1) central banks typically manage IR counter-cyclically—accumulating reserves during booms and drawing them down during downturns; and (2) such interventionist management is primarily associated with rigid exchange rate regimes. Analyzing data from 179 countries (1972-2022), we find that counter-cyclical IR management is less common than often assumed. However, as a macroprudential policy, counter-cyclical international reserves significantly reduce output volatility, particularly when interacting with de facto flexible exchange rate regimes. This stabilizing effect is especially pronounced in emerging markets between the 1997 Asian financial crisis and the 2008 global financial crisis. |
| Keywords: | international reserves, cyclicality, exchange rate regime, macroprudential policy, output volatility. |
| JEL: | F34 F31 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11800 |
| By: | Ingman, Gustav (Stockholm University) |
| Abstract: | Recently, there has been increasing research interest in the historical composition of central bank reserves. However, studies in this area is hindered by a lack of data, as such data spanning multiple centuries is only available for a small number of countries. This paper presents an empirical analysis of the development of the Swedish Riksbank’s foreign exchange (FX) reserves from 1823 to 2023. It introduces two new datasets: a monthly time series with the composition of the FX reserve’s components from 1908 to 2023, and an annual dataset providing the distribution of foreign currencies within the FX reserve from 1823 to 2023. This paper offers new insights into the long-run evolution of the central bank reserves of Sweden, contributing to the broader understanding of the trajectory of historical foreign currency reserves. It is published together with an appendix file containing the data. |
| Keywords: | Central; bank; balance; sheet;; Reserve; currencies;; Currency; composition |
| JEL: | E58 F31 N23 N24 |
| Date: | 2025–03–01 |
| URL: | https://d.repec.org/n?u=RePEc:hhs:rbnkwp:0449 |
| By: | Amarendra Sharma |
| Abstract: | The U.S. dollar's status as the global reserve currency faces growing challenges from a 36 trillion dollar national debt, geopolitical shifts, and the emergence of digital currencies. This paper introduces the Quantum Reserve Token (QRT), a decentralized digital currency backed by quantum computational capacity - a scarce, productive resource projected to add over 1 trillion dollars to global GDP by 2035. Unlike Bitcoin's fixed-supply volatility, stablecoins' dependence on fiat trust, or central bank digital currencies' jurisdictional limits, QRT uses quantum computing power as a novel value anchor. This study develops a monetary theory-based framework for QRT, compares it to existing digital currency models, and evaluates its feasibility across technological, economic, geopolitical, and adoption dimensions. QRT offers a stable, neutral, and scalable reserve currency alternative, potentially reshaping the global monetary system. |
| Date: | 2025–03 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2503.22056 |
| By: | Marco Migueis |
| Abstract: | Banks have incentives to operate with lower capital ratios than would be socially optimal due to deposit insurance and implicit government guarantees that socialize part of the costs of bank failures, particularly for the largest banks. Given these incentives, regulatory capital requirements contribute to the safety and soundness of individual banks and to financial stability by setting minimum expectations for the amount of loss-absorbing equity that banks need to employ in their funding. |
| Date: | 2025–03–28 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedgfn:2025-03-28-3 |
| By: | Nie, George Y. (Concordia University) |
| Abstract: | We argue that a payment’s risk approaches zero as maturity approaches zero, and that the central bank’s short-term rate best captures the risk-free rate of various assets. We employ two factors to model the expected risk-free rate that the market expects the current monetary policy to move towards the neutral rate over a certain period. Expecting that the T-bill risk (i.e., the macrorisk) largely reflects a country’s inflation risk, we measure the risk as a 5-year payment’s risk to be comparable across assets. To solve the model factors, we use repeated trials to minimize the prediction errors. Our models thus split US and Canada T-bill yields into the risk and risk-free rate, on average explaining 98.7% of the returns. The models assuming independence of the two returns show similar power in predicting T-bill returns, which can significantly simplify the formulas. We also find that the inclusion of a risk constant over maturity, which has a small value of several basis points, significantly reduces the prediction errors. The risk and the risk-free rate is the gateway to corporate the risk of various assets in the country. |
| Date: | 2025–03–01 |
| URL: | https://d.repec.org/n?u=RePEc:osf:socarx:2dazg_v2 |
| By: | Pei Kuang; Michael Weber; Shihan Xie; Michael Weber |
| Abstract: | This paper examines the impact of political polarization on public trust in the Fed and its influence on macroeconomic expectations. Using a large-scale survey experiment which we fielded on President Trump’s 2025 inauguration day, we study how households form beliefs about the Fed regarding its political leaning, independence, and trustworthiness. Political alignment significantly shapes perceptions: individuals who view the Fed as politically aligned report higher independence of and trust in the Fed, leading to lower inflation expectations and uncertainty. Strategic communication on institutional structure and policy objectives effectively mitigates perception biases, reinforcing the Fed’s credibility and enhancing its policy effectivenes. |
| Keywords: | central bank communication, partisan, trust, expectations |
| JEL: | D83 D84 D72 E70 E31 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11708 |
| By: | Vasileios Karaferis (School of Economics, University of Edinburgh) |
| Abstract: | This paper investigates whether redistributive fiscal policy can be reconciled with macroeconomic efficiency in a heterogeneous agent economy featuring labour market frictions and monetary policy trade-offs. The paper develops a Finitely-Lived Agent New Keynesian (FLANK) model with search-and-matching frictions and a novel participation margin, where households face a constant probability of permanent exclusion from both labour and financial markets. This structure generates persistent inter-generational and cross-sectional inequality and breaks the Ricardian equivalence through finite lifespans and realistic levels of government debt. The model is used to examine the transitional dynamics following a stylized fiscal expansion in the form of transfers to inactive households. The findings suggest that a dovish monetary stance—characterized by a more muted response to inflation—consistently improves labour market outcomes and mitigates inefficiencies, even when fiscal interventions fail to stimulate aggregate demand. These results imply that accommodative monetary policy can enhance the effectiveness of redistribution in heterogeneous-agent environments. |
| Keywords: | Heterogeneous Agents; Monetary Policy; Fiscal Policy; Inequality; Redistribution; Labour Market Frictions |
| JEL: | E21 E24 E52 E62 D63 D91 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:edn:esedps:319 |
| By: | Domenica Di Virgilio; Duarte Maia |
| Abstract: | In this paper, the authors introduce a dividend prudential target rule (DPT) à la Muñoz (2021) in a DSGE model, by Clerc et al. (2015), where banks can default, and extend the model by introducing bankers’ preference for dividend smoothing. Both versions of the model - the original by Clerc et al. (2015) and the extension to banker dividend smoothing – shed light on the same transmission channels of the DPT. However, the results are quantitatively more pronounced in the extended version. The results show the beneficial impact of the DPT on bank resilience and in mitigating the credit downturn and supporting the economic recovery in response to shocks, originating either from the financial system or from the real economy. Moreover, the paper shows the existence of complementarities between the DPT and the countercyclical capital buffer (CCyB) in smoothing the credit cycle and in improving the social welfare. Compared to the original version of the model, in presence of the more realistic assumption of bankers’ preference for dividend smoothing the benefits of the synergy between the CCyB and the DPT rule appear to be bigger. |
| JEL: | C53 G21 G28 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ptu:wpaper:w202504 |
| By: | DiGiuseppe, Matthew; Garriga, Ana Carolina; Kern, Andreas |
| Abstract: | How does partisanship affect inflation expectations? While most research focuses on how inflation impacts political approval and voter behavior, we analyze the political roots of inflation expectations. We argue that elections serve as key moments when citizens update their economic outlook based on anticipated policy changes, and that partisanship influences these re-evaluations. Using a two-wave panel survey conducted before and after the 2024 U.S. Presidential Election, we show that partisan alignment strongly shapes inflation expectations. Democrats reported heightened inflation expectations, anticipating inflationary policies under a Trump administration, while Republicans expected inflation to fall. These shifts reflect partisan interpretations of economic policy rather than objective forecasts. We also analyze the characteristics of those who are more likely to update inflation expectations and in what direction. Importantly, we verify that individuals with strong partisan attitudes exhibit less anchored inflation expectations. Our findings have implications beyond the case under analysis. From a policy perspective, our results underscore the challenges central banks face in anchoring inflation expectations in an era of political polarization, where economic perceptions differ sharply across partisanship lines. |
| Keywords: | Inflation expectations, Survey data, Partisanship, United States, Polarization |
| JEL: | D83 E03 E31 E58 Y80 |
| Date: | 2025–04–09 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:124391 |