nep-mon New Economics Papers
on Monetary Economics
Issue of 2017‒09‒24
twenty-one papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Has inflation targeting anchored inflation expectations? Evidence from Peru By Miguel Saldarriaga; Pablo del Aguila; Kevin Gershy-Damet
  2. How to normalize monetary policy in the Euro area By Beck, Guenter W.; Wieland, Volker
  3. Transmission of monetary policy and exchange rate shocks under foreign currency lending By Malgorzata Skibinska
  4. Monetary Policy and Digital Currencies: Much Ado about Nothing? By C. Pfister
  5. Liquidity, Monetary Policy and Unemployment: A New Monetarist Approach By Mei Dong; Sylvia Xiaolin Xiao
  6. Macroprudential policies in a low interest-rate environment. By Fang Yao; Margarita Rubio
  7. Potential Impact of Financial Innovation on Financial Services and Monetary Policy By Marek Dabrowski
  8. A Central Bank's Optimal Balance Sheet Size? By Goodhart, Charles A
  9. Do highly liquid banks insulate their lending behavior? By Supriya Kapoor
  10. Global Banking and the Conduct of Macroprudential Policy in a Monetary Union By Poutineau, Jean-Christophe; Vermandel, Gauthier
  11. Did QE Lead Banks to Relax Their Lending Standards? Evidence from the Federal Reserve's LSAPs By Robert J. Kurtzman; Stephan Luck; Thomas Zimmermann
  12. Optimal Inflation Target: Insights from an Agent-Based Model By Jean-Philippe Bouchaud; Stanislao Gualdi; Marco Tarzia; Francesco Zamponi
  13. The macroprudential policy framework in Colombia By Hernando Vargas; Pamela Cardozo; Andrés Murcia
  14. Monetary Policy and Asset Valuation By Bianchi, Francesco; Lettau, Martin; Ludvigson, Sydney
  15. Long-run equilibrium exchange rate in Latin America and Asia: a comparison using cointegrated vector By Cuiabano, Simone
  16. A Model of Secular Stagnation: Theory and Quantitative Evaluation By Eggertsson, Gauti B.; Mehrotra, Neil; Robbins, Jacob A.
  17. How was the Quantitative Easing Program of the 1930s Unwound? By Matthew Jaremski; Gabriel Mathy
  18. Market Reactions to ECB Policy Innovations: A Cross-Country Analysis By Fausto Pacicco; Luigi Vena; Andrea Venegoni
  19. Macroeconomic effects of varied mortgage instruments studied using agent-based model simulations By Thorir Bjarnason; Einar Jón Erlingsson; Bulent Ozel; Hlynur Stefánsson; Jón Thor Sturluson; Marco Raberto
  20. Gravity in FX R-Squared: Understanding the Factor Structure in Exchange Rates By Hanno Lustig; Robert J. Richmond
  21. Findings of the recent literature on international capital flows: Implications and suggestions for further research By Stéphanie Guichard

  1. By: Miguel Saldarriaga (Central Reserve Bank of Peru); Pablo del Aguila (Central Reserve Bank of Peru); Kevin Gershy-Damet (Central Reserve Bank of Peru)
    Abstract: Inflation expectations play a key role in inflation dynamics and monetary policy effectiveness. Thus, anchoring inflation expectations have become paramount for Central Banks across the world, mainly for inflation-targeting Central Banks. Yet, the evidence that inflation targeting has anchored inflation expectations in all inflation targeting economies is mixed. Although inflation volatility declined after the inflation-targeting regime came into force in most countries, inflation expectations may still be not anchored, and might just exhibit lower dispersion. The Central Bank of Peru conducts a monthly survey among 350 representative firms from the non-financial sector and 45 professional forecasters since 2002. Following Kumar et al. (2015) we evaluate how anchored inflation expectations in Peru are using four measures: (i) closeness to the Central Bank inflation target, (ii) dispersion across agents, (iii) forecast revisions, and (iv) co-movement between long-run inflation expectations and short-run inflation expectations. Although inflation expectations seem to be somehow anchored to the upper limit of the target band, they do not achieve some of the basic properties required under weaker definitions of anchored expectations. This ‘imperfect anchoring’ may seem precarious as any shock can move away inflation expectations from the Central Bank target and can limit monetary policy success.
    Date: 2017–09
  2. By: Beck, Guenter W.; Wieland, Volker
    Abstract: Since 2014 the ECB has implemented a massive expansion of monetary policy including large-scale asset purchases and negative policy rates. As the euro area economy has improved and inflation has risen, questions concerning the future normalization of monetary policy are starting to dominate the public debate. The study argues that the ECB should develop a strategy for policy normalization and communicate it very soon to prepare the ground for subsequent steps towards tightening. It provides analysis and makes proposals concerning key aspects of this strategy. The aim is to facilitate the emergence of expectations among market participants that are consistent with a smooth process of policy normalization.
    Date: 2017
  3. By: Malgorzata Skibinska
    Abstract: This paper analyses the di erences in reaction of domestic and foreign currency lending to monetary and exchange rate shocks, using a panel VAR model estimated for three biggest Central and Eastern European countries (Poland, the Czech Republic and Hungary). Our results point toward a drop in domestic currency loans and an increase of foreign currency credit in reaction to monetary policy tightening in Poland and Hungary, suggesting that the presence of foreign currency debt weakens the transmission of monetary policy. A currency depreciation shock leads to an initial decline in foreign currency lending, but also in loans denominated in domestic currency as central banks react to a weaker exchange rate by increasing the interest rates. However, after several quarters, credit in foreign currency accelerates, indicating that borrowers start using it to substitute for depressed domestic currency lending.
    Keywords: foreign currency loans, lending currency structure, monetary policy and exchange rate shocks, CEE countries
    JEL: E44 E52 E58
    Date: 2017–08
  4. By: C. Pfister
    Abstract: In spite of a still very low volume at the global level, in comparison with the main reserve currencies, digital currencies attract a lot of attention. The paper reminds that it is above all the exchange mechanism incorporated in digital currencies (the distributed ledger technology) which should contribute to their success. It is shown that a widespread use of these currencies is likely to materialize only under conditions that would essentially leave unchanged the capacity of the central bank to pursue the same inflation target using the same instruments as today, by setting an interest rate level. However, some adjustments may have to be made to the definition of monetary aggregates and possibly also to the base and/or the ratios of reserve requirements. Even in the most extreme and unlikely scenario, where the central bank would issue CBDC the public would have access to and massively adopt, banks’ role in distributing credit would likely not be seriously impaired. Banks might rather have less direct information on their clients. They would possibly also become more dependent on central bank refinancing, which would call for a clear and pre-announced lending of last resort policy in order to limit moral hazard considerations.
    Keywords: Digital currencies, Money, Monetary policy.
    JEL: E52 E58
    Date: 2017
  5. By: Mei Dong (Department of Economics, University of Melbourne); Sylvia Xiaolin Xiao (School of Economics, Auckland University of Technology)
    Abstract: We discover a consumption channel of monetary policy in a model with money and government bonds. When the central bank withdraws government bonds (short-term or long-term) through open market operations, it lowers re- turns on bonds. The lower return has a direct negative impact on consumption by households that hold bonds, and an indirect negative impact on consumption by households that hold money. As a result, fi rms earn less pro fits from production, which leads to higher unemployment. The existence of such a consumption channel can help us understand the e¤ects of unconventional monetary policy.
    Keywords: interest rate, monetary policy, consumption, unemployment
    Date: 2017–07
  6. By: Fang Yao; Margarita Rubio (Reserve Bank of New Zealand)
    Abstract: In the aftermath of the global financial crisis, a new set of challenges has emerged for macroeconomic policy makers. One of the major changes in the post-crisis environment is a significant and permanent decline in interest rates. In many economies, the short-term nominal interest rate has been close to zero. Monetary policymakers have encountered difficulties in stimulating the economy because the interest rate cannot be lowered any further. Moreover, when interest rates are persistently low, agents tend to engage in speculative investment in assets, such as real estate. Therefore, low interest rates may also contribute to asset price bubbles and excessive leverage, which pose risks to financial stability. One of the policies that has become important after the crisis is the so-called macroprudential policy, aimed at ensuring a more stable financial system. In this paper, we focus on the use of macroprudential policies in an economic environment in which interest rates are low. We argue that, in a low interest-rate environment, the case for using macroprudential policies becomes even stronger. On the one hand, greater financial volatility due to low interest rates calls for macroprudential policies to contain excessive bank lending. On the other hand, macroprudential policy may also complement monetary policy when the interest rate is close to zero and cannot be used to stabilise the economy anymore. We build an economic model for policy evaluation that can take into account that nominal interest rates are subject to a zero lower bound and cannot become negative. We calibrate the model to characteristics of the US economy where the Federal funds rate has been close to zero for 7 years. Within this setting, we find that when the interest rate is persistently low, activity in the financial markets and the wider economy, becomes more volatile. Therefore, we propose macroprudential policy as a candidate to stabilise the economy in this context. On the one hand, we find that in a low interest-rate environment, tighter macroprudential policies can stabilise financial markets. We also find, on the other hand, that macroprudential policies could help monetary policy stimulate the economy when interest rates are close to zero.
    Date: 2017–09
  7. By: Marek Dabrowski
    Abstract: The recent wave of financial innovation, particularly innovation related to the application of information and communication technologies, poses a serious challenge to the financial industry’s business model in both its banking and non-banking components. It has already revolutionised financial services and, most likely, will continue to do so in the future. If not responded to adequately and timely by regulators, it may create new risks to financial stability, as occurred before the global financial crisis of 2007-2009. However, financial innovation will not seriously affect the process of monetary policymaking and is unlikely to undermine the ability of central banks to perform their price stability mission. The recent wave of financial innovation, particularly innovation related to the application of information and communication technologies, poses a serious challenge to the financial industry’s business model in both its banking and non-banking components. It has already revolutionised financial services and, most likely, will continue to do so in the future. If not responded to adequately and timely by regulators, it may create new risks to financial stability, as occurred before the global financial crisis of 2007-2009. However, financial innovation will not seriously affect the process of monetary policymaking and is unlikely to undermine the ability of central banks to perform their price stability mission.
    Keywords: monetary policy, financial innovation, electronic money
    JEL: E41 E44 E51 E52 E58 G21
    Date: 2017–07
  8. By: Goodhart, Charles A
    Abstract: Unlike other facets of monetary policy renormalisation, there has been little discussion yet of what principles should determine the optimum size of a Central Bank's balance sheet, the end-point to which on-going portfolio reductions should approach. In this note I start by addressing the arguments of those who would leave this balance sheet very large, much as now; and then continue with the counter-arguments, also stressing the nature of the relationships between monetary and fiscal policies, and between the Central Bank and the Treasury's Debt Management Office.
    Keywords: auction risk; Central Bank Balance Sheet; Debt Management; interest rate risk; liquidity; Monetary Policy Renormalisation; QE
    JEL: E50 E52 E63 H63
    Date: 2017–09
  9. By: Supriya Kapoor (UCD Geary Institute for Public Policy)
    Abstract: The role of banks in the transmission of monetary policy has been of significance lately. We aim to analyse the bank lending behaviour during changes in monetary policy. We test for loan supply shifts by segregating banks based on their liquidity along with size and capital ratio. This paper employs uninsured, non-reservable liabilities such as time deposits and investigates whether banks are able to insulate themselves during a monetary policy change. We find that the loan supply shock can be neutralized post monetary policy changes. Furthermore, the less liquid and small banks are unable to carry out such operations and are more affected by monetary shocks. This has important implication in the working of commercial banks and effects of monetary policy.
    Keywords: bank lending channel, time deposits, monetary policy, liquidity
    JEL: E52 G21 E50
    Date: 2017–11–09
  10. By: Poutineau, Jean-Christophe; Vermandel, Gauthier
    Abstract: This paper questions the role of cross-border lending in the definition of national macroprudential policies in the European Monetary Union. We build and estimate a two-country DSGE model with corporate and interbank cross-border loans, Core-Periphery diverging financial cycles and a national implementation of coordinated macroprudential measures based on Countercyclical Capital Buffers. We get three main results. First, targeting a national credit-to-GDP ratio should be favored to federal averages as this rule induces better stabilizing performances in front of important divergences in credit cycles between core and peripheral countries. Second, policies reacting to the evolution of national credit supply should be favored as the transmission channel of macroprudential policy directly impacts the marginal cost of loan production and, by so, financial intermediaries. Third, the interest of lifting up macroprudential policymaking to the supra-national level remains questionable for admissible value of international lending between Eurozone countries. Indeed, national capital buffers reacting to the union-wide loan-to-GDP ratio only lead to the same stabilization results than the one obtained under the national reaction if cross-border lending reaches 45%. However, even if cross-border linkages are high enough to justify the implementation of a federal adjusted solution, the reaction to national lending conditions remains remarkably optimal.
    Keywords: Macroprudential Policy; Global Banking; International Business Cycles; Euro Area
    JEL: E58 F34 F4 F42
    Date: 2016–11–01
  11. By: Robert J. Kurtzman; Stephan Luck; Thomas Zimmermann
    Abstract: Using confidential loan officer survey data on lending standards and internal risk ratings on loans, we document an effect of large-scale asset purchase programs (LSAPs) on lending standards and risk-taking. We exploit cross-sectional variation in banks’ holdings of mortgage-backed securities to show that the first and third round of quantitative easing (QE1 and QE3) significantly lowered lending standards and increased loan risk characteristics. The magnitude of the effects is about the same in QE1 and QE3, and is comparable to the effect of a one percentage point decrease in the Fed funds target rate.
    Keywords: Banks ; QE ; Risk ; SLOOS ; STBL
    JEL: E43 E52 G21
    Date: 2017–09–06
  12. By: Jean-Philippe Bouchaud; Stanislao Gualdi; Marco Tarzia; Francesco Zamponi
    Abstract: Which level of inflation should Central Banks be targeting? We investigate this issue in the context of a simplified Agent Based Model of the economy. Depending on the value of the parameters that describe the micro-behaviour of agents (in particular inflation anticipations), we find a surprisingly rich variety of behaviour at the macro-level. Without any monetary policy, our ABM economy can be in a high inflation/high output state, or in a low inflation/low output state. Hyper-inflation, stagflation, deflation and business cycles are also possible. We then introduce a Central Bank with a Taylor-rule-based inflation target, and study the resulting aggregate variables. Our main result is that too low inflation targets are in general detrimental to a CB-controlled economy. One symptom is a persistent under-realisation of inflation, perhaps similar to the current macroeconomic situation. This predicament is alleviated by higher inflation targets that are found to improve both unemployment and negative interest rate episodes, up to the point where erosion of savings becomes unacceptable. Our results are contrasted with the predictions of the standard DSGE model.
    Date: 2017–09
  13. By: Hernando Vargas (Banco de la República de Colombia); Pamela Cardozo (Banco de la República de Colombia); Andrés Murcia (Banco de la República de Colombia)
    Abstract: Macroprudential policy in Colombia is described along with a discussion of the main challenges faced by the authorities in implementing it and a review of episodes in which macroprudential measures were taken. An overview and some estimates of their effectiveness in preventing the buildup of imbalances, increasing buffers and cushioning downswings are presented. Classification JEL: E51, E58, F32, F38, G18, G28.
    Keywords: macroprudential policy, financial stability, financial regulation, financial safety net, central banking, Colombia
    Date: 2017–09
  14. By: Bianchi, Francesco; Lettau, Martin; Ludvigson, Sydney
    Abstract: This paper presents evidence of infrequent shifts, or "regimes," in the mean of the consumption-wealth variable cay_{t} that are strongly associated with low frequency fluctuations in the real value of the Federal Reserve's primary policy rate, with low policy rates associated with high asset valuations, and vice versa. By contrast, there is no evidence that infrequent shifts to high asset valuations and low policy rates are associated with higher economic growth or lower economic uncertainty; indeed the opposite is true. Additional evidence shows that low interest rate/high asset valuation regimes coincide with significantly lower equity market risk premia.
    Keywords: Asset Pricing; monetary policy; Real interest rate; Risk premium
    JEL: G10 G12 G17
    Date: 2017–09
  15. By: Cuiabano, Simone
    Abstract: The goal of this paper is to analyze the long-run equilibrium exchange rate in Latin America and Asia countries using the monetary model described in Obstfeld and Rogoff (1996) to evaluate the exchange rate gap between the regions. I use panel cointegration tests to verify the existence of panel cointegration for the countries. I estimate the coefficients of the long-run exchange rate function using the dynamic OLS (DOLS) from a balanced panel of 14 countries and quarterly observations that span from 1999 to 2015. The estimation shows the impact of monetary aggregates on the exchange rate. In addition, it points the exchange rate gap between Latin America and Asia. For example, long run equilibrium exchange rate between Latin America and Asia means 4% depreciation in this last region’s currency.
    Keywords: exchange rate determination; monetary model; cointegration; panel
    JEL: C22 C23 F21 F31
    Date: 2017–08
  16. By: Eggertsson, Gauti B. (Brown University); Mehrotra, Neil (Federal Reserve Bank of Minneapolis); Robbins, Jacob A. (Brown University)
    Abstract: This paper formalizes and quantifies the secular stagnation hypothesis, defined as a persistently low or negative natural rate of interest leading to a chronically binding zero lower bound (ZLB). Output-inflation dynamics and policy prescriptions are fundamentally different from those in the standard New Keynesian framework. Using a 56-period quantitative life cycle model, a standard calibration to US data delivers a natural rate ranging from -1.5% to -2%, implying an elevated risk of ZLB episodes for the foreseeable future. We decompose the contribution of demographic and technological factors to the decline in interest rates since 1970 and quantify changes required to restore higher rates.
    Keywords: Secular stagnation; Monetary policy; Zero lower bound
    Date: 2017–09–05
  17. By: Matthew Jaremski; Gabriel Mathy
    Abstract: Outside of the recent past, excess reserves have only concerned policymakers in one other period: the Great Depression. The data show that excess reserves in the 1930s were never actively unwound through a reduction in the monetary base. Nominal economic growth swelled required reserves while an exogenous reduction in monetary gold inflows due to war embargoes in Europe allowed excess reserves to naturally decline towards zero. Excess reserves fell rapidly in early 1941 and would have unwound fully even without the entry of the United States into World War II. As such, policy tightening was at no point necessary and could have contributed to the 1937-1938 Recession.
    JEL: E32 E58 N12
    Date: 2017–09
  18. By: Fausto Pacicco; Luigi Vena; Andrea Venegoni
    Abstract: Financial markets vest an important role both in conveying monetary policy innovations to the real economy and in shaping business cycle’s fluctuations. Hence, it becomes crucial to assess whether the ECB is able to wield homogeneous reactions in the main Eurozone stock markets and to quell their turbulences. The empirical analysis shows that conventional policy rate shifts affect unevenly the equity indices of the countries analysed, generating asymmetries between their business cycles. Moreover, the ECB stance proved unable to weather the storm and trigger an economic recovery. This calls for a refinement of ECB conduct and justifies the extensive employment of unconventional measures to revive the economy.
    Date: 2017–07
  19. By: Thorir Bjarnason (School of Science and Engineering, Reykjavik University, Iceland); Einar Jón Erlingsson (School of Science and Engineering, Reykjavik University, Iceland); Bulent Ozel (LEE and Department of Economics, Universitat Jaume I, Castellón, Spain); Hlynur Stefánsson (School of Science and Engineering, Reykjavik University, Iceland); Jón Thor Sturluson (School of Science and Engineering, Reykjavik University, Iceland); Marco Raberto (DIME-University of Genoa, Italy)
    Abstract: Mortgage instruments differ in many respects. Their microeconomic effects might be easily calculated but their effects on a macroeconomic level are not always easily understood. Agent-based models can be used to study the macroeconomic effects that emerge from the microeconomic behavior of multiple interacting agents. Using a macroeconomic model of a credit network economy we have found that inflation-indexed mortgages can mislead households’ expectations of risk, encouraging them to buy more housing due to their low initial amortizations which, in turn, stimulates housing prices. The results further hint that in long-run inflation-indexed mortgages create relatively more uneven housing wealth distribution in between households. We also find that the effectiveness of standard monetary policy tools is diminished when inflation-indexed mortgages are used. Banks partake in the interest rate risk with fixed rate mortgages but bear little or no risk with adjustable rate or inflation-indexed mortgages. We have seen in this study that mortgage types, macroprudential tools and other policy tools can be experimented on, give insights into the interplay between agents and insight into the effects that certain policy settings may have on a macroeconomic level.
    Keywords: Credit cycles, mortgage, housing market, agent-based model, inflation-indexation
    JEL: C63 E25 G21 R31 R38
    Date: 2017
  20. By: Hanno Lustig; Robert J. Richmond
    Abstract: We relate the risk characteristics of currencies to measures of physical, cultural, and institutional distance. The currencies of countries which are more distant from other countries are more exposed to systematic currency risk. This is due to a gravity effect in the factor structure of bilateral exchange rates: When a currency appreciates against a basket of all other currencies, its bilateral exchange rate appreciates more against the currencies of distant countries. As a result, currencies of peripheral countries are more exposed to the systematic variation than currencies of central countries. Trade network centrality is the best predictor of a currency’s average exposure to systematic risk.
    JEL: F31 G15
    Date: 2017–09
  21. By: Stéphanie Guichard
    Abstract: Financial globalisation has given international capital flows a central role in the functioning of the global economy and has therefore led to considerable economic research over the past 30 years. Making the most of capital flows by allowing countries to reap their benefits while reducing associated risks has always been a challenge. This challenge became however even more acute in the past decade: following the Global Financial Crisis new concerns have indeed emerged related to the complexity of global financial relations, their role in shock transmission as well the ability of fundamentals to protect countries from financial instability. Against this background, recent research has focused on understanding better the implications of financial globalisation for economic stability and the design of policies. This literature review assesses these recent developments. After reviewing the most important trends in capital flows over the past decade, it takes stock of the discussion on the role of the global financial cycle in driving cross-border capital flows and financial instability, reviews the new findings on the real impact of international capital flows on recipient economies, and provides an overview of the ongoing debates on the role of capital controls and the need for policy coordination.
    Keywords: cross-border capital flows, financial globalisation
    JEL: F21 F32 F42
    Date: 2017–09–19

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