nep-mon New Economics Papers
on Monetary Economics
Issue of 2021‒01‒04
37 papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. The Financial Accelerator in the Euro Area: New Evidence Using a Mixture VAR Model By Hamza Bennani; Matthias Neuenkirch
  2. Precautionary Liquidity Shocks, Excess Reserves and Business Cycles By Bratsiotis, George; Theodoridis, Konstantinos
  3. Monetary policy strategies in the New Normal: a model-based analysis for the euro area By Fabio Busetti; Stefano Neri; Alessandro Notarpietro; Massimiliano Pisani
  4. Mandates and Monetary Rules a New Keynesian Framework By Szabolcs Deak; Paul Levine; Son T. Pham
  5. European Monetary Union and Inequality: A Synthetic Control Approach By Florentin Kerschbaumer; Andreas Maschke
  6. Targeting a sustainable recovery with Green TLTROs By van 't Klooster, Jens; van Tilburg, Rens
  7. Unconventional Monetary Policy through Open Market Operations: A Principal Component Analysis By Markus Heckel; Kiyohiko G. Nishimura
  8. High-frequency Identification of Unconventional Monetary Policy Shocks in Japan By Hiroyuki Kubota; Mototsugu Shintani
  9. Whatever it takes to save the planet? Central banks and unconventional green policy By Ferrari, Alessandro; Landi, Valerio Nispi
  10. The market stabilization role of central bank asset purchases: high-frequency evidence from the COVID-19 crisis By Marco Bernardini; Annalisa De Nicola
  11. Monetary policy and inequality By Asger Lau Andersen; Niels Johannesen; Mia Jørgensen; José-Luis Peydró
  12. Euro Area Monetary Communications: Excess Sensitivity and Perception Shocks By Valentin Jouvanceau; Ieva Mikaliunaite
  13. Pro-Rich Inflation and Optimal Income Taxation By Eren Gürer; Alfons Weichenrieder
  14. Estimating a Nonlinear New Keynesian Model with the Zero Lower Bound for Japan By Hirokuni Iiboshi; Mototsugu Shintani; Kozo Ueda
  15. Oil prices, exchange rates and interest rates By Kilian, Lutz; Zhou, Xiaoqing
  16. The (in)stability of stock returns and monetary policy interdependence in the US By Emiliano A. Carlevaro; Leandro M. Magnusson
  17. How Did Market Perceptions of the FOMC’s Reaction Function Change after the Fed’s Framework Review? By Ryan Bush; Haitham Jendoubi; Matthew Raskin; Giorgio Topa
  18. Oil prices, gasoline prices and inflation expectations: A new model and new facts By Kilian, Lutz; Zhou, Xiaoqing
  19. Weigh(t)ing the basket: aggregate and component-based inflation forecasts for the euro area By Chalmovianský, Jakub; Porqueddu, Mario; Sokol, Andrej
  20. Monetary policy and the term structure of Inflation expectations with information frictions By Jmaes McNeil
  21. How informative are quantified survey data? Evidence from RBI household inflation expectations survey By Singh, Gaurav Kumar
  22. On the negatives of negative interest rates and the positives of exemption thresholds By Aleksander Berentsen; Hugo van Buggenum; Romina Ruprecht
  23. Monetary Policy with Reserves and CBDC: Optimality, Equivalence, and Politics By Dirk Niepelt
  24. Four years of the inflation targeting framework. By Patnaik, Ila; Pandey, Radhika
  25. Precautionary Money Demand in a Cash-in-Advance Model By Sergio Salas
  26. Expectations formation of household inflation expectations in India By Singh, Gaurav Kumar
  27. From Keynes' Liquidity Preference to Gesell's Basic Interest By Ahmed Anwar
  28. What share for gold? On the interaction of gold and foreign exchange reserve returns By Omar Zulaica
  29. Monetary Growth Rules in an Emerging Open Economy By Maryam Mirfatah; Vasco J. Gabriel; Paul Levine
  30. Stablecoins: potential, risks and regulation By Douglas Arner; Raphael Auer; Jon Frost
  31. Capital flows during the pandemic: lessons for a more resilient international financial architecture By Fernando Eguren Martin; Mark Joy; Claudia Maurini; Alessandro Moro; Valerio Nispi Landi; Alessandro Schiavone; Carlos van Hombeeck
  32. Supply and demand shifts of shorts before Fed announcements during QE1–QE3 By Thomas H. McInish; Christopher J. Neely; Jade Planchon
  33. Dominant Currencies and External Adjustment By Gustavo Adler; Camila Casas; Luis M. Cubeddu; Gita Gopinath; Nan Li; Sergii Meleshchuk; Carolina Osorio Buitron; Damien Puy; Yannick Timmer
  34. Digital Money as a Unit of Account and Monetary Policy in Open Economies By Daisuke Ikeda
  35. Climate-related Risks and Central Banks’ Collateral Policy: a Methodological Experiment By Oustry Antoine; Erkan Bunyamin; Svartzman Romain; Weber Pierre-François
  36. Risk preferences, global market conditions and foreign debt: Is there any role for the currency composition of FX reserves? By Mateane, Lebogang
  37. Two Illustrations of the Quantity Theory of Money Reloaded By ; Mariano Kulish; Juan Pablo Nicolini

  1. By: Hamza Bennani; Matthias Neuenkirch
    Abstract: We estimate a logit mixture vector autoregressive model describing monetary policy transmission in the euro area over the period 2003Q1–2019Q4 with a special emphasis on credit conditions. With the help of this model, monetary policy transmission can be described as mixture of two states (e.g., a normal state and a crisis state), using an underlying logit model determining the relative weight of these states over time. We show that shocks to the credit spread and shocks to credit standards directly lead to a reduction of real GDP growth, whereas shocks to the quantity of credit are less important in explaining growth fluctuations. Credit standards and the credit spread are also the key determinants of the underlying state of the economy in the logit submodel. Together with a more pronounced transmission of monetary policy shocks in the crisis state, this provides further evidence for a financial accelerator in the euro area. Finally, the detrimental effect of credit conditions is also reflected in the labor market.
    Keywords: credit growth, credit spread, credit standards, euro area, financial accelerator, mixture VAR, monetary policy transmission
    JEL: E44 E52 E58 G21
    Date: 2020
  2. By: Bratsiotis, George (Department of Economics, University of Manchester); Theodoridis, Konstantinos (Cardiff Business School)
    Abstract: This paper identifies a precautionary banking liquidity shock via a set of sign, zero and forecast variance restrictions imposed. The shock proxies the reluctance of the banking sector to "lend" to the real economy induced by an exogenous change in financial intermediaries' preference for "high" liquid assets. The identified shock has sizeable and state (volatility) dependent effects on the real economy. To understand the transmission of the shock, we develop a DSGE model of financial intermediation with credit and liquidity frictions. The precautionary liquidity shock is shown to work through two channels: it increases the level of reserves and the deposit rate. The former is a balance sheet effect, which reduces the loan-to-deposit ratio. The higher deposit rate affects the intertemporal decisions of households and the cost of borrowing to firms. The overall effect is a downward co-movement in output, consumption, investment and prices, which is amplified the higher are the long-run risks in the economy and the responsiveness of banks to potential risk.
    Keywords: House Prices, SVAR; Sign and Zero Restrictions; DSGE; Precautionary Liquidity Shock; Excess Reserves; Deposit Rate; Risk, Financial Intermediation.
    JEL: C10 C32 E30 E43 E51 G21
    Date: 2020–12
  3. By: Fabio Busetti; Stefano Neri (Bank of Italy); Alessandro Notarpietro (Bank of Italy); Massimiliano Pisani (Bank of Italy)
    Abstract: A New Keynesian model calibrated to the euro area is used to evaluate the stabilization properties of alternative monetary policy strategies when the natural interest rate is low (‘new normal’) and the probability of reaching the effective lower bound (ELB) is non-negligible. Price level targeting is the most effective strategy in terms of stabilizing inflation and output and of reducing the duration and frequency of ELB episodes. Temporary price level targeting is also effective in mitigating the ELB constraint, although its stabilization properties are inferior to those of price level targeting. Backward-looking average inflation targeting performs well and is preferable to inflation targeting. The effectiveness of these alternative strategies hinges upon the commitment of a central bank to keeping the policy rate ‘lower for longer’ and is influenced by the agents’ expectation formation mechanism.
    Keywords: monetary policy, natural interest rate, effective lower bound.
    JEL: E31 E32 E58
    Date: 2020–12
  4. By: Szabolcs Deak (University of Exeter and CIMS); Paul Levine (University of Surrey and CIMS); Son T. Pham (University of Surrey)
    Abstract: We develop a general mandate framework for delegating monetary policy to an instrument-independent, but goal-dependent central bank. The goal of the mandate consists of: (i) a simple quadratic loss function that penalizes deviations from target macroeconomic variables; (ii) a form of a Taylor-type nominal interest-rate rule that responds to the same target variables; (iii) a zero-lower-bound (ZLB) constraint on the nominal interest rate in the form of an unconditional probability of ZLB episodes and (iv) a long-run (steady-state) inflation target. The central bank remains free to choose the strength of its response to the targets specified by the mandate. An estimated standard New Keynesian model is used to compute household-welfare-optimal mandates with these features. We find two main results that are robust across a number of different mandates: first, the optimized rule takes the form of a Taylor simple rule close to a price-level rule. Second, the optimal level of inflation target, conditional on a quarterly frequency of the nominal interest hitting the ZLB of 0.025, is close to the typical target annual inflation of 2% and to achieve a lower probability of 0.01 requires an inflation target of 3.5%.
    JEL: E52 E58 E61
    Date: 2020–08
  5. By: Florentin Kerschbaumer; Andreas Maschke (University of Leeds)
    Abstract: The promise of greater material prosperity and economic convergence has underpinned the process of European economic integration. Its consequences for income inequalities within countries, however, have so far been little discussed. This paper seeks to contribute to the literature by investigating the effects of European economic integration on intra-country income inequality using the synthetic control method. We find that EMU, out of our sample of eight euro countries, has significant effects on inequality in Germany and Spain. From the several theories outlined in the literature, our results lend most support to the growth regime mechanism.
    Keywords: Income Inequality, European Monetary Union, Synthetic Control Method
    JEL: D63 N10 N14 P16
    Date: 2020–12
  6. By: van 't Klooster, Jens; van Tilburg, Rens
    Abstract: Since their introduction in 2014, the European Central Bank’s Targeted Longer-Term Refinancing Operations (TLTROs) have become ever larger and ever more attractive for banks. As they increasingly drive bank lending, TLTROs often enable unsustainable investments. This report proposes Green TLTROs, which are refinancing operations that provide banks with cheap funding if they lend in accordance with the EU’s taxonomy of green activities. We discuss the legality of such a market-based programme and show that it is compatible with a level playing field between banks and the singleness of monetary policy. We outline several possible technical designs of the Green TLTROs and suggest a pilot programme for energy efficient housing that can quickly be implemented.
    Date: 2020–12–18
  7. By: Markus Heckel (German Institute for Japanese Studies); Kiyohiko G. Nishimura (Graduate Institute for Policy Studies (GRIPS) and CARF, University of Tokyo)
    Abstract: This paper examines the unconventional monetary policies of the Bank of Japan from 2002 to 2019 with a focus on open market operations. We apply a principal component analysis to investigate the complexity of the operations. We find that four principal components (PCs) explain most of the variance of the Bank of Japan’s operations of various facilities and measures. We are able to distinguish between ‘quantitative easing policy’, which is ‘asset purchase measures’ including JGBs, ETF and J-REIT (PC1), and different liquidity supply measures (PC2-4). The results are robust among different variable sets and time frames. We also find the complexity, measured by the number of PCs needed to explain the variance, differs substantially between three sub-periods of different governorships: Fukui (2003-2008), Shirakawa (2008-2013) and Kuroda (2013-present). We observe that open market operations of the Shirakawa era were the most complex, resulting in an increased number of PCs (five to seven depending on particular specifications). In contrast, the corresponding number in the other eras has been at most two (Fukui) and four (Kuroda).
    Date: 2020–12
  8. By: Hiroyuki Kubota (The University of Tokyo); Mototsugu Shintani (The University of Tokyo)
    Abstract: In this paper, we consider the issue of identifying unconventional monetary policy shocks in Japan by using the market-based measure of policy surprises obtained from high-frequency data. First, we investigate the effects of the monetary policy surprises on asset prices changes as an event study, which is based on the date and time of the monetary policy announcement made by the Bank of Japan. Using the methodology developed by Gürkaynak, Sack, and Swanson (2005), we find that the contractionary monetary policy has negative effects on stock returns. Second, we estimate the effects of unconventional monetary policy on real economic activity and inflation. By combining the vector autoregressive approach of Gertler and Karadi (2015) who employ high-frequency policy surprises as external instruments to identify the structural shocks, and that of Debortoli, Galí, and Gambetti (2020), who employ the long rate as the policy indicator during the period when the short rate is constrained by the zero lower bound, we find that unconventional monetary policy has been effective in Japan over the last two decades.
    Date: 2020–12
  9. By: Ferrari, Alessandro; Landi, Valerio Nispi
    Abstract: We study the effects of a temporary Green QE, defined as a policy that temporarily tilts the central bank’s balance sheet toward green bonds, i.e. bonds issued by firms in non-polluting sectors. To this purpose, we merge a standard DSGE framework with an environmental model. In our model, detrimental emissions produced by the brown sector increase the stock of pollution. We find that the imperfect substitutability between green and brown bonds is a necessary condition for the effectiveness of Green QE. Under the assumption of imperfect substitutability, we point out the following results. A temporary Green QE is an effective tool in mitigating detrimental emissions. However, Green QE has limited effects in reducing the stock of pollution, if pollutants are slow-moving variables such as atmospheric carbon. The welfare gains of Green QE are positive but small. Welfare gains increase if the flow of emissions negatively affects also the utility of households. JEL Classification: E52, E58, Q54
    Keywords: central bank, climate change, monetary policy, quantitative easing
    Date: 2020–12
  10. By: Marco Bernardini (Bank of Italy); Annalisa De Nicola (Bank of Italy)
    Abstract: This paper uses confidential high-frequency data to investigate the dynamic effects on the government bond market of the central bank asset purchases carried out in Italy during the COVID-19 pandemic crisis. We find that in response to an outright purchase of long-term bonds: (i) long-term yields drop by 4 to 5 basis points per billion euros on impact and tend to remain subdued over the trading day; (ii) short- and medium-term bond yields are also strongly affected; (iii) the yield curve shifts downwards and flattens owing to a reduction in the credit and liquidity risk premia embedded in sovereign spreads; (iv) market liquidity improves steadily. We also show that: (v) the yield impact of a purchase is substantially larger in times of heightened market stress; (vi) asset purchases operate similarly and effectively in quieter times as well. These results suggest that actual purchases affect market prices over and above purchase announcements, and that adjusting their pace and composition according to market conditions can boost the overall effectiveness of a programme.
    Keywords: monetary policy, asset purchases, high-frequency data, local projections
    JEL: C22 E43 E44 E52 E58
    Date: 2020–12
  11. By: Asger Lau Andersen; Niels Johannesen; Mia Jørgensen; José-Luis Peydró
    Abstract: We analyze the distributional effects of monetary policy on income, wealth and consumption. For identification, we exploit administrative household-level data covering the entire population in Denmark over the period 1987-2014, including detailed information about income and wealth from tax returns, in conjunction with exogenous variation in the Danish monetary policy rate created by a long-standing currency peg. Our results consistently show that all income groups gain from a softer monetary policy, but that the gains are monotonically increasing in the ex-ante income level. Over a two-year horizon, a decrease in the policy rate of one percentage point raises disposable income by less than 0.5% at the bottom of the income distribution, by around 1.5% at the median income and by around 5% at the top. The effects on asset values through increases in house prices and stock prices are larger than the effects on disposable income by more than an order of magnitude and exhibit a similar monotonic income gradient. We show how all these distributional effects reflect systematic differences in the exposure to the direct and indirect channels of monetary policy. Consistent with the main results for disposable income and asset values, we also find that the effects on net wealth and consumption (car purchases) increase monotonically over the ex-ante income distribution. Our estimates imply that softer monetary policy increases income inequality by raising income shares at the top of the income distribution and reducing them at the bottom.
    Keywords: Monetary policy, inequality, household heterogeneity
    JEL: E2 E4 E5 G2 G1 G5
    Date: 2020–12
  12. By: Valentin Jouvanceau (Bank of Lithuania); Ieva Mikaliunaite (Bank of Lithuania)
    Abstract: We explore new dimensions of the ECB’s monetary communications using the Euro Area Monetary Policy Event-Study Database (EA-MPD) built by Altavilla et al. (2019). We find that three new factors are needed to capture an excess sensitivity of long-term sovereign yields around monetary announcements. "Duration" surprises cause variations in real long-term rates and are mainly transmitted by term premiums. The "Sovereign spread" and "Save the Euro" surprises greatly influence the long-term yields of the periphery countries. These effects are difficult to reconcile with classic monetary policy shocks. We therefore study their underlying nature and discover that they have the characteristics of "Information", or what we label "Perception" shocks.
    Keywords: Monetary surprises, Event-study, Excess sensitivity, Perception shocks, High-frequency Identification
    JEL: E43 E44 E52 E58 G12
    Date: 2020–10–08
  13. By: Eren Gürer; Alfons Weichenrieder
    Abstract: This paper studies the implications of an increase in the price of necessities, which disproportionally hurts the poor, for optimal income taxation. Our analyses show that, when the government is utilitarian and disutility from labor supply is linear, the optimal net nominal tax schedule is unchanged and the government expects households to supply more labor in order to secure their consumption expenditures. Quantitative analyses with convex disutility of labor supply reveal that, because of positive labor supply effects, keeping average tax rates constant suffices to optimally react to the asymmetric price shock. However, the poorest agents are expected to increase their labor supply the most. Thus, optimal income tax policy in response to asymmetric price changes does not prevent the disproportional decline in the indirect utility of poorer households.
    Keywords: pro-rich inflation, optimal income taxation
    JEL: H21 E31
    Date: 2020
  14. By: Hirokuni Iiboshi; Mototsugu Shintani; Kozo Ueda
    Abstract: Which type of monetary policy rule best describes the policy conducted by the Bank of Japan during the period when the nominal interest rate is constrained at the zero lower bound (ZLB)? What are the economic fundamentals that explain Japan's prolonged stagnation? How important is incorporating nonlinearities in the analysis? We answer these questions by estimating a small-scale nonlinear DSGE model. We find that: the Bank of Japan conducted a threshold-based forward guidance policy; adverse demand shocks explain Japan's experience; and nonlinear models are very useful in the analysis of the Japanese economy during the ZLB period.
    Date: 2020–12
  15. By: Kilian, Lutz; Zhou, Xiaoqing
    Abstract: There has been much interest in the relationship between the price of crude oil, the value of the U.S. dollar, and the U.S. interest rate since the 1980s. For example, the sustained surge in the real price of oil in the 2000s is often attributed to the declining real value of the U.S. dollar as well as low U.S. real interest rates, along with a surge in global real economic activity. Quantifying these effects one at a time is difficult not only because of the close relationship between the interest rate and the exchange rate, but also because demand and supply shocks in the oil market in turn may affect the real value of the dollar and real interest rates. We propose a novel identification strategy for disentangling the causal effects of traditional oil demand and oil supply shocks from the effects of exogenous variation in the U.S. real interest rate and in the real value of the U.S. dollar. Our approach exploits a combination of sign and zero restrictions and narrative restrictions motivated by economic theory and extraneous evidence. We empirically evaluate popular views about the role of exogenous real exchange rate shocks in driving the real price of oil, and we examine the extent to which shocks in the global oil market drive the U.S. real exchange rate and U.S. real interest rates. Our evidence for the first time provides direct empirical support for theoretical models of the link between these variables.
    Keywords: exchange rate,market rate of interest,oil price,global real activity,commodity
    JEL: E43 F31 F41 Q43
    Date: 2020
  16. By: Emiliano A. Carlevaro (Economics Discipline, Business School, University of Western Australia); Leandro M. Magnusson (Economics Discipline, Business School, University of Western Australia)
    Abstract: We investigate the relationship between conventional monetary policy and stock market returns before, during, and after the zero lower bound (ZLB) period. Our inferential method, which exploits the exogenous changes in the variance of the structural shocks, allows us to recover both effects simultaneously without the need for restrictive identification assumptions. We find dramatic changes in the relationship between monetary policy and stock market returns over the period. Before the ZLB, policymakers reacted to stock returns. Their reaction has been muted since then. Regarding the stock market response, we find that, before the ZLB, a contractionary (expansionary) monetary policy reduces (increases) returns. Since the ZLB period, however, we cannot rule out a positive response of equity prices to monetary tightening.
    Keywords: Structural VAR, Identification, Instability, Monetary Policy
    JEL: C12 E44 G10
    Date: 2020
  17. By: Ryan Bush; Haitham Jendoubi; Matthew Raskin; Giorgio Topa
    Abstract: In late August, as part of the Federal Reserve’s review of Monetary Policy Strategy, Tools, and Communications, the Federal Open Market Committee (FOMC) published a revised Statement on Longer-Run Goals and Monetary Policy Strategy. As observers have noted, the revised statement incorporated important changes to the Federal Reserve’s approach to monetary policy. This includes emphasizing maximum employment as a broad-based and inclusive goal and focusing on “shortfalls” rather than “deviations” of employment from its maximum level. The statement also noted that, in order to anchor longer-term inflation expectations at the FOMC’s longer-run goal, the Committee would seek to achieve inflation that averages 2 percent over time. In this post, we investigate the possible impact of these changes on financial market participants’ expectations for policy rate outcomes, based on responses to the Survey of Primary Dealers (SPD) and Survey of Market Participants (SMP) conducted by the New York Fed’s Open Market Trading Desk both shortly before and after the conclusion of the framework review. We find that the conclusion of the framework review coincided with a notable shift in market participants’ perceptions of the FOMC’s policy rate “reaction function,” in the direction of higher expected inflation and lower expected unemployment at the time of the next increase in the federal funds target range (or “liftoff”).
    Keywords: survey of primary dealers; survey of market participants
    JEL: E58 D53
    Date: 2020–12–18
  18. By: Kilian, Lutz; Zhou, Xiaoqing
    Abstract: The conventional wisdom that inflation expectations respond to the level of the price of oil (or the price of gasoline) is based on testing the null hypothesis of a zero slope coefficient in a static single-equation regression model fit to aggregate data. Given that the regressor in this model is not stationary, the null distribution of the t-test statistic is nonstandard, invalidating the use of the normal approximation. Once the critical values are adjusted, these regressions provide no support for the conventional wisdom. Using a new structural vector regression model, however, we demonstrate that gasoline price shocks may indeed drive one-year household inflation expectations. The model shows that there have been several such episodes since 1990. In particular, the rise in household inflation expectations between 2009 and 2013 is almost entirely explained by a large increase in gasoline prices. However, on average, gasoline price shocks account for only 39% of the variation in household inflation expectations since 1981.
    Keywords: inflation,expectations,anchor,missing disinflation,oil price,gasoline price,household survey
    JEL: E31 E52 Q43
    Date: 2020
  19. By: Chalmovianský, Jakub; Porqueddu, Mario; Sokol, Andrej
    Abstract: We compare direct forecasts of HICP and HICP excluding energy and food in the euro area and five member countries to aggregated forecasts of their main components from large Bayesian VARs with a shared set of predictors. We focus on conditional point and density forecasts, in line with forecasting practices at many policy institutions. Our main findings are that point forecasts perform similarly using both approaches, whereas directly forecasting aggregate indices tends to yield better density forecasts. In the aftermath of the Great Financial Crisis, relative forecasting performance was typically only affected temporarily. Inflation forecasts made by Eurosystem/ECB staff perform similarly or slightly better than those from our models for the euro area. JEL Classification: C11, C32, C53, E37
    Keywords: aggregation, Bayesian VAR model, inflation forecasting
    Date: 2020–12
  20. By: Jmaes McNeil (Department of Economics, Dalhousie University)
    Date: 2020–12–16
  21. By: Singh, Gaurav Kumar
    Abstract: Quantification of the ordinal survey responses on inflation expectations ease and important preliminary step for undertaking further macroeconomic analysis of the data. In this paper, we briefly describe the standard quantification methods along with the underlying assumptions. We also propose two new methods for Quantification. We than apply these methods to quantify the IESH data collected by the Reserve Bank of India (RBI). An interesting fact that emerges from this exercise is simpler quantification methods are found to perform better that more complex methods for IESH data. Also, the methods with time varying weights or time varying thresholds, as the case may be, work significantly better.
    Date: 2020–12–14
  22. By: Aleksander Berentsen; Hugo van Buggenum; Romina Ruprecht
    Abstract: Major central banks remunerate reserves at negative interest rates and it is increasingly likely that they will keep rates negative for many more years. To study the long run implications of negative rates, we construct a dynamic general equilibrium model with commercial banks funding investment projects and a central bank issuing reserves. Negative rates distort investment decisions resulting in lower output and welfare. These findings sharply contrast the short-run expansionary effects ascribed to negative rate policies by most of the existing literature. Negative rates also reduce commercial bank profitability. Exempting a fraction of reserves from negative rates can resolve profitability concerns without affecting the central bank's ability to control the money market rate. However, exemption thresholds do no mitigate the investment distortions created by negative rates.
    Keywords: Negative interest rate, money market, monetary policy, interest rates
    JEL: E40 E42 E43 E50 E58
    Date: 2020–12
  23. By: Dirk Niepelt
    Abstract: We analyze policy in a two-tiered monetary system. Noncompetitive banks issue deposits while the central bank issues reserves and a retail CBDC. Monies differ with respect to operating costs and liquidity. We map the framework into a baseline business cycle model with “pseudo wedges” and derive optimal policy rules: Spreads satisfy modified Friedman rules and deposits must be taxed or subsidized. We generalize the Brunnermeier and Niepelt (2019) result on the macro irrelevance of CBDC but show that a deposit based payment system requires higher taxes. The model implies annual implicit subsidies to U.S. banks of up to 0:8 percent of GDP during the period 1999-2017.
    Keywords: reserves, deposits, central bank digital currency, monetary policy, Friedman rule, equivalence, Ramsey policy, bank profits, money creation
    JEL: E42 E43 E51 E52
    Date: 2020
  24. By: Patnaik, Ila (National Institute of Public Finance and Policy); Pandey, Radhika (National Institute of Public Finance and Policy)
    Abstract: In 2016, India adopted a flexible inflation targeting framework. A six member MPC,with three internal and three external members was set up to determine the policy rate to achieve the inflation target. The CPI based inflation target was set by the Government at 4 percent with a tolerance band of plus/minus 2 percent for the period from August, 2016 to March, 2021. The review of the target is due in a few months. The tenure of the first MPC came to an end with the August, 2020 meeting. In this backdrop, this paper presents a review of the inflation targeting framework in India.
    Date: 2020–11
  25. By: Sergio Salas
    Abstract: Despite a plethora of studies in monetary economics regarding the study of inflation, interest rates, stock returns, and velocity of money, a model that helps to jointly characterize these interactions is still scarce in the literature. A key missing piece in most of the literature attempting such a characterization is idiosyncratic precautionary money demand, which is prevalent in the data. This paper presents a simple model where precautionary money demand arises due to heterogeneity in households' liquidity needs. In spite of its heterogeneous complexity, aggregation in the model is straightforward, this is one of the main contributions of the paper, and therefore an analysis of the models' implications can be undertaken when households' portfolio is composed of cash, government bonds, and equity. The empirical analysis is conducted separately for the time spans 1984.I-2007.IV and 2008.I-2019.IV. The model can capture important time-series properties that a model without the idiosyncratic feature is unable to achieve. However, the model falls short of providing an adequate match of some moments, especially in the second sub-sample of the analysis.
    Keywords: Precautionary money demand, Portfolio allocation, Heterogeneity, Government bonds, Stock Market, Open market operations
    JEL: E41 E51
    Date: 2020–12
  26. By: Singh, Gaurav Kumar
    Abstract: Inflation expectations data are commonly used to address a number of important questions primarily related to the inflation expectations formation. This work presents such an empirical analysis of Reserve Bank of India’s (RBI) inflation expectations data for Indian urban population. First, we apply a battery of tests for verifying the assumptions of rationality of household expectations. The tests lead to the outright rejection of the assumptions. On the other hand, the inflation forecasts by professional forecasters seem to support the rational expectations assumptions. Second, considering a regression model we find that the inflation forecasts by the professionals forecast the actual inflation better than what could be predicted by the recently available actual inflation data. Finally, using a sticky information model (Mankiw Reis (2001, 2002), Carroll (2003)) we also find the support for Carroll’s contention that relevant macroeconomic information about future inflation flows from experts to the households, not vice versa. Additionally, if the sticky inflation model describes the household inflation expectations formation, it is natural to expect that more news about inflation in the news channels would lead to the reduction of disagreement. Our empirical analysis using Google trend data supports this hypothesis.
    Date: 2020–12–14
  27. By: Ahmed Anwar
    Abstract: In his General Theory of Employment, Interest and Money, John Maynard Keynes devotes a section in chapter 23 on the theories of Silvio Gesell, best known for the proposal to use stamped money. Although the account is generally favourable, Keynes finds key defects in Gesell’s proposed monetary reforms. We look carefully at this section together with Keynes’ own theory of liquidity preference which Keynes considers a completion of Gesell’s imperfect insights. We will argue that Keynes was in fact mistaken on these defects and that although both Keynes and Gesell identify the same theoretical problem, a special role that money plays in preventing the optimal accumulation of capital, it is only Gesell’s reform that in theory provides a solution.
    Date: 2020–12
  28. By: Omar Zulaica
    Abstract: Almost five decades after the collapse of the Bretton Woods system, gold continues to form an important share of global foreign exchange reserves. This may be because gold has traditionally offered reserve managers many benefits, such as the absence of default risk. This paper explores whether these large investment shares in gold are also justified from a risk-return standpoint, or whether any other explanations have to be brought to bear. To do this, we go beyond the simple application of portfolio optimisation techniques, comprehensively analysing all possible long-only combinations of gold and representative fixed income reserve portfolios. We conclude that the market risk associated with gold is substantial when evaluated against a broad range of criteria, such as mitigating portfolio volatility, tail-risk, the probability of loss, and measures of diversification. This will tend to limit overall allocations. Nonetheless, for portfolios with higher sensitivity to interest rates (duration) and for reserve managers who measure their returns in a non-reserve currency, we find evidence that gold may function as a hedge, making it easier to justify sizeable gold holdings from a purely quantitative perspective.
    JEL: E58 F31 G11 G17
    Date: 2020–11
  29. By: Maryam Mirfatah (University of Surrey and CIMS); Vasco J. Gabriel (University of Surrey and CIMS); Paul Levine (University of Surrey and CIMS)
    Abstract: We develop a small open economy model interacting with a rest-of-the-world bloc, containing several emerging economies' features: Calvo-type nominal frictions in prices and wages, financial frictions in the form of limited asset markets participation (LAMP), as well as both formal and informal sectors. In addition, we introduce incomplete exchange rate pass-through via a combination of producer and local currency pricing for exports, as well commodity-dependence in the form of an oil export sector. We contrast the stability and determinacy properties of money growth and standard Taylor-type interest rate rules, showing that monetary rules are stable regardless of the level of asset market participation, i.e. they avoid the inversion of the Taylor principle. We estimate our 2-bloc model using data for Iran and the USA employing Bayesian methods and we study the empirical relevance of the frictions in our model. Our results reveal important propagation channels active in emerging economies and that taking these into account is essential for policymaking decisions. Indeed, shocks to the economy are amplified by the presence of LAMP, while trade autarky further intensifies the effects of financial frictions. On the other hand, the informal sector acts as buffer to several shocks, lowering the variability of aggregate and formal fluctuations.
    Date: 2020–09
  30. By: Douglas Arner; Raphael Auer; Jon Frost
    Abstract: The technologies underlying money and payment systems are evolving rapidly. Both the emergence of distributed ledger technology (DLT) and rapid advances in traditional centralised systems are moving the technological horizon of money and payments. These trends are embodied in private "stablecoins": cryptocurrencies with values tied to fiat currencies or other assets. Stablecoins - in particular potential "global stablecoins" such as Facebook's Libra proposal - pose a range of challenges from the standpoint of financial authorities around the world. At the same time, regulatory responses to global stablecoins should take into account the potential of other stablecoin uses, such as embedding a robust monetary instrument into digital environments, especially in the context of decentralised systems. Looking forward, in such cases, one possible option from a regulatory standpoint is to embed supervisory requirements into stablecoin systems themselves, allowing for "embedded supervision". Yet it is an open question whether central bank digital currencies (CBDCs) and other initiatives could in fact provide more effective solutions to fulfil the functions that stablecoins are meant to address.
    Keywords: stablecoins, cryptocurrencies, crypto-assets, blockchain, distributed ledger technology, central bank digital currencies, fintech, central banks, regulation, supervision, money
    JEL: E42 E51 E58 F31 G28 L50 O32
    Date: 2020–11
  31. By: Fernando Eguren Martin (Bank of England); Mark Joy (Bank of England); Claudia Maurini (Bank of Italy); Alessandro Moro (Bank of Italy); Valerio Nispi Landi (Bank of Italy); Alessandro Schiavone (Bank of Italy); Carlos van Hombeeck (Bank of England)
    Abstract: This paper studies the sudden stop in capital flows that emerging markets have experienced throughout the first months of the pandemic. First, we find that the sudden stop in capital flows has been strongly affected by lower portfolio investments of non-bank financial intermediaries: for many emerging markets, the magnitude of the sudden stop has exceeded that of the Global Financial Crisis. Second, we show that emerging markets have adopted expansionary fiscal and monetary policies to face the sudden stop and the resultant recession; moreover, the use of macroprudential measures and unconventional monetary policy document a wider policy toolkit, compared to other crises. Third, we estimate the adequacy of current IMF resources if emerging markets were hit by a further global sudden stop: we find that the IMF resources are adequate, in case of a moderate sudden stop; in case of a more severe scenario, financing needs of emerging markets could go beyond the IMF’s lending capacity, even after the other layers of the global financial safety net have been deployed.
    Keywords: International Finance, International Financial Data, Foreign Exchange Reserves, Capital Flow, IMF
    JEL: F31 F32 F33
    Date: 2020–12
  32. By: Thomas H. McInish; Christopher J. Neely; Jade Planchon
    Abstract: Cohen, Diether, and Malloy (Journal of Finance, 2007), find that shifts in the demand curve predict negative stock returns. We use their approach to examine changes in supply and demand at the time of FOMC announcements. We show that shifts in the demand for borrowing Treasuries and agencies predict quantitative easing. A reduction in the quantity demanded at all points along the demand curve predicts expansionary quantitative easing announcements.
    Keywords: Quantitative Easing; Treasury bond short interest; Monetary Policy; Large-Scale Asset Purchases (LSAP); Agency securities; Treasury securities
    JEL: E4 E44 E52 G1 G18 G14
    Date: 2020–12–17
  33. By: Gustavo Adler; Camila Casas; Luis M. Cubeddu; Gita Gopinath; Nan Li; Sergii Meleshchuk; Carolina Osorio Buitron; Damien Puy; Yannick Timmer
    Abstract: The extensive use of the US dollar when firms set prices for international trade (dubbed dominant currency pricing) and in their funding (dominant currency financing) has come to the forefront of policy debate, raising questions about how exchange rates work and the benefits of exchange rate flexibility. This Staff Discussion Note documents these features of international trade and finance and explores their implications for how exchange rates can help external rebalancing and buffer macroeconomic shocks.
    Keywords: Currencies;Exchange rates;Exports;Depreciation;Imports;SDN,currency pricing,financing currency,Colombian peso,currency financing,expenditure switching
    Date: 2020–07–20
  34. By: Daisuke Ikeda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: Further progress in digital money, electronically stored monetary value, may enable pricing in units of any currency in any country. This paper studies monetary policy in such a world, using a two- country open economy model with nominal rigidities. The findings are three-fold. First, domestic monetary policy becomes less effective as digital dollarization - pricing using digital money, denominated in and pegged to a foreign currency - deepens. Second, digital dollarization is more likely to occur in a smaller country that is more open to trade and has a greater tradable sector and stronger input-output linkages. Third, monetary policy can facilitate or discourage digital dollarization depending on its stance on the stabilization of macroeconomic variables.
    Keywords: Digital money, monetary policy, dollarization
    JEL: E52 F41
    Date: 2020–12
  35. By: Oustry Antoine; Erkan Bunyamin; Svartzman Romain; Weber Pierre-François
    Abstract: Central banks increasingly acknowledge that climate change is a source of financial risks, which is likely to also impact their conduct of monetary policy. Against this backdrop, the aim of this paper is to explore one potential approach to factoring climate-related transition risks into a central bank’s collateral framework. Given the radical uncertainty associated with measuring such risks, this approach relies on so-called climate “alignment” methodologies, which enable to assess the consistency of eligible and pledged marketable assets with specific climate targets. Moreover, this paper proposes a “climate-hedging portfolio approach”: instead of seeking to “align” the collateral on an asset-by-asset basis, central banks could aim for “alignment”, in aggregate, of the collateral pools pledged by their counterparties with a given climate target. The rationale for this choice is that assessing climate-related risk at the pool level avoids the Eurosystem having to decide on which assets/issuers in the pools should be excluded or capped, and is therefore more compatible with a market neutrality approach. The numerical experiment using Eurosystem marketable criteria data suggests that, in aggregate, neither the Eurosystem eligible collateral universe nor the collateral pledged is “aligned” with the climate targets of the European Union. From this perspective, the Eurosystem marketable collateral can be considered to be exposed to climate-related transition risks. We discuss the potential practical implications of aiming to “align” collateral pools, and suggest avenues for further work.
    Keywords: Monetary policy, Collateral framework, Climate change, Risk and uncertainty, Eurosystem.
    JEL: D81 E52 E58 G32 Q51 Q54
    Date: 2020
  36. By: Mateane, Lebogang
    Abstract: I use a transition probability matrix associated with different global market conditions and I assume that it captures switches in central bank preferences between approximated constant relative risk aversion (CRRA) expected utility and approximated increasing relative risk aversion (IRRA) expected utility. I approximate CRRA and IRRA expected utility, to construct and propose constrained portfolio selection frameworks with skewness, for the currency composition of FX reserves over different global market conditions that influence central bank preferences. These portfolio selection frameworks account for portfolio rebalancing, they satisfy Pratt-Arrow measures of risk aversion and are constrained by the country's currency composition of foreign debt. Thus, for these portfolios, the currency composition of FX reserves is motivated by its country's currency composition of foreign debt. I propose these frameworks for 6 emerging market economies (EMEs) and this is only for a small portion of the total portfolio of FX reserves. These EMEs are Brazil, India, Indonesia, Mexico, South Africa and Turkey and five of these EMEs have been denoted as the "Fragile Five". Using different methods of computing expected FX reserves returns and different maturity structures on FX reserves, I validate my proposal using data over the 2010-2018 period on these EMEs by simulating optimal FX reserve weights for each EME; where each country's actual currency composition of foreign debt is a constraint.
    Keywords: IRRA and CRRA Expected Utility,Global Market Conditions,Currency Composition of FX Reserves,Foreign Debt,Portfolio Selection,Skewness,Emerging Market Economies
    JEL: E58 F31 G11 G15
    Date: 2020
  37. By: ; Mariano Kulish; Juan Pablo Nicolini
    Abstract: In this paper, we review the relationship between inflation rates, nominal interest rates, and rates of growth of monetary aggregates for a large group of OECD countries. We conclude that the low-frequency behavior of these series maintains a close relationship, as predicted by standard quantity theory models. In an estimated model, we show those relationships to be relatively invariant to alternative frictions that can deliver very different high-frequency dynamics. We argue that these relationships are useful for policy design aimed at controlling inflation.
    Keywords: Money demand; Monetary aggregates; Monetary policy
    JEL: E41 E51 E52
    Date: 2020–12–15

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