nep-mon New Economics Papers
on Monetary Economics
Issue of 2022‒03‒14
twenty-six papers chosen by
Bernd Hayo
Philipps-Universität Marburg

  1. Understanding consumer inflation expectations during the COVID-19 pandemic By Gunda Alexandra Detmers; Sui-Jade Ho; Özer Karagedikl
  2. How to Limit the Spillover from the 2021 Inflation Surge to Inflation Expectations? By Dräger, Lena; Lamla, Michael J.; Pfajfar, Damjan
  3. Making sense of consumer inflation expectations: the role of uncertainty By Reiche, Lovisa; Meyler, Aidan
  4. Market-stabilization QE By Motto, Roberto; Özen, Kadir
  5. Monetary Policy and the Top 1%: Evidence from a Century of Modern Economic History By Mehdi El Herradi; Aurélien Leroy
  6. What Are Consumers’ Inflation Expectations Telling Us Today? By Olivier Armantier; Leo Goldman; Gizem Koşar; Giorgio Topa; Wilbert Van der Klaauw; John C. Williams
  7. Moral Hazard and Lending of Last Resort By Stefano Ugolini
  8. Pandemic Recession and Helicopter Money: Venice, 1629–1631 By Charles Goodhart; Donato Masciandaro; Stefano Ugolini
  9. Optimal Fiscal and Monetary Policy with Distorting Taxes By Christopher A. Sims
  10. The Augmented Bank Balance-Sheet Channel of Monetary Policy By Christian Bittner; Diana Bonfim; Florian Heider; Farzad Saidi; Glenn Schepens; Carla Soares
  11. Refinancing and The Transmission of Monetary Policy to Consumption By Arlene Wong
  12. The Making of Fallen Angels—and What QE and Credit Rating Agencies Have to Do with It By Viral V. Acharya; Ryan N. Banerjee; Matteo Crosignani; Tim Eisert; Renée Spigt
  13. Securing green development: Can Asia-Pacific central banks and financial supervisory authorities do more? By Xiang-li Lim; Vatcharin Sirimaneetham
  14. Devaluations, Deposit Dollarization, and Household Heterogeneity By Francesco Ferrante; Nils Gornemann
  15. Political science research on the reasons for the (non) adoption and (non) implementation of EMU reform proposals: The state of the art By Lindner, Vincent; Eckert, Sandra; Nölke, Andreas
  16. Comparing Monetary Policy Tools in an Estimated DSGE model with International Financial Markets By Gelfer, Sacha; Gibbs, Christopher
  17. Welfare costs of exchange rate fluctuations: Evidence from the 1972 Okinawa reversion By Kazuko Kano; Takashi Kano
  18. Política monetaria y formación de expectativas en un modelo neokeynesiano By Patricia Carballo
  19. What to expect from inflation expectations: theory, empirics and policy issues By Luigi Bonatti,; Andrea Fracasso; Roberto Tamborini
  20. Caution: do not cross! Capital buffers and lending in Covid-19 times By Couaillier, Cyril; Lo Duca, Marco; Reghezza, Alessio; Rodriguez d’Acri, Costanza
  21. A Personal View from the Wrong Side of the Subsequent Fifty Years By David Laidler
  22. Monetary policy shocks and exchange rate dynamics in small open economies By Firmin Doko Tchatoka; Qazi Haque; Madison Terrell
  23. Central bank digital currency: A review and some macro-financial implications By Hongyi Chen; Pierre Siklos
  24. Financial Stability Considerations for Monetary Policy: Theoretical Mechanisms By Andrea Ajello; Nina Boyarchenko; Francois Gourio; Andrea Tambalotti
  25. Original sin redux: a model-based evaluation By Boris Hofmann; Nikhil Patel; Steve Pak Yeung Wu
  26. Financial Stability Considerations for Monetary Policy: Empirical Evidence and Challenges By Nina Boyarchenko; Giovanni Favara; Moritz Schularick

  1. By: Gunda Alexandra Detmers; Sui-Jade Ho; Özer Karagedikl
    Abstract: We study how individuals’ formation of inflation expectations are affected by the stringent containment and economic support measures put in place during the Covid-19 pandemic. Using the New York Fed Survey of Consumer Expectations (SCE) and the Oxford Covid-19 Government Response Tracker (OxCGRT), we find that policies aimed to contain the pandemic lead to an increase in individuals’ inflation expectations and inflation uncertainty. We also find some heterogeneity in the impact across different demographic groups.
    JEL: J31 J64
    Date: 2022–01
  2. By: Dräger, Lena; Lamla, Michael J.; Pfajfar, Damjan
    Abstract: By providing numerical inflation projections. Many central banks currently face inflation well above their targets and with that the challenge to prevent spillovers on inflation expectations. We study the effect of different communication about the 2021 inflation surge on German consumers' inflation expectations using a randomized control trial. We show that information about rising inflation increases short- and long-term inflation expectations. This initial increase in expectations can be mitigated using information about inflation projections, where numerical information about professional forecasters' projections seems to reduce inflation expectations by more than policymaker’s characterization of inflation as a temporary phenomenon.
    Keywords: Short-run and long-run inflation expectations; inflation surge; randomized control trial; survey experiment; persistent or transitory in inflation shock
    JEL: E31 E52 E58 D84
    Date: 2022–02
  3. By: Reiche, Lovisa; Meyler, Aidan
    Abstract: Consumers’ inflation expectations play a key role in the monetary transmission mechanism. As such, it is crucial for monetary policymakers to understand what they are and how they are formed. In this paper we introduce the (un)certainty channel as means to shed light on some of the more puzzling aspects of reported quantitative inflation perceptions and expectations. These include the apparent overestimation of inflation by consumers as well as the negative correlation observed between the economic outlook and inflation expectations. We also show that the uncertainty framework fits with some of the stylised facts of consumers’ inflation expectations, such as their correlation with socio-demographic characteristics and economic sentiment. JEL Classification: D11, D12, D84, E31, E52
    Keywords: consumers, expectations, inflation, uncertainty
    Date: 2022–02
  4. By: Motto, Roberto; Özen, Kadir
    Abstract: We identify a novel dimension of monetary policy from high-frequency changes in asset prices around ECB policy events, orthogonal to surprises extracted from risk-free interest rates. We find that it is present in policy events that were interpreted by real-time market commentaries as containing information about asset purchase programmes aimed to stabilise financial markets and safeguard the monetary policy transmission by implementing asset purchases in a flexible manner across asset classes and euro area countries. We label this dimension of policy “market-stabilization QE” to contrast it with conventional QE programmes such as the APP launched by the ECB in 2015 aimed to extract duration risk. When including our market-stabilization QE, the R2 for the regression of sovereign yields during the sovereign debt crisis increases by about 50 percentage points and the one of the stock market by 35 percentage points; during the COVID-19 pandemic by 25 and 15 percentage points, respectively. Although it moves euro area stressed-country sovereign yields down and German sovereign yields up as a result of the reversal of flight-to-safety dynamics, it generates strong expansionary macroeconomic effects in all euro area countries including Germany. JEL Classification: E43, E44, E52, E58, E65, G01, G14
    Keywords: Central Bank Communication, COVID-19 pandemic, European debt crisis, monetary policy shocks, unconventional monetary policies
    Date: 2022–02
  5. By: Mehdi El Herradi (AMSE - Aix-Marseille Sciences Economiques - EHESS - École des hautes études en sciences sociales - AMU - Aix Marseille Université - ECM - École Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique); Aurélien Leroy (UB - Université de Bordeaux)
    Abstract: This paper examines the distributional effects of monetary policy in 12 OECD economies between 1920 and 2016. We exploit the implications of the macroeconomic policy trilemma with an external instrument approach to analyze how top income shares respond to monetary policy shocks. The results indicate that monetary tightening strongly decreases the share of national income held by the top 1 percent and vice versa for a monetary expansion, irrespective of the position of the economy. This effect (i) holds for the top percentile and the ultrarich (top 0.1 percent and 0.01 percent income shares), while (ii) it does not necessarily induce a decrease in income inequality when considering the entire income distribution. Our findings also suggest that the effect of monetary policy on top income shares is likely to be channeled via real asset returns.
    Date: 2021–12
  6. By: Olivier Armantier; Leo Goldman; Gizem Koşar; Giorgio Topa; Wilbert Van der Klaauw; John C. Williams
    Abstract: The United States has experienced a considerable rise in inflation over the past year. In this post, we examine how consumers’ inflation expectations have responded to inflation during the pandemic period and to what extent this is different from the behavior of consumers’ expectations before the pandemic. We analyze two aspects of the response of consumers’ expectations to changing conditions. First, we examine by how much consumers revise their inflation expectations in response to inflation surprises. Second, we look at the pass-through of revisions in short-term inflation expectations to revisions in longer-term inflation expectations. We use data from the New York Fed’s Survey of Consumer Expectations (SCE) and from the Michigan Survey of Consumers to measure these responses. We find that over the past two years, consumers’ shorter-horizon expectations have been highly attuned to current inflation news: one-year-ahead inflation expectations are very responsive to inflation surprises, in a pattern similar to what we witnessed before the pandemic. In contrast, three-year-ahead inflation expectations are now far less responsive to inflation surprises than they were before the pandemic, indicating that consumers are taking less signal from the recent movements in inflation about inflation at longer horizons than they did before. We also find that the pass-through from revisions in one-year-ahead expectations to revisions in longer-term expectations has declined during the pandemic relative to the pre-pandemic period. Taken together, these findings show that consumers expect inflation to behave very differently than it did before the pandemic, with a smaller share of short-term movements in inflation expected to persist into the future.
    Keywords: inflation expectations; inflation; monetary policy
    JEL: E31 D84
    Date: 2022–02–14
  7. By: Stefano Ugolini (LEREPS - Laboratoire d'Etude et de Recherche sur l'Economie, les Politiques et les Systèmes Sociaux - UT1 - Université Toulouse 1 Capitole - Université Fédérale Toulouse Midi-Pyrénées - UT2J - Université Toulouse - Jean Jaurès - Institut d'Études Politiques [IEP] - Toulouse - ENSFEA - École Nationale Supérieure de Formation de l'Enseignement Agricole de Toulouse-Auzeville)
    Abstract: Nowadays, the idea that lending of last resort is necessarily conducive to moral hazard appears to be generally accepted. This chapter questions this received wisdom by tracking the evolution of monetary theory and practice over the very long term. While most economists have seen as inevitable the association between lending of last resort and moral hazard, others (especially Walter Bagehot) have claimed that the two may be separable if "constructive ambiguity" surrounds the conditions at which emergency liquidity may be accessed by banks. A brief overview of the practices adopted by monetary authorities over the centuries tends to confirm that the separability between lending of last resort and moral hazard may be attainable, but only through a correct design of banking regulation and liquidity-injecting operations.
    Keywords: Central banking,Moral hazard,Lending of last resort
    Date: 2021–12–13
  8. By: Charles Goodhart; Donato Masciandaro; Stefano Ugolini (LEREPS - Laboratoire d'Etude et de Recherche sur l'Economie, les Politiques et les Systèmes Sociaux - UT1 - Université Toulouse 1 Capitole - Université Fédérale Toulouse Midi-Pyrénées - UT2J - Université Toulouse - Jean Jaurès - Institut d'Études Politiques [IEP] - Toulouse - ENSFEA - École Nationale Supérieure de Formation de l'Enseignement Agricole de Toulouse-Auzeville)
    Abstract: We analyse the money-financed fiscal stimulus implemented in Venice during the famine and plague of 1629–31, which was equivalent to a ‘net-worth helicopter money' strategy – a monetary expansion generating losses to the issuer. We argue that the strategy aimed at reconciling the need to subsidize inhabitants suffering from containment policies with the desire to prevent an increase in long-term government debt, but it generated much monetary instability and had to be quickly reversed. This episode highlights the redistributive implications of the design of macroeconomic policies and the role of political economy factors in determining such designs.
    Keywords: Monetary policy,Helicopter money,Pandemic,Venice 1629-1631
    Date: 2022
  9. By: Christopher A. Sims (Princeton University)
    Abstract: When the interest rate on government debt is low enough, it becomes possible to roll it over indefinitely, never taxing to retire it, without producing a growing debt to GDP ratio. This has been called a situation with zero "fiscal cost" to debt. But when low interest on debt arises from its providing liquidity services, zero fiscal cost is equivalent to finance through seigniorage. Some finance through seigniorage is generally optimal, however, despite results in the literature seeming to show that this is not so.
    Keywords: monetary policy, fiscal policy
    JEL: E52 E62
    Date: 2021–10
  10. By: Christian Bittner (Bundesbank & Goethe University); Diana Bonfim (Banco de Portugal & Católica Lisbon); Florian Heider (ECB & CEPR); Farzad Saidi (University of Bonn & CEPR); Glenn Schepens (ECB); Carla Soares (Banco de Portugal)
    Abstract: This paper studies how banks’ balance sheets and funding costs interact in the transmission of monetary-policy rates to banks’ credit supply to firms. To do so, we use creditregistry data from Germany and Portugal together with the European Central Bank’s policy-rate cuts in mid-2014. The pass-through of the rate cuts to banks’ funding costs differs across the euro-area currency union because deposit rates vary in their distance to the zero lower bound (ZLB). When the distance is shorter, banks’ financing constraints matter less for the supply of credit and there is more risk taking. To rationalize these findings, we provide a simple model of an augmented bank balance-sheet channel where in addition to costly external financing, there is screening of borrowers and a ZLB on retail deposit rates. An impaired pass-through of monetary policy to banks’ funding costs reduces their ability to lever up and weakens their lending standards.
    Keywords: transmission of monetary policy, bank lending, bank risk taking, bank balance sheets, euro-area heterogeneity
    JEL: E44 E52 E58 E63 F45 G20 G21
    Date: 2022–02
  11. By: Arlene Wong (Princeton University)
    Abstract: This paper examines the role of the refinancing channel and the mortgage market structure for the transmission of monetary policy to consumption. First, I document heterogeneous consumption responses to monetary policy shocks. I find a large consumption response for homeowners who refinance or enter new loans, which is concentrated among younger people. Second, I develop a life-cycle model with fixed rate mortgages that explains these facts. Moving from a fixed to a variable rate mortgage structure reduces the heterogeneous effects of monetary policy on consumption by age. At the same time, the aggregate effects of monetary policy on consumption are increased substantially.
    Keywords: Consumption; monetary policy; refinancing; heterogeneous responses; age
    JEL: E52 E21
    Date: 2021–03
  12. By: Viral V. Acharya; Ryan N. Banerjee; Matteo Crosignani; Tim Eisert; Renée Spigt
    Abstract: Riskier firms typically borrow at higher rates than safer firms because investors require compensation for taking on more risk. However, since 2009 this relationship has been turned on its head in the massive BBB corporate bond market, with risky BBB-rated firms borrowing at lower rates than their safer BBB-rated peers. The resulting risk materialized in an unprecedented wave of “fallen angels” (or firms downgraded below the BBB investment-grade threshold) at the onset of the COVID-19 pandemic. In this post, based on a related Staff Report, we claim that this anomaly has been driven by a combination of factors: a boost in investor demand for investment-grade bonds associated with the Federal Reserve’s quantitative easing (QE) and sluggish adjustment of credit ratings for risky BBB issuers.
    Keywords: corporate bond market; investment-grade bonds; large-scale asset purchases; credit ratings
    JEL: G3 G2
    Date: 2022–02–16
  13. By: Xiang-li Lim (Green Templeton College, and Saïd Business School, University of Oxford); Vatcharin Sirimaneetham (Economic Affairs Officer, Macroeconomic Policy and Analysis Section, Macroeconomic Policy and Financing for Development Division, ESCAP)
    Abstract: This paper discusses how central banks and financial supervisory authorities (CBFSAs) can foster green development in Asia and the Pacific. It argues that while fiscal policy has received much attention, CBFSAs can certainly play a complementary role in speeding up the transition towards low-carbon, climate-resilient economies. Indeed, CBFSAs are obliged to act as inaction could compromise their mandate of maintaining economic and price stability given that climate change poses an emerging risk to the financial system. The paper first shows that around half of Asia-Pacific central banks either have sustainability-oriented mandates or began integrating climate issues into their policy conduct. It then demonstrates that while the region remains at the early stage of green monetary and financial policies, some CBFSAs are at the forefront in deploying monetary policy tools, prudential measures, and broader initiatives to support green finance. To further promote green central banking, having clear guiding principles, effective communication, and adequate technical capacity to customize the green approach is critical. Moving forward, CBFSAs should be mindful about possible unintended, adverse impacts of sustainable central banking, such as interfering with market neutrality, supporting greenwashing, and crowding out green private investments.
    Keywords: central banking, monetary policy, green development, green finance, climate risks
    JEL: E52 E58
    Date: 2021–12
  14. By: Francesco Ferrante; Nils Gornemann
    Abstract: We study the aggregate and re-distributive effects of currency devaluations in a small open economy heterogeneous households model with leverage-constrained banks. Our framework captures three stylized facts about liability dollarization in emerging economies: i) banks and firms borrow in foreign currency; ii) households save in dollar-denominated local bank deposits; and iii) such deposits are mainly held by wealthier households. The resulting currency mismatch causes an erosion of banks' net worth during a devaluation, depressing credit supply. The ensuing macroeconomic downturn is amplified by a strong reduction of consumption among poorer households in response to rising borrowing costs and falling labor income. Richer households are partially insured, as they are holding a larger share of their wealth in foreign currency denominated assets. We show that a larger currency hedging by wealthier households deepens the recession and amplifies the negative spillovers for poorer agents. When deposit dollarization is high, welfare gains can arise if monetary policy dampens a depreciation.
    Keywords: Dollarization; Currency Depreciation; Household Heterogeneity; Redistribution
    JEL: E21 F32 F41
    Date: 2022–02–16
  15. By: Lindner, Vincent; Eckert, Sandra; Nölke, Andreas
    Abstract: There have been numerous attempts to reform the Economic and Monetary Union (EMU) after the Great Recession, however the reform success varies greatly among sub-fields. Additionally, the political science research community has engaged a diverse set of theory- driven explanations, causal mechanisms, and variables to explain respective reform success. This article takes stock of reform policies in the EMU from two angles. First, it outlines distinct theoretical approaches that seek to explain success and failure of reform proposals and second, it surveys how they explain policy output and policy outcome in four policy subfields: financial stabilization, economic governance, financial solidarity, and cooperative dissolution. Finally, the article develops a set of explanatory factors from the existing literature that will be used for a Qualitative Comparative Analysis (QCA).
    Keywords: Economic and Monetary Union,European integration,neoinstitutionalism,political economy,European Banking Union,European Capital Markets Union,economic governance,fiscal solidarity,policy reform
    Date: 2022
  16. By: Gelfer, Sacha; Gibbs, Christopher
    Abstract: We evaluate the dynamics of conventional and unconventional monetary policy using an estimated two-region dynamic stochastic general equilibrium (DSGE) model. In addition to traditional nominal frictions the open-economy model also includes financial frictions, international portfolio balance effects, and correlated global financial shocks. We find that both conventional and unconventional monetary policy is effective in stimulating output and in inflation. However, the type of expansionary monetary policy used has heterogeneous effects on domestic investment, imports, exports and hours worked. Further, including a financial accelerator to the DSGE model significantly dampens the impact of aggregate investment that is expected to occur with quantitative easing. This is because unconventional monetary policy in the model is associated with an expansion in banking deposits and a minimal impact on loan demand, thus creating a fall in the loan to deposit ratio as was seen after the global financial crisis. Using historical decompositions, we find that unconventional monetary policy had a significant positive impact on output and hours worked during the global financial crisis and the preceding years after, but becomes negligible after 2014. Yet, its impact on equity and bond markets remained through 2019.
    Keywords: Unconventional Monetary Policy; Quantitative Easing; International Bond Portfolio; DSGE; Financial accelerator
    Date: 2021–12
  17. By: Kazuko Kano; Takashi Kano
    Abstract: The main tenet of the New Keynesian (NK) paradigm is that price dispersion caused by nominal price stickiness is the primary source of allocative inefficiency. This study empirically evaluates the welfare implications of NK models by observing how internal and external price dispersion responds to two types of large aggregate shocks: high inflation and sharp currency depreciation. For this purpose, we consider the history of US military deployment on a small southern island in Japan called Okinawa following the Pacific War. We investigate unique data variations in micro-level retail prices surveyed in Okinawa and mainland Japan before and after the Okinawan reversion to Japanese sovereignty in May of 1972. By considering the Okinawan experience of three currency regimes during the high inflation period of the early 1970s as valid quasi-natural experiments, we identify statistically significant deteriorations of currency misalignment associated with the sudden exogenous large USD depreciation versus the JPY following the Nixon Shock. Furthermore, we observe that these massive aggregate shocks left the average absolute size of price changes mostly unchanged, but significantly increased the average frequency of price changes in Okinawa. Because a calibrated small open-economy menu cost model fits these empirical findings better than the Calvo model, the welfare costs of exchange rate fluctuations may be more elusive than suggested by the open economy NK literature.
    Keywords: Currency regime, Currency misalignment, Welfare cost, Okinawan reversion, Menu cost model
    JEL: F31 F41 F45
    Date: 2022–01
  18. By: Patricia Carballo (Banco Central del Uruguay)
    Abstract: This paper studies the relationship between expectation formation and monetary policy in a New Keynesian general equilibrium framework. To do this, a model that incorporates an equation for the formation of private sector inflation expectations, is developed. Based on the results obtained in the gap estimation and shock simulation exercises, the model constitutes an ideal tool for the analysis of monetary policy in Uruguay. The impulse response exercises illustrate the importance of formation of expectations and credibility for the design of monetary policy. Likewise, the results obtained in the decomposition of the variance of the forecast errors show the importance of shocks on the inflation target and private sector expectations to explain the behavior of inflation and the formation of expectations.
    Keywords: semi-structural model, monetary policy, expectations, Uruguay
    JEL: E37 E47 E52 E58 F41
    Date: 2022
  19. By: Luigi Bonatti,; Andrea Fracasso; Roberto Tamborini
    Abstract: We examine the role of inflation expectations in conditioning monetary policy, addressing three of its facets. The first concerns the channels through which inflation expectations impinge upon actual inflation, and their policy implications. The second facet regards the technical and empirical issues involved in keeping track of inflation expectations for monetary policy purposes. The final facet is an assessment of inflation expectations vis-à-vis the current upsurge of inflation, wondering whether, after being unanchored on the downside, can now become unanchored on the upside.
    Date: 2021
  20. By: Couaillier, Cyril; Lo Duca, Marco; Reghezza, Alessio; Rodriguez d’Acri, Costanza
    Abstract: While regulatory capital buffers are expected to be drawn to absorb losses and meet credit demand during crises, this paper shows that banks were unwilling to do so during the pandemic. To the contrary, banks engaged in forms of pro-cyclical behaviour to preserve capital ratios. By employing granular data from the credit register of the European System of Central Banks, we isolate credit supply effects and find that banks with little headroom above regulatory buffers reduced their lending relative to other banks, also when controlling for a broad range of pandemic support measures. Firms’ inability to reallocate their credit needs to less constrained banks had real economic effects, as their headcount went down, although state guarantee schemes acted as partial mitigants. These findings point to some unintended effects of the capital framework which may create incentives for pro-cyclical behaviour by banks during downturns. They also shed light on the interactions between fiscal and prudential policies which took place during the pandemic. JEL Classification: E61, G01, G18, G21
    Keywords: bank lending, Buffer usability, coronavirus, credit register, macroprudential policy, MDA distance
    Date: 2022–02
  21. By: David Laidler (University of Western Ontario)
    Abstract: Lucas (1972) was a paper that permanently changed the course of macroeconomics, even though its “money supply surprise†model lost its central place in the area within a decade because of empirical difficulties. However, Lucas’s novel methodology, based on clearing markets and rational expectations, still dominates orthodox macroeconomic theorising. An unfortunate side effect of this has been that, because mainstream models have no analytic room for money to play a key role in economic activity, the theoretical case for taking that role seriously was undermined just at the time when traditional monetarist macro-models were facing empirical problems. The consequences of all this for today’s monetary policy environment are briefly discussed.
    Keywords: Lucas; neutral money, monetarism, Keynesianism; micro-foundations; clearing-markets; inflation; recession
    JEL: E13 E31 E40 E52 N01
    Date: 2021
  22. By: Firmin Doko Tchatoka; Qazi Haque; Madison Terrell
    Abstract: In this paper we provide new insights on the dynamics between monetary policy shocks and real exchange rates in small open economies using a time-varying structural vector autoregression model with stochastic volatility. Identification is achieved using a combination of short-run and long-run restrictions while preserving the contemporaneous interaction between monetary policy and the exchange rate. For several small open economies, we find no evidence of the ‘exchange rate puzzle’ or the ‘delayed overshooting puzzle,’ in line with recent studies on this topic (see e.g. Bj rnland, 2009). However, there is evidence of the ‘forward discount puzzle’ in some countries, suggesting that the uncovered interest parity (UIP) is violated. In addition, a substantial decrease in the volatility of monetary policy shocks is evident in most countries, accompanied by a decline in the importance of policy shocks in explaining the volatility of exchange rates and other macroeconomic variables since the 1990s.
    Keywords: Monetary policy shocks, Exchange rate, TVP-VARs, UIP
    JEL: C32 E52 F31 F41
    Date: 2022–01
  23. By: Hongyi Chen; Pierre Siklos
    Abstract: Central Bank Digital Currency (CBDC) has attracted considerable interest and its deployment on a global scale is imminent. However, digital currencies face several challenges. They include: legal, technological, and political considerations. We summarize those challenges and add a few more that have not received much attention in the literature. We then consider two forms of CBDC: a narrow version that only replaces notes and coins and a broader form with a deposit feature. The narrow CBDC is the most likely one to be first introduced. Next, relying on evidence of past episodes of financial innovation, and using cross-country data, we explore the hypothetical impact of CBDC on inflation and financial stability, based on the historical behaviour of the velocity of circulation and incorporating a CBDC’s impact in McCallum’s policy rule which defines the stance of monetary policy based on money growth. Our simulations suggest that CBDC need not produce higher inflation, but financial stability remains at risk. We provide some policy implications.
    Keywords: Central Bank Digital Currency, Velocity, Money Demand, Monetary Policy, McCallum Rule
    JEL: O31 O33 E41 E42 E51 E52
    Date: 2022–01
  24. By: Andrea Ajello; Nina Boyarchenko; Francois Gourio; Andrea Tambalotti
    Abstract: This paper reviews the theoretical literature at the intersection of macroeconomics and finance to draw lessons on the connection between vulnerabilities in the financial system and the macroeconomy, and on how monetary policy affects that connection. This literature finds that financial vulnerabilities are inherent to financial systems and tend to be procyclical. Moreover, financial vulnerabilities amplify the effects of adverse shocks to the economy, so that even a small shock to fundamentals or a small revision of beliefs can create a self-reinforcing feedback loop that impairs credit provision, lowers asset prices, and depresses economic activity and inflation. Finally, monetary policy may affect the buildup of vulnerabilities, but the sign of the impact along some of its transmission channels is theoretically ambiguous and may vary with the state of the economy.
    Keywords: monetary policy; financial stability; credit; leverage; liquidity; asset prices
    JEL: E44 E52 E58 G2
    Date: 2022–02–01
  25. By: Boris Hofmann; Nikhil Patel; Steve Pak Yeung Wu
    Abstract: Many emerging markets (EMs) have graduated from "original sin" and are able to borrow from abroad in their local currency. Using a two-country model, this paper shows that the shift from foreign currency to local currency external borrowing does not eliminate the vulnerability of EMs to foreign financial shocks but instead results in "original sin redux" (Carstens and Shin (2019)). Even under local currency borrowing from foreign lenders, a monetary tightening abroad is propagated to EM financial conditions through a tightening of foreign lenders' financial constraints. Moreover, local currency borrowing does not eliminate currency mismatches, but shifts them from the balance sheets of EM borrowers to the balance sheets of financially constrained global lenders, so that amplifying financial effects of exchange rate fluctuations remain. We provide empirical evidence in line with this prediction of the model using data on currency composition of external debt of emerging and advanced economies. Our model-based analysis further suggests that foreign exchange intervention and capital flow management measures can mitigate the adverse effects of capital flow swings in the short run and that a larger domestic investor base can reduce the vulnerability to such swings in the longer run.
    Keywords: emerging market, capital flows, exchange rate, currency mismatch.
    JEL: E3 E5 F3 F4 F6 G1
    Date: 2022–02
  26. By: Nina Boyarchenko; Giovanni Favara; Moritz Schularick
    Abstract: This paper reviews literature on the empirical relationship between vulnerabilities in the financial system and the macroeconomy, and how monetary policy affects that connection. Financial vulnerabilities build up over time, with both risk appetite and risk taking rising during economic expansions. To some extent, financial crises are predictable and have severe real economic consequences when they occur. Empirically it is difficult to link monetary policy to financial vulnerabilities, in part because financial cycles have long durations, making it difficult to separate effects of changes in monetary policy from other business cycle effects.
    Keywords: Monetary Policy; Financial Stability; Financial Crises; Credit; Leverage; Liquidity; Asset Prices
    JEL: E44 E52 E58 G20
    Date: 2022–02–15

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