nep-mon New Economics Papers
on Monetary Economics
Issue of 2023‒09‒25
23 papers chosen by
Bernd Hayo, Philipps-Universität Marburg

  1. Preaching to the agnostic: Inflation reporting can increase trust in the central bank but only among people with weak priors By Bernd Hayo; Pierre-Guillaume Méon
  2. Analysis of CBDC Narrative OF Central Banks using Large Language Models By Andres Alonso-Robisco; Jose Manuel Carbo
  3. Learning monetary policy strategies at the effective lower bound with sudden surprises By Krane, Spencer David; Melosi, Leonardo; Rottner, Matthias
  4. Monetary Policy Implementation with Ample Reserves By Gara Afonso; Kyungmin Kim; Antoine Martin; Ed Nosal; Simon M. Potter; Sam Schulhofer-Wohl
  5. The Profitability of Monetary Policy Transmission By Alex Hsu; Indrajit Mitra; Linghang Zeng
  6. Financial Inclusion and Monetary Policy: A Study on the Relationship between Financial Inclusion and Effectiveness of Monetary Policy in Developing Countries By Gautam Kumar Biswas; Faruque Ahamed
  7. The Inflation Attention Threshold and Inflation Surges By Oliver Pf\"auti
  8. The ECB and the inflation monsters: strategic framing and the responsibility imperative (1998-2023) By Fontan, Clément; Goutsmedt, Aurélien
  9. The Distribution of Sectoral Price Changes and Recent Inflation Developments By Christopher D. Cotton; Vaishali Garga; Giovanni P. Olivei; Viacheslav Sheremirov
  10. Unveiling the Interplay between Central Bank Digital Currency and Bank Deposits By Hanfeng Chen; Maria Elena Filippin
  11. US Monetary Policy and the Return to Price Stability By Richard H. Clarida
  12. Oligopolistic Competition, Price Rigidity, and Monetary Policy By Kozo Ueda; Kota Watanabe
  13. Effects of the ECB's communication on government bond spreads By Camarero Garcia, Sebastian; Neugebauer, Frederik; Russnak, Jan; Zimmermann, Lilli
  14. The Trend Effect of Foreign Exchange Intervention By FATUM, Rasmus; YAMAMOTO, Yohei; CHEN, Binwei
  15. Tell Me Something I Don't Already Know: Learning in Low- and High-Inflation Settings By Bernardo Candia; Olivier Coibion; Serafin Frache; Dmitris Georgarakos; Yuriy Gorodnichenko; Geoff Kenny; Saten Kumar; Rodrigo Lluberas; Brent Meyer; Robele Tiziano; Michael Weber
  16. Monetary Policy with Racial Inequality By Makoto Nakajima
  17. Cross-country price and inflation dispersion: Retail network or national border By Messner, Teresa; Rumler, Fabio; Strasser, Georg
  18. Future of the Euro: pay everywhere and whenever you want By BELLIA Mario; DI GIROLAMO Francesca; NAI FOVINO Igor; PETRACCO GIUDICI Marco; SPORTIELLO Luigi; VESPE Michele
  19. Same old song: On the macroeconomic and distributional effects of leaving a Low Interest Rate Environment By Alberto Botta; Eugenio Caverzasi; Alberto Russo
  20. US dollar is losing it position of a reserve currency: How the BRICS development bank can ensure the soft landing By Popov, Vladimir
  21. Forecasting inflation using disaggregates and machine learning By Gilberto Boaretto; Marcelo C. Medeiros
  22. Has the 2021 general SDR allocation been useful? For what and for whom? By Isabel Garrido; Irune Solera
  23. Liquidity Spirals By Farmer, J. Doyne; Wiersema, Garbrand; Kemp, Esti

  1. By: Bernd Hayo; Pierre-Guillaume Méon
    Abstract: Using a randomized controlled trial, we study whether showing German respondents a graph plotting the European Central Bank’s inflation target alongside inflation in the euro area from 1999 to 2017 affects respondents’ trust in the ECB. The treatment has, on average, no significant effect on the level of trust in the ECB respondents report, but trust increases among respondents who report no preference for any political party. Within this group, the information about the actual development of the inflation rate, and not information about the inflation target itself, appears to be the main driving force.
    Keywords: Central bank trust; European Central Bank; Central bank communication; Monetary policy; Germany; Household survey; RCT
    JEL: E52 E58 Z10
    Date: 2023–08–31
  2. By: Andres Alonso-Robisco (Banco de España); Jose Manuel Carbo (Banco de España)
    Abstract: Central banks are increasingly using verbal communication for policymaking, focusing not only on traditional monetary policy, but also on a broad set of topics. One such topic is central bank digital currency (CBDC), which is attracting attention from the international community. The complex nature of this project means that it must be carefully designed to avoid unintended consequences, such as financial instability. We propose the use of different Natural Language Processing (NLP) techniques to better understand central banks’ stance towards CBDC, analyzing a set of central bank discourses from 2016 to 2022. We do this using traditional techniques, such as dictionary-based methods, and two large language models (LLMs), namely Bert and ChatGPT, concluding that LLMs better reflect the stance identified by human experts. In particular, we observe that ChatGPT exhibits a higher degree of alignment because it can capture subtler information than BERT. Our study suggests that LLMs are an effective tool to improve sentiment measurements for policy-specific texts, though they are not infallible and may be subject to new risks, like higher sensitivity to the length of texts, and prompt engineering.
    Keywords: ChatGPT, BERT, CBDC, digital money
    JEL: G15 G41 E58
    Date: 2023–08
  3. By: Krane, Spencer David; Melosi, Leonardo; Rottner, Matthias
    Abstract: We examine how private sector agents might learn a new monetary strategy that is adopted while at the ELB. Little can be discovered until the economy improves enough that rates would be near liftoff under the old strategy. Recessionary shocks would thus delay learning while large inflationary shocks could outright stop it and so inhibit the ability of the new strategy to address future ELB episodes. The central bank can offset some of the inflation-induced learning loss by deviating from its new strategy, but this decision comes at the cost of higher near-term inflation and greater uncertainty about monetary policy.
    Keywords: New framework, central bank's communications, deflationary bias, asymmetric average inflation targeting, imperfect credibility, liftoff, Bayesian learning
    JEL: E52 C63 E31
    Date: 2023
  4. By: Gara Afonso; Kyungmin Kim; Antoine Martin; Ed Nosal; Simon M. Potter; Sam Schulhofer-Wohl
    Abstract: We offer a parsimonious model of the reserve demand to study the tradeoffs associated with various monetary policy implementation frameworks. Prior to the 2007–09 financial crisis, many central banks supplied scarce reserves to execute their interest-rate policies. In response to the crisis, central banks undertook quantitative-easing policies that greatly expanded their balance sheets and, by extension, the amount of reserves they supplied. When the crisis and its aftereffects passed, central banks were in a position to choose a framework that has reserves that are (1) abundant—by keeping their balance sheets and reserves at the expanded level; (2) scarce—by vastly decreasing their balance sheets and reserves; or (3) somewhere in between abundant and scarce—by moderately decreasing their balance sheets and reserves. We find that the best policy implementation outcomes are realized when reserves are somewhere between scarce and abundant. This outcome is consistent with the Federal Open Market Committee’s 2019 announcement to implement monetary policy in a regime with an ample supply of reserves.
    Keywords: federal funds market; monetary policy implementation; ample reserves
    JEL: E42 E58
    Date: 2023–08–31
  5. By: Alex Hsu; Indrajit Mitra; Linghang Zeng
    Abstract: We provide firm-level evidence that Federal Open Market Committee announcements have real effects by changing expectations of firm profitability. We use an existing decomposition of a monetary policy shock into a central bank information component (CBI) and a conventional monetary component (MP). We find (1) firms with a higher value of capital asset pricing model (CAPM) beta have a higher investment rate sensitivity to the CBI component; no similar heterogeneity in investment response is observed for the MP component. We also find (2) the heterogeneity in investment sensitivity is due to innovations to firm profitability.
    Keywords: monetary policy; Fed information shocks; investments; CAPM beta
    JEL: E22 E52 G31
    Date: 2023–06–20
  6. By: Gautam Kumar Biswas; Faruque Ahamed
    Abstract: The study analyzed the impact of financial inclusion on the effectiveness of monetary policy in developing countries. By using a panel data set of 10 developing countries during 2004-2020, the study revealed that the financial inclusion measured by the number of ATM per 100, 000 adults had a significant negative effect on monetary policy, whereas the other measure of financial inclusion i.e. the number of bank accounts per 100, 000 adults had a positive impact on monetary policy, which is not statistically significant. The study also revealed that foreign direct investment (FDI), lending rate and exchange rate had a positive impact on inflation, but only the effect of lending rate is statistically significant. Therefore, the governments of these countries should make necessary drives to increase the level of financial inclusion as it stabilizes the price level by reducing the inflation in the economy.
    Date: 2023–08
  7. By: Oliver Pf\"auti
    Abstract: At the outbreak of the recent inflation surge, the public's attention to inflation was low but increased rapidly once inflation started to rise. In this paper, I develop a general equilibrium monetary model where it is optimal for agents to pay little attention to inflation when inflation is low and stable, but in which they increase their attention once inflation exceeds a certain threshold. Using survey inflation expectations, I estimate the attention threshold to be at an inflation rate of 4%, with attention in the high-attention regime being twice as high as in the low-attention regime. When calibrated to match these findings, the model generates inflation and inflation expectation dynamics consistent with the recent inflation surge in the US. The attention threshold induces a state dependency: cost-push shocks become more inflationary in times of loose monetary policy. These state-dependent effects are absent in the model with constant attention or under rational expectations. Following simple Taylor rules triggers frequent and prolonged episodes of heightened attention, thereby increasing the volatility of inflation, and-due to the asymmetry of the attention threshold-also the average level of inflation, which leads to substantial welfare losses.
    Date: 2023–08
  8. By: Fontan, Clément; Goutsmedt, Aurélien (UC Louvain - F.R.S-FNRS)
    Abstract: The recent resurgence of inflation in Europe has led the ECB to increase interest rates and phase out asset purchase programs designed to address the effects of the Great Financial Crisis. This article investigates how the ECB adjusts its logic of responsibility throughout this series of crises. Using a topic model and in-depth analysis of speeches, we examine the ECB's strategic framing of causal linkages related to inflation during three historical periods: the Central Bank Independence (CBI) era (1998-2011), the secular stagnation era (2011-2021), and the new inflation era (2021-). Our findings indicate that modifications made to the CBI's causal linkages during the secular stagnation era shaped the ECB's framing of the new inflation era in a novel way. However, despite acknowledging difficult policy tradeoffs, which they tended to obscure in the past, ECB policymakers still seek to uphold the imperative of responsibility by adapting it to varying policy contexts.
    Date: 2023–08–19
  9. By: Christopher D. Cotton; Vaishali Garga; Giovanni P. Olivei; Viacheslav Sheremirov
    Abstract: Inflation has declined across many sectors so far in 2023, but the distribution of sectoral price changes still shows atypical features, such as bimodality in which substantial masses of sectors record price changes both below and above the Federal Reserve’s 2 percent inflation target. Such bimodality was not typical before the pandemic, suggesting that sector-specific price adjustments are now playing a more important role in inflation developments. The recent slowdown in inflation was partly caused by a larger-than-normal share of the consumption basket being located in the left tail of the distribution. However, current estimates of inflation persistence at the sectoral level are relatively low, and thus the beneficial effect of deflation in a few sectors could prove short-lived. These findings suggest that uncertainty around underlying inflation may now be higher than in the years immediately preceding the pandemic.
    Keywords: inflation persistence; bimodality; sectoral price change distribution; underlying inflation
    JEL: E31 E52
    Date: 2023–08–30
  10. By: Hanfeng Chen; Maria Elena Filippin
    Abstract: We extend the Real Business Cycle model in Niepelt (2022) to analyze the risk to financial stability following the introduction of a central bank digital currency (CBDC). CBDC competes with commercial bank deposits as households' source of liquidity. We consider different degrees of substitutability between payment instruments and review the equivalence result in Niepelt (2022) by introducing a collateral constraint banks must respect when borrowing from the central bank. When CBDC and deposits are perfect substitutes, the central bank can offer loans to banks that render the introduction of CBDC neutral to the real economy. We show that the optimal level of the central bank's lending rate depends on the restrictiveness of the collateral constraint: the tighter it is, the lower the loan rate the central bank needs to post. However, when CBDC and deposits are imperfect substitutes, the central bank cannot make banks indifferent to the competition from CBDC. It follows that the introduction of CBDC has real effects on the economy.
    Date: 2023–08
  11. By: Richard H. Clarida
    Abstract: This paper assesses the proximate causes of the post pandemic surge in US inflation, the Federal Reserve's real time reaction to and interpretation of incoming data in 2021, and the pivot to raising rates and shrinking the balance sheet that commenced in 2022 and continues in 2023. Particular attention is devoted to the role, if any, that Fed's August 2020 revisions to its monetary policy framework may have played in delaying lift - off relative to counterfactuals informed by simple policy rules, including a framework - consistent "shortfalls" policy rule featured in its semi - annual Monetary Policy Reports.
    JEL: E30 E4 E5
    Date: 2023–08
  12. By: Kozo Ueda (Waseda University); Kota Watanabe (Canon Institute for Global Studies and University of Tokyo)
    Abstract: This study investigates how strategic and heterogeneous price setting influences the real effect of monetary policy. Japanese data show that firms with larger market shares exhibit more frequent and larger price changes than those with smaller market shares. We then construct an oligopolistic competition model with sticky prices and asymmetry in terms of competitiveness and price stickiness, which shows that a positive cross superelasticity of demand generates dynamic strategic complementarity, resulting in decreased price adjustments and an amplified real effect of monetary policy. Whether a highly competitive firm sets its price more sluggishly and strategically than a less competitive firm depends on the shape of the demand system, and the empirical results derived from the Japanese data support Hotelling’s model rather than the constant elasticity of substitution preferences model. Dynamic strategic complementarity and asymmetry in price stickiness can substantially enhance the real effect of monetary policy.
    Keywords: strategic complementarity; price stickiness; real rigidity; competition
    JEL: D43 E31 E52 L11
    Date: 2023–07
  13. By: Camarero Garcia, Sebastian; Neugebauer, Frederik; Russnak, Jan; Zimmermann, Lilli
    Abstract: This paper investigates the financial market effects of the ECB's communication on the Pandemic Emergency Purchase Programme (PEPP). Using data for 10 euro area countries, we first analyse the impact of different communication channels such as press releases, ECB blog contributions, speeches and interviews on changes in government bond spreads. Second, we assess whether spreads react differently to communication by specific ECB Executive Board members. Markets turn out to be sensitive to both the communication channel and the communicating ECB Executive Board member.
    Keywords: Event study, central bank communication, ECB, PEPP, sovereign yields
    JEL: E52 E58 G14
    Date: 2023
  14. By: FATUM, Rasmus; YAMAMOTO, Yohei; CHEN, Binwei
    Abstract: The 2022 and the 2010-2011 Bank of Japan interventions provide an opportunity for investigating whether unusually large-scale and infrequent interventions are capable of generating trend effects. To this end, we estimate the counterfactual exchange rate and analyze structural changes in the level and the trend of the gap sequence between actual and counterfactual exchange rates. Our results show that the trend of the gap sequence reversed in the desired direction around the intervention dates, indicating that the intervention policy instrument is potentially powerful enough to generate long-term trend effects. This is an important insight not previously found in the intervention literature.
    Keywords: Foreign Exchange Intervention, Counterfactual Exchange Rate, Currency Factors, Synthetic Control Methods, Structural Changes
    JEL: F31 C38
    Date: 2023–08
  15. By: Bernardo Candia; Olivier Coibion; Serafin Frache; Dmitris Georgarakos; Yuriy Gorodnichenko; Geoff Kenny; Saten Kumar; Rodrigo Lluberas; Brent Meyer; Robele Tiziano; Michael Weber
    Abstract: Using randomized control trials (RCT) applied over time in different countries, we study how the economic environment affects how agents learn from new information. We show that as inflation has risen in developed economies, both households and firms have become more attentive and informed about inflation, leading them to respond less to exogenously provided information about inflation and monetary policy. This observation holds for both firms and households. We also study the effects of RCTs in countries where inflation has been consistently high (Uruguay) and low (New Zealand) as well as what happens when the same agents are repeatedly provided information in both low- and high-inflation environments (Italy). Our results broadly support models in which inattention is an endogenous outcome that depends on the economic environment.
    Keywords: inattention; RCTs; inflation expectation
    JEL: E3 E4 E5
    Date: 2023–07–31
  16. By: Makoto Nakajima
    Abstract: I develop a heterogeneous-agent New-Keynesian model featuring racial inequality in income and wealth, and studies interactions between racial inequality and monetary policy. Black and Hispanic workers gain more from accommodative monetary policy than White workers mainly due to higher labor market risks. Their gains are larger also because of a larger proportion of them are hand-to-mouth, while wealthy White workers gain more from asset price appreciation. Monetary and fiscal policies are substitutes in providing insurance against cyclical labor market risks. Racial minorities gain even more from an accommodative monetary policy in the absence of income-dependent fiscal transfers.
    Keywords: monetary policy; racial inequality; labor market; unemployment; wealth distribution; hand-to-mouth; marginal propensity to consume; business cycle; heterogeneous agents
    JEL: E21 E52 J15 J64
    Date: 2023–05–30
  17. By: Messner, Teresa (Oesterreichische Nationalbank); Rumler, Fabio (Oesterreichische Nationalbank); Strasser, Georg (European Central Bank)
    Abstract: (Why) do prices and inflation rates differ within the euro area? We study the relevance of a national border for grocery prices in the otherwise homogenous and highly integrated border region of Austria and Germany. Using transaction data on prices and quantities from a large household panel, we compare the prices of identical products within a narrow band along the border. We find large assortment and price differences between these two regions. Even within multinational retail chains the prices of identical products on the two sides of the border differ on average by about 21%. These price differences are not very persistent over time indicating little arbitrage gain from undifferentiated cross-border shopping. Ensuing product-level inflation rates differ for only half of the chains between the two countries. The results highlight the importance of the history-dependent evolution of distribution networks and of the structure of the sales organisation as a driver of price and inflation heterogeneity.
    Keywords: Price discrimination, goods market integration, border effect, cross-border arbitrage, market power
    JEL: D12 E31 D43 F15 F4
    Date: 2022–12
  18. By: BELLIA Mario (European Commission - JRC); DI GIROLAMO Francesca (European Commission - JRC); NAI FOVINO Igor (European Commission - JRC); PETRACCO GIUDICI Marco (European Commission - JRC); SPORTIELLO Luigi (European Commission - JRC); VESPE Michele (European Commission - JRC)
    Abstract: A digital euro contributes to strengthening the international role of the euro and Europe’s open strategic autonomy against other currencies, such as third country central bank digital currencies and private non-bank digital moneys. The proposal protects stability of the payment system by ensuring that the euro remains its reference point as the European economy keeps digitalizing. At the same time, introducing a digital euro could present some drawbacks that would need to be minimized by careful design options.
    Date: 2023–07
  19. By: Alberto Botta (School of Accounting, Finance and Economics, University of Greenwich, London, UK); Eugenio Caverzasi (Department of Economics, Università degli Studi dell’Insubria, Varese, Italy); Alberto Russo (Department of Economics and Social Sciences, Università Politecnica delle Marche, Ancona, Italy and Department of Economics, Universitat Jaume I, Castellón, Spain)
    Abstract: This paper analyzes the macroeconomic and distributional implications of central banks’decisions to raise interest rates after a prolonged period at near the Zero Lower Bound (ZLB). The main goal of our study is to assess the interaction between monetary policy, inequality, and financial fragility, in a financialized economic system. Financialization is here portrayed as the presence in the economy of complex financial products, i.e., assetbacked securities, produced via the securitization of banks’ loans. We do so in the context of a hybrid Agent-Based Model (ABM). We first compare the prevailing macroeconomic and financial features of a low interest rate environment (LIRE) with respect to a “Great Moderation”(GM)-like setting. As expected, we show that LIRE tends to stimulate faster growth and higher employment, and to reduce income and wealth inequality, as well as (poor) households’ indebtedness. Consistent with existing empirical literature, this comes at the cost of higher inflation and some signs of financial system’s fragility, i.e., lower banks’ profitability and Capital Adequacy Ratio (CAR), and higher “search for risk” given by credit extension to poorer households. We then show that increases in the central bank’s policy rate, as motivated by the central bank’s willingness to reduce inflation, effectively curb price dynamics and accomplish with central bank’s inflation targeting mandate. Higher interest rates also improve commercial banks’ CAR and profitability. However, they also cause a pronounced increase in non-performing loans (stronger tan what possibly observed in a GM scenario) and some worrisome macro-financial dynamics. In fact, higher interest rates give rise to higher households’ and overall economy indebtedness as allowed by wealthier households’ demand for high-yield complex financial products and mounting securitization. We finally show how financialization structurally changes the functioning of the economy and the behavior of central banks. Financialization actually contributes to create a (private sector) debt-led economy, which becomes structurally more resistant to central bank’s attempts to control inflation. Central bank’s reaction in terms of higher interest rates could likely come with perverse distributional consequences.
    Keywords: Low interest rate environment, Contractionary monetary policy, Securitization
    JEL: E24 E44 E52
    Date: 2023
  20. By: Popov, Vladimir
    Abstract: The current process of moving away from the US dollar as a reserve currency will cause the outflow of capital from the US, leading to the depreciation of the dollar and/or increase in the interest rates that will cause costly real restructuring – reallocation of resources from less competitive to more competitive export-oriented industries accompanied by an increase in unemployment. This paper makes parallels with the decline of the British pound after the Second World War, arguing that the loss of competitiveness and the stop-go policies in Britain in the 1950s-70s can well be an indicator of what is going to happen in the US. One of the new features of the current situation, however, is the freezing of reserve assets of many developing countries (Syria, Libya, Iran, Venezuela, Afghanistan, Russia) and the danger of freezing assets of other countries (China and Saudi Arabia included) – this can make the run away from the US dollar an uncontrolled process. Whereas in the long term this process may be beneficial for the US and the world economy, short- and medium- term adjustment costs can be extremely high. To ensure a soft landing the New Development Bank of BRICS countries can issue bonds that would be sold to developing countries, whose assets have been frozen or may be frozen by the West, so that they can store their foreign exchange reserves in these bonds. The Bank will invest the proceeds from the sale of these bonds in the traditional financial instruments for storing foreign exchange reserves - US and EU treasury bills and bonds denominated in the same dollars and euros. Bonds of the Bank would be considered safe because the US and EU will not risk freezing the assets of the Bank, as this would mean a major conflict with all BRICS countries and the Global South. For the Western countries, this option is not only acceptable, but also desirable: the new Bank will transfer the current direct holding of Western securities by developing countries into the holdings of the same Western financial instruments through the Bank, ensuring the soft landing.
    Keywords: Pound and dollar as reserve currencies, outflow of capital, accumulation of foreign exchange reserves (FOREX), BRICS, New Development Bank
    JEL: F31 F32 F33 F63 N14 O19
    Date: 2023–08–20
  21. By: Gilberto Boaretto; Marcelo C. Medeiros
    Abstract: This paper examines the effectiveness of several forecasting methods for predicting inflation, focusing on aggregating disaggregated forecasts - also known in the literature as the bottom-up approach. Taking the Brazilian case as an application, we consider different disaggregation levels for inflation and employ a range of traditional time series techniques as well as linear and nonlinear machine learning (ML) models to deal with a larger number of predictors. For many forecast horizons, the aggregation of disaggregated forecasts performs just as well survey-based expectations and models that generate forecasts using the aggregate directly. Overall, ML methods outperform traditional time series models in predictive accuracy, with outstanding performance in forecasting disaggregates. Our results reinforce the benefits of using models in a data-rich environment for inflation forecasting, including aggregating disaggregated forecasts from ML techniques, mainly during volatile periods. Starting from the COVID-19 pandemic, the random forest model based on both aggregate and disaggregated inflation achieves remarkable predictive performance at intermediate and longer horizons.
    Date: 2023–08
  22. By: Isabel Garrido (Banco de España); Irune Solera (Banco de España)
    Abstract: In the face of the COVID-19 crisis, the International Monetary Fund (IMF), other multilateral institutions and countries took unprecedented measures. Inter alia, the IMF agreed on an historical SDR allocation that more than tripled the volume of SDRs to cover long-term global reserve needs and ultimately support vulnerable countries. Member countries can keep SDRs to boost their reserves or use them in other ways, including to cancel their debts with the IMF, lend to the IMF or exchange SDRs for currencies. This document evaluates how members have used the 2021 SDR allocation. The findings show that most of the allocation has been used to increase reserves, although 40% of emerging economies and more than 60% of low-income countries have used SDRs to service their debts with the IMF or to exchange for currency, mainly for budgetary purposes in relation to social and health policies. Furthermore, in line with the G20’s objective to channel USD 100 bn of SDRs to countries in need, members with sound economic positions have voluntarily lent some of their SDRs to IMF trusts that finance vulnerable countries in affordable terms.
    Keywords: IMF, special drawing rights (SDRs), SDR allocation, liquidity, international cooperation
    JEL: F30 F33 O19 F02
    Date: 2023–08
  23. By: Farmer, J. Doyne; Wiersema, Garbrand; Kemp, Esti
    Abstract: We introduce a novel method for studying liquidity spirals and use this method to identify spirals before stock prices plummet and funding markets lock up. We show that liquidity spirals may be underestimated or completely overlooked when interactions between contagion channels are ignored, and find that financial stability is greatly affected by how institutions choose to respond to liquidity shocks, with some strategies yielding a \robust-yet-fragile" system. To demonstrate the method, we apply it to a highly granular data set on the South African banking sector and investment fund sector. We find that liquidity spirals are exacerbated when the liquidity positions of institutions worsen, and that central bank-provided liquidity can greatly dampen liquidity spirals. We also show that, depending on the market conditions, a liquidity spirals is sometimes caused by the banking and fund sectors' collective dynamics, but at other times by one sector's individual impact. The approach developed here can be used to formulate interventions that specifically target the sector(s) causing the liquidity spiral.
    Keywords: Liquidity Spiral, Financial Stability, Systemic Risk, Financial Contagion, Interacting Contagion Channels, Intersectoral Contagion Channels, Multiplex Networks, Stress Test, Solvency-Liquidity Nexus
    JEL: G01 G17 G18 G21 G23 G28
    Date: 2023–09

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