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on Central Banking |
| By: | Billi, Roberto M. (Research Department, Central Bank of Sweden) |
| Abstract: | Policymakers often use the output gap, a noisy signal of economic activity, as a guide for setting monetary policy. Noise in the data argues for policy caution. At the same time, the zero bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. In such an environment, greater policy stimulus may be needed to stabilize the economy. Thus, noisy data and the zero bound present policymakers with a dilemma in deciding the appropriate stance for monetary policy. I investigate this dilemma in a small New Keynesian model, and show that policymakers should pay more attention to output gaps than suggested by previous research. |
| Keywords: | output gap; measurement errors; monetary policy; zero lower bound |
| JEL: | E52 E58 |
| Date: | 2012–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0260&r=cba |
| By: | Luis Fernando Melo; Rubén Albeiro Loaiza Maya |
| Abstract: | Typically, when forecasting inflation rates, there are a variety of individual models and a combination of several of these models. We implement a Bayesian shrinkage combination methodology to include information that is not captured by the individual models using expert forecasts as prior information. To take into account two common characteristics in emerging countries’ economies, possible parameter instabilities and non-stationary dynamics, we use a rolling estimation windows technique for series integrated of order one. The empirical results of Colombian inflation show that the Bayesian forecast combination model outperforms the individual models and the random walk predictions for every evaluated forecast horizon. Moreover, these results outperform shrinkage forecasts that consider other priors as equal or zero weights. |
| Date: | 2012–04–22 |
| URL: | http://d.repec.org/n?u=RePEc:col:000094:009511&r=cba |
| By: | Apel, Mikael (Monetary Policy Department, Central Bank of Sweden); Blix Grimaldi, Marianna (Monetary Policy Department, Central Bank of Sweden) |
| Abstract: | One characteristic feature of central banks today is that policy decisions are almost exclusively made by a committee rather than by a single policy maker. Another is that central banks are considerably more transparent than they used to be. Together, this has brought to the fore an important but so far unresolved issue: to what extent should a central bank’s communication reflect the full spectrum of opinions among its committee members? Does information on all members’ views make monetary policy easier to understand and predict, or does it make it harder? We address this issue by employing a novel method. We measure the sentiment and tone of the minutes of the Swedish central bank using an automated content analysis that converts the qualitative information in the minutes to a quantitative measure. We find that this measure is useful in predicting future policy rate decisions. |
| Keywords: | Central Bank Communication; Minutes; Content Analysis |
| JEL: | D71 D83 E52 E58 |
| Date: | 2012–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0261&r=cba |
| By: | Yunus Aksoy (Department of Economics, Mathematics & Statistics, Birkbeck); Henriqu S Basso (University of Warwick) |
| Abstract: | We propose a model that delivers endogenous variations in term spreads driven primarily by banks' portfolio decision and their appetite to bear the risk of maturity transformation. We first show that fluctuations of the future profitability of banks' portfolios affect their ability to cover for any liquidity shortage and hence influence the premium they require to carry maturity risk. During a boom, profitability is increasing and thus spreads are low, while during a recession profitability is decreasing and spreads are high, in accordance with the cyclical properties of term spreads in the data. Second, we use the model to look at monetary policy and show that allowing banks to sell long-term assets to the central bank after a liquidity shock leads to a sharp decrease in long-term rates and term spreads. Such interventions have significant impact on long-term investment, decreasing the amplitude of output responses after a liquidity shock. The short-term rate does not need to be decreased as much and inflation turns out to be much higher than if no QE interventions were implemented. Finally, we provide macro and micro-econometric evidence for the U.S. confirming the importance of expected financial business profitability in the determination of term spread fluctuations. |
| Keywords: | Yield Curve, Quantitative Easing, Maturity Risk, Bank Portfolio |
| JEL: | E43 E44 E52 G20 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:bbk:bbkefp:1211&r=cba |
| By: | Victor E. Li (Department of Economics and Statistics, Villanova School of Business, Villanova University) |
| Abstract: | This paper evaluates the implications of search and matching frictions in the financial market for the transmission of monetary policy. Borrowers and lenders participate in a decentralized loan market for the purpose of establishing long-term credit relationships and the provision of loanable funds to productive firms. Locating credit relationships is costly in terms of time and real resources and the interest rate is negotiated via a bargaining mechanism. This structure is incorporated into an otherwise standard monetary business cycle framework and used to study how such frictions in the credit market contribute to explaining the contemporaneous impact and propagation of monetary growth shocks and inflation. It is found that while anticipated inflation negatively impacts real activity it can also increase loan market participation and the inflow of newly established credit relationships. It is shown that while bargaining and costly search mitigate the traditional inflation tax effect of monetary injections, the existence of long term lending relations tend to dampen the immediate liquidity effects. The model also indicates that there may not necessarily exist a negative correlation between credit market tightness and aggregate activity. Furthermore, search frictions provide a potentially important mechanism for explaining the persistence of monetary shocks, an issue that has been problematic in limited participation models of the transmission mechanism. |
| Keywords: | Firms; Search Model, Financial Market, Bargaining, Monetary Transmission |
| JEL: | D83 D9 E0 E4 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:vil:papers:19&r=cba |
| By: | Riccardo Bonci (Bank of Italy) |
| Abstract: | This paper provides new evidence on the transmission of monetary policy in the euro area, assessing the impact of an unexpected increase of the short-term interest rates on the lending and borrowing activity in different economic sectors. We exploit the information content of the flow-of-funds statistics, providing the best framework to analyse the flow of funds from lenders to borrowers. After estimating a small VAR for the euro area, we extend the benchmark model with the flow-of-funds series, analysing the response of these variables to a contractionary monetary policy shock. We find that the policy tightening is followed by a worsening of the budget deficit, firms cut down on their demand for bank loans, partially replacing them with inter-company loans, and draw on their liquidity to try to offset the fall in revenue associated with the slowdown in economic activity, while households increase precautionary saving in the short run. Consistent with the bank lending channel of monetary policy, the interest rate hike is followed by a short-run deceleration in credit growth, mainly driven by the response of banks. |
| Keywords: | euro area, monetary policy, flow of funds, credit growth. |
| JEL: | E32 E4 E52 G11 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_861_12&r=cba |
| By: | Caglayan, Mustafa; Jehan, Zainab; Mouratidis, Kostas |
| Abstract: | This study presents an analytical framework to examine the policy reaction function of a central bank in an open economy context while allowing for asymmetric preferences. The paper then empirically examines the policy rule obtained from this framework using quarterly data for the US, Canada, Japan, and the UK. The results, based on GMM approach, provide evidence that domestic policy is affected by changes in the foreign interest rate and exchange rate. We also provide evidence of the presence of asymmetries in response to the inflation rate and output gap for all the sample countries. |
| Keywords: | Monetary policy rule; asymmetric preferences; open economy |
| JEL: | E58 E52 F41 |
| Date: | 2012–04–26 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:37401&r=cba |
| By: | Eijffinger, Sylvester C W; Nijskens, Rob |
| Abstract: | Bailout expectations have led banks to behave imprudently, holding too little capital and relying too much on short term funding to finance long term investments. This paper presents a model to rationalize a constructive ambiguity approach to liquidity assistance as a solution to forbearance. Faced with a bank that chooses capital and liquidity, the institution providing liquidity assistance can commit to a mixed strategy: never bailing out is too costly and therefore not credible, while always bailing out causes moral hazard. In equilibrium, the bank chooses above minimum capital and liquidity, unless either capital costs or the opportunity cost of liquidity are too high. We also find that the probability of a bailout is higher for a regulator more concerned about bank failure, and when the bailout penalty for the bank is higher; this suggests that forbearance is not entirely eliminated by adopting ambiguity. |
| Keywords: | banking; commitment; Lender of Last Resort; liquidity; regulation |
| JEL: | E58 G21 G28 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8953&r=cba |
| By: | Reinhart, Carmen |
| Abstract: | Periods of high indebtedness have historically been associated with a rising incidence of default or restructuring of public and private debts. Sometimes the debt restructuring is more subtle and takes the form of 'financial repression'. Consistent negative real interest rates are equivalent to a tax on bond holders and, more generally, savers. In the heavily regulated financial markets of the Bretton Woods system, a variety of financial domestic and international restrictions facilitated a sharp and rapid reduction or 'liquidation' of public debt from the late 1940s to the 1970s. The restrictions or regulatory measures of that era had their origins in what would now come under the heading of 'macroprudential' concerns in the wake of the severe banking crises that swept many countries in the early 1930s. The surge in public debts that followed during the Great Depression and through World War II only made the case for stable and low interest rates and directed credit more compelling to policymakers. The resurgence of financial repression in the wake of the 2007-2009 financial crises alongside the surge in public debts in advanced economies is documented here. This process of financial 'de-globalization' may have only just begun. |
| Keywords: | capital controls; debt; financial repression; inflation; interest rates; regulation |
| JEL: | E2 E3 E6 F3 F4 H6 N10 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8947&r=cba |
| By: | Levieuge, Grégory; Lucotte, Yannick |
| Abstract: | In this paper we suggest a simple empirical and model-independent measure of Central Banks' Conservatism, based on the Taylor curve. This new indicator can easily be extended in time and space, whatever the underlying monetary regime of the considered countries. We demonstrate that it evolves in accordance with the monetary experiences of 32 OECD member countries from 1980, and is largely equivalent to the model-based measure provided by Krause & Méndez [Southern Economic Journal, 2005]. We finally bring forward the interest of such an indicator for further empirical analysis dealing with the preferences of Central Banks. |
| Keywords: | Central Banks' preferences; Conservatism; Taylor curve; Taylor rule |
| JEL: | E43 E58 E52 E47 |
| Date: | 2012–04–28 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:38424&r=cba |
| By: | Jan Willem van den End; Mark Kruidhof |
| Abstract: | The Basel 3 Liquidity Coverage Ratio (LCR) is a micro prudential instrument to strengthen the liquidity position of banks. However if in extreme scenarios the LCR becomes a binding constraint, the interaction of bank behaviour with the regulatory rule can have negative externalities. We simulate the systemic implications of the LCR by a liquidity stress-testing model, which takes into account the impact of bank reactions on second round feedback effects. We show that a flexible approach of the LCR, in particular one which recognises less liquid assets in the buffer, is a useful macroprudential instrument to mitigate its adverse side-effects during times of stress. At extreme stress levels the instrument becomes ineffective and the lender of last resort has to underpin the stability of the system. |
| Keywords: | Financial stability; Banks; Liquidity; Regulation |
| JEL: | C15 E44 G21 G32 G28 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:342&r=cba |
| By: | Alfredo Martín-Oliver (Universitat de les Illes Balears); Sonia Ruano (Banco de España); Vicente Salas-Fumás (Universidad de Zaragoza) |
| Abstract: | We examine the consequences of imposing higher capital requirements on banks (as under Basel III or, recently, in the case of large banks in the European context) for bank dynamics in complying with the new standards and for the long-term effects on bank lending rates and the demand for bank credit. The analysis combines econometric estimations of the determinants of equity capital ratios and lending rates with simulations of market equilibrium results for loan interest rates and the demand for bank credit, based on a parameterised model of the Spanish banking industry. We find that the gap between the target and the actual capital ratio is reduced by around 40% every year, mainly with retained earnings. We also find that raising the equity capital ratio by one percentage point increases bank lending rates by 4.2 basis points. Finally, the simulation exercise shows that the estimated increase in the cost of funds for banks associated with a one percentage point increase in the equity capital ratio leads to a fall of 0.8% in the total demand for bank credit. These results suggest that the social costs of higher equity capital requirements for banks are expected to be greater in the transition period, when banks are adjusting to the new standards, than in the steady state of the new industry equilibrium, when all banks comply with the new ratio |
| Keywords: | Bank capital regulation, Basel III, bank lending rates, demand for credit |
| JEL: | D24 G21 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:1218&r=cba |
| By: | Renato Maino |
| Abstract: | Systemic risk is, by nature, unpredictable. Statistical models can fail to identify it. We need to maintain resource buffers as well as to implement better regulatory controls, and to improve managerial experience, and contingent strategies. International imbalances are nearly up to their sustainable limits, creating new systemic challenges. Some major financial institutions have recently assumed a critical position: they are highly interconnected and hard to replace in a panic. These institutions play key roles in the economy, such as providing market liquidity and pricing assets efficiently. Following deregulation, these institutions became “universal” groups covering a large range of financial markets and products. Internal conflicts of interest, opacity, and manipulated risk measures may arise. Regulation must change and new market instruments could exacerbate these internal problems. Here, we discuss some proposals to enhance the role of the Resolution Authorities (American and European laws are in the process of defining them). In particular, we examine a proposal for high-trigger contingent convertible bonds (HT CoCos), especially conceived for Systemically Important Financial Institutions – SIFIs (Calomiris and Herring, 2011).We propose that the bond conversion should be applied to all SIFIs’ HT CoCos as soon as one SIFI defaults. This solution could have many advantages: less costly recapitalization of the SIFIs’ system, more level playing field in the financial industry, good incentives to shareholders and supervisors to react promptly to potential systemic crisis, introducing breaks in SIFIs’ market values correlation (and with Sovereigns, too). We also provide a quantification of the potential market for such instruments. |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgsps:sp207&r=cba |
| By: | Evzen Kocenda; Vit Bubak; Filip Zikes |
| Abstract: | This paper studies the dynamics of volatility transmission between Central European (CE) currencies and the EUR/USD foreign exchange using model-free estimates of daily exchange rate volatility based on intraday data. We formulate a flexible yet parsimonious parametric model in which the daily realized volatility of a given exchange rate depends both on its own lags as well as on the lagged realized volatilities of the other exchange rates. We find evidence of statistically significant intra-regional volatility spillovers among the CE foreign exchange markets. With the exception of the Czech and, prior to the recent turbulent economic events, Polish currencies, we find no significant spillovers running from the EUR/USD to the CE foreign exchange markets. To measure the overall magnitude and evolution of volatility transmission over time, we construct a dynamic version of the Diebold-Yilmaz volatility spillover index and show that volatility spillovers tend to increase in periods characterized by market uncertainty. |
| Keywords: | Foreign exchange markets; Volatility; Spillovers; Intraday data; Nonlinear dynamics; European emerging markets |
| JEL: | C5 F31 G15 |
| Date: | 2011–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:wdi:papers:2011-1020&r=cba |