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on Central Banking |
| By: | Tayler, William; Zilberman, Roy |
| Abstract: | This paper examines the macroprudential roles of bank capital regulation and monetary policy in a Dynamic Stochastic General Equilibrium model with endogenous financial frictions and a borrowing cost channel. We identify various transmission channels through which credit risk, commercial bank losses, monetary policy and bank capital requirements affect the real economy. These mechanisms generate significant financial accelerator effects, thus providing a rationale for a macroprudential toolkit. Following credit shocks, countercyclical bank capital regulation is more effective than monetary policy in promoting financial, price and overall macroeconomic stability. For supply shocks, macroprudential regulation combined with a strong response to inflation in the central bank policy rule yield the lowest welfare losses. The findings emphasize the importance of the Basel III regulatory accords and cast doubt on the desirability of conventional Taylor rules during periods of financial distress. |
| Keywords: | Bank Capital Regulation; Macroprudential Policy; Basel III; Monetary Policy; Borrowing Cost Channel |
| JEL: | E32 E44 E52 E58 G28 |
| Date: | 2014–04 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:037&r=cba |
| By: | Labonne, C.; Lamé, G. |
| Abstract: | This paper examines the sensitivity of NFC lending to banks' capital ratios and their supervisory capital requirements. We use a unique database for the French banking sector between 2003 and 2011 combining confidential bank-level Bank Lending Survey answers with the discretionary capital requirements set by the supervisory authority. We find that on average, more capital means more credit. But the elasticity of lending to capital depends on the intensity of the supervisory capital constraint. More supervisory capital constrained banks tend to have a slower credit growth than unconstrained banks. We also find that the ratio of non-performing loans to total loans granted may be considered a transmission channel for supervisory requirements. More supervisory capital constrained banks tend to be more reactive to this ratio than unconstrained banks. The former are more prone to reduce credit allocation after a rise in non-performing loans than the latter. |
| Keywords: | Lending, Bank Regulation, Capital. |
| JEL: | G21 G28 G32 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:481&r=cba |
| By: | Blaise Gadanecz; Aaron Mehrotra; Madhusudan S Mohanty |
| Abstract: | Large-scale forex intervention in emerging market economies (EMEs) aimed at resisting currency appreciation has major implications for the composition of banking system balance sheets. The domestic monetary consequences depend on the nature of central bank liabilities that are the counterpart of forex reserves. Even if the immediate change in bank reserves due to FX intervention is offset by the sale of securities, bank lending may still be stimulated, running counter to the aims of the monetary authority. In this paper, we empirically investigate the impact of banks’ holdings of liquid government securities, generated by such intervention, on bank credit in a panel of EMEs. We find that, for well capitalised banking systems, holdings of government and central bank paper over time lead to an expansion in their credit to the private sector. This result is confirmed at both country and bank level. The balance sheet effects of large-scale FX intervention therefore require close attention. |
| Keywords: | bank lending; sterilised intervention; foreign exchange reserves; central bank securities; emerging market economies |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:445&r=cba |
| By: | Humpage, Owen F. (Federal Reserve Bank of Cleveland) |
| Abstract: | Independence is the hallmark of modern central banks, but independence is a mutable and fragile concept, because the governments to whom central banks are ultimately responsible can have objectives that take precedence over price stability. This paper traces the Federal Reserve’s emergence as a modern central bank beginning with its abandonment of monetary policy for debt-management operations during the Second World War and through the controversies that led to the Treasury-Federal Reserve accord in 1951. The accord, however, did not end the Federal Reserve’s search for independence. After the accord, the Federal Reserve’s view of responsibilities "within" government led it to policies—even keel and foreign exchange operations—that complicated the System’s ability to conduct monetary policy. |
| Keywords: | Second World War; U.S. Treasury-Federal Reserve Accord; Even Keel |
| JEL: | E4 E5 E6 N1 |
| Date: | 2014–03–27 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:1402&r=cba |
| By: | Burgert, Matthias; Schmidt, Sebastian |
| Abstract: | How does the need to preserve government debt sustainability affect the optimal monetary and fiscal policy response to a liquidity trap? To provide an answer, we employ a small stochastic New Keynesian model with a zero bound on nominal interest rates and characterize optimal time-consistent stabilization policies. We focus on two policy tools, the short-term nominal interest rate and debt-financed government spending. The optimal policy response to a liquidity trap critically depends on the prevailing debt burden. In our model, while the optimal amount of government spending is decreasing in the level of outstanding government debt, future monetary policy is becoming more accommodative, triggering a change in private sector expectations that helps to dampen the fall in output and inflation at the outset of the liquidity trap. JEL Classification: E31, E52, E62, E63, D11 |
| Keywords: | deficit spending, discretion, monetary and fiscal policy, new Keynesian model, zero nominal interest rate bound |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20131622&r=cba |
| By: | Colliard, Jean-Edouard |
| Abstract: | The regulatory use of banks' internal models aims at making capital requirements more accurate and reducing regulatory arbitrage, but may also give banks incentives to choose their risk models strategically. Current policy answers to this problem include the use of risk-weight floors and leverage ratios. I show that banks for which those are binding reduce their credit supply, which drives interest rates up, invites other banks to adopt optimistic models and possibly increases aggregate risk in the banking sector. Instead, the strategic use of risk models can be avoided by imposing penalties on banks with low risk-weights when they suffer abnormal losses or bailing out defaulting banks that truthfully reported high risk measures. If such selective bail-outs are not desirable, second-best capital requirements still rely on internal models, but less than in the first-best. JEL Classification: D82, D84, G21, G32, G38 |
| Keywords: | Basel risk-weights, internal risk models, leverage ratio, tail risk |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141641&r=cba |
| By: | Paul Hubert (Ofce,Sciences-po); Harun Mirza (European Central Bank) |
| Abstract: | Assuming that private agents need to learn inflation dynamics to form their inflation expectations and that they believe a hybrid New-Keynesian Phillips Curve (NKPC) is the true data generating process of inflation, we aim at establishing the role of forward-looking information in inflation expectation dynamics. We find that longer term expectations are crucial in shaping shorter-horizon expectations. Professional forecasters put a greater weight on forward-looking information presumably capturing beliefs about the central bank inflation target or trend inflation while lagged inflation remains significant. Finally,the NKPC-based inflation expectations model fits well for professional forecasts in contrast to consumers. |
| Keywords: | Survey expectations,inflation,New Keynesian Philipps Curve |
| JEL: | E31 |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:fce:doctra:1407&r=cba |
| By: | Herrala, Risto |
| Abstract: | This paper presents evidence that banks react to regulation in a forward-looking manner. A case study documents a reaction to Basel II as early as 2000, in other words about seven years prior to the implementation of the regulation in 2007. Based on the initial information released on Basel II, banks loosened their credit policies towards households. The changes were substantial, improving household credit availability by 20-50%. A new approach to estimate borrowing constraints from loan samples is also presented. JEL Classification: D14, E32, E51, G21 |
| Keywords: | bank regulation, borrowing constraints, credit policy |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141645&r=cba |
| By: | Darracq Pariès, Matthieu; Maurin, Laurent; Moccero, Diego |
| Abstract: | We implement a two-step approach to construct a financing conditions index (FCI) for the euro area and its four larger member states (Germany, France, Italy and Spain). The method, which follows Hatzius et al. (2010), is based on factor analysis and enables to summarise information on financing conditions from a large set of financial indicators, controlling for the level of policy interest rates, changes in output and inflation. We find that the FCI tracks successfully both worldwide and euro area specific financial events. Moreover, while the national FCIs are constructed independently, they display a similar pattern across the larger euro area economies over most of the sample period and varied more widely since the start of the sovereign debt crisis in 2010. Focusing on the euro area, we then incorporate the FCI in a VAR model comprising output, inflation, the monetary policy rate, bank loans and bank lending spreads. The credit supply shock extracted with sign restrictions is estimated to have caused around one fifth of the decline in euro area manufacturing production at the trough of the financial crisis and a rise in bank lending spreads of around 30 basis points. We also find that adding the FCI to the VAR enables an earlier detection of credit supply shocks. JEL Classification: E17, E44, E50 |
| Keywords: | credit supply shocks, euro area, factor models, financial conditions index, large dataset, sign restrictions, structural VAR |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141644&r=cba |
| By: | Thomas Conlon; John Cotter |
| Abstract: | To mitigate potential contagion from future banking crises, the European Commission recently proposed a framework which would provide for the $\textit{bail-in}$ of bank creditors in the event of failure. In this study, we examine this framework retrospectively in the context of failed European banks during the global financial crisis. Empirical findings suggest that equity and subordinated bond holders would have been the main losers from the 535 billion euro impairment losses realized by failed European banks. Losses attributed to senior debt holders would, on aggregate, have been proportionally small, while no losses would have been imposed on depositors. Cross-country analysis, incorporating stress-tests, reveals a divergence of outcomes with subordinated debt holders wiped out in a number of countries, while senior debt holders of Greek, Austrian and Irish banks would have required bail-in. |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1403.7628&r=cba |
| By: | Arratibel, Olga; Michaelis, Henrike |
| Abstract: | This paper follows the Bayesian time-varying VAR approach with stochastic volatility developed by Primiceri (2005), to analyse whether the reaction of output and prices to interest rate and exchange rate shocks has changed across time (1996-2012) in the Polish economy. The empirical findings show that: (1) output appears more responsive to an interest rate shock at the beginning of our sample. Since 2000, absorbing this shock has become less costly in terms of output, notwithstanding some reversal since the beginning of the global financial crisis. The exchange rate shock also has a time-varying effect on output. From 1996 to 2000, output seems to decline, whereas for periods between 2000 and 2008 it has a positive significant effect. (2) Consumer prices appear more responsive to an interest rate shock during the first half of our sample, when Poland experienced high inflation. The impact of an exchange rate shock on prices seems to slightly decrease across time. JEL Classification: C30, E44, E52, F41 |
| Keywords: | Bayesian time-varying parameter VAR, exchange rate pass-through, monetary policy transmission |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141636&r=cba |
| By: | Gabriele Sarais; Damiano Brigo |
| Abstract: | We develop a model to price inflation and interest rates derivatives using continuous-time dynamics that have some links with macroeconomic monetary DSGE models equipped with a Taylor rule: in particular, the reaction function of the central bank, the bond market liquidity, inflation and growth expectations play an important role. The model can explain the effects of non-standard monetary policies (like quantitative easing or its tapering) and shed light on how central bank policy can affect the value of inflation and interest rates derivatives. The model is built under standard no-arbitrage assumptions. Interestingly, the model yields short rate dynamics that are consistent with a time-varying Hull-White model, therefore making the calibration to the nominal interest curve and options straightforward. Further, we obtain closed forms for both zero-coupon and year-on-year inflation swap and options. The calibration strategy we propose is fully separable, which means that the calibration can be carried out in subsequent simple steps that do not require heavy computation. A market calibration example is provided. The advantages of such structural inflation modelling become apparent when one starts doing risk analysis on an inflation derivatives book: because the model explicitly takes into account economic variables, a trader can easily assess the impact of a change in central bank policy on a complex book of fixed income instruments, which is normally not straightforward if one is using standard inflation pricing models. |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1403.7799&r=cba |
| By: | Schmidt, Sebastian |
| Abstract: | I show that the zero nominal interest rate bound may render it desirable for society to appoint a fiscally activist policy-maker who cares less about the stabilisation of government spending relative to inflation and output gap stabilisation than the private sector does. I work with a simple New Keynesian model where the government has to decide each period afresh about the optimal level of public consumption and the one period nominal interest rate. A fiscally activist policy-maker uses government spending more aggressively to stabilise inflation and the output gap in a liquidity trap than an authority with preferences identical to those of society as a whole would do. The appointment of an activist policy-maker corrects for discretionary authorities’ disregard of the expectations channel, thereby reducing the welfare costs associated with zero bound events. JEL Classification: E52, E62, E63 |
| Keywords: | discretion, fiscal policy, monetary policy, zero nominal interest rate bound |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141653&r=cba |
| By: | El-Shagi, Makram; Giesen, Sebastian; Jung, Alexander |
| Abstract: | The aim of this paper is to assess whether the findings of Romer and Romer (2000) on the superiority of staff forecasts are still valid today. The paper uses both latest available econometric techniques as well as conventional tests. Several tests for forecast rationality show that a necessary condition for good forecast performance is satisfied both for Greenbook and private forecasts, as measured by the Survey of Professional Forecasters (SPF). Tests for forecast accuracy and the encompassing test confirm the superiority of Greenbook forecasts for inflation and output using an extended sample (1968 to 2006). The relative forecast performance is, however, not robust in the presence of large macroeconomic shocks such as the Great Moderation and oil price shocks. Other econometric tests show that a relative better forecast performance by staff is observed when there is increased uncertainty. Staff’s better knowledge about the Fed’s future interest rate path also plays an important role in this respect. JEL Classification: C53, E37, E52, E58 |
| Keywords: | forecast performance, forecast rationality, forecast stability, greenbook forecasts, of professional forecasters, survey |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141635&r=cba |
| By: | Conesa, Juan Carlos (Stony Brook University); Kehoe, Timothy J. (Federal Reserve Bank of Minneapolis) |
| Abstract: | In January 1995, U.S. President Bill Clinton organized a bailout for Mexico that imposed penalty interest rates and induced the Mexican government to reduce its debt, ending the debt crisis. Can the Troika (European Commission, European Central Bank, and International Monetary Fund) organize similar bailouts for the troubled countries in the Eurozone? Our analysis suggests that debt levels are so high that bailouts with penalty interest rates could induce the Eurozone governments to default rather than reduce their debt. A resumption of economic growth is one of the few ways that the Eurozone crises can end. |
| Keywords: | Sovereign debt; Bailout; Penalty interest rate; Collateral |
| JEL: | F34 F53 G01 |
| Date: | 2014–02–05 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:497&r=cba |
| By: | Ghysels, Eric; Idier, Julien; Manganelli, Simone; Vergote, Olivier |
| Abstract: | Policy impact studies often suffer from endogeneity problems. Consider the case of the ECB Securities Markets Programme: If Eurosystem interventions were triggered by sudden and strong price deteriorations, looking at daily price changes may bias downwards the correlation between yields and the amounts of bonds purchased. Simple regression of daily changes in yields on quantities often give insignificant or even positive coefficients and therefore suggest that SMP interventions have been ineffective, or worse counterproductive. We use high frequency data on purchases of the ECB Securities Markets Programme and sovereign bond quotes to address the endogeneity issues. We propose an econometric model that considers, simultaneously, first and second conditional moments of market price returns at daily and intradaily frequency. We find that SMP interventions succeeded in reducing yields and volatility of government bond segments of the countries under the programme. Finally, the new econometric model is broadly applicable to market intervention studies. JEL Classification: E52, E44, G12, C58 |
| Keywords: | component models, euro area crisis, high frequency data, SMP, unconventional monetary policy |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141642&r=cba |
| By: | Beirne, John; Fratzscher, Marcel |
| Abstract: | The paper analyses the drivers of sovereign risk for 31 advanced and emerging economies during the European sovereign debt crisis. It shows that a deterioration in countries’ fundamentals and fundamentals contagion – a sharp rise in the sensitivity of financial markets to fundamentals – are the main explanations for the rise in sovereign yield spreads and CDS spreads during the crisis, not only for euro area countries but globally. By contrast, regional spill overs and contagion have been less important, including for euro area countries. The paper also finds evidence for herding contagion – sharp, simultaneous increases in sovereign yields across countries – but this contagion has been concentrated in time and among a few markets. Finally, empirical models with economic fundamentals generally do a poor job in explaining sovereign risk in the pre-crisis period for European economies, suggesting that the market pricing of sovereign risk may not have been fully reflecting fundamentals prior to the crisis. JEL Classification: E44, F30, G15, C23, H63 |
| Keywords: | bond spreads, CDS spreads, contagion, ratings, sovereign debt crisis, sovereign risk |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20131625&r=cba |
| By: | Angelini, Elena; Ca' Zorzi, Michele; Forster, Katrin |
| Abstract: | A balanced current account in the euro area has disguised sizeable net lending imbalances at the country level, exposing the common currency area to severe pressures during the financial crisis. The key contribution of this paper is to evaluate the adjustment process through the lenses of the New Multi Country Model at the country and sectoral level. We find that shocks to the external, fiscal and monetary environment help explain, to a large degree, the sizeable current account adjustment and rise in unemployment in Spain. The model also suggests that a recovery in wage competitiveness helps to reduce external deficits at the cost of higher net borrowing by households. The stimulus effects on aggregate demand, via the interest rate response of the common monetary authority and the competitiveness channel, are present but not overly large, as the rebound in economic activity depends mainly on global demand, supportive monetary policy, business and consumer confidence. JEL Classification: C5, F32, F41, O52 |
| Keywords: | current account, euro area countries, modeling, net lending |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141647&r=cba |
| By: | Georgiadis, Georgios; Gräb, Johannes |
| Abstract: | Existing evidence suggests that protectionist activity since the financial crisis has been muted, raising the question whether the historically well-documented relationship between growth, real exchange rates and trade protectionism has broken down. This paper re-visits this relationship for the time period since 2009. To this end, we use a novel and comprehensive dataset which considers a wide range of trade policies stretching beyond the traditionally considered tariff and trade defence measures. We find that the specter of protectionism has not been banished: Countries continue to pursue more trade-restrictive policies when they experience recessions and/or when their competitiveness deteriorates through an appreciation of the real exchange rate; and this finding holds for a wide array of contemporary trade policies, including “murky” measures. We also find differences in the recourse to trade protectionism across countries: trade policies of G20 advanced economies respond more strongly to changes in domestic growth and real exchange rates than those of G20 emerging market economies. Moreover, G20 economies’ trade policies vis-à-vis other G20 economies are less responsive to changes in real exchange rates than those pursued vis-à-vis non-G20 economies. Our results suggest that—especially in light of the sluggish recovery—the global economy continues to be exposed to the risk of a creeping return of trade protectionism. JEL Classification: F13, F14 |
| Keywords: | exchanges rates, growth, trade protectionism |
| Date: | 2013–11 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20131618&r=cba |
| By: | George Chouliarakis (The University of Manchester and Bank of Greece); Sophia Lazaretou (Bank of Greece) |
| Abstract: | The past Greek crisis experience is more or less terra incognita. In all historical empirical studies Greece is systematically neglected or included only sporadically in their cross-country samples. In the national literature too there is little on this topic. In this paper we focus on the Greek experience of the Great Depression and use it as a benchmark against which to assess the policy choices and constraints that Greece faces today, with the ultimate aim to draw policy lessons from history and warn against a repeat of the same outcome. The 1930s crisis episode is used as a useful testing ground to compare the two crises episodes, ‘then’ and ‘now’; detect differences and similarities, discuss the policy facts and assess the impact of policy pursued on output. To the best of our knowledge, this paper is the first attempt to study the Greek crisis experience over the two historical episodes and detect similarities and differences. Comparisons with the interwar period show that the current crisis of the Greek economy should be classified a great depression rather than a great recession and that the inability of the national authorities to credibly adhere to their commitment to a nominal anchor was at the root of the country’s failure. |
| Keywords: | economic crisis; economic policy; interwar Greece |
| JEL: | F33 H6 N14 N24 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:bog:wpaper:176&r=cba |
| By: | Mengus, E. |
| Abstract: | The internal cost of default, an important driver of sovereign debt repayment, increases with domestic portfolios' home bias. And so, when using capital controls or other instruments to steer these portfolios, a country faces a trade-off between commitment to repay and diversification. But why does a borrowing country not eschew the internal cost of default through domestic sector bailouts? And why does their sovereign not intermediate the diversification through swaps and other hedging devices? Answering these two questions is key to fathom the nature of internal costs of default. This paper investigates sovereign debt sustainability in a model where domestic and foreign investors optimally select their portfolios and the sovereign optimizes over its debt, default and bailout policies. It derives conditions under which internal bailouts do not preclude sovereign borrowing and establishes when, despite their disciplining benefits, capital controls are undesirable. |
| Keywords: | sovereign debt, internal cost of default, bailouts, capital controls. |
| JEL: | F34 G15 G18 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:480&r=cba |
| By: | Bover, Olympia; Casado, Jose Maria; Costa, Sonia; Du Caju, Philip; McCarthy, Yvonne; Sierminska, Eva; Tzamourani, Panagiota; Villanueva, Ernesto; Zavadil, Tibor |
| Abstract: | The aim of this paper is twofold. First, we present an up-to-date assessment of the differences across euro area countries in the distributions of various measures of debt conditional on household characteristics. We consider three different outcomes: the probability of holding debt, the amount of debt held and, in the case of secured debt, the interest rate paid on the main mortgage. Second, we examine the role of legal and economic institutions in accounting for these differences. We use data from the first wave of a new survey of household finances, the Household Finance and Consumption Survey, to achieve these aims. We find that the patterns of secured and unsecured debt outcomes vary markedly across countries. Among all the institutions considered the length of asset repossession periods best accounts for the features of the distribution of secured debt. In countries with longer repossession periods, the fraction of people who borrow is smaller, the youngest group of households borrow lower amounts (conditional on borrowing), and the mortgage interest rates paid by low-income households are higher. Regulatory loan-to-value ratios, the taxation of mortgages and the prevalence of interest-only or fixed rate mortgages deliver less robust results. JEL Classification: D14, G21, G28, K35 |
| Keywords: | financial literacy, fixed rate mortgages, household debt and interest rate distributions, loan-to-value ratios, taxation, time to foreclose |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20141639&r=cba |
| By: | Nancy van Beers; Michiel Bijlsma; Gijsbert T. J. Zwart |
| Abstract: | Countries in a monetary union can adjust to shocks either through internal or external mechanisms. We quantitatively assess for the European Union a number of relevant mechanisms suggested by Mundellâ??s optimal currency area theory, and compare them to the United States. For this purpose, we update a number of empirical analyses in the economic literature that identify (1) the size of asymmetries across countries and (2) the magnitude of insurance mechanisms relative to similar mechanisms and compare results for the European Monetary Union (EMU) with those obtained for the US. To study the level of synchronization between EMU countries we follow Alesina et al. (2002) and Barro and Tenreyro (2007). To measure the effect of an employment shock on employment levels, unemployment rates and participation rates we perform an analysis based on Blanchard and Katz (1992) and Decressin and Fatas (1995). We measure consumption smoothing through capital markets, fiscal transfers and savings, using the approach by Asdrubali et al. (1996) and Afonso and Furceri (2007). To analyze risk sharing through a common safety net for banks we perform a rudimentary simulation analysis. |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:bre:wpaper:821&r=cba |