|
on Central Banking |
| By: | Harrison, Richard (Bank of England) |
| Abstract: | This paper studies optimal monetary policy in a New Keynesian model with portfolio frictions that create a role for the central bank balance sheet as a policy instrument. Central bank purchases of long‑term government debt (‘quantitative easing’) reduce average portfolio returns, thereby increasing aggregate demand and inflation. Optimal time‑consistent policy prescribes large and rapid asset purchases when the policy rate hits the zero bound. Optimal balance sheet reduction (‘quantitative tightening’) is more gradual. A central bank that pursues a flexible inflation target can achieve similar welfare to optimal policy if quantitative tightening is calibrated appropriately. |
| Keywords: | Quantitative easing; quantitative tightening; optimal monetary policy; zero lower bound |
| JEL: | E52 E58 |
| Date: | 2024–03–08 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1063&r=cba |
| By: | Bandera, Nicolò (Bank of England); Stevens, Jacob (University of St Andrews) |
| Abstract: | We study the macroeconomic implications of non-bank financial institutions (NBFIs) in the context of the 2022 UK gilt crisis and estimate the monetary policy spillovers of financial stability interventions. We make three contributions. First, we develop the first DSGE model featuring liability driven investment (LDI) and pension funds. This novel framework in which LDI activity amplifies the movements in gilt prices allows us to replicate the UK gilt crisis, demonstrating a crucial mechanism through which NBFIs can amplify financial and economic distress. Second, we quantitatively estimate the monetary policy spillovers of the Bank of England financial stability asset purchases. We find that the asset purchases were successful in offsetting LDI-driven gilt market dysfunction. The temporary, targeted nature of these purchases was crucial in avoiding monetary spillovers. Third, we model two counterfactual instruments – an NBFI repo tool and a macroprudential liquidity buffer – and compare their effectiveness as well as monetary spillovers. Our results show that the central bank can successfully address NBFI-driven market stress without loosening monetary policy, avoiding potential tensions between price and financial stability |
| Keywords: | Monetary policy; financial stability; asset purchases; liquidity crisis; liability-driven investors; gilt; DSGE model |
| JEL: | C68 E44 E52 E58 G01 G23 |
| Date: | 2024–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1070&r=cba |
| By: | van der Ploeg, Frederick (University of Oxford, University of Amsterdam and CEPR); Willems, Tim (Bank of England) |
| Abstract: | Since the post‑Covid rise in inflation has been accompanied by strong wage growth, the distributional conflict between wage and price‑setters (both wishing to attain a certain markup) has regained prominence. We examine how a central bank should resolve a ‘battle of the markups’ when aspired markups are cyclically sensitive, highlighting a new ‘aspirational channel’ of monetary transmission. We establish conditions under which an inflationary situation characterised by inconsistent aspirations requires a reduction in economic activity, to eliminate worker‑firm disagreement over the appropriate level of the real wage. We find that countercyclical markups and/or a flat Phillips curve call for more dovish monetary policy. Estimating price markup cyclicality across 44 countries, we find that monetary contractions are better able to lower inflation when markups are procyclical. |
| Keywords: | Inflation; wage-price dynamics; markups; monetary policy transmission; Taylor principle; determinacy |
| JEL: | E31 E32 E52 E58 |
| Date: | 2024–03–08 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1065&r=cba |
| By: | Cañon, Carlos (Bank of England); Gerba, Eddie (Bank of England); Pambira, Alberto (Bank of England); Stoja, Evarist (University of Bristol) |
| Abstract: | We examine how the tail risk of currency returns of nine countries, from 2000 to 2020, were impacted by central bank monetary and liquidity measures across the globe with an original and unique dataset that we make publicly available. Using a standard factor model, we derive theoretical measures of tail risks of currency returns which we then relate to the various policy instruments employed by central banks. We find empirical evidence for the existence of a cross-border transmission channel of central bank policy through the FX market. The tail impact is particularly sizeable for asset purchases and swap lines. The effects last for up to one month, and are proportionally higher in a hypothetical joint QE action scenario. This cross-border source of tail risk is largely undiversifiable, even after controlling for the US dollar dominance and the effects of its own monetary policy stance. |
| Keywords: | Unconventional and conventional monetary policy; liquidity measures; currency tail risk; systematic and idiosyncratic components of tail risk |
| JEL: | E44 E52 G12 G15 |
| Date: | 2024–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1068&r=cba |
| By: | Long, Jamie (Bank of England); Fisher, Paul (Senior Research Fellow, King’s Business School, King’s College London, Data Analytics for Finance and Macro Research Centre) |
| Abstract: | Central banks retain a portion of their net profits as reserves and distribute the remainder to their finance ministry, typically in the form of a dividend. Few central banks have a reciprocal arrangement in place for covering financial losses with a transfer of capital. This paper reports the findings of a survey of central bank profit distribution and recapitalisation arrangements across 70 jurisdictions and examines the range of features present, such as revaluation accounts and requirements for capital injections. The findings help establish the importance of a robust framework for managing central bank profit distribution and recapitalisation. The presence of such a framework should allow central banks to retain more of profits and access external resources when capital is low, and to function as an income generating asset for the government when capital is high, therefore ensuring both an appropriate use of public funds and the presence of a credible and financially independent central bank that stands ready to act when needed. |
| Keywords: | Central bank balance sheet; central bank profit distribution; central bank recapitalisation; monetary policy; financial stability |
| JEL: | E52 E58 |
| Date: | 2024–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1069&r=cba |
| By: | Lambert, Claudia; Meller, Barbara; Pancaro, Cosimo; Pellicani, Antonella; Radulova, Petya; Soons, Oscar; van der Kraaij, Anton |
| Abstract: | A digital euro would provide the general public with an additional means of payment in the form of risk-free central bank money in digital form that is universally accepted for digital payments across the euro area. A digital euro would offer a wide range of financial stability benefits, including safeguarding the role of public money and strengthening the strategic autonomy and monetary sovereignty of the euro area in the digital era. It would be designed to have no material impact on financial stability or the transmission of monetary policy. This paper shows the usefulness of digital euro safeguards, such as holding limits, that would limit the impact of the introduction of a digital euro on banks’ liquidity and on their reliance on central bank funding. To this end, it assesses how banks might respond to the introduction of a digital euro while seeking to maximise profitability and manage their risks for a range of holding limit scenarios. The results of the simulated impact on key liquidity metrics show that, with safeguards in place and on aggregate, the liquidity metrics of euro area banks would decline but remain well above regulatory minimums. In addition, the central bank funding ratios of euro area banks would not increase materially on aggregate and would remain contained overall. JEL Classification: E42, E58, G21 |
| Keywords: | bank intermediation, CBDC, digital euro, financial stability risks |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbops:2024346&r=cba |
| By: | Shangshang Li |
| Abstract: | This paper evaluates gains from international monetary policy cooperation between the financial centre and periphery countries in a two-country open economy model consistent with global financial cycles. Compared to the non-cooperative Nash equilibrium, the optimal cooperative equilibrium robustly fails to benefit both countries simultaneously. The financial periphery is more likely to gain from cooperation if it raises less foreign currency debt or is relatively small. These results also hold when considering the transitional gains and losses of moving from non-cooperation to cooperation. The uneven distribution of gains from cooperation persists when both countries adopt implementable policy rules with and without cooperation. Nevertheless, both countries gain when transitioning from the Nash to the cooperative implementable rules. Regardless of the financial centre's policy, rules responding to the exchange rate dominate over purely inward-looking rules for the financial periphery. |
| Keywords: | policy cooperation, global financial cycle, currency mismatch |
| JEL: | E44 E52 E58 E61 F34 F42 |
| URL: | http://d.repec.org/n?u=RePEc:liv:livedp:202405&r=cba |
| By: | Makram El-Shagi (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan); Yishuo Ma (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan) |
| Abstract: | While policy reaction functions of most major central banks are routinely approximated by fitting Taylor (type) rules to their policy rate, there is no such consensus for the People's Bank of China (PBoC). What makes it hard to get a clear impression of the “true†reaction function is that most papers in the extensive literature focus on a single aspect of the reaction function typically mostly comparing it to one (or a few) widely used baseline models. Contrarily, we assess a broad range of questions regarding the reaction function in a unified approach, estimating several hundred reaction functions. While we find that no single policy measure fully captures all aspects of the PBoC's policy, our paper provides clear evidence for asymmetric behavior, support for an important role of monetary aggregates, and robust evidence for the PBoC considering both financial stability and exchange rate stabilization in its policy deliberations. |
| Keywords: | China, monetary policy, reaction function, Taylor rule |
| JEL: | E58 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:fds:dpaper:202405&r=cba |
| By: | Ida, Daisuke |
| Abstract: | This study explores how the real money balance effect (RMBE) affects the neo-Fisherian effect (NFE) in a standard new Keynesian model. First, we find that the presence of the RMBE can partly explain the occurrence of the NFE, and that increasing the nonseparability parameter magnifies the positive response of the nominal interest rate to a persistent inflation target shock. Second, we show that the degree of nominal price stickiness is important in explaining how the RMBE amplifies the NFE. In sum, this study addresses how the presence of the RMBE facilitates generating the NFE. |
| Keywords: | Neo-Fisherian effect; New Keynesian model; Real money balances; Interest rates; Inflation |
| JEL: | E52 E58 |
| Date: | 2024–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:120575&r=cba |
| By: | Bardoscia, Marco (Bank of England); Carro, Adrian (Banco de España, Institute for New Economic Thinking at the Oxford Martin School, University of Oxford); Hinterschweiger, Marc (Bank of England); Napoletano, Mauro (Scuola Superiore Sant’Anna); Popoyan, Lilit (Queen Mary, University of London); Roventini, Andrea (Scuola Superiore Sant’Anna); Uluc, Arzu (Bank of England) |
| Abstract: | We develop a macroeconomic agent-based model to study the joint impact of borrower and lender-based prudential policies on the housing and credit markets and the economy more widely. We perform three experiments: (i) an increase of total capital requirements; (ii) an introduction of a loan-to-income (LTI) cap on mortgages to owner-occupiers; and (iii) a joint introduction of both experiments at the same time. Our results suggest that tightening capital requirements leads to a sharp decrease in commercial and mortgage lending, and housing transactions. When the LTI cap is in place, house prices fall sharply relative to income, and the homeownership rate decreases. When both policy instruments are combined, we find that housing transactions and prices drop. Both policies have a positive impact on real GDP and unemployment, while there is no material impact on inflation and the real interest rate. |
| Keywords: | Prudential policies; housing market; macroeconomy; agent-based models |
| JEL: | C63 D10 D31 E58 G21 G28 R20 R21 R31 |
| Date: | 2024–03–15 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1066&r=cba |
| By: | Coroneo, Laura (University of York); Kaminska, Iryna (Bank of England); Pastorello, Sergio (University of Bologna) |
| Abstract: | This paper presents a non-linear framework to evaluate spillovers across domestic and international yield curves when policy rates are constrained by the zero lower bound. Based on the sample of US and UK data, we estimate a joint shadow rate model of international yield curves, accounting for the zero lower bound, no-arbitrage conditions within and between government bond markets, and the global nature of some of the bond risk factors. Results indicate that the post-2009 US monetary policy transmission mechanism and its spillover effects on the UK yield curve are non-linear and asymmetric. |
| Keywords: | Joint term structure models; local projections; monetary policy; non-linear responses; shadow rate term structure models; yield curve; zero lower bound |
| JEL: | E43 E47 E52 G15 |
| Date: | 2024–02–09 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1062&r=cba |
| By: | Serena Merrino; Ilias Chondrogiannis |
| Abstract: | We examine the effect of post-2010 banking regulation in South Africa on financial stability, macroeconomic variables and bank performance. We focus on risk spillovers and increased network and tail connectedness between banks, using a sample of nine listed South African banks in 20082023. The implementation of Basel III regulation, particularly capital adequacy ratios, has reduced connectedness-related risks but there is weak evidence of an effect of regulation on bank performance. |
| Date: | 2024–04–15 |
| URL: | http://d.repec.org/n?u=RePEc:rbz:wpaper:11060&r=cba |
| By: | Christopher J. Erceg; Marcin Kolasa; Jesper Lindé; Mr. Andrea Pescatori |
| Abstract: | Many countries have used energy subsidies to cushion the effects of high energy prices on households and firms. After documenting the transmission of oil supply shocks empirically in the United States and the Euro Area, we use a New Keynesian modeling framework to study the conditions under which these policies can curb inflation. We first consider a closed economy model to show that a consumer subsidy may be counterproductive, especially as an inflation-fighting tool, when applied globally or in a segmented market, at least under empirically plausible conditions about wage-setting. We find more scope for energy subsidies to reduce core inflation and stimulate demand if introduced by a small group of countries which collectively do not have much influence on global energy prices. However, the conditions under which consumer energy subsidies reduce inflation are still quite restrictive, and this type of policy may well be counterproductive if the resulting increase in external debt is high enough to trigger sizeable exchange rate depreciation. Such effects are more likely in emerging markets with shallow foreign exchange markets. If the primary goal of using fiscal measures in response to spikes in energy prices is to shield vulnerable households, then targeted transfers are much more efficient as they achieve their goals at lower fiscal cost and transmit less to core inflation. |
| Keywords: | Energy Prices; Energy Subsidies; Monetary Policy; International Spillovers |
| Date: | 2024–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2024/081&r=cba |
| By: | Stefano Colonnello (Department of Economics, Ca’ Foscari University of Venice); Giuliano Curatola (University of Siena; Leibniz Institute for Financial Research SAFE); Shuo Xia (Leipzig University; Halle Institute for Economic Research (IWH)) |
| Abstract: | To contain bankers' risk-shifting behavior, policymakers use a variety of tools. Among them, mandating the use of default-linked (i.e., debt-like) pay features prominently, typically in the form of bonus deferrals. In our model, a risk-neutral manager is in charge of choosing bank-level asset risk, receiving in exchange a compensation package consisting of a bonus and a default-linked component. In the spirit of existing regulation and widespread industry practices, we give the manager discretion over the allocation of the personal default-linked account between own bank's shares and an alternative asset. The possibility for the manager to tie the value of default-linked pay to equity weakens its debt-like feature and, in the same way, its ability to rein in excessive risk-taking. Bank leverage and bailout expectations appear to exacerbate these effects, which may be further aggravated by the endogenous shareholders' choice to design a more convex bonus as a response to mandatory default-linked pay. Our analysis raises concerns on the robustness of the theoretical foundations of some recent regulatory efforts. |
| Keywords: | Bank Risk-Taking, Banking Regulation, Default-Linked Compensation |
| JEL: | G21 G28 G34 M12 |
| Date: | 2024 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2024:07&r=cba |
| By: | Luciana Juvenal; Ivan Petrella |
| Abstract: | We examine the impact of commodity price changes on the business cycles and capital flows in emerging markets and developing economies (EMDEs), distinguishing between their role as a source of shock and as a channel of transmission of global shocks. Our findings reveal that surges in export prices, triggered by commodity price shocks, boost domestic GDP, an effect further amplified by the endogenous decline of country spreads. However, the effects on capital flows appear muted. Shifts in U.S. monetary policy and global risk appetite drive the global financial cycle in EMDEs. Eased global credit conditions, attributed to looser U.S. monetary policy or lower global risk appetite, lead to a rise in export prices, higher output, a decrease in government borrowing costs, and stimulate greater capital flows. The endogenous response of export prices amplifies the output effects of a more accommodative U.S. monetary policy while country spreads magnify the impact of shifts in global risk appetite. |
| Date: | 2024–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2024/082&r=cba |
| By: | Philippe Goulet Coulombe; Karin Klieber; Christophe Barrette; Maximilian Goebel |
| Abstract: | Timely monetary policy decision-making requires timely core inflation measures. We create a new core inflation series that is explicitly designed to succeed at that goal. Precisely, we introduce the Assemblage Regression, a generalized nonnegative ridge regression problem that optimizes the price index's subcomponent weights such that the aggregate is maximally predictive of future headline inflation. Ordering subcomponents according to their rank in each period switches the algorithm to be learning supervised trimmed inflation - or, put differently, the maximally forward-looking summary statistic of the realized price changes distribution. In an extensive out-of-sample forecasting experiment for the US and the euro area, we find substantial improvements for signaling medium-term inflation developments in both the pre- and post-Covid years. Those coming from the supervised trimmed version are particularly striking, and are attributable to a highly asymmetric trimming which contrasts with conventional indicators. We also find that this metric was indicating first upward pressures on inflation as early as mid-2020 and quickly captured the turning point in 2022. We also consider extensions, like assembling inflation from geographical regions, trimmed temporal aggregation, and building core measures specialized for either upside or downside inflation risks. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2404.05209&r=cba |
| By: | Grace, Charlotte (Nuffield College, University of Oxford) |
| Abstract: | This paper provides a method for comparing the performance of different models of bidding behaviour. It uses data on participants’ bids but does not require data on their values. I find that a model of ‘truthful bidding’ – bidding one’s true value for liquidity – outperforms a conventional model in which bidders shade their bids to maximise their expected surpluses, in the Bank of England’s uniform-price divisible-good liquidity auctions. I provide two possible explanations for this result. First, when bidders are sufficiently risk averse, optimal strategies in the conventional model approximate truthful bidding. For the conventional model, I develop new identifying conditions which allow for risk aversion. I find that the degree of risk aversion required for truthful bidding to be approximately optimal is consistent with that found in studies that are the most similar to my setting. Second, the optimal strategy can be complicated. Truthful bidding is preferable, even for risk neutral bidders, if the cost of calculating what would otherwise be the optimal strategy exceeds around 5% of bidder surplus. |
| Keywords: | Auctions; bid shading; central bank liquidity provision; product mix auction |
| JEL: | D44 E58 |
| Date: | 2024–02–09 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1061&r=cba |
| By: | Iñaki Aldasoro; Sebastian Doerr; Leonardo Gambacorta; Daniel Rees |
| Abstract: | This paper studies the effects of artificial intelligence (AI) on sectoral and aggregate employment, output and inflation in both the short and long run. We construct an index of industry exposure to AI to calibrate a macroeconomic multi-sector model. Building on studies that find significant increases in workers' output from AI, we model AI as a permanent increase in productivity that differs by sector. We find that AI significantly raises output, consumption and investment in the short and long run. The inflation response depends crucially on households' and firms' anticipation of the impact of AI. If they do not anticipate higher future productivity, AI adoption is initially disinflationary. Over time, general equilibrium forces lead to moderate inflation through demand effects. In contrast, when households and firms anticipate higher future productivity, inflation rises immediately. Inspecting individual sectors and performing counterfactual exercises we find that a sector's initial exposure to AI has little correlation with its long-term increase in output. However, output grows by twice as much for the same increase in aggregate productivity when AI affects sectors producing consumption rather than investment goods, thanks to second round effects through sectoral linkages. We discuss how public policy should foster AI adoption and implications for central banks. |
| Keywords: | artificial intelligence, generative AI, inflation, output, productivity, monetary policy |
| JEL: | E31 J24 O33 O40 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1179&r=cba |