Dichotomy between macroprudential policy and monetary policy on credit and inflation

This paper compares macroprudential policy and monetary policy using a simple New Keynesian model with credit. Macroprudential policy is effective in stabilizing credit with limited impact on inflation. Monetary policy stabilizes inflation, but is ‘too blunt’ for credit stabilization.     

Inside the bank lending channel

This paper tests cross-sectional differences in the effectiveness of the bank lending channel. The results, derived from a comprehensive sample of Italian banks, suggest that heterogeneity in the monetary policy pass-through exists. After a monetary tightening the decrease in lending is lower for well-capitalized banks that are perceived as less risky by the market and are better able to raise uninsured deposits. Liquid banks can protect their loan portfolio against monetary tightening simply by drawing down cash and securities. The presence of internal capital markets in bank holding companies also contributes to insulate monetary shocks. Bank size is never relevant.     

Cross-country differences in monetary policy execution and money market rates’ volatility

Volatility patterns in overnight interest rates display differences across industrial countries that existing models—designed to replicate the features of individual countries’ markets—cannot account for. This paper presents an equilibrium model of the overnight interbank market that matches cross-country differences in patterns in interest volatility by incorporating differences in how central banks manage liquidity in response to shocks. Our model is consistent with central banks’ practice of rationing access to marginal facilities when the objective of stabilizing short-term interest rates conflicts with another high-frequency objective, such as an exchange rate target.     

Securitisation and the bank lending channel

The dramatic increase in securitisation activity experienced in Europe in the years following the introduction of the euro has altered the liquidity, credit and maturity transformation role traditionally performed by banks. We claim that the changing role of credit intermediaries due to securitisation has also modified the effectiveness of the bank lending channel and banks’ ability to grant loans. We use a novel database of securitisation activity and a large sample of European banks and find that the use of securitisation shelters banks’ loan supply from the effects of monetary policy. Securitisation activity has also strengthened banks’ capacity to supply new loans. This capacity, however, depends on business cycle conditions and, notably, on banks’ risks positions. The recent credit crisis is instructive in this respect.     

Financial market imperfections and monetary policy strategy

In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank applying the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if interest rate pass-through is incomplete, the central bank can use a narrow monetary aggregate and the discount interest rate as independent and complementary policy instruments to reinforce the credibility of its announcements and the role of inflation target as a nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman's k-percent money growth rule, which can generate dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.     

Information acquisition, dissemination, and transparency of monetary policy

Abstract.  This paper examines the role of transparency in a benevolent monetary authority's policies. Each firm's payoff depends on unobservable macroeconomic conditions and firms may incur a cost to acquire private information about macroeconomic conditions. The policy authority attempts to infer the underlying macroeconomic conditions from a noisy measure of aggregate actions and makes a public announcement to inform firms of this inference. High-quality announcements provide firms the incentive not to gather private information and base actions solely on information contained in policy announcements. However, this makes the observed actions of firms less informative to the policy authority.     

Distortionary fiscal policy and monetary policy goals

We reconsider the role of an inflation conservative central banker in a setting with distortionary taxation. To do so, we assume monetary and fiscal policy are decided by independent authorities that do not abide to past commitments. If the two authorities make policy decisions simultaneously, inflation conservatism causes fiscal overspending. But if fiscal policy is determined before monetary policy, inflation conservatism imposes fiscal discipline. These results clarify that in our setting the value of inflation conservatism depends crucially on the timing of policy decisions.     

Household's preferences and monetary policy inertia

Interest rates set by central banks puzzlingly move with a certain inertia. We show that household's preferences can be important determinants of the optimal interest rate inertia due to their impact on the efficiency of the monetary policy transmission mechanism.     

The financial accelerator and monetary policy rules

Comparing Bernanke et al.’s (1999) financial accelerator model to a comparable model without an operational financial accelerator mechanism, we find that financial acceleration is reduced when monetary policy reacts to the output gap and when firm-specific volatility rises.     

Inflation, unemployment, and the time consistency of the US monetary policy

This paper verifies the performance of the Barro and Gordon (1983) model to explain the US inflation since the early 1950s. We divide the period from 1951:2 to 2010:2 according to each chairman of the Federal Reserve (FED). In addition, we consider aggregated periods, represented by pre-Volcker, Volcker-Greenspan, Greenspan-Bernanke, and whole sample. A genetic algorithm of stochastic search is applied to reduce the sensitivity of the maximum likelihood estimator to the initial parameter values. Surprisingly, our results show that the time consistency problem explains the US inflation during the Greenspan chairmanship at the FED.     

Do asymmetries matter for European monetary policy?

In this paper we analyze the impact of economic and institutional (ECB decision rules) asymmetries on the effectiveness of monetary policy in Euroland. We consider a model where asymmetric shocks and divergent propagation of shocks in output and inflation are potential causes of tensions within the ECB concerning the conduct of common monetary (interest rate) policy. Welfare implications of the alternative decision procedures are discussed.     

Introduction to monetary policy and capital accumulation

The papers in this symposium address the issue of multiple equilibria that can be induced by monetary policy in models with capital accumulation. In particular they examine how the “Taylor Principle”, under which interest rates respond more than proportionately to increases in inflation, can generate multiple equilibria. They also explore the design of policies to avoid the problem of multiple equilibria and indeterminacy.     

Liquidity risk, economic development, and the effects of monetary policy

Empirical evidence indicates that monetary policy is not super-neutral in many countries. In particular, in high inflation economies, inflation is negatively related to economic activity. By comparison, inflation may be positively correlated with output in low inflation countries. We present a neoclassical growth model with money in which the incidence of liquidity risk is inversely related to aggregate capital formation. Interestingly, there may be multiple monetary steady-states where the effects of monetary policy vary. In poor economies, the financial system is highly distorted and higher rates of money growth are associated with less capital formation. In contrast, in advanced economies, a Tobin effect is observed. Since inflation exacerbates distortions from a coordination failure in the low-capital steady-state, individuals become much more exposed to liquidity risk. Consequently, optimal monetary policy depends on the level of development.     

Time consistent monetary policy with endogenous price rigidity

I characterize time consistent equilibrium in an economy with price rigidity and an optimizing monetary authority operating under discretion. Firms have the option to increase their frequency of price change, at a cost, in response to higher inflation. Previous studies, which assume a constant degree of price rigidity across inflation regimes, find two time consistent equilibria—one with low inflation, the other with high inflation. In contrast, when price rigidity is endogenous, the high inflation equilibrium ceases to exist. Hence, time consistent equilibrium is unique. This result depends on two features of the analysis: (1) a plausible quantitative specification of the fixed cost of price change, and (2) the presence of an arbitrarily small cost of inflation that is independent of price rigidity.     

Optimal monetary policy: distribution efficiency versus production efficiency

This paper investigates the trade‐off between distribution effect and production effect of monetary policy when there exist unobservable idiosyncratic liquidity shocks. In the absence of risk‐sharing arrangements such as a credit market, monetary policy serves to provide ex post insurance to smooth consumption. Specifically, issuing interest‐bearing bonds restores credit transactions on money through bond‐money exchanges. Such a policy has a positive distribution effect, but the resulting inflation hampers production efficiency. It is demonstrated that the trade‐off between distribution efficiency gain and production efficiency loss would result in net welfare enhancement if consumers are relative‐risk‐averse enough.     

Inflation dynamics and the cost channel of monetary transmission

Evidence from vector autoregressions indicates that the impact of interest rate shocks on macroeconomic aggregates can substantially be affected by the so-called cost channel of monetary transmission. In this paper, we apply a structural approach to examine the relevance of the cost channel for inflation dynamics in G7 countries. Since firms’ costs of working capital increase with interest rates, we augment a (hybrid) New Keynesian Phillips curve by including the short-run nominal interest rate. We find significant and varying direct interest rate effects for the majority of countries, including member countries of the EMU. Simulations further demonstrate that the estimated interest rate coefficients can substantially affect inflation responses to monetary policy shocks, and can even lead to inverse inflation responses, when the cost channel is - relative to the demand channel - sufficiently strong.     

A two-pillar DSGE monetary policy model for the euro area

The current financial crisis has revived the interest for monitoring both monetary and credit developments. Over the past two decades, consistent with the adoption of inflation targeting strategies by a growing number of central banks and the development of New Keynesian models for which monetary aggregates are largely irrelevant, money and credit have been progressively neglected in the conduct of monetary policy. A striking exception has been the Eurosystem, which has implemented a strategy known as the “two-pillar monetary policy strategy” giving a prominent role for money. In this paper, we develop a small optimizing model based on Ireland (2004), estimated on euro area data and featuring this two-pillar strategy. We evaluate an ECB-style cross-checking policy rule in a DSGE model with real balance effects of money. We find some evidence that indeed money plays a non-trivial role in explaining the euro area business cycle. This provides a rationale for the central bank to factor in monetary developments but also raises some issues regarding the reliability of M3 as an appropriate monetary indicator. We find some evidence that the ECB has systematically reacted to a filtered measure of money growth but weak evidence it has reacted more aggressively during excess money growth periods.     

The design of monetary and fiscal policy: A global perspective

We study the emergence of multiple equilibria in models with capital and bonds under various monetary and fiscal policies. We show that the presence of capital is indeed another independent source of local and global multiplicities, even under active policies that yield local determinacy. We also show how a very similar mechanism generates multiplicities in models with bonds and distortionary taxation. We then explore the design of monetary policies that avoid multiple equilibria. We show that interest rate policies that respond to the output gap, while potentially a source of significant inefficiencies, may be effective in preventing multiple equilibria and costly oscillatory equilibrium dynamics.