Overbidding in fixed rate tenders—an empirical assessment of alternative explanations

This paper investigates various theories explaining banks’ overbidding in the fixed rate tenders of the European Central Bank (ECB). Using auction data from both the Bundesbank and the ECB, we show that none of the theories can on its own explain the observed overbidding. This implies that the proposed new rules by the ECB, aimed at neutralizing interest rate expectations, would not eliminate overbidding if the rationing rule in the fixed rate tenders remains unchanged.     

Over- and Underbidding in Central Bank Open Market Operations Conducted as Fixed Rate Tender

Abstract. Open market operations play a key role in allocating central bank funds to the banking system and thereby in steering short‐term interest rates in line with the stance of monetary policy. Many central banks apply so‐called ‘fixed rate tender’ auctions in their open market operations. This paper presents, on the basis of a survey of central bank experience, a model of bidding in such tenders. In their conduct of fixed rate tenders, many central banks faced specifically an ‘under‐’ and an ‘overbidding’ problem. These phenomena are revisited in the light of the proposed model, and the more general question of the optimal tender procedure and allotment policy of central banks is addressed.     

Writing Clearly: The ECB's Monetary Policy Communication

The article presents a novel methodology for measuring the clarity of central bank communication using content analysis, illustrating the methodology with the case of the European Central Bank (ECB). The analysis identifies the ECB's written communication as clear in about 85–95% of instances, which is comparable with, or better than, similar results available for other central banks. We also find that the additional information on risk to inflation and especially projection risk assessment contained in the ECB's Monthly Bulletins helps to improve communication clarity compared to ECB's press releases. In contrast, the bulletin's communication on monetary developments has a negative, albeit small, impact on clarity.     

Are monetary policy shocks causal to bank health? Evidence from the euro area

Despite considerable efforts of the European Central Bank (ECB) to support bank intermediation after the 2008 financial crisis, the recovery of euro area banks remained incomplete. Although many studies indicate that central banks can influence the stock prices of firms through their policy actions and communication, a knowledge gap exists as to whether the ECB's monetary policy can influence bank health. Through a high-frequency identification approach, this study reveals that the causal effect of conventional monetary policy action and communication by the ECB on bank stock prices differed over time, whereas its influence on bank financing costs was robust. This study provides new evidence showing that information effects related to policy easing surprises in the aftermath of the 2008 financial crisis hampered the ECB efforts to improve bank health and that its Odyssean communication signals (related to forward-looking announcements of policy easing) supported bank health during this phase. Local projections suggest that the response of banks to monetary policy shocks displayed some persistence, where ECB policy surprises and communications that shifted up (down) the yield curve were normally positive (negative) for bank health. The findings solicit a new perspective when assessing the influence of the ECB's monetary policy measures on euro area banks.     

How the ECB and the US Fed set interest rates

Monetary policies of the European Central Bank (ECB) and US Fed can be characterized by ‘Taylor rules’, that is both central banks seem to be setting rates by taking into account the ‘output gap’ and inflation. We also set up and tested Taylor rules which incorporate money growth and the euro–dollar exchange rate, thereby improving the ‘fit’ between actual and Taylor rule based rates. In general, Taylor rules appear to be a much better way of describing Fed policy than ECB policy. Simulations suggest that the ECB's short-term interest rates have been at a much lower level in the last 2 years compared with what a Taylor rule would suggest.     

What's in a second opinion? Shadowing the ECB and the Bank of England

One way of evaluating how well monetary authorities perform is to provide the public with a regular and independent second opinion. The European Central Bank (ECB) and the Bank of England (BoE) are shadowed by professional and academic economists who provide a separate policy rate recommendation in advance of the central bank announcement. In this paper, we systematically evaluate this second opinion and find that, first, the shadow committee of the ECB tends to be relatively less inflation averse than the ECB. In contrast, the shadow committee of the BoE proposes a more hawkish monetary policy stance than the BoE. Second, consensus within a shadow committee is far easier to reach when there is no pressure to change the policy rate. Third, the ECB's shadow committee is more activist than the ECB's Governing Council and a larger degree of consensus within the former brings about a greater likelihood that the two committees will agree.     

Games of monetary and fiscal interactions in the EMU

This paper constructs various models of the EMU and ECB when member countries have different objectives. Voting in pursuit of national interest can yield moderate and stable inflation. The metaphor of Walsh-type contracts implements a monetary policy rule that averages the member countries’ most preferred rules. In a repeated relationship where a country suffering a large adverse shock can use political bargaining to subvert the ECB's commitment, the optimal rule should incorporate some flexibility to forestall that. Finally, freedom of national fiscal policies undermines the ECB's monetary commitment; this may justify fiscal constraints like the Stability and Growth Pact.     

Testing for asymmetries in the preferences of the euro-area monetary policymaker

This article tests for asymmetries in the preferences of the euro-area monetary policymaker with 1995:1–2005:2 data from the latest update of the European Central Bank's (ECB's) Area-wide database. Following the relevant literature, we distinguish between three types of asymmetry: precautionary demand for expansions, precautionary demand for price stability and interest rate smoothing asymmetry. Based on the joint generalized method of moments (GMM) estimation of the Euler equation of optimal policy and the aggregate supply-aggregate demand (AS-AD) structure of the macroeconomy, we find evidence of precautionary demand for price stability in the preferences revealed by the monetary policymaker. This type of asymmetry is consistent with the ECB's definition of price stability and with the priority of credibility-building by a recently created monetary authority.     

Interests and 'Independence': The European Central Bank and the theory of bureaucracy

The European Central Bank has an unprecedented degree of statutory independence. This is presumably attributable to the view that central banks, unimpeded by external forces, pursue the public interest. That presumption has not always been common in the economics literature, even in the discussion of central banking. The theory of bureaucracy suggests that such institutions pursue their own interests. It is here applied to the European central bank as it was in the past to other central banks. First, consideration is given to what is today implied by the view that central banks are primarily interested in maintaining their independence, maximising their discretion, and avoiding blame for poor outcomes. Second, the ECB's explanations of how it sees its role and status and its presentation of its strategy are considered. Certain limitations in the form of obscure explanation, confused analysis and selective referencing are identified. These appear to suggest that the ECB is concerned with the pursuit of its own agenda. Particular attention is drawn to the danger of paying too much attention to what it says about its own 'accountability'.     

The Monetary Policies of the European Central Bank and the Euro's (Mal-)Performance: A stability-oriented assessment

The stability-oriented macroeconomic framework established in the Treaties on European Union, especially the unparalleled status of independence and peculiar mandate of the European Central Bank (ECB), were promised virtually to guarantee price stability and a strong euro. Shattering these hopes and promises in a rather drastic way, the euro's external value has declined markedly while consumer price inflation has quadrupled since the new currency's inception. This paper assesses the ECB's role in relation to the euro's (mal-)performance. It challenges the truly odd conventional wisdom that, despite these dismal monetary developments, neither the Maastricht regime nor the ECB might possibly be at fault. Reviewing the ECB's interest rate policies and scrutinising its rationale, a conspicuous anti-growth bias is diagnosed that has produced rather perverse consequences.This stability-oriented assessment concludes that the ECB has been key to the 'euro puzzle', propagating euro weakness and pushing up inflation. Euroland's democratically elected representatives are therefore urged to reform Europe's key structural problem, namely, the ECB, an independent monetary policymaker whose unbounded discretion allows it to pursue ill-guided and thoroughly idiosyncratic policies without being held to account for the consequences.     

Banking business models and risk: Findings from the ECB's comprehensive assessment

We use the results of the ECB's comprehensive assessment to evaluate the importance of the bank business model on risk assessment and the persuasive effectiveness of different supervisory styles on banks’ recapitalization. Our analysis reveals inconsistencies in the information content provided by the various regulatory measures used for assessing bank stability. Moreover, opposite to CET1 ratio, the leverage ratio provides assessments on business models more consistent with a market-based measure of bank risk exposure and Z-SCORE. Accounting for several control variables both at the bank and country level, we also find evidence that the effectiveness of the supervisory action depends on the specific type of supervisory model. In particular, countries adopting the hybrid model seem more effective in persuading banks to recapitalize preventively. Differently, countries adopting the integrated and the sectorial model seem less effective in their requests.     

Enterprise life cycle,financial technology and digital transformation of banks—Evidence from China

Financial technology formed by the combination of digital technology and traditional finance is gradually changing the financial services model. The development of financial technology has influenced the behaviour of commercial banks. It has promoted the innovation of commercial banks. And it has promoted the digital transformation of commercial banks. In this paper, it is intended to explore the relationship between financial technology and digital transformation of banks through positive analysis. As well as to explore how the age of enterprises listed and enterprise life cycle affect the relationship between financial technology and digital transformation of banks. This paper conducts an empirical research on the data of China's A-share listed banks from 2011 to 2021 using a two-way fixed effects regression method. The results of the research indicate that financial technology promotes banks' digital transformation. Meanwhile, the age of enterprise listing and enterprise life cycle play a positive moderating role in financial technology promoting banks' digital transformation. In this paper, it is the first time to conduct an empirical research with the number of monthly active users of mobile banking as a proxy variable for digital transformation of banks, which enriches the study of financial technology. It has certain reference value for promoting digital transformation of banks.     

What matters when? The impact of ECB communication on financial market expectations

This article analyses financial markets’ reaction to European Central Bank's (ECB) communication. We apply a novel indicator that quantifies the contents of the ECB's introductory statements and allows disentangling ECB statements on prices, the real and the monetary sector. We provide evidence that it matters what issue the ECB is speaking about: especially, the ECB's statements on price developments represent important news to financial markets. It also matters when the ECB affects markets: communication drives maturities above 4 months.     

Fixed versus variable rate loans under state-dependent preferences

This paper examines the optimal mix of fixed and variable rate loans of a competitive bank facing uncertain funding costs. The bank's preferences are state-dependent in that the utility function depends on a state variable. We show that the optimal amount of loans extended by the bank depends neither on the state-dependent preferences of the bank, nor on the joint distribution of the marginal cost of funds and the state variable. The bank, however, optimally lends less should it be forced to assume all interest rate risk by exclusively extending fixed rate loans. We show further that a non-positive spread between fixed and variable rate loans is no longer a necessary and sufficient condition for the bank to refrain from extending fixed rate loans should the marginal cost of funds be correlated with the state variable in the sense of expectation dependence. State-dependent preferences as such play a pivotal role in determining the bank's optimal choice between fixed and variable rate loans.     

Monetary Policy and Financial Stability: The Role of Inflation Targeting

This article examines the relationship between Inflation targeting (IT) and financial instability from 1990 to 2015 for Asian economies. To measure financial instability, a multidimensional financial conditioning index is calculated following the ECB's approach. Using a fixed effects panel data model the study finds that adoption of IT policy in Asian economies has an adverse impact on financial stability, thus rejecting the ‘conventional wisdom’ hypothesis. Further, the Vector Autoregression (VAR) result shows that an IT regime increases housing returns and encourages investors to take higher risks.     

Fixed versus variable rate loans under regret aversion

This paper examines the optimal mix of fixed and variable rate loans of a competitive bank facing funding cost uncertainty, where the bank is not only risk averse but also regret averse. Regret aversion is characterized by a utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that a negative spread between fixed and variable rate loans is a necessary but not sufficient condition for the dominance of variable rate loans over fixed rate loans. If the bank optimally extends both fixed and variable rate loans, the total amount of loans depends neither on the bank's regret aversion nor on the funding cost uncertainty. The bank, however, optimally lends less should it be forced to assume the entire funding cost uncertainty by exclusively extending fixed rate loans. Finally, using a two-state example, we show that the bank optimally extends more (less) fixed rate loans than in the case of pure risk aversion if the high (low) marginal cost of funds is more likely to prevail. Regret aversion as such plays a crucial role in determining the bank's optimal choice between fixed and variable rate loans.     

Controllability and Persistence of Money Market Rates along the Yield Curve: Evidence from the Euro Area

Abstract. Controllability of longer‐term interest rates requires that the persistence of their deviations from the central bank's policy rate (i.e. the policy spreads) remains sufficiently low. This paper applies fractional integration techniques to assess the persistence of policy spreads of euro area money market rates along the yield curve. Independently from anticipated policy rate changes, there is strong evidence for all maturities that policy spreads exhibit long memory. We show that recent changes in the operational framework and the communication strategy of the European Central Bank (ECB) have significantly decreased the persistence of euro area policy spreads and, thus, have enhanced the ECB's influence on longer‐term money market rates.     

TALKING LESS AND MOVING THE MARKET MORE: EVIDENCE FROM THE ECB AND THE FED

This paper examines and compares the communication strategies of the Federal Reserve and the European Central Bank, and their effectiveness. First, we find that the surprise components of both monetary policy actions and statements have important but differing effects on asset prices, with unexpected communication having a much greater impact on longer‐term interest rates. Second, both the ECB and the Fed have proven to be equally successful in moving their domestic asset prices using either monetary policy or news shocks. However, the response of the American yield curve to the surprise component of Fed's statements is larger than the reaction of the European term structure to ECB's announcements. This result is intimately related to the amplitude of the policy rate cycle that is much larger in the US than in the euro area combined with the bounded support of the news shock. Third, we analyze the cross‐effects and show that the Fed has been more able to move the European interest rates of all maturities than the ECB to move American rates. This finding is tied to the predominance of dollar fixed income assets rather than to an attempt of the ECB to mimic the Fed.     

Requiem for the interest rate controls in China

This paper reviewed the retail interest rate control deregulation in China over the period 1993–2015 to provide a preliminary assessment of the People's Bank of China's (PBC's) new operating framework. The interest rate controls triggered the development of deposit substitutes that banks used to circumvent the restrictions, which, in turn, drove deposits out of commercial banks. This gave rise to concerns about a deterioration of bank profits and a build-up of financial fragility, which have pushed up the PBC's deregulation acceleration over the post-2012 period. This study quantified the distortionary effects of these controls: disintermediation, a rising shadow banking system, and financial repression. Despite the official lifting of controls, retail interest rates are still subject to the PBC's window guidance and other pricing mechanism guidance. The preliminary assessment of the new interest rate corridor system is encouraging: Its bounds are effective most of the time.     

Non-linearities in euro area inflation persistence

This paper investigates the nature of inflation dynamics with a special focus on inflation persistence. Using data from euro area member-states we estimate dynamic non-linear panel models addressing in detail econometric issues concerning unobserved heterogeneity, genuine state dependence, and the initial conditions problem. After controlling for observed and unobserved heterogeneity, our results suggest that the degree of inflation persistence is genuine and varies depending on whether the inflation rate is too high, within the range of ECB's target of price stability, too low or negative. This implies that policies to stabilize inflation in the short run will have longer-run effects.