ECB repo rate setting during the financial crisis

I estimate a reaction function for the ECB using an ordered logit model for the period 1999-2009. Allowing for a smooth transition from one set of parameters to another, I detect a rapid change in the middle of 2008.     

Links between trust in the ECB and its interest rate policy

We analyse determinants of trust in the European Central Bank (ECB). Our main finding is that when households have pessimistic expectations, aggressive cuts in interest rates have an adverse effect on their trust in central bank. This result is in accordance with the ‘lack-of-confidence shock’ hypothesis developed by Schmitt-Grohé and Uribe (2012) and in contrast with the ‘fundamental shock’ hypothesis which implies positive effects of aggressive cuts for trust in the ECB. The result is robust to various changes in the modelling approach.     

What is on the ECB’s mind? Monetary policy before and after the global financial crisis

This paper analyzes the monetary policy of the European Central Bank (ECB) both before and after the outbreak of the global financial crisis in 2008. In the literature, researchers typically select one Taylor rule-based model to analyze monetary policy of central banks and to derive determinants for the interest rate setting. However, uncertainty about the choice of this respective model is typically neglected. In contrast, we apply a Bayesian model averaging (BMA) approach to extend the Taylor rule to account for model uncertainty driven by heterogeneity in the ECB’s decision-making body, the Governing Council. Our results suggest the following: First, the ECB focuses on the inflation rate when setting interest rates. Second, economic activity indicators were in the focus of the ECB before the financial crisis. Third, over the last decade, the role of economic activity decreased, indicating that inflation is the main driver of monetary policy decisions in the post-crisis period. Fourth, when setting interest rates, central bankers appear to consider more than one model.     

Monetary policy in a financial crisis

What are the economic effects of an interest rate cut when an economy is in the midst of a financial crisis? Under what conditions will a cut stimulate output and employment, and raise welfare? Under what conditions will a cut have the opposite effects? We answer these questions in a general class of open economy models, where a financial crisis is modelled as a time when collateral constraints are suddenly binding. We find that when there are frictions in adjusting the level of output in the traded good sector and in adjusting the rate at which that output can be used in other parts of the economy, then a cut in the interest rate is most likely to result in a welfare-reducing fall in output and employment. When these frictions are absent, a cut in the interest rate improves asset positions and promotes a welfare-increasing economic expansion.     

Asymmetric monetary policy and the effective lower bound

We use the canonical New Keynesian model to study optimal discretionary policy when the nominal interest rate is constrained by the effective lower bound (ELB). We show that policymakers who seek to minimize a (symmetric) quadratic loss function involving deviations of inflation and output from targets will achieve an average inflation rate below target due to the contractionary effects associated with hitting the ELB. We also characterize optimal discretionary policy for policymakers who view output losses as asymmetric: they place weight on the output gap when output is below potential but place little or no weight on the gap when output is above potential. In comparison to optimal policy using the symmetric loss function, the average inflation rate is higher and closer to the central banks target. Moreover, in response to contractionary demand shocks that push the nominal interest rate to the effective lower bound, policymakers with an asymmetric loss function adopt a policy rate path that remains at the ELB longer but eventually rises more quickly than the path adopted by a policymaker with a symmetric loss function.     

Central banks' voting records,the financial crisis and future monetary policy

We examine whether central banks' voting records help predict the future course of monetary policy in the Czech Republic, Hungary, Poland, Sweden and the United Kingdom, controlling for financial market expectations. Unlike previous research, we first examine the period of the global financial crisis, characterized by a high level of uncertainty, and second, examine the predictive power of voting records over longer time horizons, i.e., the next monetary policy meeting and beyond. We find that voting records predict the policy rate set at the next meeting in all central banks that are recognized as independent. In some central banks, voting records are found—before, but not during, the financial crisis—to be informative about monetary policy at even more distant time horizons.     

Monetary policy uncertainty and interest rate targeting

This paper studies the issue of monetary delegation in the case where central banker’s preferences are uncertain. A distinctive feature of the analysis is that it introduces nominal interest rate targets to the monetary delegation scheme in addition to linear contracts, quadratic punishments, and inflation targets. This paper shows that the implementation of interest rate targeting will improve social welfare since it leads the central bank to make smaller interventions, which limits the scope for the central bank’s uncertain preferences to impact the economy.     

Monetary policy committees and interest rate setting

This paper shows that it is preferable for monetary policy to be conducted by a committee instead of a single policy maker if there is uncertainty about potential output. We examine three decision procedures - an optimal procedure, averaging and voting - and find that the latter is the appropriate way to reach decisions if policy makers are not equally skilled. Finally, we demonstrate that efficient decision procedures reduce the persistence of shocks.     

Monetary policy responses to the exchange rate: Empirical evidence from the ECB

The exchange rate is an important part of the transmission mechanism in the determination of monetary policy because movements in the exchange rate have significant effect on the macroeconomy. It can be difficult to measure the reaction of monetary policy to the movements of the exchange rate, due to the simultaneous response of monetary policy to the exchange rate and the possibility that both variables respond to several other variables. This study addresses these problems by using an identification method based on the heteroscedasticity in the high-frequency data. The results in this paper suggest that the ECB systematically responds to exchange rate movements but that quantitative effects are small. Such a significant but small reaction coefficient seems consistent with the hypothesis that the central banks do not target the fluctuations in the exchange rate but consider them only to the extent they impact on the expected inflation and output path.     

Competition policy: ten lessons learnt from the financial crisis

The financial crisis brought great challenges also for competition policy. The aim of this paper is to summarize the most important insights for competition policy that could be derived from the turbulent period 2008–2010. The financial crisis is seen as project that demanded sound management from competition policy and enforcement. The insights will be presented in the instructive form of ‘lessons learnt’ which represents a common approved project management technique. We come to the result that the financial crisis is not the result of ‘too much competition’, but of regulatory failure and that the main answers to the financial crisis have to come from ‘smart regulation’. The relaxation of competition policy would be the wrong policy response in troubled times since competition policy can play an important role in bringing the crisis economy back on track. In contrast to banking we see no economic rationale for rescue packages for other economic sectors by referring to systemic risk. The renaissance of industrial policy is viewed with great skepticism since empirical evidence shows that the effort of picking ‘winners’ all too often results in saving ‘losers’.     

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.     

ECB monetary policy and commodity prices

We assess the impact of ECB monetary policy on global aggregate and sectoral commodity prices over 2001–2019. We employ an SVAR model and separately assess periods before and after the global financial crisis. Our key results indicate that contractionary monetary policy shocks have positive effects on commodity prices during both conventional and unconventional monetary policy periods, indicating the effectiveness of unconventional monetary policy tools. The largest impact is documented on energy (fuel) and food commodities. Our results also suggest that the effect of ECB monetary policy on commodity prices transmits through the exchange rate channel, which influences European market demand.     

The eurozone financial crisis: debt,credit ratings and monetary and fiscal policy

This paper discusses the eurozone financial crisis. It argues that it was largely the result of a common monetary policy not being suitable for individual countries which led to excessive private and public borrowing and a debt crisis. Neither borrowing rates nor credit ratings anticipated the crisis. Fundamental changes to eurozone governance are being proposed. The paper examines whether instead there might be a market solution if financial markets priced risk better. Accordingly, a more timely way of obtaining credit ratings is shown.     

Fiscal expansion, monetary policy, interest rate risk premia, and wage reactions

We examine the macroeconomic implications of fiscal policy in a small open economy, with emphasis on the interactions between fiscal, monetary and labour market policies. The paper uses the NBNZ-DEMONZ macroeconometric model. Novel features of the model are that it includes an endogenous interest rate risk premium (IRRP), and forward-looking monetary and fiscal policy reaction functions which capture the essence of New Zealand's Reserve Bank and Fiscal Responsibility Acts. The most important empirical result is that the postulated IRRP, proxying financial market mechanisms, can contribute at least as much as the monetary policy reaction function to maintaining price stability. Also of significance are that an income tax cuts package shows more damped real GDP and underlying inflation paths than does an expenditure increases equivalent; and that the inflationary and real sector impacts of a personal income tax cut package depend heavily on how the cut is `shared' between firms and workers. The nature and interdependence of monetary and fiscal policies and labour market conditions are therefore crucial to the macroeconomic outcomes.     

ECB monetary policy and the DM–dollar exchange rate: evidence from a Bayesian VAR

Since the start of the European Monetary Union (EMU) in January 1999, the DM has depreciated considerably against the currencies of major industrial countries. Whether there is a systematic failure of vector autoregressive (VAR) models fitted to the pre-EMU period to predict forward looking variables in the year 1999 is investigated. Conditional forecasts are used in order to capture the potential effects of real shocks and to assess the ECB's reaction to these shocks. The findings suggest that neither real shocks nor the actual ECB-policy reaction can explain the exchange-rate devaluation. This points to important effects of increased uncertainty following the regime shift resulting in an increased risk premium in the foreign exchange market.     

What drives the global official/policy interest rate?

We construct a GFAVAR model with newly released global data from the Federal Reserve Bank of Dallas to investigate the drivers of global official/policy interest rate. We find that 66% of movement in global official/policy interest rates is attributed to changes in global monetary aggregates (23%), oil prices (19%), global output (16%) and global prices (8%). Global official/policy interest rates respond significantly to increases in global output, inflation and oil prices. Increases in global policy interest rates are associated with reductions in global prices and global output. The response in official/policy interest rate for the emerging countries is more to global inflation, for the advanced countries (excluding the U.S.) is more to global output, and for the U.S. is to both global output and inflation.     

Bank behavior, incomplete interest rate pass-through, and the cost channel of monetary policy transmission

This paper employs a New Keynesian DSGE model to explore the role of banks within the cost channel of monetary policy transmission for shaping the interest rate pass-through from money market rates to loan rates. Banks extend loans to firms in an environment of monopolistic competition by setting their loan rates in a staggered way, which means that the adjustment of the aggregate loan rate to a monetary policy shock is sticky. We estimate the model for the euro area by adopting a minimum distance approach. Our findings exhibit that (i) financial costs are an important factor for price changes, (ii) frictions in the loan market have an effect on the propagation of monetary policy shocks as the pass-through from a change in money market rates to loan rates is incomplete, and (iii) the strength of the cost channel is mitigated as banks shelter firms from monetary policy shocks by smoothing loan rates.     

Equilibrium risk shifting and interest rate in an opaque financial system

We analyse the risk-taking behaviour of heterogenous intermediaries that are protected by limited liability and choose both their amount of leverage and the risk exposure of their portfolio. Due to the opacity of the financial sector, outside providers of funds cannot distinguish “prudent” intermediaries from those “imprudent” ones that voluntarily hold high-risk portfolios and expose themselves to the risk of bankrupcy. We show how the number of imprudent intermediaries is determined in equilibrium jointly with the interest rate, and how both ultimately depend on the cross-sectional distribution of intermediaries' capital. One implication of our analysis is that an exogenous increase in the supply of funds to the intermediary sector lowers interest rates and raises the number of imprudent intermediaries. Another one is that easy financing may lead an increasing number of intermediaries to gamble for resurection following a bad shock to the sector's capital, again raising economywide systemic risk.