Monetary Policy
Paper Session
Sunday, Jan. 8, 2017 3:15 PM – 5:15 PM
Hyatt Regency Chicago, Michigan 3
- Chair: Douglas Pearce, North Carolina State University
Tight Money-Tight Credit: Coordination Failure in the Conduct of Monetary and Financial Policies
Abstract
Quantitative analysis of a New Keynesian model with the Bernanke-Gertler accelerator and risk shocks shows that violations of Tinbergen’s Rule and strategic interaction among policymaking authorities undermine significantly the effectiveness of monetary and financial policies. Separate monetary and financial policy rules, with the latter subsidizing lenders to encourage lending when credit conditions tighten, produce higher social welfare and smoother business cycles than a monetary rule augmented with financial goals. The latter yields a tight money-tight credit regime in which the interest rate responds too much to inflation and not enough to adverse credit conditions. Reaction curves for the choice of policy-rule elasticity that minimizes the loss function of each authority, given the other authority’s elasticity, are nonlinear, reflecting shifts from strategic substitutes to complements in setting policy parameters. The Nash equilibrium is significantly inferior to the Cooperative equilibrium, both are inferior to a first-best outcome that maximizes welfare, and both produce tight money-tight credit regimes.The Effects of Liquidity Regulation on Monetary Policy Implementation
Abstract
We estimate the effects of the liquidity coverage ratio (LCR), a liquidity requirement for banks, on the tenders that banks submit in Term Deposit Facility operations, a Federal Reserve tool created to manage the quantity of bank reserves. We identify these effects using variation in LCR requirements across banks and a change over time that allowed term deposits to count toward the LCR. Banks subject to the LCR submit tenders more often and submit larger tenders than exempt banks when term deposits qualify for the LCR. These results suggest that liquidity regulation affects bank demand in monetary policy operations.Endogenous Regime Shifts in a New Keynesian Model With a Time-Varying Natural Rate of Interest
Abstract
This paper develops a New Keynesian model with a time-varying natural rate of interest (r-star), i.e., the real interest rate that is consistent with full utilization of economic resources and steady inflation at the central bank's target rate. The time series process for r-star is calibrated to approximate the path of the U.S. natural rate series estimated by Laubach and Williams (2015). The zero lower bound (ZLB) on the nominal interest rate gives rise to two long-run endpoints, as in Benhabib, Schmitt-Grohé and Uribe (2001a,b). The representative agent in the model employs forecast rules that are constructed as a weighted-average of the forecast rules associated with each of two local rational expectations equilibria, labeled the "targeted" and the "deflation" solutions, respectively. The time-varying forecast rule weights are determined by recent performance, as measured by the root mean squared forecast errors for inflation, the output gap, and the desired nominal interest rate. Sustained periods when the exogenous real interest rate remains below the central bank's estimate of r-star can induce the agent to place a substantially higher probability on the deflation equilibrium, causing it to occasionally become self-fulfilling. These rare episodes are accompanied by highly negative output gaps and a binding ZLB, reminiscent of the U.S. Great Recession. But even outside of recessions and when the ZLB is not binding, the agent may continue to assign a nontrivial probability to the deflation equilibrium, causing the central bank to consistently undershoot its inflation target, similar to the U.S. economy since mid-2012. I show that raising the central bank's inflation target to 4% from 2% can mostly eliminate switches to the deflation equilibrium.Monetary Policy Transmission with Interbank Market Fragmentation
Abstract
This paper shows how interbank market fragmentation disrupts the transmission of monetary<br />policy. Fragmentation is defined as the situation where some banks are cut from the<br />
interbank loan market. By introducing fragmentation into a standard theoretical model of<br />
monetary policy implementation, it is shown that excess liquidity arises endogenously and<br />
the interbank rate declines below the central bank main interest rate. Using data on cross-border<br />
financial flows and monetary policy operations, it is shown that this mechanism has<br />
been at work in the Euro-Area since 2008. The model is used to analyze conventional and<br />
unconventional monetary policy measures.
JEL Classifications
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit