Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?

Capital Regulation, Risk-Taking and Monetary Policy: A Missing Link in the Transmission Mechanism?

The credit boom prevailing in the period preceding the last financial crisis was prolonged and associated with neither particularly strong output growth nor rising inflation in economies in which it occurred. This type of credit cycle and financial cycle is hard to reconcile with existing economic theory applied in monetary policy. In this paper we point out to endogenous factors behind this phenomenon. We aim to identify what is the role of bank capital regulation and bank risktaking in the transmission mechanism of monetary policy. The transmission of monetary policy impulses through capital channel is a diversified process, and depends on bank specific, background macroeconomics’s specific and other factors. Bank capital standards affect the banks’ perception, management and pricing of risks. In this area, monetary policy is also of great importance, with prominent role of the so called risk-taking channel in which central banks actions have an impact on bank risk attitudes. Consequently monetary policy is not fully neutral from a financial stability perspective. Stable level of inflation does not guarantee the stability of financial system. Therefore central banks in their conduct of monetary policy should constrain the build-up of financial imbalances.

How does capital regulation react to monetary policy? New evidence on the risk-taking channel

This study identifies differences in the monetary policy transmission mechanism across the countries in the euro area. It is argued that part of the differences in the response of economic activity to monetary policy during the pre-EMU period, found in other studies, reflected differences in monetary policy reaction functions, rather than different transmission mechanisms. In light of this, the paper constructs an empirical model on the basis of common reaction functions. The results confirm that even when a common monetary policy is implemented, its effects on economic activity are likely to differ across EMU countries. The paper also constructs an aggregate measure of the effect of monetary policy on prices and output. Finally, the paper examines the relative strength of the credit, exchange rate, and interest rate channels of monetary transmission in EMU countries.

Niveles de tasas de interes por debajo de sus niveles historicos pueden haber contribuido a una mayor inestabilidad en economias tanto desarrolladas como en desarrollo durante la decada del 2000. El canal de toma de riesgo de la transmision de la politica monetaria es una teoria reciente que explica la relacion entre las percepciones de riesgo del sistema financiero y la politica monetaria. En este articulo se presenta evidencia empirica de la evidencia del canal de toma de riesgo utilizando informacion detallada de creditos comerciales y de consumo del sistema bancario en Colombia. Mediante el uso de modelos probit y de duracion encontramos que el sistema bancario toma riesgo cuando las tasas de interes se encuentran demasiado bajas. Tambien encontramos que la respuesta a las tasas de interes es mas alta en el caso de los creditos comerciales.

Monetary policy reaction function and the financial cycle

After financial crisis in 2008, more and more researchers paid attention to not only the expansionary monetary policy but also the relationship between the risk-taking and monetary policy. Borio and Zhu firstly researched on risk-taking channel of monetary policy in 2008. This article firstly reviews some literature about the risk-taking channel of monetary policy, the transmission mechanism and the influencing factors, and then selects the data of 15 representative listed Banks in China from 2007-2016 to do empirical research and draw the following conclusions. First, this article finds evidence that the risk-taking channel of monetary policy is significant in China. Expansionary monetary policy has a positive impact on banks’ risk-taking. Second, macro-economic conditions and the micro characteristics of the bank can influence the transmission of risk-taking channel. Based on that, this article proposes the recommendation that monetary policy should be included in macro-prudential system to strengthen monitoring system of the bank’s risk management. Besides the relationship between counter-cyclical capital regulation and monetary policy control is important.

Monetary policy in a world of radical uncertainty

How to quantitatively measure the macro dynamic effect of monetary policy is one of the most critical issues in the mainstream macro research （Benanke and Gertler, 1995; Christiano, et al., 1999）. In the context of global financial integration, how will a country’s monetary policy affect the macroeconomy of other countries? This international spillover effect of monetary policy has been hotly debated in the academy, but it has not yet been conclusive. The reason is that, empirically, how to identify the impact of exogenous monetary policy has not been well resolved at the technical level; theoretically, mainstream macroeconomic models provide various transmission mechanisms, and no consensus has been reached.Due to the above difficulties, research on the international spillover effect of monetary policy is still in its early stage, and the impact of US monetary policy on China’s economy is seldom studied. From the empirical point of view, this article follows the latest literature Barakchian and Crowe （2013, hereinafter referred to as BC） to identify the impact of exogenous monetary policy in the United States, and studies the dynamic impact of US monetary policy on China’s macroeconomy and its underlying transmission mechanism. This article provides new evidence on the international spillover effect of monetary policy and also tests the existing theories in international economics from an empirical perspective.The primary issue to be addressed in monetary policy research is how to identify exogenous monetary policy shocks. However, macroeconomic regulation often relies on the current situation of aggregate economy. Since there is a strong endogenous relationship among economic variables, it is difficult to directly construct a system that includes policy variables and macroeconomic indicators to identify exogenous monetary policy shocks. To this end, BC （2013） solves the endogenous issue regarding the identification of monetary policy shocks. The exogenous shock constructed through their indicator not only avoids making ad hoc assumptions about the feedback rules of monetary policy, but also avoids the endogenous problems and the sample selection issue in traditional identification methods.Based on the US monetary policy shock constructed by BC （2013）, this article studies the spillover effect of US monetary policy on China’s macroeconomy and therefore solves the aforementioned endogenous problem of monetary policy shocks. The basic model of the empirical analysis is a three-variable structural vector autoregressive error correction model （SVECM） that includes China’s industrial output, price index, and US monetary policy shocks. Based on this model, we find that the opening-up policy of WTO accession at the end of 2001 has a significant structural impact on the spillover effect of US monetary policy and its transmission mechanism. Specifically, we divide the monthly data from 1996−2008 into two sub-samples before and after January 2002. Using the 2002−2008 subsample, we find that the impact of the US’s tightening monetary policy significantly causes China’s output to rise and prices to fall, thus performing as a positive supply shock to China’s economy. Based on the 1996−2001 subsample, US monetary policy will not have a significant impact on China’s economy. The above findings are largely different from the findings in Kim （1999, 2001）, Canova （2005）, and among others.In the analysis of the transmission mechanism, this article finds that the price channel can well explain the stylized facts in the data. Our theory proceeds as follows: The US tightening monetary policy will lead to the appreciation of the US dollar, which will cause US manufacturers to lower their export prices in US dollars （Exchange Rate Pass-Through）. Due to the yuan-dollar fixed exchange rate system, China’s import prices will decline, and the prices of domestic raw materials and CPI will decline. Lower production costs lead manufacturers to increase production, which is reflected by an increase in China’s output. Therefore, the price channel indicates that the US tightening monetary policy is equivalent to a positive supply shock, which will simultaneously increase China’s output and reduce the price level. Based on the extended SVECM system, we find that Chinese macro data can identify the price channels of imported goods. Further robustness analysis shows that our main findings are robust to different sample periods and different model settings. Besides, in order to better explain the identification of import price channels, we have conducted empirical tests on several standard theories in international economics. The results show that the standard theories fail to explain the Chinese data. Therefore, the price channel provides the primary transmission mechanism of the spillover effect of US monetary policy on China’s economy, and this channel also explains the empirical finding that WTO has a structural impact on the spillover effect.

We present a pricing kernel that summarizes well the main features of the dynamics of interest rates and risk in postwar U.S. data and use it to uncover how the pricing kernel has moved with the short rate in this data. Our findings imply that standard monetary models miss an essential link between the central bank instrument and the economic activity that monetary policy is intended to affect, and thus we call for a new approach to monetary policy analysis. We sketch a new approach using an economic model based on our pricing kernel. The model incorporates the key relationships between policy and risk movements in an unconventional way: the central bank's policy changes are viewed as primarily intended to compensate for exogenous business cycle fluctuations in risk that threaten to push inflation off target. This model, while an improvement on standard models, is considered just a starting point for their revision. It leads to critical questions that researchers need to answer as they continue to revise their approach to monetary policy analysis. Copyright © 2009 by the National Bureau of Economic Research.

The onset of the 2008 economic crisis forced central banks to acknowledge that the monetary policy and micro prudential policy-based financial regulatory framework is insufficient to avert systemic risks. Compared with the low efficiency of micro prudential supervision in preventing and controlling financial systemic risks and the weakness of a single monetary policy tool in controlling financial systemic risks, the current theorists agree that monetary policy and macro prudential supervision policies are effective in coordinating and resisting financial risks. The link with both macro prudential regulation and monetary policy, as well as how to collaborate and coordinate the two policies, are thus major issues that we must address. Based on this background, this paper systematically combs and analyzes the necessity of coordination between monetary policy and macro prudential policy and the practical experience of relevant research on coordination mode through theoretical research on macro prudential regulation and reference of relevant policies at home and abroad. This paper uses the literature research method and comparative analysis method to analyze the macro prudential policy and monetary policy in depth. The theoretical basis of macro prudential regulation and monetary policy is formed by classifying, summarizing and sorting out the relevant researches on macro prudential regulation and monetary policy made by scholars from various countries. The implementation of macro prudential policies in developed economies like the United States and the United Kingdom, as well as their monetary policy coordination models, are compared and introduced in this dissertation. It also examines the traits and practical application of macro prudential and monetary policy cooperation in various nations. Based on the systematic risk theory, micro prudential supervision, macro prudential supervision theory and monetary policy, combined with the current situation of financial regulatory structures in various countries, using the literature research method and comparative analysis, this paper mainly draws the following conclusions: The financial system can only continue to run smoothly under a combined application of macro and micro prudential regulation; Systemic hazards can be efficiently prevented and mitigated by macro prudential oversight methods; Traditional monetary policy is unable to preserve both financial system stability and monetary stability; According to international experience, the central bank’s coordination of monetary policy and macro prudential policy can better play the complementary effects of the two programs.

Financial stress is the state of the financial system when it is affected by its own vulnerability, uncertainty and various external shocks. Rationally measuring financial stress and exploring the impact of financial stress on the business cycle, is one of the core issues in the new economics” theory which is based on financial stability, and it is also a hot topic that academia and decision-making departments pay close attention to. However, in the related research on financial stress, domestic and foreign scholars have always faced two problems: Firstly, how to accurately measure financial stress under the complex and volatile economic and financial situation? Secondly, how to reasonably portray the relationship between financial stress and the business cycle in different periods? In recent years, with the continuous advancement of economic globalization and financial integration, the potential stress of the financial system has gradually emerged, and has been continuously accumulating and spreading through the financial accelerator effect and pro-cyclical effect of the financial system. Financial stress not only has a significant impact on the operation of the macro economy, but also poses serious challenges to macro-prudential supervision and financial risk prevention and control. Therefore, solving the above two problems not only helps to understand the operating laws of China’s macroeconomic and financial systems from the perspective of financial stress, but also has an important practical significance for improving the foresightedness and effectiveness of the macro-control policies. In view of this, this paper measures financial stress of China from exchange market pressure, bankingsystem pressure and financial bubble pressure respectively, incorporates all financial sub-markets into a unified framework, and then synthesizes China’s financial stress index （CFSI） based on the dynamic CRITIC method. The analysis shows that the CFSI constructed in this paper is highly coupled with the operation of China’s financial system and can reasonably reflect the stress conditions of the financial system. On this basis, this paper analyzes the typical differences in the evolution of CFSI during different periods, especially before and after the financial crisis. The empirical results obtained by using the MSAR model show that after the crisis, China’s financial stress changes show a series of asymmetric features such as rapid accumulation and slow release. Furthermore, based on the TVP-VAR model, this paper empirically explores the nonlinear impact of financial stress changes on the business cycle in China from the perspectives of the financial sub-market and the entire financial system. The results show that: firstly, the suppression effect of financial stress accumulation on the business cycle is more significant than the promotion effect of financial stress relief on the business cycle; secondly, the time lag and the limitation of monetary policy may lead to a pro-cyclical” phenomenon of financial stress and the business cycle, and then may amplify the impact of financial stress on the business cycle; finally, the suppression effects of all sub-markets’ financial stress on the business cycle show different time-varying dynamics, but all show obvious state-dependent characteristics. These findings not only help to further understand China’s macroeconomic and financial system operating conditions in the new era, but also provide useful empirical references and policy implications for the perfection of the financial regulatory system and macroeconomic control policies. This paper argues that, on the basis of paying close attention to the evolution of China’s financial stress, on the one hand, policy-makers should improve the framework of regulation underpinned by monetary policies and macro-prudential policies, and give full play to the role of macro-prudential policies in suppressing the pro-cyclical volatility of the financial system and preventing cross-market infections of risks. On the other hand, they should innovate means of macro control, use various policy tools in a flexible and appropriate fashion to carry out timely and moderate pro-cyclical fine-tuning of key areas and weak links, so as to achieve key targets for the dual stability of economics and finance.

A bank is the prototypical financial institution; there are notable outward differences between the wealth invested by owners of financial institutions and that of other industries. The capital of a financial institution consists largely of financial assets and only to a small degree of the physical plant and equipment usually associated with capital in other industries. Moreover, these physical differences are associated with important functional differences. A financial institution, like any other firm, faces the problem of combining the inputs which it purchases to produce the outputs which it sells. In banking, the most important inputs are labor and deposits, and they produce liquidity services, brokerage services, accounting and information services, and the like. In this production process, bank capital has two roles: (1) It cooperates directly with the other inputs in the production of bank services, and (2) it is used to attract the deposit input by providing insurance to depositors against a decline in the value of a bank's assets; the more capital a bank has, the more the value of its assets can fall before depositors incur losses. The difference between banking (and financial institutions in general) and most other industries is in the relative importance of these two roles. The equity capital of any firm serves, in part, to guarantee the value of the firm's fixed obligations, but that function is usually subordinate to the provision of assets to the firm. However, in banking, equity capital (and equity is the form that almost all nondeposit ownership interest in bank assets has taken) typically accounts for only about a tenth of total bank resources, and most of the returns to equity capital derive from its insurance function. Bank owners invest capital primarily to attract deposits, which are then used to buy assets, and only secondarily to buy assets directly. Apart from these novel economic aspects, a study of investment in banking provides the opportunity to study the effects of government

Monetary policy measures can affect the supply and demand for bank loans through several transmission mechanisms: the credit channel (that...

Bank capital regulation under Basel Accord has changed the allocation of credit funds and the operation rule of the economy in great degree, and subsequently affected the foundation condition and transmission mechanism of the monetary policies. Given the business cycle, this paper makes the extended analysis of the IS-LM model under capital regulation, and finds that capital regulation will induce the asymmetric effects of monetary policy through the bank lending channel, so theoretically demonstrates that the operation of monetary policy must consider the bank capital regulation. This paper also employs Stochastic Frontiers Analysis to test the joint effectiveness of monetary policy and Bank capital regulation in china from 2000-2009. This test shows that the effectiveness of the monetary policy on realizing economic objective would be weakened by bank capital regulation in China. Therefore, to achieve the objectives of stable price and output, the authority must consider the capital requirement of the banks when enacting the monetary policy,. Key words: Bank capital regulation; Monetary policy; Joint effectiveness