Balance Sheet Channel Research Articles

The Augmented Bank Balance-Sheet Channel of Monetary Policy

The Augmented Bank Balance-Sheet Channel of Monetary Policy

The Augmented Bank Balance-Sheet Channel of Monetary Policy

The Augmented Bank Balance-Sheet Channel of Monetary Policy

Balance Sheet Channel of Monetary Policy: Evidence from Credit Spreads of Russian Firms

In this paper, I analyse the relationship between the credit spreads of Russian bond issuers and monetary policy shocks. According to the theory of demand-side financial imperfections, in the presence of financial frictions, the higher the net worth of a firm, the lower its external finance premium. The theory of the balance sheet channel of monetary policy suggests that monetary shocks may affect the net worth of a firm through debt outflows. Together, these ideas predict that the external finance premium of more indebted companies is more sensitive to monetary policy shocks. However, my empirical findings from the credit spreads of Russian companies do not support this theory.

EVALUATION OF MONETARY POLICY IN EMU THROUGH CREDIT CHANNELS INTERCONNECTEDNESS: EVIDENCE USING BLS DATA

Credit channel(s) of the monetary policy transmission has not been debated much in the literature especially in the context of the European monetary union (EMU) and the apparent rising fragmentation of the previously much integrated European banking system. This discussion is even more important in the aftermath of the global financial crisis (GFC) and the decade-long European debt crisis (EDC), a number of European countries have been experiencing. This paper attempts to investigate the interconnectedness of credit channels in policy transmission in the context of EMU using bank lending survey (BLS) data for a sample of eight European countries. One of the main contributions of this paper is to use BLS data for the entire 11 credit channels. We use principal component analysis (PCA) to investigate the impact of monetary policy on the interconnectedness structure of credit channels. PCA is conducted both for EMU across channels and sample countries. EFA-orthogonal vector rotation indicates a core versus periphery interconnectedness pattern. The results suggest that the household balance sheet channel, borrower cash flow channel and interest rate channel are the most divergent channels in EMU.

Monetary policy and credit flows

The paper assesses the impact of monetary policy shocks on credit reallocation and evaluates the importance of theoretical monetary policy transmission mechanisms. Compustat data covering 1974 through 2017 is used to compute quarterly measures of credit flows of borrowing firms. I find that expansionary monetary policy is associated with positive long-term credit creation and credit destruction (i.e. credit reallocation). This impact is larger for financially constrained firms and those that are perceived as relatively risky to the lender. This is predicted by the balance sheet channel of monetary policy and mechanisms that reduce lenders’ risk perceptions and increase the tendency to search for yield.

Monetary policy transmission: Balance sheet channel and investment behavior of firms in Pakistan

Purpose - This study investigates the relevance of the balance sheet channel of monetary policy transmission concerning non-financial firms at the Pakistan Stock Exchange (PSX), a firm-level data.Methods - This paper estimates a family of panel data regression models and constructs a dummy variable for monetary policy tightness.Findings - The result indicates a positive relationship between cash flows and investment during periods of monetary tightness. The impact on cash flows is visibly more pronounced than that of the quantitative effect of an increase in capital cost, which gives rise to a balance sheet channel. Three financial constraints, namely size, leverage, and dividend policy, are used to segregate firms into financially constrained and unconstrained firms.Implication - The results highlight the balance sheet channel impact on smaller firms cash. The cash flows of highly leveraged firms were impacted more during the tight monetary policy periods and thereby were more prone to decline in investments. Results on constraints of dividend policy are, however, inconclusive.Originality - The paper contributes to the literature by investigating the relevance of the balance sheet channel of monetary policy transmission concerning non-financial firms using firm-level data. It also contributes to the literature by constructing a dummy variable to measure monetary policy tightness.

Risk Dynamics with Heterogeneous Borrowers and Intermediaries

This paper studies the effects of borrowers' balance sheet heterogeneity on economywide risks and fragility, together with effects from intermediary balance sheet channel. We build a continuous time heterogeneous agents model with financial frictions and analytically characterize the transition dynamics. Once the economy moves to high leverage states, it tends to stay there — a leverage trap. Transition speed increases (decreases) when the economy is leveraging up (deleveraging) and when interest rate is lower. Tail uncertainty lasts longer during transition. Intermediary failure risk can lead to severe decline in borrowing/lending activities that could further slow the recovery process.

Balance sheet effects of foreign currency debt and real exchange rate on corporate investment: evidence from Turkey

I analyze the balance sheet channels of depreciation of the Turkish non-financial corporations for 2003–2015. Having constructed a novel, hand-collected firm-level dataset on the composition and term structure of foreign currency assets and liabilities, I show that foreign currency debt and mismatch has a significant negative balance sheet effect on capital investment following a depreciation. The results remain same even after controlling for foreign currency assets and exports. This implies that the contractionary net worth effect of depreciation dominates its expansionary competitiveness effect. The result is more pronounced for the firms with short-term foreign currency exposures.

Interest On Reserves As Main Monetary Policy Tool

This paper examines the potential role of the interest on reserves as a main monetary policy tool, in a model of financial intermediation with financial and nominal frictions calibrated to US data (1985-2018). The interest on reserves is shown to affect financial spreads and real economic activity, through its effect on the banking system's reserves (balance sheet channel) and the price of safe liquid assets (intertemporal Euler equation channel). It is shown to provide, (i) determinacy when the interest rate is fixed to zero, through the intertemporal Euler equation channel, independently of the reserves-to-deposits ratio, or bank capital restrictions; (ii) similar welfare improvements to an optimal Taylor rule; (iii) an alternative main monetary policy tool for driving the economy out of recessions when the conventional interest rate is trapped at the zero-lower-bound.

Firm-Level Data and Monetary Policy: The Case of a Middle-Income Country

We test the existence of the balance sheet channel of monetary policy in a middle-income country. Firm-level data scarcity and quality, in such a context, make the identification of this channel a steep challenge. To circumvent this challenge, we use panel instrumental variables estimation with measurement error to analyze the financial statements of 58 500 Moroccan firms over the period 2010-2016. Our analysis confirms the existence of this channel. It shows that monetary policy has a significant impact on small and medium enterprises' access to banks' financing, and that firm-specific variables are key determinants of firms' financing decisions.

Present Bias Amplifies the Household Balance-Sheet Channels of Macroeconomic Policy

We study the effects of monetary and fiscal policy in a heterogeneous-agent model where households have present-biased time preferences and naive beliefs. The model features a liquid asset and illiquid home equity, which households can use as collateral for borrowing. Because present bias substantially increases households' marginal propensity to consume (MPC), present bias increases the impact of fiscal policy. Present bias also amplifies the effect of monetary policy but, at the same time, slows down the speed of monetary transmission. Interest rate cuts incentivize households to conduct cash-out refinances, which become targeted liquidity-injections to high-MPC households. But present bias also introduces a motive for households to procrastinate refinancing their mortgages, which slows down the speed with which this monetary channel operates.

Designing QE in a fiscally sound monetary union

This paper develops a tractable two-country model of a monetary union with a sound fiscal governance structure and a portfolio balance channel and shows how in such environment the design of QE can be linked to well-understood findings applying to single economies. If the monetary union is symmetric and there is no portfolio balance channel, our linearised model converges to the canonical New Keynesian economy, in which central bank purchases of long-term debt (QE) are ineffective at the zero lower bound constraint for the short-term interest rate. However, if the portfolio balance channel is present, monetary policy in the form of both negative short-term interest rates (up to a certain endogenous lower bound) and QE becomes effective. We prove that for shocks of certain size there exists an interest rate rule, augmented by QE, which substitutes for negative short-term rates prescribed by a conventional interest rate rule without QE. We generalise this result to an asymmetric monetary union, allowing for asymmetric shocks and asymmetric structures. As long as asymmetries between countries result from shocks, outcomes under negative short-term rates can be replicated with a rule augmented by a symmetric design of QE. By contrast, asymmetric structures affecting the transmission of monetary policy can translate into an asymmetric QE design. In general, lower bound episodes in asymmetric monetary unions give rise to current account imbalances which are, depending on the degree of financial integration, funded by private capital imports or absorbed through the central bank balance sheet channel.

Asset-side Bank Runs and Liquidity Rationing: A Vicious Cycle

I study an infinite-horizon banking model with asset-side runs on credit lines. Strategic complementarity between bankers and credit line borrowers arises from contract contingency and the bank balance sheet channel: borrowers' panic drawdowns and bankers' liquidity rationing reinforce each other, leading to a vicious cycle. Using data from U.S. banks, I estimate the model and quantify the amplification effect of the strategic complementarity. This amplification mechanism accounts for a quarter of the overall liquidity shortfalls during the 2008-09 crisis.

Balance Sheet Channel with Information-Trading Frictions in Secondary Markets

AbstractThis article develops a theory of the balance sheet channel that places a central emphasis on the liquidity of secondary markets for macro-contingent claims. We show that the presence of dispersed information and imperfect competition in secondary markets, interacted with financial constraints, results in mispricing and misallocation of aggregate risk, distorts aggregate investment, and exacerbates asset price and output volatility. The magnitude of balance sheet amplification effects becomes endogenously tied to the severity of market frictions, which likely vary over time and across economies. The laissez-faire equilibrium is constrained inefficient due to a novel externality originating from rent-extracting behaviour of agents in secondary markets. Optimal corrective policy boosts secondary market liquidity through subsidies to trade in macro-contingent claims, which enhances aggregate risk-sharing and stabilizes the business cycle.

IMPLICATIONS OF PLATFORM FINANCE ON MONETARY POLICY TRANSMISSION

The emergence of a decentralized peer-to-peer platform that matches lending and borrowing without collateral requirements has called the bank lending and balance-sheet channels for monetary transmission into question. Via a standard New Keynesian macroeconomic model expanded with two-sided platform and group identity, we put forward a novel platform density channel of monetary transmission, which could overshadow the conventional channels. An increase in policy rate, for instance, would instigate a shift toward platform borrowing. Increasing borrowers’ density attracts participation in platform deposits, which in turn further enhances borrowers’ benefit of joining the platform, making liquidity available at decreasing platform loan rates. Business investment and hence the inflation rate gets lifted despite monetary tightening. The implication of platform density channel diminishes, however, when platform borrowings complement bank borrowings, and pose nontrivial risk of default.

A Quantitative Model for the Integrated Policy Framework

Many central banks have relied on a range of policy tools, including foreign exchange intervention (FXI) and capital flow management tools (CFMs), to mitigate the effects of volatile capital flows on their economies. We develop an empirically-oriented New Keynesian model to evaluate and quantify how using multiple policy tools can potentially improve monetary policy tradeoffs. Our model embeds nonlinear balance sheet channels and includes a range of empirically-relevant frictions. We show that FXI and CFMs may improve policy tradeoffs under certain conditions, especially for economies with less well-anchored inflation expectations, substantial foreign currency mismatch, and that are more vulnerable to shocks likely to induce capital outflows and exchange rate pressures.

The Effectiveness of Bank Credit Channel in Turkey

Parasal otoritenin yürütmüş olduğu para politikası, reel ekonomiyi; geleneksel faiz kanalı, varlık fiyatları kanalı, döviz kuru kanalı, kredi kanalı ve beklenti kanalı olmak üzere parasal aktarım kanalları aracılığıyla etkilemektedir. Bu çalışmanın esas konusunu oluşturan kredi kanalı, banka kredileri kanalı ve bilanço kanalı olarak iki alt kanala ayrılmaktadır. Bu çalışmanın amacı, 2003Ç1-2018Ç4 döneminde Türkiye’de banka kredi kanalının etkinliğinin VAR modeli kullanılarak araştırılmasıdır. Analizde para politikası göstergesi olarak kısa vadeli faiz oranları kullanılmış ve faiz oranındaki değişikliklerin özel sektörün (finansal olmayan) kredi hacmine olan etkileri araştırılmıştır. Etki-tepki fonksiyonlarının sonuçları Türkiye’de banka kredi kanalı mekanizmasının çalıştığını göstermiştir.

ORIGINAL SIN, CURRENCY DEPRECIATION AND EXTERNAL DEBT BURDEN: EVIDENCE FROM INDIA

Indian Rupee has depreciated around 50 percent against the US Dollar for the last two decades. This depreciating trend generally doesn't call for any policy interventions as the conventional theories state that it is advantageous for the domestic economy through the competitiveness effect. However, depreciation is expected to increase the external debt burden when the country borrows abroad in foreign currency. At present more than 63 percent of India's external debt is foreign currency-denominated. Given this, the ramifications of a depreciating rupee through the balance sheet channel invite greater attention. This paper makes an attempt to understand the impact that a depreciating Indian Rupee will have on India's external debt dynamics. To this end, we estimated an Autoregressive Distributed Lag (ARDL) model using quarterly data for the period 2001-2018. The empirical evidence shows that the depreciation of rupee increases external indebtedness significantly. In the short run, one rupee depreciation increases external debt to GDP ratio by 0.75 percent while in the long run, the increase is 1.26 percent. The study also finds a causal link between external debt and economic growth in the Indian context, which makes the depreciation - debt valuation problem highly relevant.

Household balance sheet channels of monetary policy: A back of the envelope calculation for the euro area

This paper formulates a back of the envelope approach to study the effects of monetary policy on household consumption expenditures. We analyze several transmission mechanisms operating through direct, partial equilibrium channels—intertemporal substitution and net interest rate exposure—and indirect, general equilibrium channels—net nominal exposure, as well as wealth, collateral and labor income channels. The strength of these forces varies across households depending on their marginal propensities to consume, their balance sheet composition, the sensitivity of their own earnings to fluctuations in aggregate labor income, and the responsiveness of aggregate earnings, asset prices and inflation to monetary policy shocks. We quantify all these channels in the euro area by combining micro data from the HFCS and the EU-LFS with structural VARs estimated on aggregate time series. We find that the indirect labor income channel and the housing wealth effect are strong drivers of the aggregate consumption response to monetary policy and explain the cross-country heterogeneity in these responses.

P2P finance and the effectiveness of monetary controls

AbstractThe emergence of a decentralized peer‐to‐peer (P2P) platform that matches lending and borrowing without collateral requirement could have weakened the bank lending and balance sheet channels of monetary policy, calling monetary policy effectiveness into question. Through the perspective of a new Keynesian model expanded with a two‐sided P2P platform and group identity, we find that monetary policy can be financially destabilizing when firms have access to alternative unregulated financing instruments to dodge monetary grabs. Contractionary monetary policy that aims to disincentivize leverage could unintendedly end up with elevated debt leverage. Although the economy largely responds to productivity and investment shocks as intended by the policy, the responses become more volatile, indicating the weakening monetary grips on the economy.