Central Bank Financing Research Articles

Regional debt in monetary unions: Is it inflationary?

This paper studies the inflationary implications of interest bearing regional debt in a monetary union. Is this debt simply backed by future taxation with no inflationary consequences? Or will the circulation of region debt induce monetization by a central bank? We argue here that both outcomes can arise in equilibrium. In the model economy, there are multiple equilibria which reflect the perceptions of agents regarding the manner in which the debt obligations will be met. In one equilibrium, termed Ricardian, the future obligations are met with taxation by a regional government while in the other, termed Monetization, the central bank is induced to print money to finance the region's obligations. The multiplicity of equilibria reflects a commitment problem of the central bank. A key indicator of the selected equilibrium is the distribution of regional debt holdings. We show that regional governments, anticipating central bank financing of their debt obligations, have an incentive to create excessively large deficits. We use the model to assess the impact of some policy measures within a monetary union as well as dollarization.

Central bank independence and monetary policymaking institutions — Past, present and future

This is an extensive survey of worldwide developments in the area of monetary policymaking institutions during the second half of the twentieth century and beyond. In addition the last section discusses current open issues and future challenges. Section 2 reviews the changes that have occurred in the area of central bank independence (CBI) during the last twenty years, discusses reasons for those developments and provides an overview of accumulated empirical evidence on the relation between CBI and the performance of the economy. Section 3 discusses lessons from stabilization of inflation, reviews the evidence and implications of asymmetric central bank objectives and considers the issue of CBI within the broader context of choosing a nominal anchor. Section 4 reviews the impact of independence on economic performance in the presence of labor unions. Section 5 considers future challenges facing modern central banks. The discussion presumes that CBI and price stability are here to stay and focuses on issues relating to the conduct of monetary policy by independent central banks in an era of price stability, like the risks associated with flexible inflation targeting and the impact of central bank capital and finances on its independence.

Central Bank Financial Strength and Policy Performance: An Econometric Evaluation

The financial health of central banks and its relation to policy outcomes has recently been recognized as an important policy issue. While case study evidence clearly indicates that weak central bank finances can hamper effective policy implementation, the question of whether central bank financial strength influences policy performance remains controversial. This is due, in part, to a lack of econometric evidence. The paper presents a first step toward filling this gap, by providing a quantitative evaluation of the relationship between measures of central bank financial strength and policy performance, in particular inflation. The paper's major finding is that there indeed is a negative relationship between central bank financial strength and inflation outcomes. This relationship appears to be robust to the choice of alternative country samples, control variables, estimation strategies, and conceptualizations of central bank financial strength.

Central Bank Financial Strength and Policy Performance: An Econometric Evaluation

The financial health of central banks and its relation to policy outcomes has recently been recognized as an important policy issue. While case study evidence clearly indicates that weak central bank finances can hamper effective policy implementation, the question of whether central bank financial strength influences policy performance remains controversial. This is due, in part, to a lack of econometric evidence. The paper presents a first step toward filling this gap, by providing a quantitative evaluation of the relationship between measures of central bank financial strength and policy performance, in particular inflation. The paper's major finding is that there indeed is a negative relationship between central bank financial strength and inflation outcomes. This relationship appears to be robust to the choice of alternative country samples, control variables, estimation strategies, and conceptualizations of central bank financial strength.

Currency Crisis Theories - Some Explanations for the Russian Case

This paper studies the currency crisis theories, and with the help of them it finds out the main reasons for the Russian crisis. It goes through the exchange rate determination, first and second generation theories and, particularly, the recent theories for the Asian crisis. The basic weaknesses of the Russian economy rendered the country inefficient for growth and inclined to crisis. The main reason for the crisis were the long-time federal budget deficits, which were mostly financed through short-term domestic debt. This created expectations of central bank financing. The Asian crisis was a trigger for the Russian crisis. Inadequate financial regulations and lack of information are some explanations for this contagion -effect. But the main mistakes, which led to the crisis, are Russians own – the long-time federal budget deficits. Thus, the repairs should also start from there.

The Bank of Amsterdam and the Leap to Central Bank Money

Central bank money is the foundation of modern monetary and payment systems. Central bank money defines a unit of account. The price at which this money trades determines “monetary policy.” And most payment systems require the transfer of central bank funds before a transaction is legally final or “settled.” Despite its current ubiquity, the origins of central bank money have remained obscure, and the present-day system involves a remarkable conceptual leap from earlier coin-based systems. In this paper, we recount how the critical innovation—the creation of a unit of account that could be maintained solely through open-market operations—took place in the seventeenth-century Dutch Republic (for a more detailed examination see Quinn and Roberds 2005; Quinn and Roberds 2006). The villain in our story is the incremental debasement that unsettled the quality of new coins and the price of old coins. The protagonists are the Dutch authorities who contended with debasement by regulating the price of coins and by creating “exchange banks,” the Bank of Amsterdam in particular, to assure the quality of coins. The plot is propelled forward because well-intentioned regulatory changes exacerbated the debasement problem. Resolution began when authorities disconnected the Bank of Amsterdam from the price of circulating coins. The solution was conceptually difficult because a coin would have a different price in the Bank of Amsterdam than it had outside. Once this dichotomy was accepted, however, a robust market developed to mediate the relationship between the Bank of Amsterdam and circulating coins, and ledger accounts at the bank become the de facto means of final settlement. In the end, the final step into the world of fiat money—the elimination Monetary SySteMS: tranSitionS and experiMentS

Regional Debt in Monetary Unions: Is it Inflationary?

This paper studies the inflationary implications of interest bearing regional debt in a monetary union. Is this debt simply backed by future taxation with no inflationary consequences? Or will the circulation of region debt induce monetization by a central bank? We argue here that both outcomes can arise in equilibrium. In the model economy, there are multiple equilibria which reflect the perceptions of agents regarding the manner in which the debt obligations will be met. In one equilibrium, termed Ricardian, the future obligations are met with taxation by a regional government while in the other, termed Monetization, the central bank is induced to print money to finance the region's obligations. The multiplicity of equilibria reflects a commitment problem of the central bank. A key indicator of the selected equilibrium is the distribution of the holdings of the regional debt. We show that regional governments, anticipating central bank financing of their debt obligations, have an incentive to create excessively large deficits. We use the model to assess the impact of policy measures within a monetary union.

Securing Financial Independence in the Legal Basis of a Central Bank

textabstractTogether with institutional, functional and organizational independence, financial independence constitutes one of the cornerstones of central bank independence, the economic ratio of which has been demonstrated extensively in the literature. In broad terms financial independence may be defined as referring to the legal and practical arrangements identifying the finances of a central bank and the extent to which the bank is subject to outside influence in this regard. In the (legal) debate on central bank accountability, arguably arrangements relating to central bank finances have sometimes been treated in a rather step motherly fashion. Yet, with the wider debate on good governance structures having reached central banking, more attention is paid to such detailed arrangements. This contribution focuses on and aims at providing an overview on the impact on central bank independence of the legal arrangements relating to several aspects of central bank finances. While government access to central bank money undoubtedly has an impact on the financial position of the central bank, this contribution focuses on those elements, which are arguably more directly linked to the financial position of a central bank, including capitalization and recapitalization, the determination of the central bank budget and the arrangements on profit and loss distribution. In legal studies these arrangements have certainly received less attention. To this end a critical assessment of the role which the legal basis of a central bank plays in enhancing or undermining the financial position of a central bank vis-a-vis government and, thereafter. In this context, legal arrangements which do not only support the financial independence of a central bank but also enhance its accountability are observed. Where appropriate, references are included to legal arrangements in existing central bank systems so to provide for negative and positive examples.

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

AbstractOpen 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.

Central Bank Financial Independence

Central bank independence is a multifaceted institutional design. The financial component has been seldom analysed. This paper intends to set a comprehensive conceptual background for central bank financial independence. Quite often central banks are modelled as robot-like maximizers of some goal. This perspective neglects the fact that central bank functions are inevitably deployed on its balance sheet and have effects on its income statement. A financially independent central bank exhibits the adequate balance sheet structure and earnings generation capacity to efficiently perform its functions. From a long-term perspective, as far as the demand for banknotes is maintained seignorage waters down any central bank financial independence concern. However, from a short-term perspective central bank financial vulnerability may condition its effective independence. Vulnerability may be real or accounting based. However, no matter its origin, institutional solutions are needed to minimize their impact. Adequate capitalization turns out to be a key issue. Alternatively, contingent capital in the form of institutional arrangements to bear central bank losses may be a (second-best) solution. The paper analyses in the context of simple VAR model the interplay between capitalization, accounting rules and dividend distribution. This analysis is preceded by a thorough discussion of the risk-return profile of central banks net return on assets. Three main conclusions shape the input to the capitalization model. Central banks return on assets can be very volatile from a short term perspective. From a medium term perspective, natural earnings generation cycles dampen down volatility. On average, central banks net return on assets typically exhibits a discount over government debt financing cost. These observations shape the central bank financing planning problem as follows. Namely, the size of the discount relative to the social costs that would arise in case of a lack of central bank independence, along with central bank exposure to risks and the volatility thereof, determine the incentives of the government to maintain an excess of financial assets in the form of central bank capital. Actually, the working of smoothing mechanisms operating across time on central banks earnings leads to a distinction between short-term and medium term capital, i.e. the optimum capital solution is a band. In the same vein, the need to maintain optimal consistence between central bank financial strength and dividends distribution policy leads also to smoothing proporsals for pay-policy.

Equilibrium Bidding in the Eurosystem's Open Market Operations

Open market operations play a key role in allocating central bank funds to the banking system and thereby to steer short-term interest rates in line with the stance of monetary policy. This note presents some elements of a theory of bidding in central bank tenders in a framework such as the one of the Eurosystem. The ECB has so far used fixed rate tenders and a variant of the variable rate tender, which may be similar to a fixed rate tender depending on market circumstances. In doing so, it faced consecutively an 'under-' and an 'overbidding' issue. The tools developed in this note to understand the bidding behavior of banks in these operations allow revisiting these phenomena and the more general question of the optimal tender procedure and allotment policy. JEL Classification: D84, E43, E52

Collateral and short squeezing of liquidity in fixed rate tenders

The paper models fixed rate tenders, where a central bank offers to lend central bank funds to financial institutions. Bidders are constrained by the amount of collateral they have. We focus on the strategic interaction between bidding in the tender and trading in the interbank market after the tender, where short squeezes could occur. We examine how the design of the tender affects equilibrium bidding behavior and the incidence of short squeezes. Important elements in the analysis include the type of policy implemented by the central bank as well as bidders' initial endowments of liquidity and collateral. Three instruments for softening short squeezes are identified: the tender rate, the tender size, and admissible collateral. Increasing the tender rate or size tends to decrease the probability and severity of a short squeeze. The possibility of a short squeeze may induce bidders to oversubscribe even if the tender rate is higher than the competitive rate.

IMF-Supported Stabilization Programs and their Critics: Evidence from the Recent Experience of Egypt

The IMF-supported stabilization and structural adjustment programs implemented by Egypt in the 1990s were successful in meeting their objectives, and when compared with earlier attempts and the experience of other developing countries. The authorities undertook a sharp reduction in the government's overall deficit and its central bank financing allowing for increased credit availability to the private sector within a framework of a rapidly decelerating monetary expansion. Despite initiating comprehensive market reforms that significantly improved the environment for private investment, the response of the private sector has been disappointing. It is argued that until institutional, regulatory and political constraints are removed, Egypt will not join the group of high-investing and fast-growing economies.

Financial Stability and Fiscal Crises in a Monetary Union

The main tasks of central banks are to secure price and financial stability. These objectives can, in times of crises, conflict with one another, and the central bank may have to renounce one of them in order to secure the other. In a monetary union, this trade-off can be exacerbated by the presence of highly indebted countries or by the risk of loose fiscal policies. This paper offers a simple theoretical model that captures the trade-off. Different fiscal institutions are compared in order to evaluate their impact on the conduct of monetary policy. More specifically, the fiscal criteria of the Maastricht Treaty and the Pact for Stability and Growth in Europe are analyzed in light of this model. Fiscal mechanisms exist to help prevent or minimize the risk of fiscal crises and the corresponding risk of central bank financing and inflation.

Collateral and Short Squeezing of Liquidity in Fixed Rate Tenders

The paper models fixed rate tenders, where a central bank offers to lend central bank funds to financial institutions. Bidders are constrained by the amount of collateral they have. We focus on the strategic interaction between bidding in the tender and trading in the interbank market after the tender, where short squeezes could occur. We examine how the design of the tender affects equilibrium bidding behavior and the incidence of short squeezes. Important elements in the analysis include the type of policy implemented by the central bank as well as bidders' initial endowments of liquidity and collateral. Three instruments for softening short squeezes are identified: the tender rate, the tender sizes, and admissible collateral. Increasing the tender rate or size tends to decrease the probability and severity of a short squeeze. The possibility of a short squeeze may induce bidders to oversubscribe even if the tender rate is higher than the competitive rate.

Selected transition and Mediterranean countries: an institutional primer on EMU and EU accession

The paper examines the institutional channels through which Economic and Monetary Union (EMU) in the European Union (EU) can affect the transition countries of Central and Eastern Europe and three Mediterranean countries that aspire to join the EU.After describing the current institutional framework for relations between the EU and these countries, the paper considers two categories of institutional implications of EMU. The first stems from the need to satisfy the Maastricht convergence criteria before joining the euro area. Although the Maastricht criteria are not accession criteria, many of the countries reviewed are already formulating their macroeconomic policies in a way that will facilitate convergence toward the Maastricht targets. The second implication stems from the need to adopt the EU’s institutional and legal provisions in the area of EMU, such as those referring to the establishment of independent central banks, the prohibition of central bank financing of the government and the liberalization of capital movements. Finally, the paper discusses some of the key policy issues that EMU raises for the countries reviewed, in particular regarding exchange rate policy, capital account liberalization and the possible conflict between growth‐enhancing measures and the Maastricht criteria.

Central bank independence and financing government spending

This paper incorporates the effect of the central bank's independence into the government's optimum financing model. When the implications of the hypotheses are tested for eighteen OECD countries, this paper shows that countries with higher levels of central bank independence generate less seigniorage revenue.

Optimal Seigniorage, the Gold Standard, and Central Bank Financing

This paper extends the theory of optimal seigniorage to allow for money production costs. An important implication is tha t high money production costs, along with a requirement that the monet ary branch of government self-finance its operation, severs the connecti on between the tax rate on output and the tax rate on money. Using U.S. data, the authors find that tax rates on output and money move together only during periods when the government controls both tax rates and there is a close correspondence between revenue produced b y the monetary authority and revenue transferred to the treasury. Copyright 1993 by Ohio State University Press.

Rediscount Policy and Official Capital Flows: A Study of Monetary Control in Central America in the 1950s

A WIDE RANGE OF EMPIRICAL STUDIES HAVE RECENTLY questioned the ability of monetary authorities to exercise monetary control in the sense that they cannot divorce their foreign exchange market intervention operations from their control of domestic money supplies. ' This paper will analyze the policy implications of this large literature on monetary control in the context of institutional constraints typically found in developing countries. In particular, it will investigate the balance of payments implications of central bank financing of major export crops. It will show that, in Costa Rica, E1 Salvador, and Nicaragua in the 1950s, the central banks' rediscounting of seasonal agricultural paper caused correspondingly seasonal foreign exchange reserve movements; the central banks' policy of liberally extending seasonal agricultural credit, in the environment where they had little monetary control, meant that official capital flows substituted for private capital flows. The predominant tool of monetary policy in most developing countries takes the form of rediscount of notes and securities, owing to the absence of well-developed financial institutions.2 Additionally, such rediscounting is often done in connection

THE BANK OF JAPAN: A CASE STUDY IN THE EFFECTIVENESS OF CENTRAL BANK TECHNIQUES OF MONETARY CONTROL*

THE PURPOSE OF this study is to examine the effectiveness of monetary controls by the Japanese central bank-the Bank of Japanand to analyze the relative importance of various instruments of central bank control. The study is concerned with the description and analysis of monetary policy in Japan in the tight-money periods of 1953-55 and 1957-58 only as this is necessary to demonstrate the efficacy of monetary controls in this particular institutional and environmental context. In Part I the hypothesis is examined that Bank of Japan monetary policy can be an effective means of implementing economic stabilization policy, especially in the restriction of realized business investment under conditions of excessive domestic demand. This hypothesis is significant because, (a) given its factor proportions, Japan has had to rely structurally upon imports for economic growth and, (b) given success in meeting capital formation requirements, the major operative constraint on stable growth has been periodic balance-of-payments crises emanating from excessive domestic demand and attendant inflationary pressures. The analysis focuses on corporate business reliance on external funds to finance investment activities and the reliance of the commercial banking system on central bank financing. Internal generation of funds by corporation business has been insufficient to finance the high level of business-planned investment emanating from the rapid growth of the economy. Capital markets have been relatively undeveloped; consequently, business has relied heavily on borrowing from the banking system, especially from the city banks. Under conditions of relatively interest-inelastic demand for funds and relatively low maximum legal lending rates, the availability of funds from the banking system, rather than simply their cost, has been an important determinant of realized business investment.