Expansionary Monetary Policy Shocks Research Articles

The Risk-Taking Channel of Monetary Policy Transmission in the Euro-Area

In this paper, we provide evidence for a risk-taking channel of monetary policy transmission in the euro area that works through the relaxation of lending standards for borrowers. Our dataset covers the period 2003Q1-2016Q2 and includes, in addition to the standard variables for real GDP growth, inflation, and the monetary policy stance, indicators of bank lending standards and bank lending margins. Based on vector autoregressive models with (i) recursive identification and (ii) sign restrictions, we show that banks react aggressively to an expansionary monetary policy shock by lowering their lending standards. The banks' efforts to keep their lending margin stable, however, are not successful as we detect a significant compression. We document these findings for the euro area as a whole and for its individual member states. In particular, banks in the Netherlands, Portugal, Spain, and Ireland lowered their lending standards after expansionary monetary policy shocks. The compression of the lending margin is most pronounced in the five crisis countries (Greece, Ireland, Italy, Portugal, and Spain).

Asymmetric Effects of Monetary Policy in Regional Housing Markets

The responsiveness of house prices to monetary policy shocks depends both on the nature of the shock – expansionary versus contractionary – and on city-specific housing supply elasticities. We test and find supporting evidence for the hypothesis that expansionary monetary policy shocks have a larger impact on house prices when supply elasticities are low on 263 US metropolitan areas. We also test whether contractionary shocks are orthogonal to supply elasticities, as implied by downward rigidity of housing supply, and find supporting evidence. A final theoretical conjecture is that contractionary shocks should have a greater impact on house prices than expansionary shocks, as long as supply is not perfectly inelastic. For areas with high housing supply elasticity, our results are in line with this conjecture. However, for areas with an inelastic housing supply, we find that expansionary shocks have a greater impact on house prices than contractionary shocks. We provide evidence that this is related to a momentum effect that is more pronounced when house prices are increasing than when they are falling.

Unconventional Monetary Policy and Bank Risk Taking

In this paper we use corporate syndicated loan data to study the presence of a bank risk-taking channel of unconventional monetary policy in the United States over the period 2008-2015. To account for both actual policy decisions and anticipation effects, we measure the stance of monetary policy by estimating a financial VAR model. We find that accommodative monetary conditions are associated with overall lower loan spreads. Controlling for borrower creditworthiness, we show that the spread reduction is lower for riskier firms, indicating that risk is appropriately priced during the period of unconventional monetary policy. Banks with low non-performing loan ratios and banks characterized by high revenue diversification offer larger loan spread discounts compared to banks with a large amount of non-performing loans and banks with less income diversification. We also find that banks with low capital ratios, less profitable banks and smaller banks more aggressively reduce the corporate loan spreads following an expansionary monetary policy shock, but only for the safest firms. Our findings indicate that unconventional monetary policy actions of the Federal Reserve are not associated with excessive risk taking by banks in the syndicated loan market.

ECB Monetary Policy Transmission During Normal and Negative Interest Rate Periods

We analyze monetary policy transmission in the euro area from 2009--2016, including changes during the negative interest rate policy (NIRP) period as of June 2014. We identify three dimensions of ECB monetary policy related to surprise changes in (i) the target rate, (ii) the expected future path of the target rate (path factor), and (iii) longer-term interest rates (term factor). We find that surprise shocks about the target rate and the future path of the target rate have strong effects on interbank lending rates and government bond yields. Moreover, expansionary monetary policy surprises related to the term factor decrease government bond yields across all maturities and have strongest effects on medium- and long-term maturities. Prices of riskier assets, such as longer-term assets, sovereign bonds from crisis countries, or equities, increase significantly more in response to expansionary monetary policy shocks during the NIRP period. Moreover, during the NIRP period, expansionary target rate shocks further decrease loan interest rates and strongly increase the origination of new bank loans to businesses and households, particularly for loans with longer maturities.

Borrowing constraint, heterogeneous production sectors and policy implications: The case of China

It is well known that the financing capacity of China's private firms is negatively impacted by the discriminatory borrowing constraints imposed on them, but not on state-owned firms. In this paper, we aim to quantify the implication of the borrowing constraints on the transmission mechanism of monetary and fiscal policy, using a DSGE model with a heterogeneous production side of private and state-owned sectors. We fit our model to China's quarterly data from 2005 to 2014 and conduct several experiments. The main findings are as follows. First, a monetary policy shock interacts with private firms' borrowing constraint, thus having an additional effect on real variables, named reallocation effect. This is a deviation from the standard New Keynesian framework, where the real effect comes from the price rigidity. Second, intensified borrowing constraints of the privates firms reduce the efficacy of a tax rate cut shock for private firms and lessen the tightening effects on the state-owned firms of such shock. Third, intensified borrowing constraints on the privates firms reduce the efficacy of an expansionary monetary policy shock for private firms and enhance its effectiveness for the state-owned firms. The model can be easily extended to other developing economies in a similar environment.

Time-Varying Volatility, Financial Intermediation and Monetary Policy

We document that expansionary monetary policy shocks are less effective at stimulating output and investment in periods of high volatility compared to periods of low volatility, using a regime-switching vector autoregression. Exogenous policy changes are identified by adapting an external instruments approach to the non-linear model. The lower effectiveness of monetary policy can be linked to weaker responses of credit costs, suggesting a financial accelerator mechanism that is weaker in high volatility periods. To rationalize our robust empirical results, we use a macroeconomic model in which financial intermediaries endogenously choose their capital structure. In the model, the leverage choice of banks depends on the volatility of aggregate shocks. In low volatility periods, financial intermediaries lever up, which makes their balance sheets more sensitive to aggregate shocks and the financial accelerator more effective. On the contrary, in high volatility periods banks decrease leverage, which renders the financial accelerator less effective; this in turn decreases the ability of monetary policy to improve funding conditions and credit supply, and thereby to stimulate the economy. Hence, we provide a novel explanation for the non-linear effects of monetary stimuli observed in the data, linking the effectiveness of monetary policy to the procyclicality of leverage.

Monetary transmission mechanism with firm turnover

An expansionary monetary policy shock increases the entry rate and the number of firms in the US. A pure sticky price model predicts that the number of firms in the economy should go down after a monetary expansion, but this prediction is at odds with the empirical findings. In marked contrast, the cost channel mechanism generates an increase in the number of firms that is consistent with the data. A key insight is that the greater price stickiness is, the stronger the cost channel needs to be to generate firm dynamics that are consistent with the data.

Monetary Transmission Mechanism with Firm Turnover

An expansionary monetary policy shock increases the entry rate and the number of firms in the US. A pure sticky price model predicts that the number of firms in the economy should go down after a monetary expansion, but this prediction is at odds with the empirical findings. In marked contrast, the cost channel mechanism generates an increase in the number of firms that is consistent with the data. A key insight is that the greater price stickiness is, the stronger the cost channel needs to be to generate firm dynamics that are consistent with the data.

The effectiveness of conventional and unconventional monetary policy: Evidence from a structural dynamic factor model for Japan

I investigate the effectiveness of both conventional and unconventional Japanese monetary policy measures targeting either the short-term interest rate or the monetary base. Using a 1985–2014 data set covering 135 variables, the analysis is based on a structural dynamic factor model. An expansionary monetary policy shock, identified via theoretically plausible sign restrictions, is found to significantly increase real and nominal economic activity. With regard to the policy instrument, its effectiveness differs. A shock that decreases the short-term interest rate has a strong positive effect on output and a modest effect on prices. A monetary policy shock that raises the monetary base has a positive – but weak and rather transitory – effect on output, and a strong effect on goods and stock prices.

Time-Varying Volatility, Financial Intermediation and Monetary Policy

We document that expansionary monetary policy shocks are less effective at stimulating output and investment in periods of high volatility compared to periods of low volatility, using a regime-switching vector autoregression. Exogenous policy changes are identified by adapting an external instruments approach to the non-linear model. The lower effectiveness of monetary policy can be linked to weaker responses of credit costs, suggesting a financial accelerator mechanism that is weaker in high volatility periods. To rationalize our robust empirical results, we use a macroeconomic model in which financial intermediaries endogenously choose their capital structure. In the model, the leverage choice of banks depends on the volatility of aggregate shocks. In low volatility periods, financial intermediaries lever up, which makes their balance sheets more sensitive to aggregate shocks and the financial accelerator more effective. On the contrary, in high volatility periods, banks decrease leverage, which renders the financial accelerator less effective; this in turn decreases the ability of monetary policy to improve funding conditions and credit supply, and thereby to stimulate the economy. Hence, we provide a novel explanation for the non-linear effects of monetary stimuli observed in the data, linking the effectiveness of monetary policy to the procyclicality of leverage.

Show Me the Money: The Monetary Policy Risk Premium

Measuring the monetary policy exposure of an individual stock is challenging because the large idiosyncratic volatility of individual stock returns leads to imprecise estimates of the exposure. In this study, we generate a parsimonious monetary policy exposure (MPE) index based on observable firm characteristics that are likely to drive the exposure of firms to monetary policy. Using this index, we find that stocks whose prices react more positively to expansionary monetary policy shocks earn lower average returns, consistent with the intuition that monetary policy is expansionary in bad times when marginal value of wealth is high and thereby provides a hedge for the investors of high MPE stocks. A long-short trading strategy designed to exploit this effect achieves an annualized return of 10.56% (t-statistic of 6.19), an annualized Sharpe Ratio of 0.98, and a Fama-French-Carhart alpha of 7.56% (t-statistic 6.51) between 1975 and 2014. Our findings build a bridge between the literature that connects firm characteristics to expected returns and the literature that studies macroeconomic aggregates as predictors of asset returns.

Effects of US Monetary Policy Shocks during Financial Crises A Threshold Vector Autoregression Approach

This paper analyzes the impact and effectiveness of conventional monetary policy during periods of low and high financial stress in the US economy. Using data from 1973Q1 to 2008Q4, the analysis is conducted by estimating a Threshold Vector Autoregression (TVAR) model to capture switching between the low and high financial stress regimes implied by the theoretical literature. The empirical findings support regime-dependent effects of conventional US monetary policy. In particular, the output response to monetary policy shocks is larger during periods of high financial stress than in periods of low financial stress. The existence of a cost channel effect during periods of high financial stress imply a worsening of the short run output-inflation trade off during financial crises. When the sample period is extended to 2012Q4, there is evidence that expansionary monetary policy continues to be effective during periods of high financial stress when the prevailing interest rate is at the zero lower bound. By keeping interest rates and credit spreads low, expansionary monetary policy helps shift the US economy from high to low financial stress regimes. Large expansionary monetary policy shocks also increase the likelihood of moving the economy out of a high financial stress regime.

HEALTH CARE INFLATION AND ITS IMPLICATIONS FOR MONETARY POLICY

Motivated by recent findings on the cyclical movement of both health and health spending, we construct a general equilibrium model that distinguishes health care demand from the demand for other goods. Using this model, we are able to generate inflation dynamics and cyclicality of health that match the US data. When the model is subjected to an expansionary monetary policy shock, it yields different output and inflation responses compared with a two‐sector model with homogeneous demand. We show that the trade‐off between leisure and health spending plays an important role in model dynamics. The model further predicts different degrees of inflation stabilization across sectors when a shift in the monetary policy occurs. (JEL E52, E31, E32, I10)

House Price Booms, Current Account Deficits, and Low Interest Rates

Domestic factors, such as credit and preference shocks, can explain the negative correlation between house prices and the current account in the U.S. and several other countries before the recent crisis. These shocks, however, cannot account for the fall of world real interest rates observed in the data. Expansionary monetary policy shocks in the U.S., coupled with exchange rate pegs to the dollar in emerging economies, are crucial to understanding the evolution of the real interest rate. Yet, monetary policy factors play virtually no role for house prices and the current account.

Unconventional Monetary Policy and Uncertainty

Using a structural factor-augmented vector autoregression (FAVAR) model and a large database of daily time series, we examine the impact of unconventional monetary policy on multiple proxies of economic and financial uncertainty. Our findings indicate that expansionary unconventional monetary policy shocks lead to large reductions in uncertainty across markets. More specifically, a surprise unconventional monetary easing lowers equity market, policy, housing and mortgage market, exchange rate, and Treasury market uncertainty. Research results further suggest that these reductions in uncertainty differ in magnitude across asset classes and largest for equity markets. Lastly, we find that the effects of these monetary shocks on uncertainty attenuate quickly and dissipate after about 150 days.

Unconventional Monetary Policy, Media Uncertainty, and Expected Stock Market Volatility

This paper investigates the relationship between unconventional monetary policy, media uncertainty, and expected stock market volatility. We find that (1) expansionary unconventional monetary policy shocks induce higher media uncertainty as news reports aim to describe the uncertain economic environment leading up to these monetary policy events; and (2) that expansionary unconventional monetary shocks, when coupled with higher media uncertainty, lead to higher subsequent realizations of expected stock market volatility. These effects, which are asymmetric across the different rounds of the Federal Reserve's Quantitative Easing program, then reverse after several days in line with a behavioral interpretation of the results.

Macroeconomic Factors and Microlevel Bank Behavior

We analyze the link between banks and the macroeconomy using a model that extends a macroeconomic VAR for the U.S. with a set of factors summarizing conditions in about 1,500 commercial banks. We investigate how macroeconomic shocks are transmitted to individual banks and obtain the following main findings. Backward‐looking risk of a representative bank declines, and bank lending increases following expansionary shocks. Forward‐looking risk increases following an expansionary monetary policy shock. There is, however, substantial heterogeneity in the transmission of macroeconomic shocks, which is due to bank size, capitalization, liquidity, risk, and the exposure to real estate and consumer loans.

In search for yield? Survey-based evidence on bank risk taking

Monetary policy can have an impact on economic and financial stability through the risk taking of banks. Falling interest rates might induce investment into risky activities. This paper provides evidence on the link between monetary policy and bank risk taking. We use a factor-augmented vector autoregressive model (FAVAR) for the US for the period 1997–2008. Besides standard macroeconomic indicators, we include factors summarizing information provided in the Federal Reserve’s Survey of Terms of Business Lending (STBL). These data provide information on banks׳ new loans as well as interest rates for different loan risk categories and different banking groups. We identify a risk-taking channel of monetary policy by distinguishing responses to monetary policy shocks across different types of banks and different loan risk categories. Following an expansionary monetary policy shock, small domestic banks increase their exposure to risk. Large domestic banks do not change their risk exposure. Foreign banks take on more risk only in the mid-2000s, when interest rates were ‘too low for too long’.

Monetary policy shocks and real commodity prices

In this paper we document the effects of monetary policy shocks on real commodity prices. Based on a VAR estimated using long-run restrictions, an expansionary monetary policy shock causes real commodity prices and output both to rise sharply for a short period of time. We find that a simple dynamic equilibrium model of commodity supply and demand can give a realistic response of real commodity prices to monetary policy shocks, for a wide range of parameter values. Furthermore, we find that based on historical simulations, shocks to monetary policy played an important role in commodity price fluctuations during the Great Recession, but they have contributed negligibly to commodity price movements overall since 1970. Even though monetary policy shocks have a robust and large marginal effect on real commodity prices, most monetary policy shocks are small, and most fluctuations in real commodity prices are correspondingly small.

Effects of US Monetary Policy Shocks During Financial Crises - A Threshold Vector Autoregression Approach

This paper analyzes the impact and effectiveness of conventional monetary policy during periods of low and high financial stress in the US economy. Using data from 1973Q1 to 2008Q4, the analysis is conducted by estimating a Threshold Vector Autoregression (TVAR) model to capture switching between the low and high financial stress regimes implied by the theoretical literature. The empirical findings support regime-dependent effects of conventional US monetary policy. In particular, the output response to monetary policy shocks is larger during periods of high financial stress than in periods of low financial stress. The existence of a cost channel effect during periods of high financial stress imply a worsening of the short run output-inflation trade off during financial crises. When the sample period is extended to 2012Q4, there is evidence that expansionary monetary policy continues to be effective during periods of high financial stress when the prevailing interest rate is at the zero lower bound. By keeping interest rates and credit spreads low, expansionary monetary policy helps shift the US economy from high to low financial stress regimes. Large expansionary monetary policy shocks also increase the likelihood of moving the economy out of a high financial stress regime.