Financial Stability Objectives Research Articles

Connectedness between central bank digital currency index, financial stability and digital assets

This study examines the interconnectedness between central bank digital currencies (CBDC) index, digital assets and financial stability. First, we use the CBDC index as a measure of financial stability and examine its connectedness with other known measures of financial stability used in the literature. Secondly, we analyse the connectedness of CBDC index with digital assets such as cryptocurrencies and non-fungible tokens and various measures of financial stability. By analysing index returns of CBDC data and applying various connectedness measures to CBDC index, cryptocurrencies, stablecoins and NFTs, we gain insights into the relationships among these assets within a framework. The findings reveal a significant level of connectedness between CBDCs index, digital assets and financial stability. Our analysis shows a weak positive connectedness between CBDCs index and digital assets, indicating that movements in the CBDC index are not closely related to the performance of various digital assets and have a very small contribution to the changes in the returns of digital assets. Furthermore, the study finds bidirectional connectedness between CBDCs and other financial stability measures, suggesting that changes in CBDC performance can influence the overall stability of the financial system, and vice versa. This highlights the importance of carefully considering the design and implementation of CBDCs to ensure they support financial stability objectives.

Disinflation costs and macroprudential policies: real and welfare effects

PurposeThis paper analyzes real and welfare effects of a permanent change in inflation rate, focusing on macroprudential policy’ role and its interaction with monetary policy.Design/methodology/approachWhile investigating disinflation costs, the authors simulate a medium-scale dynamic general equilibrium model with borrowing constraints, credit frictions and macroprudential authority.FindingsProviding discussions on different policy scenarios in a context where still it is expected high inflation, there are three key contributions. First, when macroprudential authority actively operates to improve financial stability, losses caused by disinflation are limited. Second, a Taylor rule directly responding to financial variables might entail a trade-off between price and financial stability objectives, by increasing disinflation costs. Third, disinflation is welfare improving for savers, while costly for borrowers and banks. Indeed, while savers benefit from policies reducing price stickiness distortion, borrowers are worried about credit frictions, coming from collateral constraint.Practical implicationsThe paper suggests threefold policy implications: the macroprudential authority should actively intervene during a disinflation process to minimize costs and financial instability deriving from it; policymakers should implement a disinflationary policy stabilizing also output; the central bank and the macroprudential regulator should pursue financial and price stability goals, separately.Originality/valueThis paper is the first attempt to study effects of a permanent inflation target reduction in focusing on the macroprudential policy’ role.

Impact of capital controls on banking crises and economic growth

This study examines the expected impact of capital control tools on financial stability. We demonstrate that capital controls lower the probability of a banking crisis (positive effect) and simultaneously reduce economic growth (negative effect). We apply a dynamic panel logit model with fixed effects on a sample of countries composed of emerging and advanced economies for the period 2000–2020. Moreover, we use an impulse response function analysis to assess the net effect of capital controls. The results show that while regulation of capital flows directly stabilizes the economy, it also indirectly destabilizes it by impeding economic growth. Furthermore, we found that the positive impact of lowering the probability of a crisis dominates the adverse effect on economic growth. These impacts are different across the subgroups of emerging market economies and advanced countries. However, in both subgroups the effect of capital controls is independent of capital controls tightening. These results have significant implications for policymakers, who must adjust the capital flows regulatory policy according to economic growth and financial stability objectives.

Monetary Policy and Financial Stability: Lessons from the Global Financial Crisis

The Global Financial Crisis (GFC) of 2007-2008 was a watershed moment that reshaped the landscape of monetary policy and financial regulation worldwide. This research paper delves into the pivotal role of monetary policy in fostering financial stability, drawing lessons from the tumultuous events of the GFC. Through an extensive review of literature and empirical analysis, this paper examines the various monetary policy tools employed by central banks to mitigate systemic risks and promote stability in the aftermath of the crisis. The paper begins by elucidating the complex interplay between monetary policy, financial markets, and systemic risk, emphasizing the importance of maintaining a delicate balance between price stability and financial stability. It explores the conventional and unconventional measures adopted by central banks during the crisis, including interest rate adjustments, liquidity provision, and asset purchase programs, and assesses their effectiveness in stabilizing financial markets and averting systemic collapse. Furthermore, the paper evaluates the evolution of monetary policy frameworks in response to the lessons learned from the GFC, such as the adoption of macroprudential tools and the reassessment of inflation targeting regimes. It analyzes the challenges and trade-offs faced by policymakers in pursuing dual objectives of price and financial stability, highlighting the need for a holistic approach to monetary policy formulation. Moreover, this paper examines the implications of post-crisis monetary policy measures on financial markets, asset prices, and economic activity, addressing concerns regarding moral hazard, excessive risk-taking, and asset price bubbles. It also discusses the role of regulatory reforms in strengthening the resilience of the financial system and enhancing the effectiveness of monetary policy transmission mechanisms.

Introduction to the special issue: the persistent challenges to European Banking Union

ABSTRACT The papers of this special issue investigate the persistent challenges to European Banking Union and explore the tensions between broader financial stability objectives and national political and socio-economic pressures through a diversity of lenses. In this introduction, we examine two main issues that need to be addressed in order to strengthen Banking Union: the incomplete institutional design of Banking Union and the difficulties encountered in applying the different elements of Banking Union to loosen sovereign-bank ties. These elements include the so-called ‘single’ rulebook, supervision, resolution, and financial mechanisms to support and resolve banks.

THE INTERCONNECTEDNESS OF STOCK PRICES, MONEY, AND CREDIT ACROSS TIME AND FREQUENCY FROM 1970 TO 2016

This article applies continuous wavelet and maximal overlap discrete wavelet transforms to study the co-movements and the direction of causality between money (M3 and M2), bank credit, credit from all sectors vs. stock price dynamics across time and frequency for 12 developed countries. The time-varying linkages were significant typically for credit rather than money developments. Particularly, these linkages appeared during phases of house and stock price boom and bust at a business cycle frequency. The discovered lead-lag patterns give relatively much time for monetary policy authorities to support their financial stability objectives by imposing restrictions on credit. Closing the channel through which credit and stock prices interact may counteract the rising financial imbalances. This finding holds also for the euro area where the monetary pillar is based on broad money. The new application of wavelets allowed discovering the varying linkages that were not necessarily evident in the standard methods of analysing data.

Monetary Policy and Macroprudential Policy in Fixed Exchange: The Case of the Bank of Central African States

This article examines the nature of the policy-mix between monetary policy and macroprudential policy in the member countries of the Bank of Central African States (BCAS). For this, we test a monetary rule “augmented” by the financial stability objective using a regime-switching panel model over the period 2006-2018. The results show that the nature of the policy-mix between monetary policy and macroprudential policy depends on the economic situation, assessed by the evolution of BCAS’s net foreign assets.

Addressing the challenges of post-pandemic debt management in the consumer and SME sectors: a proposal for the roles of UK financial regulators

Regulatory actions for short-term debt-relief during the Covid-19 pandemic are facilitating a significant level of indebtedness. We argue that regulators, in leaving the banking sector to manage small business and consumer debtors in ‘tailored arrangements’, risk allowing financial welfare goals to be unmet. Financial welfare goals are important to the Financial Conduct Authority’s (FCA) consumer protection objective and give substantive meaning to the long-term financial stability objective of the Prudential Regulation Authority (PRA). Although the struggles with debt on the part of small and medium-sized businesses and households are not capable of complete resolution by financial regulators, who are constrained by their statutory mandates, we argue that the PRA and FCA should establish a coordinated supervisory framework of ‘tailored supervision’ for banks’ ‘tailored arrangements’ with their debtors. This proposal allows both regulators to address to an extent the needs of unsophisticated post-pandemic debtors and meet their objectives in a joined-up and holistic manner.

How effective have measures by Central Banks been in mitigating the impact of financial crisis

During the global financial crisis, central banks around the globe implemented a series of unconventional monetary policy measures such as quantitative easing among others to avert the impact of financial crisis on financial system. There exist numerous studies on this area of interest, with each guided by a specific view of the problem and selectively chosen empirical observations with regard to the different developments. This paper reviewed literature to ascertain the effectiveness of conventional monetary policy measures and unconventional monetary measures used in mitigating the impact of the 2007/2008 global financial crisis, specifically by the major central banks including the Federal Reserve, European Central Bank and Bank of England. The study used systematic quantitative assessment technique (SQAT) to determine a high quality of papers that have been reviewed in the study. The result proved that conventional monetary policy measures are still potent to deliver their desired objectives but inadequate in times of acute crisis. Empirical evidences proved that central banks have not practically abandoned the core elements of their pre-crisis monetary policy. Through a complex form of strengthening and reassessment, they have instead complimented, extended and somewhat improved their measures to mitigate the impact of the financial crisis. An important lesson of the crisis is that there is opportunity to reinforce central banks with macro prudential supervision and regulation. This should be seen as complementary to the existing monetary policy measure in order to deliver the twin objectives of price and financial stability.

Central banks and climate change - the case for action

Central banks are increasingly considering their role in meeting climate objectives. Often, central banks justify this by arguing that climate considerations directly impact on their primary objectives of price and financial stability. We argue that a stronger case is that the urgency of climate risks is such that standard neutrality-based objections to central bank involvement in economic allocation are obviated. Indeed, neutrality-based arguments look especially weak when it is realised neutrality is essentially impossible for central banks to achieve.

Farmer flexibility concerning future rotation planning is affected by the framing of climate predictions

Arable crops are typically grown in annual rotations. Diverse rotations can deliver ecosystem services, provide economic resilience, and support adaptation to climate change. Our aim was to assess farmers’ attitudes to planning and diversifying crop rotations, focusing on their responses in the face of contrasting climate viewpoints.We interviewed 75 farmers from four regions along a latitudinal gradient from the south of the UK to the south of France. We used a semi-structured questionnaire with face-to-face interviews and asked farmers to respond to two narrative viewpoints of climate change impacts: one viewpoint focused on opportunities, the other on constraints.We found in all four regions that farmers’ use rotations, and the crops within rotations, to achieve their main objectives of financial stability and improved soil health. Most farmers (79–100% depending on region) said they had experienced climate change, and many (54–83%) had already implemented changes in their farming practices. We did not find a difference in these results based on latitude. However, farmers’ self-reported outlook was mostly optimistic in southern UK and become progressively more pessimistic further south. When presented with a viewpoint of climate change impacts focusing on opportunities, more farmers were likely to diversify and lengthen rotations, and fewer were likely to shorten them, compared to a viewpoint presenting constraints from these impacts.Crucially, here we show that the presentation of climate change affects the ways in which farmers predict how they will respond to climate change. Diversified rotations align with multiple other economic and environmental benefits. Therefore, it is essential to consider the way in which climate change impacts are communicated, and the effect this has farmers’ behavior, when designing measures to support environmentally sustainable adaptation to climate change.

Les politiques monétaires à l'épreuve de la libéralisation financière

Cet article se propose de retracer brièvement l’histoire des politiques monétaires depuis l’après-guerre pour mettre en perspective et faire ressortir l’incidence du processus de libéralisation financière sur ces politiques. On observe en effet qu’à partir des années 1980 la plupart des pays avancés ont adopté un même modèle de « central banking » concentrant l’action des autorités monétaires sur l’objectif de stabilité des prix et réduisant leur domaine et leurs instruments d’intervention. On montre que la négligence de l’objectif de stabilité financière a remis en cause, après la crise de 2007, le modèle en question et peut-être aussi le processus de libéralisation. Classification JEL : E50, E52, E58, G01.

Central Bank Communication with a Financial Stability Objective

An endogenous financial crisis is introduced into the canonical model used to study central bank transparency. The central bank is endowed with private information about the real economy and credit conditions which jointly determine financial vulnerabilities. An optimal choice is made regarding whether to communicate this information to the public. A key finding is that the optimal communication strategy depends on the state of the credit cycle and the \ composition of shocks driving the cycle. From a policy perspective, this raises the possibility that central bank communication in the presence of a financial stability objective faces a time inconsistency problem.

Macroprudential ring-fencing

PurposeThis paper aims to focus on capital-related macroprudential policies in the context of recent policy discussions on the removal of barriers to the mobility of capital and liquidity of cross-border banks in the European Union (EU).Design/methodology/approachThis study first discusses the link between financial stability and internal resource mobility of cross-border banks. Then, it examines past heterogeneity in structural capital buffers as key macroprudential capital instruments applied in the EU and relate them to costs of policy action, degree of foreign penetration and membership in the Banking Union.FindingsObserved phase-in patterns of structural capital buffers in the EU are broadly consistent with costs of policy action, degree of foreign penetration and membership in the Banking Union as potential factors. The process of financial integration could be further enhanced through reduced uncertainty in the application of macroprudential policies that constrain capital mobility of cross-border banks.Originality/valueThis paper anchors macroprudential policies into a wider discussion on the mechanism and implications of ring-fencing in the EU over time. It discusses two policy areas, macroprudential policies and proposals for deeper financial integration, that share the same financial stability objective but tend to emphasize different implications of the mobility of capital and liquidity of cross-border banks in the EU. The study provides a discussion of potential implications of the recent adoption of the CRRII/CRDV legislation for future heterogeneity of macroprudential policies in the EU.

Value Creation in the Listed Banks: Do Governance Matter?

We assess the relationship between bank governance practice (GCG), efficiency, capital and risk on value creation in a sample of Indonesia commercial banks using the balance panel methodology. Our results suggest that GCG has a positive impact on value creation and performance. We also find that higher interest margin eventually becomes more profitable, better capitalized and that higher capital levels tend to have a neutral or negative effect on value creation. Efficiency levels are positive to value creation. These results are generally confirmed by a series of robustness tests. The findings convey potentially important implications for bank prudential supervision and underline the importance of attaining better governance to support sustainability and financial stability objectives.

The real effects of loan-to-value limits: empirical evidence from Korea

This study adds to a recent and growing literature that assesses the effects of macroprudential policy. We compare the effects of monetary policy and loan-to-value ratio shocks for Korea, an inflation-targeting economy and an active user of loan-to-value limits. We identify shocks using sign restricted structural VARs and rely on a recent approach within this method to conduct structural inference. This study finds that both monetary policy and loan-to-value ratio shocks have effects during the period that our sign restrictions applies on different measures of credit, i.e., real bank credit, real total credit and real household credit, as well as on real output, real consumption and real investment. We find though that loan-to-value ratio shocks have negligible effects on the price level. Both shocks, however, have non-negligible effects on real house prices, evidence that go beyond the period of the imposed sign restrictions. These findings indicate that for the period covered by this study, limits on loan-to-value achieved their financial stability objectives in Korea in terms of limiting credit and house price appreciation under an inflation-targeting regime. Furthermore, it attained these objectives without posing any threat to its price stability objective. Overall, these findings suggest that limits on loan-to-value have important aggregate consequences despite it being a sectoral, targeted policy instrument.

The Zero Lower Bound and Financial Stability: A New Role for Central Banks?

Are critics’ concerns for bank profitability a justification for the European Central Bank to raise interest rates from the (zero) lower bound (ZLB)? Using a general equilibrium model with banks and collateral default, we analyze optimal monetary and regulatory policy upon departure from the ZLB. Rather than supporting bank profits, higher interest rates depress inflation when higher debt servicing costs increase losses from default. Precisely these losses offset any gains from banks’ interest margin. Monetary policy operates beyond traditional channels, stressing the relevance of Fisherian debt-deflation forces. They warrant incorporating financial stability objectives into central banks’ objective function.

Monetary policy and financial stability: Should central bank lean against the wind?

After the global financial crisis, it was observed that price stability alone would not ensure financial stability. The new paradigm indeed insists on the inclusion of financial stability as an additional macroeconomic objective. In this context, it is essential to understand how exactly is the new objective of financial stability will be placed in the existing framework. Also, the efficacy of monetary policy in this regard needs to be thoroughly discussed. This paper probes into the employability of monetary policy as a tool to achieve financial stability. We, therefore, compare between interest rates obtained from the standard Taylor rule and asset price augmented Taylor rule in the Indian context. The results suggest that targeting asset prices can be one of the effective ways to contain financial instabilities and consequent economic slumps.

Nonperforming loans and competing rules of monetary policy: A statistical identification approach

We assess to what extent decisions taken by the Federal Reserve in setting interest rates can be interpreted in the light of monetary policy rules that are either built on standard objectives of output and price stabilization or based on alternative objectives of financial stability and regulation of the solvency conditions in the economic system. This goal is pursued through a comparison between the “Taylor rule” in its “original” and “augmented” versions, and an alternative “Solvency rule”. We use nonperforming loans as a proxy for the conditions of financial stability and solvency in the system. The empirical investigation is carried out following a structural vector autoregressive approach that exploits a statistical identification procedure. In this way, we are able to identify the causal structure among variables without imposing theoretical restrictions on the model. Our empirical findings provide very limited and incomplete support for the Taylor rule in its various forms while give comprehensive evidence in favor of the alternative Solvency rule.

The Real Effects of Loan-To-Value Limits: Empirical Evidence from Korea

This study adds to a recent and growing literature that assesses the effects of macroprudential policy. We compare the effects of monetary policy and loan-to-value ratio shocks for Korea, an inflation targeting economy and an active user of loan-to-value limits. We identify shocks using sign-restricted structural VARs and rely on a recent approach within this method to conduct structural inference. This study finds that both monetary policy and loan-to-value ratio shocks have effects on different measures of credit, i.e., real bank credit, real total credit and real household credit. We also find that both shocks have non-negligible effects on real house prices, including effects on real output, real consumption and real investment. We do, however, find that loan-to-value ratio shocks have negligible effects on the price level. These findings indicate that for the period covered by this study, limits on loan-to-value achieved their financial stability objectives in Korea in terms of limiting credit and house price appreciation under an inflation targeting regime. Furthermore, it attained these objectives without posing any threat to its price stability objective. Overall, these findings suggest that limits on loan-to-value have important aggregate consequences despite it being a sectoral, targeted policy instrument.