Monetary Policy Normalization Research Articles

The Unforeseen Results of Unconventional Monetary Dominance

This empirical study investigates the implications of the substantial size of central banks’ balance sheets and the potential risks of their gradual normalization. Following the global financial crisis of 2008, central banks worldwide implemented unprecedented monetary stimulus measures, including large-scale asset purchases and unconventional policy tools like quantitative easing (QE). As a result, central bank balance sheets expanded significantly, reaching historically unprecedented levels in size and composition. While these measures played a crucial role in stabilizing financial markets and supporting economic recovery, concerns have arisen regarding the eventual reduction of these balance sheets and the possibility of disruptive market dynamics. This research examines the challenges and risks of normalizing central bank balance sheets. Furthermore, it explores the potential occurrence of “hard landing” scenarios, where sudden reductions in balance sheets could trigger financial market turmoil and economic downturns. By analyzing historical precedents and theoretical frameworks, this paper offers valuable insights into the intricate relationship between central bank balance sheets and the dynamics of financial markets. It provides policymakers and market participants with valuable perspectives on navigating the path toward monetary policy normalization.

The impact of monetary policy normalisation on secured money markets

Rationale This article offers an empirical analysis of the main factors which explain the variations in the repo-deposit facility rate (DFR) spread in the euro area, focusing on the impact of monetary policy normalisation. The findings suggest that a notable rise in interest rate expectations was the main factor behind the widening of the spread in 2022. In 2023 the slowdown in the pace of interest rate hike expectations and the Eurosystem’s balance sheet reduction returned the spread to the levels prior to the start of the policy rate hiking cycle. Takeaways •The widening of the repo-DFR spread in 2022 arose mainly from interest rate hike expectations. •Other conjunctural factors such as monetary policy uncertainty and the demand for short-term assets also contributed to the widening of the spread. •The temporary tensions seen in this market in 2022 eased in 2023 with lower expectations of interest rate hikes.

Do Financial Markets Allow the Independence of Central Banks?

Abstract The research work presented below addresses the possible concern of central bank independence through the development and application of econometric models. The complexity of the modelling has allowed a step further in corroborating that financial independence is not only linked to the appointments and pressures of the states regarding their economic policy but also the role that financial markets play by acting as a force that dictates and contaminates decisions of central banks. In this sense, the paper proposes a theoretical basis for recommendations on the application of the new monetary policy in a more complex environment, both due to the pandemic that was sweeping the world and the bulky debt that countries are carrying. The paper concludes with a series of measures and suggestions that could be addressed by monetary policymakers given the necessary but not easy normalization of monetary policy required at the global level.

Equity Convexity under Major Monetary Policy Shift

In this article, the authors intend to gain an understanding of the drivers of stock convexity, also known as gamma. First, using a bottom-up—firm-level—approach, they show that stock fundamentals, particularly metrics related to value (captured by the price-to-book ratio) and historical volatility, allow us to efficiently discriminate between convex and concave stocks. Building on this result, they investigate the ties between the gamma premium and traditional risk factors. Second, they adopt a top-down—macroeconomic-driven—framework to understand which economic environment is the most favorable to convexity: They highlight the importance of the short-term interest rate, the VIX, but also oil price dynamics in a univariate cointegrating vector. These variables share long-term relationships. The authors then evaluate the ability of different models to forecast future convexity premium dynamics. Finally, they seek to employ these signals in the design of a systematic long convexity strategy and show that it leads to significantly improved risk-adjusted returns compared with a capitalization-weighted benchmark, especially in turbulent markets. Convexity exposure appears particularly relevant in a context of monetary policy normalization.

Monetary Policy Normalization and Central Bank Profits: A Break-Even Point Perspective

Abstract This paper advances a simple framework explaining how monetary policy normalization (“exit policies”) may impact central bank profits. The cases of seven central banks of major and smaller economies serve as an illustration. The notion of the break-even point is applied to study the financial situation of these institutions for the period of 2014–2021. During the normalization process, interest rate increases may adversely affect profit changes, and through transfers may have an impact on the fiscal space available to the governments, creating political economy concerns. Possible remedies are discussed together with accompanying policy dilemmas.

ПОВОЄННЕ ТАРГЕТУВАННЯ ІНФЛЯЦІЇ: КЛЮЧОВІ ВИКЛИКИ

На період воєнного стану НБУ призупинив таргетування інфляції, але анонсував повернення до нього в найближчий час з усіх можливих моментів. Повоєнна нормалізація монетарної політики в Україні є історично безпрецедентною, оскільки більшість відомих випадків стосується перезапуску грошового обігу і налагодження банківської діяльності, створення центробанку як інституції, що покликана елімінувати макроекономічні передумови внутрішньокраїнних конфліктів. Водночас воєнні конфлікти характеризуються емісійним фінансуванням бюджету, сплеском інфляції і посиленням доларизації, а сеньйораж може бути оптимальною формою компенсації раптової втрати податкових надходжень виключно в обмежених обсягах. Відновлення інфляційного таргетування в Україні наражатиметься на ряд загальних макроекономічних викликів у вигляді: прискорення інфляції, затримки коригування компонентів небазової інфляції, невизначеності щодо обсягів емісійного фінансування дефіциту після припинення воєнного стану; деградації монетарної трансмісії; погіршення інфляційних очікувань та імовірного посилення ефектів перенесення. Однак дані виклики, радше, впливатимуть на таймінг повернення до таргетування інфляції. З технічної точки зору цей процес наражатиметься на проблеми, пов’язані: із специфікацією інфляційної цілі (новий «похилий» коридор, актуалізація старої цілі в різних формах); імовірним оптимальним зниженням її рівня через євроінтеграцію; погіршенням критеріальних значень ВВП-розриву і рівня нейтральної ставки при оцінюванні стану монетарної політики; поновленням процесу нагромадження валютних резервів з відповідним продовженням тенденції до підтримки структурного профіциту ліквідності. Незалежність НБУ відіграватиме ключову роль для нейтралізації проблеми довіри в умовах потенційної альтернативності між швидкістю стабілізації інфляції і акселерацією темпів економічного відновлення.

From One Crisis to Another (2008–2020): A Transformative Decade for the Fed

This article sheds light on the crisis of September 2019 by placing these events in the broader context of monetary policy normalization. It starts by recalling how the operational framework of the Fed evolved since the global financial crisis. Normalization principles, the issues that arose from them and the actual normalization process are then examined. This historical sequence is interesting because it provides insights on (1) the interplay between monetary policy and liquidity regulations and (2) the advantages and limitations of different operational frameworks (corridor vs. floor systems).

Post-pandemic inflation: Phillips curve, trends, drivers and lessons

After several years of very low inflation, the world economy in 2021 and 2022 has been confronted with an abrupt and persistent rise in inflation rates not seen for decades. This paper investigates the main factors behind the surge in consumer price inflation in advanced economies and possible differences across them. It assesses the relative role of excess demand arising from the reopening of economies after the COVID-19 restrictive measures, global value chain and supply-side disruptions, higher energy prices, the “base effect”, and labour market pressures. We find that prices were initially pushed up by the fast world demand recovery combined with global supply disruptions, but eventually, especially since the war in Ukraine, energy prices have become the main driver of increased inflation. Differences in the contribution of the core inflation component across advanced economies, especially between the United States and the rest, reflect differences in output gaps and labour market tightness, while unit labour cost pressures remained muted almost everywhere. Given that inflation is expected to remain elevated for longer than initially anticipated, monetary authorities are expected to become more “conservative” again, defending their credibility. Past experience suggests that, as the economic slowdown becomes inevitable, the short-term costs of a gradual and orderly monetary policy normalisation to activity and employment are probably lower than the potential longer-term costs of a more popular prolonged accommodative policy. The anchoring of inflation expectations is not a free lunch.

Die EZB-Geldpolitik in der Zwickmühle

AbstractIt seems clear that the ECB will raise interest rates in July 2022 and end its asset purchase program. This should send a strong and important signal to markets and economic players that the ECB continues to take its mandate for price stability seriously. However, it cannot be said with absolute certainty that these monetary policy decisions herald the start of a gradual tighter stance toward monetary policy normalisation. This is because economic uncertainty is currently extremely high. The ECB therefore finds itself in a difficult dilemma: It must take decisive action against high inflation, but should retain plenty of flexibility to be able to respond to a renewed crisis.

Interest rate risk and monetary policy normalisation in the euro area

A low interest rate environment is susceptible to sudden increases in policy rates and heightened interest rate risk (IRR). By using a sample of 81 euro area banks during the period 2014Q4-2018Q1 and a confidential supervisory measure of IRR, this paper identifies which bank-specific characteristics can amplify or weaken the impact of a 200 basis points positive shock in interest rates. We find that banks reliant on core deposits, that hold more floating-interest rate loans and that diversify their lending, either by sector or geography, are less exposed to a positive change in interest rates. Interestingly, we discover that banks that did not exploit the exceptional financing provided by the European Central Bank (ECB) reveal greater IRR exposure. These findings advance the debate on the impact of a possible return to a normalised monetary policy on the euro area banking sector.

The Spillover Effects of U.S. Monetary Policy Normalization on the BRICS Based on Panel VAR Model

Using the monthly data from December 2008 to March 2018 and a panel vector autoregression (PVAR) model, this paper empirically analyzes the spillover effects of U.S. monetary policy normalization on the total output, inflation, trade balance, and exchange rates in BRICS. The results show that the Fed’s interest rate hike and balance sheet shrinking will both lead to a decrease in BRICS’ output, a decline in inflation, a deterioration in the trade balance, and a depreciation of the exchange rate. In addition, the spillover effects of the Fed’s interest rate hike and shrinking of a balance sheet are both relatively long lasting, but there is a certain difference between the two effects; that is, the Fed’s interest rate hike has a greater impact on the macroeconomic variables of BRICS countries than the shrinking of balance sheet. Based on the conclusions, we propose to establish and improve the regulatory system of international capital flows, pay close attention to commodity prices, and strengthen policy coordination and communication among BRICS countries so as to mitigate the adverse impact of U.S. monetary policy normalization.

Managing Monetary Policy Normalization

Managing Monetary Policy Normalization

Oil price shock in the US and the euro area – evidence from the shadow rate and the term premium

Abstract The aim of this article is to investigate the consequences of oil price changes for the economy of the US and the euro area. Oil price transmission channel is assessed using Granger causalities and structural vector autoregressive (VAR) specifications (applying the Cholesky factorization and the restrictions following the method of Blanchard and Quah). The conventional oil price transmission channel is extended by a shadow policy rate and term premium, as the importance of both indicators has been growing rapidly in recent years. The results confirm that the oil price shock is not negligible in the aftermath of the Global Financial Crisis and in the subsequent period of monetary policy normalization. The findings are confirmed by the outcomes of the Bayesian VAR specification with sign restrictions. The consequences of changes in oil prices have significantly grown since the introduction of unconventional monetary instruments. The magnitude of the response of industrial production, price level and shadow interest rate to the oil price shock is strongest in the period corresponding to the unconventional monetary policy. In many cases, however, the reaction is short-lived. The conventional instrument (policy rate) in the euro area has still not been sufficient to stabilize the economy in the recent period of monetary policy normalization in the US.

Impact of Uncertainty Created by the Us Post-Qe Monetary Policy on Emerging Economies

This research studies the impact of uncertainty generated by the US monetary policy in the post-quantitative easing period, particularly regarding the timing and pace of policy rate normalization by the Federal Reserve. We are specifically interested in the effects on emerging market economies such as South Korea. By using a news-based uncertainty index to measure the extent of monetary policy uncertainty in the US, we find that unexpected increased uncertainty with respect to the US monetary policy has significant adverse impact on the KRW/USD exchange rate, stock prices, and capital inflow to South Korea, but does not significantly affect the macroeconomic variables of the country, such as output and consumer prices. Therefore, we expect that heightened uncertainty regarding US monetary policy normalization would, at most, have temporary disruptions in financial markets but does not have a large impact on emerging market economies.

It is Only Natural

Estimates of the natural interest rate are often useful in the analysis of monetary and other macroeconomic policies. The topic gathered much attention following the great financial crisis and the Euro Area debt crisis due to the uncertainty regarding the timing of monetary policy normalization and the future path of interest rates. Using a sample of European countries (including several members of the Euro Area), this paper provides estimates of country-specific natural interest rates and some of their drivers between 2000 and 2019. In line with the literature, our findings suggest that natural interest rates declined during this period, and despite a rebound in the last few years of it, they have not recovered to their pre-crisis levels. The paper also discusses the implications of the decline in natural interest rates for monetary conditions and debt sustainability.

Spillover effects of the US monetary policy normalization on African stock markets

PurposeWe study the contemporaneous effects of US monetary policy normalization on African stock market using panel data from six African countries.Design/methodology/approachDaily data from May 1, 2013 to December 31, 2018 were used in order to accommodate the announcement effects since the US monetary policy normalization announcement was made in May 2013, while the rate hike was in December 2015. The study used the FE, RE and PMG models.FindingsThe results revealed that US 10-year bond yield and Treasury bill rate shocks negatively affect stock prices in Africa. S$P500 shock positively affects African stock prices.The result revealed that the integration of African financial market to the global financial market is a major source of vulnerability. The finding that US Treasury bill rate is a major depressant of the African stock prices reveals the short-termism of foreign polio inflows into African economies.Originality/valueWe provide inexorably insight into the interplay of financial systems globally. It can be useful for the purposes of generalization in developing economies in the shape of African countries. More so, this study could be replicated in another economic bloc or region with the aim of further exposing the far-reaching spillover effects of the US monetary policy normalization.

Investigating Financial Performance of Low-and High-Rated ETFs During the QE-Tapering

Abstract This paper investigates the financial performance of 37 low-rated and high-rated global ETFs during QE-Tapering. Weekly data are employed that cover the period from October 27, 2014 until September 24, 2018. The estimations are based on the well-known CAPM model. The measures employed are the Sharpe and Treynor ratios as well as the Jensen’s alpha, the beta and the a/b measures. Results indicate no existence of selectivity skills neither in low- nor in high-rated ETFs. It should be noted that low-rated ETFs exhibit bearish behavior whereas high-rated ones present bullish behavior. Thereby, one can see that high-rated ETFs are better able to outperform the market during periods of normalization of monetary policy after extra easing action taking has been terminated.

THE EFFECTS OF ASSET PURCHASES AND NORMALIZATION OF U.S. MONETARY POLICY

This paper examines changes in the effects of unconventional monetary policies in the United States. To this end, we estimate a Markov‐switching VAR model with absorbing regimes to capture possible structural changes. Our results detect regime changes around the beginning of 2011 and the middle of 2013. Before 2011, the U.S. large‐scale asset purchases (LSAPs) had relatively large impacts on the real economy and prices, but after the middle of 2013, their effects were weaker and less‐persistent. In addition, after the middle of 2013, which includes the monetary policy normalization period, the asset purchase (or balance sheet) shocks had slightly weaker effects than during the early stage of the LSAPs but stronger effects than during the late stage of the LSAPs, while interest rate shocks had insignificant effects on the real economy and prices. Finally, our results suggest that the positive responses of durables and capital goods expenditures to interest rate shocks weakened the negative impacts of interest rate hikes after the middle of 2013 including the period of monetary policy normalization. (JEL C32, E21, E52)

A real time leading economic indicator based on text mining for the Spanish economy. Fractional cointegration VAR and Continuous Wavelet Transform analysis

The main aim of this paper is to build a Real Time Leading Economic Indicator (RT-LEI) that improves Composite Leading Indicators (CLI)’s performance to anticipate GDP trends and turning points for the Spanish economy. The indicator has been constructed using a Factor Analysis and is composed of 21 variables concerning motor vehicle activity, financial activity, real estate activity, economic sentiment, and industrial sector. The data sources used are Google Trends and Thomson Reuters Eikon-Datastream. This work contributes to the literature, studying the dynamics of GDP, CLI and RT-LEI using Fractional Cointegration VAR (FCVAR model) and Continuous Wavelet Transform (CWT) for its resolution. The results show that the model does not present mean reversion and it is expected the RT-LEI reveals a bear trend in the next two years, alike IMF and Consensus FUNCAS′ forecasts. The reasons are mostly associated with escalating global protectionism, uncertainty related to Catalonia and faster monetary policy normalization.

Fiscal Union, Monetary Policy Normalization and Populism in the Eurozone

This article studies the different scenarios for the fiscal union in the Eurozone beyond 2019. It explains the different alternatives that the literature has explored to ensure fiscal transfers within Eurozone states as well as for common debt issuance. It also describes the role that monetary policy has played as a backstop for sovereign defaults and highlights the limits that inflation and an anti-euro backlash impose on public debt sustainability.