Path Of Monetary Policy Research Articles

Turnover in EU Monetary Policy in a Crisis

Abstract The role of monetary policy has become increasingly important in recent years, as a range of economic challenges have emerged, affecting both developing and economically advanced countries. The aim of this article is to examine the shift in the monetary policy of the EU, which has been expressed through changes in the tools used by the European Central Bank (ECB), and to consider the causes and economic implications of this shift. The descriptive analytical method was used to achieve this goal. The study identified that the aim of the ECB’s interest rate increases was primarily to slow down core inflation rates. The ECB has raised the refinancing rate from 0.5% to 2.5% in 2022 and halted asset purchase programs, such as the Pandemic Emergency Purchase Programme, which had previously stimulated liquidity growth. Despite these changes, forward guidance has been maintained as a useful tool for providing clarity and certainty to financial markets and the public about the future path of monetary policy. It is concluded in the study that the impact of the shift towards contractionary monetary policy is likely to be felt across a range of economic sectors, with higher borrowing costs potentially leading to reduced investment and lower levels of economic growth.

Pandemic meltdown and economic recovery – A multi-phase dynamic model, empirics, and policy

In this paper a two-phase pandemic-economic model is proposed, with phase-specific modeling and policy variables – as suggested by the chronicle of pandemic and economic policy developments over the period 2020–2021. In a first phase, the spread of a pandemic disease is the primary concern of authorities, that still also pay attention to economic activity. A dynamic model is introduced, embedding a two-way interaction between an extended epidemic Susceptible-Infected-Recovered (SIR) model and output gap dynamics. In the second phase, posterior to lockdowns when waves fade away, monetary policy becomes the control variable, pursuing again a joint objective, of supporting a non-inflationary recovery without causing significant fatalities. We then use a standard stylized model for the macroeconomy with simplified infection dynamics, that also enter the policy objective. The two phases are thus studied in a regime change model where the control and state variables as well as the objective function are allowed to change across phases. We solve the model over a finite horizon and derive the optimal lockdown or monetary policy path that jointly minimizes pandemic and economic losses. The two-phase finite horizon decision model is empirically calibrated and numerically solved by discretization and optimization methods. In the first phase, albeit with lasting adverse effects on output, lockdown-based control can be effective in reducing infection rates, but less so when starting from a negative output gap. In the second phase, accommodative monetary policy appears to be effective on both fronts, with even an eventual need for a return to tightening as output gap closes and inflation resumes.

The macroeconomic effect of COVID-induced economic policy uncertainty in Nigeria: a DSGE approach

PurposeThis study examined the macroeconomic effects of COVID-19-induced economic policy uncertainty (EPU) in Nigeria. The study considered the effects of three related shocks: EPU, COVID-19 and correlated economic policy uncertainty and COVID-19 shock.Design/methodology/approachFirst, the study presented VAR evidence that fiscal and monetary policy uncertainty depresses real output. Thereafter, a nonlinear DSGE model with second-moment fiscal and monetary policy shocks was solved using the third-order Taylor approximation method.FindingsThe authors found that EPU shock is negligible and expansionary. By contrast, COVID-19 shocks have strong contractionary effects on the economy. The combined shocks capturing the COVID-19-induced EPU shock were ultimately recessionary after an initial expansionary effect. The implication is that the COVID-19 pandemic-induced EPU adversely impacted macroeconomic outcomes in Nigeria in a non-trivial manner.Practical implicationsThe result shows the importance of policies to cushion the effect of uncertain fiscal and monetary policy path in the aftermath of COVID-19.Originality/valueThe originality of the paper lies in examining the impact of COVID-19 induced EPU in the context of a developing economy using the DSGE methodology.

New approach of the Fed to the implementation of monetary policy

The focus of the article — current framework of implementation of monetary policy by the Federal Reserve System (the Fed), which is substantially different from the framework used before the crisis of 2007–2009. The contemporary regime was evolving gradually and for some time the Fed discussed two possible alternatives — return to the previously used regime or remain in the framework, formed after the crisis of 2007–2009. It took about 10 years for the Fed to decide: to conduct monetary policy in the "ample reserves" regime in which control over the short-term rates is exercised through the setting of administered rates, avoiding the need to actively manage the supply of reserves. In the article we discuss the similarities and differences between regimes with limited and ample-reserves, and the effectiveness of new regime during the pandemic crisis. Since the selected monetary policy implementation framework does not rely on precise adjustments of the supply of reserves to control short-term interest rates, the shift to operating at historically maximum reserve levels resulting from large-scale asset purchases during 2020–2021 was smooth, and the effective federal funds rate and other rates remained relatively stable in this period. We also consider the peculiarities of the use of standard and unconventional monetary policy tools during the COVID-19 pandemic, the reasons for introducing in 2021 the new tools and facilities of the Fed, and possible path of monetary policy in the conditions of growing infl ation and the removal of the current level of accommodation in 2022.

Going Dutch: monetary policy in the Netherlands during the interwar gold standard, 1925–1936

Our study of the day-to-day management of monetary policy in the Netherlands between 1925 and 1936 reveals that policy leaders and central bankers were both willing and able to deviate from the monetary policy paths set by other countries, all while remaining firmly within the gold bloc. The Netherlands wielded an independent monetary policy while remaining on gold thanks to its central bank's plentiful gold reserves. Central bankers quelled any speculation against the guilder by exploiting their domestic policy influence and international reputation to restrict capital mobility. However, maintaining pre-war parity until the collapse of the gold standard in September 1936 came at a cost. Our international comparisons and counterfactual analysis suggest that Dutch officials would have avoided a deepening of the Great Depression by leaving gold alongside the UK in 1931.

What drives updates of inflation expectations? A Bayesian VAR analysis for the G‐7 countries

AbstractInflation expectations play a crucial role for monetary policy transmission, having become even more important since the emergence of unconventional monetary policy. Based on survey data provided by Consensus Economics, we assess determinants of professional inflation expectations for the G7 economies, emphasising the role of international spillovers arising from the United States in inflation expectations. We also consider several other determinants of inflation expectation updates such as changes in the path of monetary policy, oil price shocks and changes in uncertainty measures. Based on a Bayesian VAR, we find significant evidence of international spillovers stemming from expectations about US monetary policy based on impulse‐response functions and forecast error decompositions. We provide similar evidence on spillovers from the dispersion across inflation forecasts, too.

ECB language and stock returns – A textual analysis of ECB press conferences

This paper examines the language used by central bank officials in public press conferences and how it influences stock returns in the euro area. By proposing a sentiment mining approach that accounts for grammatical and syntactical cues, a distinction is drawn between (i) the general tone, (ii) uncertainty, and (iii) constraint expressed by ECB officials. The results show that as constraining language is often used to express policy commitment, press conferences with higher fractions of constraining language are associated with positive intraday stock price movements in times of unconventional monetary policy. In addition, we conclude that in times of crises, intraday returns are more sensitive towards the general tone of ECB officials as market participants may find it harder to grasp the future path of monetary policy. In further analyses, a distinction is made between sections within the press conferences that specifically address either the monetary analysis or the economic outlook. The results indicate that market participants interpret uncertain language in the economic outlook as a signal of expansive monetary policy decisions going forward as indicated by positive intraday stock returns. Finally, by proposing a novel rule-based approach to identify forward-looking statements of ECB press conferences, first evidence is provided in this paper that forward-looking answers given by ECB officials in the Q&A Sessions significantly affect euro area stock returns.

Effects of Monetary Policy Communication in Emerging Market Economies: Evidence from Malaysia

By conducting a high-frequency event study similar to Gurkaynak et al. (2005), we find that two factors are needed to adequately capture the effects of monetary policy announcements for a non-inflation targeting emerging market economy, Malaysia. These factors are the surprise changes in the policy rate (Overnight Policy Rate, OPR) and the information about the future path of monetary policy. We find that the path factor has a strong influence on long-term government bond yields, corporate bond yields and spreads. Our findings are indicative of the view that monetary policy communication is mostly about revealing information pertaining to the central bank’s assessment of the economic outlook, as opposed to an unconditional binding commitment to follow a specific policy path.

Going Dutch: How the Netherlands Escaped its Golden Fetters, 1925–1936

The interwar gold standard is long thought to have prevented central bankers from running an independent monetary policy, forcing governments to leave this fixed exchange rate system in order to take control over domestic policy. But our study of the day-to-day management of monetary policy in the Netherlands reveals that officials were both willing and able to deviate from the monetary policy paths set by other countries, all while remaining firmly within the gold bloc. The Netherlands could afford to stay on gold thanks to its central bank’s plentiful gold reserves. Additionally, we find that central bankers could quell any speculation against the guilder by exploiting their domestic policy influence and international reputation to restrict capital mobility. However, remaining on gold until September 1936 came at a cost. Our international comparisons and counterfactual simulations suggest that Dutch policymakers could have avoided a deepening the Great Depression by leaving gold alongside the UK in 1931. Our research opens new perspectives on the golden fetters literature, and revises the historiography on Dutch interwar monetary policy, by describing the operationalisation of the gold standard in the 1930s, and quantifying the costs of continued gold standard adherence.

Implied monetary policy extracted from interest rate swaps in Chile

This article describes a methodology that uses interest rate swaps in Chilean Pesos to extract monetary policy paths, as well as their probability, with nodes on future Central Bank meetings. It is concluded that implied policy paths contain term premiums that correlate with the policy cycle. Accordingly, implied paths have consistently overestimated the future path of future interest rates, pricing hikes more often than cuts and underestimating the likelihood of rates becoming more expansionary. Moreover, the level of implied rates has been governed by the front end of the curve, instead of expectations of the economic cycle. The result is that extracting implied rates from the swap curve is an ineffective tool for forecasting, and that the swap curve has not been able to anticipate changes in policy. These findings provide insights on the asymmetrical risk profile of future monetary policy and may contribute to the design of hedging strategies

ECB Language and Stock Returns – A Textual Analysis of ECB Press Conferences

We examine how the language used by central bank officials in public press conferences influences stock returns in the euro area. In line with the concept of Odyssean Forward Guidance, we find that using constraining language to express policy commitment increases the effectiveness of Forward Guidance in times of unconventional monetary policy. In further analysis, we provide strong evidence that market participants interpret higher levels of uncertain language in the economic outlook as a sign of Delphic Forward Guidance, indicated by positive intraday stock returns. In addition, we find that in a period of high economic uncertainty, tone sensitivities of financial market participants increase as they find it hard to grasp the future path of monetary policy. Finally, by proposing a novel rule-based approach to identify forward-looking statements of ECB press conferences, we provide first evidence that forward-looking statements in the answers given by ECB officials in the Q&A Sessions significantly affect Euro area stock returns.

Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates

Using a unique data set of individual professional forecasts, we document disagreement about the future path of monetary policy, particularly at longer horizons. The stark differences in short rate forecasts imply strong disagreement about the risk-return trade-off of longer-term bonds. Longer-horizon short rate disagreement co-moves with term premiums. We estimate an affine term structure model in which investors hold heterogeneous beliefs about the long-run level of rates. Our model fits U.S. Treasury yields and the short rate paths predicted by different groups of professional forecasters very well. About one-third of the variation in term premiums is driven by short rate disagreement.

Central bank hawks unlikely to gain the ascendancy

▀ Although further financial market weakness could delay or scale back central bank tightening this year, the waters are being muddied by the perception that underlying inflation pressures are building and that past exceptional measures to counter downside risks may no longer be needed. On balance, we think that it is more likely that central banks will push back, rather than bring forward, rate hikes, especially if the recent oil price weakness persists. ▀ The most crucial issues for the path of monetary policy are likely to be the outlook for inflation and the risks to growth prospects. While there may be grounds to reverse past ‘insurance’ cuts in interest rates, only a slow pace of normalisation is justified at present, in our view. In Europe in particular, sustained lowflation remains a risk. ▀ Central banks may develop a taste for raising rates if they perceive the neutral interest rate to be trending up. There may also be a desire to normalise policy to create space for future loosening, but this will only affect policy at the margin. Meanwhile, although problems such as banking troubles and the zombification of firms are often blamed on low interest rates, they are probably more a symptom of low growth and other more structural issues. Raising interest rates is unlikely to resolve these problems. ▀ At the margin, central bank behaviour may become less dovish. However, with the global economy slowing and some recession warning indicators flashing amber, the wings of the hawks will likely remain clipped.

Network Effects of Monetary Policy: Evidence from Global Value Chains

The paper investigates whether production networks are an important channel for the propagation of monetary policy shocks to the stock market in the Euro-area. To do so, it exploits a new comprehensive dataset on a time-series of input-output connections between European country-industries matched with sector-level stock market data. This dataset allows me to distinguish the distribution of the output of industries over 473 user categories (418 intermediate industries and 55 final customers) across 11 Eurozone countries. Monetary policy shocks are identified along two dimensions: one related to the current level of short-term rates (target) and a second related to expectations about the future path of monetary policy (path). First, using an event-study approach around ECB Monetary Policy Announcement dates and novel tools from spatial econometrics, this is the first paper to show that between 40% and 50% of the overall European stock market reaction is due to higher-order network effects. Second, the paper investigates the link between the network structure and the transmission of monetary policy. Industries located in the periphery of the production network react the most to policy shocks, whereas central industries are most influential and serve as an amplification mechanism for the propagation of shocks. Finally, the paper considers the effect of network connections outside of the Euro-area and finds that the response to monetary policy shocks is considerably mitigated for industries located centrally in the global production network.

Central Bank Communication in the XXI Century: A Survey of Theory and Evidence

After the recent global financial crisis, central banks in advanced and developing economies found themselves unable to stick to their mandate goal of price stability by resorting to traditional instruments of monetary policy. When key interest rates approached the zero bound, the need to develop a new toolkit of liquidity provision arose. Central banks embarked on numerous non-standard monetary policy measures aimed at ensuring financial stability and restoring economic growth. Communication has become an effective auxiliary instrument of economic policy, and markets started paying precise attention to the way central bankers report information regarding the future path of monetary policy. The purpose of this paper is to provide an overview of recent trends and developments in central bank communication strategies. By resorting to the existing literature, we analyze the origins of central bank communication and the evolution of its role in time. We also study the main instruments of communication strategies of large central banks. In the final part of the study, we investigate the communication strategy of the US Federal Reserve and the way it may cause spillovers to fragile markets abroad. We outline at least three major channels of international policy transmission: through stocks, bonds and exchange rates fluctuations.

Normalization of Monetary Policy After Global Crisis: What is Normalization?

Global financial crisis was not only created a chaos but also changed the contemporary monetary policy. The global economy faced with a shift on policy tools because by starting the liquidity trap that American economy faced forced the authorities to find new strategies. Policy makers have started to consider financial stability with price stability and to reshape monetary policy they created new policy tools. The descried tools for new exit ways of powerful central banks especially Fed, helped to overcome the global crisis while bringing new issues. Under the circumstances Fed started a normalization process for monetary policy. Due to the gravity of Fed, other central banks had to adopt the current stream. In this conjuncture Central Bank of the Republic of Turkey has changed the policy tools correspondingly. The purpose of this paper is to evaluate the change in the monetary policy path of Fed and ECB with the behavioral pattern of Central Bank of the Republic of Turkey with “New Normalization” concept.

MONETARY POLICY BEFORE AND AFTER THE FINANCIAL CRISIS. EVIDENCE FROM INFLATION TARGETING COUNTRIES IN CENTRAL AND EASTERN EUROPE

The aim of our study is to review the monetary framework and instruments adopted by the inflation-targeting countries in Central and Eastern Europe, from 2005-ownwards. We employ a qualitative approach and develop a comparative analysis of the changes that occurred in the conduct of monetary policy after the 2008 financial crisis. The results highlight that the central banks in our sample have adjusted their policy in order to counteract the effects of the financial crisis and adopt different instruments to fulfill this aim. The contribution of our study is twofold. First, we offer a review of the literature regarding the adjustments in the monetary policy after the crisis and their effectiveness. Second, we make a comparative analysis between countries with respect to the path of monetary policy from conventional to unconventional and assess the (potential) way back.

Securitization and financial markets: the implications for interest rate pass-through

PurposeThe transmission of monetary policy rates to lending rates is viewed as a crucial path of monetary policy. As an integral part of the financial system and the recent financial crisis, securitized assets have the potential to affect the interest rate pass-through process and monetary policy effectiveness. This paper aims to investigate the influence of securitization on the transmission of policy rate changes to lending rates and how rate transmission has changed since the recent financial crisis. Emphasis is placed on differences among the mortgage, consumer credit and business loan securitization markets and between agency and private-label securitization transactions.Design/methodology/approachThe empirical framework is an error-correction model augmented to directly measure the influence of securitization. Monetary policy effectiveness is measured by the size and speed of transmitted policy rate changes to lending rates. An efficiency measure of relative adjustment accounts for differences in the size of long-run responses across loan markets and changes in efficiency from securitization within loan markets.FindingsThe size and speed of interest rate pass-through tend to increase with securitization. Liquidity, capital relief and funding from securitization help to make lending rates more responsive. Increases in pass-through with securitization are less in the consumer credit and business loan markets after the recent financial crisis relative to before the crisis. In contrast, mortgage markets tend to have larger pass-through after the financial crisis. Differences in rate transmission after the recent financial crisis point to the role on nonbanks in consumer credit and business loans and asset purchase programs of the Federal Reserve in mortgage markets. Securitization tends to make the adjustment process more efficient, and gains in efficiency from securitization are larger after the financial crisis.Originality/valueA key contribution of the study differentiates securitization across markets and types to determine the effects on the interest rate pass-through process. The results show that increases in the efficiency of the adjustment process from securitization tend to be greater in mortgage markets and for all private-label securitized assets. These findings have implications for proposed government-sponsored entity (GSE) reform to reduce the role of GSEs in the housing market, promote private-label mortgage credit and strengthen securitization deals.

Mutual Fund Flows, Monetary Policy and Financial Stability

We study the links between monetary policy and mutual fund flows, and the potential risks to financial stability that might arise from such flows, using data over the 2000-14 period. We find that monetary policy can have a direct influence on the allocation decisions of mutual fund investors. In particular, we show that monetary policy shocks explain mutual fund flow dynamics and that the effect of these shocks differs by investment strategy. Results suggest that positive shocks to the path of monetary policy (unexpected tightening) are associated with persistent outflows from bond mutual funds. Conversely, a tighter-than-expected monetary policy path will cause net inflows into equity funds. In an industry that "mutualizes" redemption costs and where many funds may engage in liquidity transformation, our flow-performance analysis provides evidence of the potential existence of a first-mover advantage in less liquid segments of the market.

Monetary policy evaluation. A counterfactual analysis based on dynamic factor models

ABSTRACTThis article complements the recent literature analysing the effects of the unconventional monetary stimuli applied after the Great Recession by proposing an intuitive and easy-to-implement method to evaluate different exit strategies towards a traditional monetary context. This approach, useful for central bankers or researchers interested in the effects of tapering, allows us to evaluate the consequences of a given monetary policy path on the future evolution of key macroeconomic indicators. The results based on this methodology provide a measurement of the differences in economic performance under contractionary and expansionary policies and support the recent success of monetary stimuli in boosting real indicators while having little effect on inflation.