In this paper, we present a hybrid Agent-Based Stock-Flow-Consistent (AB-SFC) model about the macroeconomic and distributional implications of central bank’s decision to leave a “Low(-for-long) ...Interest Rate Environment” (LIRE). Our goal is to study the non-linear effects of monetary tightening when implemented under LIRE than in an alternative “Higher Interest Rate” setting (HIRE). This way, we shed light over the interaction between monetary policy, inequality, and macro-financial fragility in a financialized economy characterized by the presence of securitization and the production of complex financial products, i.e., Asset-Backed Securities (ABSs). We obtain three main findings. First, consistent with existing empirical literature, LIRE may be sources of vulnerabilities in the financial industry (i.e., lower banks’ profitability and capital adequacy ratio). However, it may reduce systemic macro-financial risk by stimulating faster growth, lower unemployment and inequality records alongside with lower public and private indebtedness and lower-scale securitization. Second, central bank’s decision to raise interest rates improves financial sector’s performance indicators at the costs of harsh real-side consequences, i.e., permanently higher unemployment and inequality, when implemented under LIRE. Third, financialization structurally changes the functioning of the economy by feeding the creation of a debt-led economy in which monetary policy becomes less effective in its attempt of controlling inflation. Central bank’s reaction in the form of a permanently tighter monetary policy stance eventually prompts a more unequal and unstable rentier-friendly economy.
•We study central bank’s decision to leave a Low Interest Rate Environment (LIRE).•We show how leaving LIRE causes permanent employment losses and higher inequality.•We show how securitization reduces the effectiveness of monetary policy.•We show how securitization may give rise to a rentier-friendly economy.
•We highlight equilibrium multiplicity in monetary economies subject to a zero bound.•With endogenous propagation, depressed current conditions must lower expectations of future conditions.•A ...recession followed by convergence back to steady state may then be an equilibrium outcome.•Expansionary fiscal policy makes the recession more severe at the margin.•A commitment to a sufficiently large expansion can rule out multiplicity.
We highlight an overlooked source of equilibrium multiplicity in monetary economies subject to a zero bound on nominal interest rates. In environments with sufficient endogenous propagation, depressed contemporary economic conditions must directly lower expectations of future output and inflation. A current recession followed by gradual convergence back to steady state may then be an equilibrium outcome, without any exogenous impulse. We present this mechanism heuristically in partial equilibrium, and in two computed examples of New Keynesian economies. Expansionary fiscal policy makes the recessionary equilibrium more severe at the margin, but commitment to a sufficiently large expansion can rule out multiplicity.
A feature of the financial crisis rarely mentioned in the academic literature is that afterwards forward interest rates remained persistently higher than future spot rates. Yet, according to the ...expectations hypothesis, forward interest rates are unbiased predictors of future spot rates. More general theories attribute the forecast errors to term premia. This paper examines whether these theories can explain data for the US that spans the financial crisis and whether alternative approaches provide better forecasts. The main findings are that before the financial crisis the theory of forward rates emanating from the term structure is not rejected and implies term premia of the order of one and a half percentage points After the financial crisis this theory is rejected. An alternative interpretation of forward deviations following the crisis is that they are forecast errors due mainly to monetary policy.
We utilize a fundamentals-based component volatility model to forecast the short-run volatility of exchange rate changes using monetary fundamentals quoted at different frequencies. Specifically, we ...allow the component volatility model to distinguish short-run exchange rate fluctuations from long-run movements that are directly linked to monetary fundamentals. Relative to more traditional time series volatility models, we find significant improvements in the ability to forecast the daily volatility of exchange rate changes by incorporating the monthly monetary fundamentals’ volatilities as predictors into the component volatility model. In the utility-based comparisons, we find that an investor is willing to pay a positive annual management fee of 5.72% on average to switch from the benchmark model to the fundamentals-based models. Of these models, the model with the symmetric and homogeneous Taylor rule and interest rate smoothing obtains the highest positive annual management fee.
A goal of this paper is to make sense of the seemingly puzzling behavior of interest rates and inflation – and the role of central banks in that behavior – during and after the Great Recession, ...particularly in the United States. To this end, we construct a model in which government debt plays a key role in exchange, and can bear a liquidity premium. If asset market constraints bind, then there need not be deflation under an indefinite zero interest rate policy (ZIRP). Further, ZIRP may not be optimal under these circumstances. A Taylor-rule central banker could be subject to a ZIRP trap and persistently undershoot target inflation. As well, a liquidity premium on government debt creates additional Taylor rule perils, because of a persistently low real interest rate. We make a case that this is the key policy predicament currently faced by many central banks in the world.
•A goal of this paper is to make sense of the seemingly puzzling behavior of interest rates and inflation.•If asset market constraints bind, then there need not be deflation under an indefinite zero interest rate policy (ZIRP).•ZIRP may not be optimal under these circumstances. A Taylor-rule central banker could be subject to a ZIRP trap.•A liquidity premium on government debt creates additional Taylor rule perils.•We make a case that this is the key policy predicament currently faced by many central banks in the world.
This paper discusses the application of techniques of business analytics in the banking industry examining stress tests in the context of financial risk management. We focus on the use of neural ...networks in combination with techniques of cointegration analysis to map swap rate projections derived from given scenarios (e.g., a certain stress scenario from the EBA/ECB 2016 EU-wide stress test) on other relevant interest rates in order to ensure that contingent projections for these time series are produced and used in the process of stress testing.
In theory, the cornerstones of Islamic finance are interest avoidance and risk-sharing. In practice, however, Islamic banks seem to be lacking both, particularly the latter. We investigate the ...interest rate impact on Islamic banks' three most-widely used types of financing instruments – i.e. sale-based, lease-based and risk-sharing – by employing the system GMM estimators on a unique panel data set of 77 Islamic banks from 13 countries over the period 2003–2017. We find that sale- and lease-based financing instruments are negatively correlated with the interest rate and that their exposure is amplified in more developed Islamic banking jurisdictions. Risk-sharing instruments, however, appear to be out of the interest rate domain of influence except in less developed Islamic banking jurisdictions, where the impact is positive. Additionally, the above effects on sale-based and risk-sharing instruments hold true only in the case of full-fledged Islamic banks and Islamic bank subsidiaries, respectively; the impact on lease-based instruments hold under all specifications. The findings imply that predominant use of sale- and lease-based financing instruments in their current form undermines the interest-free and risk-sharing essence of Islamic banking and runs the risk of converging with its conventional counterpart.
•Islamic banks’ financing is predominantly sale- and lease-based•Sale- and lease-based financing instruments of Islamic banks are negatively affected by interest rates•The above effects appear to be amplified in more developed Islamic banking jurisdictions•Risk-sharing financing appears to be free from interest rate influence only in more developed Islamic banking jurisdictions.•Full-fledged Islamic banks appear to be more susceptible to interest rate risk than Islamic bank subsidiaries.
Currency carry trades and global funding risk Filipe, Sara Ferreira; Nissinen, Juuso; Suominen, Matti
Journal of banking & finance,
April 2023, 2023-04-00, Letnik:
149
Journal Article
Recenzirano
We measure funding constraints in currency markets by deviations in the covered interest rate parity and funding risk by the standard deviation of the magnitude of the funding constraints. ...Empirically, funding risk is driven by financial sector conditions in the low interest rate countries, oil price, and the actions of the main central banks. Since 2008, funding risk has affected currency carry trading activity, carry trade returns, correlation between carry trade long and short currencies, relative equity returns, and the economic growth in the carry trade long and short countries. We develop a theory of currency markets under funding constraints to explain the phenomena. The model has additional testable implications: For instance, as funding constraints start to bind, it predicts that both the investment and the funding currencies crash relative to a safe asset. This result is observable empirically when we use gold to proxy for the safe asset.
We develop a behavioral DSGE model which addresses the forward guidance puzzle. We then use the estimated model to assess if unconventional monetary policy tools such as negative interest rates, ...forward guidance, and asset purchases can provide efficient macroeconomic stabilization in a low nominal and real interest rate environment. While these tools boost output and inflation, the rebound from deep recession can still be painfully slow. Makeup strategies, including average inflation and price level targeting, can further support recovery and reduce downside risks, though the benefits are quite modest under behavioral expectations.
We study the effects of positive steady-state inflation in New Keynesian models subject to the zero bound on interest rates. We derive the utility-based welfare loss function taking into account the ...effects of positive steady-state inflation and solve for the optimal level of inflation in the model. For plausible calibrations with costly but infrequent episodes at the zero lower bound, the optimal inflation rate is low, typically <2% even after considering a variety of extensions, including optimal stabilization policy, price indexation, endogenous and state-dependent price stickiness, capital formation, model uncertainty, and downward nominal wage rigidities. On the normative side, price-level targeting delivers large welfare gains and a very low optimal inflation rate consistent with price stability. These results suggest that raising the inflation target is too blunt an instrument to efficiently reduce the severe costs of zero bound episodes.
PDF
