FISCAL POLICY AND LENDING RELATIONSHIPS

This paper studies how fiscal policy affects loan market conditions in the United States. First, it conducts a structural vector‐autoregression analysis showing that the bank spread responds negatively to an expansionary government spending shock, while lending increases. Second, it illustrates that these results are mimicked by a dynamic stochastic general equilibrium model where the bank spread is endogenized via the inclusion of a banking sector exploiting lending relationships. Third, it shows that lending relationships represent a friction that generates a financial accelerator effect in the transmission of the fiscal shock. (JEL E44, E62)     

ECONOMIES OF SCALE IN BANKING,INDETERMINACY, AND MONETARY POLICY

This paper investigates economies of scale (ES) in financial intermediation as a source of equilibrium indeterminacy. Financial intermediation is embedded into a standard flexible‐price monetary model, and provides deposits (inside money) that substitute with currency to purchase consumption. The results indicate that equilibrium indeterminacy does not depend on a large degree of ES in intermediation nor a large intermediation sector, but on monetary policy and the determination of nominal interest rates. Monetary policies not targeting nominal rates allow for indeterminacy to arise for any positive degree of ES, while policies targeting nominal rates eliminate indeterminacy for all degrees of ES. (JEL C62, E44, E52)     

MONETARY POLICY AND ANTI‐CYCLICAL BANK CAPITAL REGULATION

The financial crisis of 2008–2009 revived attention given to booms and busts in bank credit, and their effects on real activity. This interest sparked two different strands of research in macro. The first one focuses on monetary policy in the context of financial frictions. The second studies capital regulation in banking. To the best of our knowledge, so far these two topics have mostly been studied in isolation from each other. Thus, we still lack an understanding of how monetary policy and bank capital regulation interact in the presence of financial fragility. This paper aims to contribute to furthering this understanding. Specifically, we ask how the monetary policy rule should look like in the presence of cyclical capital requirements. We extend the dynamic stochastic general equilibrium model with bank capital in Aliaga‐Díaz and Olivero by introducing price rigidities in the spirit of the New‐Keynesian literature. We find that: First, anti‐cyclical requirements have important stabilization properties relative to the case of constant requirements. This is true for all types of fluctuations that we study, which include those caused by productivity, preference, fiscal, monetary, and financial shocks. Second, output and consumption volatilities present in the no regulation economy can be recovered with anti‐cyclical requirements as long as the policy rate responds only slightly to credit spreads. Third, monetary policy rules that respond to credit conditions also perform better in terms of welfare. (JEL E32, E44)     

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)     

THE IMPACT OF RETURN ON COLLATERAL IN A CHANNEL SYSTEM

We empirically investigate the relationship between the return on collateral and monetary policy implementation in the channel system. Recent developments in monetary theory suggest that the return on government assets which measures the opportunity cost of holding collateral should have negative impacts on the interest-rate spread and the interbank market rate. The central bank should set a higher spread when the return on collateral is below a cutoff but implements a lower spread when the return on collateral is higher than the cutoff. The interbank market rate tends to lie above the policy target rate when the return on collateral is low and vice versa. We use data from Eurozone area and six industrialized countries to test these theoretical implications. We propose two econometric models: one is more structural and closely related to the monetary model to test the negative relationships, and the other is based on the threshold autoregression model to detect the potential cutoffs. Our findings provide conditional support for the negative impact of return on collateral. (JEL E40, E52, E58)     

INTRODUCTION TO THE SYMPOSIUM ON CONTEMPORARY BANKING RESEARCH: THE USE OF FIXED EFFECTS TO DISENTANGLE LOAN DEMAND FROM LOAN SUPPLY

With the onset of the financial crisis, disentangling the effects of loan demand and supply in contemporary banking research has become vital for a proper assessment of supply-related banking shocks. These shocks may negatively affect the real economy through many channels, such as the lending channel of monetary policy transmission, the bank risk-taking channel or the evaluation of macroprudential policy efficiency. All these rely on separating the two lending components. Empirical identification has largely relied on the use of demand-related fixed effects, which has also been applied in several analyses within this symposium. (JEL G21)     

STRUCTURAL ESTIMATION OF THE OUTPUT GAP: A BAYESIAN DSGE APPROACH

We estimate the output gap that is consistent with a standard New Keynesian dynamic stochastic general equilibrium (DSGE) model, where the output gap is defined as a deviation of output from its flexible‐price equilibrium, using Bayesian methods. Our output gap illustrates the U.S. business cycles well, compared with other estimates. We find that the main source of the output gap movements is the demand shocks, but that the productivity shocks contributed to the stable output gap in the late 1990s. The robustness analysis shows that the estimated output gap is sensitive to the specification for monetary policy rules. (JEL E30, E32, C11)     

LEANING AGAINST WINDY BANK LENDING

Using an estimated dynamic stochastic general equilibrium model with banking, this paper first provides evidence that monetary policy reacted to bank loan growth in the United States during the Great Moderation. It then shows that the optimized simple interest‐rate rule features no response to the growth of bank credit. However, the welfare loss associated to the empirical responsiveness is small. The sources of business cycle fluctuations are crucial in determining whether a “leaning‐against‐the‐wind” policy is optimal or not. In fact, the predominant role of supply shocks in the model gives rise to a trade‐off between inflation and financial stabilization. (JEL E32, E44, E52)     

FOREIGN BANKS AND THE BANK LENDING CHANNEL

We provide new evidence on bank ownership and transmission of monetary policy using bank‐level data on 453 banks in Central and Eastern European economies between 1998 and 2012. Only domestic banks adjust loans to changes in monetary policy, while foreign banks do not. Conventional wisdom says that this is because foreign banks can rely on parent banks' funding to insulate against monetary policy shocks. In this paper we document an alternative explanation. Deposits in foreign banks do not react to monetary policy, hence the bank lending channel is only triggered in domestic banks. (JEL E50, F36, G21)     

A MONETARY BUSINESS CYCLE MODEL FOR INDIA

A New Keynesian monetary business cycle model is constructed to study why monetary transmission in India is weak. Our models feature banking and financial sector frictions as well as an informal sector. The predominant channel of monetary transmission is a credit channel. Our main finding is that base money shocks have a larger and more persistent effect on output than an interest rate shock, as in the data. The presence of an informal sector hinders monetary transmission. Contrary to the consensus view, financial repression in the form of a statutory liquidity ratio and administered interest rates, does not weaken monetary transmission. (JEL E31, E32, E44, E52, E63)     

FINANCIAL MARKET VARIABLES DO NOT PREDICT REAL ACTIVITY

The past decade has seen an extensive empirical reassessment of the information content of financial market variables sensitive to monetary policy. Particularly provocative are recent papers suggesting that some interest rates and interest rate spreads contain more information about economic activity than monetary aggregates. This paper reviews important methodological pitfalls in these studies. We then show that none of the commonly employed measures of monetary policy contain incremental information useful in forecasting real economic activity. Two conclusions are possible. Either monetary policy innovations have no significant real effects, or we (collectively) have failed in our efforts to measure monetary policy. ( JEL E52)     

CONSUMER CREDIT,LIQUIDITY, AND THE TRANSMISSION MECHANISM OF MONETARY POLICY

That the lending channel is alive and well for consumer lending is at first glance a compelling notion given the growth in consumer credit. However, this paper demonstrates with disaggregated monthly consumer credit data that the consumer loan‐supply effect has diminished over time. Contrary to assumptions motivating the lending channel, after the mid‐1980s, households are not constrained in accessing nonrevolving or revolving bank loans in response to a monetary shock. The findings of this paper have important implications for research on the monetary transmission mechanism beyond the lending channel and for business cycle research in general. (JEL E44, E50, E60, C32)     

OPTIMAL MONETARY POLICY AND IMPERFECT FINANCIAL MARKETS: A CASE FOR NEGATIVE NOMINAL INTEREST RATES?

This article studies optimal monetary policy in a model with credit frictions and money demand. We show that augmenting a standard New Keynesian model with money demand and financial frictions generates a mechanism that, in equilibrium, gives rise to optimal negative nominal interest rates. In addition, we find that the tighter credit markets are, the lower the optimal nominal policy interest rate and the more likely it is to be negative. Quantitatively, when credit constraints are binding, a standard calibration of the model generates an optimal nominal policy interest rate that is roughly ?4% annually. (JEL E31, E41, E43, E44, E52, E58)     

THE CYCLICALITY OF PRICE‐COST MARGINS IN BANKING: AN EMPIRICAL ANALYSIS OF ITS DETERMINANTS

We study the determinants of the cyclical behavior of banks' price‐cost margins in the United States banking sector, using time series quarterly data for the period 1979–2005. We contribute to the literature by building an empirical model of the countercyclical behavior of these margins first documented by Aliaga‐Díaz and Olivero (2010a) . Doing so we are able to explore potential explanations for this behavior, and to show that margins are consistently countercyclical, even after controlling for the effects of credit risk and monetary policy. As a mechanism for the propagation of aggregate shocks, the countercyclical nature of margins in banking can provide additional support to stabilization policy. (JEL E32, E44, G21)     

BETWEEN SCYLLA AND CHARYBDIS: INCOME DISTRIBUTION,CONSUMER CREDIT,AND BUSINESS CYCLES

We introduce a macroeconomic model with heterogeneous households and an aggregate banking sector in order to analyze the impact of rising income inequality under different credit scenarios. Growing inequality produces debt‐led consumption boom dynamics when the banking sector is characterized by a lower capital requirement and a higher willingness to lend. Instead, when inequality rises but the banking sector is highly regulated, aggregate demand and output fall. Our results also yield new insights on the appropriate fiscal policy reaction to stabilize the economy: acting on the progressivity of the tax system seems more effective than a proactive countercyclical fiscal policy. (JEL C63, D31, E62, G01)     

LIMITED ASSET MARKET PARTICIPATION AND THE EURO AREA CRISIS: AN EMPIRICAL DSGE MODEL

We estimate a medium‐scale dynamic stochastic general equilibrium model for the Euro area with limited asset market participation (LAMP). Our results suggest that in the recent European Monetary Union years LAMP is particularly sizable (39% during 1993–2012) and important to understand business cycle features. The Bayes factor and the forecasting performance show that the LAMP model is preferred to its representative household counterpart. In the representative agent model the risk premium shock is the main driver of output volatility in order to match consumption correlation with output. In the LAMP model this role is played by the investment‐specific shock, because non‐Ricardian households introduce a Keynesian multiplier effect and raise the correlation between consumption and investments. We also detect the contractionary role of monetary policy shocks during the post‐2007 years. In this period consumption of non‐Ricardian households fell dramatically, but this outcome might have been avoided by a more aggressive policy stance. (JEL C11, C13, C32, E21, E32, E37)     

MONETARY POLICY AND ENDOWMENT RISK IN A LIMITED PARTICIPATION MODEL

A limited participation model is constructed to study the risk‐sharing role of monetary policy. A fraction of households exchange money for interest‐bearing government nominal bonds in the asset market and the government injects money through open market operations. In equilibrium, money is nonneutral and monetary policy redistributes consumption across households. Without idiosyncratic endowment risk, monetary policy becomes a perfect risk‐sharing tool, but with idiosyncratic endowment risk, it is not. The Friedman rule is not optimal in general. (JEL E4, E5)     

STICKY PRICE AND STICKY INFORMATION PRICE‐SETTING MODELS: WHAT IS THE DIFFERENCE?

Using a partial equilibrium framework, Mankiw and Reis show that a sticky information model can generate a lagged and gradual inflation response after a monetary policy shock, whereas a sticky price model cannot. Our study demonstrates that the finding is sensitive to their model's parameterization. To determine a plausible parameterization, we specify a general equilibrium model with sticky information. In that model, we find that inflation peaks only one period after a monetary disturbance. A sensitivity analysis of our results reveals that the inflation peak is delayed by including real rigidities when the monetary policy instrument is money growth, whereas inflation peaks immediately when the policy instrument is the nominal interest rate. ( JEL E31, E32, E52)     

THE VALUE OF RISK: MEASURING THE SERVICE OUTPUT OF U.S. COMMERCIAL BANKS

Banks often charge implicitly for their services via interest spreads, instead of explicit fees. Much of bank output thus has to be estimated indirectly. In contrast to current statistical practice, dynamic optimizing models of banks argue that compensation for bearing systematic risk is not part of bank output. We apply these models and find that in the U.S. National Accounts between 1997 and 2007, bank output was overestimated by 21% and gross domestic product (GDP) by 0.3%. Compared with current methods, our new estimates imply more plausible estimates of the income share of capital and the return on fixed capital of the banking industry. (JEL E01, E44, O47)     

FISCAL STABILIZATION WITH PARTIAL EXCHANGE RATE PASS‐THROUGH

This article examines the role of fiscal stabilization policy in a two‐country framework that allows for partial exchange rate pass‐through. Analytical solutions for optimal monetary and fiscal policy rules depend on the degree of pass‐through. Each country unilaterally uses its fiscal instrument to stabilize the costs facing exporters. The welfare effects differ strongly depending on the degree of pass‐through. For high levels, both countries are better off with the fiscal instrument and welfare is closer to the benchmark flex‐price level. For low levels, however, the unilateral equilibrium policy rules lead to high volatility in taxes, and fiscal policy ends up being destabilizing by transmitting exchange rate fluctuations. Because these results stem from strategic considerations by the two countries, the fiscal instrument is not used under policy coordination. In addition, imposing a monetary union increases welfare when pass‐through is low, including the case of local currency pricing. (JEL E52, E63, F41, F42)