Stefano Corradin, Marie Hoerova, Glenn Schepens, 12 February 2021

Euro area money markets have gone through substantial changes and turbulent periods over the past 15 years. These have included the global and euro area sovereign debt crises, new liquidity and leverage requirements, and the expansion of the Eurosystem balance sheet through asset purchase programmes. This column discusses the interaction between money markets, new Basel III regulations, and central bank policies. The analysis shows that money market conditions worsen when financial stress increases, or if central bank asset purchases induce scarcity effects. It outlines implications of changing money market conditions for monetary policy implementation and transmission.

Alina Kristin Bartscher, Moritz Kuhn, Moritz Schularick, Paul Wachtel, 10 February 2021

Racial income and wealth gaps in the US are large and persistent. Central bankers and politicians have recently suggested that monetary policy may be used to reduce these inequalities. This column investigates the distributional effects of monetary policy in a unified framework, linking monetary policy shocks both to earnings and wealth differentials between black and white households. Over multi-year horizons, it finds that while accommodative monetary policy tends to reduce racial unemployment and thus earnings differentials, it exacerbates racial wealth differentials, which implies an important trade-off for policymakers.

Ioana Duca-Radu, Geoff Kenny, Andreas Reuter, 09 February 2021

When interest rates cannot go any lower, the economy can be stabilised if consumers expect the rate of inflation to increase. Yet, the evidence for this stabilising effect has been very mixed. This column presents new evidence from a monthly survey of over 25,000 individual consumers across the euro area, showing that consumers are indeed more ready to spend if they expect inflation to be higher in the future. While generalised in the population, the stabilising effect is stronger when nominal interest rates ­are constrained at the lower bound.

David Baqaee, Emmanuel Farhi, Kunal Sangani, 28 January 2021

Monetary policy has ‘supply-side’ effects – in addition to boosting output by increasing employment, a monetary easing boosts output by increasing aggregate productivity. The link between monetary policy and productivity is absent in standard macro models, but arises if one takes into account realistic firm heterogeneity. This column discusses the supply-side transmission channel and the role it plays in flattening the Phillips curve.

Giancarlo Corsetti, Keith Kuester, Gernot Müller, Sebastian Schmidt, 27 January 2021

Recent evidence suggests flexible exchange rates do not always insulate economies from external shocks. This column provides novel evidence on how shocks that originate in the euro area spill over to its neighbour countries. In response to euro area shocks economic activity in the neighbour countries contracts as much as in the euro area – not only in countries that peg their currency to the euro, but also in those with a flexible exchange rate. It shows that a standard open economy model predicts this lack of insulation for floating exchange rates, provided the central bank targets CPI inflation. 

Lorenzo Forni, Philip Turner, 15 January 2021

Dollar bond issuance by non-US companies has dominated foreign borrowing since the global crisis. In many emerging markets, higher leverage and currency mismatches have increased the risk of corporate insolvencies and created new threats to the balance sheets of local banks. This column documents the financial risks created by these recent trends and outlines the necessary implications for regulatory policy. In addition to regulation, financial fragilities have added to demands for fiscal stimulus and led some emerging market central banks to ease monetary policy by buying government bonds, creating new links with fiscal policy. 

Moritz Schularick, Lucas ter Steege, Felix Ward, 12 January 2021

The question of whether monetary policymakers can defuse rising financial stability risks by ‘leaning against the wind’ and increasing interest rates has sparked considerable disagreement among economists. This column contributes to the debate by studying the state-dependent effects of monetary policy on financial stability, based on the ‘near-universe’ of advanced economy financial cycles since the 19th century. It shows that deploying discretionary leaning against the wind policies during credit and asset price booms are more likely to trigger crises than prevent them.

Phurichai Rungcharoenkitkul, Claudio Borio, Piti Disyatat, 22 December 2020

In recent years, a key challenge for central banks has been the shrinking room for policy manoeuvre as interest rates have declined to historical lows in many countries. The Covid-19 pandemic has inevitably exacerbated the problem. Once the worst is over, rebuilding policy space will be critical. This column presents a theoretical model in which the impact of monetary policy on financial vulnerabilities can complicate that challenge by constraining policy choices down the road. The model includes two realistic features typically excluded from standard setups: banks create money, and lending behaviour generates endogenous booms and busts. As it turns out, in such a framework the very notion of a natural rate of interest driven by saving and investment comes into question.

Kristina Bluwstein, Michał Brzoza-Brzezina, Paolo Gelain, Marcin Kolasa, 07 December 2020

Transmission of monetary policy depends to a large extent on the phase of the housing cycle. This is because residential property prices are important determinants of banks’ willingness to lend. This column presents analysis for the US which shows that in the mature phase of the housing market boom, or immediately after a bust began, the effects of a monetary expansion were smaller than they were earlier in the housing cycle. This is relevant for central banks which are considering responding to the Covid-19 pandemic by easing monetary policy during a period of relatively high house prices.

Elena Durante, Annalisa Ferrando, Philip Vermeulen, 30 November 2020

Monetary policy affects firms’ investment behaviour through an interest rate channel and a balance sheet channel. This column uses investment data from over one million firms in Germany, Spain, France, and Italy to analyse the transmission of monetary policy shocks. It finds heterogeneity in the effects depending on firm size and industry – young firms and those producing durable goods react more strongly than the average firm. Embedding these findings into macroeconomic models used in policymaking would enhance the information available to decision makers. 

Joost Bats, Massimo Giuliodori, Aerdt Houben, 17 November 2020

Interest rates have declined steadily over the last decades, recently turning negative in Europe and Japan. This column finds that negative interest rates have important implications for bank stock prices. When market interest rates are negative, but deposit rates are stuck at zero, monetary policy instruments that target the longer end of the yield curve are less detrimental to bank performance compared with instruments that target the shorter end. Therefore, quantitative easing and yield curve control deserve special consideration when interest rates are negative and further monetary accommodation is required. 

Ethan Ilzetzki, 16 November 2020

The ECB is in the process of reviewing its monetary policy strategy. This column presents the latest CfM-CEPR survey, which reveals that a majority of panel members support allowing inflation to exceed 2% following periods when inflation has been below target and making more explicit its secondary objective of supporting economic growth and full employment. Only a minority support increasing the inflation target itself. 

Rafael Repullo, 04 November 2020

The ‘reversal interest rate’ is defined as the rate at which accommodative monetary policy reverses its intended effect and becomes contractionary for lending. The idea is that excessively low monetary policy rates lead to a reduction in the value of banks’ capital, which reduces bank lending. This column shows, however, that that lower rates can only lead to a contraction in bank lending if the bank is a net investor in debt securities, a condition typically only satisfied by high deposit banks. Thus, when it exists, the reversal rate will depend on bank-specific characteristics.

Eugenio Cerutti, Maurice Obstfeld, Haonan Zhou, 08 October 2020

Covered interest rate parity has been a central principle in international finance, but important departures have persisted since the Global Crisis. This column argues that several macro-financial factors – reflecting risk appetite, monetary policies, and financial regulations – correlate over time with the evolution of covered interest parity deviations. The failure of covered interest rate parity has several policy implications, ranging from the domestic and international transmission of monetary policies to inefficient market allocations.

Luis Garicano, Jesus Saa-Requejo, Tano Santos, 06 October 2020

One lasting effect of the Global Crisis and the Covid-19 crisis will be a large increase in general government debt worldwide. This may lead to a scenario of ‘fiscal dominance’, in which expansionary fiscal policies are combined with accommodating monetary policies to alleviate the debt burden. This column argues that such a situation would put central banks in a precarious position of having to contain inflationary pressures and maintain financial stability. Expanding the independence of central banks and reaffirming the commitment to fighting inflation may be necessary in case of an unexpected inflation shock. 

Ricardo Caballero, Alp Simsek, 05 October 2020

While the Fed’s massive policy response to the Covid-19 shock was successful in reversing the financial meltdown, it did not prevent a dramatic collapse in the real economy. This column argues that the patterns observed are consistent with optimal monetary policy once the subtleties of the relationship between monetary policy, the stock market, and the economy are considered.

Signe Krogstrup, Andreas Kuchler, Morten Spange, 02 October 2020

Negative policy rates are controversial and raise questions about their transmission to the economy and financial markets. This column presents emerging evidence from Denmark, where the central bank's objective of maintaining a fixed exchange rate against the euro means that the key policy rate has been negative almost continuously since 2012. Recent and ongoing analyses suggest that the transmission is working well under negative rates, although pass-through to bank lending rates appears to be slower compared with periods of positive policy rates.

Olivier Coibion, Yuriy Gorodnichenko, Edward S. Knotek II, Raphael Schoenle, 30 September 2020

On 27 August 2020, the Federal Reserve announced the adoption of a new strategy of ‘average inflation targeting’, which is to replace traditional inflation targeting. This column uses a daily survey of US households to study how this announcement affected inflation expectations. It finds a small uptick in the share of households reporting to have heard news about monetary policy on the day of the announcement, but hearing about the news did not appear to affect their expectations. Even providing households with information on average inflation targeting directly did not change expectations relative to households who received information on traditional inflation targeting.

Márcia Pereira, José Tavares, 17 September 2020

Crises such as the sovereign debt crisis and the current Covid-19 crisis place significant pressure on European institutions, raising scepticism over policy decisions and speculation as to how member states’ differing needs are taken into account. This column uses estimated counter-factual country-specific interest rates to extract the country weights implicit in the ECB’s conventional monetary policy. Germany, Belgium and the Netherlands are associated with the largest weights, and Greece and Ireland with the smallest. Nonetheless, the weights of the larger economies are smaller than their output and population shares. The results change minimally when the crisis period is compared with the period before. In sum, while weights differ across countries, they do not seem to unduly weigh larger economies. Further, estimated country weights are positively correlated with the degree of co-movement between each country’s and Germany’s business cycles.

Itamar Drechsler, Alexi Savov, Philipp Schnabl, 11 September 2020

In a recent speech in Jackson Hole, Fed Chair Jay Powell laid out the Fed’s new monetary policy framework.  Under this framework, the Fed will allow inflation to run above its 2% target in order to boost employment following a downturn.  The new framework marks a departure from the perceived wisdom of the 1970s’ Great Inflation.  Under this perceived wisdom, the Fed must respond aggressively to rising inflation or risk losing its credibility and letting inflation spiral out of control.  New research on the Great Inflation challenges this perceived wisdom and offers a new explanation for what really drives inflation.  Instead of Fed credibility, this explanation puts the financial system and how it transmits monetary policy front and centre.  In doing so, it reconciles the 1970s with the current environment and provides a foundation for understanding why the Fed’s new framework is unlikely to trigger runaway inflation.


CEPR Policy Research