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.

Eric Lonergan, Megan Greene, 03 September 2020

The low interest rate environment since the Global Financial Crisis has led economists and analysts to suggest that major central banks have run out of monetary policy tools with which to face major downturns, including the Covid-19 crisis. This column argues that a dual interest rate approach could help to eliminate the effective lower bound and given central banks infinite fire power. By employing dual interest rates, central banks can go beyond targeting short-term interest rates and providing emergency liquidity to provide a stimulus across the economy. As political support for fiscal stimulus in the face of the Covid-19 crisis wanes, central banks can and should step in with overwhelming force.

Gregor Boehl, Gavin Goy, Felix Strobel, 30 August 2020

Despite their pivotal role, the macroeconomic effects of large-scale asset purchases, known as quantitative easing, remain open to debate. This column provides insights from a structural investigation of the macroeconomic effects of the Federal Reserve’s quantitative easing programme during the global financial crisis. In line with the general consensus, the results suggest that asset purchases substantially eased borrowing conditions and facilitated new investment. The rise in investment led to an increase in the productive capacity which, in turn, lowered firms’ marginal cost. These supply-side effects dominated demand-side effects in determining the response of inflation, leading to a mild disinflationary effect.

Aakriti Mathur, Rajeswari Sengupta, 03 September 2020

Since the 2008 Global Crisis, significant attention is paid to central bank communication, especially for countries with an inflation targeting mandate. This column analyses the monetary policy statements of the Reserve Bank of India, which formally adopted inflation targeting in 2016. It finds that the length of statements has dramatically declined, the linguistic complexity has improved, and the content is more focused on inflation topics since the regime change. In addition, there is a strong relationship between the length of statements and stock market volatility, highlighting the real impacts of effective communication.

Robert McCauley, 26 August 2020

On 23 March 2020, the Federal Reserve announced that it would buy investment grade corporate bonds, and on 9 April set the amount at up to $250 billion and extended the purchase to junk bonds. This column shows that these interventions succeeded in stabilising credit markets: prices lifted and dealing spreads narrowed. However, emergency lending powers provide an inadequate basis for Federal Reserve operations in corporate bonds. In light of these findings, congressional authority to buy and to sell corporate bonds alongside US Treasuries would help to align Federal Reserve operations with what has become a capital-market centred financial system

Gaston Gelos, Umang Rawat, Hanqing Ye, 20 August 2020

Emerging markets and developing countries are particularly vulnerable to economic shocks such as that posed by COVID-19, not least because of their often weaker monetary policy frameworks. This column discusses the extent to which these economies have been able to react to the crisis with a loosening of monetary policy. While the initial inflation level is an important determinant of a country’s ability to cut rates, additional institutional factors can also affect their ability to conduct countercyclical monetary policy during the crisis.   

Giancarlo Corsetti, Joao B. Duarte, Samuel Mann, 07 August 2020

A persistent challenge for the ECB has been meeting the various needs and demands of euro area member states. This column provides empirical and quantitative evidence suggesting that the transmission of the ECB’s monetary policy varies significantly across member states. For variables such as those related to housing and labour markets, the dispersion of responses to a monetary shock is twice as large as the average response. The results also suggest that the disruption to market integration brought about by the COVID-19 crisis may create further challenges to conducting monetary policy in the euro area.

David Martinez-Miera, Rafael Repullo, 06 August 2020

The question of whether low interest rates foster or hamper financial stability has recently received ample attention both from policy as well as the academic circles,  leading to the development of a large, mostly empirical, literature on the topic. This column presents a framework to analyse the relevance of the financial sector’s market structure in answering this question. It shows that in markets with low competition lower safe rates result in less risk-taking by financial intermediaries, while in highly competitive markets lower safe rates result in higher risk-taking.

Philippe Andrade, Erwan Gautier, Eric Mengus, 04 August 2020

According to macroeconomic theory, managing inflation expectations is crucial for stabilising the economy. This is particularly true in times of crisis, when the nominal interest rate hits its lower bound. This column provides new evidence from France on how the inflation expectation channel operates in terms of consumer spending. The results suggest that households make consumption decisions based on the broad inflation regime that they expect, rather than with regards to the precise inflation forecast.

Charles Goodhart, Tatjana Schulze, Dimitri Tsomocos, 04 August 2020

A decade of near-zero, and even negative, interest rates in advanced economies has both encouraged the continued accumulation of debt and a search for yield in riskier assets, while at the same time eroding bank profitability in the retail business. This column discusses some of the palliative measures that central banks have taken to offset the erosion of bank profitability, and raises the question of whether, and how, the longer-term implications of the excessive accretion of debt will be handled.

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