The interrelationship between monetary policy and the interbank money market during the financial crisis

Die vorliegende Dissertation besteht aus sechs Kapiteln und trägt zur Forschung in den Bereichen der Finanzmarktpolitik und der Geldpolitik bei. Das zweite Kapitel zeigt die Wechselbeziehung zwischen Geldmarktanspannungen und der Stabilität des Finanzsystems auf. Mittels der theoretischen Literatur werden verschiedene Einflussfaktoren einer aggregierten Liquiditätsnachfragefunktion präsentiert. Das dritte Kapitel untersucht den Informationsgehalt der Ergebnisse der Hauptrefinanzierungsgeschäfte für den europäischen Geldmarkt. Unsere Ergebnisse zeigen, dass sich seit der Finanzkrise der Informationsgehalt der Hauptrefinanzierungsgeschäfte in zweierlei Hinsicht verändert hat. Im vierten Kapitel untersuchen wir die Wirksamkeit der Geldpolitik während der Finanzkrise europäische Geldmarktzinssätze zu steuern. Die Ergebnisse deuten auf eine erhebliche Divergenz zwischen den Zinssätzen und den Erwartungen über die zukünftige Geldpolitik hin. Weiterhin finden wir heraus, dass die unkonventionellen Maßnahmen der EZB für einen Rückgang der Euriborsätze von bis zu 60 Basispunkten verantwortlich sind. Das fünfte Kapitel beschäftigt sich mit der Funktionsweise des besonderen geldpolitischen Instrumentariums der Schweizerischen Nationalbank.

Monetary Policy in Times of Financial Stress.

Some studies argue that the Fed reacts to financial market developments. Using data covering the period 1985:Q1 - 2008:Q4 and employing an augmented Taylor rule specification, we re-examine that conjecture. We find that evidence in favour of such a reaction is largely driven by the Fed’s behaviour during the 2007-2008 financial crisis.

Monetary policy under the Labour government 1997- 2010: the first 13 years of the MPC

This paper examines the performance of monetary policy under the new framework established in 1997 up to the end of the Labour government in May 2010. Performance was relatively good in the years before the crisis, but much weaker from 2008. The new framework largely neglected open economy issues, while the Treasury’s EMU assessment in 2003 can be interpreted in different ways. inflation targeting in the UK and elsewhere may have contributed in some way to the eruption and depth of the financial crisis from 2008, but UK monetary policy responded in a bold and innovative way. Overall, the design and operation of monetary policy were much better than in earlier periods, but there remains scope for significant further evolution.

The determination of EONIA rate: The impact of the financial crisis and the effects of the changes in the monetary policy implementation framework

EONIA is a market based overnight interest rate, whose role as the starting point of the yield curve makes it critical from the perspective of the implementation of European Central Bank´s common monetary policy in the euro area. The financial crisis that started in 2007 had a large impact on the determination mechanism of this interest rate, which is considered as the central bank´s operational target. This thesis examines the monetary policy implementation framework of the European Central Bank and changes made to it. Furthermore, we discuss the development of the recent turmoil in the money market. EONIA rate is modelled by means of a regression equation using variables related to liquidity conditions, refinancing need, auction results and calendar effects. Conditional volatility is captured by an EGARCH model, and autocorrelation is taken into account by employing an autoregressive structure. The results highlight how the tensions in the initial stage of the market turmoil were successfully countered by ECB´s liquidity policy. The subsequent response of EONIA to liquidity conditions under the full allotment liquidity provision procedure adopted after the demise of Lehman Brothers is also established. A clear distinction in the behavior of the interest rate between the sub-periods was evident. In the light of the results obtained, some of the challenges posed by the exit-strategy implementation will be addressed.

Bank liquidity, interbank markets and monetary policy

A major lesson of the recent financial crisis is that the interbank lending marketis crucial for banks facing large uncertainty regarding their liquidity needs. Thispaper studies the efficiency of the interbank lending market in allocating funds. Weconsider two different types of liquidity shocks leading to different implications foroptimal policy by the central bank. We show that, when confronted with a distributional liquidity-shock crisis that causes a large disparity in the liquidity held amongbanks, the central bank should lower the interbank rate. This view implies that thetraditional tenet prescribing the separation between prudential regulation and monetary policy should be abandoned. In addition, we show that, during an aggregateliquidity crisis, central banks should manage the aggregate volume of liquidity. Twodifferent instruments, interest rates and liquidity injection, are therefore required tocope with the two different types of liquidity shocks. Finally, we show that failureto cut interest rates during a crisis erodes financial stability by increasing the riskof bank runs.

Uncertainties, monetary policy and financial stability: challenges on inflation targeting

This work aims at presenting the challenges that inflation targeting central banks may face since uncertainties represent a harmful element for the effectiveness of monetary policy, and since financial instabilities may disturb the transmission mechanisms - in particular, the expectation channel - and thus the economic stability. Financial stability must not be considered as a simple goal of monetary policy, but a precondition for central banks operate their policies and reach the goals of inflation and output stability. The work identifies different sources of uncertainties that surround central banks' decisions; and approaches the role that inflation targeting central banks should play according to some basic principles that can serve as useful guides for central banks to help them achieve successful outcomes in their conduct of monetary policy.

The financial stability risks of ultra-loose monetary policy. Bruegel Policy Contribution Issue 2015/03

Ultra-loose monetary policies, such as very low or even negative interest rates, large-scale asset purchases, long-maturity lending to banks and forward guidance in central bank communication, aim to increase inflation and output, to the benefit of financial stability. But at the same time, these measures pose various risks and might create challenges for financial institutions. • By assessing the theoretical literature and developments in the United States, United Kingdom and Japan, where very expansionary monetary policies were adopted during the past six years, and by examining the euro-area situation, we conclude that the risks to financial stability of ultra-loose monetary policy in the euro area could be low. However, vigilance is needed. • While monetary policy should focus on its primary mandate of area-wide price stability, other policies should be deployed whenever the financial cycle deviates from the economic cycle or when heterogeneous financial developments in the euro area require financial tightening in some but not all countries. These policies include micro-prudential supervision, macro-prudential oversight, fiscal policy and regulation of sectors that pose risks to financial stability, such as construction.

From Bretton Woods to inflation targeting: financial change and monetary policy evolution in Europe

Different ‘monetary architectures’ are distinguished, as a background to a discussion of the change in developed country monetary policy frameworks from fixed exchange rates under the Bretton Woods international monetary system to, ultimately, formal or informal inflation targeting. The introduction and experience of monetary targets in the 1970s is considered, followed by an analysis of the changes in countries’ monetary architectures, with particular reference to money and bond markets and to France and Italy, in the 1980s. Exchange rate targeting in Europe in the 1980s and 1990s is examined, followed by the changes in central bank independence in the 1990s. This leads to a discussion of the introduction of inflation targeting, and the issues raised for inflation targeting by the financial crisis of the late 2000s.

Monetary policy in a systemic crisis

This paper examines the monetary policy followed during the current financial crisisfrom the perspective of the theory of the lender of last resort. It is argued that standardmonetary policy measures would have failed because the channels through whichmonetary policy is implemented depend upon the well functioning of the interbankmarket. As the crisis developed, liquidity vanished and the interbank market collapsed,central banks had to inject much more liquidity at low interest rates than predicted bystandard monetary policy models. At the same time, as the interbank market did notallow for the redistribution of liquidity among banks, central banks had to design newchannels for liquidity injection.

Monetary policy strategies, financial institutions and financial markets in the Middle East and North Africa: an overview

Three polar types of monetary architecture are identified together with the institutional and market infrastructure required for each type and the kinds of monetary policy feasible in each case: a ‘basic’ architecture where there is little or no financial system as such but an elementary central bank which is able to fix the exchange rate, as a substitute for a proper monetary policy; a ‘modern’ monetary architecture with developed banks, financial markets and central bank where policy choices include types of inflation targeting; and an ‘intermediate’ monetary architecture where less market-based monetary policies involving less discretion are feasible. A range of data is used to locate the various MENA countries with respect to these polar types. Five countries (Iran, Libya, Sudan, Syria and Yemen) are identified as those with the least developed monetary architecture, while Bahrain and Jordan are identified as the group at the other end of the spectrum, reaching beyond the intermediate polar type in some dimensions but not others. The countries in between vary on different dimensions but all lie between basic and intermediate architectures. The key general findings are that the MENA countries are both less differentiated and less ‘developed’ than might have been expected. The paper ends by calling for research on the costs and benefits of different types of monetary architecture.

Monetary policy rules and financial stress: does financial instability matter for monetary

We examine whether and how main central banks responded to episodes of financial stress over the last three decades. We employ a new methodology for monetary policy rules estimation, which allows for time-varying response coefficients as well as corrects for endogeneity. This flexible framework applied to the U.S., U.K., Australia, Canada and Sweden together with a new financial stress dataset developed by the International Monetary Fund allows not only testing whether the central banks responded to financial stress but also detects the periods and type of stress that were the most worrying for monetary authorities and to quantify the intensity of policy response. Our findings suggest that central banks often change policy

Adoption of financial technologies: Implications for money demand and monetary policy

In this paper we argue that inventory models are probably not usefulmodels of household money demand because the majority of households does nothold any interest bearing assets. The relevant decision for most people is notthe fraction of assets to be held in interest bearing form, but whether to holdany of such assets at all. The implications of this realization are interesting and important. We find that(a) the elasticity of money demand is very small when the interest rate is small,(b) the probability that a household holds any amount of interest bearing assetsis positively related to the level of financial assets, and (c) the cost ofadopting financial technologies is positively related to age and negatively relatedto the level of education. Unlike the traditional methods of money demand estimation, our methodology allowsfor the estimation of the interest--elasticity at low values of the nominalinterest rate. The finding that the elasticity is very small for interest ratesbelow 5 percent suggests that the welfare costs of inflation are small. At interest rates of 6 percent, the elasticity is close to 0.5. We find thatroughly one half of this elasticity can be attributed to the Baumol--Tobin orintensive margin and half of it can be attributed to the new adopters or extensivemargin. The intensive margin is less important at lower interest rates and moreimportant at higher interest rates.

Mapping financial stability

The ongoing global financial crisis has demonstrated the importance of a systemwide, or macroprudential, approach to safeguarding financial stability. An essential part of macroprudential oversight concerns the tasks of early identification and assessment of risks and vulnerabilities that eventually may lead to a systemic financial crisis. Thriving tools are crucial as they allow early policy actions to decrease or prevent further build-up of risks or to otherwise enhance the shock absorption capacity of the financial system. In the literature, three types of systemic risk can be identified: i ) build-up of widespread imbalances, ii ) exogenous aggregate shocks, and iii ) contagion. Accordingly, the systemic risks are matched by three categories of analytical methods for decision support: i ) early-warning, ii ) macro stress-testing, and iii ) contagion models. Stimulated by the prolonged global financial crisis, today's toolbox of analytical methods includes a wide range of innovative solutions to the two tasks of risk identification and risk assessment. Yet, the literature lacks a focus on the task of risk communication. This thesis discusses macroprudential oversight from the viewpoint of all three tasks: Within analytical tools for risk identification and risk assessment, the focus concerns a tight integration of means for risk communication. Data and dimension reduction methods, and their combinations, hold promise for representing multivariate data structures in easily understandable formats. The overall task of this thesis is to represent high-dimensional data concerning financial entities on lowdimensional displays. The low-dimensional representations have two subtasks: i ) to function as a display for individual data concerning entities and their time series, and ii ) to use the display as a basis to which additional information can be linked. The final nuance of the task is, however, set by the needs of the domain, data and methods. The following ve questions comprise subsequent steps addressed in the process of this thesis: 1. What are the needs for macroprudential oversight? 2. What form do macroprudential data take? 3. Which data and dimension reduction methods hold most promise for the task? 4. How should the methods be extended and enhanced for the task? 5. How should the methods and their extensions be applied to the task? Based upon the Self-Organizing Map (SOM), this thesis not only creates the Self-Organizing Financial Stability Map (SOFSM), but also lays out a general framework for mapping the state of financial stability. This thesis also introduces three extensions to the standard SOM for enhancing the visualization and extraction of information: i ) fuzzifications, ii ) transition probabilities, and iii ) network analysis. Thus, the SOFSM functions as a display for risk identification, on top of which risk assessments can be illustrated. In addition, this thesis puts forward the Self-Organizing Time Map (SOTM) to provide means for visual dynamic clustering, which in the context of macroprudential oversight concerns the identification of cross-sectional changes in risks and vulnerabilities over time. Rather than automated analysis, the aim of visual means for identifying and assessing risks is to support disciplined and structured judgmental analysis based upon policymakers' experience and domain intelligence, as well as external risk communication.