Table of Contents

Delays and Distorsions in Reforming Banking Regulation: A Political Economy Tale

Donato Masciandaro, Bocconi University - Department of Economics
Mattia Suardi, Paolo Baffi Center - Bocconi University, Institute of Advanced Study (IUSS - Pavia)

The Cost of Shocks in Reserve Management

Ning Cai, Hong Kong University of Science & Technology
Xuewei Yang, Nanjing University - School of Management and Engineering

Fiscal Policy and Crowding Out Effects in Capital Based Macroeconomics with Idle Resources

Adrian O. Ravier, Universidad Francisco Marroquín
Nicolas Cachanosky, Metropolitan State University of Denver

Can We Prove a Bank Guilty of Creating Systemic Risk? A Minority Report

Jon Danielsson, London School of Economics - Systemic Risk Centre
Kevin R. James, London School of Economics, Financial Conduct Authority
Marcela Valenzuela, University of Chile
Ilknur Zer, Federal Reserve Board

Regime - Switching and Fiscal Policy: Evidence from Selected Economies

Allan Silveria Wright, Central Bank of Barbados
Francisco Alberto Ramirez de Leon, Central Bank of the Dominican Republic

Inflation Targeting in ASEAN-10

Wai Ching Poon, Monash University Malaysia
Yong Shen Lee, Independent

Whither Gold?: A Reformulation of Austrian Business Cycle Theory

James Caton, George Mason University

How Central Banks End Crises

Gary B. Gorton, Yale School of Management, National Bureau of Economic Research (NBER)
Guillermo L. Ordoñez, University of Pennsylvania - Department of Economics, National Bureau of Economic Research (NBER)

Did the Reserve Requirement Increases of 1936-1937 Reduce Bank Lending? Evidence from a Quasi-Experiment

Haelim Park, Office of Financial Research
Patrick Van Horn, Southwestern University


MACROECONOMICS: MONETARY & FISCAL POLICIES eJOURNAL

"Delays and Distorsions in Reforming Banking Regulation: A Political Economy Tale" Free Download
Baffi Center Research Paper No. 2014-158

DONATO MASCIANDARO, Bocconi University - Department of Economics
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MATTIA SUARDI, Paolo Baffi Center - Bocconi University, Institute of Advanced Study (IUSS - Pavia)
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After the 2008 Financial Meltdown the need to reconsider the separation between commercial banking and other financial risky activities - ring fencing - in order to mitigate systemic risks and to address the too big to fail problems was publicly recognized both in the United States and in Europe. In spite of this widespread demand for structural banking regulation reform, the ring fencing proposals - the Volcker Rule in the US Dodd Frank-Act, the Vickers Report in the UK, the Liikanen Report in the European Union - are still in their infancy. How to explain the difficulties in enacting structural banking regulation? The article presents a political economy view: the incumbent policymakers are politicians, and their personal cost and benefit analysis in introducing ring fencing can be different from the social one, when relevant private interests - the banking constituency - are present. The article sheds light under which economic and political conditions the structural regulation is likely to be postponed, modified or even distorted, using a formal model to discuss the ongoing legislative processes both in the US and in Europe. The article highlights that the actual degree of separation between commercial and investment banking can depend on a political cost and benefit analysis and it is likely to be different from the social optimal setting the more the politicians are influenced by banking lobbies.

"The Cost of Shocks in Reserve Management" Free Download

NING CAI, Hong Kong University of Science & Technology
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XUEWEI YANG, Nanjing University - School of Management and Engineering
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We study the cost of shocks, i.e., jump risk, in reserve management when reserve process is formulated as a drift switching jump-diffusion with a reflecting barrier at 0. Inherited from the Brownian drift control model, our model better describes the dynamic behavior of international reserves than does the buffer stock model. The new model can capture both the jump behavior in reserve dynamics and the leptokurtic feature that the increment distribution has a higher peak and two asymmetric heavier tails than does the normal distribution. By selecting an initial distribution that reflects certain steady state behavior, the reserve process becomes a regenerative process. This enables us to derive a closed-form expression for the total expected discounted cost of managing reserves, which in turn facilitates us to find optimal control variables that minimize the cost. Numerical results indicate that the shocks on reserve level have a significant effect on the reserve management strategies, and that model misspecification can result in non-negligible additional cost.

"Fiscal Policy and Crowding Out Effects in Capital Based Macroeconomics with Idle Resources" Free Download

ADRIAN O. RAVIER, Universidad Francisco Marroquín
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NICOLAS CACHANOSKY, Metropolitan State University of Denver
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While Garrison’s model has been mostly used to analyze, theoretically and empirically, business cycles, other potential venues have not been explored. The effects of fiscal policy is one of these applications. In this paper we show how Garrison’s model can be used to analyze the effects of fiscal policy in the presence of idle resources. This yields two important results. Particularly, our application of Garrison’s model shows that even if starting with idle resources fiscal policy manages to reach potential output, the result is imbalances in how resources are allocated in the structure of production of the economy.

"Can We Prove a Bank Guilty of Creating Systemic Risk? A Minority Report" Free Download

JON DANIELSSON, London School of Economics - Systemic Risk Centre
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KEVIN R. JAMES, London School of Economics, Financial Conduct Authority
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MARCELA VALENZUELA, University of Chile
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ILKNUR ZER, Federal Reserve Board
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Since increasing a bank's capital requirement to improve the stability of the financial system imposes costs upon the bank, a regulator must be able to prove beyond a reasonable doubt that banks classified as systemically risky do create systemic risk before subjecting them to this capital punishment. Evaluating the performance of three leading systemic risk models, we show that estimation error alone prevents the reliable identification of the most systemically risky banks. We conclude that it will be a considerable challenge to develop a riskometer that is both sound and reliable enough to provide an adequate foundation for macroprudential policy.

"Regime - Switching and Fiscal Policy: Evidence from Selected Economies" Free Download

ALLAN SILVERIA WRIGHT, Central Bank of Barbados
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FRANCISCO ALBERTO RAMIREZ DE LEON, Central Bank of the Dominican Republic
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This paper explores the effects of changes in tax regime and fiscal policy among selected economies of Central America and the Caribbean. The results show how agents respond to changes in tax regimes and the impact upon investment, consumption and output growth. The findings will assist in determining allocation of income, consumption and investment as agents make inference regarding regime-switching of tax regimes.

"Inflation Targeting in ASEAN-10" Free Download
South African Journal of Economics, Vol. 82:1 March 2014

WAI CHING POON, Monash University Malaysia
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YONG SHEN LEE, Independent

The paper addresses the empirical question of whether economies that do not systematically target inflation (non-inflation targeters) experience higher exchange rate volatility as compared with inflation targeters in 10 countries of the Association of Southeast Asian Nation (ASEAN) from 1990 to 2010. The paper examines the role of real exchange rate, exchange rate volatility and the reaction functions of central banks using dynamic panel estimation techniques. The results indicate that the output gap offers more useful information than the inflation gap in setting interest rates for inflation targeters, implying that the real term is more important than the nominal term. In turn, this suggests that an increase in interest rate can be wielded swiftly to reduce real gross domestic product and suppress inflation. The real exchange rate appears as a weaker determinant in setting interest rates for non-inflation targeters. Inflation targeters experienced lower exchange rate volatility compared with non-targeters in the ASEAN, which implies that implementation costs to their domestic economies may be marginally lower. Meanwhile, the non-targeters follow a mixed strategy as both the inflation and real exchange rate are used as instruments to set the interest rates.

"Whither Gold?: A Reformulation of Austrian Business Cycle Theory" Free Download

JAMES CATON, George Mason University
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The textbook formulation of Austrian Business Cycle Theory argues that a boom that results from expansionary monetary policy inevitably sows the seeds of its own destruction. Monetary expansion creates nominal distortions and lengthens the structure of production by making long term investments appear to be more profitable than they actually are. Although the theory was formulated in a gold standard world, the relationship between gold flows and the capital structure in a system with less than fully backed base currency has never been fully explicated. This paper integrates gold flows into the framework and considers the interdependent nature of the policies of national monetary regimes. This framework reveals that policy is limited by the “Impossible Trinity? and that Austrian style analysis must take this monetary trilemma into consideration when critiquing monetary policy. Absent a central bank that maintains 100% reserve ratios, a monetary regime can only achieve a second best policy of exchange rate stabilization. This new perspective offers an opportunity for Austrian monetary theorists to adjust their interpretation of the Great Depression to include international factors that formerly lied outside of the purview of Austrian Business Cycle Theory. It also implies that, in the modern era, a central bank whose fiat base currency serves as base money has a responsibility to accommodate changes in demand for that money in the same way that gold flows and gold production accommodated changes in demand for gold during the classical and gold-exchange standards.

"How Central Banks End Crises" Free Download
PIER Working Paper No. 25

GARY B. GORTON, Yale School of Management, National Bureau of Economic Research (NBER)
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GUILLERMO L. ORDOÑEZ, University of Pennsylvania - Department of Economics, National Bureau of Economic Research (NBER)
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To end a financial crisis, the central bank is to lend freely, against good collateral, at a high rate, according to Bagehot’s Rule. We argue that in theory and in practice there is a missing ingredient to Bagehot’s Rule: secrecy. Re-creating confidence requires that the central bank lend in secret, hiding the identities of the borrowers, to prevent information about individual collateral from being produced and to create an information externality by raising the perceived value of average collateral. Ironically, the participation of "bad" borrowers, with low quality collateral, in the central bank’s lending program is a desirable part of re-creating confidence because it creates stigma. Stigma is critical to sustain secrecy because no borrower wants to reveal his participation in the lending program, and it is limited by the central bank charging a high rate for its loans.

"Did the Reserve Requirement Increases of 1936-1937 Reduce Bank Lending? Evidence from a Quasi-Experiment" 

HAELIM PARK, Office of Financial Research
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PATRICK VAN HORN, Southwestern University
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We analyze the impact of contractionary monetary policy through increases in reserve requirements on bank lending. We compare the lending behavior of banks that were subject to the requirement increases in 1936-1937, Federal Reserve member banks, to a group of banks that were not subject to the reserve increase, Federal Reserve nonmember banks. After implementing the difference-in-difference estimators, we find that the increases in reserve requirements did not create financing constraints for member banks and lead them to reduce lending. Therefore, the actions of the Federal Reserve concerning the required reserve ratios cannot be blamed for instigating the economic downturn of 1937-38.

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Macroeconomics: Monetary & Fiscal Policies eJournal

OLIVIER J. BLANCHARD
International Monetary Fund (IMF), National Bureau of Economic Research (NBER)

JOHN Y. CAMPBELL
Morton L. and Carole S. Olshan Professor of Economics, Harvard University - Department of Economics, National Bureau of Economic Research (NBER)

STEPHEN G. CECCHETTI
Professor of International Economics, Brandeis International Business School, National Bureau of Economic Research (NBER), Centre for Economic Policy Research (CEPR)

BENJAMIN M. FRIEDMAN
William Joseph Maier Professor of Economics, Harvard University - Department of Economics, National Bureau of Economic Research (NBER)

ROBERT E. HALL
Stanford University - The Hoover Institution on War, Revolution and Peace, National Bureau of Economic Research (NBER)

ROBERT E. LUCAS
John Dewey Distinguished Service Professor, University of Chicago - Department of Economics, National Bureau of Economic Research (NBER)

BENNETT T. MCCALLUM
Professor, Carnegie Mellon University - David A. Tepper School of Business, National Bureau of Economic Research (NBER)

ALLAN H. MELTZER
University Professor of Political Economics, Carnegie Mellon University - David A. Tepper School of Business

FREDERIC S. MISHKIN
Alfred Lerner Professor of Banking and Financial Institutions, Columbia Business School - Finance and Economics, National Bureau of Economic Research (NBER)

PAUL M. ROMER
National Bureau of Economic Research (NBER)

JULIO J. ROTEMBERG
Harvard University - Business, Government and the International Economy Unit, National Bureau of Economic Research (NBER)

MATTHEW D. SHAPIRO
Professor, University of Michigan at Ann Arbor - Department of Economics, Professor, National Bureau of Economic Research (NBER)

ROBERT J. SHILLER
Yale University - Cowles Foundation, National Bureau of Economic Research (NBER), Yale University - International Center for Finance

CHRISTOPHER A. SIMS
Princeton University - Department of Economics, National Bureau of Economic Research (NBER)

JOHN B. TAYLOR
Stanford University