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The term structure of interest rates is crucial for the transmission of monetary policy to financial markets and the macroeconomy. Disentangling the impact of monetary policy on the components of interest rates, expected short rates and term premia, is essential to understanding this channel. To accomplish this, we provide a quantitative structural model with endogenous, time-varying term premia that are consistent with empirical findings. News about future policy, in contrast to unexpected policy shocks, has quantitatively significant effects on term premia along the entire term structure. This provides a plausible explanation for partly contradictory estimates in the empirical literature.
This note argues that in a situation of an inelastic natural gas supply a restrictive monetary policy in the euro zone could reduce the energy bill and therefore has additional merits. A more hawkish monetary policy may be able to indirectly use monopsony power on the gas market. The welfare benefits of such a policy are diluted to the extent that some of the supply (approximately 10 percent) comes from within the euro zone, which may give rise to distributional concerns.
“Institutional Overburdening” to a large extent was a consequence of the “Great Moderation”. This term indicates that it was a period in which inflation had come down from rather high levels. Growth and employment were at least satisfying and variability of output had substantially declined. It was almost unavoidable that as a consequence expectations on future actions of central banks and their ability to control the economy reached an unprecedented peak which was hardly sustainable. Institutional overburdening has two dimensions. One is coming from exaggerated expectations on what central banks can achieve (“expectational overburdening”). The other dimension is “operational overburdening” i.e. overloading the central bank with more and more responsibilities and competences.
Central banks normally accept debt of their own governments as collateral in liquidity operations without reservations. This gives rise to a valuable liquidity premium that reduces the cost of government finance. The ECB is an interesting exception in this respect. It relies on external assessments of the creditworthiness of its member states, such as credit ratings, to determine eligibility and the haircut it imposes on such debt. The authors show how such features in a central bank’s collateral framework can give rise to cliff effects and multiple equilibria in bond yields and increase the vulnerability of governments to external shocks. This can potentially induce sovereign debt crises and defaults that would not otherwise arise.
This Policy White Paper assesses several main elements of ECB’s upcoming review of its monetary policy strategy, announced in January 2020. Four aspects of the review are discussed in detail: i) ECB’s definition of price stability and the arguments for and against inflation targeting; ii) the scope of ECB’s objectives, considering financial stability, employment and the sustainability of the environment; iii) an update of ECB’s economic and monetary analyses to assess the risks to price stability; iv) the ECB’s communication practice. Furthermore, an overview of the ECB’s monetary policy strategy and its last evaluation in 2003 is given.
The authors embed human capital-based endogenous growth into a New-Keynesian model with search and matching frictions in the labor market and skill obsolescence from long-term unemployment. The model can account for key features of the Great Recession: a decline in productivity growth, the relative stability of inflation despite a pronounced fall in output (the "missing disinflation puzzle"), and a permanent gap between output and the pre-crisis trend output.
In the model, lower aggregate demand raises unemployment and the training costs associated with skill obsolescence. Lower employment hinders learning-by-doing, which slows down human capital accumulation, feeding back into even fewer vacancies than justified by the demand shock alone. These feedback channels mitigate the disinflationary effect of the demand shock while amplifying its contractionary effect on output. The temporary growth slowdown translates into output hysteresis (permanently lower output and labor productivity).
Exit strategies
(2014)
We study alternative scenarios for exiting the post-crisis fiscal and monetary accommodation using a macromodel where banks choose their capital structure and are subject to runs. Under a Taylor rule, the post-crisis interest rate hits the zero lower bound (ZLB) and remains there for several years. In that condition, pre-announced and fast fiscal consolidations dominate - based on output and inflation performance and bank stability - alternative strategies incorporating various degrees of gradualism and surprise. We also examine an alternative monetary strategy in which the interest rate does not reach the ZLB; the benefits from fiscal consolidation persist, but are more nuanced.
A number of contributions to research on monetary policy have suggested that policy should be asymmetric near the lower bound on nominal interest rates. As inflation and economic activity decline, policy should ease more aggressively than it would in the absence of the lower bound. As activity recovers and inflation picks up, the central bank should act to keep interest rates lower for longer than without the bound. In this note, we investigate to what extent the policy easing implemented by the ECB since summer 2013 mirrors the rate recommendations of a simple policy rule or deviates from it in a way that indicates a “lower for longer” approach to policy near zero interest rates.
n a contribution prepared for the Athens Symposium on “Banking Union, Monetary Policy and Economic Growth”, Otmar Issing describes forward guidance by central banks as the culmination of the idea of guiding expectations by pure communication. In practice, he argues, forward guidance has proved a misguided idea. What is presented as state of the art monetary policy is an example of pretence of knowledge. Forward guidance tries to give the impression of a kind of rule-based monetary policy. De facto, however, it is an overambitious discretionary approach which, to be successful, would need much more (or rather better) information than is currently available. In Issing's view, communication must be clear and honest about the limits of monetary policy in a world of uncertainty.
Conditional yield skewness is an important summary statistic of the state of the economy. It exhibits pronounced variation over the business cycle and with the stance of monetary policy, and a tight relationship with the slope of the yield curve. Most importantly, variation in yield skewness has substantial forecasting power for future bond excess returns, high-frequency interest rate changes around FOMC announcements, and consensus survey forecast errors for the ten-year Treasury yield. The COVID pandemic did not disrupt these relations: historically high skewness correctly anticipated the run-up in long-term Treasury yields starting in late 2020. The connection between skewness, survey forecast errors, excess returns, and departures of yields from normality is consistent with a theoretical framework where one of the agents has biased beliefs.