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This paper analyzes the relationship between monetary policy and financial stability in the Banking Union. There is no uniform global model regarding the relationship between monetary policy-making on the one hand, and prudential supervision on the other. Before the crisis, EU Member States followed different approaches, some of them uniting monetary and supervisory functions in one institution, others assigning them to different, neatly separated institutions. The financial crisis has underlined that monetary policy and prudential supervision deeply affect each other, especially in case of systemic events. Even in normal times, monetary and supervisory decisions might conflict with each other. After the crisis, some jurisdictions have moved towards a more holistic approach under which monetary policy takes supervisory considerations into account, while supervisory decisions pay due regard to monetary policy.
The Banking Union puts prudential supervision in the hands of the European Central Bank (ECB), the institution responsible for monetary policy. Nevertheless, at its establishment there was the political understanding that the ECB should follow a policy of meticulous separation in the discharge of its different functions. This raises the question whether the ECB may pursue a holistic approach to monetary policy and supervisory decision-making, respectively. On the basis of a purposive reading of the monetary policy mandate and the SSM Regulation, the paper answers this question in the affirmative. Effective monetary policy (or supervision) requires financial stability (or smooth monetary policy transmission). Moreover, without a holistic approach, the SSM Regulation is more likely to provoke the adoption of mutually defeating decisions by the Governing Board. The reputation of the ECB would suffer considerably under such a situation – in a field where reputation is of paramount importance for effective policy.
As any meticulous separation between monetary and supervisory functions turns out to be infeasible, the paper explores the reasons. Parting from Katharina Pistor’s legal theory of finance, which puts the emphasis on exogenous factors to explain the (non)enforcement of legal rules, the paper suggests a legal instability theorem which focuses on endogenous reasons, such as law’s indeterminacy, contextuality, and responsiveness to democratic deliberation. This raises the question whether the holistic approach would be democratically legitimate under the current framework of the ESCB. The idea of technocratic legitimacy that exempts the ECB from representative structures is effectively called into question by the legal instability theorem. This does not imply that the independence of the ECB should be given up, as there are no viable alternatives to protect monetary policy against the time inconsistency problem. Rather, any solution might benefit from recognizing the ECB in its mixed technocratic and political shape as a centerpiece of European integration and improving.
This paper examines the welfare implications of rising temperatures. Using a standard VAR, we empirically show that a temperature shock has a sizable, negative and statistically significant impact on TFP, output, and labor productivity. We rationalize these findings within a production economy featuring long-run temperature risk. In the model, macro-aggregates drop in response to a temperature shock, consistent with the novel evidence in the data. Such adverse effects are long-lasting. Over a 50-year horizon, a one-standard deviation temperature shock lowers both cumulative output and labor productivity growth by 1.4 percentage points. Based on the model, we also show that temperature risk is associated with non-negligible welfare costs which amount to 18.4% of the agent's lifetime utility and grow exponentially with the size of the impact of temperature on TFP. Finally, we show that faster adaptation to temperature shocks results in lower welfare costs. These welfare benefits become substantially higher in the presence of permanent improvements in the speed of adaptation.
We propose a 2-country asset-pricing model where agents' preferences change endogenously as a function of the popularity of internationally traded goods. We determine the effect of the time-variation of preferences on equity markets, consumption and portfolio choices. When agents are more sensitive to the popularity of domestic consumption goods, the local stock market reacts more strongly to the preferences of local agents than to the preferences of foreign agents. Therefore, home bias arises because home-country stock represents a better investment opportunity for hedging against future fluctuations in preferences. We test our model and find that preference evolution is a plausible driver of key macroeconomic variables and stock returns.
We investigate how solvency and wholesale funding shocks to 84 OECD parent banks affect the lending of 375 foreign subsidiaries. We find that parent solvency shocks are more important than wholesale funding shocks for subsidiary lending. Furthermore, we find that parent undercapitalization does not affect the transmission of shocks, while wholesale shocks transmit to foreign subsidiaries of parents that rely primarily on wholesale funding. We also find that transmission is affected by the strategic role of the subsidiary for the parent and follows a locational, rather than an organizational pecking order. Surprisingly, liquidity regulation exacerbates the transmission of adverse wholesale shocks. We further document that parent banks tend to use their own capital and liquidity buffers first, before transmitting. Finally, we show that solvency shocks have higher impact on large subsidiary banks with low growth opportunities in mature markets.
We introduce an innovative approach to measure bank integration, based on the corporate culture of multinational banking conglomerates. The new measure, the Power Index, assesses the prevalence of a language of power and authority in the financial reports of global banks. We employ a two-step approach: as a first step, we investigate whether parent-bank or parent-country characteristics are more important for bank integration. In a second step, we analyze whether bank integration affects the transmission of shocks across borders. We find that the level of integration of global banks is determined by parent-bank-specific factors, as well as by the social centralization in the parent’s country: ethnically diverse and linguistically homogenous countries nurture decentralized corporate structures. Political and economic factors, such as corruption, political rights and economic development also affect bank integration. Furthermore, we find that organizational integration affects the transmission of exogenous shocks from parent banks to their subsidiaries: the more centralized a global bank is, the lower the lending of its subsidiaries after a solvency shock. Wholesale shocks do not appear to be transmitted through this channel. Also, past experience with solvency shocks reduces the integration between parents and subsidiaries.
We develop a state-space model to decompose bid and ask quotes of CDS into two components, fair default premium and liquidity premium. This approach gives a better estimate of the default premium than mid quotes, and it allows to disentangle and compare the liquidity premium earned by the protection buyer and the protection seller. In contrast to other studies, our model is structurally much simpler, while it also allows for correlation between liquidity and default premia, as supported by empirical evidence. The model is implemented and applied to a large data set of 118 CDS for a period ranging from 2004 to 2010. The model-generated output variables are analyzed in a difference-in-difference framework to determine how the default premium, as well as the liquidity premium of protection buyers and sellers, evolved during different periods of the financial crisis and to which extent they differ for financial institutions compared to non-financials.
SAFE Newsletter : 2017, Q2
(2017)
Given rising life expectations around the world, it seems that old-age pension benefits will need to be cut and pension contributions boosted in many nations. Yet our research on old-age system reforms does not require raising mandatory retirement ages or contributions. Instead, we offer ways to enhance incentives for people to work longer and delay retirement. There are good reasons to incentivize older people to work longer and delay retirement. These include rising longevity, the shrinking workforce, and emerging evidence indicating that working longer can be associated with better mental and physical health for many people. Nevertheless, old age Social Security systems in many nations find that people tend to claim benefits early, usually leading to reduced benefits.In the United States, for instance, a majority of Americans claim their Social Security benefits at the earlier feasible age, namely 62, even though their monthly benefits would be 75% higher if they waited until age 70. To test whether this is the result of people underweighting the economic value of higher lifetime benefit streams, we examine whether people would claim later and work longer if they were rewarded with a lump sum instead of a higher lifetime benefit stream for deferring. Two arguments have been offered to explain early claiming. One is that workers claim early to avoid potentially “forfeiting” their deferred benefits should they die too soon (Brown et al., 2016). A second explanation is that many people underweight the economic value of lifetime benefit streams (Brown et al., 2017). This latter rationale motivates the present study.
The Judgement of the EGC in the Case T-122/15 – Landeskreditbank Baden-Württemberg - Förderbank v European Central Bank is the first statement of the European judiciary on the sub-stantive law of the Banking Union. Beyond its specific holding, the decision is of great importance, because it hints at the methodological approach the EGC will take in interpreting prudential banking regulation in the appeals against supervisory measures that fall in its jurisdiction under TFEU, arts. 256(1) subpara 1 and 263(4). Specifically, the case pertained to the scope of direct ECB oversight of significant banks in the euro area and the reassignment of this competence to national competent authorities (NCAs) in individual circumstances (Single Supervisory Mechanism (SSM) Regulation, art. 6(4) subpara 2; SSM Framework Regulation, arts. 70, 71).
This paper examines the relationship between oil movements and systemic risk of financial institution in major petroleum-based economies. We estimate ΔCoVaR for those institutions and observe the presence of elevated increases in its levels corresponding to the subprime and global financial crises. The results provide evidence in favor of risk measurement improvements by accounting for oil returns in the risk functions. The spread between the standard CoVaR and the CoVaR that includes oil absorbs in a time range longer than the duration of the oil shock. This indicates that the drop in the oil price has a longer effect on risk and requires more time to be discounted by the financial institutions. To support the analysis, we consider also the other major market-based systemic risk measures.
For some time now, structural macroeconomic models used at central banks have been predominantly New Keynesian DSGE models featuring nominal rigidities and forwardlooking decision-making. While these features are widely deemed crucial for policy evaluation exercises, most central banks have added more detailed characterizations of the financial sector to these models following the Great Recession in order to improve their fit to the data and their forecasting performance. We employ a comparative approach to investigate the characteristics of this new generation of New Keynesian DSGE models and document an elevated degree of model uncertainty relative to earlier model generations. Policy transmission is highly heterogeneous across types of financial frictions and monetary policy causes larger effects, on average. The New Keynesian DSGE models we analyze suggest that a simple policy rule robust to model uncertainty involves a weaker response to inflation and the output gap in the presence of financial frictions as compared to earlier generations of such models. Leaning-against-the-wind policies in models of this class estimated for the Euro Area do not lead to substantial gains. With regard to forecasting performance, the inclusion of financial frictions can generate improvements, if conditioned on appropriate data. Looking forward, we argue that model-averaging and embracing alternative modelling paradigms is likely to yield a more robust framework for the conduct of monetary policy.
We study the general equilibrium implications of different fiscal policies on macroeconomic quantities, asset prices, and welfare by utilizing two endogenous growth models. The expanding variety model features only homogeneous innovations by entrants. The Schumpeterian growth model features heterogeneous innovations: "incremental" innovations by incumbents and "radical" innovations by entrants. The government levies taxes on labor income and corporate profits and supplies subsidies to consumption, capital investment, and investments in research and development by entrants and, if applicable, incumbents. With these models at hand, we provide new insights on the interplay of innovation dynamics and fiscal policy.
Exploiting NASDAQ order book data and difference-in-differences methodology, we identify the distinct effects of trading pause mechanisms introduced on U.S. stock exchanges after May 2010. We show that the mere existence of such a regulation constitutes a safeguard which makes market participants behave differently in anticipation of a pause. Pauses tend to break local price trends, make liquidity suppliers revise positions, and enhance price discovery. In contrast, pauses do not have a “cool off” effect on markets, but rather accelerate volatility and bid-ask spreads. This implies a regulatory trade-off between the protective role of trading pauses and their adverse effects on market quality.
During the 1970s, industrial countries, including the US and continental Europa, experienced a combination of slow productivity growth and high unemplyoment. Subsequent research has shown that the standard model of unemployment actually gives counterfactual predictions. Motivated by the observation that the 1970s were also characterized by high and rising inflation, Tesfaselassie and Wolters examine the effect of growth on unemployment in the presence of nominal price rigidity.
The authors demonstrate that the effect of growth on unemployment may be positive or negative. Faster growth leads to lower unemployment if the rate of inflation is high enough. There is a threshold level of inflation below which faster growth leads to higher unemployment and above which faster growth leads to lower unemployment. The threshold level in turn depends on labor market characteristics, such as hiring efficiency, the job destruction rate, workers' relative bargaining power and the opportunity cost of work.
To broaden the scope of monetary policy, cash abolishment is often suggested as a means of breaking through the zero lower bound. However, practically nothing is said about the welfare costs of such a proposal. Rösl, Seitz and Tödter argue that the welfare costs of bypassing the zero lower bound can be analyzed analytically and empirically by assuming negative interest rates on cash holdings. They gauge the welfare effects of abolishing cash, both, for the euro area and for Germany.
Their findings suggest that the welfare losses of negative interest rates incurred by money holders are large, notably if implemented in the current low interest rate environment. Imposing a negative interest rate of 3 percentage points on cash holdings and reducing the interest on all assets included in M3 creates a deadweight loss of € 62bn for the euro area and of €18bn for Germany. Therefore, the authors argue that cash abolishment or negative interest rates on cash to break through the zero lower bound at any price can hardly be a meaningful policy goal.
The currrent debate on monetary and fiscal policy is heavily influenced by estimates of the equilibrium real interest rate. Beyer and Wieland re-estimate the U.S. equilibrium rate with the methodology of Laubach and Williams and further modifications. They provide new estimates for the United States, the euro area and Germany and subject them to sensitivity tests. Beyer and Wieland conclude that due to the great uncertainty and sensitivity, the observed decline in the estimates is not a reliable indicator of a need for expansionary monetary and fiscal policy. Yet, if those estimates are employed to determine the appropriate monetary policy stance, such estimates are better used together with the consistent estimate of the level of potential output.
I propose a dynamic stochastic general equilibrium model in which the leverage of borrowers as well as banks and housing finance play a crucial role in the model dynamics. The model is used to evaluate the relative effectiveness of a policy to inject capital into banks versus a policy to relieve households of mortgage debt. In normal times, when the economy is near the steady state and policy rates are set according to a Taylor-type rule, capital injections to banks are more effective in stimulating the economy in the long-run. However, in the middle of a housing debt crisis, when households are highly leveraged, the short-run output effects of the debt relief are more substantial. When the zero lower bound (ZLB) is additionally considered, the debt relief policy can be much more powerful in boosting the economy both in the short-run and in the longrun. Moreover, the output effects of the debt relief become increasingly larger, the longer the ZLB is binding.
We use the Italian Survey of Household Income and Wealth, a rather unique dataset with a long time dimension of panel information on consumption, income and wealth, to structurally estimate a buffer-stock saving model. We exploit the information contained in the joint dynamics of income, consumption and wealth to quantify the degree of insurance against income risk. The estimated model implies that Italian households can insure between 89 and 95 percent of a transitory and between 7 and 9 percent of a permanent income shock. Compared to existing empirical estimates for the same dataset, our findings suggest that Italian households do not have access to significant insurance beyond self-insurance.
We designed and fielded an experimental module in the 2014 HRS which seeks to measure older persons’ willingness to voluntarily defer claiming of Social Security benefits. In addition we evaluate the stated willingness of older individuals to work longer, depending on the Social Security incentives offered to delay claiming their benefits. Our project extends previous work by analyzing the results from our HRS module and comparing findings from other data sources, which included very much smaller samples of older persons. We show that half of the respondents would delay claiming if no work requirement were in place under the status quo, and only slightly fewer, 46 percent, with a work requirement. We also asked respondents how large a lump sum they would need with or without a work requirement. In the former case, the average amount needed to induce delayed claiming was about $60,400, while when part-time work was required, the average was $66,700. This implies a low utility value of leisure foregone of only $6,300, or about 10 percent of older households’ income.
On average young people \undersave" whereas old people \oversave" with respect to the rational expectations model of life-cycle consumption and savings. According to numerous studies on subjective survival beliefs, young people also \underestimate" whereas old people \overestimate" their objective survival chances on average. We take a structural behavioral economics approach to jointly address both empirical phenomena by embedding subjective survival beliefs that are consistent with these biases into a rank-dependent utility (RDU) model over life-cycle consumption. The resulting consumption behavior is dynamically inconsistent. Considering both naive and sophisticated RDU agents we show that within this framework underestimation of young age and overestimation of old age survival probabilities may (but need not) give rise to the joint occurrence of undersaving and oversaving. In contrast to this RDU model, the familiar quasi-hyperbolic discounting (QHD), which is nested as a special case, cannot generate oversaving.