The potential role of subordinated debt programs in enhancing market discipline in banking
Previous studies have found that subordinated debt (sub-debt) markets do differentiate between banks with different risk profiles. This finding satisfies a necessary condition for regulatory proposals which would mandate increased reliance on sub-debt in the bank capital structure to discipline banks? risk taking. Such proposals, however, have not been implemented, partially because there are still concerns about the quality of the signal generated in current debt markets. We argue that previous studies evaluating the potential usefulness of sub-debt proposals have evaluated spreads in an environment that is very different from the one that will characterize a fully implemented sub-debt program. With a fully implemented program, the market will become deeper, issuance will be more frequent, debt will be viewed as a more viable means to raise capital, bond dealers will be less reluctant to publicly disclose more details on debt transactions, and generally, the market will be more closely followed. As a test to see how the quality of the signal may change, we evaluate the risk-spread relationship, accounting for the enhanced market transparency surrounding new debt issues. Our empirical results indicate a superior risk-spread relationship surrounding the period of new debt issuance due, we posit, to greater liquidity and transparency. Our results overall suggest that the degree of market discipline would likely be enhanced by a mandatory sub-debt program requiring banks to regularly approach the market to issue sub-debt.
AUTHORS: Jagtiani, Julapa; Evanoff, Douglas D.; Nakata, Taisuke
Fiscal Multipliers at the Zero Lower Bound: The Role of Policy Inertia
The presence of the lagged shadow policy rate in the interest rate feedback rule reduces the government spending multiplier nontrivially when the policy rate is constrained at the zero lower bound (ZLB). In the economy with policy inertia, increased inflation and output due to higher government spending during a recession speed up the return of the policy rate to the steady state after the recession ends. This in turn dampens the expansionary effects of the government spending during the recession via expectations. In our baseline calibration, the output multiplier at the ZLB is 2.5 when the weight on the lagged shadow rate is zero, and 1.1 when the weight is 0.9.
AUTHORS: Nakata, Taisuke; Hills, Timothy S.
Equilibrium Yield Curves and the Interest Rate Lower Bound
We study the term structure of default-free interest rates in a sticky-price model with an occasionally binding effective lower bound (ELB) constraint on interest rates and recursive preferences. The ELB constraint induces state-dependency in the dynamics of term premiums by affecting macroeconomic uncertainty and interest-rate sensitivity to economic activities. In a model calibrated to match key features of the aggregate economy and term structure dynamics in the U.S. above and at the ELB, we find that the ELB constraint typically lowers the absolute size of term premiums at the ELB and increases their volatility around the time of liftoff. The central bank's announcement to keep the policy rate at the ELB for longer than previously expected lowers the expected short rate path, but its effect on term premiums depends on the risk exposure of bonds to the macroeconomy; while the announcement increases term premiums if bonds are a hedge against economic downturns, it decreases them otherwise.
AUTHORS: Nakata, Taisuke; Tanaka, Hiroatsu
Monetary Policy Options at the Effective Lower Bound : Assessing the Federal Reserve's Current Policy Toolkit
We simulate the FRB/US model and a number of statistical models to quantify some of the risks stemming from the effective lower bound (ELB) on the federal funds rate and to assess the efficacy of adjustments to the federal funds rate target, balance sheet policies, and forward guidance to provide monetary policy accommodation in the event of a recession. Over the next decade, our simulations imply a roughly 20 to 50 percent probability that the federal funds rate will be constrained by the ELB at some point. We also find that forward guidance and balance sheet polices of the kinds used in response to the Global Financial Crisis are modestly effective in speeding up the labor market recovery and return of inflation to 2 percent following an economic slump. However, these policies have only small effects in limiting the initial rise in the unemployment rate during a recession because of transmission lags. As with any model-based analysis, we also discuss a number of c aveats regarding our results.
AUTHORS: Chung, Hess; Gagnon, Etienne; Nakata, Taisuke; Paustian, Matthias; Schlusche, Bernd; Trevino, James; Vilan, Diego; Zheng, Wei
Speed Limit Policy and Liquidity Traps
The zero lower bound (ZLB) constraint on interest rates makes speed limit policies (SLPs)---policies aimed at stabilizing the output growth---less effective. Away from the ZLB, the history dependence induced by a concern for output growth stabilization improves the inflation-output tradeoff for a discretionary central bank. However, in the aftermath of a deep recession with a binding ZLB, a central bank with an objective for output growth stabilization aims to engineer a more gradual increase in output than under the standard discretionary policy. The anticipation of a more restrained recovery exacerbates the declines in inflation and output when the lower bound is binding.
AUTHORS: Yoo, Paul; Nakata, Taisuke; Schmidt, Sebastian
Optimal Government Spending at the Zero Lower Bound: A Non-Ricardian Analysis
This paper analyzes the implications of distortionary taxation and debt financing for optimal government spending policy in a sticky-price economy where the nominal interest rate is subject to the zero lower bound constraint. Regardless of the type of tax available and the initial debt level, optimal government spending policy in a recession is characterized by an initial increase followed by a reduction below, and an eventual return to, the steady state. The magnitude of variations in the government spending as well as their welfare implications depend importantly on the available tax instrument and the initial debt level.
AUTHORS: Nakata, Taisuke
Conservatism and Liquidity Traps
Appointing Rogoff's (1985) conservative central banker improves welfare if the economy is subject to large contractionary shocks and the policy rate occasionally falls to the zero lower bound (ZLB). In an economy with occasionally binding ZLB constraints, the anticipation of future ZLB episodes creates a trade-off between inflation and output stabilization. As a consequence, inflation systematically falls below target even when the policy rate is above zero. A conservative central banker mitigates this deflationary bias away from the ZLB, improving allocations both at and away from the ZLB through expectations.
AUTHORS: Schmidt, Sebastian; Nakata, Taisuke
Gradualism and Liquidity Traps
Modifying the objective function of a discretionary central bank to include an interest-rate smoothing objective increases the welfare of an economy in which large contractionary shocks occasionally force the central bank to lower the policy rate to its effective lower bound. The central bank with an interest-rate smoothing objective credibly keeps the policy rate low for longer than the central bank with the standard objective function. Through expectations, the temporary overheating of the economy associated with such a low-for-long interest rate policy mitigates the declines in inflation and output when the lower bound constraint is binding. In a calibrated model, we find that the introduction of an interest-rate smoothing objective can reduce the welfare costs associated with the lower bound constraint by more than one-half.
AUTHORS: Nakata, Taisuke; Schmidt, Sebastian
A Promised Value Approach to Optimal Monetary Policy
This paper characterizes optimal commitment policy in the New Keynesian model using a novel recursive formulation of the central bank's infinite horizon optimization problem. In our recursive formulation motivated by Kydland and Prescott (1980), promised inflation and output gap---as opposed to lagged Lagrange multipliers---act as pseudo-state variables. Using three well known variants of the model---one featuring inflation bias, one featuring stabilization bias, and one featuring a lower bound constraint on nominal interest rates---we show that the proposed formulation sheds new light on the nature of the intertemporal trade-off facing the central bank.
AUTHORS: Sunakawa, Takeki; Nakata, Taisuke; Hills, Timothy S.
Reputation and Liquidity Traps
Can the central bank credibly commit to keeping the nominal interest rate low for an extended period of time in the aftermath of a deep recession? By analyzing credible plans in a sticky-price economy with occasionally binding zero lower bound constraints, I find that the answer is yes if contractionary shocks hit the economy with sufficient frequency. In the best credible plan, if the central bank reneges on the promise of low policy rates, it will lose reputation and the private sector will not believe such promises in future recessions. When the shock hits the economy sufficiently frequently, the incentive to maintain reputation outweighs the short-run incentive to close consumption and inflation gaps, keeping the central bank on the originally announced path of low nominal interest rates.
AUTHORS: Nakata, Taisuke