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Working Paper
Interbank Markets and Banking Crises: New Evidence on the Establishment and Impact of the Federal Reserve
This paper examines the impact of the Federal Reserve?s founding on seasonal pressures and contagion risk in the interbank system. Deposit flows among classes of banks were highly seasonal before 1914; amplitude and timing varied regionally. Panics interrupted normal flows as banks throughout the country sought funds from the central money markets simultaneously. Seasonal pressures and contagion risk in the system were lower by the 1920s, when the Fed provided seasonal liquidity and reserves. Panics returned in the 1930s, due in part to shocks from nonmember banks and because the Fed?s decentralized structure hampered a vigorous response to national crises.
AUTHORS: Carlson, Mark A.; Wheelock, David C.
DATE: 2015-11-01

Working Paper
Three Scenarios for Interest Rates in the Transition to Normalcy
This article develops time-series models to represent three alternative, potential monetary policy regimes as monetary policy returns to normal. The first regime is a return to the high and volatile inflation rate of the 1970s. The second regime, the one that most Federal Reserve officials and business economists expect, is a return to the credible low inflation policy that characterized the U.S. economy from 1983 to 2007, a period that has come to be known as the Great Moderation. The third regime is one in which policymakers decide to keep policy interest rates at or near zero for the foreseeable future. Japanese data are used to estimate this regime. These time-series models include four variables, per capita GDP growth, CPI inflation, the policy rate and the 10-year bond rate. These models are used to forecast the U.S. economy from 2008 through 2013 and represent the possible outcomes for interest rates that may follow the return of monetary policy to normal. Here, normal depends on the policy regime that follows the liftoff of the federal funds rate target that is expected in mid-2015.
AUTHORS: Cooke, Diana A.; Gavin, William T.
DATE: 2014-10-03

Working Paper
The Value of Constraints on Discretionary Government Policy
This paper investigates how institutional constraints discipline the behavior of discretionary governments subject to an expenditure bias. The focus is on constraints implemented in actual economies: monetary policy targets, limits on the deficit and debt ceilings. For a variety of aggregate shocks considered, the best policy is to impose a minimum primary surplus of about half a percent of output. Most welfare gains from constraining government behavior during normal times, which to a large extent is sufficient to discipline policy in adverse times. Monetary policy targets are not generally desirable as they hinder the ability of governments to smooth distortions. Allowing for the effective use of inflation during transitions is a key component of good institutional design. Debt ceilings are benign, but always dominated by deficit constraints. More pre-commitment to government actions is ineffective in curbing inefficiently high public expenditure.
AUTHORS: Martin, Fernando M.
DATE: 2016-02-27

Working Paper
Money, Banking and Financial Markets
The fact that money, banking, and financial markets interact in important ways seems self-evident. The theoretical nature of this interaction, however, has not been fully explored. To this end, we integrate the Diamond (1997) model of banking and financial markets with the Lagos and Wright (2005) dynamic model of monetary exchange?a union that bears a framework in which fractional reserve banks emerge in equilibrium, where bank assets are funded with liabilities made demandable in government money, where the terms of bank deposit contracts are affected by the liquidity insurance available in financial markets, where banks are subject to runs, and where a central bank has a meaningful role to play, both in terms of inflation policy and as a lender of last resort. Among other things, the model provides a rationale for nominal deposit contracts combined with a central bank lender-of-last-resort facility to promote efficient liquidity insurance and a panic-free banking system.
AUTHORS: Andolfatto, David; Berentsen, Aleksander; Martin, Fernando M.
DATE: 2017-08-03

Working Paper
Debt and Stabilization Policy: Evidence from a Euro Area FAVAR
The Euro-area poses a unique problem in evaluating policy: a currency union with a shared monetary policy and country-specific fiscal policy. Analysis can be further complicated if high levels of public debt affect the performance of stabilization policy. We construct a framework capable of handling these issues with an application to Euro-Area data. In order to incorporate multiple macroeconomic series from each country but, simultaneously, treat country-specific fiscal policy, we develop a hierarchical factor-augmented VAR with zero restrictions on the loadings that yield country-level factors. Monetary policy, then, responds to area-wide conditions but fiscal policy responds only to its country level conditions. We find that there is broad quantitative variation in different countries'' responses to area-wide monetary policy and both qualitative and quantitative variation in responses to country-specific fiscal policy. Moreover, we find that debt conditions do not diminish the effectiveness of policy in a significant manner, suggesting that any negative effects must come through other channels.
AUTHORS: Jackson, Laura E.; Owyang, Michael T.; Zubairy, Sarah
DATE: 2017-07-27

Working Paper
Banking on the Boom, Tripped by the Bust: Banks and the World War I Agricultural Price Shock
How do banks respond to asset booms? This paper examines i) how U.S. banks responded to the World War I farmland boom; ii) the impact of regulation; and iii) how bank closures exacerbated the post-war bust. The boom encouraged new bank formation and balance sheet expansion (especially by new banks). Deposit insurance amplified the impact of rising crop prices on bank portfolios, while higher minimum capital requirements dampened the effects. Banks that responded most aggressively to the asset boom had a higher probability of closing in the bust, and counties with more bank closures experienced larger declines in land prices.
AUTHORS: Jaremski, Matthew; Wheelock, David C.
DATE: 2017-11-03

Working Paper
Flight to What? — Dissecting Liquidity Shortages in the Financial Crisis
We endogenize the liquidity and the quality of private assets in a tractable incomplete-market model with heterogeneous agents. The model decomposes the convenience yield of government bond into a "liquidity premium" (flight to liquidity) and a "safety premium" (flight to quality) over the business cycle. When calibrated to match the U.S. aggregate output fluctuations and bond premiums, the model reveals that a sharp reduction in the quality, instead of the liquidity, of private assets was the culprit of the recent financial crisis, consistent with the perception that it was the subprime mortgage problem that triggered the Great Recession. Since the provision of public liquidity endogenously affects the provision of private liquidity, our model indicates that excessive injection of public liquidity during financial crisis can be welfare reducing under either conventional or unconventional policies. In particular, too much intervention for too long can depress capital investment.
AUTHORS: Dong, Feng; Wen, Yi
DATE: 2017-08-01

Working Paper
An Analysis of the Literature on International Unconventional Monetary Policy
This paper critically evaluates the literature on international unconventional monetary policies. We begin by reviewing the theories of how such heterogeneous policies could work. Empirically, event studies provide compelling evidence that international asset purchase announcements have strongly influenced international bond yields, exchange rates, and equity prices in the desired manner and curtailed market perceptions of extreme events. Calibrated modeling and vector autoregressive (VAR) exercises imply that these policies significantly improved macroeconomic outcomes, raising output and prices. Central bankers give a measured, positive assessment to most unconventional monetary policy. Despite qualified successes, we recommend that central banks reserve these policies for financial crises and/or times when the zero bound constrains conventional monetary policy.
AUTHORS: Bhattarai, Saroj; Neely, Christopher J.
DATE: 2016-11-28

Working Paper
The stimulative effect of forward guidance
This paper examines the stimulative effect of central bank forward guidance?the promise to keep future policy rates lower than its policy rule suggests?when the short-term nominal interest rate is stuck at its zero lower bound (ZLB).We utilize a standard New Keynesian model in which forward guidance enters our model as news shocks to the monetary policy rule. Three key findings emerge: (1) Forward guidance is more stimulative at the ZLB when households believe the economic recovery will be strong. When households expect a weak recovery or initially have low confidence in the economy, forward guidance is less stimulative because interest rates are already expected to remain low; (2) Longer forward guidance horizons do not cause the stimulative effect to explode or reverse, but rather spread the effect across the entire horizon; and (3) Failing to include a ZLB constraint causes the model to substantially overstate the stimulative effect of forward guidance. Given those findings, we use Blue Chip survey data to compare our model?s predictions of the stimulative effect of forward guidance to data before and after the Fed?s historic policy announcement on August 9, 2011. The results in that case study provide an explanation for the Forward Guidance Puzzle?the claim that New Keynesian models overestimate the effect of forward guidance.
AUTHORS: Gavin, William T.; Keen, Benjamin D.; Richter, Alexander W.; Throckmorton, Nathaniel
DATE: 2013

Working Paper
Chinese Foreign Exchange Reserves, Policy Choices and the U.S. Economy
China is both a major trading partner of the United States and the largest official holder of U.S. assets in the world. The value of Chinese foreign exchange reserves peaked at just over $4 trillion in June 2014, but has since declined to $3.19 trillion as of August 2016. This very large decline is in foreign exchange reserves is unprecedented and some analysts have speculated that continued sales of these (mostly U.S.) assets might significantly impact the U.S. and global economies. This article explains the reasons for this large decline in official assets, what China?s policy choices are, and how these choices could affect the U.S. economy.
AUTHORS: Neely, Christopher J.
DATE: 2017-01-09

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