Central banks

FEDS Paper: Government-Sponsored Mortgage Securitization and Financial Crises

01/19/2024 Federal Reserve Central banks

Wayne Passmore and Roger SparksThis paper analyzes a model of the mortgage market, considering scenarios with and without government-sponsored mortgage securitization. Conventional wisdom says that securitization, by fostering diversification and creating a “safe” asset in the form of mortgage-backed security (MBS), will reduce risk and enhance liquidity, thereby mitigating financial crises. We construct a strategic-game framework to model the interaction between the securitizer and banks.

Insurance corporations’ balance sheets, financial stability and monetary policy

01/17/2024 European Central Bank Central banks

The euro area insurance sector and its relevance for real economy financing have grown significantly over the last two decades. This paper analyses the effects of monetary policy on the size and composition of insurers’ balance sheets, as well as the implications of these effects for financial stability. We find that changes in monetary policy have a significant impact on both sector size and risk-taking.

Granular shocks to corporate leverage and the macroeconomic transmission of monetary policy

01/17/2024 European Central Bank Central banks

We study how shocks to corporate leverage alter the macroeconomic transmission of monetary policy. We identify leverage shocks as idiosyncratic firm-level disturbances that are aggregated up to a size-weighted country-level average to generate a Granular Instrumental Variable (Gabaix and Koijen, forthcoming). Interacting this instrumental variable with high-frequency identified monetary policy shocks, we find that transmission to the price level strengthens in the presence of leverage shocks, while the real effects of monetary policy are unaffected.

FEDS Paper: A Field Guide to Monetary Policy Implementation Issues in a New World with CBDC, Stablecoin, and Narrow Banks

01/16/2024 Federal Reserve Central banks

James A. ClouseThis paper develops an analytical framework aimed at shedding light on the implications of the evolution of financial market structure for monetary policy implementation and transmission. The basic model builds on that developed in Chen et. al. (2014) which, in turn, draws inspiration from the pioneering work of Tobin (1969) and Gurley and Shaw (1960).

Firm heterogeneity, capital misallocation and optimal monetary policy

01/16/2024 European Central Bank Central banks

This paper analyzes the link between monetary policy and capital misallocation in a New Keynesian model with heterogeneous firms and financial frictions. In the model, firms with a high return to capital increase their investment more strongly in response to a monetary policy expansion, thus reducing misallocation. This feature creates a new time-inconsistent incentive for the central bank to engineer an unexpected monetary expansion to temporarily reduce misallocation. However, price stability is the optimal timeless response to demand, financial or TFP shocks.

Monetary-fiscal policy interactions when price stability occasionally takes a back seat

01/16/2024 European Central Bank Central banks

What are the macroeconomic consequences of a government that is limited in its willingness or ability to raise primary surpluses, and a central bank that accommodates its interest-rate policy to the fiscal conditions? I address this question in a dynamic stochastic sticky-price model with endogenous shifts between an “orthodox” and a “fiscally-dominant” policy regime. The risk of future regime shifts has encompassing effects on equilibrium.

Central bank digital currency: when price and bank stability collide

01/15/2024 European Central Bank Central banks

This paper shows the existence of a central bank trilemma. When a central bank is involved in financial intermediation, either directly through a central bank digital currency (CBDC) or indirectly through other policy instruments, it can only achieve at most two of three objectives: a socially eÿcient allocation, financial stability (i.e., absence of runs), and price stability. In particular, a commitment to price stability can cause a run on the central bank. Implementation of the socially optimal allocation requires a commitment to inflation.

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