Integrating Monetary Policy and Financial Stability: A New Framework
Since the aftermath of the Global Financial Crisis during 2007-2008, financial stability (FS) has become top priority for central banks around the world. The conduct of monetary policy (MP) sees no exception. By leveraging on the existing literature, we propose a systematic approach to incorporate FS considerations into MP framework. This starts with calculating a financial cycle (FC) which is a measure of financial imbalances and a predictor of financial crises. We then look at an FS dashboard which consolidates pockets of risks facing the financial sector, and show how it may be used in FS surveillance. Next, we discuss the concept of model development and introduce an example of a model platform to facilitate MP formulation. Nevertheless, when implementing MP to address FS risks, policymakers encounter an inter-temporal trade-off between financial and price stability. A key challenge towards MP decision-making is, therefore, to strike a balance between both mandates by designing the appropriate policy mix between monetary and macroprudential policies. As a demonstration of our approach, we discuss, in each section, an on-going attempt at the Bank of Thailand to systematically incorporate FS into flexible inflation targeting.
What Anchors for the Natural Rate of Interest?
The paper takes a critical look at the conceptual and empirical underpinnings of prevailing explanations of low real (inflation-adjusted) interest rates over long horizons and finds them incomplete. The role of monetary policy, and its interaction with the financial cycle in particular, deserve greater attention. By linking booms and busts, the financial cycle generates important path dependencies that give rise to intertemporal policy trade-offs. Policy today constrains policy tomorrow. The policy regime is not neutral and can exert a persistent influence on the economy’s evolution, including on the real interest rate. This raises serious conceptual and practical questions about the use of the natural interest rate as a monetary policy guidepost. In developing the analysis, the paper also provides a specific critique of the safe asset shortage hypothesis – a hypothesis that has gained considerable popularity in recent years.
Bank Profitability and Risk-Taking in a Low Interest Rate Environment: The Case of Thailand
This paper studies the effects of monetary policy on the bank profitability and risk-taking. Using banklevel and account-level data sets of Thai banks during the period 2004-2017, we find that lower interest rates tend to reduce profitability. The effect works mainly through the impact of the interest rates on bank net interest income. At the bank level we find limited evidence of increased riskiness in the overall balance sheet of Thai banks when interest rates are low. However, the account-level results from a duration analysis suggest that low rates may lead to higher loan default risk and lower loan quality for long-term loans, particularly those in the portfolio of small and medium banks. Small firms seem to be more affected by bank risk-taking behavior. We also find that when the interest rate remains low for a protracted period, this tends to further increase bank risk-taking in new loans, though it helps lower the default risk for existing loans. The findings overall point to the potential unintended consequences of a low-for-long monetary policy accommodation with implications on financial stability.
Thai Inflation Dynamics: A View from Micro CPI Data
This paper examines the patterns of price adjustment at the micro level in order to further our understanding of price rigidity at the aggregate level. We highlight 5 stylized facts: 1) Prices change infrequently with a mean duration of approximately 4 to 7 months between price changes; 2) Price decreases are common accounting for roughly 45 percent of all price changes; 3) Price changes, both increases and decreases, are sizable compared to the prevailing in ation rate; 4) The size of price changes covaries strongly with the rate of in ation, whereas the fraction of items changing prices does not; and 5) There is signicant dispersion in price levels as well as in the synchronicity of price changes across geographical regions. Based on a dynamic factor model, we also utilize prices at the disaggregated level to perform an in ation decomposition to understand the underlying driving factors of in ation. The key ndings are: 1) Prices at the micro level are driven mainly by idiosyncratic shocks but these shocks become less important for CPI in ation at the aggregate level; 2) Pure in ation which drives long-term price movements in Thailand is responsible for approximately 10 percent of overall price movements; 3) More than half of all within-quarter uctuations can be classied as relative price changes in response to aggregate shocks; 4) The short-run in ation-output tradeoff which appears weak in aggregate data becomes much stronger once volatile idiosyncratic price changes are removed.
Why So Low for So Long? A long-term View of Real Interest Rates
Prevailing explanations of the decline in real interest rates since the early 1980s are premised on the notion that real interest rates are driven by variations in desired saving and investment. But based on data stretching back to 1870 for 19 countries, our systematic analysis casts doubt on this view. The link between real interest rates and saving-investment determinants appears tenuous. While it is possible to find some relationships consistent with the theory in some periods, particularly over the last 30 years, they do not survive over the extended sample. This holds both at the national and global level. By contrast, we find evidence that persistent shifts in real interest rates coincide with changes in monetary regimes. Moreover, external influences on countries’ real interest rates appear to reflect idiosyncratic variations in interest rates of countries that dominate global monetary and financial conditions rather than common movements in global saving and investment. All this points to an underrated role of monetary policy in determining real interest rates over long horizons.
Distributional Effects of Monetary Policy on Housing Bubbles: Some Evidence
Empirical asset pricing has always considered housing only as an investment good. This paper explores empirically the effect of monetary policy on housing bubbles when there exists a duality in housing markets: invest (own) vs. consume (rent). Using both simple and time-varying structural vector autoregression (SVAR and TVC-SVAR) with the U.S. housing market data between 1983-2017, this paper studies monetary transmission separately in the homeowners’ market and the renters’ market. Major findings are: (i) house price is sticky in that it takes more than 2.5 years for the full impact of monetary policy to occur; (ii) there is heterogeneity in the two housing markets: house price dynamic is more consistent with its fundamental in the renters’ market rather than in the homeowners’ market. This suggests that the two markets differ in their vulnerability to housing bubbles. (iii) monetary policy can play a useful role in stabilizing housing bubbles. Results are robust to alternative identifications of monetary policy shock.
Monetary Policy, the Financial Cycle and Ultra-low Interest Rates
Do the prevailing unusually and persistently low real interest rates reflect a decline in the natural rate of interest as commonly thought? We argue that this is only part of the story. The critical role of financial factors in influencing medium-term economic fluctuations must also be taken into account. Doing so for the United States yields estimates of the natural rate that are higher and, at least since 2000, decline by less. As a result, policy rates have been persistently and systematically below this measure. Moreover, we find that monetary policy, through the financial cycle, has a long-lasting impact on output and, by implication, on real interest rates. Therefore, a narrative that attributes the decline in real rates primarily to an exogenous fall in the natural rate is incomplete. The influence of monetary and financial factors should not be ignored. Exploiting these results, an illustrative counterfactual experiment suggests that a monetary policy rule that takes financial developments systematically into account during both good and bad times could help dampen the financial cycle, leading to higher output even in the long run.
More Than Words: A Textual Analysis of Monetary Policy Communication
This paper employs various tools from computational linguistics to monetary policy statements to gain exploratory insights into the nature of central bank communication. The sample was taken from a wide array of central banks, covering major central banks and others under the inflation-targeting (IT) regime, from 2000 to 2015. Three major aspects of communication were examined in this study, namely (i) readability – the ease with which a reader can understand a written text, (ii) topics – the key themes that are discussed in the policy statements, and (iii) tones – how positive/negative the outlook is in the central bank’s language assessment.
Trend Inflation Estimates for Thailand from Disaggregated Data
This paper constructs a new trend inflation measure for Thailand based on the multivariate unobserved components model with stochastic volatility and outlier adjustments (MUCSVO) of Stock and Watson (2015). Similar to core inflation, the MUCSVO constructs a measure of the underlying trend based on disaggregated data, but with time-varying sectoral weights that vary with the volatility, persistence and co-movement of the sectoral inflation series. Based on the empirical results, the majority of sectoral weights show significant time-variation, in contrast to their relatively stable expenditure shares. Volatile food and energy sectors that are typically excluded from core inflation measures also turn out to be less volatile, more persistent and explain approximately 10 percent of filtered trend inflation rate movements. Compared to various other trend inflation measures, we show that the MUCSVO delivers trend estimates that are smoother, has narrower confidence bands, and are able to forecast 8 quarter-ahead average inflation more accurately both in-sample and out-of-sample, especially in the post 2000 period.
Monetary Policy, Bank Lending and Corporate Investment
The purpose of this study is to shed light on the chain of causality from macroeconomic financial policy to the microeconomic investment function. Concretely, we aim to provide an in-depth analysis of the relationships between the monetary policy of central banks, the loan policy of commercial banks, and the investment behavior of firms. We focus on countries that conduct their monetary policy under the inflation-targeting framework. Our empirical analysis with data from Germany, Switzerland and Thailand provides several new insights. First, after controlling for the US monetary policy, the monetary policy in Germany and Thailand appears to influence the banks’ lending rate in the short run (i.e. within two months), whereas the monetary policy in Switzerland seems to be ineffective at influencing the banks’ lending rate in the short run. Second, our results show that the banks’ lending rate has a negative effect on their loans and that this negative effect is weakened by their growth opportunities. Third, we find that the supply of bank loans plays a more pivotal role in determining firms’ investment than the lending rate. Last but not least, we document that neither the lending rate nor the loan-to-assets ratio moderates the sensitivity of the firms’ investment to growth opportunities.