What Has Publishing Inflation Forecasts Accomplished? Central Banks and Their Competitors

This chapter explores short-term sources of inflation forecast disagreement in nine advanced economies. Domestic versus global factors among other determinants are considered. The chapter also adapts an idea from the model confidence set approach to obtain a quasi-confidence interval for inflation forecast disagreement. Some forecasters may change their outlook, especially when data are frequently revised (e.g., the output gap). This extension is also considered. Estimates of disagreement are found to be sensitive to the chosen benchmark, and central banks need not always be the benchmark of choice. The range of forecast disagreement can be high even when levels of disagreement are low. There is little evidence that forecasts are strongly coordinated with those of the central bank. Finally, at least over the period considered, which covers the end of the Great Moderation and the global financial crisis, there is consistent evidence that global factors impact forecast disagreement.

Peaks and Troughs

This chapter investigates the endogenous evolution of central bank institutional design over the past four decades. From a theoretical perspective, it employs a stylized political economy model to highlight some key determinants of the level of central bank independence as a function of macroeconomic shocks and political economy characteristics of countries. It then employs recently developed dynamic indices of central bank design to describe the evolution of central bank independence over the period 1972–2014. In a sample of sixty-five countries, it shows that the increasing trend in central bank independence during 1972–2007 has been reversing after the 2008 financial crisis, mainly due to significant changes to the roles of central banks in banking supervision. The authors find that this evolution can be related to several macroeconomic shocks, such as inflationary, fiscal, and exchange-rate shocks.

Central Banks and the New Regulatory Regime for Banks

The most serious global banking crisis in living memory has given rise to one of the most substantial changes in the regulatory regime of banks. While not all central banks have responsibility for regulation, because they are almost universally responsible for systemic stability, they have an interest in bank regulation. Two core objectives of regulation are discussed: lowering the probability of bank failures and minimizing the social costs of failures that do occur. The underlying culture of banking creates business standards and employee attitudes and behavior. There are limits to what regulation can achieve if the underlying cultures of regulated firms are hazardous. There are limits to what can be achieved through detailed, prescriptive, and complex rules, and when, because of what is termed the endogeneity problem, rules escalation raises issues of proportionality, a case is made for banking culture to become a supervisory issue.

Inside the Bank Box

Central bank policy operates first through financial markets and then through banks as they adjust their interest rates. This chapter discusses the transmission of policy in this first step of the monetary transmission mechanism, known as interest-rate pass-through. Historically, the focus of attention has been the interest-rate channel. We show the origins of this channel via a microfounded model of interest-rate setting by deposit-taking institutions that are Cournot oligopolists facing adjustment costs. We then examine other channels such as the bank lending channel and the bank capital channel and the role of central bank communications, signaling, and forward guidance over future interest rates. Each is shown to influence the setting of current short-term interest rates. The chapter closes with some issues for the future of pass-through in the transmission process.

Can the Central Bank Alleviate Fiscal Burdens?

Central banks affect the resources available to fiscal authorities through the impact of their policies on the public debt, as well as through their income, their mix of assets, their liabilities, and their own solvency. This chapter inspects the ability of the central bank to alleviate the fiscal burden by influencing different terms in the government resource constraint. It discusses five channels: (i) how inflation can (and cannot) lower the real burden of the public debt, (ii) how seigniorage is generated and subject to what constraints, (iii) whether central bank liabilities should count as public debt, (iv) how central bank assets create income risk and whether or not this threatens its solvency, and (v) how the central bank balance sheet can be used for fiscal redistributions. Overall, it concludes that the scope for the central bank to lower the fiscal burden is limited.

Monetary Policy Committees and Voting Behavior

In this chapter we suggest to use Bayesian ideal point estimation to analyze voting in monetary policy committees. Using data from the Riksbank we demonstrate what this entails and we compare ideal point estimates with the results from traditional approaches. We end by suggesting possible extensions.

Macroprudential Regulation of Banks and Financial Institutions

Regulation of financial institutions to avoid the worst effects of financial crises has become a major topic of research and a focus of regulators’ efforts. Policies designed to reduce crises’ effects on real GDP and employment are called macroprudential. Moral hazard has been introduced by deposit insurance and bailouts of banks and large financial institutions. Too little is known to premise macroprudential regulation on externalities. That said, higher capital at banks and other institutions counteracts one effect of deposit insurance and would make the financial system more resilient. Living wills are likely not to be time-consistent. Regulators will not have an incentive to use them in a financial crisis. Instead, they will bail out firms to avoid adverse effects on the economy. Institutions determining regulators’ choices in a crisis need to be designed to make it equilibrium behavior for regulators to let financial firms fail.

Central Banking and Prudential Regulation

The financial deregulation in major Western economies in the 1970s and 1980s freed banks from many preexisting constraints, facilitating competition and greater risk-taking and eventually leading to prudential regulation and supervision as a specific, well-defined area of regulatory activity. It was codified in the Basel Accord, which allowed banks considerable discretion in how they met broadly specified regulatory requirements and was focused primarily on individual bank safety. The financial crisis of 2007–2008 highlighted numerous weaknesses in the design and application of this approach. The previous micro-orientation has been complemented by a macroprudential focus, suggesting a strengthened case for central bank involvement in prudential regulation. Microprudential regulation has been strengthened, with changes reflecting less confidence in the previous market-oriented approach and more reliance on direct controls. The wheel has turned such that prederegulation approaches and attitudes have been incorporated into the postcrisis design and approach of prudential regulation.

Open Market Operations

Open market operations are the buying and selling of securities by the central bank. Such operations differ from discount operations in that open market operations are undertaken at the initiative of the central bank rather than a commercial bank. Historically, such trading of securities has predated the setting of interest rates. The emergence of long-term finance and complex financial systems has extended the range of securities in which central banks may deal. Open market operations depend on the policy framework set by the central bank. But such operations are not necessary for the setting of interest rates. Such operations are often undertaken when the monetary transmission mechanism from interest rates appears to have failed, as in the case of recent quantitative easing operations. In general, open market operations have proved effective in times of banking or financial crisis.

Real Estate, Construction, Money, Credit, and Finance

This chapter examines the interactions between real estate markets on the one side and, on the other, interest rates, credit, and financial variables. A simple model is set up to analyze the key ideas, which will yield long run equilibrium values for the housing stock and the price of dwellings. It also shows the path that these variables will take toward the long run equilibrium, provided there are no further shocks, from any initial position of the housing stock. Next, the model is extended to explore complications. The chapter then turns to the recent historical record of the links between real estate and financial crises and to relevant policy issues.