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  5. Channels of Monetary Policy Transmission
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Channels of Monetary Policy Transmission

Paper Session

Friday, Jan. 6, 2023 10:15 AM - 12:15 PM (CST)

Hilton Riverside, Grand Salon C Sec 16
Hosted By: American Economic Association
  • Chair: Ron Mau, University of Mississippi

Identifying Channels of Macroeconomic Shock Propagation

Pascal Paul
,
Federal Reserve Bank of San Francisco
Kilian Huber
,
University of Chicago
Christian Wolf
,
Massachusetts Institute of Technology

Abstract

We provide two empirical strategies that allow researchers to decompose the aggregate causal effects of macroeconomic shocks into their underlying channels of transmission. Our first contribution is to define what we mean by a “channel of transmission”. We offer two such definitions, distinguished by whether or not they also take into account higher-order general equilibrium effects. Our first empirical strategy that is free of such effects relies on a combination of separately identified pieces of micro- and macro-level quasi-experimental variation. We apply it to several classic channels of monetary policy transmission, finding evidence for the quantitative importance of income and credit channels, but limited support for a collateral channel. Our second strategy instead relies on time series macro quasi-experimental variation alone. This strategy is a refinement of the popular practice of “zeroing-out” coefficients in Vector Autoregressions, and correctly identifies our second channel concept that is inclusive of higher-order general equilibrium effects. We use the approach to establish that asset price channels are quantitatively important in monetary transmission to household consumption.

A Reassessment of Monetary Policy Surprises and High-Frequency Identification

Michael Bauer
,
University of Hamburg
Eric Swanson
,
University of California-Irvine

Abstract

High-frequency changes in interest rates around FOMC announcements are an important tool for identifying the effects of monetary policy on asset prices and the macroeconomy. However, some recent studies have questioned both the exogeneity and the relevance of these monetary policy surprises as instruments,
especially for estimating the macroeconomic effects of monetary policy shocks. For example, monetary policy surprises are correlated with macroeconomic and financial data that is publicly available prior to the FOMC announcement. We address these concerns in two ways: First, we expand the set of monetary policy announcements to include speeches by the Fed Chair, which doubles the number and importance of announcements; Second, we explain the predictability of the monetary policy surprises in terms of the “Fed response to news” channel of Bauer and Swanson (2021) and account for it by orthogonalizing the surprises with respect to macroeconomic and financial data that pre-date the announcement. Our subsequent reassessment of the effects of monetary policy yields two key results: First, estimates of the high-frequency effects on asset prices are largely unchanged; Second, estimates of the effects on the macroeconomy are substantially larger and more significant than what previous studies using high-frequency data have typically found.

China's Monetary Transmission and Systemic Risk: A Role of Interbank Bond Markets

Kaiji Chen
,
Emory University and Federal Reserve Bank of Atlanta
Tao Zha
,
Federal Reserve Bank of Atlanta, Emory University, and NBER
Yiqing Xiao
,
Peking University

Abstract

Recently, the debt problem of China property giant Evergrande has threatened China's financial stability, and especially the soundness of its banking system, which have been heavily exposed to Evergrande's debt. How does China's banking system facilitate the transmission of monetary policy into the real economy (e.g., the real estate sector) and what are the general implications for China's financial stability? By constructing a bank-panel dataset, we find that wholesale funding via interbank bond markets not only facilitates policy interest rates to transmit into loan by non-state banks, but also leads to fast growth in their financial fragility as an unintended consequence. Accordingly, non-state banks with a heavier exposure to wholesale funding witness a larger increase in systemic risks in response to negative shocks to the economy since 2018. We advance a theoretical explanation of our empirical findings and quantify the trade-off of banking regulation on wholesale funding between the effectiveness of monetary policy transmission and exposure to systemic risks within this framework.

Foreign Institutional Investors, Monetary Policy, and Reaching for Yield

Boris Hofmann
,
Bank for International Settlements
Ahmed Ahmed
,
University of Chicago
Martin Schmitz
,
European Central Bank

Abstract

This paper uses a unique security-level data set to demonstrate that foreign institutional investors shift their U.S. corporate bond portfolios toward bonds with higher credit spreads when U.S. monetary policy tightens, which reflects institutional factors related to nominal return targets and foreign exchange hedging strategies. Foreign institutional investors in low-yielding jurisdictions are unable to meet their return target by only investing in their home bond market. To close this return gap, they increase their exposure to higher yielding USD-denominated bonds. However, due to regulatory requirements and internal risk management, they hedge against foreign exchange risk. To take advantage of the yield differential, they invest in long-term USD bonds while hedging the foreign exchange risk through short-term swaps on a rolling basis. This makes the shape of the USD yield curve the key factor for the hedged return on their USD-denominated bonds, especially given the persistent premium to access the USD in the swap market since 2008. When U.S. monetary policy tightens, the USD yield curve flattens, erasing the yield differential once the cost of hedging is applied. As a result, to improve returns on USD-denominated bonds, foreign institutional investors need to take more credit risk. This behavior has meaningful effects on corporate bond prices and issuances.
JEL Classifications
  • E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit