Monetary Economics

Members of the NBER's Monetary Economics Program met March 8 in the Federal Reserve Bank of Chicago. Faculty Research Fellow David W. Berger of Northwestern University, Research Associate Giorgio Primiceri of Northwestern University, and Program Directors Emi Nakamura and Jón Steinsson, both of University of California, Berkeley organized the meeting . These researchers' papers were presented and discussed:

Jasmine Xiao, University of Notre Dame

Borrowing to Save and Investment Dynamics

Existing literature on financial frictions argue that firms reduce investment in a crisis due to a lack of credit. However, U.S. public firms, which together accounted for 89 percent of the decline in investment during the Great Recession, experienced no drop in borrowing. Instead of investing, they borrowed to expand their stock of safe assets -- that is, they borrowed to save. Xiao models borrowing to save as an optimal portfolio choice when firms face gradually resolving uncertainty. In a quantitative general equilibrium model with heterogeneous firms, Xiao shows that this mechanism can simultaneously generate a sharp downturn and a slow recovery.

Gauti B. Eggertsson, Brown University and NBER; Ella Wold, Brown University; Ragnar Juelsrud, BI Norwegian Business School; and Lawrence H. Summers, Harvard University and NBER

Negative Nominal Interest Rates and the Bank Lending Channel

Following the crisis of 2008, several central banks engaged in a new experiment by setting negative policy rates. Using aggregate and bank level data, Eggertsson, Wold, Juelsrud, and Summers document that deposit rates stopped responding to policy rates once they went negative and that bank lending rates in some cases increased rather than decreased in response to policy rate cuts. Based on the empirical evidence, the researchers construct a macro-model with a banking sector that links together policy rates, deposit rates and lending rates. Once the policy rate turns negative, the usual transmission mechanism of monetary policy through the bank sector breaks down. Moreover, because a negative policy rate reduces bank profits, the total effect on aggregate output can be contractionary. A calibration which matches Swedish bank level data suggests that a policy rate of -0.50 percent increases borrowing rates by 15 basis points and reduces output by 7 basis points.

Pierpaolo Benigno, LUISS Guido Carli

Interest Rate and Prices in a World of Cryptocurrencies

Benigno studies whether currency competition can destabilize central banks'control of interest rates and prices? Yes, it can. In a two-currency world, the growth rate of cryptocurrency sets a lower bound on the nominal interest rate and the attainable inflation rate. In a world of multiple competing currencies issued by profit maximizing agents, the central bank completely loses control of the nominal interest rate and the inflation rate, which are both determined by structural factors, and thus not subject to manipulation, a result welcomed by the proponents of currency competition. The research also proposes some fixes for the classical problem of indeterminacy of exchange rates.

Gabriel Chodorow-Reich and Gita Gopinath, Harvard University and NBER; Prachi Mishra, Goldman Sachs; and Abhinav Narayanan, Reserve Bank of India

Cash and the Economy: Evidence from India's Demonetization (NBER Working Paper No. 25370)

Chodorow-Reich, Gopinath, Mishra, and Narayanan analyze a unique episode in the history of monetary economics, the 2016 Indian "demonetization.'' This policy made 86% of cash in circulation illegal tender overnight, with new notes gradually introduced over the next several months. The researchers present a model of demonetization where agents hold cash both to satisfy a cash-in-advance constraint and for tax evasion purposes. They test the predictions of the model in the cross-section of Indian districts using several novel data sets including: a data set containing the geographic distribution of demonetized and new notes for causal inference, nightlights data and employment surveys to measure economic activity including in the informal sector, debit/credit cards and e-wallet transactions data, and banking data on deposit and credit growth. Districts experiencing more severe demonetization had relative reductions in economic activity, faster adoption of alternative payment technologies, and lower bank credit growth. The cross-sectional responses cumulate to a contraction in employment and nightlights-based output due to demonetization of 2 percentage points and of bank credit of 2 percentage points in 2016Q4 relative to their counterfactual paths, effects which dissipate over the next few months. The researchers use their model to show these cumulated effects are a lower bound for the aggregate effects of demonetization. They conclude that unlike in the cashless limit of new-Keynesian models, in modern India cash serves an essential role in facilitating economic activity.

Stefano Giglio, Yale University and NBER; Matteo Maggiori, Harvard University and NBER; Johannes Stroebel, New York University and NBER; and Stephen Utkus, Vanguard

Five Facts about Beliefs and Portfolios

Giglio, Maggiori, Stroebel, and Utkus administer a newly-designed survey to a large panel of individual investors who have substantial wealth invested in financial markets. The survey elicits beliefs that are crucial for macroeconomics and finance, and matches respondents with administrative data on their portfolio composition and their trading activity. The researchers establish five facts in this data. (1) Beliefs are reflected in portfolio allocations. The sensitivity of portfolios to beliefs is small on average, but varies significantly with investor wealth, attention, trading frequency, and confidence. (2) It is hard to predict when investors trade, but conditional on trading, belief changes affect both the direction and the magnitude of trades. (3) Beliefs are mostly characterized by large and persistent individual heterogeneity, demographic characteristics struggle to explain why some individuals are optimistic and some are pessimistic. (4) Investors disagree about both expected cash flows and discount rates. At the investor level, higher expected cash flows are associated with higher discount rates. (5) Expected returns and the probability of rare disasters are negatively related. These results challenge the rational expectation framework for macro-finance, and provide important guidance for the design of behavioral models.

Carlo Altavilla and Frank Smets, European Central Bank; Miguel Boucinha, European Central Bank; and Jose-Luis Peydro, Universitat Pompeu Fabra

Banking Supervision, Monetary Policy and Risk-Taking: Big Data Evidence from 15 Credit Registers

Altavilla, Boucinha, Peydro, and Smets analyse the role of banking supervision for banks' risk-taking behaviour, and its interactions with monetary policy. They exploit a new, proprietary dataset based on 15 European credit registers, in conjunction with the centralization of bank supervision for some banks at the supranational level, over a period of unprecedented monetary policy action. The researchers find that: (1) banks with higher ex-ante non-performing loans (NPL) supply more credit toward riskier firms, with identical effects for banks headquartered in stressed and nonstressed countries. Results are identical to considering a measure of NPL that excludes the borrower's industry, and also to the inclusion of a large set of controls, such as borrower-lending matching and time-varying unobserved borrower and lender fundamentals that explain 70 percentage points of the R-squared, thereby suggesting strong exogeneity of the results to credit demand and other bank characteristics, (2) For banks operating in stressed countries only, centralized supervision compresses lending to riskier firms, although by a smaller extent for banks with higher NPL. Effects are similar if the researchers include only banks around the threshold of eligibility for centralized supervision, and effects are only significant after the centralization of supervision, (3) Monetary policy easing increases bank risk-taking, but only in stressed countries this is partly offset by centralized supervision, with weaker effects for banks with higher NPLs. Overall, the results show that leveraging on multiple credit registers as done in this paper for the first time is crucial for analyzing heterogeneous effects and for the external validity.

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