Research

Abstract: This paper studies the role of international investment funds in the transmission of global financial conditions to the euro area using structural Bayesian vector auto regressions. While cross-border banking sector capital flows receded significantly in the aftermath of the global financial crisis, portfolio flows of investors actively searching for yield on financial markets world-wide gained importance during the post-crisis “second phase of global liquidity” (Shin, 2013). The analysis presented in this paper shows that a loosening of US monetary policy leads to higher investment fund inflows to equities and debt globally. Focussing on the euro area, these inflows do not only imply elevated asset prices, but also coincide with increased debt and equity issuance. The findings demonstrate the growing importance of non-bank financial intermediation over the last decade and have important policy implications for monetary and financial stability.

• Abstract: In this paper we use a medium-scale DSGE model to quantitatively assess the macroeconomic stabilisation properties of a supranational unemployment insurance scheme. The model is calibrated to the euro area’s core and periphery and features a rich fiscal sector, sovereign risk premia and labour market frictions. Adopting both simple policy rules and optimal policies for the centralised insurance scheme, our simulations point to enhanced business cycle synchronisation and inter-regional consumption smoothing. The results suggest a sizeable reduction in the volatility of macroeconomic aggregates at the region-level, while the cross-regional correlation of unemployment and inflation increases significantly, compared to the decentralised setting. The higher degree of inter-regional risk-sharing comes at the cost of sizable fiscal transfers. Limiting such transfers via claw-back mechanisms reduces the degree of stabilisation across countries.

Abstract: This paper investigates whether the funding behaviour of euro area debt management offices (DMOs) changed with the start of the ECB’s Public Sector Purchase Programme (PSPP). Our results show that (i) lower yield levels and (ii) PSPP purchases supported higher maturities at issuance. The former indicates a behaviour of "locking in low rates for longer", while the latter suggests the existence of an additional "demand effect" of the PSPP on DMO strategies beyond the PSPP's effect via yields. The combined impact of the PSPP via these channels amounts to maturity extensions at issuance of about one year in our estimation.

Abstract: This paper studies optimal monetary and fiscal policy in a New Keynesian 2-country open economy framework, which is used to assess how far fiscal policy can substitute for the role of nominal exchange rates within a monetary union. Giving up exchange rate flexibility leads to welfare costs that depend significantly on whether the law of one price holds internationally or whether firms can engage in pricing-to-market. Calibrated to the euro area, the welfare costs can be reduced by 86% in the former and by 69% in the latter case by using only one tax instrument per country. Fiscal devaluations can be observed as an optimal policy in a monetary union: if a nominal devaluation of the domestic currency were optimal under flexible exchange rates, optimal fiscal policy in a monetary union is an increase of the domestic relative to the foreign value added tax.

Abstract: Demographic change raises demand for non‐tradable old‐age related services relative to tradable commodities. This demand shift increases the relative price of non‐tradables and thereby causes real exchange rates to appreciate. We claim that the change in demand affects prices via imperfect intersectoral factor mobility. Using a sample of 15 OECD countries, we estimate a robust increase of relative prices. According to our main estimate, up to one fifth of the average increase in relative prices between 1970 and 2009 can be attributed to population ageing. Further findings confirm the relevance of imperfect factor mobility: Countries with more rigid labour markets experience stronger price effects. 

Abstract: We document that compared to all other investor groups investment funds exhibit a distinctly procyclical behavior when financial-market beliefs about the probability of a euro-related, institutional rare disaster spike. In response to such euro disaster risk shocks, investment funds shed periphery but do not adjust core sovereign debt holdings. The periphery debt shed by investment funds is picked up by investors domiciled in the issuing country, namely banks in the short term and insurance corporations and households in the medium term.

Abstract: We explore whether investment funds transmit spillovers from local shocks to financial markets in other economies. As a laboratory we consider shocks to financial-market beliefs about the probability of a rare, euro-related disaster and their spillovers to Asian sovereign debt markets. Given their geographic distance from and relatively limited macroeconomic exposure to the euro area, these markets are an ideal testing ground a priori stacking the deck against finding evidence for investment funds transmitting spillovers from euro disaster risk shocks. Analyzing proprietary security-level holdings data over the period from 2014 to 2023, we find that investment funds strongly shed Asian sovereign debt in response to euro disaster risk shocks. Markets with greater investment-fund presence exhibit considerably larger price spillovers. The main driver of this sell-off is the need to generate liquidity to meet investor redemption demands rather than portfolio rebalancing. Especially market liquidity determines which sovereign debt investment funds shed. Taken together, our findings suggest that due to a flighty investor base investment funds are powerful transmitters of spillovers from local shocks across global financial markets.

Abstract: This paper examines the interplay between macroprudential policy, monetary policy and the non-bank financial intermediation (NBFI) sector, drawing on recent research and zooming in particularly on evidence from the euro area. It documents the growth in the NBFI sector over the past two decades and its particular role in financing the real economy, assesses systemic risks that can emanate from the sector, considers how it interacts with monetary policy, and discusses the implications for macroprudential regulation. Firms are increasingly turning to capital markets for debt financing, with the NBFI sector thereby increasing its provision of credit to the real economy relative to banks. At the same time, the growth of market-based finance has been accompanied by increased liquidity and credit risk in the NBFI sector, together with pockets of high leverage. Monetary policy has also intersected with these dynamics. Recent episodes have shown that vulnerabilities in the NBFI sector can amplify market dynamics and create systemic risk in a highly interconnected financial system. Against this backdrop, the resilience of the NBFI sector should be strengthened, including from a macroprudential perspective, to support financial stability and the smooth transmission of monetary policy. Several open issues and challenges remain for future research and policy making. 

Abstract: 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. Insurers’ balance sheets grow materially after a monetary loosening, implying an increase of the sector’s financial intermediation capacity and an active transmission of monetary policy through the insurance sector. We also find evidence of portfolio re-balancing consistent with the risk-taking channel of monetary policy. After a monetary loosening, insurers increase credit, liquidity and duration risk-taking in their asset portfolios. Our results suggest that extended periods of low interest rates lead to rising financial stability risks among non-bank financial intermediaries. 

Abstract: The investment fund sector, the largest component of the non-bank financial system, is growing rapidly and the economy is becoming more reliant on investment fund financial intermediation. This paper builds a dynamic stochastic general equilibrium model with banks and investment funds. Banks grant loans and issue liquid deposits, which are valuable to households. Funds invest in corporate bonds and may hold liquidity in the form of bank deposits to meet investor redemption requests. Without regulation, funds hold insufficient deposits and must sell bonds when hit by large redemptions. Bond liquidation is costly and eventually reduces investment funds’ intermediation capacity. Even when accounting for side effects due to a reduction of deposits held by households, a macroprudential liquidity requirement improves welfare by reducing bond liquidation and by increasing the economy’s resilience to financial shocks akin to March 2020. 

Abstract: We examine the transmission of monetary policy via the euro area investment fund sector using a BVAR framework. We find that expansionary shocks are associated with net inflows and that these are strongest for riskier fund types, reflecting search for yield among euro area investors. Search for yield behaviour by fund managers is also evident, as they shift away from low yielding cash assets following an expansionary shock. While higher risk-taking is an intended consequence of expansionary monetary policy, this dynamic may give rise to a build-up in liquidity risk over time, leaving the fund sector less resilient to large outflows in the face of a crisis.

Abstract: We provide evidence that liquidity premia on assets that are more relevant for private agents' intertemporal choices than near-money assets increase in response to expansionary forward guidance announcements. We introduce a structural specification of liquidity premia based on assets' differential pledgeability to a basic New Keynesian model to replicate this finding. This model predicts that output and inflation effects of forward guidance do not increase with the length of the guidance period and are substantially smaller than if liquidity premia were neglected. This indicates that there are no puzzling forward guidance effects when endogenous liquidity premia are taken into account.