Research

Working Papers

A Financial Stress Index for a  Small Open Economy: The Australian Case (Working Paper)
with Pedro Gomis-Porqueras (Queensland University of Technology) and Xuan Zhou (Renmin University of China)
We construct a Financial Stress Index (FSI) for a small open economy, which aims to provide clear and timely signals of financial market strains. This can be used in developing appropriate responses to address these adverse events. To do so, we use the principal component framework and apply it to Australian monthly data on interest rates, spreads, exchange rates, house price growth and inflation expectations. Decomposing the index into foreign and domestic components, we find that the foreign factors can explain more than half (57.4%) of our Australian Financial Stress Index (AFSI). To determine the information content of our index, we run a series of Granger causality tests on several economic and financial observables. We also estimate whether including the AFSI can improve the prediction of the different economic and financial outcomes relative to a specification that uses only its own previous data. We find that including the AFSI improves the forecasts for future retail sales growth and bank credit growth. Finally, we show that financial stress can have non-linear effects on bank credit growth. In particular, an increase in financial stress affects credit growth more adversely if AFSI is high. This result further highlights the importance of an accurate and timely measure of financial stress in an economy for researchers and policy makers.

Negative Interest Rates, Capital Flows and Exchange Rates (Working Paper)
This paper develops a dynamic general equilibrium model with two currencies to study the effect of negative interest rates on domestic money demand and exchange rates. Money demand for a currency depends on the relative ratio of the money market rate and the deposit rate of the central bank. If agents choose to hold only domestic currency, a decrease in the deposit rate of the central bank will not affect the exchange rate. If agents choose to hold both currencies, a decrease in the deposit rate will cause an appreciation (depreciation) if the money market rate decreases to a larger (smaller) extent. If agents are subject to bank deposit rates that are sticky below zero, then a decrease of the central bank deposit rate leads to a depreciation of the currency regardless of the size of the effect on the money market rate.

On the Negatives of Negative Interest Rates and the Positives of Exemption Thresholds (Working Paper)
with Aleksander Berentsen (University of Basel and FRB of St. Louis) and Hugo van Buggenum (ETH Zürich)
Major central banks remunerate reserves at negative interest rates and it is increasingly likely that they will keep rates negative for many more years. To study the long run implications of negative rates, we construct a dynamic general equilibrium model with commercial banks funding investment projects and a central bank issuing reserves. Negative rates distort investment decisions resulting in lower output and welfare. These findings sharply contrast the short-run expansionary effects ascribed to negative rate policies by most of the existing literature. Negative rates also reduce commercial bank profitability. Exempting a fraction of reserves from negative rates can resolve profitability concerns without affecting the central bank's ability to control the money market rate. However, exemption thresholds do no mitigate the investment distortions created by negative rates.

Work in Progress

Negative Interest Rates  and Bank Lending Rates (Link)
This paper studies the effects of negative interest rates on bank lending rates in a dynamic general equilibrium model. I find that a decrease in the interest rate on excess reserves leads to a decrease in lending rates for unconstrained banks but to increasing lending rates for constrained banks, leading to a larger dispersion of lending rates. There exists furthermore a compositional channel as a change in the policy rate affects the share of constrained and unconstrained banks in the economy. Lastly, the level of competition in the bank lending sector crucially affects average lending rates and their dispersion. In my numerical analysis I find that a decrease in the interest rate on excess reserves leads to increasing average lending rates.

Stop Believing in Reserves
with Sriya Anbil (Federal Reserve Board),  Alyssa Anderson (Federal Reserve Board) and Ethan Cohen (Federal Reserve Board)
The deposit channel of monetary policy is well understood when the Federal Reserve (Fed) tightens monetary policy by raising interest rates. Shadow banks increase their investment yields in response to rising interest rates more than banks, so deposits flow from banks to shadow banks. However, the deposit effects of tightening through the Fed’s balance sheet are not as clear. Using a structural model of bank reserve demand and lending, the deposit market, and the repurchase (repo) market, we show that deposits also flow to shadow banks when the Fed tightens monetary policy by reducing the size of its balance sheet. Then, shadow banks lend out these deposits in the repo market to meet increased funding demand. In contrast, when the Fed’s balance sheet is large and the Fed tightens through interest rates, shadow banks invest their new deposits at the Fed rather than in the repo market. We show that the size of the Fed’s balance sheet is constrained by both banks’ demand for reserves and by the capacity of the repo market, and therefore, an ample reserves monetary policy framework must also consider the demand for cash by shadow banks.