Research

Research interests: Macroeconomics, Monetary Economics, Banking, and International Finance.

Publications

Assessing the impact of Basel III: Review of transmission channels and insights from policy models (with Olivier De Bandt, Bora Durdu, Hibiki Icihue, Jolan Mohimont, Kalin Nikolov, Sigrid Roehrs, Jean-Guillaume Sahuc, Valerio Scalone and Michael Straughan), International Journal of Central Banking, 2024, Vol . 20 (1), 1-52. Working paper version

Abstract: This paper (i) reviews the different channels of transmission of prudential policy highlighted in the literature and (ii) provides a quantitative assessment of the impact of Basel III reforms using several policy-oriented DSGE models. It shows that the long-term effects on GDP of higher capital requirements are positive when the associated benefits are accounted for in addition to their costs. However, the results crucially depend on assumptions about crisis probability and severity. For liquidity regulations, only models capturing benefits of increased liquidity (e.g., preventing bank runs) show a net benefit.

External Shocks, Banks and Optimal Monetary Policy: A Recipe for Emerging Market Central Banks (with Enes Sunel), International Journal of Central Banking, 2019, Vol. 15 (2), 235-299. Working paper version

Abstract: We document empirically that the 2007-09 Global Financial Crisis exposed emerging market economies (EMEs) to an adverse feedback loop of capital outflows, depreciating exchange rates, deteriorating balance sheets, rising credit spreads and falling real economic activity. In order to account for these empirical findings, we build a New-Keynesian DSGE model of a small open economy with a banking sector that has access to both domestic and foreign funding. Using the calibrated model, we investigate optimal, simple and operational monetary policy rules that respond to domestic/external financial variables alongside inflation and output. The Ramsey-optimal policy rule is used as a benchmark. The results suggest that such optimized rules feature direct and non-negligible responses to lending spreads, the real exchange rate and the US policy rate, together with a mild anti-inflationary policy stance.

Financial Intermediaries, Credit Shocks and Business Cycles, Oxford Bulletin of Economics and Statistics, 2016, Vol. 78 (1), 42-74. Working paper version

Abstract: We document the cyclical properties of aggregate balance sheet variables of the US commercial banks: (i) Bank credits and deposits are less volatile than output, while net worth and leverage ratio are several times more volatile, (ii) bank credits and net worth are procyclical, while deposits, leverage ratio and loan spread are countercyclical. We then present a real business cycle model with a financial sector to investigate how the dynamics of macroeconomic aggregates and balance sheet variables of the US banks are influenced by empirically disciplined shocks to bank networth. Both calibrated and estimated versions of the model show that these financial shocks are important not only for explaining the dynamics of financial flows but also for the dynamics of macroeconomic variables.We find that the recent deterioration in aggregate net worth of the US banking sector contributed significantly to the 2007–09 recession.

On International Consumption Risk Sharing, Financial Integration and Financial Development, Emerging Markets Finance and Trade, 2016, Vol. 52 (5), 1241-1258. Working paper version

Abstract: This article investigates the empirical link between international consumption risk sharing, financial integration, and financial development for a group of twenty-nine developed and developing countries in the G7, the Euro area, and the OECD. Estimation results indicate that (1) risk sharing in the Euro area is higher than those in the G-7 and the OECD, and (2) a higher degree of risk sharing is associated with a greater degree of financial integration and a lower level of financial development. These results suggest that more financially integrated countries might be better able to insure themselves against idiosyncratic income shocks and countries with more developed financial markets might tend to engage in less consumption risk sharing with other countries thanks to their own sophisticated financial markets. Holding financial integration and financial development equal, countries in the Euro area engage in significantly more risk sharing than the ones in the G7 and the OECD.

Cross-sectional Facts on Bank Balance Sheets over the Business Cycle (with O. F. Abbasoğlu and Şerife Genç), Central Bank Review, 2015, Vol. 15, 31-60. Working paper version

Abstract: We investigate the cyclical behavior of commercial banks’ balance sheet variables for different size groups using bank-level Turkish data. We first rank banks based on the size of their assets, and then systematically document business cycle facts of various balance sheet items and profitability measures of different bank groups. We find that the cyclical behavior of these variables is quite heterogeneous at the cross-sectional level: (i) Bottom 25 percent banks finance 30 percent of their assets with equity while for larger banks this ratio is around 12 percent, implying that debt financing is more prevalent for larger banks, (ii) bank assets and credits are highly procyclical and the level of procyclicality is lower for larger banks, (iii) security holdings of small banks are countercyclical whereas those of large banks are procyclical, (iv) total deposits are procyclical except for top 25 percent and equity issuance is acyclical to countercyclical at best, (v) loan spread is strongly countercyclical except for small banks while return on assets and equity are acyclical, and (vi) switching between debt and equity financing is more pronounced for the top 25 percent banks. The rich set of cross-sectional empirical facts about the cyclicality of bank balance sheets presented in this paper should be helpful for researchers to build and evaluate theoretical heterogeneous models about financing sources of banks.

Required Reserves as a Credit Policy Tool (with Enes Sunel and Temel Taşkın), The B.E. Journal of Macroeconomics, 2013, Vol. 13 (1), 823-880. Working paper version

Abstract: This paper quantitatively investigates the role of reserve requirements as a credit policy tool. We build a monetary dynamic stochastic general equilibrium (DSGE) model with a banking sector in which an agency problem between households and banks leads to endogenous capital constraints for the latter. In this setup, a countercyclical required reserves ratio (RRR) rule that responds to expected credit growth is found to countervail the negative effects of the financial accelerator mechanism triggered by productivity and bank capital shocks. Furthermore, it reduces the procyclicality of the financial system compared to a fixed RRR policy regime. The credit policy is most effective when the economy is hit by a financial shock. A time-varying RRR policy reduces the intertemporal distortions created by the fluctuations in credit spreads at the expense of generating higher inflation volatility, indicating an interesting trade-off between price stability and financial stability.

Papers under review

Fear (no more) of Floating: Asset Purchases and Exchange Rate Dynamics (with Enes Sunel), Submitted. (previously circulated as "Asset Purchases as a Remedy for the Original Sin Redux) [Online Appendix]

Abstract: We provide a theory on currency dynamics, capital flows and conditions for central bank asset purchases to leave room for maneuver on conventional monetary policy. Asset purchases ease financial conditions and boost banks’ foreign borrowing capacity. The ensuing capital inflows lead to an exchange rate appreciation, which passes through to inflation and facilitates a policy rate easing. We find asset purchases curb the financial amplification of capital flow quantity shocks (but not price shocks) through this transmission mechanism. Our framework sheds light on stable currency dynamics observed after the unprecedented asset purchase announcements in emerging markets during the COVID-19 crisis.

Leaning against Persistent Financial Cycles with Occasional Crises (with Thore Kockerols and Erling M. Kravik), Submitted. [Online Appendix]

Abstract: We study conditions under which a leaning against the wind (LAW)-type monetary policy is advisable to address risks to financial stability. We do so within a regime-switching dynamic stochastic general equilibrium (DSGE) model with endogenous crises and persistent financial cycles based on partly backward-looking house price beliefs. Under empirically plausible financial cycles, LAW increases inflation volatility because it amplifies the effects of supply shocks on inflation. It also leads to a lower average inflation, resulting in more frequent episodes of a binding lower bound on interest rates. LAW is advisable only if (i) the central bank puts more weight on output stability or (ii) financial cycles are less persistent than observed. Higher long-run capital requirements are better suited to address risks to financial stability as they reduce the fluctuations in inflation and output considerably by reducing both the frequency of effective lower bound episodes and the severity of crises.

Distributional Effects of Monetary Policy (with Kjersti N. Torstensen and Mathis Mæhlum) Revisions requested, Oxford Bulletin of Economics and Statistics.

Abstract: We quantify the channels through which monetary policy affects the distribution of income and wealth using the universe of tax returns in Norway. An expansionary monetary policy shock is found to disproportionally benefit the young as well as households with middle to lower income and wealth. These households tend to be highly leveraged home owners who gain from higher house prices, lower interest expenses on debt, and a stronger labor market. We find that a lower interest rate reduces both income and wealth inequality in the short run, and that the systematic conduct of monetary policy tends to dampen the distributional impact of business cycle fluctuations.

Blog posts and policy notes

A more resilient euro area navigates financial imbalances and macroeconomic instability (with Lorenzo Ricci), ESM Blog, 2023.

Fear (no more) of Floating: How emerging market central banks avoided a currency meltdown during the pandemic despite purchasing local-currency assets (with Enes Sunel), SUERF Policy Brief, 2023, No 684.

Navigating the Tightrope: Balancing Financial Stability and Inflation in the Age of Persistent Financial Cycles and Crises (with Thore Kockerols and Erling M. Kravik), SUERF Policy Brief, 2023, No 600.

Quantitative Easing in Emerging Market Economies (with Enes Sunel), VoxEU, 2021.

The Forward Guidance Puzzle (with Drago Bergholt, Sara S. Meyer, and Øistein Røisland), Bankplassen Blogg, 2019.

Navigating the Norwegian Economy with NEMO (with Erling M. Kravik), Bankplassen Blogg, 2019.

A Recipe for Monetary Policy in Emerging Market Economies (with Enes Sunel), VoxEU, 2018.

Working papers

Leaning against Persistent Financial Cycles with Occasional Crises (with Thore Kockerols and Erling M. Kravik), Norges Bank Working Papers, 2021, No. 11/2021.

Abstract: Should central banks use leaning against the wind (LAW)-type monetary or macroprudential policy to address risks to financial stability? We address this question in a setting with empirically plausible persistent financial cycles and occasional crises. Our findings do not support LAW by monetary policy because the costs of depressing the economy in normal times far outweigh the benefits of a less likely and less severe crisis. We first assess LAW as a one-off (nonsystematic) policy using an estimated large-scale dynamic stochastic general equilibrium (DSGE) model combined with a stylized regime-switching (RS) framework of normal and crisis times. We then evaluate policy-rule based (systematic) LAW using an endogenous RS version of our DSGE model with financial crises, effective lower bound (ELB) on interest rates, and an asymmetric LAW policy. The results under nonsystematic LAW are driven by long-run output costs while under systematic LAW they are driven by lower mean inflation. Furthermore, in both cases, LAW increases inflation volatility. Systematic LAW policies also result in more frequent ELB episodes due to the lower mean inflation rate they induce. LAW is only advisable if for systematic LAW the policymaker puts more weight on output relative to inflation or if financial cycles are less persistent. Finally, we find that capital regulation is better suited to addressing risks to financial stability and the benefits increase with higher capital requirements in normal times.

Asset Purchases as a Remedy for the Original Sin Redux (with Enes Sunel), Norges Bank Working Papers, 2021, No. 8/2021. [Online Appendix] VoxEU blogpost

Abstract: We provide a theory on how a wider foreign lending base of local-currency sovereign debt may lead to destabilising effects (the original sin redux). Bond sell-offs by foreigners induce domestic banks to fund the government, reducing the credit for investment and tightening financial conditions. Currency mismatches exacerbate the ensuing deterioration in financial sector balance sheets, which amplifies the repercussions of the initial shock by prompting private sector capital outflows and larger currency depreciations. We then explore the role of central bank government bond and firm security purchases in countervailing the ramifications of bond sell-offs. Our estimated model reflects the regularities of the representative emerging-market economy that deployed quantitative easing policies during the pandemic. It further offers an explanation to the puzzle of stable exchange-rate dynamics accompanied by a reduction in excess sovereign bond yields and larger room for conventional monetary policy easing. We conclude asset purchases should be large in size to have a persistent effect on financial conditions and are less effective when they de-anchor inflation expectations or pose balance sheet risks to the consolidated government.

Assessing the impact of Basel III: Evidence from macroeconomic models: literature review and simulations, Basel Committee on Banking Supervision Working Paper, 2021, No. 38. SUERF Policy Brief, No 102

Abstract: Following the global financial crisis, several macroeconomic models with a rich banking sector were developed. They are particularly useful for assessing the overall macroeconomic impact of the Basel III reforms. Based on a report by the Basel Committee on Banking Supervision (BCBS, 2021), this policy brief highlights the different transmission channels of prudential policies by distinguishing according to the type of models, structural and empirical, and concludes that so far more attention was given to the modelling of solvency as opposed to liquidity requirements. It also reveals that, when both short term costs and long term benefits of regulation are fully imbedded in the models, Basel III had a positive effect on GDP and lending.

Distributional Effects of Monetary Policy in Norway (with Kjersti N. Torstensen and Mathis Mæhlum), Norges Bank Staff Memo, 2021, No. 4/2021.

Abstract: We quantify the short-term effects of both non-systematic and systematic monetary policy on the income and wealth distribution in Norway, and measure the relative importance of the various channels. An expansionary monetary policy shock is found to disproportionally benefit the young as well as households with middle to lower income and wealth, and it reduces inequality in disposable income and wealth. The key channel for disposable income is the savings redistribution channel, whereby households with high debt-to-income ratios gain relatively more from a lower interest rate. Because of the high home ownership rate in Norway, most households gain from higher house prices, but the middle and lower part of the distribution gain relatively more as they are more indebted. We also find that systematic monetary policy, aimed at stabilizing cyclical fluctuations in output and inflation, also tends to stabilize income and wealth inequality.

Monetary Policy in Norway - A counterfactual view on the 2000s (with Øyvind Eitrheim and Erling M. Kravik), Norway's Road to Inflation Targeting: Overcoming the Fear of Floating (Øyvind Eitrheim and Jan Fredrik Qvigstad eds.), Norges Bank Occasional Papers, 2020, No. 56.

Abstract: Norway changed its monetary policy regime to that of inflation targeting and flexible exchange rates around the turn of the millennium. When the financial crisis hit in 2008 and when oil prices fell in 2014, the exchange rate channel in both cases helped absorb the shock and cushion the effects on the Norwegian economy. Using Norges Bank’s current main macroeconomic model, NEMO, we show that for both episodes we have considered in the 2000s, the financial crisis in 2008 and the fall in oil prices in 2014, respectively, a return to the old fixed exchange rate regime would have incurred dramatic output costs following a substantial tightening of monetary policy in order to maintain a stable exchange rate.

Navigating with NEMO (with Erling M. Kravik), Norges Bank Staff Memo, 2019, No 5/2019.

Abstract: This paper describes NEMO, the main dynamic stochastic general equilibrium model used at Norges Bank for monetary policy analysis and forecasting. NEMO has been used to identify the sources of business cycle fluctuations in Norway, to conduct scenario analysis, to produce macroeconomic forecasts, and to conduct monetary policy analysis. The model has recently been re-calibrated and re-estimated to reflect economic conditions since the introduction of inflation targeting in 2001 and other structural changes. This paper presents the estimation of the model using Bayesian methods. It then evaluates its dynamic properties through examining model-based sample moments, conducting impulse response analysis as well as historical shock and forecast-error-variance decompositions, and assessing its forecasting performance against a suite of empirical models. NEMO is used in combination with a broad set of data, empirical models and judgement to make forecasts for key variables in the Norwegian economy. Re-estimation and further development of NEMO are important for the model to continue to be a useful tool for monetary policy analysis.

The Power of Forward Guidance in NEMO (with Drago Bergholt, Sara S. Meyer and Øistein Røisland), Norges Bank Staff Memo, 2019, No 7/2019.

Abstract: This staff memo revisits the power of forward guidance with particular emphasis on the effectiveness of anticipated policy in Norges Bank’s main policy model NEMO. First we explain, within the context of a simple toy model, why and how forward guidance has implausible effects in standard monetary policy frameworks. Second, we discuss some of the main solutions to the so-called forward guidance puzzle. We argue that existing proposals, including effective discounting as in Gabaix (2018), come with serious limitations once guidance about nominal policy rates is considered. With these lessons in mind, we proceed with a quantitative assessment of forward guidance in NEMO. It is shown that the presence of several real and nominal frictions reduces the net effects of forward guidance compared with the simple model. A powerful expectations channel is still at play: agents in NEMO believe that expansionary interest rate paths will be counteracted at some point in the future, resulting in limited net effects of forward guidance policies. We briefly discuss the realism of this feature.

Work in Progress

Financial Imbalances and Macroeconomic Tail Risks: A Structural Regime-Switching Investigation (with Lorenzo Ricci)

Permanent Working Papers

Central Bank Collateral Framework as an Unconventional Policy Tool (with Osman Furkan Abbasoğlu and Birol Kanık).

Abstract: This paper investigates the macroeconomic effects of easing collateral standards in open market operations (OMOs), an unconventional policy tool that central banks in advanced economies (AE) implemented during the Great Recession to attenuate the effects of financial market disruptions on the real economy. Using a New-Keynesian general equilibrium model with an explicit banking sector and central bank collateralized lending, we study the central bank policy of broadening the range of assets that are accepted as collateral in OMOs, e.g. accepting a wider range of government bonds or taking corporate loans as eligible. Taking the analysis to the experience of central banks in AE during the Great Recession, when the policy rate endogenously hits the zero lower bound (ZLB) due to sudden rise in funding stress, active use of collateral policies helps mitigate the sharp drop in asset prices, credit, investment, and output. Our analysis also reveals that under severe financial market conditions, central banks do not need to wait until the policy rate hits the ZLB: active collateral policies reduce the need for looser conventional policy response and can help central banks avoid the ZLB.

The Transmission of Fiscal Stimulus in Small Open Economies: The Role of Finance Channel (with Enes Sunel).

Abstract: Empirical literature documents that the size of fiscal multipliers crucially depends on country characteristics such as openness to trade, exchange rate regimes and sovereign indebtedness. We study a unified framework to explore the channels through which these characteristics shape the nature of how fiscal stimulus operates in emerging market economies. The analytical setup is a New Keynesian small open economy model with banks. Financial intermediaries make loans to both the private sector and the government, leading to financial crowding effects via the credit channel. We find that fiscal multipliers are larger under exchange rate pegs than floating regimes and financial frictions play a fundamental role in the transmission of stimulus under the two regimes.

External Shocks, Banks and Optimal Monetary Policy in an Open Economy: Loss Function Approach (with Enes Sunel)

Abstract: We systematically document that the 2007-09 financial crisis exposed emerging market economies (EMEs) to an adverse feedback loop of capital outflows, depreciating exchange rates, deteriorating balance sheets, rising credit spreads and falling real economic activity. Using a medium-scale New Keynesian DSGE model of a small open economy augmented with a banking sector that has access to both domestic and foreign funds, we explore the quantitative performances of alternative augmented IT rules in terms of macroeconomic and financial stabilization. In response to external financial shocks, credit-augmented IT rules are found to outperform output and exchange rate augmented rules in achieving policy mandates that target financial and external stability. A countercyclical reserve requirement policy that positively responds to the non-core liabilities share is found effective especially in coordination with monetary policy in reducing the procyclicality of the financial system.