Gravity Among Central Bank Balance Sheets: Monetary Policy Spill-Over on FX Volatility

Gábor Dávid Kiss 1  and Mercédesz Mészáros 1
  • 1 University of Szeged, Faculty of Economics and Business Administration, Hungary

Abstract

Following the subprime crisis, most of the European central banks implemented several unconventional monetary instruments. As a result of the late quantitative easing, there was a shift from stimulating lending to the immediate stimulation of the securities market in the monetary policy of the European Central Bank (ECB) and of the smaller central banks, too. These securities purchase programs, first and second-market transactions, and asset purchases have led to an increase in the stock of securities held by the central banks, whose spill-over effects have not been fully explored yet. The aim of our research is to identify the spill-over effects of the central banks’ unconventional instruments and quantitative easing on currency volatility while considering the relative size of the issuing central bank and the situation of small open economies. By running an adapted version of gravity models, we analyzed a sample of six European central banks and the ECB. Based on our results, the high volatility levels of European currencies around the eurozone have come from their relative smallness and unconventional monetary policy, and considerations about safe havens have a reducing power on F X volatility.

If the inline PDF is not rendering correctly, you can download the PDF file here.

  • Acharya, V. V., Pierret, D., and Steffen, S. (2018). Lender of last resort, buyer of last resort, and a fear of fire sales in the sovereign bond market. ZEW-Centre for European Economic Research Discussion Paper, 16-019:18–35.

  • Adler, G., Lama, R., and Medina, J. P. (2019). Unconventional policies and exchange rate dynamics. Journal of International Money and Finance, 95:402–423.

  • Aggarwal, R. (1981). Exchange rates and stock prices: A study of the US capital markets under floating exchange rates. Akron Business and Economic Review, 3(9).

  • Albertazzi, U., Becker, B., and Boucinha, M. (2018). Portfolio rebalancing and the transmission of large-scale asset programmes: evidence from the euro area. Technical report, ECB Working Paper, No 2125.

  • Altavilla, C., Carboni, G., and Motto, R. (2015). Asset purchase programmes and financial markets: lessons from the euro area. Technical report, ECB Working Paper Series, No 1864.

  • Bank of International Settlements (2011). Global liquidity – concept, measurement and policy implications. Technical Report 45, Bank of International Settlements CGFS Publications.

  • Bekaert, G., Engstrom, E., and Xing, Y. (2009). Risk, uncertainty, and asset prices. Journal of Financial Economics, 91(1):59–82.

  • Bernanke, B., Reinhart, V., and Sack, B. (2004). Monetary policy alternatives at the zero bound: An empirical assessment. Brookings papers on economic activity, 2004(2):1–100.

  • Bernanke, B. S. (2012). Monetary Policy since the Onset of the Crisis. Remarks at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, 2012.09.31. Online: http://www.federalreserve.gov/newsevents/speech/bernanke20120831a.pdf.

  • Bernanke, B. S. and Reinhart, V. R. (2004). Conducting monetary policy at very low short-term interest rates. American Economic Review, 94(2):85–90.

  • Blanchard, O., Cerutti, E., and Summers, L. (2015). Inflation and activity–two explorations and their monetary policy implications. Technical report, National Bureau of Economic Research, No w21726.

  • Blinder, A. S. et al. (2010). Quantitative easing: entrance and exit strategies. Federal Reserve Bank of St. Louis Review, 92(6):465–479.

  • Borio, C. and Disyatat, P. (2010). Unconventional monetary policies: an appraisal. The Manchester School, 78:53–89.

  • Calvo, G. A. and Reinhart, C. M. (2002). Fear of floating. The Quarterly Journal of Economics, 117(2):379–408.

  • Cecchetti, S. G. and Disyatat, P. (2010). Central bank tools and liquidity shortages. Economic Policy Review, 16(1):29–42.

  • Chen, H., Cúrdia, V., and Ferrero, A. (2012). The macroeconomic effects of large-scale asset purchase programmes. The Economic Journal, 122(564):F289–F315.

  • Cushman, D. O. and Zha, T. (1997). Identifying monetary policy in a small open economy under flexible exchange rates. Journal of Monetary Economics, 39(3):433–448.

  • Demir, ˙I. (2014). Monetary policy responses to the exchange rate: Empirical evidence from the ECB. Economic Modelling, 39(4):63–70.

  • Draghi, M. (2019). Twenty Years of the ECB’s monetary policy. In Speech by Mario Draghi, President of the ECB, ECB Forum on Central Banking, Sintra, 18 June 2019. Online: https://www.ecb.europa.eu/press/key/date/2019/html/ecb.sp190618\{}ec4cd2443b.en.html.

  • Ellison, M. and Tischbirek, A. (2014). Unconventional government debt purchases as a supplement to conventional monetary policy. Journal of Economic Dynamics and Control, 43:199–217.

  • Fratzscher, M. (2009). What explains global exchange rate movements during the financial crisis? Journal of International Money and Finance, 28(8):1390–1407.

  • Fratzscher, M., Duca, M. L., and Straub, R. (2014). ECB Unconventional Monetary Policy Actions: Market Impact, International Spillovers and Transmission Channels. Technical report, Policy Research Working Paper, (6820).

  • Fratzscher, M., Duca, M. L., and Straub, R. (2016). ECB unconventional monetary policy: Market impact and international spillovers. IMF Economic Review, 64(1):36–74.

  • Gabrisch, H. (2017). Monetary policy independence reconsidered: evidence from six noneuro members of the European Union. Empirica, 44(3):567–584.

  • Goldstein, I., Witmer, J., and Yang, J. (2018). Following the money: Evidence for the portfolio balance channel of quantitative easing. Technical Report 2018-33, Bank of Canada Sta Working Paper.

  • Greene, W. H. (2003). Econometric Analysis. Prentice Hall. Pearson. New Jersey.

  • Habib, M. M. and Stracca, L. (2012). Getting beyond carry trade: What makes a safe haven currency? Journal of International Economics, 87(1):50–64.

  • Hamori, S. and Hamori, N. (2010). Introduction of the euro and the monetary policy of the European Central Bank. World Scientific.

  • Hau, H. and Rey, H. (2004). Can portfolio rebalancing explain the dynamics of equity returns, equity flows, and exchange rates? American Economic Review, 94(2):126–133.

  • Herger, N. (2016). Panel Data Models and the Uncovered Interest Parity Condition: The Role of Two-Way Unobserved Components. International Journal of Finance & Economics, 21(3):294–310.

  • Im, K. S., Pesaran, M. H., and Shin, Y. (2003). Testing for unit roots in heterogeneous panels. Journal of econometrics, 115(1):53–74.

  • IMF (2017). Annual Report on Exchange Arrangements and Exchange Restrictions 2017. Technical report, International Monetary Fund.

  • Inoue, A. and Rossi, B. (2019). The effects of conventional and unconventional monetary policy on exchange rates. Journal of International Economics, 118:419–447.

  • Jammazi, R., Ferrer, R., Jareño, F., and Hammoudeh, S. M. (2017). Main driving factors of the interest rate-stock market Granger causality. International Review of Financial Analysis, 52:260–280.

  • Joyce, M., Miles, D., Scott, A., and Vayanos, D. (2012). Quantitative easing and unconventional monetary policy–an introduction. The Economic Journal, 122(564):F271–F288.

  • Kenourgios, D., Drakonaki, E., and Dimitriou, D. (2019). ECB’s unconventional monetary policy and cross-financial-market correlation dynamics. The North American Journal of Economics and Finance, 50:101045.

  • Kool, C. J. and Thornton, D. L. (2012). How effective is Central Bank Forward Guidance. Technical report, Federal Reserve Bank of St. Louis, Working Paper N. 2012-063A.

  • Krugman, P. (2014). Currency regimes, capital flows, and crises. IMF Economic Review, 62(4):470–493.

  • Kucharčuková, O. B., Claeys, P., and Vašíček, B. (2016). Spillover of the ECB’s monetary policy outside the euro area: How different is conventional from unconventional policy? Journal of Policy Modeling, 38(2):199–225.

  • Mishkin, F. S. (2001). The transmission mechanism and the role of asset prices in monetary policy (No. w8617). Technical report, National bureau of economic research.

  • Neely, C. J. (2015). Unconventional monetary policy had large international effects. Journal of Banking & Finance, 52:101–111.

  • Pesaran, M. H. (2007). A simple panel unit root test in the presence of cross-section dependence. Journal of Applied Econometrics, 22(2):265–312.

  • Plümper, T. and Troeger, V. E. (2008). Fear of floating and the external effects of currency unions. American Journal of Political Science, 32(3):656–676.

  • Ranaldo, A. and Söderlind, P. (2010). Safe haven currencies. Review of Finance, 14(3):385–407.

  • Raskin, M. (2013). The Effects of the Federal Reserve’s Date-Based Forward Guidance. Technical report, FEDS Working Paper No. 2013-37.

  • Rogers, J. H., Scotti, C., and Wright, J. H. (2018). Unconventional monetary policy and international risk premia. Journal of Money, Credit and Banking, 50(8):1827–1850.

  • Rybacki, J. P. (2019). Does Forward Guidance Matter in Small Open Economies? Examples from Europe. Econometric Research in Finance, 4(1):1–26.

  • Šimáková, J. (2016). The Gravity Modelling of the Relationship between Exchange Rate Volatility and Foreign Trade in Visegrad Countries. Economic Studies & Analyses/Acta VSFS, 10(1):7–31.

  • Stavarek, D. (2010). Exchange market pressure and de facto exchange rate regime in the euro-candidates. Romanian Journal of Economic Forecasting, 13(2):119–139.

  • Svensson, L. E. (2000). Open-economy inflation targeting. Journal of International Economics, 50(1):155–183.

  • Swanson, E. T. (2017). Measuring the effects of Federal Reserve forward guidance and asset purchases on financial markets (No. w23311). Technical report, National Bureau of Economic Research.

  • Taylor, J. B. (1993). Discretion versus policy rules in practice. In Carnegie-Rochester conference series on public policy, North-Holland, volume 39, pages 195–214. Elsevier.

  • Taylor, J. B. (2001). The role of the exchange rate in monetary-policy rules. American Economic Review, 91(2):263–267.

  • Thornton, D. L. et al. (2014). QE: is there a portfolio balance effect? Federal Reserve Bank of St. Louis Review, 96(1):55–72.

  • Van Bergeijk, P. A. and Brakman, S. (2010). The gravity model in international trade: Advances and applications. Cambridge University Press.

  • Woodford, M. (2012). Inflation targeting and financial stability. Technical report, NBER Working Paper No.17967, National Bureau of Economic Research.

OPEN ACCESS

Journal + Issues

Search