Economics of Central Banking

Explain the money market chart

1. Blue line (repo) is below the yellow (3M Libor) since the 1 Week repo is a secured contract and the 3M libor is unsecured. (->risk premium) 2. 3 months is more dangerous than 1 week (-> term spread) Normalization takes place gradually. (-> in steps) but in a crisis interest rates are changed directly -> asymmetry. Also note that the blue line is moved to absorb the shocks of the yellow line (you see that in 2007 to 2008 the SNB had to make a lot of repo trades to stabilize the yellow 3M libor rate) -> also note that the 3M EURIBOR interest rate has much more volatility in this time The 1 Week repo auctions have been removed in 2012. In January 2015 the negative interest rates have been introduced leading to a drop of 3M libor rate to -0.75. (not sure) Exam question: The red line (reverse repo) is to mop up liquidity from the financial system. To blue line (repo) is to provide liquidity to the financial system (even if negative rate). The time when the repo rate was negative was to force commercial banks to accept more money from the CB.

Taxomy of ledgers (3 types)

1. Centralized ledger 2. Distributed ledger permissioned 3. Distributed ledger permissionless

Explain the current illustration of cryptocurrencies from the SNB?

1. Currency (state vs. private) 2. Issuer (state vs private) 3. Type cash 4. (Book money) 5. Digital token money Note: Bank deposits are privately emitted (issuer) from commercial banks (liabilities side) but they use a state currency to do it. Note: bitcoin has no 3party

Which are the 3 Departments of the SNB? Who is the owner?

1. Monetary policy design 2. Cash management, fin. stability 3. Mon. policy implementation shareholders: - 2/3 of capital held by public sector (cantons, cantonal banks) - the federal government does not hold any shares

What is the hash?

- A cryptographic hash function converts any combination of input information into a unique output, represented as a string of letters and numbers (hash value or hash) - A hash is a digital fingerprint

Explain the 3 Methods to collateralize stable coins.

- Algorithmic, seignorage-style, by means of using an algorithm to control the money supply, thereby stabilizing its price (e.g. Basis) - Collateralized, currency backing, offchain (backed by traditional currencies) or onchain (backed by cryptocurrencies) - Collateralized, commodity backing, e.g. Digix Gold Tokens or DGLD

Motivation against the emission of CBDC?

- CBDC could be more expensive than cash management (not proven yet, difficult to measure) -CBDC is such a quantum leap and a technological challenge, that some knowledge is still missing correct, much more research needed, public awareness to be improved (correct) -CBDC may not be legal (correct in certain jurisdictions, a change of law may be needed before a possible emission)

What are the design features of CBDC?

- CBDC will probably not be on a blockchain (=decentralized) since the CB wants to be the 3party - Twint has a netting form -> meaning that if i transact with a person than at the end of day the net of transactions will be settled -irrevocability (=bank note when i give a note to you this is irrevocable since the operation is done)

Explain the revision of the conditional inflation forecast (the yellow line = March 2020 moved downwards = red line June 2020.

- It is definitely not due to a change in monetary policy (interest rate change) Note: in this communication device grafik the MP is only given by the interest rate. - What are reason that we have less inflation this quarter than last quarter? 1. Oil price is much cheaper shock (is 5% of CPI) 2. In the period between March 2020 and June 2020 Inflation was clearly lower than we had expected (=negative surprise) Therefore, the inflation forecast was revised onwards downwards 2. Small Open economy approach (view) This view has probably revised onwards meaning less demand from abroad. Which will less boost our economy leading to less inflation. 3. Strong appreciation shock on the CHF currency leading to less exports and cheaper imports and deflation. (=note: normally if the change is purely exchange rate driven it should not last 3 year and it would only change the first year of the expectation)

How looks the illustration of cryptocurrencies from Cuche-Curti?

- Note: Libra is not equal to the Facebook dollar in this illustration. - REKA card is closed not in term of community it is closed in term of use. - Digital money can be emitted by the public -> giro = sight deposit accounts which commercial banks have at the SNB - ZKB account is the money which the commercial banks can create.

Explain the best graphical illustration of cryptocurrencies? (Money Flower which uses BIS and comes from ECB) Cash, Commodity Money, Bank deposits, retail CBDC, wholesale CBDC, Central bank reserves and settlement accounts, Central bank deposited currency accounts, Cryptocurrency (permissioned DLT), Cryptocurrency (permissionless DLT)

- Widely accessible - Digital - Central bank-issued - Peer-to-peer (even it is peer to peer does not mean that there is no 3party involved. It means that during a payment the 3party is not needed)

1980

- advantages of monetary targeting are theoretically confirmed - search for a better nominal anchor -> policymakers are unable to consistently follow an optimal plan over time (time-inconsistency problem meaning that CB makes commitment but as soon as policy is implemented it changes its mind) - inflation as a strong nominal anchor

What are the implications of libra for financial stability?

- banks lose (part of) their payments business - banks lose customers' deposits (but some banks get deposits from Libra Reserve) - if libra's bank deposit are collateralized: banks lose collateral -if libra becomes full-fledged bank: increased competition - Increased competition for local payment providers -Drain transactions from SIC into libra system Note: It is a sort of bank run but you do not go and withdraw your money so that banks do not have any deposits because you pay with your money for the coins.

Explain the conditional inflation forecast!

- blue line yoy headline inflation - yellow and red line give the inflation forecast from different point in time This forecast curve is a weighted average (not equally weighted) of different models. Six models actually. Average Forecasting lead to better forecast and sometimes one models are more weighted. For example for short-term other models are overweight than in the long term. 1. The assumption of interest rate is that it is a flat line at -0.75 The BoE also uses an exogenous interest rate but not a flat line since it takes market expectations. (note the plot is useful to communicate since it is handy but not good to use as a decision device) 2. There is also another inflation forecast based on an endogenous interest rate path which is used only internally at the SNB

How is the capitalization of gold?

- cryptocurrencies have a very low market capitalization - Euro has higher market cap than USD

What is a cryptocurrency? (note read very carefully the question will be difficult. Probably everything sounds right but there is somewhere a trap)

- digital money emitted privately - use cryptographic technology - money transfers can be performed without the need of a central intermediary (peer-to-peer) Virtual currency (no clear definition) = cryptocurrency The role of 3 party is important, since this was the innovation of bitcoin. Due to the mistrust of 3 parties bitcoins avoid it.

What is digital Central Bank money?

- digital/electronic CB money is not a new concept. It has existed for decades, as reserves held at a CB by commercial banks and other selected financial institutions - its purpose is to facilitate cashless settlement in Real Time Gross Settlement (RTGS) systems - any digital/electronic, fiat liability of a CB that can be used to settle payments, or as a store of value - as such, CBDC can be viewed as digital/electronic narrow money (monetary basis and/or M1) - already exists in the form of CB reserves - potentially a new form of electronic CB money that can be distinguished from CB reserves

1960

- fixed exchange rate regimes dominate - PC curve was discovered (short term trade off between output and inflation). -> to reduce unemployment increase money supply But the PC was just a scatterplot and not microfunded as today a DSGE model would do.

Why has a CB a strategy?

- framework for explaining monetary policy decisions and stabilizing private sector expectations -framework for understanding and anticipating the response pattern of policy to economic developments

What are the legal properties of money?

- regulation: is the currency regulated by a legal system? - legal tender: is the currency recognized as a valid medium of payment by a legal system? - issuer: is the issuer a central bank, a commercial bank or another private entity?

What are other properties of money?

- settlement: are transfers performed through a central intermediary or peer-to-peer? (is there a netting and you pay at the end of the day or do you pay directly with settlement) TWINT has no immediate settlement even though is shows the amount directly on the other account. -form: is it physical or electronic/digital? (bitcoin can also have a form of physical (ubs stick) -degree of accessibility: is it widely or narrowly accessible? TWINT accessibility is restricted because you need a bank account first. - degree of acceptance: is it widely or narrowly accepted? -anonymity: is the use of the currency anonym (counterparty and third party)?

Empirical evidence of inflation bias

- very little evidence that there is a bias, which could have 2 reasons: 1. There is no inflation bias 2. Maybe it was so well solved that we where not able to see it. TI literature indicated that: - CB should be credible and independent - CB better do communicate - CB have some degree of commitment - CB have some degree of accountability

Assume: The world is normalizing its MP but Switzerland not since we assume a flat curve of interest rate in the model (which is equal to be still expansionary). What are the implications?

-> implication this will produce inflation -> also look how strong the impact is, the longer it will be like this the model will always give stronger inflation outputs (explosive pattern) -> depending on which level of inflation we are in the conditional inflation model we can expect a convex pattern of inflation -> the higher level we are the more can the inflation pattern explode

1970

-collapse of the fixed exchange rate system -rational expectations revolution which means that a CB has to make unexpected actions to change inflation -only unanticipated monetary policy matters (is wrong today)

What is the implications for the Money Market coming from CBDC?

CBDC will completely change the interbank market. When a bank needs money to fulfill the liquidity requirements it can go to Novartis for one night. This will be a new world and the CB needs to assess all the risks and chances when bank suddenly can lend money from the non-bank/private sector. It is not better or worse but just note that it has a lot of implications. CBDC will change the demand for reserves. The reserve curve from the money market floor system will shift to the right since also the Non-bank sector is able to demand money from the CB. Which increases the interest rate and could bring the whole system back to a corridor. Maybe it will not be enough demand to reach a corridor but the CB could also expand supply then it keeps the prevailing interest rate at the floor.

How is inflation computed?

CPI: consumer price index, based on a basket of goods and services, weighted by shares in average household expenditures Important items are oil product (about 5% = we spend on average 5% of our income in oil products). E.g The statistical office will gather the prices of oil products and then create an index of that. In the second part it will create a weight out of our average expenditures. The weights are revised once a year. Coverages of Swiss CPI: - acquisition concept (prices included in the index int the corresponding month in which they are purchased) - demographic coverage (tourists, cross-border workers excluded, only permanently CH residents, homes for elderly are excluded) - expenditure coverage (only goods and services by final consumption, transfer payments excluded) - geographic coverage (only prices collected in CH)

What is CBDC?

Central bank digital currency is digital central bank money Central bank money in a digital form, that can be used to settle payments, or as a store of value

How is the communication about the used models in CB?

Central banks are not very transparent in their models The give the right information about their models so that agents can anchor their inflation expectations.

3 innovations in digital transformations

Challenge will be to merge the new with the old world. - complementarity vs. competition - cost/benefit analysis unclear We have now big data where we can gather much more prices (20 Mio observations). This is a big database and not directly big data because the data is structured. Big data refers to internet data activity. Machine learning helps to bring information or meaning out of a huge amount of data DLT is another innovation

How have the instrument changed at the SNB?

Check the 3 implications on the graphic. We will discuss them later. 1973-1999: Currency swaps 2000-2009: 3M Libor / Conditional inflation forecast / explicit price definition from then (meaning the SNB tells it wants it on medium term) March 2009-June 2019: 3M libor / exchange rate floor / conditional inflation forecast since June 2019: forex interventions if necessary negative interest rate on reserves / policy rate SARON

How differs the claim of a stable coin to a CHF coin?

Collateralized stablecoins can entail either a fixed redemption claim or a claim dependent on price developments of the underlying assets. For example if you want to exchange a stable coin you can go to the Reseller and change it for another currency. With a CHF note you have no claim to the reserve (=no claim on the asset side) of the SNB

How does competition affect price stickiness?

Competition should reduce price stickiness, since when competitions change price you also have the incentive to reduce/change the price. Price stickiness can change over time since competition can also change.

Continuous vs. discrete time models

Continuous time models are not useful for CB. Since the data is not continuously available since it is often only quarterly available. Therefore, discrete models are used from Central bankers. T-1 and T

Money Market -> Difference of Quantity management vs. price management?

Corridor system (quantity management) You need to estimate the money demand very well. If you suddenly supply too much then you will get inflation. Every change in demand will lead to volatility and change in money market interest rate. Corridor is between lending facility rate (LoL rate) and deposit facility rate (excess money that banks can park at CB) The corridor can be narrowed with liquidity management. Floor system (price management) After Financial crisis the money market changed to floor system. You can stabilize interest rate on the same level but the volatility is now in the reserves amount (which has less impact on the economy).

What is the definition of Seignorage?

Cost of issuance is smaller than the value of the money

Credit Channel

Credit channel refers to bank lending channel. Bank lend more money if they have low interest rates Credit channel also refers to balance-sheet channel. Asset/Bond prices increase with decreased interest rates. Interest changes lead to changes in wealth (e.g. financial assets change and with that our ability to pledge collateral and get a loan)

How could the libra basket look?

Cuche Curti thinks that CHF will never be in the basket even though we have the credit quality in Switzerland but not the market liquidty. Switzerland is a small country with small debt. Therefore libra needs huge markets with liquidity.

Advantages and Disadvantages of Floor System

Currently we are in the floor system meaning that the commercial banks have enough liquidity = excess reserves. How to normalize interest rates: 1. CB has to move the brown line to the left for that the CB has to reduce the reserves which means that the CB has to reduce the size of its balance sheet. If the SNB has to sell its foreign currency investment then it will probably impact the exchange rate. 2. Option is to raise the deposit facility rates. Raising the brown line can you do without reducing the size of the balance sheet.

Deflation vs. Disinflation?

Deflation = negative growth rate of price index Disinflation= positive inflation rate becoming smaller

What is distributed ledger?

Digital record-keeping or database that is consensually shared, replicated and synchronized across the network Note: Blockchain is a specific form of a distributed ledger which is organized as a chain of blocks containing validated transactions, usually of ownership rights.

What are the direct and indirect effects of the crisis?

Direct effects - result from containment measures (e.g. stay-at-home, social distancing recommendations, lockdowns) - hamper production as well as demand for certain goods and services - should diminish and vanish as restrictive measures are being eased Indirect effects - repercussions from the crisis immediate impact (e.g. higher unemployment, unplanned increases in private sector debt, bankruptcies, etc.) - last much longer than measures taken from governments - results in an incomplete V shape difficult to predict. (meaning GDP will not reach the same level as before the crisis)

The statistical office publishs inflation with seasons. How does the SNB consider that?

Due to y/y reporting the SNB has not to deseasonalize the inflation since it compares peaks with peaks. It is also easier to anchor inflation expectation.

What happened to price niveau during pandemic?

During pandemic people loose their jobs and will consume much less. -Income less - not possible to consume certain goods and service due to lockdown Aggregate Demand shifted to left but their was also positive demand movements: - run on food, toilet paper, masks - home office devices The overall impact on price level is unclear. But how can you tell that the board.

Why do agents need to anchor inflation?

Dynamics of the forecast gives some hints about likely future interest rates If the forecast at the end of the forecast period is near or above 2% (or below 0%), the likelihood of increasing (decreasing) interest rate is high

Whats the difference between estimation vs. calibration of the parameters in a model?

Estimated: You using data. Econonometrics method to Calibrated: you give some value to the parameters.

Difference conditional and non-conditional inflation forecast?

Every forecast is conditional since you have to make some assumptions. Conditional inflation forecast = you make the assumption that the interest rate is flat (given/exogenous) Unconditional inflation forecast = The interest rate in the model is endogenous.

ARIMAnext (non-structual)

Every item in the model of the CPI can modeled with an autoregressive structure. 1. Indices are not stationary so we need to make them first stationary using the growth rate (trend) 2. Then you try to explain with autoregressive structure (a lag of itself) and a moving average. You just use the ARIMA structure which the computer says and then it gives a forecast for each item. This gives 220 forecasts -> e.g carrots has a forecast. Then you reagreggate all time-series and you have a new forecast.

What is the Base effect?

Exam Question: we have 4% price inflation in this y/y number. Should the CB now get more restrictive since it has a goal of 2%? This phenomena explains that due to the reporting of inflation (y/y) the official inflation curve is sometimes above/beyond target inflation but the price dynamic is already flat.

Explain the game setup in TI 2

Expectation formation: two type of inflation expectation formation. Either you set you expectation below the bias or like the bias. The agents behave correctly but as soon as the CB cheats the agents trigger their behavior (Trigger strategy) CB behavior The CB compares the gain of inflation with the costs in the next episode of the game. The gain today (should be higher as the punishment tomorrow.

Motivation for the emission of CBDC

For - the CBDC emission could be cheaper because production, management, and destruction of cash are expensive duties (not proven yet, difficult to measure) - a CBDC could make monetary policy easier and more effective (not proven yet, shown in certain models, under which economic circumstances still completely open) - CB may fear competition from privately-issued currencies (wrong, competition not new and not forbidden, moreover only CB offer legal tender money) - the society is moving towards a paperless society (correct, but only in the long term) - CBDC could be a natural development in a paperless society (correct, but the speed of adjustment is not clear yet)

How can you show the board how inflation will change?

For each item in CPI was calculated if there was a demand movement or a supply movement as well. If supply is cut then it is difficult to calculate wether demand was also cut. In the end all is sum up and then you can report that to the board how the inflation could change.

GDP deflator

GDP deflator = nominal GDP / real GDP * 100 The GDP deflator measures the impact of inflation on GDP during a specified period, usually a year or quarter Advantages - GDP deflator does not need a consumption basket -covers price changes of goods and services consumed by businesses and government - measures the prices of total production in the economy - does not suffer from the substitution and quality bias - incorporates price changes of newly introduced products (bitcoin) Disadvantages - GDP deflator is affected by changes in product taxes - does not measure price changes for imports - GDP deflator does not measure cost of living - available only quarterly and not monthly

Whats the outcome of discretion game (case 1)?

Game outcome When the CB acts with discretion, it produces an inflation rate of alpha*Lambda (inflation bias) which has no effect on output, since private agents anticipate it The higher the inflation currently is, the higher become the marginal cost of increasing inflation. Marginal benefit is not influenced by inflation it is given by the incentive parameter a and lamda which are parameters from the supply curve Main message: Without any credible commitment, private agents know that the central bank will inflate (MB > MC), so they fully anticipate the central bank's move increasing their inflation expectations, which in turn the central bank delivers Note: in this case the CB can not precommit in the beginning to a 0 average inflation rate.

2000 until today (Mishkin principles) -> see exercises

Guiding principles 1. price stability should be set as a goal 2. fiscal policy should be aligned with monetary policy 3. time inconsistency is a serious problem and thus should be avoided (there is no clear evidence that it has happen or exists) 4. monetary policy should be forward looking (due to the time lag of MP) 5. policymakers should be accountable 6. monetary policy should be concerned with output as well as price fluctuations 7. policymakers should know that the most economic downturn are associated with financial instability

Again what the lucas critic question?

How can I manipulate some monetary policy when i will make my policy based on this model This is not a question of true or false. It is not always clear and its more about the degree of impact.

How can you describe the Time Inconsistency problem of Central Banks?

How can agents be sure that the Central bank does behave as it has announced? It may be optimal for the central bank to deviate from the rule once private agents have made decisions based on the expectation that the rule will be followed Thus, agents consider the incentive of policymakers to deviate and anticipate the consequences of the deviation (e.g. higher inflation) Game theory is used to solve the TI problem

Which restrictions (assumptions) are implemented to identify the SVAR?

I need 4 pieces of information. 1. So I can normalize the diagonal elements of the A matrix which gives 2 restrictions. 2. We can also make the assumption that the shocks are uncorrelated which gives us another 1 restriction. 3. For the last one assumption/restriction is in the next slide. We assume that in the matrix A is a lower triangular which implies the ordering.

How can you calibrate the VAR model?

If the model (VAR) is correctly calibrated. Then you start with an exogenous shock (25 bp increase of interest rate (restrictive shock) is the only MP instrument in the unconditional inflation forecast model) and you can exactly see how unemployment change and how many people will lose their job. You will also see how strong the deflationary pressure will be. If the target MP instrument does not give the wanted output you adapt the exogenous shock input. But not it is crucial that the model is well identified.

How is the currency value changing in comparing the conditional with unconditional model? and what are the implications for the conditional inflation forecast curve

If the world is normalizing but you not. In other words if the unconditional forecast model assumes normalizing interest rates and the conditional assumes flat interest rates. The currency is undervalued in the conditional inflation forecast in comparison to uncondtional. (= the CHF is depreciating) This means that it will produce inflation in the conditional curve and explode at some point -> convex pattern.

If the interest rate is endogenous in the inflation forecasting model what are the implications? Is the conditional model with exogenous interest rate more expansionary (lower interest rates) than the endogenous inflation forecast?

Imagine the interest rate is endogenous. You can imagine the interest rate will probably have some normalization in the path. (since model always come back to the long-term steady state value = it come back to some level of stationary) This means we are in very deep recession with low interest rates. Then I expect that interest rate will rise in the future. So the endogenous curve will have some normalization. Question: If your endogenous model is giving you this endogenous curve of interst rates (back to normalization -> increasing rates if we are in recession). But now you want to force your model (conditional with exogenous interest rate) to have lower interest rates (since we assue that the rates stay flat) than the one given by your endogenous model. Then we can say that the endogenous model is in comparison more restrictive.

Reserve averaging (libor market spikes)

In a reserve system, the CB imposes reserve requirements on banks (in CH it is 2.5%) Holding reserves is costly for banks (like a tax), if the CB does not remunerate reserves Reserve averaging reserve requirements have to be met on average over a given maintenance period. Reserve averaging deals with interest rate volatility, which may be induced by the reserve requirements. Depending on the lag between the calculation period and the maintenance period, two types of requirements: 1. lagged reserve requirements: - the calculation period precedes the maintenance period - CB with an operating interest rate favor a system of lagged reserve requirements 2. contemporaneous reserve requirements (Stichtag reporting) - CB with an operating reserve target favor a system of contemporaneous reserve requirements -on the last day of the period, the CB might be more active in the market in order to keep the interest rate at its targeted level

SVAR (Structural VAR)

In addition to the AR behavior, structural VAR (SVAR) assumes a contemporaneous structure among the variables present in the vector SVAR are not identified VAR can be directly estimated, SVAR cannot be directly estimated A reduced form has to be first computed, then estimated, then SVAR coefficients have to be recovered using identification assumptions

Exchange rate regimes?

In historical perspective: During many years floating was not seen as good. Fixed regime was seen as the best one. Since your country is not tempted to devaluate your currency. But after the end of Breton woods the view has changed. Note: in a fixed regime you loose power about your MP.

How many assumptions are needed?

In the reduced form = VAR we estimated 4 elements in the A matrix , 2 variances and 1 covariance. -> So we have estimated 7 pieces of information. But you want to go back to a SVAR. In the SVAR you need 11 pieces of information. Conclusion: Therefore 11-7 = 4 we need 4 pieces of information. Adding restrictions on the structural parameters makes SVAR just identified

Quantity theory of money

Inflation is always a monetary phenomenon. (Or in the long run money printing does not have an impact on Y) M * V = P * Y Today not anymore very important. A theory about the connection between money and prices that assumes that the velocity of money is constant

Taxonomy (different channels of monetary policy)

Interest rate channel (pure interest rate) - rising key interest rates trigger an increase in short-term market rates - the real interest rate and the cost of capital rise, slowing down investment and consumption, which in turn causes aggregate demand to weaken Exchange rate channel - rising key interest rates provide an incentive to invest in the domestic currency rather than in foreign currencies -the inflow of funds into the domestic currency area causes the domestic currency to appreciate Expectation Channel - any changes in key interest rates influence expectations of economic agents differently - expectations about income, interest rate, and inflation influence households' decisions (e.g. consumption, saving) and firms' decision (e.g. in- vestment, production)

Which Centralbanks are more progressively by including financial variables into their considerations?

Interestingly, central banks which do not have to make monetary policy decisions (Bank of France, Deutsche Bundesbank) are much more progressively in thinking about to change the investment behaviour or innovate the models in regard to climate risk in contrast to central banks which have to make monetary policy decisions (SNB, BoE, ECB) Cuche-curti thinks that the changes in consumer preferences and behaviro (regarding to transition risk) will become much more important in the future.

Optimal Currency Area (OCA)

Is never perfectly fulfilled -> It is a question of judgement but you can focus on the 4. criterias: 1. Integration 2. Symmetry of shocks 3. Factor mobiltiy 4. Fiscal sphere

What is important about the Cholesky Decomposition?

Is pure mathematics and has nothing to do with economic assumptions. With 6 or 7 variables the ordering is very difficult. This is not robust and therefore you check the robustness with different orders of the variables. No CB uses the cholesky decomposition to identify a SVAR. Note: The cholesky decomposition is not the only method to identify a SVAR.

What is the double-spending problem?

It is a technological challenge in digital peer-to-peer exchange that arises because any digital form of money is easily replicable and thus can be fraudulently spent more than once. Bitcoin has solved the problem of doublespending without a third party institution which normally would control and observe transactions.

Why not a inflation rate target of 0?

It is difficult to measure and you need some levy. Time-inconsistency problem

How can you solve the TI problem?

It is easy to find a solution to avoid the TI problem if you are in a state of law and have contracts. Even though evidence on TI is weak, central bank independence among the industrial economies is negatively correlated with average inflation

Which items do contribute the most to CPI Inflation?

It is important to know which goods are domestic and which are imported. (distinguish between imports and locally produced) Switzerland does record that. From time to time is measured how much of the sold cars are imported. Cars is probably 100% then all belong to the green part. In the grafik you can see that the appreciation of the CHF impacted the imports heavily. The green area does always contribute negatively to inflation. The blue area has also decreased at the beginning. The explanation is that the domestic producers are in competition to foreign imports. Therefore if more is imported maybe the local producers have to decrease their prices. This is kind of substitution effect between the green areas and the blue ares.

Whats the difference between targeting the price level with a drift or inflation targeting?

Its a huge difference. Price level targeting with drift means that you tolerate a certain increase in the price level. (non-zero slope) After a shock you have to come back to the path of your price level. (never been used from CB) If you just target inflation and then you have a shock you can go on from the level you are. So you do not have to go back. (Therefore, it has the ability to absorb shocks better.

How do the stylized Balance sheet look (CB, aggregated bank sector, private sector?

Liabilities of CB is what it has to pay the banks of private people to pay sometime (in future) Private Sector can only hold Cash at CB liabilities side. Sight deposits domestic are the bank accounts which banks have at the CB CB can issue debt certificates to mop up liquidity (=with that a CB can reduce the sight deposits liability account by issuing debt certificate / otherwise it must sell assets to reduce the sight deposits liability accounts) Some CB give out equities at the end of year (e.g. SNB it has a large equity position but dividend is fixed) But a huge provisions account on the liability side is important so that the bank can face exchange rate risk which the SNB is strongly imposed.

How does a libra transaction take place?

Libra has no Central bank account but it has also a bank where their deposits is placed. As soon as the libra does not back its emitted libra coins equally to the currencies the payer pays for a coin it will impact exchange rates. In the case that libra only backs the emitted coins with USD then an initial payment of libra with CHF would impact the exchange rate. The CHF would deprecate and USD would appreciate. If libra also uses bonds in the basket to back their coins it will also affect interest rates. If libra generates a demand of the Swiss franc it will create an appreciation of the Swiss franc it will create a downward movement of the interest rate. Here it is already difficult to back the emitted libra coins with a single currency and even more difficult to back with a basket. Since you have to decide if the weights of the basket should be constant (simpler) or the weights are changing (more difficult). How should the weights be done maybe by GDP?

Explain the illustration of Libra project? (important)

Libra promises that you can go at any time to a reseller and change your libra coins vs. fiat money but you do not have any claim on the reserves (like a central bank). But I know there is a reserve which should keep the currency stable.

How do economist deal with non-linearity?

Linearization Economist can not work vey well with non-linear models. But if you focus on small parts of the functions then you can linearize the equations (around the steady state). Before a shock the model is in the steady state. After a shock, the model leaves the steady state and then returns to it more or less quickly; this 'period' is called 'transitional dynamics' You should use different models to balance the fact that you maybe not return to the same steady state as before the shock.

How will the term structure change when CBDC is introduced?

Longer term - currently, term lending of CB reserves is limited to relatively short horizons - the broader nature of the CBDC market results in a more varied range of motives for lending and borrowing CBDC - therefore, it may be more likely that CBDC is lent at longer terms than traditional CB reserves

How have the Monetary aggregates changed?

M1 = Sight deposits (which commercial banks hold at SNB) + Cash M2 = M1 + Time deposits M3 = M2 + Savings deposits

Machine learning

Machine learning -automated process machines use to identify meaningful pattern in data -a field that develops algorithms designed to be applied to data sets, with the main areas of focus being prediction (regression), classification, and clustering or grouping tasks -also known as predictive analytics or statistical learning Data science -interdisciplinary field that uses scientific methods, processes, algorithms and systems to extract knowledge and insights from structured and unstructured databases

What are the main elements of independece?

Main elements - two sorts of independence: 1. goal independence - autonomy in objectives setting - the SNB precises its goal 2. instrument independence - conduct of policy independent of government influence - the SNB has full power accountability (= Rechenschaftspflicht -> the SNB has to report since it has huge power) - counterpart of independence - written annual report - various hearings in parliamentary commissions

What is written in the constitution?

Main elements in the constitution (Bundesverfassung): - monopole: notes, coins, and seignorage addressed, but no mention of the central bank - independence: mentioned, but no specification - general interest of the country mentioned, but no specification - cooperation and supervision of the Confederation mentioned, but no specification National Bank act - The SNB is the only one allowed to produce CHF (note: digital currencies is everyone allowed to produce but this is not legal tender) -precision of general interest -> no regional or sectoral interest - definition of main goals: It shall ensure price stability. (=main goal) In so doing, it shall take to account of the development of the economy. - also defined that SNB shall contribute to financial stability

Another problem is the question of what do you take as monetary policy instrument?

Measuring the impact of monetary policy shocks is difficult when operating procedures (MP instruments) change over time. the best measure during a period may no longer reflect policy in another period if the implementation or the strategy of monetary policy has changed In the short past of curse you use the interest rate as monetary policy instrument. You will never be completely sure about your model. Interpretation of the interest rate equation as a rule is difficult; some coefficients are not significant, some lags are useless, the form is useless.

Microfunded models (DSGE) vs. non-microfunded models.

Micro-funded model is based on optimization on your agent and focused on deep parameters so that it does not conflict the lucas critics (lucas critic= a model that is not microfunded you will estimate parametes which are pollutet by the current policy in place because you use a model which already has you policy in it) But note: CB also use models that are not microfunden and their forecasts are quite well.

An article in the newspaper says that negative interest rates will not work since the commercial banks can just withdraw their money from the sight deposits. Is this true?

Negative rates will always work. If a customer has charged negative rates he can go to the commercial bank and withdraw the money charged with the negative rate -> the balance sheet of the bank decreases But a commercial bank can not do the same with the sight deposits account hold at the CB. The commercial bank has reserve requirements which is not charged with negative rates. But the excess reserves are charged. Since they maybe try to trade more money on the interbank market. But they can not leave the balance sheet of the CB (the system is closed) since even cash is on the liability side. -> Only the CB can reduce the size of the balance sheet.

Can the conditional inflation forecast change due to a change in monetary policy?

No, The difference between yellow and red line is not linked to a change in interest rate (or monetary policy) since both lines have a conditional interest rate of -0.75. conditional -> interest rate is given before the forecast and exogenous

What are nominal rigidities? and what are real rigidities?

Nominal rigidities An interest change does not directly lead to a price change -> prices and wages are sticky Real rigidities Refers to market imperfections. (e.g monpoly)

What is the HICP? (harmonized index of consumer prices)

Not important since the SNB does not define price stability with this index. If you compare with Europe this indicator is better. Difference to CPI: utilization concept: prices (in particular for some services) are included in the index for the month in which their consumption can begin demographic coverage: national territory (residents and visitors) private and institutional households, e.g. prisons, convents, homes are included

Note that the normalization of interest rate in the unconditional model is very tiny since the whole world has currently very low interest rate. So Switzerland is in the same situation as the world. And the models used is a small open economy model. The world has influence on Switzerland but Switzerland not on the world.

Note that the normalization of the interest rates in the unconditional model depends on how the situation in the world is. Currently there is corona and the world is in a crisis therefore probably the interest rate is also on a very low level (as in the conditional inflation forecast model).

Partial equilibrium vs. general equilibrium

Partial equilibrum is easier to model since you only use the market (sectors). Several variables, such as prices and quantities of substitutes and complements or consumer income are exogenous. For example the labor market. vs. General equilibrium where you model the whole economy. You model the behavior of supply, demand, and prices in a whole economy with several markets are cleared altogether for example, firms maximizing their profit determine the output supply and the labor demand at the same time and endogenously, while house- holds, maximizing their utility, deter- mine what they want to consume and how many hours they want to work CB use General equlibrium models

Why was the yield at 10-Year Swiss Bond Market negative after 2014-2017 and 2018-2020?

People/Banks want to hold save assets since there they have too much liquidity and do not know where to park the money. They were even ready to pay a negative rate for investing money into the Swiss govie bonds. The save haven of CHF means not that only foreigners want to hold assets in CHF it also means that a lot of Swiss citizens decide to buy assets in CHF. The bond yield is nominal. If you add inflation to that then the real yield is maybe around 0.

Which risks are included in climate risk?

Physical risks Physical risks include the extreme weather events and changes in the clima (which is not observable in short term) which impacts the economy and prices. You should include these variables in the model of CB. Impacts are: -on economy: drop in production (increase in commodity prices), longer-term growth prospects (low willingness to invest) - on financial system: value of assets, underwriting losses Transition risk Transition risk has climate policy (carbon tax), technology (impact on prices) or consumer preferences (what does the customers want) as driver. The transition risk increases also the risk of financial stability since a lot of banks are also invested in oil. Transition risk can also impact the economy by increased energy prices and low reinvestment. CB should anticipate that.

How are variables correlated? GDP and Inflation (prices measured by GDP deflator)

Prices are countercyclical. If you look at a comovement of prices (GDP deflator) and GDP it is negative which shows us the data. But different samples also give different correlation coefficients. A negative supply shock (like corona crisis or oil price shock) the red line moves to the left which increases the price and reduces GDP growth. This makes the negative correlation. So we can tell that the picture shows data in which a lot of negative supply shocks have occured. It maybe true but it maybe wrong. If prices are flexibel and change then it will be correct. But if we assume the economy has sticky prices. Then positive demand is doing that. Positive demand shock shifts the blue curve (aggregate demand) to the right immediately, which increases the output very fast. (prices do not change) But after some time the economy moves slowly and prices increases (higher wages) with the GDP decreasing. Conclusions: Both movements create a negative correlation between GDP and inflation but they are two different stories. Therefore, you need more information maybe you know the stickiness of the prices in the economy.

How does the simultaneous game works?

Private agents also have some loss function. You expect inflation to remain at the current level. This is a way how you or agents form inflation Simultaneous game, but timing in five steps: 1. private sector sets inflation expectations 2. supply shock is realized 3. monetary policy is set 4. velocity shock happens 5. equilibrium is determined

What are the Pros and Contras to Libra?

Pros - Fosters Switzerland's position as an innovation center - Might allow collaboration with Libra Association and allows to receive first hand information Cons - Potential impact on monetary policy and other statutory tasks - If not received well abroad, might lead to political repercussions - Switzerland could be held responsible in case something goes wrong (LOLR, KYC/AML, . . . )

The implications of unconventional Policy is completely different on the exchange rate channel than on the interest rate channel. What are implications for SNB?

QE is not available for SNB. The public debt level is very slow in Switzerland. Therefore the QE tool is not very good available. Instead the SNB makes Forex interventions.

What are points about regulation regarding libra?

Regulation: - Libra does not accept funds from public directly - Swiss payment system license possible - Libra likely subject to regulation in multiple jurisdictions - Touchpoints with Swiss regulation uncertain at this stage - Need for cooperation between authorities

What are the risk of CBDC?

Risk of CBDC is Disintermediation: It poses a challenge to banks daily business since it can move depositors away from the banks. -allowing CBDC withdrawals from deposits on demand has implications for banks' funding and liquidity -the reduction in demand for deposits has the effect of shrinking the aggregate size of the banking sector's balance sheet -CBDC create the opportunity to hold digital outside money This risk is small since CBDC is not a perfect substitute for deposits and banks respond to the competition by offering higher return to maintain their deposit base. Risk of Runs to CBDC - possibility of a rapid substitution from deposits to CBDC, i.e. a so-called bank run - theoretically, run risks can be mitigated by removing the requirement for banks to convert deposits to CBDC

How is the game with conservative central banker à la Rogoff different?

Rogoff (1985) suggested to appoint a central banker more conservative than the society, with weight of 1 + δ > 1 You overweight the inflation in the loss function of the Central bank (overweight in contrast to output gap). This rule change is to reduce the incentive of the CB to cheat.

How can you calculate core inflation (Cross sectional approach)?

SFSO1 (no oil products) and SFSO2 there are different volatile items excluded. Note: But in some periods oil is e.g not volatile then maybe you want to have it in the basket but in this approach you still neglect it. An alternative to that is the TM. TM15 is just once decided to use 15 but there is no theory about it. TM is Trim-mean method. With this approach both tails highest and lowest are cut from the distribution. 15 that leads that 15 percent are cut on top and bottom so that in the basket are only 70% included. But the name of the items in the basket are changing every month. So you do not know exactly which items are in this 70 % basket. Median line is the same story but you cut 50% of each side and take only the inflation of the items in the middle.

Decision Power of CB?

SNB -> 3 heads of department have all an equal vote (same decision power) No minutes are published.

How is price stability defined?

SNB = explicit definition, inflation < 2% but non negative, yoy headline, quarterly data in the medium term no true inflation target (range) since there is a double flexibility: 1. vertical -> between 0 and 2 2. timeframe -> medium term

Structure of Balance sheet will reflect the past monetary decisions (how does the asset side look at SNB and FED)

SNB has a lot of foreign currency investment (=foreign exchange risk) FED has most of the assets in dollar (=FED has only the dollar interest rate risk in the balance sheet)

Show the steps to identify a SVAR!

SVAR(1) You can not estimate that because it violates some basic assumptions of econometrics:

What is the view on the world in the unconditional inflation forecasting model?

Small open economy

Example CBDC: account-based, retail (general purpose)

Some implications - only two types of CB money, notes (cash) and CBDC (replacing and extending reserves) - notes and CBDC can be used by both the banking sector and the non-bank, private sector Impact on composition/size of the different balance sheets depends on the substitution: - from banknotes: changes the composition of CB liabilities and private sector assets - from deposits/bonds: has more significant impacts on the balance sheets of the banking and private sector. For example the customers (non-banking sector) withdraw money to buy CBDC. Therefore the balance sheet size of the banking sector gets smaller and the composition of the balance sheet from non bank sector changes. Balance sheet implications: Case 1: Asset purchase of CB The CB buys bonds from the non-bank sector and gives CBDC out. -> The non-bank sector has the same portfolio size but the composition has changed from bonds to CBDC. The CB has a larger balance sheet and the banking sector has still the same balance sheet. Case 2: Deposit withdrawal - IF the CB issues the CBDC which the non-bank sector can buy directly. The CB balance sheet has then expanded and it makes the size of the banking sector smaller because the customers use their deposits at their private banks to go into CBDC. Meaning that the bank sells it CBDC on the asset side to the customer and the deposits on the liability side will be used to pay.

What does the literature think about the Inflation bias?

Some part of the literature say there is no inflation bias. It is difficult to see really a inflation bias. This literature has also opened the door for independent CB. Since one ability to commit for CB is to make them inedependent.

Why are stable coins more credible than bitcoins?

Stable coins will probably have a better future than bitcoin. They have something on the asset side (stability feature). Which is crucial in terms of credibility.

Time Inconsistency problem 2

TI problem: If the marginal cost of cheating is higher than marginal benefit you will not do this anymore. The main idea is to increase the MC of 'cheating' as perceived by the central bank The central bank bears some cost - a lost of reputation - if it deviates from its announced policy of low inflation, thereby raising the central bank's MC of inflation Repeated game with infinite number of periods

How looks a stylized description of CB decisions?

The CB makes quartely decisions (even if they do not change anything this is a decision) since data is always available quarterly. But normally the board meets more times.

How does the European Central Bank (ECB) make its inflation forecast? (compare with SNB)

The ECB publish the forecast from the staff in comparison to the SNB where the staff shows the forecast to the board which endorses the forecast. Note: The ECB sometimes also say that the governing board is maybe a little bit less optimistic than the staff. The ECB defines inflation as the year on year percentage change in the euro area all items Harmonised Index of Consumer Prices (HICP) The ECB makes some technical assumptions. They use market expectations for interest rates and commodity prices like the BoE. Market expectations are taken from futures contracts -> the forward rates In Switzerland for commodities we have a random-walk assumption so this is a flat line with the implication that there is no inflation dynamic from oil price after one year (because we report in year on year inflation). But in the ECB the oil price changes over time. The ECB makes the assumption on exchange rate that they remain unchanged over the projection horizon. (random walk projection like we use at the SNB) For the international environment the ECB (assume Euro zone is open economy) takes the world GDP. The ECB also publishes alternative scenarios which the SNB does not. The ECB does publish sensititvity analysis where they change only one assumptions in the model and change these (so you play with tiny changes and check how the model is changing) ECB also shows the forecasts of other institutions (eg. IMF) to show they are not a outlier in their assumption. But according to Cuche-curti they maybe make other assumptions or make unconditional forecasts -> so it is not comparable.

Why is it important to hold provisions for the CB?(especially for the SNB)

The SNB is exposed to currency risks. The Purchasing Power Parity suggests, that an inflation e.g in Europe of 2% and inflation in Switzerland of 1 % will led to an increase of the CHF currency of 1% every year. Which means that the foreign currency investment asset account can loose in the longterm 1% every year.

What does the SNB publish about climate risks?

The SNB made a press release with statements from all 3 departments. 1. Climate risk on monetary policy. 2. Climate risk on financial stability. 3. Climate risk on the financial market and portfolios. CB has become since the last decade huge portfolio managers and people want that their portfolio will become cleaner. They also hope that the private sector will follow. The Problem is when CB invest in green bonds maybe they are not liquid and therefore bad to react in case of a monetary policy decision where the balance sheet needs to be reduced. Asset management is governed by the primacy of monetary policy. two main objectives: 1. balance sheet can be used for monetary policy purposes at any time. 2. preserve the value of the currency reserves in the long term.

How do the time-series of the different CPI items look in ARIMAnext? (Beyeler and Cordonier, 2020)

The algorithm will find for each time-series of items in the CPI the best ARIMA patterns. For some items (3 categories related to tourism) big data is included an ML algorithms to forecast their pattern. (since they have structural breaks in their time-series) 1. AIR Transport (there are very different phases in the time-series which could be due to a huge change of the behavior of the consumers. Or the airlines have suddenly changed their pricing system. ML algorithms learn and can faster anticipate these price behavior changes.) 2. Hotel 3. ..

What does the random walk assumption (flat line) for oil or exchange rates indicate to the conditional inflation forecast?

The conditional inflation forecast is based on the assumption of a flat oil price (= assume it was taken the last 10 days of the oil price) Then the oil price change shock can only influence the curve in the period of 1 year since afterwards it is flat. (= Das hängt zusammen damit das die yoy inflation genommen wird. Nach einem Jahr ist kann keine Dynamik mehr durch oil price oder Wechselkurse die nicht mit dem CHF zusammenhängen kommen.) But if the oil price shock leads to second round effects and changes the assumptions then it could also change the inflation curve later than 1 year.

Consumption deflator (CD) ?

The consumption deflator basket is broader than the one in a CPI CD = nominal consumption / real consumption * 100

How works the indicator approach (alternative of using a model at the CB)?

The difference between a model and an Indicator is not very clear. But in the Monetary Policy Analysis (MPA) you have a portfolio of indicators like in the screenshot (taylor, interest rate, exchange rate, asset prices). You compare these indicators with their benchmark. When the SNB says "our currency is overvalued" it needs a benchmark for the CHF currency to say that. Meaning that you have to calculate some kind of equilibrium of the CHF which is very difficult.

How does the Bank of England (BoE) make its inflation forecast?

The first thing you have to check when you look at a central bank outlook how it handles it own instrument = the interest rate. The BoE uses Bank rate implied by forward market interest rates even if the BoE completely has a different view than the market has. BoE also makes conditional forecasts but on market expectations. BoE does not need the output gap. They use the wording Excess supply/demand. If you publish Inflation forecast conditional bases on constant interest rate and market expectation then you can see how strong the normalization of interest rate impacts the inflation. Note: the BoE has also a small part in the communication with a conditional CPI inflation forecast based on constant interest rates but no picture and not in very detail. This is more as a complementary view.

How looks the simplest DSGE model ?(Dynamik, stochastic, General Equlibrium model)

The goal is to develop a dynamic, microfounded, general equilibrium, three-equation model for a closed economy where monetary policy is non-neutral in the short term. New Keynesian or dynamic stochastic general equilibrium (DSGE) models have sticky prices. Since it is a short-run analysis. The simplest DSGE has 3 equations: 1. aggregate demand or IS curve (behavior of agents) 2. aggregate supply or Phillips curve (behavior of firms) 3. monetary policy rule (behavior of CB)

Why do Central bankers have to look into the future?

The need forward looking models because monetary policy acts with a lag.

How does CBDC impact the different transmission channels?

The pass through from the policy rate to other rates will also change with CBDC. Along the term structure we speak about the credit market and here we change the actors on these markets. transmission to financial markets: if the CBDC interest rate changes, but deposit rates do not move by an equal amount, then people may reallocate their portfolio interest rate channel: there is no reason why a CBDC influences the strength of the interest rate channel. This channel is based on the deep parameters determining the intertemporal preferences and decision making of economic agents, which are unlikely to be influenced by the choosen medium of payment, i.e. a CBDC, bank deposits, or some other assets. Exchange rate channel: The exchange rate channel may become more sensitive to a change in the policy rate, as international differentials in market interest rates widen by more Bank lending channel The funding costs of banks likely become more sensitive to changes in policy rates Transmission to real economy CBDC may most likely strengthen the impact of changes in the policy rate on the real economy. Predominantly through increased PT from policy rates to other interest rates in the economy Monetary policy transmission CBDC do not affect the CB discretion in implementing monetary policy. If flows into CBDC are large and not associated with offsetting declines in banknotes, some challenges may arise CBDC theoretically makes helicopter money possible

PCE (Personal consumption expenditures)

The personal consumption expenditures (PCE) deflator/index calculates inflation based on a basket of goods It is based on surveys of business sales, while a CPI is based on household surveys The FED uses PCE instead of PCI Advantages -The weights can change as people substitute goods and services -PCE includes a broader range of goods and services than a CPI Disadvantages -Initial estimates may be inaccurate due to incomplete data -High vola

What is the prediction of Cuche-Curti?

The point is that the type we assumed the CBDC in the last slides will have huge implications on the CB monetary policy therefore it will probably not be the first way the CB will follow. Guess: That CB will make tokens which are available only on wholesale level and eventually sometime also for retail.

How can the PPI (producer price index) or IPI help to give indications to the CPI?

The producer price index and imported price index. You could think that these measures are good warning system for CPI. Since we are in the production chain and not on the consumption level as the CPI is. But PPI an IPI are very crude approximation of CPI and they do not help to predict CPI inflation.

How does the FED communicate?

The publish the meeting minutes. There are much more people and voting rights in the meeting than at SNB. Then they publish the staff review of the economic situation and then in another chapter the participants view. Every participants gives his forecast under their individual assumption of appropriate monetary policy. (Names are not shown) Then it will produced a histogram from which the median / central tendency (cut outliers) is shown. The participants agreed in the short-term completely. But in the long-term there is a huge dispersion. You can assume the points in the second graphic as endogenous interest rate. But at the same time the FED will do the conditional inflation forecast. The FED sees the current crisis as only temporary since on the long run the projections (forecasts) have not been revised for unemployment or inflation. And the participants agree -> histogram is not stretched. The FED also shows figures about the risks (uncertainty) on each participants view to the different variables. (Lower/broadly similar/ higher)

Where are the rents in the TM15 contribution to CPI?

The rents are always in the middle of the distribution.

How is the output gap calculated?

The rigidities will remain also in the potential output (full employment)

How does the Monetary base look?

The sight deposit of domestic banks was much below off the banknotes in circulation in normal times. But now bank notes are the small part and we have a lot of sight deposits. After 2011 the monetary base increased rapidly. The monetary base data relate to money created by the Swiss National Bank (SNB). This comprises the entire circulation of banknotes as well as sight deposits held by commercial banks at the SNB. Defining the M1, M2 and M3 monetary aggregates is somewhat more complex, with the liquidity of different financial assets playing a major distinguishing role. This can be explained in terms of the different functions of money. Thus, M1 comprises those financial assets that can be used directly as a means of payment. However, money can be also used as a store of value, over and above its function as a means of payment. Accordingly, the M2 and M3 aggregates also include financial assets that focus on savings or temporary investment.

How do you know wether the calibrated shock in the endogenous inflation forecast model is positive or negative?

The way the conditional inflation forecast (assumes flat line of interest rates) will behave with respect to the unconditional inflation forecast (assumes normalization of interest rates) comes direct from the type of shocks you add to your model. The difference between the interest rates levels in the models indicates wether the shock is positive or negative.

How is the CHF currency time-series in terms of effective rates?

There is a trend appreciation (note in the plot an upwards movement is appreciation of CHF) in nominal exchange rates. For this indices you take the most important exchange rates (given by bilateral trading partners of Switzerland) and weight them according to the net-export trading activities. Real effective exchange rate => corrected for price differences between the countries (inflation)

What are the violations of the SVAR(1)

Therefore, you have to transform it to a reduced form VAR.

Do you think CB will have done a good job if they were focused only on inflation?

They do not stabilize turbulences on the supply side and demand side. It would not have done a good job. Since it is important that the CB focus on his commitments. In Case 5: forced commitment. The agents force the CB to focus on inflation but then the CB has not enough levy to react to shocks affecting output. And in overall this is not desirable for the agents. Therefore it is important like the inflation targeting strategy does that CB can make their own commitments but still with some levy. So that CB can react without agents re-anchoring their inflation expectations.

Lets go to the structural models why do non micro-funded models violate the lucas critic? (LSEM, CVAR, BVAR)

They have an equation which explains some structure of the economy. 1. When you estimate the model and enter into the coefficients the current policy in place 2. Then you change the policy. How can you change a policy with a model which has in it already a given policy? You can not do that and for that you need micro-funded models like DSGE which are based on deep parameters (like technology which are not a function of the current policy) Conclusion: micro-funded models normally are more suited to new policy implementations (or policy experiments). But the lucas critic is not very clear. It does not hold always.

How is the conditional inflation forecast calculated with different model?

This curve is a weighted average (not equally weighted) of different mdels. Six models acutally. Average Forecasting lead to better forecast and sometimes one models are more weighted. For example for short-term other models are overweight than in the long term. You want some diversification of the model, so they do not communicate with each other. The models are combined in that way that all are in the VAR form and then you only need your observations today and then the models can make a forecast. (no vector of shocks is needed) In the model you have to specify a mp instrument lets say 2 % which you want to have and when you feed that in the model the endogenous variables will react and you will get an exogenous monetary policy rate (unexplained variation). Some CB also have one core model and validate that with other model but then you have to assume that the core model is the best.

Expansionary Policy how is the impact on the different measures? (Main channels)

This defines the direction but if you make a model you look at the impact (size). In a model you need to calibrate that using data or estimate that using that.

What is the definition of the Granger Causality test?

This is pure statistics and not economics behind. Definition: a variable X is said to Granger cause another variable Y if and only if lagged values of X have marginal predictive content in a forecasting equation for Y.

How works the narrative identification?

This method consists of isolating periods in history where central banks were clearly restrictive or expansive without any connection to the economic context

What means currency competition in Switzerland? What is the traditional money?

Tradtional money Central bank money, recognized by a legal system as a valid medium of payment (legal tender are): 1. cash 2. sight deposits of commercial banks at CB Bank deposits is not legal tender in Switzerland.

Why is the so called "price puzzle" not relevant for Switzerland?

USA, small VAR with different identifications reveals various puzzles, i.e. behaviors of the IRF, which are not 'compatible' with the theory. For example: 1. liquidity puzzle: a rise in the money supply raises, does not lower interest rates 2. price puzzle: When you do a shock in MP to contract the economy (restricitve shock = increasing interest rates) -> Very often after a few quarters you see the price level rising. This is not what a CB wants since when a CB raise interest rates the price level should decrease. In the American literature you find a lot of how getting rid of the price puzzle. For examle explanations are: In Switzerland is not a problem: The price puzzle is an institution. After interest rate increases, mortgage rates increase, which in turn increases rents (due to the linkage of rents to mortgage rates and not to the CPI), which make the price level higher. Rents are in the price level.

How does the conditional inflation forecast look at the BoE?

Uncertainty is very wide.

VAR (Vector Autoregressive Regressions)

VAR are used in every Central Bank because they are very easy to prepare. VAR models are used to gather empirical evidence but also for forecasting. VAR approach underscores the role of data with no particular theoretical foundation and treats all variables as endogenous and exploiting their autoregressive behavior Each variable in a VAR is explained by a linear function of its own lagged values and the lagged values of all other variables

How can you explain the trend increase in frequency of price changes?

We get data from the statistical office of Switzerland we have 20 Million price code. Half of them we can not use. You see here an example of more flexibility. Basic rationale say we have just more competition -> leading to these increase in price changes. Or maybe the menu costs (cost of changing prices) have reduced and therefore firms can change their prices faster. But these are just assumptions.

What are the open question regulation or operation?

What is the Libra Coin from a legal point of view? - What licenses will Libra aim for and where? - Implications for competition policy and data privacy Open questions operations - Will Libra manage the Libra Reserve on its own? - Who will Libra's bank deposit partners be? - Who are the authorized resellers? - KYC and AML done by authorized resellers?

When is an equation just identified or underidentified or overidentified?

When an equation is just identified then you have exactly one solution for your variable. Your system can be underidentified which means you do not have enough information to find the coefficients. So you have to identify your system. As an economist you just basically make assumptions. Lets say 1 in the equation for x and then y is 6.

When you look out of the window and you see the interest rate is changing. Then you do not know if the central banks has done something to change the interest rate or if the central banks reacts to change of the interest rate. But you can observe many days and then you can see that the central banks react.

When you want to isolate the empirical evidence of your future interest rate change you need to isolate the acts apart. (alle faktoren die eine rolle spielen) interest rates are the endogenous reaction to the economy and exogenous monetary policy shocks uncorrelated to the economy You take your instrument and regress on all explanatory variables you find until the fact that you have isolated an exogenous monetary policy shock. You stop doing your regression until you have a mean of zero of the exogenous monetary policy shock and it is not correlated with the explanatory variables. When we plot then the exogenous mp shock (residual) we see noise. The irony of the system is that I will exactly use this system to make a small movement (e.g 25 bp increase in interest rate) in the residual to start a propagation mechanism so that you can see in the end how strong a move in interest rate will affect the other variables in the system. -> Impuls answer function You need to identify your shock. You can formulate the model in a VAR and then there is a method to identify the exogenous monetary policy shock. When you make a simulation you need a system which is in its steady state. Conclusion: CB do know which impact can be expected based on these evidence and this model.

What are the challenges of CB?

Which strategy should CB follow? This is political process and evolves over time. The definition of your inflation target. There is the discussion that CB should make their inflation targets higher to avoid the zero lower bound. If the inflation rate target is higher the nominal interest rate is also higher and you have more levy when you have to cut interest rate to zero. Problem is then inflation expectation is also higher. Back to normalization: We are not in the back in steady state yet. At some time CB will have to normalize interest rate. CB will normalize their Balance sheet or maybe only normalize the interest rates. Demographic aging: Theoretically no link between central banks and this structural challenge. Central banks earn seignorage and do not create wealth. (CB can not improve the technological progress or total factor productvity which is responsible for growth). But some politicians propose to distribute the CBs revenue to the public. National accounts surplus In Switzerland we have an huge excess Saving over investment and then you can do two things either finance your public hand or finance the rest of the world with a huge current account surpulus (swiss case) Meaning with our surplus we finance the rest of the world so that they can buy our products and services. Macroprudential policy All CB will have now a financial stability department to address systemic risk

Wholesale vs Retail (General purpose) CBDC

Wholesale CBDC - limits access to a group of users - may enhance settlement efficiency for transactions involving e.g. securities - has to comply with existing settlement requirements Retail CBDC - is accessible to several groups of users - serves as an alternative payment instrument, compared to bank deposits, in countries with a disappearing cash demand - its use may be limited if private payment products are already in place Broad vs. Restricted - both CBDC forms can be further restricted within any group of users - e.g. only a subset of commercial banks uses a given wholesale CBDC e.g. only a given community can have access to a general purpose CBDC

Impulse response function (IRF)

With IRF you can play with a structural shock. The IRF shows how the vector reacts after a shock and returns to its average You never play with two shocks at the same time since then it would not be an identified shock. There is no consensus on the way to solve the identification problem, but in the IRF form. IRF after a monetary policy shock is hump-shaped for the real output. If you do not have a hump-Shaped IRF you probably do not have a good model

How do you get the reduced form

With the reduced form VAR you can calculate the coefficients without violating the econometric assumptions. But you can not go back to the system at the beginning. Underidentification The reduced form does not allow recovering all the structural parameters.

Transparency vs. Predictability

You can be very transparent but very difficult to predict. The ECB or the FED are very transparent (publish much more on the web) compared to the SNB. But is this useful? Is the CB more predictable if it is more transparent?

Two types of models?

You can have two types of equations. 1. Model based on definitions (production function) 2. Model with equations based on behavioral after optimization (you use first order condition and is not based on mechanical definition / As soon you have agents behaving something it is a behavioral base equation.

We have the red line as conditional inflation forecast. The unconditional is not published. Where is the unconditional inflation forecast line?

You have to ask yourself 2 questions: 1. Is the interest rate in the unconditional (endogenous interest rate) model close to the conditional model 2. Is the interest rate (-0.75) in the conditional model crazy expansionary or restrictive? The unconditional forecast assumes (that the world is normalizing and Switzerland will also normalize since the model is a small-open economy model) a normalization of interest rates which means that interest rates will increase sometimes. This leads to an inflation forecast which is below the red line.

Problem of seasonally-adjustments?

You need in economic models often no seasonality. (time-series need to be stationary) To get rid of season you smooth out a time-series where you will loose information and also there are several options to do that.

What is the conclusion of the repeated game (TI problem 2)?

alpha = preferences lamda = slope alpha*lambda= inflation bias (1-beta)/ (1+beta) = discount factor Conclusion is that the CB should not set a inflation target of 0.

Correlation vs. Causality Cross correlation Dynamik correlation

correlation does not mean causality, but causality implies correlation Cross correlation: correlation between the same variables in different periods of time Time direction gives causality. Dynamik correlation: correlation between two different variables in different periods of time.

What is a stable coin?

cryptocurrencies that attempt to peg their market value to some external reference Stablecoins may be pegged to a currency or a commodity such as gold Stablecoins achieve their price stability via collateralization (backing) or through algorithmic mechanisms of buying and selling the reference asset or its derivatives

How do you find empirical evidence?

economic models should be able to replicate all or some of the facts gathered from the empirical evidence identification problem -> the problem of untangling observed data or phenomena in order to test theoretical hypotheses Before you can make policy you need to gather data.

Core inflation (filtered headline inflation)?

headline inflation equals core inflation plus 'noisy' elements κ and a white noise ε Note: we reduce signals for core inflation (= information reduction) core inflation (= Trend inflation) is a measure of price developments without 'noise', being e.g. local market effects, transitory shocks, or measurements errors Many CB define Price stability in Headline inflation (SNB) and not core (but the FED communicates with core). Approaches Cross-sectional approaches: i.e. reweighting CPI items in the basket such that 'noisy' items receive less weigh or are excluded Time-series approach:, i.e. apply filter techniques on headline inflation (e.g. like HP filtering to extract a stochastic trend)

What are the features of CBDC per defintion?

issuer: - CB (compared to private issuers) form: - digital/electronic (compared to physical form)

What are the Measurement biases in inflation?

main biases - substitution bias: consumers substitute when relative prices change; with fixed basket, no substitution - new product bias: new products introduced in the basket with a lag - quality bias: improved products cost more due to their enhanced features; such improvements should not count as price increase - outlet bias: prices of hard discounters only partially included chain linking joining together two indices that overlap in one period by rescaling one of them to make its value equal to that of the other in the same period, thus combining them into single time series The statistical office changes the weight of the index every year and every 5 years the CPI is reset to 100. When you do that you have to chan link the index. (very complex)

How does the Redistribution channel work?

monetary policy is not intended to benefit one segment of the population at the expense of another by redistributing income and wealth Note: Also the asymmetric of business cycles (e.g 15 year boom, 2 year recession) may lead to redistributional effects. - but redistributive effects may exist and not average out because business cycles are asymmetric - the channel acts through portfolio composition, wage heterogeneity, and income composition - portfolio composition channel : unexpected inflation transfers wealth from agents with nominal assets to those with nominal debt - wage heterogeneity channel: monetary policy affects wages of different groups of the population differently through its diverse effects on employment - income composition channel: because households have different mixes of wages and financial income, and because monetary policy affects wages differently than it affects financial income Basic standard model at CB -> DSGE model where we have only 1 representative agent. This is not representative if we say there is a redistribution effect. We need at least 2 or more agents

Which models are used at SNB to forecast inflation?

non-structural models - ARIMAnext (Autoregressive Integrated Moving Average) This model is overweighted for the very short-term forecasting period because it is based on time-series. It is pretty good for the short term meaning a very small error rate. Non-structural models are good using the information content of data but after a longer period you need a structure of the data. - BVAR (Bayesian Vector AutoRegressive) semi-structural models - CVAR (Cointegrated Vector AutoRegressive) structural - LSEM (Large Structural Econometric Model) - DSGE (Dynamic Stochastic General Equilibrium) - NOEM (New Open Economy Model)

What is the CPI (Headline) inflation? How does the SNB calculate the inflation?

positive increase (in percent) in the level of prices (index) for consumer goods and services different rates - yearly or annual average - (y/y) inflation, with monthly or quarterly data - (q/q) inflation, with monthly or quarterly data, annualized or not - (m/m) inflation, annualized or not

Token vs. account based

token-bases CBDC (no 3party does SNB not want) direct-account-based CBDC (will probably never exists since today are thousands of banks responsible for all accounts which only one institution can not handle)

Explain the identification problem of demand curve?

you want to find the demand curve model: ln(quantitiy) = beta(0) + beta(1)*ln(price) + error term With the data and the regression you may have a positive coefficient. Is it now the demand curve? For the identification of the curve you make assumption that one curve is not moving. For example when you know that demand is very stable and you know only supply changes. Then you can slowly simulate the change of the supply curve which will give you then the demand curve. Actually when you make an assumption you give your model more information to help answering your question.

On what is the conditional inflation forecast conditioned?

1. interest rate 2. world view 3. random walk assumption (oil price, exchange rate of EUR/USD)

CVAR = Cointegrated Vector AutoRegressive (semi-structural)

2 time series are cointegrated when they move together. When they move together (even if they are not stationary) they can help predict each other.

How is the contribution to domestic inflation?

A lot of depreciation of domestic goods (due to competition and substitution effects to import goods) Negative public services is linked to healthcare meaning that premiums have been lowered. Domestic Private services without rents are always positive because this is related to buildings and labor which are not very tradable and therefore their prices often increase (dark blue bar is always positive) Note: the exchange rate mechanism can also impact the domestic private services. A gym can buy the fitness equipment cheaper. Or a coiffeur can buy the shampoos from germany cheaper and then then offer its service to a lower price.

When is a policy time consistent? Give an example of the "Wirtschaftsförderung" making a policy to attract firms.

A policy is time consistent if an action planned at time t for time t + 1 remains optimal to implement when time t + 1 actually arrives Die "Wirtschaftsförderung" is actually not time consistent since the canton say that firms will have to pay less taxes if the move in the corresponding canton but as soon as they have moved the canton has an incentive to increase taxes. So the way to make it consistent -> you sign a contract like for the next 10 years the taxes will not increased for this firm.

For the identification with short-run restrictions you make the last assumption that the Matrix A is lower triangular. How does the order impact the interpretation?

Assume: y = real output x = monetary policy (interest rate) This is probably wrong or not used x comes first: monetary policy affects output with a lag; non-policy innovations are exogenous with respect to the policy innovations Basically, monetary policy influencing output right now. But output not incluencing monetary policy This is the classic model y comes first: output affects interest rates but the interest rate do not affect output within the same period. In the second period it can also affect the output. This sound plausible with quarterly data. since maybe a monetary policy implementation takes a bit time until it affects output. Basically, output influencing monetary policy right now. But monetary policy not influencing output right now. In later periods they can influence each other. Very important: With annual data the model will not be good. Since this implies that the monetary policy will not impact GDP within a year. This depends on what you want to achieve but probably monetary policy will affect earlier than a year the GDP.

How is the uncertainty of the conditional inflation forecast communicated?

At SNB the uncertainty is not communicated with a graphic. It is communicated with comments in the press statement. SNB does not publish fan chart even they are more transparent but they maybe help not to anchor better inflation expectation. In comparison to BoE which has in the inflation forecast plot also the dispersion of the inflation forecast. (fan chart) If a fan chart is produced only with your errors. The fan will be symmetric. The goal is to find the variance of the error. Actually fan chart is a measure where you can see how good your forecast is but it does not show wether you are optimistic or pessimistic. (then the distribution will not be symmetric anymore) eg. If I assume the risk is downwards for my inflation then the fanchart would have more colors below curve than above the curve. -> negative skewed you see a forecast, a certainty and there is more information below than above which is clearly a judgment of BoE seeing more risk on downward pressure on GDP. The skewness of the fanchart is based on judgement. The GDP has also a fan chart in the past (unemployment not). Since there is often data revision.

At the beginning of the pandemic what kind of shock happened in the AS-AD model?

At the beginning of the crisis we had a negative supply shock. (AS curve shifts to the left). Nightmare for central banks since you have higher inflation (where they should increase interest rates) but you also have smaller output (where they should decrease interest rates)

How can you incentive banks to lend money in a pandemic?

Bank do not have any incentive to lend money in a crisis since they even need the liquidity for their own. When the restaurant will not have any customers why should a bank give them money? But the loans where backed by the government. Without the collateral of the public hand for credits bank did not have any incentive to grant loans in March. COVID-19 refinancing facility (CRF) allows banks to obtain liquidity from the SNB by assigning credit claims from corporate loans as collateral

What is the SNB monetary policy rate?

Basically, this is just a figure communicated by the SNB but it is actually not a market where you can lend money for the policy rate. The SNB then ensures that the secured short-term money market rates are close to the SNB policy rate. In this regard, the SNB is focusing on SARON, the most representative of the short-term Swiss franc rates Note: almost 20 years between 2000 and 2019 the SNB used a target range for the 3M Libor. The SNB usually influenced the Libor through ON to 3W repos The conditions on the money market are currently determined by the interest rate banks pay on their sight deposits at the SNB -> floor system SARON is an overnight rate, there is no need for a target range

Why is the SNB is a pseudo inflation targeter?

Because the SNB does not fulfill all requirement from the literature. Inflation targeting is a framework rather than a rigid set of rules for monetary policy 1. price stability explicitly recognized as the main goal of monetary policy 2. public announcement of a quantitative target for inflation (helps anchor inflation and gives an indicator benchmark to check ex-post) 3. monetary policy is based on a wide set of information, including an inflation forecast 4. transparency 5. accountability mechanisms If it only has the rules it can not cover all possibilities. So it needs a mix out of rules and discretion (ability to decide on its own) - inflation targeting combines elements of both 'rules' and 'discretion' in monetary policy, and is characterized as 'constrained discretion' -> the inflation target provides a rule-like framework on which the private sector can anchor its inflation expectations; within this framework, the CB has discretion in reacting to shocks

Explain the EURCHF exchange rate floor

Before the floor was introduced the Swiss franc appreciated very strong due to debt euro crisis (startet in 2010). In the euro area was a lot of uncertainty -> safe haven currency CHF appreciated From year 2010 -2011 the EURCHF 1.5 -> 1.05 = appreciation of 40% which is very huge for export sector in Switzerland Floor was established from (sept 2011 -> jan 2015 ) Floor was never cut. Since a speculative attack was not possible like in a fixed exchange rate system. Literatur is not useful. Normally the Cb has to sell foreign exchange reserves but in the Swiss case the SNB is able to print as much money it wants and can buy foreign assets as much it wants. Press relaese of floor removal The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%. It is moving the target range for the three-month Libor further into negative territory, to between -1.25% and −0.25%, from the current range of between −0.75% and 0.25%. The SNB is lowering interest rates significantly to ensure that the discontinuation of the minimum exchange rate does not lead to an inappropriate tightening of monetary conditions. The SNB will continue to take account of the exchange rate situation in formulating its monetary policy in future. If necessary, it will therefore remain active in the foreign exchange market to influence monetary conditions.

Big data defnition

Big data -very large sets of data produced by people using the internet -big data can only be stored, understood, and used with help of special tools and methods -big data encompasses the volume of information, the velocity/speed at which it is created and collected, and the variety or scope of the data points being covered -big data often comes from multiple sources and arrives in multiple formats

Definition of Blockchain?

Blockchain is a specific type of distributed ledger where the ledger is updated in groups of transactions (blocks); the sequence of blocks stringed together forms a blockchain Blocks are linked together meaning you can not change a block without infering others A block contains: 1. a set of transactions (becomes after validation a 'digital fingerprint') 2. A timestamp 3. A 'digital fingerprint' of the previous block, this fingerprint is called hash

What is the Proof-of-work puzzle? What is the Proof-of-stake?

Both are ways to achieve consensus in the network. Proof-of-work To solve the puzzle is very costly but it is simple to check the solution. - since it is costly to solve the puzzle, the successful node wants its solution to be accepted; adding fraudulent transactions in the proposed solution is avoided - since it is easy to check the solution, approving it comes at almost no cost: this secures transaction verification, as it is easy to observe fraud Proof-of-Stake To validate transactions and create new blocks, a (known) user - so- called forger, not miner - must first put his/her own coins at stake; his/her holdings being held in an es-crow (time-locked) account.

Advantages and Disadvantages of Corridor System

CB needs to do a very active reserve management to stabilize the overnight rate. By narrowing the corridor the risk increases that the market dries up.

Which 5 different cases (games) of TI can you model?

CB preferences: A: - maximization problem -linear objective function B: - minimization problem - quadratic loss function Cases: 1. discretion with A 2. commitment with A 3. discretion with B 4. discretion with B 5. forced commit. with B