Central Banks and Frictions
Paper Session
Sunday, Jan. 3, 2027 8:00 AM - 10:00 AM (EST)
- Chair: Rebecca Chambers, Federal Reserve Bank of Philadelphia
The Macroeconomic Consequences of Undermining Central Bank Independence: Evidence from Governor Transitions
Abstract
This paper studies the macroeconomic consequences of undermining central bank independence through politically motivated transitions of central bank governors. Leveraging a new panel dataset covering 132 central bank governor transitions in 28 advanced and emerging market economies since 2000, we document the timing, frequency, and political drivers of these leadership changes. Tenures of governors with politically motivated appointments are associated with higher and more volatile inflation, realized and expected. Professional forecasters also tend to expect such governors to be more dovish when responding to shifts in inflation. Using local projections in a difference-in-difference setting, we find that following the announcement of a politically motivated governor transition nominal and real short rates decline and expected and realized inflation rise. At the same time, GDP growth increases in the aftermath of such transitions, consistent with an expansionary short-run macroeconomic impulse. These effects are more pronounced when the incoming governor professes unorthodox views on monetary policy, suggesting that political interference in central bank leadership induces a temporary growth–inflation trade-off. Long-term inflation expectations only rise in the case of unorthodox governors with politically motivated appointments, suggesting costs to central bank credibility are much more pronounced in those cases.An Expectations-Based Measure of Central Bank Transparency
Abstract
This paper develops an empirical measure of central bank transparency by estimating how much market implied policy expectations would improve under additional information disclosure by the Federal Reserve. Using text analysis techniques powered by large language models, we find that the mean squared error of market expectations would have been 19-40% lower given enhanced access to information provided in FOMC meetings, highlighting a sizable information asymmetry. Forecast gains almost entirely occur during easing cycles. Improved short-rate expectations would have lowered 10-year Treasury yields by up to 29 basis points during easing cycles, indicating that transparency materially affects monetary policy transmissionto long rates. Information asymmetries appear to be primarily driven by information about the FOMC’s sensitivity to downside risk, particularly with respect to economic growth and financial stability.
Corporate Effects of Monetary Policy: Evidence from Central Bank Liquidity Lines
Abstract
Monetary policy tools increasingly involve operations with corporate assets. This paper examines how these tools directly impact real activity by influencing demand for firms’ debt instruments and firms’ liquidity management policies. Using quasi-experimental variation from the inclusion of eligible corporate debt instruments in the Central Bank of Brazil’s collateral framework, combined with a novel dynamic regression discontinuity design methodology, we find that eligibility increased firms’ debt issuance, modestly decreased spreads, and reduced firms’ holdings of safe assets, indicating a decrease in precautionary savings and leading to significant increases in firms’ employment and supply chain liquidity. To interpret this mechanism, we discuss how inelastic (segmented) financial markets induce this policy to create a permanent borrowing subsidy, akin to a liquidity injection that can relax firms’ borrowing constraints. This easing of expected future borrowing constraints reduces firms’ liquidity risk, amplifying the policy passthrough as firms have more incentives to reduce cash hoarding and expand production. We develop a semi-structural approach based on our reduced-form RDD estimates to measure firms’ responses, finding that each 0.8% increase in the induced borrowing subsidy leads to a 1% increase in debt issuance, a 0.2% reduction in cash holdings, and a 0.4% increase in the wage bill. We discuss how to leverage the model to study the trade-off between expanded credit and increased risk versus greater liquidity access and its pass-through to real activity, and to quantify these effects.Why Central Bank Credibility Matters for Inflation Targeting
Abstract
Inflation targeting (IT) has become the dominant nominal anchor among emerging market central banks, yet the post pandemic inflation episode underscores a persistent puzzle: economies that tightened by less subsequently experienced higher inflation on average, but inflation paths and the degree of expectations re anchoring still varied substantially even among comparably tightening central banks. This paper treats central bank credibility as a latent, time varying state variable that disciplines the expectations formation process and therefore the mapping from policy actions into expected and realized inflation, output, and exchange rates. The paper makes three contributions. First, it provides the first comprehensive set of time varying, country specific credibility estimates for a sample of emerging market economies, constructed from professional forecast microdata. Credibility is identified from forecast based elasticities informed by theoretical models in which higher credibility attenuates expectation updating and flattens the perceived output–inflation tradeoff. These measures are forward looking and policy contingent, rather than outcome-based, because they are pinned down by real time belief updating in response to observables informative about the policy regime. Second, the paper establishes the critical role of credibility in explaining heterogeneity in monetary policy transmission and in estimated monetary policy reaction functions. Third, it embeds the empirically estimated credibility dynamics in a structural model with adaptive learning to characterize an optimal (state contingent) monetary policy rule along credibility transitions and under large supply shocks. The results show that credibility accumulation strengthens the expectations channel, reduces inflation persistence and sacrifice ratios, and expands the scope for shock accommodation without de-anchoring expectations. The findings establish central bank credibility as a key state variable for monetary policy transmission and inform optimal monetary policy rule contingent on credibility.Barriers to a European Banking Union
Abstract
This paper estimates barriers to cross-border banking within the euro area and their consequences for credit allocation and output. We develop a quantitative spatial equilibrium model in which heterogeneous banks decide whether to expand abroad and set lending rates, while firms choose how much to borrow to finance investment. Cross-border frictions operate along three margins: relationship formation, loan pricing, and banks’ branching decisions. Using loan-level data from the European credit registry (AnaCredit), we estimate these barriers at the country-pair level. We find that barriers to forming cross-border lending relationships are extremely large—and larger than what aggregate data would suggest—while implicit taxes on interest rates and loan quantities are comparatively small. We show that the estimated wedges are strongly associated with differences in national banking regulations, measured using a novel dataset on regulatory fragmentation. Embedding these estimates in the calibrated model, we assess the effect of partially lifting cross-border barriers on credit allocation and output.JEL Classifications
- E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit