Abstract Although housing markets are inherently local, they have become increasingly influenced by global capital movements in recent decades. Rising house prices are often found to be associated with large capital inflows, but the relationship has fluctuated over time and is far from uniform across time and across countries. It was strongest immediately before and after the global financial crisis, a period that was quite special because a global savings glut coincided with domestic financial deregulation in many countries. In contrast, the capital-flow–house-price link seems to have weakened again over the past decade as macroprudential regulation has attempted to mitigate the impact of capital flows on house prices. This article argues that the correlation between capital inflows and house prices, as well as the degree of international synchronization of house prices, will continue to fluctuate over time, even as housing prices increasingly are related to the same global risk factors that drive global capital flows and the prices of financial assets.

The New Keynesian argument is that flexible exchange rate regimes cannot stabilize cyclical developments at the ZLB, as the real exchange rate appreciates in response to adverse demand shocks. We estimate the effects of a negative domestic demand shock on the real exchange rate for the euro area vis-à-vis the United States, Canada, and Japan by state-dependent sign-restricted local projection methods. We find a real depreciation when interest rates are not at the ZLB, but also when they are. The exchange rate can accommodate considerable variations in output, confirming its shock-absorbing capacity before and during the ZLB episode. The stabilizing role of the exchange rate is accompanied by a significant expansion of the ECB's balance sheet at the ZLB, while it remained unaffected in the pre-ZLB period. Our empirical results can be reconciled with an open economy New Keynesian model extended with unconventional monetary policy measures when interest rates are at the ZLB.

During the post-pandemic inflation surge, many central banks used communication about the inflation outlook to limit spillovers from realized to expected inflation. We present novel survey evidence showing that ECB guidance about the projected inflation path lowers households’ inflation expectations when inflation is unusually high. Qualitative, positively framed messages have the largest effects on short-term expectations, while simple visualizations are particularly effective at longer horizons. Effects are heterogeneous across socio-demographic groups. Our findings suggest that, regarding their communication, central banks should ‘keep it sophisticatedly simple (KISS)’.

In Japan in the 1920s, several financial crises and government policy led to bank mergers and the consolidation and expansion of branch networks. Using unique historical bank branch-level lending and deposit data, we show that branch banking integrated peripheral markets with the rest of the country, with large urban banks - those headquartered in Tokyo and Osaka - using deposit supply shocks in peripheral areas to fund lending in their core markets. While these findings support contemporary concerns about branch banking draining funds from peripheral markets, we argue that the export of liquidity by urban banks likely represented an efficient reallocation of credit, driven primarily by competition in funding markets. Faced with high-yielding lending opportunities in central prefectures, urban banks bid up deposit rates in peripheral areas, raising local banks' funding costs. Local banks responded by lowering intermediation margins and reducing lending to traditional industries, which suggests that they shifted their lending to less risky and more efficient customers. We speculate that this competitive reallocation of capital across regions and sectors allowed banks to maintain a functional specialization in different customer segments, which may explain the continued coexistence of small relationship lenders and large integrated arm's-length lenders in local banking markets.

We estimate the effects of a negative asymmetric demand shock on the real exchange rate for the euro area vis-à-vis the United States, Canada, and Japan by state-dependent sign-restricted local projection methods. We find a real depreciation when interest rates are not at the ZLB, but also when they are. The exchange rate can accomodate considerable variations in output, confirming its shock-absorbing capacity before and during the ZLB episode. The stabilizing role of the exchange rate is accompanied by a significant expansion of the ECB's balance sheet at the ZLB, while it remained unaffected in the pre-ZLB period. Our empirical results can be reconciled with an open economy New Keynesian model extended with unconventional monetary policy measures when interest rates are at the ZLB.

We study how households adjust their medium-term inflation expectations under the new ECB strategy. We find that survey respondents make little difference between the previous strategy of targeting inflation rates close to but below 2% and the new strategy with a symmetric 2% target. Yet, participants informed that the ECB might tolerate rates exceeding the target for some time, expect somewhat higher medium-term inflation. Respondents asked to assume inflation currently running below target place a significantly higher probability on outcomes above 2% in the medium term. Participants do not expect an undershooting when inflation is currently running above target.

In this paper, we present empirical evidence that higher income inequality is associated with a greater equity share in countries’ external liabilities, and we develop a theoretical model that can explain this observation: In a small open economy with traded and non-traded goods, entry barriers depress entrepreneurial activity in non-traded industries and raise income inequality. The small number of domestic non-traded goods firms leaves room for foreign firms to operate on the domestic market, and it reduces external borrowing. The model thus suggests that barriers to entrepreneurial activity raise both inequality and the equity share in foreign liabilities. Our empirical results lend some support to this conjecture.

Yes, they would. In a randomized control trial, we provide groups of respondents from the Bundesbank Online Panel Households with information about a hypothetical alternative ECB monetary policy regime akin to the Federal Reserve’s flexible average inflation targeting (AIT). Inflation expectations significantly increase for the treated individuals. When provided with additional assumptions about current inflation, individuals update their expected inflation path in line with the central banks’ intentions. Individuals with a high trust in the ECB’s ability to achieve price stability adjust their inflation expectations particularly strongly. We assess the economic significance of our findings by comparing two model economies under different monetary policy strategies, calibrated to match the difference in medium-term inflation expectations from our survey results. Inflation is substantially less volatile and the frequency of hitting the lower bound of interest rates considerably reduced under AIT.

After the inception of the euro, the real economy in most member countries remained dependent on credit by domestic banks, which increasingly funded themselves through cross-border interbank funding. We find that this pattern of ‘double-decker’ banking integration exposed domestic banks to sharp declines in cross-border interbank lending during the eurozone crisis. As a result, domestic banks reduced lending, which led to large declines in output in sectors with many small (bank-dependent) firms. We propose a quantitative small open economy model to account for these patterns and conclude that a global banking shock leading to a sudden stop in cross-border interbank lending in the eurozone is required to account for them.

U.S. state-level banking deregulation during the 1980’s mitigated the impact of the China trade shock (CTS) on local economies (states and commuting zones) a decade later, in the 1990s. Local economies, where local banking markets opened up earlier, were also effectively financially more integrated by the 1990’s and saw smaller declines in house prices, wages, and income following the CTS. We explain this pattern in a theoretical model that emphasizes the stabilizing effect of financial integration on demand for housing and on housing prices: faced with an adverse shock to their region’s terms-of-trade (i.e. the CTS), households in more open states can more easily access credit to smooth consumption. This stabilizes consumer demand for housing, keeps the relative price of housing up, stabilizes wages in the non-tradable sector and thus facilitates the sectoral reallocation of labor away from import-exposed manufacturing towards the housing sector. This in turn stabilizes income and consumption. We corroborate these predictions of our model in state- and commuting zone level data. Then, using granular bank-county-level data,we show that household consumption smoothing in response to the CTS was easier in financially open areas, because geographically diversified banks were more elastic in their lending response to household’s increased demand for credit. Our findings highlight that household access to finance is important to ease adjustment after asymmetric terms-of-trade shocks in monetary unions, in particular when the geographical mobility of labor is limited.

We exploit the natural experiment of Japan’s opening to international trade to examine how comparative advantage can shape a country’s long-run path towards financial development. In the late 19th century, many of Japan’s prefectures had a natural comparative advantage in silk reeling. Producing silk for export required access to finance. At the same time, for technological reasons, borrower-quality in the silk reeling industry was notoriously hard to assess. Silk exporters overcame these frictions by forming local cooperative banks. We show that in the ancient silk prefectures, local cooperative banks continued to dominate local banking markets for over a century while bigger, country-wide banks came to dominate in other regions. By the late 20th century, the silk prefectures are indistinguishable from other regions in terms of their general level of financial development. However, our results suggest that they were effectively less financially integrated with the rest of the country. Hence, comparative advantage in silk favored the emergence of a banking-system dominated by small relationship lenders. But due to the local nature of these lenders, it also caused long-term geographical segmentation in banking markets.

According to the two-country full information New Keynesian model with flexible exchange rates, the real exchange rate appreciates in response to an asymmetric negative demand shock at the zero lower bound (ZLB) and exacerbates the adverse macroeconomic effects. This finding requires inflation expectations to adjust counterfactually large. When modeling inflation expectations consistent with survey expectations using imperfect information, we find that exchange rates can absorb demand shocks at the ZLB. In sharp contrast to the full information model: (i) A negative demand shock concentrated in the home country causes a real exchange rate depreciation that partially absorbs the demand shock. (ii) A VAR with an identified demand shock via sign restrictions is consistent with a real exchange rate depreciation at the ZLB. (iii) When the ZLB is binding in the home country, it is optimal for the foreign policymaker to reduce rather than increase foreign interest rates. (iv) Forward guidance that reveals the true state of the economy exacerbates the negative output gap in the two countries.

The vast macroeconomic literature trying to explain the widely observed equity home bias disregards internationally active firms. In a DSGE model that features the endogenous choice of firms to become internationally active through either exports or foreign direct investment (FDI), we find that the optimal equity holdings of agents are biased towards domestic firms. Our finding indicates that international diversification is not as bad as empirical measures of the equity home bias suggest.

We explore empirically how capital inflows into the US and financial deregulation within the United States interacted in driving the run-up (and subsequent decline) in US housing prices over the period 1990-2010. To obtain an ex ante measure of financial liberalization, we focus on the history of interstate-banking deregulation during the 1980s, i.e. prior to the large net capital inflows into the US from China and other emerging economies. Our results suggest a long shadow of deregulation: in states that opened their banking markets to out-of-state banks earlier, house prices were more sensitive to capital inflows. We provide evidence that global imbalances were a major positive funding shock for US wide banks: different from local banks, these banks held a geographically diversified portfolio of mortgages which allowed them to tap the global demand for safe assets by issuing private-label safe assets backed by the country-wide US housing market. This, in turn, allowed them to expand mortgage lending and lower interest rates, driving up housing prices.

US net capital inflows drive the international synchronization of house price growth. An increase (decrease) in US net capital inflows improves (tightens) US dollar funding conditions for non-US global banks, leading them to increase (decrease) foreign lending to third-party borrowing countries. This induces a synchronization of lending across borrowing countries, which translates into an international synchronization of mortgage credit growth and, ultimately, house price growth. Importantly, this synchronization is driven by non-US global banks’ common but heterogenous exposure to US dollar funding conditions, not by the common exposure of borrowing countries to non-US global banks. Our results identify a novel channel of international transmission of US dollar funding conditions: As these conditions vary over time, borrowing country pairs whose non-US global creditor banks are more dependent on US dollar funding exhibit higher house price synchronization.

We assess to what extent wage inflation policies in Germany could contribute to an economic rebalancing in the euro area and the rest of the world. We find that a rise in nominal wage inflation has positive short-run effects on inflation and output in Germany and the rest of the euro area. The duration of constant interest rates and expectations about the monetary policy stance matter to the magnitude of the results obtained. We establish that the modelling of the trade relationships with the rest of the world is of particular importance, as it allows to capture the induced relative price movements and hence changes in competitiveness within the three regions. Our results are obtained from an estimated DSGE model which consists of Germany, the rest of the euro area, and the rest of the world.

Time-variation in disagreement about future inflation is a stylized fact in survey data, but little is known on how disagreement interacts with the efficacy of monetary policy. We show that a contractionary 100 bps U.S. monetary policy shock leads to a statistically significant increase in inflation and inflation expectations of up to 0.7 percentage points in times of high disagreement, whereas in times of low disagreement it leads to a significant decline in these variables of around 0.8 percentage points. We reconcile these state dependent effects with a regime-switching dispersed information New Keynesian model, where we calibrate the information structure to match disagreement about inflation expectations in U.S. data. ? 2019 Elsevier B.V. All rights reserved.

We study channels of risk sharing in the EMU before and after 2008, when the Great Recession started. Empirically, higher cross-border equity holdings and more direct bank-to-nonbank lending are associated with more risk sharing while interbank integration is not. Equity market integration in the EMU remains limited while banking integration is dominated by interbank integration. Further, interbank integration proved to be highly procyclical, which contributed to a freeze in risk sharing after 2008. Based on this evidence, and results from simulations of a stylized DSGE model, we discuss implications for banking union. Our results show that direct banking integration and capital market integration are complements and that robust risk sharing in the EMU requires integration on both fronts.

Cross-sectional evidence for 119 developing, emerging, and developed countries shows over the last three decades that countries with an on average higher volatility of output growth experience more procyclical capital outflows over the business cycle than those countries with the same growth rate but a more stable output path. This stylized pattern shows up in addition to the recently established fact that countries with higher macroeconomic uncertainty tend to accumulate higher external asset positions. To explain this finding we present an open-economy real business cycle model with stochastic growth rates in which higher uncertainty of the expected income stream increases the precautionary savings of households. We show that the combination of income risk and the precautionary savings motive leads to both more procyclical capital outflows in the shorter run and a higher long-run external asset position.