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on Central Banking |
| By: | John M. Roberts |
| Abstract: | Since the early 1980s, the United States economy has changed in some important ways: Inflation now rises considerably less when unemployment falls and the volatility of output and inflation have fallen sharply. This paper examines whether changes in monetary policy can account for these phenomena. The results suggest that changes in the parameters and shock volatility of monetary policy reaction functions can account for most or all of the change in the inflation-unemployment relationship. As in other work, monetary-policy changes can explain only a small portion of the output growth volatility decline. However, changes in policy can explain a large proportion of the reduction in the volatility of the output gap. In addition, a broader concept of monetary-policy changes--one that includes improvements in the central bank's ability to measure potential output--enhances the ability of monetary policy to account for the changes in the economy. |
| Keywords: | Monetary policy - United States ; Inflation (Finance) |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2004-62&r=cba |
| By: | Bernardino Adão; Isabel Correia; Pedro Teles |
| Abstract: | What instruments of monetary policy must be used in order to implement a unique equilibrium? This paper revisits the issues addressed by Sargent and Wallace (1975) on the multiplicity of equilibria when policy is conducted with interest rate rules. We show that the appropriate interest rate instruments under uncertainty are state- contingent interest rates, i.e. the nominal returns on state-contingent nominal assets. A policy that pegs state-contingent nominal interest rates, and sets the initial money supply, implements a unique equilibrium. These results hold whether prices are flexible or set in advance. |
| Keywords: | Monetary policy ; Interest rates |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedhwp:wp-04-26&r=cba |
| By: | William T. Gavin; Benjamin D. Keen; Michael R. Pakko |
| Abstract: | This paper revisits the issue of money growth versus the interest rate as the instrument of monetary policy. Using a dynamic stochastic general equilibrium framework, we examine the effects of alternative monetary policy rules on inflation persistence, the information content of monetary data, and real variables. We show that inflation persistence and the variability of inflation relative to money growth depends on whether the central bank follows a money growth rule or an interest rate rule. With a money growth rule, inflation is not persistent and the price level is much more volatile than the money supply. Those counterfactual implications are eliminated by the use of interest rate rules whether prices are sticky or not. A central bank's utilization of interest rate rules, however, obscures the information content of monetary aggregates and also leads to subtle problems for econometricians trying to estimate money demand functions or to identify shocks to the trend and cycle components of the money stock. |
| Keywords: | Monetary policy ; Prices |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2004-026&r=cba |
| By: | Stefano Eusepi |
| Abstract: | This paper explores the effects of central bank transparency on the performance of optimal inflation targeting rules. I assume that both the central bank and the private sector face uncertainty about the "correct" model of the economy and have to learn. A transparent central bank can reduce one source of uncertainty for private agents by communicating its policy rule to the public. ; The paper shows that central bank transparency plays a crucial role in stabilizing the agents' learning process and expectations. By contrast, lack of transparency can lead to expectations-driven fluctuations that have destabilizing effects on the economy, even when the central bank has adopted optimal policies. |
| Keywords: | Monetary policy ; Inflation (Finance) ; Banks and banking, Central ; Uncertainty |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:199&r=cba |
| By: | Tobías Broer |
| Abstract: | This paper identifies the information content of monetary aggregates for output and inflation in Chile, using a large set of reduced-form statistics and regression specifications. Unlike almost all previous studies on money in Chile, we compare 10 traditional and new definitions of money, rather than just looking at the customary definition M1A. Also, given the changes in the financial system and disinflation in Chile over the last 20 years, as well as contrasting growth rates of GDP and narrow money in recent times, we report recursive estimations for all our statistics to highlight parameter constancy. While there seems to be a strong and often one-to-one association between money growth and inflation on average over the whole sample as indicated by Nelson (2003) type regressions, the relation drops strongly during the last 10 years, and thus seems much lower in times of low inflation. Also, an increase in nominal money growth never causes acceleration of inflation in a Granger sense. However, we do find a significant and positive impact of deviations from (an estimated or HP-filtered) equilibrium level of money holdings on inflation, as indicated by error-correction and Pstar models. But the deviations from a simple estimated equilibrium are very large for both broad money aggregates and M1A at the end of the sample, casting some doubt on the stability of their demand relation. Accordingly, cointegration tests for the existence of a stable demand for money function over the whole sample are somewhat inconclusive. We find a strong Granger causality relationship between money and output, which however vanishes once we control for the effect of past inflation and changes in the monetary policy rate. Also, the information in lags of M1A for GDP drops strongly towards the end of the sample. More generally, M1A does not seem to merit its role as the money sum par excellence in Chile, being inferior in information content for example to Notes and Coin, or a broad money sum excluding bonds (M7 minus Central Bank documents). |
| Date: | 2005–05 |
| URL: | http://d.repec.org/n?u=RePEc:chb:bcchwp:319&r=cba |
| By: | Joanna Stavins |
| Abstract: | The recent decline in the Federal Reserve’s check volumes has received a lot of attention. Although switching to electronic payments methods and electronic check-processing has been credited for much of that decline, some of it could be caused by changes following bank mergers involving Federal Reserve customer banks. This paper evaluates the effect of bank mergers on Federal Reserve check-processing volumes. ; Using inflow-outflow and regression methods, we find that mergers between two or more Reserve Bank customers have resulted in volume losses, especially during the first quarter following the merger. On average, the estimated cumulative loss of volume during the first five post-merger quarters was 2.6 million checks. While the overall number of checks in the United States has declined during the past few years, the Federal Reserve has lost additional check-processing volume because of bank mergers. |
| Keywords: | Bank mergers ; Check collection systems |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbpp:04-7&r=cba |
| By: | Charles T. Carlstrom; Timothy S. Fuerst |
| Abstract: | This paper reviews three recent books. Two books, one by Carl Walsh and one by Michael Woodford, focus on the development of monetary theory. In contrast, the third book is a collection of papers in an NBER volume on inflation targeting. This volume outlines some of the issues that arise when applying the tools described by Walsh and Woodford to the policy goal of targeting inflation rates. A central theme of all three works is the desirability of abstracting from money demand in the analysis of monetary policy. In our review we focus the bulk of our discussion on the absence of money in these models. |
| Keywords: | Monetary policy ; Money |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0410&r=cba |
| By: | William A. Branch; John Carlson; George W. Evans; Bruce McGough |
| Abstract: | This paper addresses the output-price volatility puzzle by studying the interaction of optimal monetary policy and agents' beliefs. We assume that agents choose their information acquisition rate by minimizing a loss function that depends on expected forecast errors and information costs. Endogenous inattention is a Nash equilibrium in the information processing rate. Although a decline of policy activism directly increases output volatility, it indirectly anchors expectations, which decreases output volatility. If the indirect effect dominates then the usual trade-off between output and price volatility breaks down. This provides a potential explanation for the "great moderation" that began in the 1980s. |
| Keywords: | Monetary policy ; Inflation (Finance) |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0411&r=cba |
| By: | Charles T. Carlstrom; Timothy S. Fuerst |
| Abstract: | Should monetary policy respond to asset prices? This paper analyzes this question from the vantage point of equilibrium determinacy. |
| Keywords: | Monetary policy ; Banks and banking, Central |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedcwp:0413&r=cba |
| By: | Michelle L. Barnes; Jose Lopez |
| Abstract: | The Monetary Control Act of 1980 requires the Federal Reserve System to rovide payment services to depository institutions through the twelve Federal Reserve Banks at rices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French (1997) conclude that COE estimates are “woefully” and “unavoidably” imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the CAPM model and compare them using econometric and materiality criteria. Our results suggests that the benchmark CAPM model applied to a large peer group of competing firms provides a COE estimate that is not clearly improved upon by using a narrow peer group, introducing additional factors into the model, or taking account of additional firm-level data, such as leverage and line-of-business concentration. Thus, a standard implementation of the benchmark CAPM model provides a reasonable COE estimate, which is needed to impute costs and set prices for the Reserve Banks’ payments business. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfam:2005-06&r=cba |
| By: | Bruce McGough; Glenn D. Rudebusch; John C. Williams |
| Abstract: | Using a short-term interest rate as the monetary policy instrument can be problematic near its zero bound constraint. An alternative strategy is to use a long-term interest rate as the policy instrument. We find when Taylor-type policy rules are used to set the long rate in a standard New Keynesian model, indeterminacy--that is, multiple rational expectations equilibria--may often result. However, a policy rule with a long rate policy instrument that responds in a "forward-looking" fashion to inflation expectations can avoid the problem of indeterminacy. |
| Keywords: | Monetary policy ; Interest rates |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfap:2004-22&r=cba |
| By: | Robert M. Adams; Dean F. Amel |
| Abstract: | We study the relationship between banking competition and the transmission of monetary policy through the bank lending channel. Using business small loan origination data provided from the Community Reinvestment Act from 1996-2002 in our analysis, we are able to reaffirm the existence of the bank lending channel of monetary transmission. Moreover, we find that the impact of monetary policy on loan originations is weaker in more concentrated markets. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2005-16&r=cba |
| By: | William T. Gavin; David M. Kemme |
| Abstract: | Empirical work in macroeconomics is plagued by small sample size and large idiosyncratic variation. This problem is especially severe in the case of transition economies. We use a mixed estimation method incorporating information from OECD country data to estimate the parameters of a reduced-form transition economy model. An exactly identified structural VAR model is then constructed to analyze monetary policy. The OECD information increases the precision of the impulse response functions in the transition economies. The method provides a systematic way to use extraneous information to analyze monetary policy in the transition economies where data availability is limited. |
| Keywords: | Monetary policy ; Macroeconomics |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2004-034&r=cba |
| By: | Argia M. Sbordone |
| Abstract: | This article discusses a more general interpretation of the two-step minimum distance estimation procedure proposed in earlier work by Sbordone. The estimator is again applied to a version of the New Keynesian Phillips curve, in which inflation dynamics are driven by the expected evolution of marginal costs. The article clarifies econometric issues, addresses concerns about uncertainty and model misspecification raised in recent studies, and assesses the robustness of previous results. While confirming the importance of forward-looking terms in accounting for inflation dynamics, it suggests how the methodology can be applied to extend the analysis of inflation to a multivariate setting. |
| Keywords: | Phillips curve ; Keynesian economics ; Econometric models ; Inflation (Finance) |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:204&r=cba |
| By: | Gauti Eggertsson; Eric Le Borgne |
| Abstract: | We propose a theory to explain why, and under what circumstances, a politician endogenously gives up rent and delegates policy tasks to an independent agency. Applied to monetary policy, this theory (i) formalizes the rationale for delegation highlighted by Alexander Hamilton, the first Secretary of the Treasury of the United States, and by Alan S. Blinder, former Vice Chairman of the Board of Governors of the Federal Reserve System; and (ii) does not rely on the inflation bias that underlies most existing theories of central bank independence. Delegation trades off the cost of having a possibly incompetent technocrat with a long-term job contract against the benefit of having a technocrat who (i) invests more effort into the specialized policy task and (ii) has less incentive to pander to public opinion than a politician. Our key theoretical predictions are broadly consistent with the data. |
| Keywords: | Banks and banking, Central ; Monetary policy ; Political science |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:205&r=cba |
| By: | Thomas M. Humphrey |
| Abstract: | Marshall made at least four contributions to the classical quantity theory. He endowed it with his Cambridge cash-balance money-supply-and-demand framework to explain how the nominal money supply relative to real money demand determines the price level. He combined it with the assumption of purchasing power parity to explain (i) the international distribution of world money under metallic standards and fixed exchange rates, and (ii) exchange rate determination under floating rates and inconvertible paper currencies. He paired it with the idea of money wage and/or interest rate stickiness in the face of price level changes to explain how money-stock fluctuations produce corresponding business-cycle oscillations in output and employment. He applied it to alternative policy regimes and monetary standards to determine their respective capabilities of delivering price-level and macroeconomic stability. In his hands the theory proved to be a powerful and flexible analytical tool. |
| Keywords: | Economists ; Money |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedrwp:04-10&r=cba |
| By: | Charles Goodhart (Financial Markets Group, London School of Economics); Dirk Schoenmaker |
| Abstract: | This paper investigates whether monetary policy and banking supervision should be separated, or not. It starts with an account of the historical evolution of the Central Bank's micro-function (banking supervision). The role of the lender of last resort and the introduction of deposit insurance is discussed. There is currently a diversity of institutional arrangements, but the differences are found to be greater in appearance than in reality. The main argument of divorcing the monetary from the regulatory authority is that the combination of functions might lead to a conflict of interest. This conflict can arise in different ways. The most important instance is that interest rates are held down because of concern with the "health" of the banking system, when purely monetary considerations suggest higher rates. It is argued that this conflict between "regulatory" and "monetary" objectives depends to some extent on the structure of the banking and financial systems (i.e. whether banks are dependent on wholesale or retail markets for short term funding). A First argument against separation is the role of the Central Bank in the payment system, in particular with respect to preventing systemic risk. The massive intra-day credit exposures in large value payment systems could give rise to settlement failure(s), which in turn could generate a systemic crisis. Settlement risk is therefore increasingly an area of supervisory concern for Central Banks. In so far as the Central Bank as lender of last resort is likely to support a failing participant, it is assuming the risks and effectively becoming the implicit guarantor of the system. Although Central Banks implement risk reduction policies, some risks originate beyond the settlement system, e.g. in foreign exchange trading, securities transactions and interbank transactions. It is argued that Central Banks should have a regulatory and oversight role in the payment system, although it does not follow that they should also operate them. Turning to the broader concern of the Central Bank of systemic stability, it is claimed that the Central Bank usually has to use its lender of last resort function not only in cases of liquidity difficulties, but also where the solvency of banks is uncertain. A cross-country survey of 104 bank failures is assembled in an appendix. We focus on the provision of funding for rescues: central bank, deposit insurance, government or other banking system should lie with the agency which pays if, and when , banks are to be rescued. So long as rescue and insurance is undertaken on an implicit Central Bank basis, then the Central Bank would naturally want to undertake regulation and supervision. However, there is a trend towards using tax-payer money for bank rescues which strengthens the case for separation of the monetary and supervisory functions and establishment of a government agency for the latter. It would, however, be difficult to have a complete division, since the Central Bank would generally remain the only source of immediate funding. |
| Keywords: | Finance; Banking |
| JEL: | G0 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgsps:sp0052&r=cba |
| By: | Mervyn King (Bank of England) |
| Abstract: | Mervyn King is the Deputy Governor of the Bank of England and a co-founder of the LSE Financial Markets Group. On Wednesday 29 October 1997 he gave a public lecture at the LSE to mark the 10th anniversary of the Financial Markets Group and the 5th annivesay of the Bank of England Inflation Target. This Special Paper is the Transcript of that lecture. |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgsps:sp0099&r=cba |
| By: | Bengtsson, Ingemar (Department of Economics, Lund University) |
| Abstract: | This paper presents a model that pictures how inflation is determined in a decentralized market process where prices are set in both simultaneous and sequential contracts. Price setting is seen as a coordination game between the price setters of sequential contracts. An important property of the model is that inflation thus can be explained without any reference to the quantity of money.Following up the finding that inflation is determined in a coordination game, it is subsequently claimed that whenever inflation does not follow a random path, people do seem to follow some rule of thumb when predicting future price levels. In the last section of the paper, it is finally claimed that this rule is best understood as a focal point, and furthermore that the central banks provides the focal point for inflation in the western world today. Central banks could thus be shown to be able to influence inflation rates, although the quantity of money plays no part in this process. |
| Keywords: | Central Banking; Focal Points; Inflation; Monetary Policy; Money; Quantity Theory |
| JEL: | C70 E31 E42 E43 E44 E51 E52 E58 |
| Date: | 2005–05–16 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:lunewp:2005_028&r=cba |
| By: | Bengtsson, Ingemar (Department of Economics, Lund University) |
| Abstract: | In the paper, an analogy with length measurement is applied in order to explore the nature of the unit for value measurement, i.e. the unit of account. As the meter is defined as the length traveled by light in vacuum during 1/299 792 458 of a second, the unit of account krona is defined as the purchasing power of the medium of exchange krona. However, one should be cautious when drawing conclusions from this analogy. Our unit of account is defined in our medium of exchange, but it is meaningful only because we can observe prices on real goods expressed in it. As it would be pointless to define the meter as the length traveled by light in vacuum during 1/299 792 458 of a second if we could not compare this length with anything else, it would be pointless to define our unit of account in something that is not priced. In the paper it is explained how different payment techniques help to overcome transaction costs in the market. In particular, following Alchian (1977), it is argued that to reap the full benefit from the use of payment techniques, it has to be combined with the use of both a unit of account and specialist middlemen. The use of payment techniques helps to reduce costs due to sequential payment, but to reduce costs due to sequential quality evaluation, you need unit of account as well as reputable middlemen. |
| Keywords: | Medium of Exchange; Money; Payment Techniques; Quantity Theory; Transaction Costs; Unit of Account |
| JEL: | B52 D23 E31 E41 E42 E51 |
| Date: | 2005–05–16 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:lunewp:2005_029&r=cba |
| By: | Bjørnland, Hilde C. (Dept. of Economics, University of Oslo); Leitemo, Kai (Norwegian School of Management) |
| Abstract: | We estimate the interdependence between US monetary policy and the S&P 500 using structural VAR methodology. A solution is proposed to the simultaneity problem of identifying monetary and stock price shocks by using a combination of short-run and long-run restrictions that maintains the qualitative properties of a monetary policy shock found in the established literature (CEE 1999). We find great interdependence between interest rate setting and stock prices. Stock prices immediately fall by 1.5 percent due to a monetary policy shock that raises the federal funds rate by ten basis points. A stock price shock increasing stock prices by one percent leads to an increase in the interest rate of five basis points. Stock price shocks are orthogonal to the information set in the VAR model and can be interpreted as non-fundamental shocks. We attribute a major part of the surge in stock prices at the end of the 1990s to these non-fundamental shocks. |
| Keywords: | VAR; monetary policy; asset prices; identification |
| JEL: | E43 E52 E61 |
| Date: | 2005–05–15 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:osloec:2005_012&r=cba |