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on Central Banking |
| By: | V. V. Chari; Patrick J. Kehoe; Ellen R. McGrattan |
| Abstract: | Macroeconomists have largely converged on method, model design, reduced-form shocks, and principles of policy advice. Our main disagreements today are about implementing the methodology. Some think New Keynesian models are ready to be used for quarter-to-quarter quantitative policy advice; we do not. Focusing on the state-of-the-art version of these models, we argue that some of its shocks and other features are not structural or consistent with microeconomic evidence. Since an accurate structural model is essential to reliably evaluate the effects of policies, we conclude that New Keynesian models are not yet useful for policy analysis. |
| Keywords: | Keynesian economics ; Macroeconomics |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:409&r=cba |
| By: | Joshua Aizenman; Reuven Glick |
| Abstract: | This paper investigates the changing pattern and efficacy of sterilization within emerging market countries as they liberalize markets and integrate with the world economy. We estimate the marginal propensity to sterilize foreign asset accumulation associated with net balance of payments inflows, across countries and over time. We find that the extent of sterilization of foreign reserve inflows has risen in recent years to varying degrees in Asia as well as in Latin America, consistent with greater concerns about the potential inflationary impact of reserve inflows. We also find that sterilization depends on the composition of balance of payments inflows. |
| Keywords: | Emerging markets ; Bank reserves ; International finance |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2008-15&r=cba |
| By: | Martin Bodenstein; Christopher J. Erceg; Luca Guerrieri |
| Abstract: | In a stylized DSGE model with an energy sector, the optimal policy response to an adverse energy supply shock implies a rise in core inflation, a larger rise in headline inflation, and a decline in wage inflation. The optimal policy is well-approximated by policies that stabilize the output gap, but also by a wide array of "dual mandate" policies that are not overly aggressive in stabilizing core inflation. Finally, policies that react to a forecast of headline inflation following a temporary energy shock imply markedly different effects than policies that react to a forecast of core, with the former inducing greater volatility in core inflation and the output gap. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:941&r=cba |
| By: | THORBECKE, Willem; Hanjiang ZHANG |
| Abstract: | Romer and Romer (R&R) reported that federal funds rate increases may raise expected inflation by revealing the Fed's private information about inflation. Gurkaynak, Sack, and Swanson (GSS) presented evidence that funds rate increases lowered long-term expected inflation. To choose between these hypotheses we examine how monetary policy surprises affect daily traded commodity prices, term interest rates, and forward interest rates. We find that funds rate increases in the 1970s raised gold and silver prices and that increases after 1989 lowered gold and silver prices. We also find that funds rate hikes over both sample periods primarily affected short-term interest rates and near-term forward rates. For the 1970s, these results suggest that R&R's explanation is correct. For recent years, they indicate that funds rate increases affect real rates and may also be consistent with GSS's findings. |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:eti:dpaper:08031&r=cba |
| By: | Marcel Fratzscher; Luciana Juvenal; Lucio Sarno |
| Abstract: | This paper analyses the role of asset prices in comparison to other factors, in particular exchange rates, as a driver of the US trade balance. It employs a Bayesian structural VAR model that requires imposing only a minimum of economically meaningful sign restrictions. We find that equity market shocks and housing price shocks have been major determinants of the US current account in the past, accounting for up to 32% of the movements of the US trade balance at a horizon of 20 quarters. By contrast, shocks to the real exchange rate have been much less relevant, explaining less than 7% and exerting a more temporary effect on the US trade balance. Our findings suggest that sizeable exchange rate movements may not necessarily be a key element of an adjustment of today's large current account imbalances, and that in particular relative global asset price changes could be a more potent source of adjustment. |
| Keywords: | Asset pricing ; Foreign exchange rates ; Balance of trade |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2008-031&r=cba |
| By: | Pfajfar, D.; Santoro, E. |
| Abstract: | In this paper we develop a sticky price DSGE model to study the role of capital market imperfections for monetary policy implementation. Recent empirical and theoretical studies have stressed the e¤ect of .rms.external .nance on their pricing decisions. The so-called cost channel of the transmission mechanism has been explored within New Keynesian frameworks that pose particular emphasis on in.ation dynamics. These models generally disregard the role of external .nance for the dynamics of asset prices. We ask whether monetary policy should respond to deviations of asset prices from their frictionless level and, more importantly, if the answer to this question changes when financial frictions are properly taken into account. We analyze these issues from the vantage of equilibrium determinacy and stability under adaptive learning. We show that usual conditions for equilibrium uniqueness and E-stability are significantly altered when the cost channel matters. Nevertheless, we find that responding to actual or expected asset price misalignments helps at restoring determinacy and stability under learning. These conclusions are further enforced in the presence of a high degree of pass-through from policy to bank lending rates. |
| Keywords: | Monetary Policy, Capital Market Imperfections, Cost Channel, Asset Price. |
| JEL: | E31 E32 E52 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:cam:camdae:0825&r=cba |
| By: | Pfajfar, D.; Santoro, E. |
| Abstract: | Relying on University of Michigan data on consumers.in.ation expectations, we establish some stylized facts on the process of in.ation expectation formation across different demographic groups. Percentile time series models are employed to test for rationality and to study learning dynamics across the whole cross-sectional spectrum of responses. These display a significant degree of heterogeneity and asymmetry. Income, education, and gender seem to be rather important characteristics when forecasting inflation. In particular, high income, highly educated, and male agents produce lower mean squared errors. Moreover, socioeconomically "disadvantaged" respondents assume as a reference point their specific consumption basket, while more advantaged respondents actually observe the general price level. A common observation applying to all socioeconomic groups is that agents positioned around the center of the distribution behave roughly in line with the rational expectations hypothesis. Agents on the left hand side of the median (LHS) of the distribution update information very infrequently. As to agents on the right hand side of the median (RHS), we can affirm that their expectations are consistent with adaptive learning and staggered information updating. However, the speed of learning can vary significantly across percentiles and di¤erent demographic groups. |
| Keywords: | Heterogeneous Expectations, Adaptive Learning, Survey Expectations. |
| JEL: | E31 C53 D80 J10 |
| Date: | 2008–05 |
| URL: | http://d.repec.org/n?u=RePEc:cam:camdae:0824&r=cba |
| By: | Berriel, Tiago; Sinigaglia, Daniel |
| Abstract: | This paper characterizes optimal fiscal and monetary policy in a new keynesian model with sectorial heterogeneity in price stickiness. In particular, we (i) derive a purely quadratic welfare-based loss function from an approximation of the representative agent's utility function and (ii) provide the optimal target rule for fiscal and monetary policy. Differently from the homogeneous case, the loss function includes sectorial inflation variances instead of aggregate inflation, with weights proportional to the degree of price stickiness; and sectorial output gaps instead of aggregate output gap with equal weight in each sector. Optimal policy implies a very strong positive correlation among sectorial output gaps and some dispersion of sectorial inflation in response to shocks. Larger heterogeneity in price stickiness implies larger impact of shocks on aggregate inflation. Optimal taxes are more responsive in sectors with stickier prices. |
| JEL: | E52 E63 |
| Date: | 2008–04–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:10233&r=cba |
| By: | Christopher Gust; Sylvain Leduc; Nathan Sheets |
| Abstract: | This paper assesses whether partial exchange rate pass-through to trade prices has important implications for the prospective adjustment of global external imbalances. To address this question, we develop and estimate an open-economy DGE model in which pass-through is incomplete due to the presence of local currency pricing, distribution services, and a variable demand elasticity that leads to fluctuations in optimal markups. We find that the overall magnitude of trade adjustment is similar in a low and high pass-through world with more adjustment in a low pass-world occurring through a larger response of the exchange rate and terms of trade rather than real trade flows. |
| Keywords: | Foreign exchange rates ; Imports - Prices |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2008-16&r=cba |
| By: | Konstantin Kholodilin; Alberto Montagnoli; Oreste Napolitano; Boriss Siliverstovs |
| Keywords: | Higher Education, Financial Incentives, Competing Risk Model |
| JEL: | H52 H24 I28 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp814&r=cba |
| By: | Michael Kumhof; Ricardo Nunes; Irina Yakadina |
| Abstract: | This paper asks whether an aggressive monetary policy response to inflation is feasible in countries that suffer from fiscal dominance, as long as monetary policy also responds to fiscal variables. We find that if nominal interest rates are allowed to respond to government debt, even aggressive rules that satisfy the Taylor principle can produce unique equilibria. But following such rules results in extremely volatile inflation. This leads to very frequent violations of the zero lower bound on nominal interest rates that make such rules infeasible. Even within the set of feasible rules the optimal response to inflation is highly negative, and more aggressive inflation fighting is inferior from a welfare point of view. The welfare gain from responding to fiscal variables is minimal compared to the gain from eliminating fiscal dominance. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:937&r=cba |
| By: | Ippei Fujiwara; Yasuo Hirose; Mototsugu Shintani |
| Date: | 2008–08–29 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levrem:122247000000002352&r=cba |
| By: | Luciana Juvenal; Mark P. Taylor |
| Abstract: | Using self-exciting threshold autoregressive models, we explore the validity of the law of one price (LOOP) for sixteen sectors in nine European countries. We and strong evidence of nonlinear mean reversion in deviations from the LOOP and highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to measure speeds of real exchange rate adjustment. Using the US dollar as a reference currency, the half-lives of sectoral real exchange rates shocks, calculated by Monte Carlo integration, imply much faster adjustment than the consensus half-life estimates of three to five years. The results also imply that transaction costs vary significantly across sectors and countries. |
| Keywords: | Prices ; Foreign exchange rates |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2008-027&r=cba |
| By: | Enrique G. Mendoza; Marco E. Terrones |
| Abstract: | This paper proposes a methodology for measuring credit booms and uses it to identify credit booms in emerging and industrial economies over the past four decades. In addition, we use event study methods to identify the key empirical regularities of credit booms in macroeconomic aggregates and micro-level data. Macro data show a systematic relationship between credit booms and economic expansions, rising asset prices, real appreciations, widening external deficits and managed exchange rates. Micro data show a strong association between credit booms and firm-level measures of leverage, firm values, and external financing, and bank-level indicators of banking fragility. Credit booms in industrial and emerging economies show three major differences: (1) credit booms and the macro and micro fluctuations associated with them are larger in emerging economies, particularly in the nontradables sector; (2) not all credit booms end in financial crises, but most emerging markets crises were associated with credit booms; and (3) credit booms in emerging economies are often preceded by large capital inflows but not by financial reforms or productivity gains. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:936&r=cba |
| By: | Andrea Ferrero |
| Abstract: | This paper investigates the consequences of debt stabilization for inflation targeting. If the monetary authority perfectly stabilizes inflation while the fiscal authority holds constant the real value of debt at maturity, the equilibrium dynamics might be indeterminate. However, determinacy can be restored by committing to targeting rules for either monetary or fiscal policy that include a concern for stabilization of the output gap. In solving the indeterminacy problem, flexible inflation targeting appears to be more robust than flexible debt targeting to alternative parameter configurations and steady-state fiscal stances. Conversely, flexible fiscal targeting rules lead to more desirable welfare outcomes. The paper further shows that if considerations beyond stabilization call for a combination of strict inflation and debt targeting rules, the indeterminacy result can be overturned if the fiscal authority commits to holding constant debt net of interest rate spending. |
| Keywords: | Inflation targeting ; Banks and banking, Central ; Monetary policy ; Fiscal policy ; Debts, External |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:339&r=cba |
| By: | Yelena Takhtamanova |
| Abstract: | Recent research suggests that there has been a decline in the extent to which firms “pass through” changes in exchange rates to prices. Beyond providing further evidence in support of this claim, this paper proposes an explanation for the phenomenon. It then presents empirical evidence of a structural break during the 1990s in the relationship between the real exchange rate and CPI inflation for a set of fourteen OECD countries. It is suggested that the recent reduction in the real exchange rate pass-through can be attributed in part to the low-inflation environment of the 1990s. |
| Keywords: | Foreign exchange rates |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2008-13&r=cba |
| By: | Meredith J. Beechey; Jonathan H. Wright |
| Abstract: | This paper uses high-frequency intradaily data to estimate the effects of macroeconomic news announcements on yields and forward rates on nominal and index-linked bonds, and on inflation compensation. To our knowledge, it is the first study in the macro announcements literature to use intradaily real yield data, which allow us to parse the effects of news announcements on real rates and inflation compensation far more precisely than we can using daily data. Long-term nominal yields and forward rates are very sensitive to macroeconomic news announcements. We find that inflation compensation is sensitive to announcements about price indices and monetary policy. However, for news announcements about real economic activity, such as nonfarm payrolls, the vast majority of the sensitivity is concentrated in real rates. Accordingly, we conclude that most of the sizeable impact of news about real economic activity on the nominal term structure of interest rates represents changes in expected future real short-term interest rates and/or real risk premia rather than changes in expected future inflation and/or inflation risk premia. This suggests that explanations for the puzzling sensitivity of long-term nominal rates need to look beyond just inflation expectations and toward models that encompass uncertainty about the long-run real rate of interest. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2008-39&r=cba |
| By: | Martin Møller Andreasen (School of Economics and Management, University of Aarhus, Denmark) |
| Abstract: | This paper shows how a standard DSGE model can be extended to reproduce the dynamics in the 10 year yield curve for the post-war US economy with a similar degree of precision as in reduced form term structure models. At the same time, we are able to reproduce the dynamics of four key macro variables almost perfectly. Our extension of a standard DSGE model is to introduce three non-stationary shocks which allow us to explain interest rates with medium and long maturities without distorting the dynamics of the macroeconomy. |
| Keywords: | Price stickiness, Stochastic and deterministic trends, Term structure model, The Central Difference Kalman Filter, Yield curve |
| JEL: | E10 E32 E43 E44 |
| Date: | 2008–09–02 |
| URL: | http://d.repec.org/n?u=RePEc:aah:create:2008-43&r=cba |
| By: | Todd E. Clark; Michael W. McCracken |
| Abstract: | Recent work suggests VAR models of output, inflation, and interest rates may be prone to instabilities. In the face of such instabilities, a variety of estimation or forecasting methods might be used to improve the accuracy of forecasts from a VAR. The uncertainty inherent in any single representation of instability could mean that combining forecasts from a range of approaches will improve forecast accuracy. Focusing on models of U.S. output, prices, and interest rates, this paper examines the effectiveness of combining various models of instability in improving VAR forecasts made with real-time data. |
| Keywords: | Econometric models ; Economic forecasting |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2008-030&r=cba |
| By: | Michael T. Kiley |
| Abstract: | I examine the common trend in inflation for consumer prices and consumer prices excluding prices of food and energy. Both the personal consumption expenditure (PCE) indexes and the consumer price indexes (CPI) are examined. The statistical model employed is a bivariate integrated moving average process; this model extends a univariate model that fits the data on inflation very well. The bivariate model forecasts as well as the univariate models. The results suggest that the relationship between overall consumer prices, consumer prices excluding the prices of food and energy, and the common trend has changed significantly over time. In the 1970s and early 1980s, movements in overall prices and prices excluding food and energy prices both contained information about the trend; in recent data, the trend is best gauged by focusing solely on prices excluding food and energy prices. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2008-38&r=cba |
| By: | Antoine Martin; James McAndrews |
| Abstract: | In this paper, we consider the case for an intraday market for reserves. We discuss the separate roles of intraday and overnight reserves and argue that an intraday market could be organized in the same way as the overnight market. We present arguments for and against a market for intraday reserves when the marginal cost of overnight reserves is positive. We also consider how reserves should be supplied when the cost of overnight reserves is zero. In that case, the distinction between overnight and intraday reserves becomes blurred, raising an important question: What is the role of the overnight market? |
| Keywords: | Bank reserves ; Money market ; Banks and banking, Central |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fednsr:337&r=cba |
| By: | Camilo E Tovar |
| Abstract: | Over the past 15 years there has been remarkable progress in the specification and estimation of dynamic stochastic general equilibrium (DSGE) models. Central banks in developed and emerging market economies have become increasingly interested in their usefulness for policy analysis and forecasting. This paper reviews some issues and challenges surrounding the use of these models at central banks. It recognises that they offer coherent frameworks for structuring policy discussions. Nonetheless, they are not ready to accomplish all that is being asked of them. First, they still need to incorporate relevant transmission mechanisms or sectors of the economy; second, issues remain on how to empirically validate them; and finally, challenges remain on how to effectively communicate their features and implications to policy makers and to the public. Overall, at their current stage DSGE models have important limitations. How much of a problem this is will depend on their specific use at central banks. |
| Keywords: | DSGE models, central banks, monetary policy, communication and forecasting |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:258&r=cba |
| By: | Alan J. Auerbach |
| Abstract: | Like many other developed economies, the United States has imposed fiscal rules in attempting to impose a degree of fiscal discipline on the political process of budget determination. The federal government has operated under a series of budget control regimes that have been complex in nature and of debatable impact. Much of the complexity of these federal budget regimes relates to the structure of the U.S. federal government. The controversy over the impact of different regimes relates to the fact that the rules have no constitutional standing, leading to the question of whether they do more than clarify a government's intended policies. In this paper, I review US federal budget rules and present some evidence on their possible effects. From an analysis of how components of the federal budget behaved under the different budget regimes, it appears that the rules did have some effects, rather than simply being statements of policy intentions. The rules may also have had some success at deficit control, although such conclusions are highly tentative given the many other factors at work during the different periods. Even less certain is the extent to which the various rules achieved whatever objectives underlay their introduction. |
| JEL: | D78 H62 J11 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14288&r=cba |
| By: | Stephan Schulmeister (WIFO) |
| Abstract: | The study analyses the interaction between the trading behaviour of 1,024 moving average and momentum models and the fluctuations of the yen-dollar exchange rate. I show first that these models would have exploited exchange rate trends quite profitably between 1976 and 2007. I then show that the aggregate transactions and positions of technical models exert an excess demand pressure on currency markets since they are mostly on the same side of the market. When technical models produce trading signals almost all of them are either buying or selling, when they maintain open positions they are either long or short. A strong interaction prevails between exchange rate movements and the transactions triggered by technical models. An initial rise of the exchange rate due to news, e.g., is systematically lengthened through a sequence of technical buy signals. |
| Keywords: | Exchange rate, Technical Trading, Speculation, Heterogeneous Agents |
| Date: | 2008–07–10 |
| URL: | http://d.repec.org/n?u=RePEc:wfo:wpaper:y:2008:i:324&r=cba |
| By: | Lamont K. Black |
| Abstract: | The presence of private information about a firm can affect the competition among potential lenders. In the Sharpe (1990) model of information asymmetry among lenders (with the von Thadden (2004) correction), an uninformed outside bank faces a winner’s curse when competing with an informed inside bank. This paper examines the model’s prediction for observed interest rates at an inside vs. outside bank. Although the outside bank wins more bad firms than the inside bank, the winner’s curse also causes the outside rate conditional on firm type to be lower in expectation than the inside rate conditional on firm type. I show analytically that the expected interest rate at the outsider can be either higher or lower than the expected interest rate at the insider, depending on the net of these two effects. Under the assumption that the banks split the firms in a tie bid, a numerical solution shows that the outside expected interest rate is higher than the inside expected interest rate for high quality borrower pools, but the outside expected interest rate is lower for low quality borrower pools. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2008-36&r=cba |
| By: | Barnett, William A.; Chauvet, Marcelle |
| Abstract: | This paper comprises a survey of a half century of research on international monetary aggregate data. We argue that since monetary assets began yielding interest, the simple sum monetary aggregates have had no foundations in economic theory and have sequentially produced one source of misunderstanding after another. The bad data produced by simple sum aggregation have contaminated research in monetary economics, have resulted in needless “paradoxes,” and have produced decades of misunderstandings in international monetary economics research and policy. While better data, based correctly on index number theory and aggregation theory, now exist, the official central bank data most commonly used have not improved in most parts of the world. While aggregation theoretic monetary aggregates exist for internal use at the European Central Bank, the Bank of Japan, and many other central banks throughout the world, the only central banks that currently make aggregation theoretic monetary aggregates available to the public are the Bank of England and the St. Louis Federal Reserve Bank. No other area of economics has been so seriously damaged by data unrelated to valid index number and aggregation theory. In this paper we chronologically review the past research in this area and connect the data errors with the resulting policy and inference errors. Future research on monetary aggregation and policy can most advantageously focus on extensions to exchange rate risk and its implications for multilateral aggregation over monetary asset portfolios containing assets denominated in more than one currency. The relevant theory for multilateral aggregation with exchange rate risk has been derived by Barnett (2007) and Barnett and Wu (2005). |
| Keywords: | Measurement error; monetary aggregation; Divisia index; aggregation; monetary policy; index number theory; exchange rate risk; multilateral aggregation; open economy monetary economics |
| JEL: | C43 E58 E52 E40 E41 |
| Date: | 2008–08–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:10242&r=cba |
| By: | Carmen Broto (Banco de España); Javier Díaz-Cassou (Banco de España); Aitor Erce-Domínguez (Banco de España) |
| Abstract: | This paper analyzes the determinants of the volatility of different types of capital inflows to emerging countries. After calculating a variable that proxies capital flows volatility, we study its possible causality relations with a set of explanatory variables by type of flow through a panel data model. We show that in recent years the significance of global factors, beyond the control of emerging economies, has increased at the expense of that of country specific factors. In addition, various factors exhibit a non-robust effect on the volatility of the three different categories of capital flows, which poses additional challenges for policy-makers. |
| Keywords: | capital fl ows, volatility, panel data, emerging markets |
| JEL: | F21 F36 C22 C23 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:0817&r=cba |
| By: | Tobias Straumann; Ulrich Woitek |
| Abstract: | The paper re-examines Sweden’s price level targeting during the 1930s which is regarded as a precursor of today’s inflation targeting. According to conventional wisdom the Riksbank was the first central bank to adopt price level targeting as the guideline for its activities, although in practice giving priority to exchange rate stabilisation over price level stabilisation. On the basis of econometric analysis (Bayesian VAR) and the evaluation of new archival sources we come to a more skeptical conclusion. Our results suggest that it is hard to reconcile the Riksbank’s striving for a fixed exchange rate with the claim that it adopted price level targeting. This finding has implications for the prevailing view of the 1930s as a decade of great policy innovations. |
| Keywords: | Sweden, monetary policy, price level targeting, Great Depression |
| JEL: | N14 E42 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:386&r=cba |