nep-cba New Economics Papers
on Central Banking
Issue of 2008‒12‒07
47 papers chosen by
Alexander Mihailov
University of Reading

  1. Facts and myths about the financial crisis of 2008 By V.V. Chari; Lawrence J. Christiano; Patrick J. Kehoe
  2. Current account dynamics and monetary policy By Andrea Ferrero; Mark Gertler; Lars E.O. Svensson
  3. Real exchange rate movements and the relative price of non-traded goods By Caroline M. Betts; Timothy J. Kehoe
  4. Eight Hundred Years of Financial Folly By Reinhart, Carmen
  5. The End of the Great Moderation? By William Barnett; Marcelle Chauvet
  6. The stability of macroeconomic systems with Bayesian learners By James B. Bullard; Jacek Suda
  7. Sluggish responses of prices and inflation to monetary shocks in an inventory model of money demand By Fernando Alvarez; Andrew Atkeson; Chris Edmond
  8. Uncertainty and disagreement in economic forecasting By Stefania D'Amico; Athanasios Orphanides
  9. Central Bank misperceptions and the role of money in interest rate rules. By Guenter W. Beck; Volker Wieland
  10. Money, Prices and Liquidity Effects: Separating Demand from Supply By Chadha, J.S.; Corrado, L.; Sun, Q.
  11. Reconnecting Money to Inflation: The Role of the External Finance Premium By Jagjit S. Chadha; Luisa Corrado; Qi Sun
  12. Reconnecting Money to Inflation: The Role of the External Finance Premium By Jagjit S. Chadha; Luisa Corrado; Sean Holly
  13. Monetary Policy Analysis: An Undergraduate Toolkit By Jagjit S. Chadha
  14. How forward-looking is the Fed? Direct estimates from a ‘Calvo-type’ rule By Vasco J. Gabriel; Paul Levine; Christopher Spencer
  15. Do nominal rigidities matter for the transmission of technology shocks? By Zheng Liu; Louis Phaneuf
  16. Priors from DSGE Models for Dynamic Factor Analysis By Gregor Bäurle
  17. The case for TIPS: an examination of the costs and benefits By Jennifer Roush; William Dudley; Michelle Steinberg Ezer
  18. How Misleading is Linearization? Evaluating the Dynamics of the Neoclassical Growth Model By Manoj Atolia; Santanu Chatterjee; Stephen J. Turnovsky
  19. Managing Beliefs about Monetary Policy under Discretion? By Elmar Mertens;
  20. Central Bank Losses and Economic Convergence By Martin Cincibuch; Tomas Holub; Jaromir Hurnik
  21. The topology of the federal funds market By Morten L. Bech; Enghin Atalay
  22. Do energy prices respond to U.S. macroeconomic news? a test of the hypothesis of predetermined energy prices By Lutz Kilian; Clara Vega
  23. Do fundamentals explain the internationaliImpact of U.S. interest rates? evidence at the firm level By John Ammer; Clara Vega; Jon Wongswan
  24. Interacting nominal and real labour market rigidities By Vogel, Lukas
  25. Determinacy, Stock Market Dynamics and Monetary Policy Inertia By Damjan Pfajfar; Emiliano Santoro
  26. Imperfect information and monetary models: multiple shocks and their consequences By Leon W. Berkelmans
  27. The Taylor rule and forecast intervals for exchange rates By Jian Wang; Jason J. Wu
  28. The Volatility of International Trade Flows and Exchange Rate Uncertainty By Christopher F. Baum; Mustafa Caglayan
  29. Why do foreigners invest in the United States? By Kristin J. Forbes
  30. The Fed’s new front in the financial crisis By Tatom, John
  31. Monetary policy and housing prices in an estimated DSGE model for the US and the euro area. By Matthieu Darracq Pariès; Alessandro Notarpietro
  32. Measuring the Welfare Costs of Inflation in a Life-cycle Model By Paul Gomme
  33. Estimating the parameters of a small open economy DSGE model: identifiability and inferential validity By Daniel O. Beltran; David Draper
  34. The Federal Home Loan Bank System: the lender of next-to-last resort? By Adam B. Ashcraft; Morten L. Bech; W. Scott Frame
  35. Individual Expectations and Aggregate Behavior in Learning to Forecast Experiments By Cars Hommes; Thomas Lux
  36. Imperfectly credible disinflation under endogenous time-dependent pricing By Marco Bonomo; Carlos Carvalho
  37. When bonds matter: home bias in goods and assets By Nicolas Coeurdacier; Pierre-Olivier Gourinchas
  38. Are Spectral Estimators Useful for Implementing Long-Run Restrictions in SVARs? By Nils Herger;
  39. Testing the expectations hypothesis when interest rates are near integrated By Meredith Beechey; Erik Hjalmarsson; Par Osterholm
  40. Keynesian economics without the LM and IS curves: a dynamic generalization of the Taylor-Romer model By Evan F. Koenig
  41. Coin sizes and payments in commodity money systems By Angela Redish; Warren E. Weber
  42. Metropolis-Hastings prefetching algorithms By Strid, Ingvar
  43. Neural Network Models for Inflation Forecasting: An Appraisal By Ali Choudhary; Adnan Haider
  44. Do China and oil exporters influence major currency configurations? By Marcel Fratzscher; Arnaud Mehl
  45. Monetary Policy in a Small Open Economy Model: A DSGE-VAR Approach for Switzerland By Gregor Bäuerle; Tobias Menz
  46. Which bank is the "central" bank? an application of Markov theory to the Canadian Large Value Transfer System By Morten L. Bech; James T. E. Chapman; Rod Garratt
  47. Causation analysis between stock price and exchange rate: Pre and post crisis study on Malaysia By Baharom, A.H.; Royfaizal, R. C; Habibullah, M.S.

  1. By: V.V. Chari; Lawrence J. Christiano; Patrick J. Kehoe
    Abstract: The United States is indisputably undergoing a financial crisis. Here we examine four claims about the way the financial crisis is affecting the economy as a whole and argue that all four claims are myths. Conventional analyses of the financial crisis focus on interest rate spreads. We argue that such analyses may lead to mistaken inferences about the real costs of borrowing and argue that, during financial crises, variations in the levels of nominal interest rates might lead to better inferences about variations in the real costs of borrowing.
    Keywords: Financial crises
    Date: 2008
  2. By: Andrea Ferrero; Mark Gertler; Lars E.O. Svensson
    Abstract: We explore the implications of current account adjustment for monetary policy within a simple two country SGE model. Our framework nests Obstfeld and Rogoff's (2005) static model of exchange rate responsiveness to current account reversals. It extends this approach by endogenizing the dynamic adjustment path and by incorporating production and nominal price rigidities in order to study the role of monetary policy. We consider two different adjustment scenarios. The first is a "slow burn" where the adjustment of the current account deficit of the home country is smooth and slow. The second is a "fast burn" where, owing to a sudden shift in expectations of relative growth rates, there is a rapid reversal of the home country's current account. We examine several different monetary policy regimes under each of these scenarios. Our principal finding is that the behavior of the domestic variables (for instance, output, inflation) is quite sensitive to the monetary regime, while the behavior of the international variables (for instance, the current account and the real exchange rate) is less so. Among different policy rules, domestic inflation targeting achieves the best stabilization outcome of aggregate variables. This result is robust to the presence of imperfect pass-through on import prices, although in this case stabilization of consumer price inflation performs similarly well.
    Date: 2008
  3. By: Caroline M. Betts; Timothy J. Kehoe
    Abstract: We study the quarterly bilateral real exchange rate and the relative price of non-traded to traded goods for 1225 country pairs over 1980?2005. We show that the two variables are positively correlated, but that movements in the relative price measure are smaller than those in the real exchange rate. The relation between the two variables is stronger when there is an intense trade relationship between two countries and when the variance of the real exchange rate between them is small. The relation does not change for rich/poor country bilateral pairs or for high inflation/low inflation country pairs. We identify an anomaly: The relation between the real exchange rate and relative price of non-traded goods for US/EU bilateral trade partners is unusually weak.
    Keywords: Trade
    Date: 2008
  4. By: Reinhart, Carmen
    Abstract: The economics profession has an unfortunate tendency to view recent experience in the narrow window provided by standard datasets. With a few notable exceptions, cross-country empirical studies on financial crises typically begin in 1980 and are limited in other important respects. Yet an event that is rare in a three decade span may not be all that rare when placed in a broader context. In my paper with Kenneth Rogoff we introduce a comprehensive new historical database for studying debt and banking crises, inflation, currency crashes and debasements. The data covers sixty-six countries in across all regions. The range of variables encompasses external and domestic debt, trade, GNP, inflation, exchange rates, interest rates, and commodity prices. The coverage spans eight centuries, going back to the date of independence or well into the colonial period for some countries.
    Keywords: Financial crises; inflation;; default
    JEL: E0
    Date: 2008–03
  5. By: William Barnett (Department of Economics, The University of Kansas); Marcelle Chauvet (University of California at Riverside)
    Abstract: The current financial crisis followed the “great moderation,” according to which some commentators and economists believed that the world’s central banks had gotten so good at countercyclical policy that the business cycle volatility had declined to low levels. As more and more economists and media people became convinced that the risk of recessions had moderated, lenders and investors became willing to increase their leverage and risk-taking activities. Mortgage lenders, insurance companies, investment banking firms, and home buyers increasingly engaged in activities that would have been considered unreasonably risky, prior to the great moderation that was viewed as having lowered systemic risk. It is the position of this paper that the great moderation did not reflect improved monetary policy, and the perceptions that systemic risk had decreased and that the business cycle had ended were based on other phenomena, such as improved technology and communications. Contributing to the misperceptions about monetary policy solutions was low quality data provided by central banks. 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,” have produced decades of misunderstandings in economic research and policy, and contributed to the widely held views about decreased systemic risk. While better data, based correctly on index number theory and aggregation theory, now exist, the usual official central bank data are not based on that better approach. 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. Dual to the aggregation-theoretic monetary aggregates are the aggregation-theoretic user-cost and interest rate aggregates, which similarly are not in official use by central banks. The failure to use aggregation-theoretic quantity, user-cost price, and interest-rate index numbers as official data by central banks often is connected with the misstatement that expenditure share weights move in a predictable manner, when interest rates change. In fact the direction in which a share will change when an interest rate changes depends upon whether or not the price elasticity of demand is greater than or less than -1. No other area of economics has been so seriously damaged by data unrelated to valid index-number and aggregation theory. We provide evidence supporting the view that misperceptions based upon poor data were responsible for excess risk taking by financial firms and borrowers, and by regulators at central banks. We also provide evidence indicating the poor data may have induced the Federal Reserve to underestimate the rate of growth of monetary services and hence to have fed the bubbles with excess liquidity unintentionally. We also provide evidence indicating that a similar misperception produced an excessively contractionary policy that finally burst the bubble. Many commentators have been quick to blame insolvent financial firms for their “greed” and their presumed self-destructive, reckless risk taking. Perhaps some of those commentators should look more carefully at their own role in propagating the misperceptions that induced those firms to be willing to take such risks. While there are many considerations relevant to the misguided actions of private firms, individuals, and central banks during the period leading up to the current financial crisis, there is one common thread associated with all of them: misperceptions induced by poor data disconnected from the relevant economic aggregation theory.
    Keywords: Measurement error, monetary aggregation, Divisia index, aggregation, monetary policy, index number theory, financial crisis, great moderation, Federal Reserve.
    JEL: E40 E52 E58 C43 E32
    Date: 2008–11
  6. By: James B. Bullard; Jacek Suda
    Abstract: We study abstract macroeconomic systems in which expectations play an important role. Consistent with the recent literature on recursive learning and expectations, we replace the agents in the economy with econometricans. Unlike the recursive learning literature, however, the econometricians in the analysis here are Bayesian learners. We are interested in the extent to which expectational stability remains the key concept in the Bayesian environment. We isolate conditions under which versions of expectational stability conditions govern the stability of these systems just as in the standard case of recursive learning. We conclude that the more sophisticated Bayesian learning schemes do not alter the essential expectational stability findings in the literature.
    Keywords: Rational expectations (Economic theory)
    Date: 2008
  7. By: Fernando Alvarez; Andrew Atkeson; Chris Edmond
    Abstract: We examine the responses of prices and inflation to monetary shocks in an inventory-theoretic model of money demand. We show that the price level responds sluggishly to an exogenous increase in the money stock because the dynamics of households' money inventories leads to a partially offsetting endogenous reduction in velocity. We also show that inflation responds sluggishly to an exogenous increase in the nominal interest rate because changes in monetary policy affect the real interest rate. In a quantitative example, we show that this nominal sluggishness is substantial and persistent if inventories in the model are calibrated to match U.S. households' holdings of M2.
    Keywords: Demand for money ; Inflation (Finance) ; Prices
    Date: 2008
  8. By: Stefania D'Amico; Athanasios Orphanides
    Abstract: Using the probabilistic responses from the Survey of Professional Forecasters, we study the evolution of uncertainty and disagreement associated with inflation forecasts in the United States since 1968. We compare and contrast alternative measures summarizing the distributions of mean forecasts and forecast uncertainty across individuals at an approximate one-year-ahead horizon. In light of the heterogeneity in individual uncertainty reflected in the survey responses, we provide quarterly estimates for both average uncertainty and disagreement regarding uncertainty. We propose direct estimation of parametric distributions characterizing the uncertainty across individuals in a manner that mitigates errors associated with rounding and approximation of responses when individual uncertainty is small. Our results indicate that higher average expected inflation is associated with both higher average inflation uncertainty and greater disagreement about the inflation outlook. Disagreement about the mean forecast, however, may be a weak proxy for forecast uncertainty. We also examine the relationship of these measures with the term premia embedded in the term-structure of interest rates.
    Date: 2008
  9. By: Guenter W. Beck (Goethe University Frankfurt, Mertonstrasse 17, D-60325 Frankfurt am Main, Germany.); Volker Wieland (Goethe University Frankfurt, Mertonstrasse 17, D-60325 Frankfurt am Main, Germany.)
    Abstract: Research with Keynesian-style models has emphasized the importance of the output gap for policies aimed at controlling inflation while declaring monetary aggregates largely irrelevant. Critics, however, have argued that these models need to be modified to account for observed money growth and inflation trends, and that monetary trends may serve as a useful cross-check for monetary policy. We identify an important source of monetary trends in form of persistent central bank misperceptions regarding potential output. Simulations with historical output gap estimates indicate that such misperceptions may induce persistent errors in monetary policy and sustained trends in money growth and inflation. If interest rate prescriptions derived from Keynesian-style models are augmented with a cross-check against money-based estimates of trend inflation, inflation control is improved substantially. JEL Classification: E32, E41, E43, E52, E58.
    Keywords: Taylor rules, money, quantity theory, output gap uncertainty, monetary policy under uncertainty.
    Date: 2008–11
  10. By: Chadha, J.S.; Corrado, L.; Sun, Q.
    Abstract: In the canonical monetary policy model, money is endogenous to the optimal path for interest rates and output. But when liquidity provision by banks dominates the demand for transactions money from the real economy, money is likely to contain information for future output and inflation because of its impact on financial spreads. And so we decompose broad money into primitive demand and supply shocks. We find that supply shocks have dominated the time series in both the UK and the US in the short to medium term. We further consider to what extent the supply of broad money is related to policy or to liquidity effects from financial intermediation.
    Keywords: Money, Prices, Bayesian VAR Identi.cation, Sign Restrictions.
    JEL: E32 F32 F41
    Date: 2008–11
  11. By: Jagjit S. Chadha; Luisa Corrado; Qi Sun
    Abstract: In the canonical monetary policy model, money is endogenous to the optimal path for interest rates, output. But when liquidity provision by banks dominates the demand for transactions money from the real economy, money is likely to contain information for future output and inflation because of its impact on financial spreads. And so we decompose broad money into primitive demand and supply shocks. We find that supply shocks have dominated the time series in both the UK and the US in the short to medium term. We further consider to what extent the supply of broad money is related to policy or to liquidity effects from financial intermediation.
    Keywords: Money; Prices; Bayesian; VAR Identification; Sign Restrictions
    JEL: E32 F32 F41
    Date: 2008–11
  12. By: Jagjit S. Chadha; Luisa Corrado; Sean Holly
    Abstract: We re-connect money to inflation using Goodfriend and McCallum’s (2007) model where banks supply loans to cash-in-advance constrained consumers on the basis of the value of collateral provided and the monitoring skills of banks. We show that when shocks to monitoring and collateral dominate those to goods productivity and the velocity of money demand, money and the external finance premium become closely linked. This is because increases in asset prices allow banks to raise the supply of loans leading to an expansion in aggregate demand, via a compression of financial interest rates spreads, which in turn tends to be inflationary. Thus money and financial spreads are negatively correlated when banking sector shocks dominate. We suggest a simple augmented stabilising monetary policy rule that exploits the joint information from money and the external finance premium.
    Keywords: money, DSGE, policy rules, external finance premium
    JEL: E31 E40 E51
    Date: 2008–11
  13. By: Jagjit S. Chadha
    Abstract: We develop simple diagrams that can be used by undergraduates to understand interest rate setting by policy- makers. We combine an inflation target, Fisher equation, policy reaction function and short and long run aggregate supply analysis to give a depiction of the policy problem. We illustrate the appropriate response by the policy maker to each of a positive shock to demand, a negative supply shock and dislodged inflation expectations. We also illustrate the problems of a zero bound for policy rates within this framework and consider the role of an interest rate rule in offsetting money market perturbations. Some key readings are introduced.
    Keywords: Interest rate setting; monetary policy; zero-bound; money markets
    JEL: E42 E52 E58
    Date: 2008–11
  14. By: Vasco J. Gabriel (Department of Economics, University of Surrey and Universidade do Minho - NIPE); Paul Levine (Department of Economics, University of Surrey); Christopher Spencer (Department of Economics, Loughborough University)
    Abstract: We estimate an alternative type of monetary policy rule, termed Calvo rule, according to which the central bank is assumed to target a discounted infinite sum of future expected inflation. Compared to conventional inflation forecast-based rules, which are typically of the Taylor-type with discrete forward looking horizons, this class of rule is less prone to the problem of indeterminacy. Parameter estimates obtained from GMM estimation provide support for Calvo-type rules, suggesting that the Federal Reserve targeted a mean forward horizon of between 4 and 8 quarters.
    Keywords: Calvo-type interest rules, Inflation Forecast Based rules, GMM, indeterminacy.
    JEL: C22 E58
    Date: 2008
  15. By: Zheng Liu; Louis Phaneuf
    Abstract: A commonly held view is that nominal rigidities are important for the transmission of monetary policy shocks. We argue that they are also important for understanding the dynamic effects of technology shocks, especially on labor hours, wages, and prices. Based on a dynamic general equilibrium framework, our closed-form solutions reveal that a pure sticky-price model predicts correctly that hours decline following a positive technology shock, but fails to generate the observed gradual rise in the real wage and the near-constance of the nominal wage; a pure sticky-wage model does well in generating slow adjustments in the nominal wage, but it does not generate plausible dynamics of hours and the real wage. A model with both types of nominal rigidities is more successful in replicating the empirical evidence about hours, wages and prices. This finding is robust for a wide range of parameter values, including a relatively small Frisch elasticity of hours and a relatively high frequency of price reoptimization that are consistent with microeconomic evidence.
    Date: 2008
  16. By: Gregor Bäurle
    Abstract: We propose a method to incorporate information from Dynamic Stochastic General Equilibrium (DSGE) models into Dynamic Factor Analysis. The method combines a procedure previously applied for Bayesian Vector Autoregressions and a Gibbs Sampling approach for Dynamic Factor Models. The factors in the model are rotated such that they can be interpreted as variables from a DSGE model. In contrast to standard Dynamic Factor Analysis, a direct economic interpretation of the factors is given. We evaluate the forecast performance of the model with respect to the amount of information from the DSGE model included in the estimation. We conclude that using prior information from a standard New Keynesian DSGE model improves the forecast performance. We also analyze the impact of identified monetary shocks on both the factors and selected series. The interpretation of the factors as variables from the DSGE model allows us to use an identification scheme which is directly linked to the DSGE model. The responses of the factors in our application resemble responses found using VARs. However, there are deviations from standard results when looking at the responses of specific series to common shocks.
    Keywords: Dynamic Factor Model; DSGE Model; Bayesian Analysis; Forecasting; Transmission of Shocks
    JEL: C11 C32 E0
    Date: 2008–08
  17. By: Jennifer Roush; William Dudley; Michelle Steinberg Ezer
    Abstract: Several studies have shown that, ex-post, the issuance of Treasury Inflation-Protected Securities (TIPS) has cost U.S. taxpayers money. We propose that evaluations of the TIPS program be more comprehensive and focus on the ex-ante costs of TIPS issuance versus nominal Treasury issuance and, especially when these costs are negligible, the more difficult-to-measure benefits of the program. Our study finds that the ex-ante costs of TIPS issuance versus nominal Treasury issuance are currently about equal and that TIPS provide meaningful benefits to investors and policymakers.
    Keywords: Treasury bonds ; Government securities ; Inflation risk ; Liquidity (Economics)
    Date: 2008
  18. By: Manoj Atolia (Department of Economics, Florida State University); Santanu Chatterjee (Terry College of Business, University of Georgia); Stephen J. Turnovsky (Department of Economics, University of Washington)
    Abstract: The standard procedure for analyzing transitional dynamics in non-linear macro models has been to employ linear approximations. This raises the central question of this paper: How reliable is this procedure in evaluating the dynamic adjustments to policy changes or structural shocks? This question is significant since one of the basic objectives of contemporary micro-based macroeconomic models is the analysis of intertemporal welfare. We analyze this issue in the context of a neoclassical Ramsey growth model, with two alternative specifications of productive government spending, by employing both linearization and non-linear solution techniques. We find that if government expenditure is introduced as a flow and the dynamic adjustment is fast, linearization may be a reasonably good approximation of the true dynamics even for fairly large policy shocks. In contrast, if government expenditure assumes the form of a stock, leading to more sluggish adjustment, linearization is more problematic. The linearization procedure may yield misleading predictions, both qualitatively and quantitatively. These occur at the beginning of the transition and therefore weigh heavily in intertemporal welfare calculations. These patterns are verified for temporary shocks as well.
    Keywords: Public expenditure, growth, nonlinearities, welfare analysis
    JEL: E62 O41
    Date: 2008–01
  19. By: Elmar Mertens (Study Center Gerzensee and University of Lausanne);
    Abstract: Optimal monetary policy becomes tricky when the central bank has better information than the public: Policy does not only affect economic fundamentals, but also people’s beliefs. For a general class of widely studied DSGE models, this paper derives the optimal discretionary policy under hidden information. Illustrated with a simple New Keynesian model, the introduction of hidden information has striking effects on discretionary policies: Policy losses are better under hidden information than under full transparency. Looking at Markov-perfect policies excludes reputational mechanisms via history dependent strategies. Under full transparency, discretion policies are then myopic, since a current policymaker cannot influence future decisions. But imperfect information adds public beliefs as a distinct, endogenous state variable. Managing beliefs connects the actions of policymakers such that they realize the inflationary consequences of expansionary policies. The optimal policy shares similarities with those from commitment models. Additionally, disinflations are pursued more vigorously the larger the credibility problems from hidden information. Optimal policy also responds to belief shocks, which shift public perceptions about fundamentals even when those fundamentals are unchanged.
    Date: 2008–11
  20. By: Martin Cincibuch; Tomas Holub; Jaromir Hurnik
    Abstract: This paper discusses the issue of central bank losses, developing a framework for assessing the ability of a central bank to keep its balance sheet sustainable without having to default on its policy objectives. Compared to the earlier literature, it analyses in more depth the consequences of economic convergence for the evolution of the central bank’s balance sheet and the important role played in this process by the risk premium and equilibrium real exchange rate appreciation. A combination of a closed-form comparative-static analysis and numerical solutions of the future evolution of the central bank’s own capital is used. Applying the framework to the Czech National Bank’s case, the paper concludes that the CNB should be able to repay its accumulated loss in about 15 years without any transfer from public budgets.
    Keywords: Balance sheet, central bank, economic convergence, monetary policy, real appreciation, risk premium, seigniorage, transition.
    JEL: E52 E58
    Date: 2008–10
  21. By: Morten L. Bech; Enghin Atalay
    Abstract: The recent turmoil in global financial markets underscores the importance of the federal funds market as a means of distributing liquidity throughout the financial system and a tool for implementing monetary policy. In this paper, we explore the network topology of the federal funds market. We find that the network is sparse, exhibits the small-world phenomenon, and is disassortative. In addition, reciprocity loans track the federal funds rate, and centrality measures are useful predictors of the interest rate of a loan.
    Keywords: Federal funds market (United States) ; Liquidity (Economics) ; Monetary policy ; Federal funds rate
    Date: 2008
  22. By: Lutz Kilian; Clara Vega
    Abstract: Models that treat innovations to the price of energy as predetermined with respect to U.S. macroeconomic aggregates are widely used in the literature. For example, it is common to order energy prices first in recursively identified VAR models of the transmission of energy price shocks. Since exactly identifying assumptions are inherently untestable, this approach in practice has required an act of faith in the empirical plausibility of the delay restriction used for identification. An alternative view that would invalidate such models is that energy prices respond instantaneously to macroeconomic news, implying that energy prices should be ordered last in recursively identified VAR models. In this paper, we propose a formal test of the identifying assumption that energy prices are predetermined with respect to U.S. macroeconomic aggregates. Our test is based on regressing cumulative changes in daily energy prices on daily news from U.S. macroeconomic data releases. Using a wide range of macroeconomic news, we find no compelling evidence of feedback at daily or monthly horizons, contradicting the view that energy prices respond instantaneously to macroeconomic news and supporting the use of delay restrictions for identification.
    Date: 2008
  23. By: John Ammer; Clara Vega; Jon Wongswan
    Abstract: This paper analyzes the impact of U.S. monetary policy announcement surprises on U.S. and foreign firm-level equity prices. We find that U.S. monetary policy has important influences on foreign equity prices on average, but with considerable variation across firms. We have found that this differing response reflects a range of factors, including the extent of a foreign firm's exposure to U.S. demand, its dependence on external financing, the behavior of interest rates in its home country, and its sensitivity to portfolio adjustment by U.S. investors. The cross-firm variation in the response is correlated with the firm's CAPM beta; but it cannot fully explain this variation. More generally, we see these results as shedding some additional light on the nature and extent of the monetary and financial linkages between the United States and the rest of the world. In particular, since we are able to explain differences across foreign firms' responses through established theories of monetary transmission, our results are consistent with the surprisingly large average foreign response to U.S. rates reflecting fundamentals, rather than an across-the-board behavioral over-reaction.
    Date: 2008
  24. By: Vogel, Lukas
    Abstract: Abstract: This note investigates the interaction between nominal and real labour market rigidities. It shows nominal wage rigidity to have little effect on the welfare loss from labour adjustment costs under a labour supply shock. This implies that the second best effect of nominal price stickiness under real wage persistence studied in Duval and Vogel (2007) does not apply to the propagation of supply shocks under nominal wage rigidity and labour adjustment costs.
    Keywords: Labour adjustment costs; wage stickiness; rigidity interaction
    JEL: E32 E24 J23 J30
    Date: 2008–11
  25. By: Damjan Pfajfar (Tilburg University); Emiliano Santoro (Department of Economics, University of Copenhagen)
    Abstract: This note deals with the stability properties of an economy where the central bank is concerned with stock market developments. We introduce a Taylor rule reacting to stock price growth rates along with inflation and output gap in a New-Keynesian setup. We explore the performance of this rule from the vantage of equilibrium uniqueness. We show that this reaction function is isomorphic to a rule with an interest rate smoothing term, whose magnitude increases in the degree of aggressiveness towards asset prices growth. As shown by Bullard and Mitra (2007, Determinacy, learnability, and monetary policy inertia, Journal of Money, Credit and Banking 39, 1177-1212) this feature of monetary policy inertia can help at alleviating problems of indeterminacy.
    Keywords: monetary policy; asset prices; rational expectation equilibrium uniqueness
    JEL: E31 E32 E52
    Date: 2008–11
  26. By: Leon W. Berkelmans
    Abstract: This paper examines the role of multiple aggregate shocks in monetary models with imperfect information. Because agents can draw mistaken inferences about which shock has occurred, the existence of multiple aggregate shocks profoundly influences macroeconomic dynamics. In particular, after a contractionary monetary shock these models can generate an initial increase in inflation (the "price puzzle") and a delayed disinflation (a "hump"). A conservative numerical illustration exhibits these patterns. In addition, the model shows that increased price flexibility is potentially destabilizing.
    Date: 2008
  27. By: Jian Wang; Jason J. Wu
    Abstract: This paper attacks the Meese-Rogoff (exchange rate disconnect) puzzle from a different perspective: out-of-sample interval forecasting. Most studies in the literature focus on point forecasts. In this paper, we apply Robust Semi-parametric (RS) interval forecasting to a group of Taylor rule models. Forecast intervals for twelve OECD exchange rates are generated and modified tests of Giacomini and White (2006) are conducted to compare the performance of Taylor rule models and the random walk. Our contribution is twofold. First, we find that in general, Taylor rule models generate tighter forecast intervals than the random walk, given that their intervals cover out-of-sample exchange rate realizations equally well. This result is more pronounced at longer horizons. Our results suggest a connection between exchange rates and economic fundamentals: economic variables contain information useful in forecasting the distributions of exchange rates. The benchmark Taylor rule model is also found to perform betterthan the monetary and PPP models. Second, the inference framework proposed in this paper for forecast-interval evaluation, can be applied in a broader context, such as inflation forecasting, not just to the models and interval forecasting methods used in this paper.
    Keywords: Foreign exchange ; Forecasting ; Taylor's rule ; Econometric models - Evaluation
    Date: 2008
  28. By: Christopher F. Baum (Boston College; DIW Berlin); Mustafa Caglayan (University of Sheffield)
    Abstract: Empirical evidence obtained from data covering Eurozone countries, other industrialized countries, and newly industrialized countries (NICs) over 1980–2006 shows that exchange rate uncertainty has a consistent positive and significant effect on the volatility of bilateral trade flows. A one standard deviation increase in exchange rate uncertainty leads to an eight per cent increase in trade volatility. These effects differ markedly for trade flows between industrialized countries and NICs, and are not mitigated by the presence of the Eurozone. Contrary to earlier findings, our results also suggest that exchange rate uncertainty does not affect the volume of trade flows of either industrialized countries or NICs.
    Keywords: exchange rates, uncertainty, volatility, trade flows, industrialized countries, Eurozone, newly industrialized countries
    JEL: F17 F31 C22
    Date: 2008–11–27
  29. By: Kristin J. Forbes
    Abstract: Why are foreigners willing to invest almost $2 trillion per year in the United States? The answer affects if the existing pattern of global imbalances can persist and if the United States can continue to finance its current account deficit without a major change in asset prices and returns. This paper tests various hypotheses and finds that standard portfolio allocation models and diversification motives are poor predictors of foreign holdings of U.S. liabilities. Instead, foreigners hold greater shares of their investment portfolios in the United States if they have less-developed financial markets. The magnitude of this effect decreases with income per capita. Countries with fewer capital controls and greater trade with the United States also invest more in U.S. equity and bond markets, and there is no evidence that foreigners invest in the United States based on diversification motives. The empirical results showing a primary role of financial market development in driving foreign purchases of U.S. portfolio liabilities supports recent theoretical work on global imbalances.
    Date: 2008
  30. By: Tatom, John
    Abstract: The continuing foreclosure crisis worsened in October 2008. The Federal Reserve (Fed) continued the aggressive expansion of new private credit that it began in mid-September and it created three new credit facilities to add to the plethora of other facilities created since the financial crisis component of the foreclosure crisis began in August 2007. These new facilities are aimed at stabilizing the commercial paper (CP) market, most recently adversely affected by the failure of Lehman Brothers and the failures of several money market mutual funds (MMMF). From mid-September to the end of October, the Fed more than doubled its total assets, largely by expanding its private sector lending. Perhaps the most significant question to emerge over the past two months is whether the Fed has an exit strategy to pull all of this new financial asset creation out after it succeeds in stemming deflation and before it kick starts the economy into a major inflation problem.
    Keywords: commercial paper; monetary policy; financial crisis
    JEL: E58 G28 G21
    Date: 2008–10–31
  31. By: Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alessandro Notarpietro (Università Bocconi, Via Sarfatti 25, I-20136 Milano, Italy.)
    Abstract: We estimate a two-country Dynamic Stochastic General Equilibrium model for the US and the euro area including relevant housing market features and examine the monetary policy implications of housing-related disturbances. In particular, we derive the optimal monetary policy cooperation consistent with the structural specification of the model. Our estimation results reinforce the existing evidence on the role of housing and mortgage markets for the US and provide new evidence on the importance of the collateral channel in the euro area. Moreover, we document the various implications of credit frictions for the propagation of macroeconomic disturbances and the conduct of monetary policy. We find that allowing for some degree of monetary policy response to fluctuations in the price of residential goods improves the empirical fit of the model and is consistent with the main features of optimal monetary policy response to housing-related shocks. JEL Classification: E4, E5, F4.
    Keywords: Housing, credit frictions, optimal monetary policy, new open economy macroeconomics, Bayesian estimation.
    Date: 2008–11
  32. By: Paul Gomme (Department of Economics, Concordia University)
    Abstract: In macroeconomics, life-cycle models are typically used to address exclusively life-cycle issues. This paper shows that modeling the life-cycle may be important when addressing public policy issues, in this case the welfare costs of inflation. In the representative agent model, the optimal inflation rate is characterized by the Friedman rule: deflate at the real interest rate. In the corresponding life-cycle model, the optimal inflation rate is quite high: for the benchmark calibration, it is around 95% per annum. Much of the paper is concerned with understanding this result. Briefly, in the life-cycle model there are distributional consequences of injecting money via lump-sum transfers. The net effect is to transfer income from old, rich agents to young, poor ones. These transfers twist the age-utility profile in a way that agents find desirable from a lifetime utility point of view. A second issue concerns how to assess the costs of inflation in a life-cycle model. Metrics that are equivalent in the representative agent model can give very different answers in a life-cycle model.
    Keywords: monetary policy, inflation, welfare costs, life-cycle model
    JEL: E52 E31 E32 D58 D91
    Date: 2008–08
  33. By: Daniel O. Beltran; David Draper
    Abstract: This paper estimates the parameters of a stylized dynamic stochastic general equilibrium model using maximum likelihood and Bayesian methods, paying special attention to the issue of weak parameter identification. Given the model and the available data, the posterior estimates of the weakly identified parameters are very sensitive to the choice of priors. We provide a set of tools to diagnose weak identification, which include surface plots of the log-likelihood as a function of two parameters, heat plots of the log-likelihood as a function of three parameters, Monte Carlo simulations using artificial data, and Bayesian estimation using three sets of priors. We find that the policy coefficients and the parameter governing the elasticity of labor supply are weakly identified by the data, and posterior predictive distributions remind us that DSGE models may make poor forecasts even when they fit the data well. Although parameter identification is model- and data-specific, the lack of identification of some key structural parameters in a small-scale DSGE model such as the one we examine should raise a red flag to researchers trying to estimate--and draw valid inferences from--large-scale models featuring many more parameters.
    Date: 2008
  34. By: Adam B. Ashcraft; Morten L. Bech; W. Scott Frame
    Abstract: The Federal Home Loan Bank (FHLB) System is a large, complex, and understudied government-sponsored liquidity facility that currently has more than $1 trillion in secured loans outstanding, mostly to commercial banks and thrifts. In this paper, we document the significant role played by the FHLB System at the onset of the ongoing financial crises and then provide evidence on the uses of these funds by the System's bank and thrift members. Next, we identify the trade-offs faced by member-borrowers when choosing between accessing the FHLB System or the Federal Reserve's Discount Window during the crisis period. We conclude by describing the fragmented U.S. lender-of-last-resort framework and finding that additional clarity about the respective roles of the various liquidity facilities would be helpful.
    Keywords: Federal home loan banks ; Discount window ; Liquidity (Economics) ; Financial crises
    Date: 2008
  35. By: Cars Hommes; Thomas Lux
    Abstract: Models with heterogeneous interacting agents explain macro phenomena through interactions at the micro level. We propose genetic algorithms as a model for individual expectations to explain aggregate market phenomena. The model explains all stylized facts observed in aggregate price fluctuations and individual forecasting behaviour in recent learning to forecast laboratory experiments with human subjects (Hommes et al. 2007), simultaneously and across different treatments
    Keywords: Learning, heterogeneous expectations, genetic algorithms, experimental economics
    JEL: C91 C92 D83 D84 E3
    Date: 2008–11
  36. By: Marco Bonomo; Carlos Carvalho
    Abstract: The real effects of an imperfectly credible disinflation depend critically on the extent of price rigidity. Therefore, the study of how policymakers' credibility affects the outcome of an announced disinflation should include an analysis of the determinants of the frequency of price adjustments. In this paper, we examine how credibility affects the outcome of a disinflation in a model with endogenous time-dependent pricing rules. Both the initial degree of price rigidity, calculated optimally, and, more notably, changes in the duration of price spells during disinflation play an important role in explaining the effects of imperfect credibility. We initially consider the costs of disinflation when the degree of credibility is fixed, and then allow agents to use Bayes' rule to update beliefs about the "type" of monetary authority that they face. In both cases, the interaction between the endogeneity of time-dependent rules and imperfect credibility increases the output costs of disinflation. The pattern of the output response is more realistic in the case with learning.
    Keywords: Inflation (Finance) ; Pricing ; Monetary policy ; Price levels
    Date: 2008
  37. By: Nicolas Coeurdacier; Pierre-Olivier Gourinchas
    Abstract: Recent models of international equity portfolios exhibit two potential weaknesses: 1) the structure of equilibrium equity portfolios is determined by the correlation of equity returns with real exchange rates; yet empirically equities don't appear to be a good hedge against real exchange rate risk; 2) Equity portfolios are highly sensitive to preference parameters. This paper solves both problems. It first shows that in more general and realistic environments, the hedging of real exchange rate risks occurs through international bond holdings since relative bond returns are strongly correlated with real exchange rate fluctuations. Equilibrium equity positions are then optimally determined by the correlation of equity returns with the return on non-financial wealth, conditional on the bond returns. The model delivers equilibrium portfolios that are well-behaved as a function of the underlying preference parameters. We find reasonable empirical support for the theory for G-7 countries. We are able to explain short positions in domestic currency bonds for all G-7 countries, as well as significant levels of home equity bias for the US, Japan and Canada.
    Date: 2008
  38. By: Nils Herger (Study Center Gerzensee);
    Abstract: Using count data on the number of bank failures in US states during the 1960 to 2006 period, this paper endeavors to establish how far sources of economic risk (recessions, high interest rates, in ation) or differences in solvency and branching regulation can explain some of the fragility in banking. Assuming that variables are predetermined, lagged values provide instruments to absorb potential endogeneity between the number of bank failures and economic and regulatory conditions. Results suggest that bank failures are not merely self-fulfilling prophecies but relate systematically to inflation as well as to policy changes in banking regulation. Furthermore, in terms of statistical and economic significance, the distribution and development of bankruptcies across US states depends crucially on past bank failures suggesting that contagion provides an important channel through which banking crises emerge.
    Date: 2008–11
  39. By: Meredith Beechey; Erik Hjalmarsson; Par Osterholm
    Abstract: Nominal interest rates are unlikely to be generated by unit-root processes. Using data on short and long interest rates from eight developed and six emerging economies, we test the expectations hypothesis using cointegration methods under the assumption that interest rates are near integrated. If the null hypothesis of no cointegration is rejected, we then test whether the estimated cointegrating vector is consistent with that suggested by the expectations hypothesis. The results show support for cointegration in ten of the fourteen countries we consider, and the cointegrating vector is similar across countries. However, the parameters differ from those suggested by theory. We relate our findings to existing literature on the failure of the expectations hypothesis and to the role of term premia.
    Date: 2008
  40. By: Evan F. Koenig
    Abstract: John Taylor and David Romer champion an approach to teaching undergraduate macroeconomics that dispenses with the LM half of the IS-LM model and replaces it with a rule for setting the interest rate as a function of inflation and the output gap?i.e., a Taylor rule. But> the IS curve is problematic, too. It is consistent with the permanent-income hypothesis only when the interest rate that enters the IS equation is a long-term rate?not the short-term rate controlled by the monetary authority. This article shows how the Taylor-Romer framework can be readily modified to eliminate this maturity mismatch. The modified model is a dynamic system in output and inflation, with a unique stable path that behaves very much like Taylor and Romer?s aggregate demand (AD) schedule. Many?but not all?of the original Taylor-Romer model?s predictions carry over to the new framework. It helps bridge the gap between the Taylor-Romer analysis and the more sophisticated models taught in graduate-level courses.
    Keywords: Economics - Study and teaching ; Taylor's rule ; Interest rates ; Macroeconomics ; Monetary policy
    Date: 2008
  41. By: Angela Redish; Warren E. Weber
    Abstract: Contemporaries, and economic historians, have noted several features of medieval and early modern European monetary systems that are hard to analyze using models of centralized exchange. For example, contemporaries complained of recurrent shortages of small change and argued that an abundance/dearth of money had real effects on exchange. To confront these facts, we build a random matching monetary model with two indivisible coins with different intrinsic values. The model shows that small change shortages can exist in the sense that adding small coins to an economy with only large coins is welfare improving. This effect is amplified by increases in trading opportunities. Further, changes in the quantity of monetary metals affect the real economy and the amount of exchange as well as the optimal denomination size. Finally, the model shows that replacing full-bodied small coins with tokens is not necessarily welfare improving.
    Keywords: Coinage
    Date: 2008
  42. By: Strid, Ingvar (Dept. of Economic Statistics, Stockholm School of Economics)
    Abstract: Prefetching is a simple and general method for single-chain parallelisation of the Metropolis-Hastings algorithm based on the idea of evaluating the posterior in parallel and ahead of time. In this paper improved Metropolis-Hastings prefetching algorithms are presented and evaluated. It is shown how to use available information to make better predictions of the future states of the chain and increase the efficiency of prefetching considerably. The optimal acceptance rate for the prefetching random walk Metropolis-Hastings algorithm is obtained for a special case and it is shown to decrease in the number of processors employed. The performance of the algorithms is illustrated using a well-known macroeconomic model. Bayesian estimation of DSGE models, linearly or nonlinearly approximated, is identified as a potential area of application for prefetching methods. The generality of the proposed method, however, suggests that it could be applied in many other contexts as well.
    Keywords: Prefetching; Metropolis-Hastings; Parallel Computing; DSGE models; Optimal acceptance rate
    JEL: C11 C13 C63
    Date: 2008–12–02
  43. By: Ali Choudhary (University of Surrey and State Bank of Pakistan); Adnan Haider (State Bank of Pakistan)
    Abstract: We assess the power of artificial neural network models as forecasting tools for monthly inflation rates for 28 OECD countries. For short out-of-sample forecasting horizons, we find that, on average, for 45% of the countries the ANN models were a superior predictor while the AR1 model performed better for 21%. Furthermore, arithmetic combinations of several ANN models can also serve as a credible tool for forecasting inflation.
    Keywords: Artificial Neural Networks; Forecasting; Inflation
    JEL: C51 C52 C53 E31 E37
    Date: 2008–11
  44. By: Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Arnaud Mehl (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper analyses the impact of the shift away from a US dollar focus of systemically important emerging market economies (EMEs) on configurations between the US dollar, the euro and the yen. Given the difficulty that fixed or managed US dollar exchange rate regimes remain pervasive and reserve compositions mostly kept secret, the identification strategy of the paper is to analyse the market impact on major currency pairs of official statements made by EME policy-makers about their exchange rate regime and reserve composition. Developing a novel database for 18 EMEs, we find that such statements not only have a statistically but also an economically significant impact on the euro, and to a lesser extent the yen against the US dollar. The findings suggest that communication hinting at a weakening of EMEs’ US dollar focus contributed substantially to the appreciation of the euro against the US dollar in recent years. Interestingly, EME policy-makers appear to have become more cautious in their communication more recently. Overall, the results underscore the growing systemic importance of EMEs for global exchange rate configurations. JEL Classification: E58, F30, F31, F36, G15.
    Keywords: communication, exchange rate regime, reserves, euro, dollar, emerging economies.
    Date: 2008–12
  45. By: Gregor Bäuerle (University of Bern); Tobias Menz (University of Bern and Study Center Gerzensee)
    Abstract: We study the transmission of monetary shocks and monetary policy with a behavioral model, corrected for potential misspecification using the DSGE-VAR framework elaborated by DelNegro and Schorfheide (2004). In particular, we investigate if the central bank should react to movements in the nominal exchange rate. We contribute to the empirical literature as we use Swiss data, which is very rarely used in that context.
    Date: 2008–11
  46. By: Morten L. Bech; James T. E. Chapman; Rod Garratt
    Abstract: Recently, economists have argued that a bank's importance within the financial system depends not only on its individual characteristics but also on its position within the banking network. A bank is deemed to be "central" if, based on our network analysis, it is predicted to hold the most liquidity. In this paper, we use a method similar to Google's PageRank procedure to rank banks in the Canadian Large Value Transfer System (LVTS). In doing so, we obtain estimates of the payment processing speeds for the individual banks. These differences in processing speeds are essential for explaining why observed daily distributions of liquidity differ from the initial distributions, which are determined by the credit limits selected by banks.
    Keywords: Banks and banking, Central ; Banks and banking ; Liquidity (Economics) ; Electronic funds transfers
    Date: 2008
  47. By: Baharom, A.H.; Royfaizal, R. C; Habibullah, M.S.
    Abstract: The furore and chaos created by the Asian financial crisis have ignited many studies on numerous subjects, and it is believed that the crisis has changed the way nations being administered and policies formed and implemented especially those regarding monetary and fiscal policies. Johansen (1991) cointegration method was used and the period was divided into two sub periods, albeit pre crisis and post crisis. The results obtained are similar with a number of past literatures pointing to no long run relationship between stock price and exchange rate for both periods.
    Keywords: Stock price; exchange rate; Asian financial crisis; Cointegration.
    JEL: G14 F31
    Date: 2008–02–17

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