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on Central Banking |
| By: | Robin Pope; Reinhard Selten; Sebastian Kube; Jürgen von Hagen |
| Abstract: | The prior paper in this sequel, Pope (2009) introduced the concept of a nominalist heuristic, defined as a focus on prominent numbers, indices or ratios. In this paper the concept is used to show three things in how scientists and practitioners analyse and evaluate to decide (conclude). First, in constructing theories such as purchasing power and interest parity to predict exchange rates and to advocate floating exchange rates, economists unwittingly employ nominalist heuristics. Second, nominalist heuristics have influenced actual exchange rates through the centuries, and this finding is replicated in the laboratory. Third, nominalist heuristics are incompatible with expected utility theory which excludes the evaluation stage, and are also incompatible with prospect theory which assumes that, while the evaluation stage can involve systematic mistakes, the overall decision situation is ultra simple. It is so simple that: a) economists and psychologists can mechanically model and identify what is a mistake, and b) decision makers can maximise. However, contrary to prospect theory, in the typical complex situation, neither a) nor b) holds. Assuming that a) and b) hold has resulted in the 1988 crisis from applying the Black Scholes formulae to forward exchange rates and contributed to sequel financial crises including that of 2007-2009. What is required is a fundamentally different class of models that allow for the progressive anticipated changes in knowledge ahead faced under risk and uncertainty, namely models under the umbrella of SKAT, the Stages of Knowledge Ahead Theory. The paper’s findings support a single world currency rather than variable unpredictable exchange rates subjected to the vagaries of how prominent numbers, ratios and indices influence events via the models of scientists and practitioners. |
| Keywords: | nominalism, money illusion, heuristic, unpredictability, experiment, SKAT the Stages of Knowledge Ahead Theory, prominent numbers, prominent indices, prominent ratios, transparent policy, nominal equality, historical benchmarks, complexity, decision costs, evaluation, maximisation, Black Scholes, Lehmann Brothers, sub-prime crisis, central bank swaps |
| JEL: | D80 D81 F31 F33 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse18_2009&r=cba |
| By: | Fabio Milani |
| Abstract: | Recent papers have argued that one implication of globalization is that domestic inflation rates may have now become more a function of "global," rather than domestic, economic conditions, as postulated by closed-economy Phillips curves. This paper aims to assess the empirical importance of global output in determining domestic inflation rates by estimating a structural model for a sample of G-7 economies. The model can capture the potential effects of global output fluctuations on both the aggregate supply and the aggregate demand relations in the economy and it is estimated using full-information Bayesian methods. The empirical results reveal a significant effect of global output on aggregate demand in most countries. Through this channel, global economic conditions can indirectly affect inflation. The results, instead, do not seem to provide evidence in favor of altering domestic Phillips curves to include global slack as an additional driving variable for inflation. |
| Keywords: | Globalization ; Inflation (Finance) ; Group of Seven countries ; Monetary policy ; Banks and banking, Central ; Phillips curve |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:33&r=cba |
| By: | Fabio Milani |
| Abstract: | This paper estimates a structural New Keynesian model to test whether globalization has changed the behavior of U.S. macroeconomic variables. Several key coefficients in the model--such as the slopes of the Phillips and IS curves, the sensitivities of domestic inflation and output to "global" output, and so forth--are allowed in the estimation to depend on the extent of globalization (modeled as the changing degree of openness to trade of the economy), and, therefore, they become time-varying. The empirical results indicate that globalization can explain only a small part of the reduction in the slope of the Phillips curve. The sensitivity of U.S. inflation to global measures of output may have increased over the sample, but it remains very small. The changes in the IS curve caused by globalization are similarly modest. Globalization does not seem to have led to an attenuation in the effects of monetary policy shocks. The nested closed economy specification still appears to provide a substantially better fit of U.S. data than various open economy specifications with timevarying degrees of openness. Some time variation in the model coefficients over the postwar sample exists, particularly in the volatilities of the shocks, but it is unlikely to be related to globalization. |
| Keywords: | Globalization ; Macroeconomics - Econometric models ; Inflation (Finance) ; Monetary policy ; Banks and banking, Central ; Phillips curve |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:32&r=cba |
| By: | Horag Choi; Nelson C. Mark |
| Abstract: | Trending current accounts pose a challenge for intertemporal open-economy macro models. This paper shows that a two-country representative-agent business cycle model is able to explain the historical time-paths of the US and Japanese current accounts, both of which display trends but in opposite directions. Households have a state-dependent subjective discount factor such that they become relatively impatient (patient) when societal consumption is abnormally high (low). We present agents in the model with historical observations on the exogenous state variables, run the economy, and compare the current account implied by the model with the data. We find that the model generates national saving behavior that matches the current account's trend. Investment dynamics are important for explaining current account fluctuations around the trend, but not for the trend itself. The model also accounts for the timing of cyclical current account fluctuations around the trend. |
| JEL: | F3 F41 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15244&r=cba |
| By: | Tim Willems (University of Amsterdam); Sweder van Wijnbergen (University of Amsterdam) |
| Abstract: | This paper first documents the increase in the time lag with which labor input reacts to output fluctuations ("the labor adjustment lag") that is visible in US data since the mid-1980s. We show that a lagged labor adjustment response is optimal in a setting where there is uncertainty about the persistence of shocks and where labor input is costly to adjust. We then present evidence that both the nature of shocks as well as labor adjustment costs may have changed during the 1980s in a direction that could explain the observed increase in the lag. Finally, we argue that the increased labor adjustment lag has the potential to explain some macroeconomic puzzles that characterize post-1984 US data, such as the reduced procyclicality of labor productivity and the reduction in output volatility (known as the Great Moderation). |
| Keywords: | imperfect information; labor adjustment; jobless growth; option value of waiting; Great Moderation |
| JEL: | E24 E32 J23 J24 |
| Date: | 2009–07–17 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20090063&r=cba |
| By: | Emi Nakamura; Dawit Zerom |
| Abstract: | Recent theoretical work has suggested a number of potentially important factors in causing incomplete pass-through of exchange rates to prices, including markup adjustment, local costs and barriers to price adjustment. We empirically analyze the determinants of incomplete pass-through in the coffee industry. The observed pass-through in this industry replicates key features of pass-through documented in aggregate data: prices respond sluggishly and incompletely to changes in costs. We use microdata on sales and prices to uncover the role of markup adjustment, local costs, and barriers to price adjustment in determining incomplete pass-through using a structural oligopoly model that nests all three potential factors. The implied pricing model explains the main dynamic features of short and long-run pass-through. Local costs reduce long-run pass-through (after 6 quarters) by a factor of 59% relative to a CES benchmark. Markup adjustment reduces pass-through by an additional factor of 33%, where the extent of markup adjustment depends on the estimated "super-elasticity'' of demand. The estimated menu costs are small 0.23% of revenue) and have a negligible effect on long-run pass-through, but are quantitatively successful in explaining the delayed response of prices to costs. The estimated strategic complementarities in pricing do not, therefore, substantially delay the response of prices to costs. We find that delayed pass-through in the coffee industry occurs almost entirely at the wholesale rather than the retail level. |
| JEL: | E30 F10 L11 L16 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15255&r=cba |
| By: | William R. White |
| Abstract: | It has been contended by many in the central banking community that monetary policy would not be effective in "leaning" against the upswing of a credit cycle (the boom) but that lower interest rates would be effective in "cleaning" up (the bust) afterwards. In this paper, these two propositions (can't lean, but can clean) are examined and found seriously deficient. In particular, it is contended in this paper that monetary policies designed solely to deal with short term problems of insufficient demand could make medium term problems worse by encouraging a buildup of debt that cannot be sustained over time. The conclusion reached is that monetary policy should be more focused on "preemptive tightening" to moderate credit bubbles than on "preemptive easing" to deal with the after effects. There is a need for a new macrofinancial stability framework that would use both regulatory and monetary instruments to resist credit bubbles and thus promote sustainable economic growth over time. |
| Keywords: | Monetary policy ; Financial crises |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:34&r=cba |
| By: | Erasmus K. Kersting |
| Abstract: | This paper examines the role of fiscal stabilization policy in a two-country framework that allows for a general degree of exchange rate pass-through. I derive analytical solutions for optimal monetary and fiscal policy which are shown to depend on the degree of pass-through. In the case of partial pass-through, an optimizing policy maker uses countercyclical fiscal stabilization in addition to monetary stabilization. However, in the extreme cases of complete or zero pass-through, the fiscal stabilization instrument is not employed. There is also no additional gain from the fiscal instrument in the case of coordination between the two countries. These results are due to the specific way the optimal fiscal policy rule affects marginal costs: Rather than being a substitute for monetary policy, fiscal policy complements it by increasing the correlation of the marginal cost terms within and across countries. This in turn makes monetary policy more effective at stabilizing them. |
| Keywords: | Economic stabilization ; Monetary policy ; Fiscal policy |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:31&r=cba |
| By: | Jean-Marc Natal |
| Abstract: | How should monetary authorities react to an oil price shock? This paper argues that a meaningful trade-off between stabilizing inflation and the welfare relevant output gap arises in a distorted economy once one recognizes (1) that oil (energy) cannot be easily substituted by other factors, (2) that monopolistic competition implies that production is suboptimally low in the steady state, and (3) that increases in oil prices also directly affect consumption by raising the price of fuel, heating oil, and other energy sources. While the first two conditions are necessary to introduce a microfounded monetary policy trade-off, the third one makes it quantitatively significant. ; The optimal precommitment monetary policy relies on unobservables and is therefore hard to implement. To address this concern, I derive a simple interest rate feedback rule that mimics the optimal plan for all practical purposes but that depends only on observables, namely core inflation, oil price inflation, and the growth rate of output. |
| Keywords: | Monetary policy ; Petroleum products - Prices |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2009-16&r=cba |
| By: | Seiya Fujisaki (Graduate School of Economics, Osaka University) |
| Abstract: | We examine macroeconomic stability of a monetary economy with habit formation in consumption. We assume that monetary authority controls the rate of nominal interest in response to inflation and output gap. We show that in the presence of habit persistence not only active but also passive monetary policy can generate equilibrium determinacy under empirically plausible values of the elasticity of intertemporal substitution in felicity. |
| Keywords: | equilibrium determinacy, habit formation, Taylor rule, endogenous labor. |
| JEL: | E21 E52 O42 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:0923&r=cba |
| By: | Yener Altunbas (University of Wales, Bangor, Gwynedd LL57 2DG, Wales, United Kingdom.); Leonardo Gambacorta (Bank for International Settlements, Monetary and Economics Department, Centralbahnplatz 2, CH-4002 Basel, Switzerland.); David Marques-Ibanez (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.) |
| Abstract: | We find evidence of a bank lending channel for the euro area operating via bank risk. Financial innovation and the new ways to transfer credit risk have tended to diminish the informational content of standard bank balance-sheet indicators. We show that bank risk conditions, as perceived by financial market investors, need to be considered, together with the other indicators (i.e. size, liquidity and capitalization), traditionally used in the bank lending channel literature to assess a bank’s ability and willingness to supply new loans. Using a large sample of European banks, we find that banks characterized by lower expected default frequency are able to offer a larger amount of credit and to better insulate their loan supply from monetary policy changes. JEL Classification: E44, E55. |
| Keywords: | bank, risk, bank lending channel, monetary policy. |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20091075&r=cba |
| By: | Uluc Aysun (University of Connecticut); Ryan Brady (Unites States Naval Academy); Adam Honig (Amherst College) |
| Abstract: | This paper examines the effect of financial frictions on the strength of the credit channel of monetary policy. First, we use a DSGE model characterized by financial frictions as in Bernanke, Gertler, and Gilchrist (1999), and calibrate it using parameter values for countries with different levels of financial frictions. We find that the credit channel is stronger in countries with high levels of financial frictions. The intuition is that in these countries, external finance premiums are more sensitive to firms' financial leverage. By affecting asset prices, therefore, monetary policy has greater impact on external finance premiums and output. Second, we provide empirical evidence for this relationship. We use cross-country data in SVAR models to generate indicators for credit channel strength. We then show that there is a positive relationship between financial frictions, captured by bankruptcy recovery rates, and credit channel strength, confirming the predictions of the model. |
| Keywords: | credit channel, financial frictions, bankruptcy costs |
| JEL: | E44 F31 F41 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:uct:uconnp:2009-24&r=cba |
| By: | Jennings, Anne (ESRI); Lyons, Seán (ESRI); Tol, Richard S. J. (ESRI) |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:esr:wpaper:wp308&r=cba |
| By: | Michael Artis; Christian Dreger; Konstantin Kholodilin |
| Abstract: | We examine real business cycle convergence for 41 euro area regions and 48 US states.Results obtained by a panel model with spatial correlation indicate that the relevance ofcommon business cycle factors is rather stable over the past two decades in the euro area andthe US. Ongoing business cycle convergence often detected in cross-country data is notconfirmed at the regional level. The degree of synchronization across the euro area is similarto that to be found for the US states. Thus, the lack of convergence does not seem to be animpediment to a common monetary policy. |
| Keywords: | Business cycle convergence, spatial correlation, spatial panel model |
| JEL: | E32 C51 E37 |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:cep:sercdp:0022&r=cba |
| By: | Lieven Baele; Geert Bekaert; Koen Inghelbrecht |
| Abstract: | We study the economic sources of stock-bond return comovements and its time variation using a dynamic factor model. We identify the economic factors employing a semi-structural regime-switching model for state variables such as interest rates, inflation, the output gap, and cash flow growth. We also view risk aversion, uncertainty about inflation and output, and liquidity proxies as additional potential factors. We find that macro-economic fundamentals contribute little to explaining stock and bond return correlations, but that other factors, especially liquidity proxies, play a more important role. The macro factors are still important in fitting bond return volatility; whereas the "variance premium" is critical in explaining stock return volatility. However, the factor model primarily fails in fitting covariances. |
| JEL: | E43 E44 G11 G12 G14 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15260&r=cba |
| By: | Andrea Brandolini; Antonio Bassanetti (Banca d'Italia); Martina Cecioni (Banca d'Italia); Andrea Nobili (Banca d'Italia); Giordano Zevi (Banca d'Italia) |
| Abstract: | This paper proposes a comparative analysis of the main macroeconomic aggregates (both real and credit aggregates), and the monetary policy response during the most severe recessions experienced by the Italian economy. This descriptive study focuses mainly on the last forty years, a period for which there is ample and detailed information available. In particular, the paper contrasts the data on the current deep recession with those in 1974-75 and 1992-93, at the times of the oil crisis and the currency crisis respectively. For a selected list of variables, a comparison is made with the dynamics of the recession of the 1930s. |
| Keywords: | gcyclical fluctuations, recession, credit supply, monetary policy |
| JEL: | E20 E32 E50 N14 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:opques:qef_46_09&r=cba |