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on Central Banking |
| By: | Aleksander Berentsen; Christopher J. Waller |
| Abstract: | We construct a dynamic stochastic general equilibrium model to study optimal monetary stabilization policy. Prices are fully flexible and money is essential for trade. Our main result is that if the central bank pursues a price-level target, it can control inflation expectations and improve welfare by stabilizing short-run shocks to the economy. The optimal policy involves smoothing nominal interest rates which effectively smooths consumption across states. |
| Keywords: | Monetary policy ; Econometric models |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-33&r=cba |
| By: | Aleksander Berentsen; Christopher J. Waller |
| Abstract: | We study optimal monetary stabilization policy in a dynamic stochastic general equilibrium model where money is essential for trade and firm entry is endogenous. We do so when all prices are flexible and also when some are sticky. Due to an externality affecting firm entry, the central bank deviates from the Friedman rule. Calibration exercises suggest that the nominal interest rate should have been substantially smoother than the data if preference shocks were the main disturbance and much more volatile if productivity was the driving shock. This result is a direct consequence of policy actions to control entry. |
| Keywords: | Monetary policy ; Econometric models |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-32&r=cba |
| By: | S. Boragan Aruoba; Christopher J. Waller; Randall Wright |
| Abstract: | We study the effects of money (anticipated inflation) on capital formation. Previous papers on this topic adopt reduced-form approaches, putting money in the utility function or imposing cash in advance, but use otherwise frictionless models. We follow a literature that is more explicit about the frictions making money essential. This introduces several new elements, including a two-sector structure with centralized and decentralized markets, stochastic trading opportunities, and bargaining. We show how these elements matter qualitatively and quantitatively. Our numerical results differ from findings in the reduced-form literature. The analysis reduces the previously large gap between mainstream macro and monetary theory. |
| Keywords: | Money ; Monetary theory ; Capital ; Search theory |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-31&r=cba |
| By: | Christopher J. Waller |
| Abstract: | The objective of this paper is to study optimal fiscal and monetary policy in a dynamic Mirrlees model where the frictions giving rise to money as a medium of exchange are explicitly modeled. The framework is a three period OLG model where agents are born every other period. The young and old trade in perfectly competitive centralized markets. In middle age, agents receive preference shocks and trade amongst themselves in an anonymous manner. Since preference shocks are private information, in a record-keeping economy, the planner's constrained allocation trades off efficient risk sharing against production efficiency in the search market. In the absence of record-keeping, the government uses flat money as a substitute for dynamic contracts to induce truthful revelation of preferences. Inflation affects agents' incentive constraints and so distortionary taxation of money may be needed as part of the optimal policy even if lump-sum taxes are available. |
| Keywords: | Money ; Taxation |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-35&r=cba |
| By: | Christopher J. Waller |
| Abstract: | I use the monetary version of the neoclassical growth model developed by Aruoba, Waller and Wright (2008) to study the properties of the model when there is exogenous growth. I first consider the planner's problem, then the equilibrium outcome in a monetary economy. I do so by first using proportional bargaining to determine the terms of trade and then consider competitive price taking. I obtain closed form solutions for the balanced growth path of all variables in all cases. I then derive closed form solutions for the transition paths under the assumption of full depreciation and, in the monetary economy, a non-stationary interest rate policy. |
| Keywords: | Monetary policy ; Econometric models |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-34&r=cba |
| By: | Eric M. Leeper |
| Abstract: | In this lecture, I argue that there are remarkable parallels between how monetary and fiscal policies operate on the macro economy and that these parallels are sufficient to lead us to think about transforming fiscal policy and fiscal institutions as many countries have transformed monetary policy and monetary institutions. Making fiscal transparency comparable to monetary transparency requires fiscal authorities to discuss future possible fiscal policies explicitly. Enhanced fiscal transparency can help anchor expectations of fiscal policy and make fiscal actions more predictable and effective. As advanced economies move into a prolonged period of heightened fiscal activity, anchoring fiscal expectations will become an increasingly important aspect of macroeconomic policy. |
| JEL: | E52 E63 H60 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15269&r=cba |
| By: | Pierre-Richard Agénor; Koray Alper |
| Abstract: | This paper analyzes the transmission process of monetary policy in a closed-economy New Keynesian model with monopolistic banking, credit market imperfections, and a cost channel. Lending rates incorporate a risk premium, which depends on firms' net worth and cyclical output. The supply of bank loans is perfectly elastic at the prevailing bank rate and so is the provision of central bank liquidity at the official policy rate. The model is calibrated for a middle-income country. Numerical simulations show that credit market imperfections and sluggish adjustment of bank deposit rates (rather than lending rates) may impart a substantial degree of persistence in the response of output and inflation to monetary shocks. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:120&r=cba |
| By: | Andrew Ang; Jean Boivin; Sen Dong; Rudy Loo-Kung |
| Abstract: | We estimate the effect of shifts in monetary policy using the term structure of interest rates. In our no-arbitrage model, the short rate follows a version of the Taylor (1993) rule where the coefficients on the output gap and inflation vary over time. The monetary policy loading on the output gap has averaged around 0.4 and has not changed very much over time. The overall response of the yield curve to output gap components is relatively small. In contrast, the inflation loading has changed substantially over the last 50 years and ranges from close to zero in 2003 to a high of 2.4 in 1983. Long-term bonds are sensitive to inflation policy shifts with increases in inflation loadings leading to higher short rates and widening yield spreads. |
| JEL: | E4 E5 G1 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15270&r=cba |
| By: | Hassan Bougrine; Teppo Rakkolainen |
| Abstract: | The literature on growth theory is rich with models attempting to explain growth differences among countries. Several variables have been proposed many of which were found to be positively related to growth. However, a major problem with these models is that the factors explaining growth are endogenously determined by their environment so that a slow-growing or a poor country will find itself helpless because all the crucial variables it has `inherited' are either deficient or inexistent. We propose policyoriented model that empowers (poor or slow-growing) countries in the sense that they can use economic policies to achieve high growth and eliminate the gap of unused productive capacity of society. We demonstrate that such objectives are possible by manipulating some key control variables, namely the rate of interest and the net government spending. |
| Keywords: | growth, maximization, fiscal policy, interest rates, deficit, money |
| JEL: | O11 O23 H2 H3 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:tkk:dpaper:dp50&r=cba |
| By: | Heinz-Peter Spahn |
| Abstract: | New Keynesian Macroeconomics (NKM) obeys to the new dogma that macroeconomics should be firmly grounded in First Principles of micro theory. Households are assumed to run an intertemporal optimization calculus with respect to leisure and consumption by making use of perfect financial markets. The supply side is organized so that full employment prevails. Macroeconomic coordination problems between saving and investment are absent. In order to make model predictions more compatible with empirical facts, NKM chooses "ad hoc" microfoundations: utility functions and market structures are designed arbitrarily to allow for persistence of macro variables. NKM's reduced hybrid macro model, with lags and expectational leads, is a useful "work horse", compatible with various micro reasoning. However, NKM's insistence on the representative agent obstructs an understanding of heterogeneous beliefs and learning. |
| Keywords: | Representative Agent, Ramsey Saving, Calvo Pricing, Sticky Information, Rational Expectations, Heterogeneous Beliefs |
| JEL: | B22 E12 E2 E3 E44 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:hoh:hohdip:317&r=cba |
| By: | Thórarinn G. Pétursson |
| Abstract: | This paper focuses on two important questions concerning inflation performance in a country sample of forty-two of the most developed countries in the world. The firrst is why inflation tends to be more volatile in some countries than in others, in particular in very small, open economies and emerging market economies compared to the large and more developed ones. The empirical analysis suggests that the volatility of the risk premium in multilateral exchange rates, the degree of exchange rate pass-through to inflation, and monetary policy predictability play a key role in explaining the cross-country variation in inflation volatility. Other variables, related to economic development and size, international trade, output volatility, exposure to external shocks, and central bank independence are not found significant. The second question is what explains the general decline in inflation volatility over the sample period. Using a panel approach, the empirical analysis confirms that the adoption of inflation targeting has played a critical role in this improvement in addition to the three variables found important in the cross-country analysis. Inflation targeting therefore continues to play an important role in reducing inflation volatility even after adding the three controls to the panel analysis. The main conclusions are found to be robust to changes in the country sample and to different estimation methods. |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:ice:wpaper:wp42&r=cba |
| By: | Dino Martellato (Department of Economics, University Of Venice Cà Foscari) |
| Abstract: | This paper examines the likely direction of real interest rates in the Euro area and the United States from April 2009 on. It is argued that the crisis that began in 2007 and the ensuing recession changed the descending trend in real interest rates which started a long time ago. If real interest rates were to rise too much, private and public finances, housing markets and stock markets would suffer particularly in the countries where the past credit binge and the crisis response has made debts mount, thus prolonging the current crisis. Economic theory should help shed light on the likely future direction of long-term real interest rates. In the paper, growth models are briefly discussed and shown to offer disparate predictions about the level of real interest rates in a growing economy and little practical guidance. Monetary theories, i.e. theories explicitly focused on the role of interest rates in balancing supply and demand in the single markets of the economy, make reference to some normal or natural level of real interest rate but obviously suffer from the difficulties of estimating such normal or natural levels both in general and particularly in a unusually dynamic and uncertain situation such as the current one. The more pragmatic approach, consisting in the assessment of the relevant single components of the long-term real nominal interest rate over the cycle, points to the risks of a surge in the risk premium as well as in expected short-term real interest rates and thus to a prolongation of the current economic contraction. |
| Keywords: | Interest rates |
| JEL: | E4 E5 E1 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2009_14&r=cba |
| By: | Xavier Gabaix |
| Abstract: | This paper proposes that idiosyncratic firm-level fluctuations can explain an important part of aggregate shocks, and provide a microfoundation for aggregate productivity shocks. Existing research has focused on using aggregate shocks to explain business cycles, arguing that individual firm shocks average out in aggregate. I show that this argument breaks down if the distribution of firm sizes is fat-tailed, as documented empirically. The idiosyncratic movements of the largest 100 firms in the US appear to explain about one third of variations in output and the Solow residual. This "granular" hypothesis suggests new directions for macroeconomic research, in particular that macroeconomic questions can be clarified by looking at the behavior of large firms. This paper's ideas and analytical results may also be useful to think about the fluctuations of other economic aggregates, such as exports or the trade balance. |
| JEL: | E32 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15286&r=cba |
| By: | Gary B. Gorton; Andrew Metrick |
| Abstract: | When "confidence" is lost, "liquidity dries up." We investigate the meaning of "confidence" and "liquidity" in the context of the current financial crisis. The financial crisis is a manifestation of an age-old problem with private money creation, banking panics. We explain this and provide some evidence with respect to the current crisis. |
| JEL: | G0 G1 G14 G3 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15273&r=cba |
| By: | Philip Hans Franses (Econometric Institute, Erasmus University Rotterdam); Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Rianne Legerstee (Econometric Institute and Tinbergen Institute, Erasmus University Rotterdam) |
| Abstract: | The primary purpose of the paper is to answer the following two questions regarding the performance of the influential Federal Open Market Committee (FOMC) of the Federal Reserve System, in comparison with the forecasts contained in the "Greenbooks" of the professional staff of the Board of Governors: Does the FOMC have expertise, and can it forecast better than the staff? The FOMC forecasts that are analyzed in practice are nonreplicable forecasts. In order to evaluate such forecasts, this paper develops a model to generate replicable FOMC forecasts, and compares the staff forecasts, non-replicable FOMC forecasts, and replicable FOMC forecasts, considers optimal forecasts and efficient estimation methods, and presents a direct test of FOMC expertise on nonreplicable FOMC forecasts. The empirical analysis of Romer and Romer (2008) is reexamined to evaluate whether their criticisms of the FOMC's forecasting performance should be accepted unreservedly, or might be open to alternative interpretations. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf648&r=cba |
| By: | Ansgar Belke; Daniel Gros |
| Abstract: | The purpose of this contribution is to illustrate the mechanism by which higher oil prices might lead to lower interest rates in the context of a simple model that takes into account the global external savings equilibrium. The simple model has interesting implications for how one views the huge US current account deficit and how the emergence of China’s savings surplus and oil supply shocks impact the global economy.We show that the new equilibrium is located at a lower interest rate but also at a lower income level than without the China effect. Moreover, we argue that the lower real interest rates resulting from excess OPEC savings have facilitated the adjustment to the subprime crisis. |
| Keywords: | China factor, current account adjustment, interest rate, oil prices, saving glut |
| JEL: | E21 E43 F32 Q43 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:rwi:repape:0128&r=cba |
| By: | Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Juan-Angel Jimenez-Martin (Department of Quantitative Economics, Complutense University of Madrid); Teodosio Perez-Amaral (Department of Quantitative Economics, Complutense University of Madrid) |
| Abstract: | The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. In this paper we define risk management in terms of choosing sensibly from a variety of risk models, discuss the selection of optimal risk models, consider combining alternative risk models, discuss the choice between a conservative and aggressive risk management strategy, and evaluate the effects of the Basel II Accord on risk management. We also examine how risk management strategies performed during the 2008-09 financial crisis, evaluate how the financial crisis affected risk management practices, forecasting VaR and daily capital charges, and discuss alternative policy recommendations, especially in light of the financial crisis. These issues are illustrated using Standard and Poor's 500 Index, with an emphasis on how risk management practices were monitored and encouraged by the Basel II Accord regulations during the financial crisis. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf643&r=cba |
| By: | Michael McAleer (Econometric Institute, Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo); Juan-Angel Jimenez-Martin (Department of Quantitative Economics, Complutense University of Madrid); Teodosio Perez-Amaral (Department of Quantitative Economics, Complutense University of Madrid) |
| Abstract: | When dealing with market risk under the Basel II Accord, variation pays in the form of lower capital requirements and higher profits. Typically, GARCH type models are chosen to forecast Value-at-Risk (VaR) using a single risk model. In this paper we illustrate two useful variations to the standard mechanism for choosing forecasts, namely: (i) combining different forecast models for each period, such as a daily model that forecasts the supremum or infinum value for the VaR; (ii) alternatively, select a single model to forecast VaR, and then modify the daily forecast, depending on the recent history of violations under the Basel II Accord. We illustrate these points using the Standard and Poor's 500 Composite Index. In many cases we find significant decreases in the capital requirements, while incurring a number of violations that stays within the Basel II Accord limits. |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf636&r=cba |
| By: | Giuliano, Paola (University of California, Los Angeles); Spilimbergo, Antonio (International Monetary Fund) |
| Abstract: | Do generations growing up during recessions have different socio-economic beliefs than generations growing up in good times? We study the relationship between recessions and beliefs by matching macroeconomic shocks during early adulthood with self-reported answers from the General Social Survey. Using time and regional variations in macroeconomic conditions to identify the effect of recessions on beliefs, we show that individuals growing up during recessions tend to believe that success in life depends more on luck than on effort, support more government redistribution, but are less confident in public institutions. Moreover, we find that recessions have a long-lasting effect on individuals' beliefs. |
| Keywords: | beliefs formation, macroeconomic shocks |
| JEL: | P16 E60 Z13 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4365&r=cba |