nep-cba New Economics Papers
on Central Banking
Issue of 2009‒09‒05
twelve papers chosen by
Alexander Mihailov
University of Reading

  1. Expectational stability under non-zero trend inflation By Kobayashi, Teruyoshi; Muto, Ichiro
  2. Is there a Case for Price-level Targeting? By Boris Cournède; Diego Moccero
  3. Inflation dynamics with labour market matching: assessing alternative specifications By Christoffel, Kai; Costain, James; de Walque, Gregory; Kuester, Keith; Linzert, Tobias; Millard, Stephen; Pierrard, Olivier
  4. Wage, inflation and employment dynamics with labour market matching By Kai Christoffel; James Costain; Gregory de Walque; Keith Kuester; Tobias Linzert; Stephen Millard; Olivier Pierrard
  5. On the (de)stabilizing effects of news shocks By Roland Winkler; Hans-Werner Wohltmann
  6. International financial transmission: emerging and mature markets By Felices, Guillermo; Grisse, Christian; Yang, Jing
  7. How do different models of foreign exchange settlement influence the risks and benefits of global liquidity management? By Schanz, Jochen
  8. A Financial Conditions Index for the United States By Kimberly Beaton; René Lalonde; Corinne Luu
  9. "Asymptotic Expansion Approaches in Finance: Applications to Currency Options" By Akihiko Takahashi; Kohta Takehara
  10. Expectations, Monetary Policy, and Labor Markets: Lessons from the Great Depression By Christopher P. Reicher
  11. Analysis of the Dynamics of Mexican Inflation Using Wavelets. By Carla Ysusi
  12. Market Forecasts in Brazil: performance and determinants By Fabia A. de Carvalho; André Minella

  1. By: Kobayashi, Teruyoshi; Muto, Ichiro
    Abstract: This study examines the expectational stability of the rational expectation equilibria(REE) under Taylor rules when trend inflation is non-zero. We find that whether or not a higher (lower) trend inflation makes the REE more (less) unstable depends largely on the data (such as contemporaneous data, forecasts and lagged data) used in the conduct of monetary policy.
    Keywords: adaptive learning; E-stability; Taylor rule; trend inflation
    JEL: D84 E31 E52
    Date: 2009–09–03
  2. By: Boris Cournède; Diego Moccero
    Abstract: There is a case, but there are also counter-arguments. With sufficient forward-looking behaviour among firms and households, price-level targeting can act as a powerful built-in stabiliser through automatic shifts in inflation expectations. This stabilisation mechanism reduces the need for large shifts in policy rates, alleviating the risk of hitting the zero lower bound of nominal interest rates and falling into a liquidity trap. Furthermore, credible price-level targeting can support capital accumulation by protecting the long-run purchasing power of money and reducing the inflation risk premium embedded in actual long-term real interest rates. However, price-level targeting can imply welfare-reducing policy-induced output volatility in situations where the degree of forward-looking behaviour is very low. The self-regulating capacity of price-level targeting can be undermined if central banks are not fully credible. Besides, aggressive inflation targeting can replicate some of (but not all) the benefits of price-level targeting. On balance, the case for adopting price-level targeting is not clear-cut, all the more so since transition costs are likely to be significant.<P>Y a-t-il beaucoup à dire en faveur du ciblage du niveau des prix ?<BR>Oui, mais il y a aussi de sérieux contre-arguments. Si une part suffisante des entreprises et des ménages présente un comportement tourné vers l’avenir, le ciblage du niveau des prix peut fonctionner comme un puissant outil de stabilisation autonome grâce aux ajustements automatiques des anticipations des inflations. Ce mécanisme limite le besoin d’opérer de larges mouvements des taux directeurs, ce qui réduit le risque de heurter la borne zéro sur les taux d’intérêt et de tomber dans une trappe à liquidités. Qui plus est, grâce à la manière dont elle protège le pouvoir d’achat de la monnaie, une politique crédible de ciblage du niveau des prix peut encourager l’accumulation de capital en réduisant la prime contre le risque d’inflation qui est incorporée aux taux d’intérêts réels effectifs. Néanmoins, le ciblage du niveau des prix peut entraîner une volatilité de l’activité préjudiciable au bien-être social si la part des ménages et des entreprises qui sont tournés vers l’avenir est très faible. La capacité de stabilisation automatique d’un régime de ciblage du niveau des prix peut aussi être moindrie si la banque centrale manque de crédibilité. Par ailleurs, une stratégie de ciblage agressif du taux d’inflation peut reproduire une partie (mais non pas l’ensemble) des avantages du ciblage du niveau des prix. Tout bien pesé, les arguments en faveur du ciblage du niveau des prix ne justifient pas de manière nette un changement de stratégie monétaire, d’autant plus que les coûts de transition risquent d’être élevés.
    Keywords: monetary policy, politique monétaire, central bank, banque centrale, inflation targeting, ciblage d’inflation, zero lower bound, borne zéro des taux d’intérêt, monetary systems, régimes monétaires, price level targeting, ciblage du niveau des prix, price stability, stabilité des prix, trappe à liquidités, liquidity trap
    JEL: E42 E52
    Date: 2009–08–24
  3. By: Christoffel, Kai (European Central Bank); Costain, James (Banco de Espana); de Walque, Gregory (National Bank of Belgium); Kuester, Keith (Federal Reserve Bank of Philadelphia); Linzert, Tobias (European Central Bank); Millard, Stephen (Bank of England); Pierrard, Olivier (Banque Centrale du Luxembourg)
    Abstract: This paper reviews recent approaches to modelling the labour market, and assesses their implications for inflation dynamics through both their effect on marginal cost and on price-setting behaviour. In a search and matching environment, we consider the following modelling set-ups: right-to-manage bargaining versus efficient bargaining, wage stickiness in new and existing matches, interactions at the firm level between price and wage-setting, alternative forms of hiring frictions, search on-the-job and endogenous job separation. We find that most specifications imply too little real rigidity relative to the data and, so, too volatile inflation. Models with wage stickiness and right-to-manage bargaining, or with firm-specific labour emerge as the most promising candidates.
    Keywords: Inflation dynamics; labour market; business cycle; real rigidities
    JEL: E24 E31 E32 J64
    Date: 2009–08–24
  4. By: Kai Christoffel (European Central Bank); James Costain (Banco de España); Gregory de Walque (Banque Nationale de Belgique); Keith Kuester (Federal Reserve Bank of Philadelphia); Tobias Linzert (European Central Bank); Stephen Millard (Bank of England); Olivier Pierrard (Banque Centrale du Luxembourg)
    Abstract: In a search and matching environment, this paper assesses a range of modeling setups against macro evidence for the monetary transmission mechanism in the euro area. In particular, we assess right-to-manage vs. efficient bargaining, flexible vs. sticky wages, interactions at the firm level between price and wage-setting, alternative forms of hiring frictions, search on-the-job and endogenous job separation. Models with wage stickiness and right-to-manage bargaining or with firm-specific labour imply a sufficient degree of real rigidity, and so can reproduce inflation dynamics well. However, they imply too small a response on the employment margin. The other model variants fit employment dynamics better, but then imply too little real rigidity and, so, too volatile inflation, owing to strong responses of marginal wages and hours per employee. Further sources of real rigidities - possibly from outside of the labour market - seem to be needed to simultaneously explain the responses of wages, inflation and employment.
    Keywords: Inflation Dynamics, Labour Market, Business Cycle, Real Rigidities
    JEL: E31 E32 E24 J64
    Date: 2009–08
  5. By: Roland Winkler; Hans-Werner Wohltmann
    Abstract: This paper analyzes the impacts of news shocks on macroeconomic volatility. Whereas anticipation amplifies volatility in any purely forward-looking model, such as the baseline New Keynesian model, the results are ambiguous when including a backward-looking component. In addition to these theoretical findings, we use the estimated model of Smets and Wouters (2003) to provide numerical evidence that news shocks increase the volatility of key macroeconomic variables in the euro area when compared to unanticipated shocks.
    Keywords: Anticipated Shocks, Business Cycles, Volatility
    JEL: E32
    Date: 2009–08
  6. By: Felices, Guillermo (Citigroup); Grisse, Christian (Federal Reserve Bank of New York); Yang, Jing (Bank of England)
    Abstract: With an increasingly integrated global financial system, we frequently observe that shocks to individual asset markets affect financial markets worldwide. The aim of this paper is to quantify the comovements between bond markets in the US and emerging market economies using daily data from prior to the East Asian crisis through to the early stages of the current global financial crisis. We exploit the changing volatility of the data to fully identify a structural VAR, without imposing ad hoc restrictions. We find that shocks that widen emerging market sovereign debt (EMBIG) spreads have a negative effect on US interest rates in the short run (consistent with 'flight to quality' effects), while shocks that increase US interest rates raise EMBIG spreads over longer horizons (consistent with 'financing cost' or 'search for yield' effects). We also find that shocks that increase EMBIG spreads tend to widen US high-yield spreads and vice versa, constituting an important contagion channel through which crises in emerging market economies can affect mature markets. Forecast error variance decompositions show that shocks to US long rates can explain around 60%-70% of the variation of EMBIG and US high-yield spreads.
    JEL: C32 F30 G15
    Date: 2009–08–24
  7. By: Schanz, Jochen (Bank of England)
    Abstract: Large, international banking groups have sought to centralise their cross-currency liquidity management: liquidity shortages in one currency are financed using liquidity surpluses in another currency. The nature of risks to financial stability emerging from global liquidity management depends on how these foreign exchange transactions settle. I analyse these risks in a game of asymmetric information. The main result is that the transition from local to global liquidity management, and better co-ordination in settlement of foreign exchange transactions, have two effects. On the one hand, the likelihood rises that payments are delayed beyond their due date. On the other hand, solvency shocks are less likely to be passed on to other banks. The main assumption is that lending between subsidiaries of the same banking group takes place under symmetric information, while external interbank market loans are extended under asymmetric information. More co-ordinated settlement increases the exposure of the intragroup lender relative to the interbank lender and leads to more informed lending.
    Keywords: Liquidity risk; foreign exchange settlement
    JEL: D82 F36 G20 G32
    Date: 2009–08–24
  8. By: Kimberly Beaton; René Lalonde; Corinne Luu
    Abstract: The financial crisis of 2007-09 has highlighted the importance of developments in financial conditions for real economic activity. The authors estimate the effect of current and past shocks to financial variables on U.S. GDP growth by constructing two growthbased financial conditions indexes (FCIs) that measure the contribution to quarterly (annualized) GDP growth from financial conditions. One FCI is constructed using a structural vector-error correction model and the other is constructed using a large-scale macroeconomic model. The authors' results suggest that financial factors subtracted around 5 percentage points from quarterly annualized real GDP growth in the United States in 2008Q4 and 2009Q1 and should subtract another 5 percentage points from growth in 2009Q2. Moreover, to assess the effect of financial shocks in terms of policy interest rate equivalent units, the authors convert the effect of financial developments on growth into the number of basis points by which the federal funds rate has been tightened. The authors show that the tightening of financial conditions since mid-2007 is equivalent to about 300 basis points of tightening in terms of the federal funds rate. Thus, the aggressive monetary easing undertaken by the Federal Reserve over the financial crisis has not been sufficient to offset the tightening of financial conditions. Finally, in a key contribution to the literature, the authors assess the relationship between financial shocks and real activity in the context of the zero lower bound. They find that the effect of the tightening of financial conditions on GDP growth in the current crisis may have been amplified by as much as 40 per cent due to the fact that policy interest rates reached the zero lower bound.
    Keywords: Business fluctuations and cycles; Monetary conditions index; Monetary and financial indicators; Recent economic and financial developments
    JEL: E32 E44 E47 E51
    Date: 2009
  9. By: Akihiko Takahashi (Faculty of Economics, University of Tokyo); Kohta Takehara (Graduate School of Economics, University of Tokyo)
    Abstract: This chapter presents a basic of the methodology so-called an asymptotic expansion approach, and applies this method to approximation of prices of currency options with a libor market model of interest rates and stochastic volatility models of spot exchange rates. The scheme enables us to derive closed-form approximation formulas for pricing currency options even with high flexibility of the underlying model; we do not model a foreign exchange rate's variance such as in Heston [27], but its volatility that follows a general time-inhomogeneous Markovian process. Further, the correlations among all the factors such as domestic and foreign interest rates, a spot foreign exchange rate and its volatility, are allowed. At the end of this chapter some numerical examples are provided and the pricing formula is applied to the calibration of volatility surfaces in the JPY/USD option market.
    Date: 2009–08
  10. By: Christopher P. Reicher
    Abstract: This paper estimates a series of shocks to hit the US economy during the Great Depression, using a New Keynesian model with unemployment and bargaining frictions. Shocks to long-run inflation expectations appear to account for much of the cyclical behavior of employment, while an increase in labor’s bargaining power also played an important role in deepening and lengthening the Depression. Government spending played very little role during the Hoover Administration and New Deal, until the rise in military spending effectively brought an end to the Depression in 1941. With the economy at or near the zero interest rate bound, interest rates and monetary aggregates provided a misleading indicator as to the true stance of inflation expectations; in fact, conditions were deflationary all throughout the 1930s in spite of high money growth and low interest rates. The experience of the 1930s offers lessons to modern policymakers who find themselves in a similar situation
    Keywords: Great Depression, expectations, deflation, zero bound, liquidity trap
    JEL: E24 E31 E52 E65
    Date: 2009–08
  11. By: Carla Ysusi
    Abstract: This paper studies the dynamics of Mexican inflation by using a wavelet multiresolution analysis on 16 indexes of the Mexican Consumer Price Index. This enables us to estimate the long-term trend, seasonality, and local shocks of the inflation series, even when the series are non-stationary. The energy distribution between the high frequency, seasonal, and trend components, as well as its evolution through time, are compared. In particular, headline and core inflations show a more stable behavior in all the scales since 2001. Also, an increase in the proportion of variance explained by short-term variations is detected in the inflation series. In relative terms, the short run is becoming as important for headline inflation as the medium and long run, and more important for non-core inflation. These results are in line with previous studies documenting the reduction in the Mexican inflation persistence.
    Keywords: Inflation dynamics, wavelets, multiresolution analysis, energy decomposition.
    JEL: C19 C49 E31
    Date: 2009–09
  12. By: Fabia A. de Carvalho; André Minella
    Abstract: This paper assesses a wide set of aspects of market forecasts in Brazil: rationality, predictive power, joint performance, epidemiology and determinants. Using the survey conducted by the Central Bank of Brazil (CBB) among professional forecasters during the inflation targeting period, the main results are as follows: i) credibility in Brazilian monetary policy has increased over time, since inflation targets are important to explain inflation expectations, and private agents perceive the CBB as following a Taylor-type rule that is consistent with the inflation targeting framework; ii) market inflation forecasts had similar or better forecast performance than ARMA-, VAR- and BVAR-based forecasts with standard information sets; iii) the joint performance of market forecasts has improved over the past years; iv) in the decomposition of forecast errors for inflation, interest rate and exchange rate, the common forecast error component prevails over the idiosyncratic component across survey respondents; v) top-five forecasters published by the CBB are influential in other respondents’ forecasts; vi) inflation forecasts are unbiased but not fully efficient; and vii) inflation forecast uncertainty is positively related to increasing inflation and to country-risk premium.
    Date: 2009–04

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