nep-cba New Economics Papers
on Central Banking
Issue of 2010‒04‒17
forty-two papers chosen by
Alexander Mihailov
University of Reading

  1. Simple and robust rules for monetary policy By John B. Taylor; John C. Williams
  2. How Has the Monetary Transmission Mechanism Evolved Over Time? By Jean Boivin; Michael T. Kiley; Frederic S. Mishkin
  3. The changing nature of financial intermediation and the financial crisis of 2007-09 By Tobias Adrian; Hyun Song Shin
  4. Large-scale asset purchases by the Federal Reserve: did they work? By Joseph Gagnon; Matthew Raskin; Julie Remache; Brian Sack
  5. New Monetarist Economics: models By Stephen D. Williamson; Randall Wright
  6. The Relationship between Exchange Rates and Interest Rate Differentials: a Wavelet Approach By Hacker, Scott; Kim, Hyunjoo; Månsson, Kristofer
  7. Modeling Monetary Policy By Reynard, Samuel; Schabert, Andreas
  8. The Macroeconomic Consequences of EMU : International Evidence from a DSGE Model By Jürgen Jerger; Oke Röhe
  9. Expectations and economic fluctuations: an analysis using survey data By Sylvain Leduc; Keith Sill
  10. Funding Liquidity Risk and Deviations from Interest-Rate Parity During the Financial Crisis of 2007-2009 By Cho-Hoi Hui; Hans Genberg; Tsz-Kin Chung
  11. Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of the Trilemma By Aizenman, Joshua; D. Chinn, Menzie; Ito, Hiro
  12. "Are Forecast Updates Progressive?" By Chia-Lin Chang; Philip Hans Franses; Michael McAleer
  13. Measuring the Natural Output Gap using Actual and Expected Output Data By Kevin Lee
  14. Evaluating Macroeconomic Forecast: A Review of Some Recent Developments By Franses, Ph.H.B.F.; McAleer, M.J.; Legerstee, R.
  15. Reconciling Microeconomic and Macroeconomic Estimates of Price Stickiness By Adam Cagliarini; Tim Robinson; Allen Tran
  16. Inventories, inflation dynamics, and the New Keynesian Phillips Curve By Thomas A. Lubik; Wing Leong Teo
  17. Macroeconomic Shocks and the Business Cycle: Evidence from a Structural Factor Model By Mario Forni; Luca Gambetti
  18. Is a Calvo price setting model consistent with micro price data? By Luis J. Álvarez; Pablo Burriel
  19. Inflation and Globalisation: A Dynamic Factor Model with Stochastic Volatility By Joseph P. Byrne; Fatima Kaneez; Alexandros Kontonikas
  20. Bank-Lending Standards, the Cost Channel and Inflation Dynamics By Sylvia Kaufmann; Johann Scharler
  21. The Euro Through the Looking-Glass: Perceived Inflation Following the 2002 Currency Changeover By Lunn, Pete; Duffy, David
  22. Global Relative Price Shocks: The Role of Macroeconomic Policies By Adam Cagliarini; Warwick McKibbin
  23. Modeling U.S. Inflation Dynamics: A Bayesian Nonparametric Approach By Markus Jochmann
  24. A Sticky-Dispersed Information Phillips Curve: A model with partial and delayed information By Marta Areosa; Waldyr Areosa; Vinicius Carrasco
  25. Beyond DSGE: A macrodynamic model with intertemporal coordination failure By Ronny Mazzocchi
  26. Liquidity demand and welfare in a heterogeneous-agent economy By Yi Wen
  27. A microeconometric investigation into bank interest rate rigidity By Ben R Craig; Valeriya Dinger
  28. Optimal versus realized policy rules in a regime-switching framework By Sophie Pardo; Nicolas Rautureau; Thomas Vallée
  29. The Power of Many: Assessing the Economic Impact of the Global Fiscal Stimulus By Carlos de Resende; René Lalonde; Stephen Snudden
  30. News Shocks and the Slope of the Term Structure of Interest Rates By André Kurmann; Christopher Otrok
  31. Is low inflation really causing the decline in exchange rate pass-through? By Miguel A. León-Ledesma; Reginaldo P. Nogueira Júnior
  32. Monetary Transmission Right from the Start: The (Dis)Connection Between the Money Market and the ECB’s Main Refinancing Rates By Puriya Abbassi; Dieter Nautz
  33. Can News Be a Major Source of Aggregate Fluctuations? A Bayesian DSGE Approach By Ippei Fujiwara; Yasuo Hirose; Mototsugu Shintani
  34. Degree of Openness and Inflation Targeting Policy: Model of a Small Open Economy By Bousrih Jihene; Bousrih Jihene
  35. Time Varying Inflation Targets, Inflation Expectations and Credibility By Bedri Kamil Onur Tas
  36. Housing Cycles In The Major Euro Area Countries By Luis J. Álvarez; Guido Bulligan; Alberto Cabrero; Laurent Ferrara; Harald Stahl
  37. Using Long-Run Restrictions to Investigate the Sources of Exchange Rate Fluctuations By Pao-Lin Tien
  38. Financial Market Conditions, Real Time, Nonlinearity and European Central Bank Monetary Policy: In-Sample and Out-of-Sample Assessment By Costas Milas; Ruthira Naraidoo
  39. Identification in Structural Vector Autoregressions Through Graphical Modelling and Monetary Policy: A Cross-Country Analysis By Fragetta, Matteo
  40. Macroeconomic Implications of Near Rational Behavior: an Application to the Italian Phillips Curve By Novella Maugeri
  41. Zone targeting monetary policy preferences and financial market conditions: a flexible nonlinear policy reaction function of the SARB monetary policy By Ruthira Naraidoo; Leroi Raputsoane
  42. Implementation of Monetary Policy in India By Deepak Mohanty

  1. By: John B. Taylor; John C. Williams
    Abstract: This paper focuses on simple normative rules for monetary policy which central banks can use to guide their interest rate decisions. Such rules were first derived from research on empirical monetary models with rational expectations and sticky prices built in the 1970s and 1980s. During the past two decades substantial progress has been made in establishing that such rules are robust. They perform well with a variety of newer and more rigorous models and policy evaluation methods. Simple rules are also frequently more robust than fully optimal rules. Important progress has also been made in understanding how to adjust simple rules to deal with measurement error and expectations. Moreover, historical experience has shown that simple rules can work well in the real world in that macroeconomic performance has been better when central bank decisions were described by such rules. The recent financial crisis has not changed these conclusions, but it has stimulated important research on how policy rules should deal with asset bubbles and the zero bound on interest rates. Going forward the crisis has drawn attention to the importance of research on international monetary issues and on the implications of discretionary deviations from policy rules.
    Keywords: Monetary policy
    Date: 2010
  2. By: Jean Boivin; Michael T. Kiley; Frederic S. Mishkin
    Abstract: We discuss the evolution in macroeconomic thought on the monetary policy transmission mechanism and present related empirical evidence. The core channels of policy transmission – the neoclassical links between short-term policy interest rates, other asset prices such as long-term interest rates, equity prices, and the exchange rate, and the consequent effects on household and business demand – have remained steady from early policy-oriented models (like the Penn-MIT-SSRC MPS model) to modern dynamic-stochastic-general-equilibrium (DSGE) models. In contrast, non-neoclassical channels, such as credit-based channels, have remained outside the core models. In conjunction with this evolution in theory and modeling, there have been notable changes in policy behavior (with policy more focused on price stability) and in the reduced form correlations of policy interest rates with activity in the United States. Regulatory effects on credit provision have also changed significantly. As a result, we review the empirical evidence on the changes in the effect of monetary policy actions on real activity and inflation and present new evidence, using both a relatively unrestricted factor-augmented vector autoregression (FAVAR) and a DSGE model. Both approaches yield similar results: Monetary policy innovations have a more muted effect on real activity and inflation in recent decades as compared to the effects before 1980. Our analysis suggests that these shifts are accounted for by changes in policy behavior and the effect of these changes on expectations, leaving little role for changes in underlying private-sector behavior (outside shifts related to monetary policy changes).
    JEL: E2 E3 E4 E5
    Date: 2010–04
  3. By: Tobias Adrian; Hyun Song Shin
    Abstract: The financial crisis of 2007-09 highlighted the changing role of financial institutions and the growing importance of the "shadow banking system," which grew out of the securitization of assets and the integration of banking with capital market developments. This trend was most pronounced in the United States, but it also had a profound influence on the global financial system as a whole. In a market-based financial system, banking and capital market developments are inseparable, and funding conditions are tied closely to fluctuations in the leverage of market-based financial intermediaries. Balance-sheet growth of market-based financial intermediaries provides a window on liquidity by indicating the availability of credit, while contractions of balance sheets have tended to precede the onset of financial crises. We describe the changing nature of financial intermediation in the market-based financial system, chart the course of the recent financial crisis, and outline the policy responses that have been implemented by the Federal Reserve and other central banks.
    Keywords: Financial crises ; Intermediation (Finance) ; Liquidity (Economics) ; Monetary policy ; Capital market
    Date: 2010
  4. By: Joseph Gagnon; Matthew Raskin; Julie Remache; Brian Sack
    Abstract: Since December 2008, the Federal Reserve's traditional policy instrument, the target federal funds rate, has been effectively at its lower bound of zero. In order to further ease the stance of monetary policy as the economic outlook deteriorated, the Federal Reserve purchased substantial quantities of assets with medium and long maturities. In this paper, we explain how these purchases were implemented and discuss the mechanisms through which they can affect the economy. We present evidence that the purchases led to economically meaningful and long-lasting reductions in longer-term interest rates on a range of securities, including securities that were not included in the purchase programs. These reductions in interest rates primarily reflect lower risk premiums, including term premiums, rather than lower expectations of future short-term interest rates.
    Keywords: Monetary policy ; Interest rates ; Federal funds rate ; Securities ; Federal Reserve System ; Rate of return
    Date: 2010
  5. By: Stephen D. Williamson; Randall Wright
    Abstract: The purpose of this paper is to discuss some of the models used in New Monetarist Economics, which is our label for a body of recent work on money, banking, payments systems, asset markets, and related topics. A key principle in New Monetarism is that solid microfoundations are critical for understanding monetary issues. We survey recent papers on monetary theory, showing how they build on common foundations. We then lay out a tractable benchmark version of the model that allows us to address a variety of issues. We use it to analyze some classic economic topics, like the welfare effects of inflation, the relationship between money and capital accumulation, and the Phillips curve. We also extend the benchmark model in new ways, and show how it can be used to generate new insights in the study of payments, banking, and asset markets.
    Date: 2010
  6. By: Hacker, Scott (Jonkoping International Business School); Kim, Hyunjoo (Jonkoping International Business School); Månsson, Kristofer (Jonkoping International Business School)
    Abstract: This paper uses wavelet analysis to investigate the relationship between the spot exchange rate and the interest rate differential for seven pairs of countries, with a small country, Sweden, included in each of the cases. The key empirical results show that there tends to be a negative relationship between the spot exchange rate (domestic-currency price of foreign currency) and the nominal interest rate differential (approximately the domestic interest rate minus the foreign interest rate) at the shortest time scales, while a positive relationship is shown at the longest time scales. This indicates that among models of exchange rate determination using the asset approach, the sticky-price models are supported in the short-run while in the long-run the flexible-price models appear to better explain the sign of the relationship.
    Keywords: exchange rates; interest rate differential; uncovered interest parity; monetary approach; small-economy; wavelet analysis
    JEL: E44 F31 F42
    Date: 2010–02–11
  7. By: Reynard, Samuel (Swiss National Bank); Schabert, Andreas (University of Dortmund)
    Abstract: We develop a macroeconomic framework where money is supplied against only few eligible securities in open market operations. The relationship between the policy rate, expected inflation and consumption growth is affected by money market conditions, i.e. the varying liquidity value of eligible assets and the associated risk. This induces a liquidity premium, which explains the observed systematic wedge between the policy rate and consumption Euler interest rate that standard models equate. It further implies a dampened response of consumption to policy rate shocks that is humpshaped when we account for realistic central bank transfers and the dynamics of bond holdings.
    Keywords: Monetary Policy; Open market operations; Liquidity premium; Money market rate; Consumption Euler rate; Monetary policy transmission
    JEL: E32 E43 E52 E58
    Date: 2009–11–09
  8. By: Jürgen Jerger (Osteuropa-Institut, Regensburg (Institut for East European Studies)); Oke Röhe (University of Regensburg)
    Abstract: In this paper, we estimate a New Keynesian DSGE model developed by Ireland (2003) on French, German and Spanish data with the aim to explore the macroeconomic consequences of EMU. In order to validate the results from the DSGE model, we amend this analysis by stability tests of monetary policy reaction functions for these countries. We find that (a) the DSGE structure is well suited for the characterization of key macroeconomic features of the three economies; (b) significant effciency gains were realized in terms of lower adjustment cost of prices and the capital stock; (c) the behavior of monetary policy did not change in Germany, unlike in France and Spain. Specifically, the impact of inflation on interest rates increased considerably in the two latter countries.
    Keywords: DSGE, monetary policy, EMU
    JEL: E31 E32 E52
    Date: 2009–10
  9. By: Sylvain Leduc; Keith Sill
    Abstract: Using survey-based measures of future U.S. economic activity from the Livingston Survey and the Survey of Professional Forecasters, we study how changes in expectations, and their interaction with monetary policy, contribute to fluctuations in macroeconomic aggregates. We find that changes in expected future economic activity are a quantitatively important driver of economic fluctuations: a perception that good times are ahead typically leads to a significant rise in current measures of economic activity and inflation. We also find that the short-term interest rate rises in response to expectations of good times as monetary policy tightens. Our results provide quantitative evidence on the importance of expectations-driven business cycles and on the role that monetary policy plays in shaping them.
    Keywords: Economic forecasting ; Monetary policy ; Business cycles
    Date: 2010
  10. By: Cho-Hoi Hui (Research Department, Hong Kong Monetary Authority); Hans Genberg (Research Department, Hong Kong Monetary Authority); Tsz-Kin Chung (Research Department, Hong Kong Monetary Authority)
    Abstract: Significant deviations from covered interest parity were observed during the financial crisis of 2007-2009. This paper finds that before the failure of Lehman Brothers the market-wide funding liquidity risk was the main determinant of these deviations in terms of the premiums on swap-implied US dollar interest rates for the euro, British pound, Hong Kong dollar, Japanese yen, Singapore dollar and Swiss Franc. This suggests that the deviations can be explained by the existence and nature of liquidity constraints. After the Lehman default, both counterparty risk and funding liquidity risk in the European economies were the significant determinants of the positive deviations, while the tightened liquidity condition in the US dollar was the main driving factor of the negative deviations in the Hong Kong, Japan and Singapore markets. Federal Reserve Swap lines with other central banks eased the liquidity pressure and reduced the positive deviations in the European economies.
    Keywords: Sub-prime crisis, funding liquidity, covered interest parity, FX swaps
    JEL: F31 F32 F33
    Date: 2009–07
  11. By: Aizenman, Joshua (University of California Sta. Cruz); D. Chinn, Menzie (University of Wisconsin); Ito, Hiro (Portland State University)
    Abstract: Using the “trilemma indexes” developed by Aizenman et al. (2008) that measure the extent of achievement in each of the three policy goals in the trilemma—monetary independence, exchange rate stability, and financial openness—this paper examines how policy configurations affect macroeconomic performances with focus on the Asian economies. We find that the three policy choices do not matter for per capita economic growth. However, they do matter for output volatility and the medium-term level of inflation. Greater monetary independence is associated with lower output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated if a country holds international reserves (IR) at a higher level than a threshold (about 20% of gross domestic product). Greater monetary autonomy is associated with a higher level of inflation while greater exchange rate stability and greater financial openness could lower the inflation level. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of IR. Greater financial openness helps reduce real exchange rate volatility. These results indicate that policy makers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. Asian emerging market economies are found to be equipped with macroeconomic policy configurations that help the economies to dampen the volatilities in both investment and real exchange rate. These economies’ sizeable amount of international reserves holding appears to help enhance the stabilizing effect of the trilemma policy choices, which explains the recent phenomenal buildup of international reserves in the region.
    Keywords: trilemma policy; Asian emerging market economies; financial globalization; output volatility
    Date: 2009–11
  12. By: Chia-Lin Chang (Department of Applied Economics, National Chung Hsing University); Philip Hans Franses (Erasmus School of Economics, Erasmus University Rotterdam); Michael McAleer (Econometric Institute, Erasmus University Rotterdam and Tinbergen Institute)
    Abstract: Macro-economic forecasts typically involve both a model component, which is replicable, as well as intuition, which is non-replicable. Intuition is expert knowledge possessed by a forecaster. If forecast updates are progressive, forecast updates should become more accurate, on average, as the actual value is approached. Otherwise, forecast updates would be neutral. The paper proposes a methodology to test whether forecast updates are progressive and whether econometric models are useful in updating forecasts. The data set for the empirical analysis are for Taiwan, where we have three decades of quarterly data available of forecasts and updates of the inflation rate and real GDP growth rate. The actual series for both the inflation rate and the real GDP growth rate are always released by the government one quarter after the release of the revised forecast, and the actual values are not revised after they have been released. Our empirical results suggest that the forecast updates for Taiwan are progressive, and can be explained predominantly by intuition. Additionally, the one-, two- and three-quarter forecast errors are predictable using publicly available information for both the inflation rate and real GDP growth rate, which suggests that the forecasts can be improved.
    Date: 2010–04
  13. By: Kevin Lee
    Abstract: An output gap measure is suggested based on the Beveridge-Nelson decomposition of output using a vector-autoregressive model that includes data on actual output and on expected output obtained from surveys. The paper explains the advantages of using survey data in business cycle analysis and the gap is provided economic meaning by relating it to the natural level of output defined in Dynamic Stochastic General Equilibrium models. The measure is applied to quarterly US data over the period 1970q1-2007q4 and the resultant gap estimates are shown to have sensible statistical properties and perform well in explaining inflation in estimates of New Keynesian Phillips curves.
    Keywords: Trend Output; Natural Output Level; Output Gap; Beveridge-Nelson Decomposition; Survey-based Expectations; New Keynesian Phillips Curve
    JEL: C32 D84 E32
    Date: 2009–10
  14. By: Franses, Ph.H.B.F.; McAleer, M.J.; Legerstee, R. (Erasmus Econometric Institute)
    Abstract: Macroeconomic forecasts are frequently produced, published, discussed and used. The formal evaluation of such forecasts has a long research history. Recently, a new angle to the evaluation of forecasts has been addressed, and in this review we analyse some recent developments from that perspective. The literature on forecast evaluation predominantly assumes that macroeconomic forecasts are generated from econometric models. In practice, however, most macroeconomic forecasts, such as those from the IMF, World Bank, OECD, Federal Reserve Board, Federal Open Market Committee (FOMC) and the ECB, are based on econometric model forecasts as well as on human intuition. This seemingly inevitable combination renders most of these forecasts biased and, as such, their evaluation becomes non-standard. In this review, we consider the evaluation of two forecasts in which: (i) the two forecasts are generated from two distinct econometric models; (ii) one forecast is generated from an econometric model and the other is obtained as a combination of a model, the other forecast, and intuition; and (iii) the two forecasts are generated from two distinct combinations of different models and intuition. It is shown that alternative tools are needed to compare and evaluate the forecasts in each of these three situations. These alternative techniques are illustrated by comparing the forecasts from the Federal Reserve Board and the FOMC on inflation, unemployment and real GDP growth
    Keywords: macroeconomic forecasts;econometric models;human intuition;biased forecasts;forecast performance;forecast evaluation;forecast comparison
    Date: 2010–03–30
  15. By: Adam Cagliarini (Reserve Bank of Australia); Tim Robinson (Reserve Bank of Australia); Allen Tran (Reserve Bank of Australia)
    Abstract: This paper attempts to reconcile the high estimates of price stickiness from macroeconomic estimates of a New-Keynesian Phillips Curve (NKPC) with the lower values obtained from surveys of firms’ pricing behaviour. This microeconomic evidence also suggests that the frequency with which firms adjust their prices varies across sectors. The paper shows that in the presence of this heterogeneity, estimates of aggregate price stickiness from microeconomic and macroeconomic data should differ. Heterogeneity in firms’ pricing decisions, as well as a more realistic production structure, is introduced into an otherwise standard New-Keynesian model. Using a model calibrated with microeconomic pricing survey data for Australia, the paper shows that estimates of the NKPC considerably overstate the true degree of price stickiness and may falsely suggest that some prices are indexed to past inflation. These problems arise because of a type of misspecification and a lack of suitable instruments.
    Keywords: separate by New-Keynesian Phillips Curve; inflation
    JEL: E31 E32
    Date: 2010–03
  16. By: Thomas A. Lubik; Wing Leong Teo
    Abstract: We introduce inventories into an otherwise standard New Keynesian model and study the implications for inflation dynamics. Inventory holdings are motivated as a means to generate sales for demand-constrained firms. We derive various representations of the New Keynesian Phillips curve with inventories and show that one of these specifications is observationally equivalent to the standard model with respect to the behavior of inflation when the model's cross-equation restrictions are imposed. However, the driving variable in the New Keynesian Phillips curve - real marginal cost - is unobservable and has to be proxied by, for instance, unit labor costs. An alternative approach is to impute marginal cost by using the model's optimality conditions. We show that the stock-sales ratio is linked to marginal cost. We also estimate these various specifications of the New Keynesian Phillips curve using GMM. We find that predictive power of the inventory-specification at best approaches that of the standard model, but does not improve upon it. We conclude that inventories do not play a role in explaining inflation dynamics within our New Keynesian Phillips curve framework.
    Keywords: Inflation (Finance)
    Date: 2010
  17. By: Mario Forni; Luca Gambetti
    Abstract: We use a dynamic factor model to provide a semi-structural representation for 101 quarterly US macroeconomic series. We find that (i) the US economy is well described by a number of structural shocks between two and six. Focusing on the four-shock specification, we identify, using sign restrictions, two non-policy shocks, demand and supply, and two policy shocks, monetary and fiscal. We obtain the following results. (ii) Both supply and demand shocks are important sources of fluctuations; supply prevails for GDP, while demand prevails for employment and inflation. (ii) Policy matters: Both monetary and fiscal policy shocks have sizeable effects on output and prices, with little evidence of crowding out; both monetary and fiscal authorities implement important systematic countercyclical policies reacting to demand shocks. (iii) Negative demand shocks have a large long-run positive effect on productivity, consistently with the Schumpeterian "cleansing" view of recessions.
    Keywords: structural factor model; sign restrictions; monetary policy; fiscal policy; demand; supply
    JEL: C32 E32 E52 F31
    Date: 2010–02
  18. By: Luis J. Álvarez (Banco de España); Pablo Burriel (Banco de España)
    Abstract: This paper shows that the standard Calvo model clearly fails to account for the distribution of price durations found in micro data. We propose a novel price setting model that fully captures heterogeneity in individual pricing behavior. Specifically, we assume that there is a continuum of firms that set prices according to a Calvo mechanism, each of them with a possibly different price adjustment parameter. The model is estimated by maximum likelihood and closely matches individual consumer and producer price data. Incorporating estimated price setting rules into a standard DSGE model shows that fully accounting for pricing heterogeneity is crucial to understanding inflation and output dynamics. The standard calibration that assumes within sector homogeneity, as in Carvalho (2006), is at odds with micro data evidence and leads to a substantial distortion of estimates of the real impact of monetary policy.
    Keywords: price setting, Calvo model, heterogeneity, hazard rate
    JEL: C40 D40 E30
    Date: 2010–04
  19. By: Joseph P. Byrne; Fatima Kaneez; Alexandros Kontonikas
    Abstract: National inflation rates reflect domestic and international (regional and global) influences. The relative importance of these components remains a controversial empirical issue. We extend the literature on inflation co-movement by utilising a dynamic factor model with stochastic volatility to account for shifts in the variance of inflation and endogenously determined regional groupings. We find that most of inflation variability is explained by the country specific disturbance term. Nevertheless, the contribution of the global component in explaining industrialised countries’ inflation rates has increased over time.
    Keywords: Inflation, Dynamic Factor Model, Stochastic Volatility, Globalisation
    JEL: C32 E31 E52
    Date: 2010–01
  20. By: Sylvia Kaufmann; Johann Scharler
    Abstract: If firms borrow working capital to finance production, then nominal interest rates have a direct influence on inflation dynamics, which appears to be the case empirically. However, interest rates may only partly mirror the cost of working capital. In this paper we explore the role of bank lending standards as a potential additional cost source and evaluate their empirical importance in explaining inflation dynamics in the US and in the euro area.
    Keywords: New Keynesian Phillips Curve, Cost Channel, Bank Lending Standards, Bayesian Analysis
    JEL: E40 E50
    Date: 2009–10
  21. By: Lunn, Pete; Duffy, David
    Abstract: Following the Euro changeover in January 2002, consumers across the Euro Area perceived a sharp rise in inflation, in contrast to official figures. Several theories have been advanced to explain this apparent economic illusion, but they struggle to account for its striking scale and persistence. We offer an alternative account, based on the premise that the currency changeover increased consumers' perceptual error when assessing the value of monetary amounts. Under plausible assumptions, this would lead them to experience a loss of purchasing power. We confirm two empirical hypotheses in support of the theory: (1) the extent of overestimation of inflation was strongly associated with subjective difficulty using the Euro; (2) there was a simultaneous downward shift in expected inflation. Our results imply that currency changeovers are not simple matters of numerical conversion.
    Keywords: consumer behaviour/Euro changeover/inflation expectations/inflation perceptions/uncertainty
    Date: 2010–03
  22. By: Adam Cagliarini (Reserve Bank of Australia); Warwick McKibbin (Centre for Applied Macroeconomic Analysis, Australian National University)
    Abstract: We use the multi-sector and multi-country G-Cubed model to explore the potential role of three major shocks – to productivity, risk premia and US monetary policy – to explain the large movements in relative prices between 2002 and 2008. We find that productivity shocks were major drivers of relative price movements, while shocks to risk premia and US monetary policy contributed temporarily to some of the relative price dispersions we observe in the data. The effect of US monetary policy shocks on relative prices was most pronounced in countries that fix their currency to the US dollar. Those countries that float were largely shielded from these effects. We conclude that the shocks we consider cannot fully capture the magnitude of the relative price movements over this period, suggesting that other driving forces could also be responsible, including those outside of the model.
    Keywords: productivity; relative prices; G-Cubed; risk premia; economic policy
    JEL: E37 E52 E65
    Date: 2009–12
  23. By: Markus Jochmann (Department of Economics, University of Strathclyde)
    Abstract: This paper uses an infinite hidden Markov model (IHMM) to analyze U.S. inflation dynamics with a particular focus on the persistence of inflation. The IHMM is a Bayesian nonparametric approach to modeling structural breaks. It allows for an unknown number of breakpoints and is a flexible and attractive alternative to existing methods. We found a clear structural break during the recent financial crisis. Prior to that, inflation persistence was high and fairly constant.
    Keywords: inflation dynamics, hierarchical Dirichlet process, IHMM, structural breaks, Bayesian nonparametrics
    JEL: C11 C22 E31
    Date: 2010–01
  24. By: Marta Areosa (Banco Central do Brasi); Waldyr Areosa (Banco Central do Brasil); Vinicius Carrasco (Department of Economics PUC-Rio)
    Abstract: We study the interaction between dispersed and sticky information by assuming that firms receive private noisy signals about the state in an otherwise standard model of price setting with sticky-information. We show that there exists a unique equilibrium of the incomplete information game induced by the firms’ pricing decisions, and derive the resulting Sticky-Dispersed Information (SDI) Phillips curve. The (equilibrium) aggregate price level and the inflation rates we derive depend on all values they have taken in the past. We perform several numerical simulations to evaluate how the Sticky-Dispersed Phillips curve we derive respond to changes in the main parameters of the model.
    Keywords: Sticky information, dispersed information, Phillips curve JEL Codes: D82, D83, E31
    Date: 2010–03
  25. By: Ronny Mazzocchi
    Abstract: The current consensus in macroeconomics, or New Neoclassical Synthesis (NNS), is based on dynamically stochastic general equilibrium (DSGE) modelling with a RBC core to which nominal rigidities are added by way of imperfect competition. The strategy is to minimize the frictions that are required to reproduce Keynesian results (in terms of persistent real effects of monetary policy) and Wicksellian results (in terms of interaction of interest and prices) in a rigorous framework with intertemporal optimization of consumption, forward-looking behavior and continously clearing markets. In reality the main contention of Keynes and Wicksell was saving-investment imbalances (i.e. capital market failures and intertemporal disequilibrium in modern parlance) that are notably absent from the NNS. The paper presents a dynamic model with endogenous capital stock whereby it is possible to assess, and hopefully clarify, some basic issues concerning the macroeconomics of saving-investment imbalances and to explore the dynamic properties of the system under different monetary policy rules.
    Keywords: macroeconomics, monetary policy, New Neoclassical Synthesis, saving-investment imbalances, intertemporal coordination failure.
    JEL: E21 E22 E31 E32 E52
    Date: 2010–01
  26. By: Yi Wen
    Abstract: This paper provides an analytically tractable general-equilibrium model of money demand with micro-foundations. The model is based on the incomplete-market model of Bewley (1980) where money serves as a store of value and provides liquidity to smooth consumption. The model is applied to study the effects of monetary policies. It is shown that heterogeneous liquidity demand can lead to sluggish movements in aggregate prices and positive responses from aggregate output to transitory money injections. However, permanent money growth can be extremely costly: With log utility function and an endogenously determined distribution of money balances that matches the household data, agents are willing to reduce consumption by 8% (or more) to avoid 10% annual inflation. The large welfare cost of inflation arises because inflation destroys the liquidity value and the buffer-stock function of money, thus raising the volatility of consumption for low-income households. The astonishingly large welfare cost of moderate inflation provides a justification for adopting a low inflation target by central banks and offers an explanation for the empirical relationship between inflation and social unrest in developing countries.
    Keywords: Liquidity (Economics)
    Date: 2010
  27. By: Ben R Craig; Valeriya Dinger
    Abstract: Using a unique dataset of interest rates offered by a large sample of U.S. banks on various retail deposit and loan products, we explore the rigidity of bank retail interest rates. We study periods over which retail interest rates remain fixed ("spells") and document a large degree of lumpiness of retail interest rate adjustments as well as substantial variation in the duration of these spells, both across and within different products. To explore the sources of this variation we apply duration analysis and calculate the probability that a bank will change a given deposit or loan rate under various conditions. Consistent with a nonconvex adjustment costs theory, we find that the probability of a bank changing its retail rate is initially increasing with time. Then as heterogeneity of the sample overwhelms this effect, the hazard rate decreases with time. The duration of the spells is significantly affected by the accumulated change in money market interest rates since the last retail rate change, the size of the bank and its geographical scope.
    Keywords: Interest rates ; Bank deposits
    Date: 2010
  28. By: Sophie Pardo (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Nicolas Rautureau (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Thomas Vallée (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272)
    Abstract: In this paper we compare a deterministic model and a Markov switching model to analyze the behavior of the US economy and the Federal Reserve. We examine both optimal and empirical monetary policies for the US Federal Reserve between 1960 and 2008. We compare the optimal monetary policy to the actual interest rates and to the empirical reaction function. We also evaluate the sensitivity of the results to the preferences assigned to each objective. We find that there is no unique optimal solution that fits the Federal Reserve behavior over the entire period. The best fit to the actual interest rates is obtained by an optimal policy with preference switches following the rule: a high-volatility regime coincides with a priority on inflation alone while in a low-volatility regime there is equal policy priority on output stabilization and inflation.
    Date: 2010
  29. By: Carlos de Resende; René Lalonde; Stephen Snudden
    Abstract: The Bank of Canada Global Economy Model (BoC-GEM) is used to examine the effect of various types of discretionary fiscal policies on different regions of the globe. The BoC-GEM is a microfounded dynamic stochastic general-equilibrium global model with six regions, multiple sectors, and international linkages. The authors use the model to assess four main fiscal policy concerns: (i) how the effect of an isolated local fiscal stimulus differs from one jointly implemented in all regions; (ii) which regions are most likely to gain from joint fiscal stimuli, and why; (iii) how the impact of fiscal stimulus can differ conditional on how it is implemented, its timing and duration, and its magnitude relative to that of other regions; and (iv) how the impact of fiscal policy is affected by the inability of monetary policy to push nominal interest rates below zero. The authors use their results to gauge the potential effect of fiscal policy initiatives of the G-20 countries in 2009 and 2010.
    Keywords: Business fluctuations and cycles; Fiscal policy; International topics; Recent economic and financial developments
    JEL: E52 E58 E61 E63 F42
    Date: 2010
  30. By: André Kurmann; Christopher Otrok
    Abstract: We provide a new structural interpretation of the relationship between the slope of the term structure of interest rates and macroeconomic fundamentals. We first adopt an agnostic identification approach that allows us to identify the shocks that explain most of the movements in the slope. We find that two shocks are sufficient to explain virtually all movements in the slope. Impulse response functions for the first shock, which explains the majority of the movements in the slope, lead us to interpret this main shock as a news shock about future productivity. We confirm this interpretation by formally identifying such a news shock as in Barsky and Sims (2009) and Sims (2009). We then assess to what extent a New Keynesian DSGE model is capable of generating the observed slope responses to a news shock. We find that augmenting DSGE models with a term structure provides valuable information to discipline the description of monetary policy and the model’s response to news shocks in general.
    Keywords: Term structure of interest rates, news, productivity shocks, business cycles, monetary policy
    JEL: E30 E43 E52
    Date: 2010
  31. By: Miguel A. León-Ledesma; Reginaldo P. Nogueira Júnior
    Abstract: Recent literature has argued that exchange rate pass-through (ERPT) into domestic inflation has been declining in many countries following a dramatic change in inflation environment during the 1990s. Available empirical results face two central challenges: (i) the evidence on declining ERPT is mostlybased on sample-splitting approaches and hence subject to a degree of arbitrariness; and (ii) the link between a lower ERPT and inflation environment is usually based on simple correlation analysis and hence silent about temporal causality. We address these issues by making use of a state-space model that allows ERPT to be time-varying and dependent on the inflation environment. We estimate the model for 12 developed and emerging economies and test whether inflation contains significant information about the future evolution of the ERPT. The results reinforce the view of a smooth decline in the impact of exchange rates on domestic inflation, but do not support the hypothesis that lower inflation precedes this declining ERPT.
    Keywords: Exchange Rate Pass-Through, Inflation, State-space Models, Causality Tests.
    JEL: E42 E52 E58 F31 F41
    Date: 2010–04
  32. By: Puriya Abbassi; Dieter Nautz
    Abstract: The relation between the ECB’s main refinancing (MRO) rates and the money market is key for the monetary transmission process in the euro area. This paper investigates how money market rates respond to the new information revealed by MRO auctions. Our results confirm a stabilizing level relationship between the overnight rate Eonia and MRO rates before the financial crisis. Since the start of the financial crisis, however, we find that MRO auction outcomes even exacerbated the disconnection of money market rates from the policy-intended interest rate level. These findings support the fixed rate full allotment policy introduced by the ECB as an unconventionalmeasure to re-stabilize banks’ refinancing conditions.
    Keywords: Financial Crisis, Monetary transmission process, Central bank auctions, European Central Bank, Money markets
    JEL: E43 E52 E58 D44
    Date: 2010–03
  33. By: Ippei Fujiwara (Financial Markets Department, Bank of Japan); Yasuo Hirose (Monetary Affairs Department, Bank of Japan); Mototsugu Shintani (Department of Economics, Vanderbilt University)
    Abstract: We examine whether the news shocks, as explored in Beaudry and Portier(2004), can be a major source of aggregate fluctuations. For this purpose, we extend a standard dynamic stochastic general equilibrium model of Christiano, Eichenbaum, and Evans (2005), and Smets and Wouters (2003, 2007) by allowing news shocks on the total factor productivity, and estimate the model using Bayesian methods. Estimation results on the U.S. and Japanese economies suggest that (1) news shocks play a relatively more important role in the U.S. than in Japan; (2) a news shock with a longer forecast horizon has larger effects on nominal variables; and (3) the overall effect of the total factor productivity on hours worked becomes ambiguous in the presence of news shocks.
    Keywords: Bayesian estimation, business cycles, news
    JEL: E30 E40 E50
    Date: 2009–12
  34. By: Bousrih Jihene (UNIVERSITY OF RENNES 1); Bousrih Jihene
    Abstract: In this paper, we present the dynamics of a Neo-Keynesian model applied to a small open economy in order to study the impact of openness on the choice of the appropriate inflation targeting policy. In the event of exogenous shocks, we can use either a CPI inflation targeting policy or a domestic inflation targeting policy. We conclude that there is a relation between the degree of openness of the economy and the type of infation targeting policy. By considering a domestic shock, when the economy is more open towards outside, we may find that the adoption of CPI inflation targeting is benefical. Whereas in the event of foreign shock, the optimal rule would be the domestic inflation targeting. By considering the criteria of social welfare, we find that for an important degree of openness, the policy of CPI inflation targeting remains the optimal monetary rule.
    Keywords: Monetary policy, Domestic Inflation, CPI Inflation, Pass-Through, Degree of Openness
    JEL: E31 E37 E52 F41
    Date: 2010
  35. By: Bedri Kamil Onur Tas
    Date: 2009–12
  36. By: Luis J. Álvarez (Banco de España); Guido Bulligan (Banca d’Italia); Alberto Cabrero (Banco de España); Laurent Ferrara (Banque de France); Harald Stahl (Deutsche Bundesbank)
    Abstract: The recent burst of the house price bubble in the United States and its spillover effects on real economies worldwide has rekindled the interest in the role of housing in the business cycle. In this paper, we investigate the relationships between housing cycles among the four major euro area countries (Germany, France, Italy and Spain) over the sample 1980Q1-2008Q4. Our main findings are that GDP cycles show a high degree of comovement across these four countries, reflecting trade linkages, but much weaker ones for housing market cycles, where idiosyncratic factors play a major role. House prices are even less related than quantities across countries. We also find much stronger relationships in the common monetary policy period.
    Keywords: Housing cycles, synchronisation measures, euro area countries
    JEL: E32 R21 R32
    Date: 2010–03
  37. By: Pao-Lin Tien (Department of Economics, Wesleyan University)
    Abstract: This paper makes use of long-run restrictions to identify macroeconomic shocks and evaluate their relative importance for exchange rate fluctuations. Unlike previous studies that employ a similar approach, I consider a large eight variable vector autoregressive system that includes short term interest rates rather than money stocks in order to help identify monetary policy shocks. Results for the U.S. and the U.K. show that monetary policy shocks and other macroeconomic shocks behave according to theory. However, monetary shocks account for only a small fraction of the variance of the real exchange rate. Instead, “taste shocks” that can be associated with the degree of trade openness, terms of trade, and current account appear to be the key factor driving the U.S.-U.K. real exchange rate. Results for other countries under consideration (Canada, Germany, and Japan) are similar.
    Keywords: vector autoregression, taste shocks, monetary shocks, exchange rate movements, long-run identifying restrictions
    JEL: F31
    Date: 2009–12
  38. By: Costas Milas (Economics Group, Keele Management School, Keele University, UK and Rimini Centre for Economic Analysis, Rimini, Italy); Ruthira Naraidoo (Department of Economics, University of Pretoria)
    Abstract: We explore how the ECB sets interest rates in the context of policy reaction functions. Using both real-time and revised information, we consider linear and nonlinear policy functions in inflation, output and a measure of financial conditions. We find that amongst Taylor rule models, linear and nonlinear models are empirically indistinguishable within sample and that model specifications with real-time data provide the best description of in-sample ECB interest rate setting behavior. The 2007-2009 financial crisis witnesses a shift from inflation targeting to output stabilisation and a shift, from an asymmetric policy response to financial conditions at high inflation rates, to a more symmetric response irrespectively of the state of inflation. Finally, without imposing an a priori choice of parametric functional form, semiparametric models forecast out-of-sample better than linear and nonlinear Taylor rule models.
    Keywords: monetary policy, nonlinearity, real time data, financial conditions
    JEL: C51 C52 C53 E52 E58
    Date: 2009–10
  39. By: Fragetta, Matteo (CELPE (Centre of Labour Economics and Economic Policy), University of Salerno, Italy)
    Abstract: There is an ongoing debate on how to identify monetary policy shocks in SVAR models. Graphical modelling exploits statistical properties of data for identification and offers a data based tool to shed light on the issue. We conduct a cross-country analysis, considering European Monetary Union (EMU), Japan and US. We obtain some important results. The information set of the monetary authorities, which is essential for the identification of the monetary shock seems to depend on availability of data in terms of higher frequency with respect to the policy instrument (US and Japan). Moreover, there is not yet a widespread consensus on whether or not the European Monetary Union should be considered as a closed economy. Our results indicate that EMU official interest rate depends on the US federal funds rate.
    Keywords: monetary policy; SVAR; graphical modelling
    JEL: C32 E50
    Date: 2010–04–12
  40. By: Novella Maugeri
    Abstract: New-Keynesian macroeconomic models typically conclude that longrun unemployment gravitates around the NAIRU, regardless of the nominal inflation rate. Contrastingly, the model of Akerlof, Dickens and Perry (2000) (ADP) predicts that excessively low inflation may result in a situation where unemployment is high relative to the social optimum. This paper investigates whether ADP-type short- and long-run Phillips Curves may suit the Italian economy. Firstly we estimated a short-run non accelerationist Phillips curve (i.e. where the expected inflation coefficient depends on inflation and it is generally less than unit) on Italian post-war data. Based on these results, we then simulated the long-run Phillips Curve and ran robustness checks by using a rival cointegration approach. We have two main results. First, the Italian short-run Phillips curve is actually non-accelerationist. Second, our estimates indicate that in Italy a long-run trade-o¤ between inflation and unemployment cannot be ruled out at low and moderate inflation rates.
    Keywords: Near-rationality; Non-accelerationist Phillips Curve; Natural rate of unemployment
    JEL: E24 E31 J41
    Date: 2010–03
  41. By: Ruthira Naraidoo (Department of Economics, University of Pretoria); Leroi Raputsoane (Department of Economics, University of Pretoria)
    Abstract: Based on a representation of policymaker’s preferences that capture inflation zone targeting behaviors, we estimate a flexible model of the monetary policy reaction function of the South African Reserve Bank (SARB). To address the current debate on the importance of financial asset prices in monetary policy decision making, we augment the analysis to allow for responses to financial market conditions over and above prices and output stabilisation. The main findings are that the monetary authorities’ response towards inflation is zone symmetric. Secondly, the monetary authorities’ response towards output is asymmetric with increased reaction during business cycle downturns versus upturns. Thirdly, the monetary authorities’ pay close attention to financial conditions index. They place the same weight on financial market booms and recessions so that their response is symmetric.
    Keywords: Zones, asymmetries, financial conditions index
    JEL: C51 E12 E58
    Date: 2010–03
  42. By: Deepak Mohanty
    Abstract: How does the Reserve Bank of India implement monetary policy? The objectives and framework of monetary policy, as they have evolved, the operational aspects of monetary policy have been discussed. The processes of monetary policy formulation and communication have also been depicted. [Speech delivered at the Bankers Club, Bhubaneswar].
    Keywords: financial, GDP growth, reserve bank, India, monetary policy, communication, formulation, stability, economy, India, inflation rate, exchange, demand function,
    Date: 2010

This nep-cba issue is ©2010 by Alexander Mihailov. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.