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on Central Banking |
| By: | Peter N. Ireland (Boston College) |
| Abstract: | With an estimated New Keynesian model, this paper compares the "great recession" of 2007-09 to its two immediate predecessors in 1990-91 and 2001. The model attributes all three downturns to a similar mix of aggregate demand and supply disturbances. The most recent series of adverse shocks lasted longer and became more severe, however, prolonging and deepening the great recession. In addition, the zero lower bound on the nominal interest rate prevented monetary policy from stabilizing the US economy as it had previously; counterfactual simulations suggest that without this constraint, output would have recovered sooner and more quickly in 2009. |
| Keywords: | recession, New Keynesian, zero lower bound |
| JEL: | E32 E52 |
| Date: | 2010–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:735&r=cba |
| By: | John B. Taylor; John C. Williams |
| Abstract: | This paper focuses on simple rules for monetary policy which central banks have used in various ways to guide their interest rate decisions. Such rules, which can be evaluated using simulation and optimization techniques, 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. |
| JEL: | E5 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15908&r=cba |
| By: | Aizenman, Joshua (Asian Development Bank Institute); Chinna, Menzie (Asian Development Bank Institute); Ito, Hiro (Asian Development Bank Institute) |
| Abstract: | This paper extends our previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, we examine the channels through which the trilemma policy configurations affect output volatility. Secondly, we investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, we look into how trilemma configurations have evolved in the aftermath of economic crises in the past. 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 international reserves (IR). Greater financial openness helps reduce real exchange rate volatility. These results indicate that policymakers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. We also find that the "crisis economies" could end up with smaller output losses if they entered the crisis situation with more stable exchange rates or if they continue to hold a high level of IR and maintain greater exchange rate stability during the crisis period. Lastly, we find that developing countries are often found to have decreased the level of monetary independence and financial openness, but increased the level of exchange rate stability in the aftermath of a crisis, especially for the last two decades. This finding indicates how vulnerable developing countries, especially emerging market ones, are to volatile capital flows as a result of global financial liberalization. |
| Keywords: | trilemma policy; capital outflows; investment channel; asia regional |
| JEL: | F15 F21 F31 F36 F41 O24 |
| Date: | 2010–04–19 |
| URL: | http://d.repec.org/n?u=RePEc:ris:adbiwp:0213&r=cba |
| By: | William Barnett (Department of Economics, The University of Kansas); Logan Kelly (Department of Economics, Bryant University); John Keating (Department of Economics, The University of Kansas) |
| Abstract: | Historically, attempts to solve the liquidity puzzle have focused on narrowly defined monetary aggregates, such as non-borrowed reserves, the monetary base, or M1. Many of these efforts have failed to find a short-term negative correlation between interest rates and monetary policy innovations. More recent research uses sophisticated macroeconomic and econometric modeling. However, little research has investigated the role measurement error plays in the liquidity puzzle, since in nearly every case, work investigating the liquidity puzzle has used one of the official monetary aggregates, which have been shown to exhibit significant measurement error. This paper examines the role that measurement error plays in the liquidity puzzle by (i) providing a theoretical framework explaining how the official simple-sum methodology can lead to a liquidity puzzle, and (ii) testing for the liquidity effect by estimating an unrestricted VAR. |
| Keywords: | Liquidity Puzzle, Monetary Policy, Monetary Aggregation, Money Stock, Divisia Index Numbers |
| JEL: | E43 E50 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:kan:wpaper:201002&r=cba |
| By: | Kelly, Logan; Barnett, William A.; Keating, John W. |
| Abstract: | Historically, attempts to solve the liquidity puzzle have focused on narrowly defined monetary aggregates, such as non-borrowed reserves, the monetary base, or M1. Many of these efforts have failed to find a short-term negative correlation between interest rates and monetary policy innovations. More recent research uses sophisticated macroeconomic and econometric modeling. However, little research has investigated the role measurement error plays in the liquidity puzzle, since in nearly every case, work investigating the liquidity puzzle has used one of the official monetary aggregates, which have been shown to exhibit significant measurement error. This paper examines the role that measurement error plays in the liquidity puzzle by (i) providing a theoretical framework explaining how the official simple-sum methodology can lead to a liquidity puzzle, and (ii) testing for the liquidity effect by estimating an unrestricted VAR. |
| Keywords: | Liquidity Puzzle; Monetary Policy; Monetary Aggregation; Money Stock; Divisia Index Numbers |
| JEL: | E43 E50 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:22085&r=cba |
| By: | Kimberly Beaton; Carlos de Resende; René Lalonde; Stephen Snudden |
| Abstract: | The authors use the Bank of Canada's version of the Global Economy Model, a multi-country, multi-sector dynamic stochastic general-equilibrium model with an active banking system (the BoC-GEM-FIN), to study the evolution of global current account balances following the recent global financial crisis. More specifically, they use several shocks from the model to generate a simulated baseline scenario that mimics: (i) the initial, pre-crisis state of disequilibrium in global current account balances, and (ii) the effects of the crisis, including those of the policy responses undertaken worldwide. The authors find that a sufficient set of conditions and policies for a sustainable resolution of the global current account imbalances relies on three key elements: (i) a continuous upward adjustment of U.S. private savings, (ii) fiscal consolidation in advanced countries, and (iii) an orderly adjustment of exchange rates. These three criteria facilitate a gradual decline in the U.S. current account deficit going forward. A fourth key element, the implementation of policies aimed at stimulating domestic demand in emerging Asia, is needed to ensure that the counterpart of the decrease in the U.S. current account deficit is mainly a reduction in the surpluses of emerging Asia. Sensitivity analysis based on deviations from these conditions illustrates the factors behind the main results and the costs associated with the alternative scenarios considered. |
| Keywords: | Balance of payments and components; Business fluctuations and cycles; International topics; Recent economic and financial developments |
| JEL: | E21 F01 F32 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:10-4&r=cba |
| By: | Zeno Enders |
| Abstract: | This paper examines the implications of segmented assets markets for the real and nominal effects of monetary policy. I develop a model, in which varieties of consumption bundles are purchased sequentially. Newly injected money thus disseminates slowly through the economy via second-round effects and induces a non-degenerate, long-lasting heterogeneity in wealth. As a result, the effective elasticity of substitution differs across households, affecting optimal markups chosen by producers. In line with empirical evidence, the model predicts a short-term inflation-output trade-off, a liquidity effect, countercyclical markups, and procyclical profits and wages after monetary shocks. |
| Keywords: | Segmented Asset Markets, Monetary Policy, CountercyclicalMarkups Liquidity Effect, Limited Participation |
| JEL: | E31 E32 E51 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse08_2010&r=cba |
| By: | Stefan Niemann; Paul Pichler; Gerhard Sorger |
| Abstract: | We study the monetary instrument problem in a model of optimal discretionary fiscal and monetary policy. The policy problem is cast as a dynamic game between the central bank, the fiscal authority, and the private sector. We show that, as long as there is a conflict of interest between the two policy-makers, the central bank's monetary instrument choice critically affects the Markov-perfect Nash equilibrium of this game. Focussing on a scenario where the fiscal authority is impatient relative to the monetary authority, we show that the equilibrium allocation is typically characterized by a public spending bias if the central bank uses the nominal money supply as its instrument. If it uses instead the nominal interest rate, the central bank can prevent distortions due to fiscal impatience and implement the same equilibrium allocation that would obtain under cooperation of two benevolent policy authorities. Despite this property, the welfare-maximizing choice of instrument depends on the economic environment under consideration. In particular, the money growth instrument is to be preferred whenever fiscal impatience has positive welfare effects, which is easily possible under lack of commitment. |
| Date: | 2010–04–12 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:687&r=cba |
| By: | Maria Demertzis; Massimiliano Marcellino; Nicola Viegi |
| Abstract: | We identify credible monetary policy with first, a disconnect between inflation and inflation expectations and second, the anchoring of the latter at the inflation target announced by the monetary authorities. We test empirically whether this is the case for a number of countries that have an explicit inflation target and therefore include the Euro Area. We find that for the last 10 year period, the two series are less dependent on each other and that announcing inflation targets help anchor expectations at the right level. |
| Keywords: | Inflation Targets, Measures of Credibility |
| JEL: | E52 E58 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2010/10&r=cba |
| By: | Helmut Herwartz; Jan Roestel |
| Abstract: | According to the ’macroeconomic trilemma’ the ability of small economies to pursue an independent monetary policy is jointly determined by country specific foreign exchange (FX) rate flexibility and capital mobility. In particular, free floating economies should be able to isolate domestic interest rates even under globalized capital markets. Recent evidence casts doubts if this gain in independence is substantial. Taking advantage of semiparametric functional regression models we study the trade-off among FX stability, capital mobility and monetary autonomy for a panel of 20 developed small economies. Confirming the macroeconomic trilemma, the exposure to foreign interest rates is found to increase with country specific states of exchange rate stability and capital mobility. Gains in monetary independence appear substantial for countries that abdicate to peg their FX rates, but the marginal benefit of tolerating higher exposure to FX volatility quickly vanishes. Free floating economies might therefore be able to moderately stabilize FX rates at little cost. |
| Keywords: | monetary independence, macroeconomic trilemma, monetary policy, exchange rate regime, interest rates, functional coefficients, semiparametric models |
| JEL: | F31 F33 F36 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2010/09&r=cba |
| By: | Paula Hernandez-Verme (Department of Economics and Finance, Universidad de Guanajuato) |
| Abstract: | This paper compares the merits of alternative exchange rate regimes in small open economies where financial intermediaries perform a real allocative function, there are multiple reserve requirements, and credit market frictions may or may not cause credit rationing. Under floating exchange rates, raising domestic inflation can increase production if credit is rationed. However, there exist inflation thresholds: increasing inflation beyond the threshold level will reduce domestic output. Instability, indeterminacy of dynamic equilibria and economic fluctuations may arise independently of the exchange rate regime. Private information –with high rates of domestic inflation- increases the scope for indeterminacy and economic fluctuations. |
| Keywords: | Currency Board, Endogenously Arising Volatility, Fixed exchange rates, Floating exchange rates, Growth, Indeterminacy, Inflation, Multiple Reserve Requirements, Private Information, Stabilization |
| JEL: | E31 E32 E42 E44 F31 F33 G14 G18 O16 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:gua:wpaper:ec200906&r=cba |
| By: | Eric M. Aldrich; Jesús Fernández-Villaverde; A. Ronald Gallant; Juan F. Rubio-Ramírez |
| Abstract: | This paper shows how to build algorithms that use graphics processing units (GPUs) installed in most modern computers to solve dynamic equilibrium models in economics. In particular, we rely on the compute unified device architecture (CUDA) of NVIDIA GPUs. We illustrate the power of the approach by solving a simple real business cycle model with value function iteration. We document improvements in speed of around 200 times and suggest that even further gains are likely. |
| JEL: | C87 E0 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15909&r=cba |
| By: | Helmut Luetkepohl |
| Abstract: | Despite the fact that many aggregates are nonlinear functions and the aggregation weights of many macroeconomic aggregates are timevarying, much of the literature on forecasting aggregates considers the case of linear aggregates with fixed, time-invariant aggregation weights. In this study a framework for nonlinear contemporaneous aggregation with possibly stochastic or time-varying weights is developed and different predictors for an aggregate are compared theoretically as well as with simulations. Two examples based on European unemployment and inflation series are used to illustrate the virtue of the theoretical setup and the forecasting results. |
| Keywords: | Forecasting, stochastic aggregation, autoregression, moving average,vector autoregressive process |
| JEL: | C32 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2010/11&r=cba |
| By: | Carlos Montoro |
| Abstract: | In practice, central banks have been confronted with a trade-off between stabilising inflation and output when dealing with rising oil prices. This contrasts with the result in the standard New Keynesian model that ensuring complete price stability is the optimal thing to do, even when an oil shock leads to large output drops. To reconcile this apparent contradiction, this paper investigates how monetary policy should react to oil shocks in a microfounded model with staggered price-setting and with oil as an input in a CES production function. In particular, we extend Benigno and Woodford (2005) to obtain a second order approximation to the expected utility of the representative household when the steady state is distorted and the economy is hit by oil price shocks. The main result is that oil price shocks generate an endogenous trade-off between inflation and output stabilisation when oil has low substitutability in production. Therefore, it becomes optimal for the monetary authority to stabilise partially the effects of oil shocks on inflation and some inflation is desirable. We also find, in contrast to Benigno and Woodford (2005), that this trade-off is reduced, but not eliminated, when we get rid of the effects of monopolistic distortions in the steady state. Moreover, the size of the endogenous "cost-push" shock generated by fluctuations in the oil price increases when oil is more difficult to substitute by other factors. |
| Keywords: | optimal monetary policy, welfare, second order solution, oil price shocks, endogenous trade-off |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:307&r=cba |
| By: | Andrea Carriero (Queen Mary, University of London); George Kapetanios (Queen Mary, University of London); Massimiliano Marcellino (European University Institute and Bocconi University) |
| Abstract: | We propose a new approach to forecasting the term structure of interest rates, which allows to efficiently extract the information contained in a large panel of yields. In particular, we use a large Bayesian Vector Autoregression (BVAR) with an optimal amount of shrinkage towards univariate AR models. Focusing on the U.S., we provide an extensive study on the forecasting performance of our proposed model relative to most of the existing alternative specifications. While most of the existing evidence focuses on statistical measures of forecast accuracy, we also evaluate the performance of the alternative forecasts when used within trading schemes or as a basis for portfolio allocation. We extensively check the robustness of our results via subsample analysis and via a data based Monte Carlo simulation. We find that: i) our proposed BVAR approach produces forecasts systematically more accurate than the random walk forecasts, though the gains are small; ii) some models beat the BVAR for a few selected maturities and forecast horizons, but they perform much worse than the BVAR in the remaining cases; iii) predictive gains with respect to the random walk have decreased over time; iv) different loss functions (i.e., "statistical" vs "economic") lead to different ranking of specific models; v) modelling time variation in term premia is important and useful for forecasting. |
| Keywords: | Bayesian methods, Forecasting, Term structure |
| JEL: | C11 C53 E43 E47 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp662&r=cba |
| By: | Steven P. Cassou (Kansas State University); Jesús Vázquez (Universidad del País Vasco) |
| Abstract: | This paper uses a new method for describing dynamic comovement and persistence in economic time series which builds on the contemporaneous forecast error method developed in den Haan (2000). This data description method is then used to address issues in New Keynesian model performance in two ways. First, well known data patterns, such as output and inflation leads and lags and inflation persistence, are decomposed into forecast horizon components to give a more complete description of the data patterns. These results show that the well known lead and lag patterns between output and inflation arise mostly in the medium term forecasts horizons. Second, the data summary method is used to investigate a rich New Keynesian model with many modeling features to see which of these features can reproduce lead, lag and persistence patterns seen in the data. Many studies have suggested that a backward looking component in the Phillips curve is needed to match the data, but our simulations show this is not necessary. We show that a simple general equilibrium model with persistent IS curve shocks and persistent supply shocks can reproduce the lead, lag and persistence patterns seen in the data. |
| Keywords: | New Keynesian, output and inflation comovement, inflation persistence, forecast error |
| JEL: | E31 E32 E37 |
| Date: | 2010–04–15 |
| URL: | http://d.repec.org/n?u=RePEc:ehu:dfaeii:201005&r=cba |
| By: | Robert A. Ritz |
| Abstract: | This paper presents a simple model of risk-averse banks that face uncertainty over funding conditions in the money market. It shows when increased funding uncertainty causes interest rates on loans and deposits to rise, while bank lending and bank profitability fall. It also finds that funding uncertainty typically dampens the rate of pass-through from changes in the central bank’s policy rate to market interest rates. These results help explain observed bank behaviour and reduced effectiveness of monetary policy in the 2007/9 financial crisis. Funding uncertainty also has strong implications for consumer welfare, and can turn deposits into a “loss leader” for banks. |
| Keywords: | Bank lending, Interbank market, Interest rate pass-through, Loan-to-deposite ratio, Loan-deposit synergies, Loss leader, Monetary policy |
| JEL: | E43 G21 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:481&r=cba |
| By: | C. L. Chua (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne); G. C. Lim (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne); Sarantis Tsiaplias (KPMG, Melbourne) |
| Abstract: | This paper implements a procedure to evaluate time-varying bank interest rate adjustments over a sample period which includes changes in industry structure, market and credit conditions and varying episodes of monetary policy. The model draws attention to the pivotal role of official rates and provides estimates of the equilibrium policy rate. The misalignment of actual official rates and their changing sensitivity to banking conditions is identified. Results are also provided for the variation in intermediation margins and pass-throughs as well as the interactions between lending and borrowing behaviour over the years, including behaviour before, during and after the global financial crisis. The case studies are the US and Australian banking systems. |
| Keywords: | bank interest rates; time-varying asymmetric adjustments; monetary interest rate policy |
| JEL: | C32 E43 G2 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:iae:iaewps:wp2010n04&r=cba |
| By: | Svetlana Andrianova; Panicos Demetriades; Anja Shortland |
| Abstract: | We show that previous results suggesting that government ownership of banks is associated with lower long run growth rates are not robust to adding more 'fundamental' determinants of economic growth. We also present new cross-country evidence for 1995-2007 which suggests that, if anything, government ownership of banks has been robustly associated with higher long run growth rates. While acknowledging that cross-country results need not imply causality, we nevertheless provide a conceptual framework, drawing on the global financial crisis of 2008-09, which explains why under certain circumstances government owned banks could be more conducive to economic growth than privately-owned banks. |
| Keywords: | Public banks, economic growth, quality of governance, regulation, political institutions |
| JEL: | O16 G18 G28 K42 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp987&r=cba |
| By: | Dieter Nautz; Ulrike Rondorf |
| Abstract: | The instability of standard money demand functions has undermined the role of monetary aggregates for monetary policy analysis in the euro area. This paper uses country-specific monetary aggregates to shed more light on the economics behind the instability of euro area money demand. Our results obtained from panel estimation indicate that the observed instability of standard money demand functions could be explained by omitted variables like e.g. technological progress that are important for money demand but constant across member countries. |
| Keywords: | Money demand, cross-country analysis, panel error correction model, euro area |
| JEL: | E41 E51 E52 |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2010-023&r=cba |
| By: | Markus Knell (Oesterreichische Nationalbank, Economic Studies Division, Otto-Wagner-Platz 3, POB 61, A-1011 Vienna) |
| Abstract: | In this paper I study the relation between real wage rigidity (RWR) and nominal price and wage rigidity. I show that in a standard DSGE model RWR is mainly affected by the interaction of the two nominal rigidities and not by other structural parameters. The degree of RWR is, however, considerably influenced by the modelling assumption about the structure of wage contracts (Calvo vs. Taylor) and about other institutional characteristics of wage-setting (clustering of contracts,heterogeneous contract length, indexation). I use survey evidence on price- and wage-setting for 15 European countries to calculate the degrees of RWR implied by the theoretical model. The average levels of RWR are broadly in line with empirical estimates based on macroeconomic data. In order to be able to also match the observed cross-country variation in RWR it is, however, essential to move beyond the country-specific durations of price and wages and to take more institutional details into account. |
| Keywords: | Inflation Persistence, Real Wage Rigidity, Nominal Wage Rigidity, DSGE models, Staggered Contracts, |
| JEL: | E31 E32 E24 J51 |
| Date: | 2010–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:onb:oenbwp:161&r=cba |
| By: | Davide, Furceri; Aleksandra, Zdzienicka |
| Abstract: | The aim of this work is to assess the short and medium term impact of banking crises on developing economies. Using an unbalanced panel of 159 countries from 1970 to 2006, the paper shows that banking crises produce significant output losses, both in the short and in the medium term. The effect depends on structural and policy variables. Output losses are larger for relatively more wealthy economies, characterized by a higher level of financial deepening and larger current account imbalances. Flexible exchange rates, fiscal and monetary policy have been found to be efficient tools to attenuate the effect of the crises. Among banking intervention policies, liquidity support resulted to be the one associated with lower output losses. |
| Keywords: | Output Growth; Financial Crisis. |
| JEL: | E60 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:22078&r=cba |
| By: | Olivier Coibion (Department of Economics, College of William and Mary) |
| Abstract: | This paper studies the estimated effects of monetary policy shocks from standard VAR’s, which are small, and those from the approach of Romer and Romer (2004), which are large. The differences appear to be driven by three factors: a) the contractionary impetus associated with each shock, b) the period of non-borrowed reserves targeting and c) lag length selection. Accounting for these factors, the real effects of monetary policy shocks are consistent across approaches and are most likely medium: a one-hundred basis point innovation to the Federal Funds Rate lowers production by 2-3% and raises the unemployment rate by approximately 0.50% points. In addition, alternative measures of monetary policy shocks from estimated Taylor rules also yield medium-sized real effects and indicate that the historical contribution of monetary policy shocks to real fluctuations has been nontrivial, particularly during the 1970s. |
| Keywords: | Monetary Policy, Shocks, Taylor rule |
| JEL: | E3 E5 |
| Date: | 2010–04–15 |
| URL: | http://d.repec.org/n?u=RePEc:cwm:wpaper:90&r=cba |