nep-cba New Economics Papers
on Central Banking
Issue of 2010‒05‒15
forty-two papers chosen by
Alexander Mihailov
University of Reading

  1. Does Ricardian Equivalence hold when expectations are not rational? By Evans , George W; Honkapohja , Seppo; Mitra, Kaushik
  2. Global Imbalances and the Financial Crisis By Karl Whelan
  3. Financial Contagion and the Real Economy By Dirk G. Baur
  4. Involuntary Unemployment and the Business Cycle By Christiano, Lawrence J.; Trabrandt, Mathias; Walentin, Karl
  5. How effective were the Federal Reserve emergency liquidity facilities?: evidence from the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility By Burcu Duygan-Bump; Patrick M. Parkinson; Eric S. Rosengren; Gustavo A. Suarez; Paul S. Willen
  6. Forecasting with DSGE models By Kai Christoffel; Günter Coenen; Anders Warne
  7. Forecasting from Mis-specified Models in the Presence of Unanticipated Location Shifts By Michael P. Clements; David F. Hendry
  8. How has the monetary transmission mechanism evolved over time? By Jean Boivin; Michael T. Kiley; Frederic S. Mishkin
  9. Modeling Monetary Policy By Samuel Reynard; Andreas Schabert
  10. Monetary Policy under a Fiscal Theory of Sovereign Default By Andreas Schabert
  11. Fortune or virtue: time-variant volatilities versus parameter drifting By Jesus Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez
  12. Reading the recent monetary history of the U.S., 1959-2007 By Jesus Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez.
  13. Output gaps By Michael T. Kiley
  14. The Fisher BCPI: The Bank of Canada’s New Commodity Price Index By Ilan Kolet; Ryan Mcdonald
  15. Stock market conditions and monetary policy in an DSGE model for the US By Castelnuovo , Efrem; Nisticò, Salvatore
  16. Convergence of EMU Equity Portfolios By Maela Giofré
  17. Trading off monetary and financial stability: a balance of risk framework By Jan Willem van den End
  18. Costly Information, Planning Complementarity and the New Keynesian Phillips Curve By Acharya, Sushant
  19. Towards a Program for Financial Stability. By Robert E. Krainer
  20. Measuring the Effects of Fiscal Policy By Hafedh Bouakez; Foued Chihi; Michel Normandin
  21. How do Consumption and Asset Returns React to Wealth Shocks? Evidence from the U.S. and the U.K” By Ricardo M. Sousa
  22. How Well Does Sticky Information Explain Inflation and Output Inertia? By Carrillo Julio A.
  23. Business Cycle Synchronization in Europe: Evidence from the Scandinavian Currency Union By U. Michael Bergman; Lars Jonung
  24. The Discursive Dilemma in Monetary Policy By Claussen , Carl Andreas; Røisland, Øistein
  25. The discursive dilemma in monetary policy By Carl Andreas Claussen; Øistein Røisland
  26. Housing collateral and the monetary transmission mechanism By Walentin, Karl; Sellin, Peter
  27. Structural shocks and the comovements between output and interest rates By Elmar Mertens
  28. Endogenous Money or Sticky Wages: A Bayesian Approach By Guangling 'Dave' Liu
  29. What determines euro area bank CDS spreads ? By Jan Annaert; Marc De Ceuster; Patrick Van Roy; Cristina Vespro
  30. Monetary policy through the “credit-cost channel”. Italy and Germany pre and post-EMU By Giuliana Passamani; Roberto Tamborini
  31. Pricing to Market in Business Cycle Models By Drozd, Lukasz A.; Nosal, Jaromir B.
  32. Investigating the Zero Lower Bound on the Nominal Interest Rate under Financial Instability By Carrillo Julio A.; Poilly Céline
  33. Exchange Rate Flexibility Across Financial Crises By Virginie Coudert; Cecile Couharde; Valerie Mignon
  34. GDP Trend Deviations and the Yield Spread: the Case of Five E.U. Countries By Gogas, Periklis; Pragidis, Ioannis
  35. Are policy counterfactuals based on structural VARs reliable? By Luca Benati
  36. Substitution between domestic and foreign currency loans in Central Europe. Do central banks matter? By Michał Brzoza-Brzezina; Tomasz Chmielewski; Joanna Niedźwiedzińska
  37. Off-the-Record Target Zones: Theory with an Application to Hong Kong’s Currency Board By Yu-Fu Chen; Michael Funke; Nicole Glanemann
  38. Off-the-record target zones: Theory with an application to Hong Kong's currency board By Chen, Yu-Fu; Funke, Michael; Glanemann, Nicole
  39. Offshore Markets for the Domestic Currency: Monetary and Financial Stability Issues By Dong He; Robert N. McCauley
  40. A Comparison of Inflation Expectations and Inflation Credibility in South Africa: Results from Survey Data By Jannie Rossouw; Vishnu Padayachee; Adél Bosch
  41. Should Central Banks of Small Open Economies Respond to Exchange Rate Fluctuations? The Case of South Africa By Sami Alpanda; Kevin Kotze; Geoffrey Woglom
  42. Modelling anti-inflationary monetary targeting: with an application to Romania By Marcelo Sánchez

  1. By: Evans , George W (University of Oregon, University of St Andrews); Honkapohja , Seppo (Bank of Finland); Mitra, Kaushik (University of St Andrews)
    Abstract: This paper shows that the Ricardian Equivalence proposition can continue to hold when expectations are not rational and are instead formed using adaptive learning rules. In temporary equilibrium, with given expectations, Ricardian Equivalence holds under the standard conditions for its validity under rational expectations. Furthermore, Ricardian Equivalence holds for paths of temporary equilibria under learning provided suitable additional conditions on learning dynamics are satisfied. New cases of failure of the Ricardian proposition emerge under learning. Most importantly, agents’ expectations must not depend on government financial variables under deficit financing.
    Keywords: taxation; expectations; Ramsey model; Ricardian Equivalence
    JEL: D84 E21 E43 E62
    Date: 2010–05–05
  2. By: Karl Whelan (University College Dublin)
    Abstract: Did global imbalances cause the financial crisis? A number of influential figures have argued that inflows of foreign capital into the US due to the current account deficit helped to trigger the crisis. This paper argues that the evidence for this position is weak. The capital inflows into the US associated with the current account deficit were also not the key factor driving foreign purchases of US toxic assets. The so-called global savings glut was not as significant a pattern as is often presented. Macroeconomic policies that reduced global imbalances could have been adopted but these would probably not have prevented the crisis. Global policy efforts to prevent a recurrence of the financial crisis need to focus on improved banking regulation. Reducing global imbalances should be of secondary importance.
    Date: 2010–04–15
  3. By: Dirk G. Baur
    Abstract: The global financial crisis of 2008 was a crisis affecting both the financial sector and the “real economy”. This paper analyzes the transmission of unexpected shocks from the financial sector in the US to other countries and sectors. We test the hypothesis that the financial crisis spread from the financial sector to the real economy by infecting financial stocks and real economy stocks across most financial markets. The empirical analysis comprising ten sectors in 25 major developed and emerging stock markets shows that the crisis led to an increased co-movement of unexpected shocks and thus contagion in financial stocks globally. In contrast, the evidence for contagion from the financial sector to other sectors is weak and most sectors exhibit a decreased transmission of shocks during the financial crisis. The findings suggest that investors differentiated across sectors and countries despite the severity of the financial crisis and the increased level of uncertainty.
    JEL: F30 F36 G14 G15
    Date: 2010–05
  4. By: Christiano, Lawrence J. (Northwestern University); Trabrandt, Mathias (European Central Bank); Walentin, Karl (Research Department, Central Bank of Sweden)
    Abstract: We propose a monetary model in which the unemployed satisfy the official US definition of unemployment: they are people without jobs who are (i) currently making concrete efforts to find work and (ii) willing and able to work. In addition, our model has the property that people searching for jobs are better off if they find a job than if they do not (i.e., unemployment is ‘involuntary’). We integrate our model of invol- untary unemployment into the simple New Keynesian framework with no capital and use the resulting model to discuss the concept of the ‘non-accelerating inflation rate of unemployment’. We then integrate the model into a medium sized DSGE model with capital and show that the resulting model does as well as existing models at accounting for the response of standard macroeconomic variables to monetary policy shocks and two technology shocks. In addition, the model does well at accounting for the response of the labor force and unemployment rate to the three shocks.
    Keywords: DSGE; unemployment; business cycles; monetary policy; Bayesian estima- tion.
    JEL: E20 E30 E50 J20 J60
    Date: 2010–04–01
  5. By: Burcu Duygan-Bump; Patrick M. Parkinson; Eric S. Rosengren; Gustavo A. Suarez; Paul S. Willen
    Abstract: Following the failure of Lehman Brothers in September 2008, short-term credit markets were severely disrupted. In response, the Federal Reserve implemented new and unconventional facilities to help restore liquidity. Many existing analyses of these interventions are confounded by identification problems because they rely on aggregate data. Two unique micro datasets allow us to exploit both time series and cross-sectional variation to evaluate one of the most unusual of these facilities - the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF). The AMLF extended collateralized loans to depository institutions that purchased asset-backed commercial paper (ABCP) from money market funds, helping these funds meet the heavy redemptions that followed Lehman's bankruptcy. The program, which lent $150 billion in its first 10 days of operation, was wound down with no credit losses to the Federal Reserve. Our findings indicate that the facility was effective as measured against its dual objectives: it helped stabilize asset outflows from money market mutual funds, and it improved liquidity in the ABCP market. Using a differences-in-differences approach we show that after the facility was implemented, money market fund outflows decreased more for those funds that held more eligible collateral. Similarly, we show that yields on AMLF-eligible ABCP decreased significantly relative to those on otherwise comparable AMLF-ineligible commercial paper.
    Keywords: Bank liquidity ; Global financial crisis ; Federal Reserve Bank of Boston ; Asset-backed financing ; Commercial paper ; Money market funds ; Discount window
    Date: 2010
  6. By: Kai Christoffel (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Günter Coenen (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Anders Warne (Directorate General Research, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: In this paper we review the methodology of forecasting with log-linearised DSGE models using Bayesian methods. We focus on the estimation of their predictive distributions, with special attention being paid to the mean and the covariance matrix of h-step ahead forecasts. In the empirical analysis, we examine the forecasting performance of the New Area-Wide Model (NAWM) that has been designed for use in the macroeconomic projections at the European Central Bank. The forecast sample covers the period following the introduction of the euro and the out-of-sample performance of the NAWM is compared to nonstructural benchmarks, such as Bayesian vector autoregressions (BVARs). Overall, the empirical evidence indicates that the NAWM compares quite well with the reduced-form models and the results are therefore in line with previous studies. Yet there is scope for improving the NAWM’s forecasting performance. For example, the model is not able to explain the moderation in wage growth over the forecast evaluation period and, therefore, it tends to overestimate nominal wages. As a consequence, both the multivariate point and density forecasts using the log determinant and the log predictive score, respectively, suggest that a large BVAR can outperform the NAWM. JEL Classification: C11, C32, E32, E37.
    Keywords: Bayesian inference, DSGE models, euro area, forecasting, open-economy macroeconomics, vector autoregression.
    Date: 2010–05
  7. By: Michael P. Clements; David F. Hendry
    Abstract: This chapter describes the issues confronting any realistic context for economic forecasting, which is inevitably based on unknowingly mis-specified models, usually estimated from mis-measured data, facing intermittent and often unanticipated location shifts. We focus on mitigating the systematic forecast failures that result in such settings, and describe the background to our approach, the difficulties of evaluating forecasts, and the devices that are more robust when change occurs.
    Keywords: Economic forecasting, Location shifts, Mis-specified models, Robust forecasts
    JEL: C51 C22
    Date: 2010
  8. 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).
    Date: 2010
  9. By: Samuel Reynard (Swiss National Bank); Andreas Schabert (University of Amsterdam)
    Abstract: We develop a macroeconomic framework where money is
    Keywords: Monetary policy; Open market operations; Liquidity
    JEL: E52 E58 E43 E32
    Date: 2009–11–10
  10. By: Andreas Schabert (University of Amsterdam, and TU Dortmund University)
    Abstract: This paper examines equilibrium determination under different monetary policy regimes when the government might default on its debt. We apply a cash-in-advance model where the government does not have access to non-distortionary taxation and does not account for initial outstanding debt when it sets the income tax rate. Solvency is then not guaranteed and sovereign default can affect the return on public debt. If the central bank sets the interest rate in a conventional way, the equilibrium allocation cannot be determined. If, instead, money supply is controlled, the equilibrium allocation can uniquely be determined.
    Keywords: Equilibrium determination; interest rate policy; money supply; public debt; sovereign default
    JEL: E31 E52 E63
    Date: 2009–11–06
  11. By: Jesus Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez
    Abstract: This paper compares the role of stochastic volatility versus changes in monetary policy rules in accounting for the time-varying volatility of U.S. aggregate data. Of special interest to the authors is understanding the sources of the great moderation of business cycle fluctuations that the U.S. economy experienced between 1984 and 2007. To explore this issue, the authors build a medium-scale dynamic stochastic general equilibrium (DSGE) model with both stochastic volatility and parameter drifting in the Taylor rule and they estimate it non-linearly using U.S. data and Bayesian methods. Methodologically, the authors show how to confront such a rich model with the data by exploiting the structure of the high-order approximation to the decision rules that characterize the equilibrium of the economy. Their main empirical findings are: 1) even after controlling for stochastic volatility (and there is a fair amount of it), there is overwhelming evidence of changes in monetary policy during the analyzed period; 2) however, these changes in monetary policy mattered little for the great moderation; 3) most of the great performance of the U.S. economy during the 1990s was a result of good shocks; and 4) the response of monetary policy to inflation under Burns, Miller, and Greenspan was similar, while it was much higher under Volcker.
    Keywords: Monetary policy ; Business cycles ; Board of Governors of the Federal Reserve System (U.S.) ; Econometric models
    Date: 2010
  12. By: Jesus Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez.
    Abstract: The authors report the results of the estimation of a rich dynamic stochastic general equilibrium model of the U.S. economy with both stochastic volatility and parameter drifting in the Taylor rule. They use the results of this estimation to examine the recent monetary history of the U.S. and to interpret, through this lens, the sources of the rise and fall of the great American inflation from the late 1960s to the early 1980s and of the great moderation of business cycle fluctuations between 1984 and 2007.
    Keywords: Economic conditions - United States ; Business cycles - Econometric models ; Econometric models ; Monetary policy - United States
    Date: 2010
  13. By: Michael T. Kiley
    Abstract: What is the output gap? There are many definitions in the economics literature, all of which have a long history. I discuss three alternatives: the deviation of output from its long-run stochastic trend (i.e., the "Beveridge-Nelson cycle"); the deviation of output from the level consistent with current technologies and normal utilization of capital and labor input (i.e., the "production-function approach"); and the deviation of output from "flexible-price" output (i.e., its "natural rate"). Estimates of each concept are presented from a dynamic-stochastic-general-equilibrium (DSGE) model of the U.S. economy used at the Federal Reserve Board. Four points are emphasized: The DSGE model's estimate of the Beveridge-Nelson gap is very similar to gaps from policy institutions, but the DSGE model's estimate of potential growth has a higher variance and substantially different covariance with GDP growth; the natural rate concept depends strongly on model assumptions and is not designed to guide nominal interest rate movements in "Taylor" rules in the same way as the other measures; the natural rate and production function trends converge to the Beveridge-Nelson trend; and the DSGE model's estimate of the Beveridge-Nelson gap is as closely related to unemployment fluctuations as those from policy institutions and has more predictive ability for inflation.
    Date: 2010
  14. By: Ilan Kolet; Ryan Mcdonald
    Abstract: The prices of commodities produced in Canada have important implications for the performance of the Canadian economy and the conduct of monetary policy. The authors explain an important change to the methodology used to construct the Bank of Canada commodity price index (BCPI). Since its inception, the BCPI has been a fixed-weight index of commodity prices, with weights that were updated roughly once a decade. Such indexes are subject to bias, because output shares change over time. In this paper, the authors use the chain Fisher index method to update the production weights on an annual basis, and expand the BCPI to include a broader set of commodities. They find that the new index, called the Fisher BCPI, is more comprehensive, flexible, and accurate than the fixed-weight index.
    Keywords: Inflation and prices; Econometric and statistical methods
    JEL: E3 C1
    Date: 2010
  15. By: Castelnuovo , Efrem (Università di Padova and Bank of Finland Research); Nisticò, Salvatore (Università di Roma ‘Tor Vergata’ and LUISS ‘Guido Carli’)
    Abstract: This paper investigates the relationship between stock market fluctuations and monetary policy in a DSGE model for the US economy. We initially adopt a framework in which fluctuations in households’ financial wealth are allowed – but not required – to influence current consumption. This is due to interaction in the financial markets between long-time traders holding wealth accumulated over time and zero-wealth newcomers. Importantly, we introduce nominal wage stickiness to induce pro-cyclicality in real dividends. Additional nominal and real frictions are modeled to capture the pervasive macroeconomic persistence of the observables used to estimate our model. We fit our model to US post-WWII data and report three main results. First, the data strongly support a significant impact of stock prices on real activity and business cycles. Second, our estimates also identify a significant and counteractive Fed response to stock-price fluctuations. Third, we derive from our model a microfounded measure of financial slack – the stock-price gap – which we then compare with alternative measures, currently used in empirical studies, to assess the properties of the latter for capturing the dynamic and cyclical implications of our DSGE model. The behavior of our stock-price gap is consistent with the episodes of stock-market booms and busts in the post-WWII period, as reported by independent analyses, and closely correlates with the current financial meltdown. Typically, the proxies used for financial slack, such as detrended log-indexes or growth rates, show limited capabilities of capturing the implications of our model-consistent index of financial stress. Cyclical properties of the model as well as counterfactuals regarding shocks to our measure of financial slackness and monetary policy shocks are also proposed.
    Keywords: stock prices; monetary policy; Bayesian estimation; wealth effects
    JEL: E12 E44 E52
    Date: 2010–04–28
  16. By: Maela Giofré (CeRP-Collegio Carlo Alberto, Turin)
    Abstract: This paper demonstrates that, after integration, equity portfolios of countries that joined the European Monetary Union have converged at faster rate than those of NON EMU countries. This outcome can be interpreted as a combination of the convergence of inflation rates and the convergence of investment barriers. On the one hand, the common monetary policy might have driven a stronger comovement in inflation rates, leading to increasingly similar hedging strategies among member countries. On the other hand, exposure to the common currency might have homogenized bilateral investment barriers, thus inducing increasingly similar portfolio allocations among member countries. We find that the comovement of inflation rates has not significantly increased after EMU inception, pointing toward an exclusive role for convergence in investment barriers.
    Keywords: Financial integration; EMU; inflation hedging; investment barrier
    JEL: F21 F30 F36 G11 G15
    Date: 2009–07
  17. By: Jan Willem van den End
    Abstract: This paper presents a framework that quantifies the trade-offs for a central bank that includes financial stability in its strategy and uses macroprudential instruments next to the interest rate. It is an innovative application of the Kaminsky and Reinhart early warning method, by assuming that the central bank takes into account financial variables as signals of inflation risks. The empirical application shows that trading off monetary and macroprudential policy reduces the overall costs related to inflation and financial instability. This can be achieved by changing the preferences of the central bank, lengthening the monetary policy horizon and by a more flexible inflation target. Estimation results of a probit model indicate that the monetary stance in the US and the Euro area has not adequately traded off price stability against financial stability.
    Keywords: financial stability; macroprudential policy; monetary policy; policy co-ordination; inflation
    JEL: E31 E52 E61 G28
    Date: 2010–05
  18. By: Acharya, Sushant
    Abstract: I show that in a setting with costly information processing, strategic complementarity in pricing, by generating planning complementatrities, results in the aggregate price responding slowly to nominal shocks even though individual firm prices change by large amounts in response to idiosyncratic shocks. Klenow and Kryvtsov (2008) conclude that none of the commonly used pricing models is capable of matching all the facts from micro data and at the same time generate a large and persistent response to monetary policy. Unlike the standard state dependent pricing models which rely on physical costs of changing prices to generate unresponsiveness of prices, I instead focus on costs of planning and processing information, a channel which researchers have found empirically more important than physical costs of changing prices in determining pricing decisions of firms. The model is able to match all the features of micro pricing data and at the same time generates a sluggish response of aggregate price to monetary policy, thus predicting a short run Phillips curve. Also, the model generates firms behavior in which they set price plans rather than prices and also shows that firms may choose to index prices to long run inflation optimally as is often assumed in New-Keynesian models. The paper highlights the fact that to explain non-neutrality in the short run, prices need not be sticky, it is just that they do not contain all the information in the short run but become informationally efficient in the long run resulting in a long run neutrality result.
    Keywords: Planning Complementarity; Price Rigidity; Costly Information Acquisition; Real effects of Nominal Shocks; Forecasting; Strategic Complementarity
    JEL: E5 D8 E3
    Date: 2010–04–14
  19. By: Robert E. Krainer (University of Wisconsin Madison)
    Abstract: Fifty years ago Milton Friedman published a book entitled A Program for Monetary Stability. In it he outlined a number of suggestions for the conduct of monetary and fiscal policies that he thought would contribute to monetary stability and pari passu to price stability and a greater degree of output/employment stability. In this paper I review some of his policy prescriptions in light of the financial and economic crisis of 2007-2009.From the perspective of financial development the world today is much different from the world that Friedman knew in the late 1950’s. In what way would his policy recommendations have to be modified to account for these changes in financial development? To stabilize the banking system we argue that his proposal for 100 percent reserves or narrow banking merits serious consideration in current policy discussions. To stabilize asset markets we propose two policies that Friedman would not likely endorse. The first is to reinstate selective credit controls in the areas of the securities markets and the real estate market. The second policy designed to dampen excessive variability in the stock market is for the Central Bank to carry out some open market operations in an index fund of equities.
    Keywords: Financial Stability, Narrow Banking, Open Market Operations in Equities, Selective Credit Controls.
    JEL: E32 E44 E52 G18 G21
    Date: 2010
  20. By: Hafedh Bouakez; Foued Chihi; Michel Normandin
    Abstract: Measuring the effects of discretionary fiscal policy is both difficult and controversial, as some explicit or implicit identifying assumptions need to be made to isolate exogenous and unanticipated changes in taxes and government spending. Studies based on structural vector autoregressions typically achieve identification by restricting the contemporaneous interaction of fiscal and non-fiscal variables in a rather arbitrary way. In this paper, we relax those restrictions and identify fiscal policy shocks by exploiting the conditional heteroscedasticity of the structural disturbances. We use this methodology to evaluate the macroeconomic effects of fiscal policy shocks in the U.S. before and after 1979. Our results show substantive differences in the economy’s response to government spending and tax shocks across the two periods. Importantly, we find that increases in public spending are, in general, more effective than tax cuts in stimulating economic activity. A key contribution of this study is to provide a formal test of the identifying restrictions commonly used in the literature.
    Keywords: Fiscal policy, Government spending, Taxes, Primary deficit, Structural vector auto-regression, Identification
    JEL: C32 E62 H20 H50 H60
    Date: 2010
  21. By: Ricardo M. Sousa (Universidade do Minho - NIPE)
    Abstract: In this work, I analyze the response of consumption and asset returns to unexpected wealth variation. Using data at quarterly frequency for the U.S. and the U.K., I show that: (i) while housing wealth shocks have a very persistent effect on consumption, financial wealth shocks only have transitory effects; and (ii) similarly, unexpected variation in housing wealth delivers a reasonably persistent response of real returns while financial wealth shocks have just a temporary effect.
    Keywords: financial wealth, housing wealth, consumption, asset returns.
    JEL: E21 E44 D12
    Date: 2010
  22. By: Carrillo Julio A. (METEOR)
    Abstract: This paper compares two approaches that aim to explain the lagged and persistent behaviorof inflation and output after a variation in the interest rate. Two variants that produce inertiaare added to a baseline DSGE model of sticky prices: 1) a lagged inflation indexation rulealong with habit formation; and 2) sticky information applied to firms, workers, and households. The rival models are then confronted to a monetary SVAR using U.S. data in order to estimate the rates of inflation indexation, habit formation, price rigidities, information stickiness, and the monetary policy rule parameters. It is shown that the sticky information model has a modest advantage at fitting inflation than the lagged inflation index. model with habits. For output, the opposite is true. These differences are consistent throughout the robustness analysis, but they are not big enough to imply a significant statistical difference in terms of the goodness of fit of each model. In addition, the results suggest that sticky information may replace entirely sticky prices as a explanation of price setting behavior, but the latter might not apply to wages. Finally, the analysis find that information stickiness should be pervasive (i.e., applied to households, firms, and workers) in order to replicate the responses of aggregate variables to a shock in monetary policy.
    Keywords: monetary economics ;
    Date: 2010
  23. By: U. Michael Bergman; Lars Jonung
    Abstract: This paper studies business cycle synchronization in the three Scandinavian countries Denmark, Norway and Sweden prior to, during and after the Scandinavian Currency Union 1873-1913. We find that the degree of synchronization tended to increase during the currency union, thus supporting earlier empirical evidence. Estimates of factor models suggest that common Scandinavian shocks are important for these three countries. At the same time we find evidence suggesting that the importance of these shocks does not depend on the monetary regime.
    Keywords: european union eu denmark sweden norway jonung bergman scandinavian currency union synchronisation of cycles co-movement of cycles monetary unions symnetry symmetry european business cycles
    JEL: E32 F41
    Date: 2010–02
  24. By: Claussen , Carl Andreas (Monetary Policy Department, Central Bank of Sweden); Røisland, Øistein (Monetary Policy Department)
    Abstract: The discursive dilemma implies that the policy decision of a board of policymakers depends on whether the board reaches the decision by voting directly on policy (conclusion-based procedure), or by voting on the premises for the decision (premise-based procedure). We derive results showing when the discursive dilemma may occur, both in a general model and in a standard monetary policy model. When the board aggregates by majority voting, a discursive dilemma can occur if either (i) the relationship between the premise and the decision is non- monotonic, or (ii) if the board members have di¤erent judgments on at least two of the premises. Normatively, a premise-based procedure tends to give better decisions when there is disagreement on parameters of the model.
    Keywords: Discursive dilemma; Monetary policy; MPC; Policy boards
    JEL: D71 E52 E58
    Date: 2010–04–01
  25. By: Carl Andreas Claussen (Sveriges Riksbank); Øistein Røisland (Norges Bank (Central Bank of Norway))
    Abstract: The discursive dilemma implies that the policy decision of a board of policymakers depends on whether the board reaches the decision by voting directly on policy (conclusion-based procedure), or by voting on the premises for the decision (premise-based procedure). We derive results showing when the discursive dilemma may occur, both in a general model and in a standard monetary policy model. When the board aggregates by majority voting, a discursive dilemma can occur if either (i) the relationship between the premise and the decision is non-monotonic, or (ii) if the board members have different judgments on at least two of the premises. Normatively, a premise-based procedure tends to give better decisions when there is disagreement on parameters of the model.
    Date: 2010–04–20
  26. By: Walentin, Karl (Research Department, Central Bank of Sweden); Sellin, Peter (Monetary Policy Department, Central Bank of Sweden)
    Abstract: In this paper our main aim is to quantify the role that housing collateral plays for the monetary transmission mechanism. Furthermore, we want to explore the implications of the increase in household indebtedness, and specifically the loan-to-value ratio, in the last two decades. We set up a two sector DSGE model with production of goods and housing. Households can only borrow by using their houses as collateral. The structure of the model closely follows Iacoviello and Neri (2010). To be able to do quantitatively relevant exercises we estimate the model using Bayesian methods on Swedish data for 1986q1-2008q3. We quantify the reinforcement of the monetary transmission mechanism that housing used as collateral implies in the presence of nominal loan contracts. This mechanism functions through the effects of the interest rate on house prices as well as on inflation and thereby the real value of nominal debt. This component of the monetary transmission mechanism becomes stronger the higher the loan-to-value ratio is. A change in the maximum loan-to-value ratio from 85% to 95%, all else being equal, implies that the effect of a monetary policy shock is increased by 4% for inflation, 8% for GDP and 24% for consumption. We conclude that to properly understand the monetary transmission mechanism and its changing nature over time, we need to take into account the effects of housing related collateral constraints.
    Keywords: House prices; residential investment; monetary policy; monetary transmis- sion mechanism; collateral constraints; Bayesian estimation
    JEL: E21 E32 E44 E52 R21 R31
    Date: 2010–04–01
  27. By: Elmar Mertens
    Abstract: Stylized facts on U.S. output and interest rates have so far proved hard to match with DSGE models. But model predictions hinge on the joint specification of economic structure and a set of driving processes. In a model, different shocks often induce different comovements, such that the overall pattern depends as much on the specified transmission mechanisms from shocks to outcomes, as well as on the composition of these driving processes. I estimate covariances between output, nominal and real interest rate conditional on several shocks, since such evidence has largely been lacking in previous discussions of the output-interest rate puzzle. ; Conditional on shocks to neutral technology and monetary policy, the results square with simple models, like the standard RBC model or a textbook version of the New Keynesian model. In addition, news about future productivity help to explain the overall counter-cyclical behavior of the real rate. ; A sub-sample analysis documents also interesting changes in these pattern. During the Great Inflation (1959-1979), permanent shocks to inflation accounted for the counter-cyclical behavior of the real rate and its inverted leading indicator property. Over the Great Moderation (1982-2006), neutral technology shocks were more dominant in explaining comovements between output and interest rates, and the real rate has been pro-cyclical.
    Date: 2010
  28. By: Guangling 'Dave' Liu
    Abstract: This paper attempts to answer question similar to that asked by Ireland (2003): What explains the correlations between nominal and real variables in postwar US data? More precisely, this paper aims to investigate whether endogenous money, sticky wages, or some combination of the two, are necessary features in a dynamic New Keynesian model in explaining the correlations between nominal and real variables in postwar US data. To do so, we estimate a medium-scale dynamic stochastic general equilibrium model of endogenous money. The model is estimated using Bayesian maximum likelihood and compared with a restricted version of the structural model, in which wages are flexible. We conclude that both endogenous money and sticky wages are necessary features in a dynamic New Keynesian model in explaining the variation in key macroeconomic variables, both nominal and real.
    Keywords: Endogenous money, Sticky wages, New Keynesian model, Bayesian analysis
    JEL: E31 E32 E52
    Date: 2010
  29. By: Jan Annaert (Universiteit Antwerpen); Marc De Ceuster (Universiteit Antwerpen); Patrick Van Roy (National Bank of Belgium, Financial Stability Department; Université Libre de Bruxelles); Cristina Vespro (National Bank of Belgium, Financial Stability Department)
    Abstract: This paper decomposes the explained part of the CDS spread changes of 31 listed euro area banks according to various risk drivers. The choice of the credit risk drivers is inspired by the Merton (1974) model. Individual CDS liquidity and other market and business variables are identified to complement the Merton model and are shown to play an important role in explaining credit spread changes. Our decomposition reveals, however, highly changing dynamics in the credit, liquidity, and business cycle and market wide components. This result is important since supervisors and monetary policy makers extract different signals from liquidity based CDS spread changes than from business cycle or credit risk based changes. For the recent financial crisis, we confirm that the steeply rising CDS spreads are due to increased credit risk. However, individual CDS liquidity and market wide liquidity premia played a dominant role. In the period before the start of the crisis, our model and its decomposition suggest that credit risk was not correctly priced, a finding which was correctly observed by e.g. the International Monetary Fund
    Keywords: credit default spreads, credit risk, financial crisis, financial sector, liquidity premia, structural model
    JEL: G12 G21
    Date: 2010–05
  30. By: Giuliana Passamani; Roberto Tamborini
    Abstract: In this paper we present an empirical analysis of the "credit-cost channel" (CCC) of monetary policy transmission. This model combines bank credit supply, as a means whereby monetary policy affects economic activity ("credit channel"), and interest rates on loans as a cost to firms ("cost channel"). The thrust of the model is that the CCC makes both aggregate demand and aggregate supply dependent on monetary policy. As a consequence a) credit market conditions (e.g. risk spreads) are important sources and indicators of macroeconomic shocks, b) the real effects of monetary policy are larger and persistent. We have applied the Johansen-Juselius CVAR methodology to Italy and Germany in the "hard" EMS period and in the EMU period. The short-run and long-run effects of the CCC are detectable for both countries in both periods. We have also replicated the Johansen-Juselius technique for the simulation of rule-based stabilization policy for both Italy and Germany in the EMU period. As a result, we have found confirmation that inflationtargeting by way of inter-bank rate control, grafted onto the estimated CCC model, would stabilize inflation through structural shifts of the stochastic equilibrium paths of both inflation and output.
    Keywords: Macroeconomics and monetary economics, Monetary transmission mechanisms, Structural cointegration models, Italian economy, German economy
    JEL: E51 C32
    Date: 2010
  31. By: Drozd, Lukasz A.; Nosal, Jaromir B.
    Abstract: This paper evaluates the performance of leading micro-founded pricing-to-market frictions vis-a-vis a set of robust stylized facts about international prices. In order to make that evaluation meaningful, we embed each friction into a unified IRBC framework and parameterize the models in a uniform way. Our goal is to evaluate the broad-based applicability of these frictions for policy-oriented DSGE modeling by documenting their strengths and weaknesses. We make three points: (i) the mechanisms generating pricing to market are not always neutral to business cycle dynamics of quantities, (ii) some mechanisms require producer markups at least 50% to account for the full range of estimates of the empirical exchange rate pass-through to export prices of 35%-50%, (iii) some frictions crucially depend on a particular driver of uncertainty in the underlying model.
    Keywords: pricing to market; law of one price; incomplete pass-through; international correlations; international business cycle; sticky prices; pass-through coefficient
    JEL: E32 F41 F31
    Date: 2010–03–17
  32. By: Carrillo Julio A.; Poilly Céline (METEOR)
    Abstract: This paper introduces a zero lower bound constraint on the nominal interest rate in a financial accelerator model with nominal and real rigidities. We .rst analyze the implicationsfor aggregate dynamics of binding the zero lower bound for shocks that depress the nominalinterest rate. We include a sudden decrease in the value of the business sector net worth and an increase in its returns volatility, as two financial shocks that originate in the endogenous credit market of the model. We then explore the effects of the central bank management of expectations and a fiscal stimulus in a deep recession scenario, where the interest rate initially binds its zero bound. We find that a commitment by the central bank to keep the interest rate low for more time than prescribed by a typical interest rate rule may indeed reduce the volatility of output and inflation. For government purchases, we find a fiscal multiplier greater than one for at least 5 quarters. This is due to the presence of the zero lower bound and the Fisher (1933)’s debt-deflation channel, which implies that government spending may reduce the business sector risk premium and thus the cost of investment.
    Keywords: monetary economics ;
    Date: 2010
  33. By: Virginie Coudert; Cecile Couharde; Valerie Mignon
    Abstract: This paper studies the impact of global financial turmoil on the exchange rate policies in emerging countries. Many emerging countries have loosened the link of their currencies to the US dollar since the bursting of the subprime crisis in July 2007. Spillovers from advanced financial markets to currencies in emerging countries stem from the same causes documented in the literature on contagion, such as the drying–up of investors’ liquidity, the rise in risk aversion, and the updating of their risk assessments. Consequently, interdependencies across currencies are likely to be exacerbated during crisis periods. To test this hypothesis, we assess the exchange rate policies by their degree of flexibility, itself proxied by the exchange rate volatility, and investigate their relationship to a global financial stress indicator, measured by the volatility on global markets. We introduce the possibility of non-linearities by running smooth transition regressions (STR) over a sample of 21 emerging countries from January 1994 to September 2009. The results confirm that exchange rate flexibility does increase more than proportionally with the global financial stress, for most countries in the sample. We also evidence regional contagion effects spreading from one emerging currency to other currencies in the neighboring area.
    Keywords: Financial crises; dollar pegs; contagion effects; nonlinearity
    JEL: F31 G15 C22
    Date: 2010–04
  34. By: Gogas, Periklis (Democritus University of Thrace, Department of International Economic Relations and Development); Pragidis, Ioannis (Democritus University of Thrace, Department of International Economic Relations and Development)
    Abstract: Several studies have established the predictive power of the yield curve in terms of real economic activity. In this paper we use data for a variety of E.U. countries: both EMU (Germany, France, Italy) and non-EMU members (Sweden and the U.K.). The data used range from 1991:Q1 to 2009:Q1. For each country, we extract the long run trend and the cyclical component of real economic activity, while the corresponding interbank interest rates of long and short term maturities are used for the calculation of the country specific yield spreads. We also augment the models tested with non monetary policy variables: the countries’ unemployment rates and stock indices. The methodology employed in the effort to forecast real output, is a probit model of the inverse cumulative distribution function of the standard distribution, using several formal forecasting and goodness of fit evaluation tests. The results show that the yield curve augmented with the non-monetary variables has significant forecasting power in terms of real economic activity but the results differ qualitatively between the individual economies examined raising non-trivial policy implications.
    Keywords: GDP; Probit; Forecasting; Yield Curve
    JEL: C53 E43 E44 E52
    Date: 2010–05–08
  35. By: Luca Benati (European Central Bank, Monetary Policy Strategy Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Based on standard New Keynesian models I show that policy counterfactuals based on the theoretical structural VAR representations of the models fail to reliably capture the impact of changes in the parameters of the Taylor rule on the (reduced-form) properties of the economy. Based on estimated models for the Great Inflation and the most recent period, I show that, as a practical matter, the problem appears to be non-negligible. These results imply that the outcomes of SVAR-based policy counterfactuals should be regarded with caution, as their informativeness for the specific issue at hand–e.g., understanding the role played by monetary policy in exacerbating the Great Depression, causing the Great Inflation, or fostering the Great Moderation–is, in principle, open to question. Finally, I argue that SVAR-based policy counterfactuals suffer from a cruciallogical shortcoming: given that their reliability crucially depends on unknown structural characteristics of the underlying data generation process, such reliability cannot simply be assumed, and can instead only be ascertained with a reasonable degree of confidence by estimating structural (DSGE) models. JEL Classification: E30, E32.
    Keywords: Lucas critique, structural VARs, policy counterfactuals, DSGE models, Taylor rules, monetary policy, Great Depression, Great Inflation, Great Moderation.
    Date: 2010–05
  36. By: Michał Brzoza-Brzezina (National Bank of Poland, ul. Świętokrzyska 11/21, 00-919 Warszawa, Poland.); Tomasz Chmielewski (Warsaw School of Economics, al. Niepodległości 162, 02-554 Warszawa, Poland.); Joanna Niedźwiedzińska (National Bank of Poland, ul. Świętokrzyska 11/21, 00-919 Warszawa, Poland.)
    Abstract: In this paper we analyse the impact of monetary policy on total bank lending in the presence of a developed market for foreign currency denominated loans and potential substitutability between domestic and foreign currency loans. Our results, based on a panel of four biggest Central European countries (the Czech Republic, Hungary, Poland and Slovakia) confirm significant and probably strong substitution between these loans. Restrictive monetary policy leads to a decrease in domestic currency lending but simultaneously accelerates foreign currency denominated loans. This makes the central bank’s job harder. JEL Classification: E44, E52, E58.
    Keywords: Domestic and foreign currency loans, substitution, monetary policy, Central Europe.
    Date: 2010–05
  37. By: Yu-Fu Chen; Michael Funke; Nicole Glanemann
    Abstract: This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmet- ric one-sided regimes. Market participants' beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong's one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities nally revamped the regime as a symmetric two-sided system with a narrow exchange rate band.
    Keywords: Currency Board Arrangement, Target Zone Model, Hong Kong
    JEL: C61 E42 F31 F32
    Date: 2010–05
  38. By: Chen, Yu-Fu (BOFIT); Funke, Michael (BOFIT); Glanemann, Nicole (BOFIT)
    Abstract: This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmetric one-sided regimes. Market participants' beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong's one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities finally revamped the regime as a symmetric two-sided system with a narrow exchange rate band.
    Keywords: Currency Board Arrangement; Target Zone Model; Hong Kong
    JEL: C61 E42 F31 F32
    Date: 2010–04–26
  39. By: Dong He (Research Department, Hong Kong Monetary Authority); Robert N. McCauley (Bank for International Settlements)
    Abstract: We show in this paper that offshore markets intermediate a large chunk of financial transactions in major reserve currencies such as the US dollar. We argue that, for emerging market economies that are interested to see some international use of their currencies, offshore markets can help to increase the recognition and acceptance of the currency, while still allowing the authorities to retain a measure of control on the pace of capital account liberalisation. The development of offshore markets could pose risks to monetary and financial stability in the home economy, which need to be prudently managed. Experience in dealing with the Euromarkets by the Federal Reserve and other authorities of the major reserve currency economies show that policy options are available for managing such risks.
    Keywords: offshore markets; currency internationalisation; monetary stability; financial stability
    JEL: E51 E58 F33
    Date: 2010–03
  40. By: Jannie Rossouw; Vishnu Padayachee; Adél Bosch
    Abstract: This paper reports a comparison of South African household inflation expectations and inflation credibility surveys undertaken in 2006 and 2008. The objective is to test for possible feed-through between inflating credibility and inflation expectations. It supplements similar earlier research that focused only on the 2006 survey results. The single most important difference between the survey results of 2006 and 2008 is that female and male respondents reported inflation expectations at the same level in 2006, while female respondents expected higher inflation than male respondents in the 2008 inflation expectations survey. More periodic survey data will be required for developing final conclusions on the possibility of feed-through effects. A very large percentage of respondents in the inflation credibility surveys indicate that they 'don't know' whether the historic rate of inflation is an accurate indication of price increases. It will be necessary to reconsider the structure of credibility surveys to increase the number of respondents providing views on the accuracy of historic inflation data.
    Keywords: Inflation; inflation credibility; inflation expecttaions; inflation surveys; multinomial analysis
    JEL: E31 E52 E58
    Date: 2010
  41. By: Sami Alpanda; Kevin Kotze; Geoffrey Woglom
    Abstract: We estimate a New Keynesian small open economy DSGE model for South Africa, using Bayesian techniques. The model features imperfect competition, incomplete asset markets, partial exchange rate pass-through, and other commonly used nominal and real rigidities, such as sticky prices, price indexation and habit formation. We study the effects of various shocks on macroeconomic variables, and calculate the optimal Taylor rule coefficients using a loss function for the central bank. We find that the optimal Taylor rule places a heavier weight on inflation and output than the estimated Taylor rule, but almost no weight on the depreciation of currency.
    Keywords: optimal monetary policy, small open economy, Bayesian estimation
    JEL: F41 E52
    Date: 2010
  42. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper attempts to characterise an anti-inflationary monetary targeting (MT) regime. In order to derive a formal representation of this regime, we formulate the central bank’s optimisation problem under the assumption that it is possible for the monetary targeted variable to have an impact on inflation. We apply a rather general framework to the Romanian experience with MT in the period 1999-2005. We find that during this period Romania's MT regime can be characterised by a concern for price stability and an additional role for smoothing of the central bank's instrument (base money growth). Our results suggest that exchange rate variability and output gap stability appear not to have entered the objective function significantly. JEL Classification: E52, E58, C32, C61.
    Keywords: monetary targeting, optimal monetary policy, Romania.
    Date: 2010–05

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