nep-cba New Economics Papers
on Central Banking
Issue of 2010‒05‒22
forty papers chosen by
Alexander Mihailov
University of Reading

  1. The Central Bank Balance Sheet as an Instrument of Monetary Policy By Vasco Curdia; Michael Woodford
  2. Conventional and Unconventional Monetary Policy By Vasco Curdia; Michael Woodford
  3. Optimal Monetary Stabilization Policy By Michael Woodford
  4. Quantitative Easing: Entrance and Exit Strategies By Alan S. Blinder
  5. Teaching Macro Principles after the Financial Crisis By Alan S. Blinder
  6. Monetary Policy and Heterogeneous Expectations By William A. Branch; George W. Evans
  7. Illiquidity and All Its Friends By Tirole, Jean
  8. Lessons of the Crisis for Emerging Markets By Eichengreen, Barry
  9. Inflation Target Shocks and Monetary Policy Inertia in the Euro Area By Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
  10. Hours Worked and Permanent Technology Shocks in Open Economies By Dupaigne, Martial; Fève, Patrick
  11. Minimum Distance Estimation and Testing of DSGE Models from Structural VARs By Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
  12. Euro area fiscal policies and the crisis By Ad van Riet
  13. Spain, Japan, and the Dangers of Early Fiscal Tightening By Javier Díaz Giménez; R. AntonBraun
  14. America's Financial Crisis: The End of an Era By Bosworth, Barry; Flaaen, Aaron
  15. The Great Recession of 2008-2009: Causes, Consequences and Policy Responses By Verick, Sher; Islam, Iyanatul
  16. The Role and Effectiveness of Unconventional Monetary Policy By Morgan, Peter
  17. Disinflation Shocks in the Eurozone: a DSGE Perspective By Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
  18. Trend inflation, endogenous mark-ups and the non-vertical Phillips curve By Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola
  19. Main drivers of the ECB financial accounts and ECB financial strength over the first 11 years By Olivier Vergote; Werner Studener; Ioannis Efthymiadis; Niall Merriman
  20. Will China Have Serious Inflation? By Gregory C. Chow
  21. A "quantum" approach to rational inattention By Saint-Paul, Gilles
  22. Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts By Farhi, Emmanuel; Tirole, Jean
  23. A framework for assessing systemic risk By Dijkman, Miquel
  24. Inflation, Oil Price Volatility and Monetary Policy By Castillo, Paul; Montoro, Carlos; Tuesta, Vicente.
  25. Modeling News-Driven International Business Cycles By Beaudry, Paul; Dupaigne, Martial; Portier, Franck
  26. Continuous-Time Overlapping Generations Models By d'Albis, Hippolyte; Augeraud-Véron, Emmanuelle
  27. How Should the Distant Future be Discounted When Discount Rates are Uncertain? By Gollier, Christian; Weitzman, Martin
  28. The Euro-dividend: public debt and interest rates in the Monetary Union By Simone Salotti; Luigi Marattin
  29. Fluctuation Dynamics in US Interest Rates and the Role of Monetary Policy By Daniel Oliveira Cajueiro; Benjamin M. Tabak
  30. International Monetary Transmission and Exchange Rate Regimes: Floaters vs. Non-Floaters By Kim, Soyoung; Yang, Doo Yong
  31. Empirical simultaneous confidence regions for path-forecasts By Jordà, Òscar; Knüppel, Malte; Marcellino, Massimiliano
  32. Forecast Combination Based on Multiple Encompassing Tests in a Macroeconomic DSGE System By Costantini, Mauro; Gunter, Ulrich; Kunst, Robert M.
  33. Forecast Combinations By Marco Aiolfi; Carlos Capistrán; Allan Timmermann
  34. GDP Trend Deviations and the Yield Spread: the Case of Five E.U. Countries By Periklis Gogas; Ioannis Pragidis
  35. Heterogeneity in money holdings across euro area countries: The role of housing By Setzer, Ralph; Noord, Paul van den; Wolff, Guntram
  36. Loan supply in Germany during the financial crisis By Busch, Ulrike; Scharnagl, Michael; Scheithauer, Jan
  37. Remittances, Inflation and Exchange Rate Regimes in Small Open Economies By Ball, Christopher; Lopez, Claude; Reyes, Javier; Cruz-Zuniga, Martha
  38. Trade consistency in the context of the Eurosystem projection exercises an overview By Kirstin Hubrich; Tohmas Karlsson
  39. Origins of persistent macroeconomic imbalances in the Euro area By Nils Holinski; Clemens Kool; Joan Muysken
  40. Brazilian Strategy for Managing the Risk of Foreign Exchange Rate Exposure During a Crisis By Antonio Francisco A. Silva Jr.

  1. By: Vasco Curdia (Federal Reserve Bank of New York); Michael Woodford (Columbia University - Department of Economics)
    Abstract: While many analyses of monetary policy consider only the adjustment of a central bank's target for a short-term nominal interest rate, other dimensions of policy have recently been of greater importance: changes in the supply of bank reserves beyond those required to achieve an interest-rate target, changes in the assets acquired by central banks, and changes in the interest rate paid on reserves. We extend a standard New Keynesian model to allow a role for the central bank's balance sheet in equilibrium determination, and consider the connections between these alternative dimensions of policy and traditional interest-rate policy. We distinguish between "quantitative easing" in the strict sense and targeted asset purchases by a central bank, and argue that while the former is likely be ineffective at all times, the latter dimension of policy can be effective when financial markets are sufficiently disrupted. Neither is a perfect substitute for conventional interest-rate policy, but purchases of illiquid assets are particularly likely to improve welfare when the zero lower bound on the policy rate is reached. We also consider optimal policy with regard to the payment of interest on reserves, and argue that the interest rate on reserves should be kept near the central bank's target for the policy rate at all times.
    Date: 2010
  2. By: Vasco Curdia (Federal Reserve Bank of New York); Michael Woodford (Columbia University - Department of Economics)
    Abstract: We extend a standard New Keynesian model to incorporate heterogeneity in spending opportunities and two sources of (potentially time-varying) credit spreads, and to allow a role for the central bank's balance sheet in equilibrium determination. We use the model to investigate the implications of imperfect financial intermediation for familiar monetary policy prescriptions, and to consider additional dimensions of central-bank policy | variations in the size and composition of the central bank's balance sheet, and payment of interest on reserves, alongside the traditional question of the proper choice of an operating target for an overnight policy rate. We also give particular attention to the special problems that arise when the zero lower bound for the policy rate is reached. We show that it is possible to provide criteria for the choice of policy along each of these possible dimensions, within a single unified framework, and to provide policy prescriptions that apply equally when financial markets work efficiently and when they are subject to substantial disruptions, and equally when the zero bound is reached and when it is not a concern.
    Date: 2010
  3. By: Michael Woodford (Columbia University - Department of Economics)
    Abstract: This chapter reviews the theory of optimal monetary stabilization policy in New Keynesian models, with particular emphasis on developments since the treatment of this topic in Woodford (2003). The primary emphasis of the chapter is on methods of analysis that are useful in this area, rather than on final conclusions about the ideal conduct of policy (that are obviously model-dependent, and hence dependent on the stand that one might take on many issues that remain controversial), and on general themes that have been found to be important under a range of possible model specifications. With regard to methodology, some of the central themes of this review will be the application of the method of Ramsey policy analysis to the problem of the optimal conduct of monetary policy, and the connection that can be established between utility maximization and linear-quadratic policy problems of the sort often considered in the central banking literature. With regard to the structure of a desirable decision framework for monetary policy deliberations, some of the central themes will be the importance of commitment for a superior stabilization outcome, and more generally, the importance of advance signals about the future conduct of policy; the advantages of history-dependent policies over purely forward-looking approaches; and the usefulness of a target criterion as a way of characterizing a central bank's policy commitment.
    Date: 2010
  4. By: Alan S. Blinder (Princeton University)
    Abstract: Apparently, it can happen here. On December 16, 2008, the Federal Open Market Committee (FOMC), in an effort to fight what was shaping up to be the worst recession since 1937, reduced the federal funds rate to nearly zero.1 From then on, with all of its conventional ammunition spent, the Federal Reserve was squarely in the brave new world of quantitative easing. Chairman Ben Bernanke tried to call the Fed’s new policies credit easing, probably to differentiate them from what the Bank of Japan had done earlier in the decade, but the label did not stick.
    Keywords: Recession, Federal Reserve, open market committee, banking policy, deflation, monetary policy
    JEL: E31 E58 G21
    Date: 2010–03
  5. By: Alan S. Blinder (Princeton University)
    Abstract: The stunning events of 2007-2009 both shook the world and piqued interest in economics. In the 30-plus years that I have been teaching macro principles, I have never seen the level of interest in students as high as what I observed last year rapt attention and no sleepers! Interest in economics has grown, and our students will want, expect, and deserve explanations of these events for years to come. This is truly a teaching moment, and that moment is going to be a long one. That’s the good news. The bad news is that the current curriculum fails to give students even imperfect answers. This means that the macro principles course will have to be changed. Although we can’t provide beginning students with complete answers, we can do a lot better than we have been doing.
    Keywords: macroeconomics, financial crisis, economic curriculums in schools
    JEL: A22 A23 E20 D40
    Date: 2010–04
  6. By: William A. Branch; George W. Evans
    Abstract: This paper studies the implications for monetary policy of heterogeneous expectations in a New Keynesian model. The assumption of rational expec?tations is replaced with parsimonious forecasting models where agents select between predictors that are underparameterized. In a Misspecification Equilib?rium agents only select the best-performing statistical models. We demonstrate that, even when monetary policy rules satisfy the Taylor principle by adjusting nominal interest rates more than one for one with inflation, there may exist equilibria with Intrinsic Heterogeneity. Under certain conditions, there may exist multiple misspecification equilibria. We show that these findings have im?portant implications for business cycle dynamics and for the design of monetary policy.
    Keywords: Heterogeneous expectations, monetary policy, multiple equilib?ria, adaptive learning.
    JEL: G12 G14 D82 D83
    Date: 2010–04
  7. By: Tirole, Jean (University of Toulouse Capitole)
    Abstract: The recent crisis was characterized by massive illiquidity. This paper reviews what we know and don't know about illiquidity and all its friends: market freezes, fire sales, contagion, and ultimately insolvencies and bailouts. It first explains why liquidity cannot easily be apprehended through a single statistics, and asks whether liquidity should be regulated given that a capital adequacy requirement is already in place. The paper then analyzes market breakdowns due to either adverse selection or shortages of financial muscle, and explains why such breakdowns are endogenous to balance sheet choices and to information acquisition. It then looks at what economics can contribute to the debate on systemic risk and its containment. Finally, the paper takes a macroeconomic perspective, discusses shortages of aggregate liquidity and analyses how market value accounting and capital adequacy should react to asset prices. It concludes with a topical form of liquidity provision, monetary bailouts and recapitalizations, and analyses optimal combinations thereof; it stresses the need for macroprudential policies.
    JEL: E44 E52 G28
    Date: 2009–09–12
  8. By: Eichengreen, Barry (Asian Development Bank Institute)
    Abstract: This paper attempts to draw out the implication of the financial crisis for emerging markets. The most important implications will center on financial markets, where there will be less reliance on portfolio capital flows to finance investment and some deglobalization of banking so that the domain of bank operations more closely coincides with the domain of regulation. By contrast, the implications for other dimensions of globalization and for the structure of the international monetary system will be more limited.
    Keywords: global financial crisis; lessons; exchange rate policy; financial architecture
    JEL: F00 F30
    Date: 2009–12–15
  9. By: Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
    Date: 2009–07
  10. By: Dupaigne, Martial; Fève, Patrick
    Abstract: We use Structural Vector Autoregressions to study the impact of technology improvements on hours worked in the major seven countries. While previous studies estimate the response of labor input to permanent shocks to country -level labor productivity, we consider the response of labor input to aggregate -level labor productivity. Since labor productivities do cointegrate in the G7, the estimated responses should look very similar. They do not: for each country but Germany, the responses estimated using G7 labor productivity sizeably exceed those estimated using country -level labor productivity. These results also hold in larger SVAR models.
    JEL: C32 E32 F41
    Date: 2009–11
  11. By: Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
    Date: 2009–12
  12. By: Ad van Riet (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: In mid-September 2008, a global financial crisis erupted which was followed by the most serious worldwide economic recession for decades. As in many other regions of the world, governments in the euro area stepped in with a wide range of emergency measures to stabilise the financial sector and to cushion the negative consequences for their economies. This paper examines how and to what extent these crisis-related interventions, as well as the fall-out from the recession, have had an impact on fiscal positions and endangered the longer-term sustainability of public finances in the euro area and its member countries. The paper also discusses the appropriate design of fiscal exit and consolidation strategies in the context of the Stability and Growth Pact to ensure a rapid return to sound and sustainable budget positions. Finally, it reviews some early lessons from the crisis for the future conduct of fiscal policies in the euro area. JEL Classification: E10, E62, G15, H30, H62
    Keywords: fiscal policies, financial crisis, fiscal stimulus, financial markets, sustainability, Stability and Growth Pact
    Date: 2010–04
  13. By: Javier Díaz Giménez; R. AntonBraun
    Abstract: Spain's current recession was preceded by an extended period of rapid growth in real estate and equity prices. The recent sudden and sharp decline in these asset prices has been followed by a deep economic contraction. Is this recession a large but transient phenomenon? Or is it perhaps instead the harbinger of a protracted period of depressed asset prices and economic stagnation? Japan experienced a similar pattern of growth in land and equity prices in the late 1980s. The collapse of the Japanese bubble economy was followed by a protracted period of declines in asset prices and depressed economic activity. We compare Japan's experience in the 1980s and 1990s with current developments in Spain. One message that emerges from this narrative is that a fiscal tightening in Japan in 1997 may have been premature. We develop a prototypical New Keynesian model, calibrate it to replicate the Japan's experience in the 1980s and 1990s, and use it to evaluate the risks of tightening fiscal policy too early when the nominal interest rate is low. We find that a premature fiscal tightening can have large and negative effects on the real economy.
    Date: 2010–03
  14. By: Bosworth, Barry (Asian Development Bank Institute); Flaaen, Aaron (Asian Development Bank Institute)
    Abstract: This paper reviews research on the origins of the financial crisis of 2008–2009, highlights the key events that triggered a financial panic in September 2008, and summarizes the extraordinary policy actions the United States (US) has taken to ameliorate the crisis. We discuss the proximate causes of the crisis, including the characteristics and growth of the subprime mortgage market, and the distorted incentives and flawed regulatory structure surrounding the secondary market for mortgage-backed securities. We also assess the role of more fundamental macroeconomic determinants of the bubble in US asset prices, most notably low global interest rates attributed to either loose monetary policy or excess global saving. We find that while low global interest rates may have contributed to the boom in housing markets and speculative excesses, the poorly understood innovations and microeconomic distortions of the financial system played a more fundamental role. Finally, the otherwise extraordinary policy response of the US government has been limited by the lack of an effective restructuring of the financial system, and a recovery marked by higher private saving, weak domestic investment, and a large public deficit appears to be unsustainable. Ultimately, the US economy will need to shift about 3% of GDP from domestic consumption to the export sector. This will pose some serious challenges to countries that have come to rely on exports to the US market.
    Keywords: global financial crisis; financial panic; american policy actions
    JEL: E65 E66 E69 F40
    Date: 2009–07–21
  15. By: Verick, Sher (ILO International Labour Organization); Islam, Iyanatul (Griffith University)
    Abstract: Starting in mid-2007, the global financial crisis quickly metamorphosed from the bursting of the housing bubble in the US to the worst recession the world has witnessed for over six decades. Through an in-depth review of the crisis in terms of the causes, consequences and policy responses, this paper identifies four key messages. Firstly, contrary to widely-held perceptions during the boom years before the crisis, the paper underscores that the global economy was by no means as stable as suggested, while at the same time the majority of the world’s poor had benefited insufficiently from stronger economic growth. Secondly, there were complex and interlinked factors behind the emergence of the crisis in 2007, namely loose monetary policy, global imbalances, misperception of risk and lax financial regulation. Thirdly, beyond the aggregate picture of economic collapse and rising unemployment, this paper stresses that the impact of the crisis is rather diverse, reflecting differences in initial conditions, transmission channels and vulnerabilities of economies, along with the role of government policy in mitigating the downturn. Fourthly, while the recovery phase has commenced, a number of risks remain that could derail improvements in economies and hinder efforts to ensure that the recovery is accompanied by job creation. These risks pertain in particular to the challenges of dealing with public debt and continuing global imbalances.
    Keywords: global financial crisis, unemployment, macroeconomic policy, labour market policy
    JEL: E24 E60 J08 J60
    Date: 2010–05
  16. By: Morgan, Peter (Asian Development Bank Institute)
    Abstract: This paper reviews the effectiveness of unconventional monetary policies and their relevance for emerging markets. Such policies may be useful either when interbank rates fall to zero, or when a credit crunch or rise in risk premium impairs the normal transmission mechanism of monetary policy. Unconventional monetary policy measures encompass three broad categories: (i) commitment effect, i.e., verbal commitments to maintain very low interest rates for a certain period, either conditionally or unconditionally; (ii) quantitative easing, i.e., targeting the level of current account balances of the central bank; and (iii) qualitative or credit easing, which involves purchases of targeted assets to lower rates and/or increase liquidity in the target market. It also examines issues related to the exit strategy from unconventional policy, and assesses the applicability of unconventional policies for Asian economies other than Japan. <p>Most studies of the commitment effect (or duration effect) suggest that statements by a central bank regarding the duration of a policy of very low or zero interest rates also affect market expectations of interest rates, but the impact is mainly limited to shorter-term rates. The literature on the effects of quantitative easing monetary policy is less conclusive, especially when one accounts for other announcements by the central bank. Regarding qualitative easing (credit easing) policy, the effect of expanding outright purchases of government bonds on bond yields looks limited. However, other kinds of asset purchase interventions do seem to have been more successful in relieving market stresses. <p>For Asian countries aside from Japan, unconventional policies look most attractive as a way to relieve funding blockages in specific markets rather than to stimulate overall growth. Only India; Republic of Korea; Singapore; and Taipei,China adopted unconventional measures, and those of the middle two were chiefly related to their use of the Fed's swap line for United States dollars to ease dollar shortages in the region. However, if growth of United States consumption slows structurally, this may force Asian economies to rely more on unconventional monetary policy measures during future downturns.
    Keywords: unconventional monetary policy; monetary policy emerging markets
    JEL: E50 E52 E58 F41 F42
    Date: 2009–11–11
  17. By: Fève, Patrick; Matheron, Julien; Sahuc, Jean-Guillaume
    Date: 2009–09
  18. By: Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola
    Abstract: Recent developments in macroeconomics resurrect the view that welfare costs of inflation arise because the latter acts as a tax on money balances. Empirical contributions show that wage re-negotiations take place while expiring contracts are still in place. Bringing these seemingly unrelated aspects together in a stylized general equilibrium model, we find a disciplining effect of a positive inflation target on the wage markup and identify a long-term trade-off between inflation and output.
    Keywords: trend inflation, long-run Phillips curve, inflation targeting, real money balances
    JEL: E52 E58 E24
    Date: 2010–04
  19. By: Olivier Vergote (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Werner Studener (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Ioannis Efthymiadis (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Niall Merriman (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: This paper analyses the main drivers of the ECB’s balance sheet and profit and loss account over the first 11 years of the ECB’s existence. Furthermore, the paper assesses the financial strength of the ECB. As monetary policy operations are normally conducted by national central banks under the impulse and instructions from the ECB, the Eurosystem balance sheet is the primary reference for the analysis of Eurosystem monetary policy operations. Three main drivers of the balance sheet and profit and loss account are identified. Firstly, financial market developments and portfolio management decisions imply changes in the value of the foreign reserve and own funds portfolios, which represent a substantial part of the balance sheet (with the share of own funds becoming increasingly larger over the period under review). At the same time, the profit and loss account depends to an important degree on interest income and expenses, realised gains and losses, and write-downs on these portfolios. Secondly, strong banknote demand has gradually increased the size of the balance sheet since the euro changeover in 2002. Banknotes in circulation also provide a strong base for seigniorage income, which is an important item of the profit and loss account. Thirdly, the liquidity-providing operations in foreign currency, which the Eurosystem has undertaken since 2007 in response to the financial crisis, increased significantly the size of the ECB’s (and the Eurosystem’s) balance sheet. In terms of income and expenses, these operations were rather immaterial at the level of the ECB, although the income generated was substantial at the Eurosystem level. The ECB has remained financially strong over the 11-year period. Factors that support the financial position are strong legislative provisions on e.g. independence and income, the use of financial buffers, seigniorage as a reliable income source and an effective loss-coverage mechanism. The main risk stems from adverse financial market developments, in particular low interest rates and depreciating foreign reserve currencies, implying security price and currency write-downs. JEL Classification: E58, E42, M41
    Keywords: central banking, central bank balance sheet, financial accounts, financial strength
    Date: 2010–05
  20. By: Gregory C. Chow
    Abstract: There has been much concern about inflation in China recently. The People’s Bank in the last few months has raised the reserve requirement several times to control the money supply to slow down inflation. In 1985 when I was organizing a summer workshop on macroeconomics in cooperation with the Ministry of Education, Premier Zhao Ziyang asked me to forecast inflation in 1985-1986 because in 1984 the supply of money in the form of currency in circulation increased by 50 percent. I estimated an equation using data from 1952 to 1984 to explain inflation and used the equation to project forward to forecast an inflation rate for 1985 of no more than 9 percent which turned out to be correct. This equation was published in Chow (1987, equation 18) and updated using data up to 2004 in Chow (2007, pp. 34-5).
    Keywords: inflation, china, Peoples Bank, money supply
    JEL: E30 E31 E42 E58 N15
    Date: 2010–04
  21. By: Saint-Paul, Gilles
    Abstract: In this paper, I propose a model of rational inattention where the choice variable is a deterministic function of the exogenous variables, and still only a finite amount of information is being used. This holds provided the choice variable is discrete rather than continuous; that is, the mapping from the realization of the exogenous variables to the endogenous ones is piece-wise constant. Thus, limited information is now a source of lumpiness in behavior, rather than a source of noise. A central result is that the mutual information between the exogenous variable and the endogenous one is simply equal to the entropy, in the usual discrete sense, of the endogenous variable. The approach is illustrated with two applications: a general linear-quadratic problem with a uniform distribution, and a simple static model of price-setting where individual price setters face aggregate monetary shocks and idiosyncratic productivity shocks.
    JEL: D8 E3
    Date: 2010–03–02
  22. By: Farhi, Emmanuel; Tirole, Jean
    Abstract: The paper elicits a mechanism by which private leverage choices exhibit strategic complementarities through the reaction of monetary policy. When everyone engages in maturity transformation, authorities haver little choice but facilitating refinancing. In turn, refusing to adopt a risky balance sheet lowers the return on equity. The key ingredient is that monetary policy is non-targeted. The ex post benefits from a monetary bailout accrue in proportion to the number amount of leverage, while the distortion costs are to a large extent fixed. This insight has important consequences. First, banks choose to correlate their risk exposures. Second, private borrowers may deliberately choose to increase their interest-rate sensitivity following bad news about future needs for liquidity. Third, optimal monetary policy is time inconsistent. Fourth, macro-prudential supervision is called for. We characterize the optimal regulation, which takes the form of a minimum liquidity requirement coupled with monitoring of the quality of liquid assets. We establish the robustness of our insights when the set of bailout instruments is endogenous and characterize the structure of optimal bailouts.
    JEL: E44 E52 G28
    Date: 2009–06
  23. By: Dijkman, Miquel
    Abstract: When faced with financial crises, authorities worldwide tend to respond aggressively with public support measures. Given the adverse impact on moral hazard and market discipline, support measures involving public money are ideally limited to crisis situations involving systemic risk: a disturbance in the financial system that is serious enough to affect the real economy. This note sets out the main characteristics of a systemic risk assessment framework: a simple analytical framework that can be used by authorities with financial crisis management responsibilities in times of financial crisis to assess the extent to which that particular crisis situation poses systemic risk.
    Keywords: Debt Markets,Banks&Banking Reform,Emerging Markets,Financial Intermediation,Bankruptcy and Resolution of Financial Distress
    Date: 2010–04–01
  24. By: Castillo, Paul (Banco Central de Reserva del Perú); Montoro, Carlos (Banco Central de Reserva del Perú; CENTRUM-Catolica); Tuesta, Vicente. (CENTRUM-Catolica)
    Abstract: In a fully micro-founded New Keynesian framework, we characterize analytically the relation between average inflation and oil price volatility by solving the rational expectations equilibrium of the model up to second order of accuracy. Higher oil price volatility induces higher levels of average inflation. We also show that when oil has low substitutability and the central bank responds to output fluctuations, oil price volatility matters for the level of average inflation. The model shows that when oil price volatility increases, average inflation increases whereas average output falls: this implies a trade-off also between average inflation and that of output. The analytical solution further indicates that for a given level of oil price volatility, average inflation is higher when marginal costs are convex in oil prices, the Phillips Curve is convex, and the degree of relative price dispersion is also higher. We perform a numerical exercise showing that the model with a empirically plausible Taylor rule can replicate the level of average inflation observed in the U.S. in 2000s.
    Keywords: Oil price volatility, monetary policy, perturbation method, second order solution.
    JEL: E52 E42 E12 C63
    Date: 2010–01
  25. By: Beaudry, Paul; Dupaigne, Martial; Portier, Franck
    Abstract: This paper reexamines the question of how to explain business cycle co-movements within and between countries. First, we present two simple theoretically flexible price models to illustrate how and why news shocks can generate robust positive co-movements in economic activity across countries. We also discuss under what conditions the multi-sector version of the model generates appropriate business cycle patterns within countries. Second, we develop a quantitative two-country multi-sector model that is capable of replicating many international business cycle facts. The model is a two-country extension of the closed economy model of Beaudry and Portier [2004], in which there are limited possibilities to reallocate factors between investment and consumption good sectors.
    Keywords: business cycles, expectations, international fluctuations
    JEL: E32 F41
    Date: 2009–11
  26. By: d'Albis, Hippolyte; Augeraud-Véron, Emmanuelle
    Abstract: Age structured populations are studied in economics through overlapping generations models. These models allow for a realistic characterization of life-cycle behaviors and display intertemporal equilibrium that are not necessarily efficient. This article uses the latest developments in continuous time overlapping generations models to show the influence of the vintage structure of the population on the volatility of intertemporal prices. Permanent cycles can be found on the neighborhood of steady-states while the transitional dynamics are generically governed by short run fluctuations.
    Keywords: overlapping generations, continuous time, life-cycle
    Date: 2009–06–03
  27. By: Gollier, Christian; Weitzman, Martin
    Abstract: It is not immediately clear how to discount distant-future events, like climate change, when the distant-future discount rate itself is uncertain. The so-called “Weitzman-Gollier puzzle” is the fact that two seemingly symmetric and equally plausible ways of dealing with uncertain future discount rates appear to give diametrically opposed results with the opposite policy implications. We explain how the “Weitzman-Gollier puzzle” is resolved. When agents optimize their consumption plans and probabilities are adjusted for risk, the two approaches are identical. What we would wish a reader to take away from this paper is the bottom-line message that the appropriate long run discount rate declines over time toward its lowest possible value.
    Date: 2009–11
  28. By: Simone Salotti (Dipartimento di Matematica per le Decisioni, Universita' degli Studi di Firenze); Luigi Marattin (Dipartimento di Scienze Economiche, Universita` degli Studi di Bologna)
    Abstract: The ongoing massive fiscal policy stimulus triggered increasing concerns on the potential impact on interest rate levels, as economic theory predicts. Particularly, the deterioration of some EMU countries’ fiscal positions has been putting at risk Eurozone’ financial stability. In this paper, we estimate a Panel VAR (PVAR) model on the EMU area employing annual data from 1970 to 2008 in order to assess the qualitative and quantitative impact of public debt on interest rates. Our results show that prior to the introduction of the Euro an increase in public debt led to positive and significant effect on long-term nominal interest rates, with a stronger effect for high-debt countries. After the introduction of the single currency, the effect vanishes (in line with Bernoth 2004). We interpret this result as a confirmation of the crucial role of the monetary union in weakening the automatic risk-premium-based channel between debt shocks and returns on government bond.
    Keywords: Panel VAR, Fiscal policy, government bond’s yields
    JEL: E62 G12
    Date: 2010–02
  29. By: Daniel Oliveira Cajueiro; Benjamin M. Tabak
    Abstract: This paper presents empirical evidence suggesting that the degree of long-range dependence in interest rates depends on the conduct of monetary policy. We study the term structure of interest rates for the US and find evidence that global Hurst exponents change dramatically according to Chairman Tenure in the Federal Reserve Board and also with changes in the conduct of monetary policy. In the period from 1960's until the monetarist experiment in the beginning of the 1980's interest rates had a significant long-range dependence behavior. However, in the recent period, in the second part of the Volcker tenure and in the Greenspan tenure, interest rates do not present long-range dependence behavior. These empirical findings cast some light on the origins of long-range dependence behavior in financial assets.
    Date: 2010–04
  30. By: Kim, Soyoung (Asian Development Bank Institute); Yang, Doo Yong (Asian Development Bank Institute)
    Abstract: This paper analyzes the impact of United States (US) monetary shocks on the economies of selected East Asian countries using a structural vector autoregression model. We found that the impacts of the US monetary shocks on domestic interest rates and exchange rates contradict conventional wisdom. The conventional exchange rate channel is unlikely to play much role in the transmission of US monetary policy shocks to floating exchange rate regimes in East Asian countries, excluding Japan. In these countries, the domestic interest rate responds strongly to US interest rate changes, largely by authorities giving up monetary autonomy due to fear of floating. On the other hand, the domestic interest rate does not respond much to changes in US rates in the countries with a fixed exchange rate regime and capital account restrictions, such as the People's Republic of China and Malaysia. This may suggest that the countries with a fixed exchange rate regime enjoy a higher degree of monetary autonomy, probably with the help of capital account restrictions.
    Keywords: east asian rate regimes; floating vs. non-floating; international monetary transmission
    JEL: F32 F33
    Date: 2009–12–18
  31. By: Jordà, Òscar; Knüppel, Malte; Marcellino, Massimiliano
    Abstract: Measuring and displaying uncertainty around path-forecasts, i.e. forecasts made in period T about the expected trajectory of a random variable in periods T+1 to T+H is a key ingredient for decision making under uncertainty. The probabilistic assessment about the set of possible trajectories that the variable may follow over time is summarized by the simultaneous confidence region generated from its forecast generating distribution. However, if the null model is only approximative or altogether unavailable, one cannot derive analytic expressions for this confidence region, and its non-parametric estimation is impractical given commonly available predictive sample sizes. Instead, this paper derives the approximate rectangular confidence regions that control false discovery rate error, which are a function of the predictive sample covariance matrix and the empirical distribution of the Mahalanobis distance of the path-forecast errors. These rectangular regions are simple to construct and appear to work well in a variety of cases explored empirically and by simulation. The proposed techniques are applied to provide confidence bands around the Fed and Bank of England real-time path-forecasts of growth and inflation. --
    Keywords: Path forecast,forecast uncertainty,simultaneous confidence region,Scheffé's S-method,Mahalanobis distance,false discovery rate
    JEL: C32 C52 C53
    Date: 2010
  32. By: Costantini, Mauro (Department of Economics, University of Vienna, Vienna, Austria); Gunter, Ulrich (Department of Economics, University of Vienna, Vienna, Austria); Kunst, Robert M. (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria and Department of Economics, University of Vienna, Vienna, Austria)
    Abstract: We use data generated by a macroeconomic DSGE model to study the relative benefits of forecast combinations based on forecast-encompassing tests relative to simple uniformly weighted forecast averages across rival models. Assumed rival models are four linear autoregressive specifications, one of them a more sophisticated factor-augmented vector autoregression (FAVAR). The forecaster is assumed not to know the true data-generating DSGE model. The results critically depend on the prediction horizon. While one-step prediction hardly supports test-based combinations, the test-based procedure attains a clear lead at prediction horizons greater than two.
    Keywords: Combining forecasts, encompassing tests, model selection, time series, DSGE model
    JEL: C15 C32 C53
    Date: 2010–05
  33. By: Marco Aiolfi (Goldman Sachs Asset Management); Carlos Capistrán (Banco de México); Allan Timmermann (University of California, San Diego and CREATES)
    Abstract: We consider combinations of subjective survey forecasts and model-based forecasts from linear and non-linear univariate specifications as well as multivariate factor-augmented models. Empirical results suggest that a simple equal-weighted average of survey forecasts outperform the best model-based forecasts for a majority of macroeconomic variables and forecast horizons. Additional improvements can in some cases be gained by using a simple equal-weighted average of survey and model-based forecasts. We also provide an analysis of the importance of model instability for explaining gains from forecast combination. Analytical and simulation results uncover break scenarios where forecast combinations outperform the best individual forecasting model.
    Keywords: Time-series forecasts, survey forecasts, model instability
    JEL: C22 C53
    Date: 2010–05–06
  34. By: Periklis Gogas; Ioannis Pragidis
    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.
    Date: 2010–05
  35. By: Setzer, Ralph; Noord, Paul van den; Wolff, Guntram
    Abstract: In this paper we examine why monetary aggregates of euro area Member States have developed differently since the inception of the euro. We derive a money demand equation that incorporates housing wealth and collateral as well as substitution effects on real money holdings. Empirically, we show that cross-country differences in real balances are determined not only by income differences, a standard determinant of money demand, but also by house price developments. Higher house prices and higher user costs of housing are both associated with larger money holdings. Country-specific money holdings are also connected with structural features of the housing market. --
    Keywords: Money,housing,national contribution,euro area
    JEL: E41 E51 E52
    Date: 2010
  36. By: Busch, Ulrike; Scharnagl, Michael; Scheithauer, Jan
    Abstract: Distinguishing pure supply effects from other determinants of price and quantity in the market for loans is a notoriously difficult problem. Using German data, we employ Bayesian vector autoregressive models with sign restrictions on the impulse response functions in order to enquire the role of loan supply and monetary policy shocks for the dynamics of loans to non-financial corporations. For the three quarters following the Lehman collapse, we find very strong negative loan supply shocks, while monetary policy was essentially neutral. Nevertheless, the historical decomposition shows a cumulated negative impact of loan supply shocks and monetary policy shocks on loans to non-financial corporations, due to the lagged effects of past loan supply and monetary policy shocks. However, these negative effects on loans to non-financial corporations are overcompensated by positive other shocks, which implies that loans developed more favorably than implied by the model, over the past few quarters. --
    Keywords: Loan supply,Bayesian VAR,sign restrictions
    JEL: C11 C32 E51
    Date: 2010
  37. By: Ball, Christopher; Lopez, Claude; Reyes, Javier; Cruz-Zuniga, Martha
    Abstract: Remittances are private monetary transfers. Yet the rapidly growing literature on the subject often ignores the role that exchange rate regimes play in determining the effect remittances have on a recipient economy. This paper uses a theoretical model and panel vector autoregression techniques to explore the role exchange rate regimes play in understanding the effect of remittances. The analysis considers yearly and quarterly data for seven Latin American countries. Our theoretical model predicts that remittances should temporarily increase inflation and generate an increase in the domestic money supply under a fixed regime, but temporarily decrease inflation and generate no change in the money supply under a flexible regime. These differences are borne out in the data. This adds to our understanding of the true effect of remittances on economies and suggests that other results in the literature that do not control for regimes may be biased.
    Keywords: Remittances; exchange rate regimes
    JEL: F22 F41
    Date: 2010–05
  38. By: Kirstin Hubrich (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Tohmas Karlsson (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: The Eurosystem macroeconomic projection exercises are part of the input prepared for the Governing Council’s decision-making meetings. Under the economic analysis pillar of the ECB’s monetary policy strategy, they are a key element in the assessment of economic prospects and of the short to medium-term risks to price stability. The projection exercises are conducted on the basis of a number of “technical” assumptions. In particular, assumptions are made about future developments in world trade, foreign prices and nominal exchange rates. The purpose of the trade consistency exercise (TCE) is to ensure that individual country forecasts are consistent with each other regarding the assumptions made about the international environment. Trade consistency is ensured in two directions: first, the cross-trade consistency part of the TCE involves examining the consistency of the trade projections at any given point in time; and second, the ex ante/ex post trade consistency part involves comparing the projections for a given variable across different projection rounds. This paper provides a comprehensive description of the data and techniques underlying the trade consistency exercises in the context of the projection exercises of the Eurosystem and the ECB. JEL Classification: E37, E61, F14, F16, F17
    Keywords: Trade projections, cross-country consistency, market shares, competitiveness
    Date: 2010–03
  39. By: Nils Holinski; Clemens Kool; Joan Muysken
    Abstract: In this paper we document the growing dispersion of external and internal balances between countries in the North and South of the Euro area over the time period 1992 to 2007. We find a persistent divergence process that seems to have started with the introduction of the common currency and has its roots in the savings and investment behavior of private sectors. We dismiss the common argument in the literature that imbalances are the temporary outcome of an overall European economic convergence process and argue that future research should place greater emphasis on country heterogeneity in behavior to fully understand economic developments in the Euro area and to derive policy implications.
    Keywords: Euro area, current acccount imbalances, Stability and Growth Pact
    JEL: F15 F32 F41
    Date: 2010–05
  40. By: Antonio Francisco A. Silva Jr.
    Abstract: Even in a floating foreign exchange rate regime, monetary authorities sometimes intervene in the currency market due to liquidity demand and foreign exchange crises. Typically, central banks intervene using foreign currency trades and/or by changing domestic interest rates. We discuss this framework in the context of an optimal impulse stochastic control model. The control and performance equations include interventions with swap operations in the domestic market, since the Central Bank of Brazil also uses these operations. We evaluate risk management strategies for central bank interventions in case of crisis based on the model. We conclude that the Brazilian risk management strategy of increasing holdings of international reserves and decreasing short foreign exchange rate exposure in domestic public debt after 2004 gave the country more flexibility to manage foreign exchange rate risk in 2008 and to avoid higher interest rates to attract international capital as was necessary in previous crises.
    Date: 2010–04

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