nep-cba New Economics Papers
on Central Banking
Issue of 2010‒06‒04
thirty-six papers chosen by
Alexander Mihailov
University of Reading

  1. Insulation Impossible: Fiscal Spillovers in a Monetary Union By Russell Cooper; Hubert Kempf; Dan Peled
  2. Documentation of the Estimated, Dynamic, Optimization-based (EDO) model of the U.S. economy: 2010 version By Hess T. Chung; Michael T. Kiley; Jean-Philippe Laforte
  3. Predictions of short-term rates and the expectations hypothesis By Massimo Guidolin; Daniel L. Thornton
  4. Conditional forecasts in DSGE models By Junior Maih
  5. Price, wage and employment response to shocks : evidence from the WDN survey By Giuseppe Bertola; Aurelijus Dabušinskas; Marco Hoeberichts; Mario Izquierdo; Claudia Kwapil; Jérémi Montornès; Daniel Radowski
  6. Central bank’s macroeconomic projections and learning By Giuseppe Ferrero; Alessandro Secchi
  7. Toward a global risk map By Stephen Cecchetti; Ingo Fender; Kostas Patrick McGuire
  8. A note on expectational stability under non-zero trend inflation By Kobayashi, Teruyoshi; Muto, Ichiro
  9. Equilibrium exchange rate determination and multiple structural changes By Hyunsok Kim; Ronald MacDonald
  10. Global banks and international shock transmission: evidence from the crisis By Nicola Cetorelli; Linda S. Goldberg
  11. Adaptive Interest Rate Modelling By Mengmeng Guo; Wolfgang Karl Härdle
  12. Time-Varying Beta: A Boundedly Rational Equilibrium Approach By Carl Chiarella; Roberto Dieci; Xue-Zhong He
  13. Financial Shocks, Financial Frictions and Financial Intermediaries in DSGE Models: Comments on the Recent Literature By Arend, Mario
  14. Does Foreign Exchange Reserve Decumulation Lead to Currency Appreciation? By Kathryn M.E. Dominguez; Rasmus Fatum; Pavel Vacek
  15. Endogenous Monetary Policy Regimes and the Great Moderation By Ana Beatriz Galvao; Massimiliano Marcellino
  16. Learning about informational rigidities from sectoral data and diffusion indices By Pierre-Daniel G. Sarte
  17. Liquidity Shocks and the Business Cycle By Bigio, Saki
  18. The Superiority of Greenbook Forecasts and the Role of Recessions By Kishor N. Kundan
  19. Decline in the Persistence of Real Exchange Rates : But Not Sufficient for Purchasing Power Parity By OKIMOTO, Tatsuyoshi; SHIMOTSU, Katsumi
  20. The euro as a reserve currency for global investors By Luis M. Viceira; Ricardo Gimeno
  21. For Rich or for Poor: When does Uncovered Interest Parity Hold? By Maurice J. Roche; Michael J. Moore
  22. The functioning of the European interbank market during the 2007-08 financial crisis By Silvia Gabrieli
  23. A Macro-Finance Approach to Exchange Rate Determination By Yu-chin Chen; Kwok Ping Tsang
  24. Shifts in Portfolio Preferences of International Investors: An Application to Sovereign Wealth Funds By Sá, F.; Viani, F.
  25. Inflation in the New EU Countries from Central and Eastern Europe : Theories and panel data estimations By Karsten Staehr
  26. Weights and pools for a Norwegian density combination By Hilde Bjørnland; Karsten Gerdrup; Christie Smith; Anne Sofie Jore; Leif Anders Thorsrud
  27. Trade Flows, Exchange Rate Uncertainty and Financial Depth: Evidence from 28 Emerging Countries By Mustafa Caglayan; Omar S. Dahi; Firat Demir
  28. Credit, Housing Collateral and Consumption: Evidence from the UK, Japan and the US By Janine Aron; John V. Duca; John Muellbauer; Keido Murata; Anthony Murphy
  29. Collateral Policy in a World of Round-the-Clock Payment By Kahn, Charles M.
  30. The Simple Macroeconomics of Fiscal Austerity, Public Sector Debt and Deflation By Thomas I. Palley
  31. Exchange rate regime in Asia: From crisis to crisis. By Patnaik, Ila; Shah, Ajay; Sethy, Anmol; Balasubramaniam, Vimal
  32. Combining Grounded Theorizing and Historical Methods: A Proposal to Strengthen the Power of Qualitative Research By Burgelman, Robert A.
  33. Financial Fragility and Currency Crisis: a Macrodynamical Revisitation of the Argentina’s Experience By Bernardo Maggi; Eleonora Cavallaro; Marcella Mulino
  34. Bayesian Model Averaging. An Application to Forecast Inflation in Colombia By Eliana González
  35. Loud and clear? Can we hear when the SARB speaks? By Monique Reid; Stan du Plessis
  36. Central banking and monetary management in islamic financial environment By Hanif, M. Nadim; Sheikh, Salman

  1. By: Russell Cooper; Hubert Kempf; Dan Peled
    Abstract: This paper studies fiscal spillovers in a monetary union. The focus of the analysis is on the interaction between the fiscal policy of member countries (regions) and the central monetary authority. When capital markets are integrated, the fiscal policy of one country will inuence equilibrium wages and interest rates. Thus there are fiscal spillovers within a federation. The magnitude and direction of these spillovers, in particular the presence of a crowding out effect, can be inuenced by the choice of monetary policy rules. We find that there does not exist a monetary policy rule which completely insulates agents in one region from fiscal policy in another. Some familiar policy rules, such as pegging an interest rate, can provide partial insulation.
    Date: 2010
  2. By: Hess T. Chung; Michael T. Kiley; Jean-Philippe Laforte
    Abstract: This paper provides documentation for a large-scale estimated DSGE model of the U.S. economy--the Federal Reserve Board's Estimated, Dynamic, Optimization-based (FRB/EDO) model project. The model can be used to address a wide range of practical policy questions on a routine basis. The paper discusses the model's specification, estimated parameters, and key properties.
    Date: 2010
  3. By: Massimo Guidolin; Daniel L. Thornton
    Abstract: Despite its role in monetary policy and finance, the expectations hypothesis (EH) of the term structure of interest rates has received virtually no empirical support. The empirical failure of the EH was attributed to a variety of econometric biases associated with the single-equation models most often used to test it, although no bias seems to account for the extent and magnitude of the failure. This paper analyzes the EH by focusing on the predictability of the short-term rate. This is done by comparing h-month ahead forecasts for the 1- and 3-month Treasury bill yields implied by the EH with the forecasts from random-walk, Diebold and Li’s (2006), and Duffee’s (2002) models. The evidence suggests that the failure of the EH is likely a consequence of market participants’ inability to adequately predict the short-term rate, in that none of these models out-performs a simple random walk model in recursive, real time experiments. Using standard methods that take into account the additional uncertainty caused by the need to estimate model parameters, the null hypothesis of equal predictive accuracy of each models relative to the random walk alternative is never rejected
    Keywords: Rational expectations (Economic theory) ; Interest rates
    Date: 2010
  4. By: Junior Maih (Norges Bank (Central Bank of Norway))
    Abstract: New-generation DSGE models are sometimes misspecified in dimensions that matter for their forecasting performance. The paper suggests one way to improve the forecasts of a DSGE model using a conditioning information that need not be accurate. The technique presented allows for agents to anticipate the information on the conditioning variables several periods ahead. It also allows the forecaster to apply a continuum of degrees of uncertainty around the mean of the conditioning information, making hard-conditional and unconditional forecasts special cases. An application to a small open-economy DSGE model shows that the benefits of conditioning depend crucially on the ability of the model to capture the correlation between the conditioning information and the variables of interest.
    Keywords: DSGE model, conditional forecast
    JEL: C53 F47
    Date: 2010–04–27
  5. By: Giuseppe Bertola; Aurelijus Dabušinskas; Marco Hoeberichts; Mario Izquierdo; Claudia Kwapil; Jérémi Montornès; Daniel Radowski
    Abstract: This paper analyses information from survey data collected in the framework of the Eurosystem\'s Wage Dynamics Network (WDN) on patterns of firm-level adjustment to shocks. We document that the relative intensity and the character of price vs. cost and wage vs. employment adjustments in response to cost-push shocks depend - in theoretically sensible ways - on the intensity of competition in firms\' product markets, on the importance of collective wage bargaining and on other structural and institutional features of firms and of their environment. Focusing on the pass-through of cost shocks to prices, our results suggest that the pass-through is lower in highly competitive firms. Furthermore, a high degree of employment protection and collective wage agreements tend to make this pass-through stronger
    Keywords: wage bargaining, labour-market institutions, survey data, European Union
    JEL: J31 J38 P50
    Date: 2010–05–26
  6. By: Giuseppe Ferrero (Banca d'Italia); Alessandro Secchi (Banca d'Italia)
    Abstract: We study the impact of the publication of central bank’s macroeconomic projections on the dynamic properties of an economy where: (i) private agents have incomplete information and form their expectations using recursive learning algorithms, (ii) the short-term nominal interest rate is set as a linear function of the deviations of inflation and real output from their target level and (iii) the central bank, ignoring the exact mechanism used by private agents to form expectations, assumes that it can be reasonably approximated by perfect rationality and releases macroeconomic projections consistent with this assumption. Results in terms of stability of the equilibrium and speed of convergence of the learning process crucially depend on the set of macroeconomic projections released by the central bank. In particular, while the publication of inflation and output gap projections enlarges the set of interest rate rules associated with stable equilibria under learning and helps agents to learn faster, the announcement of the interest rate path exerts the opposite effect. In the latter case, in order to stabilize expectations and to speed up the learning process the response of the policy instrument to inflation should be stronger than under no announcement.
    Keywords: Monetary policy, Communication, Interest rates, Learning, Speed of Convergence
    JEL: E58 E52 E43 D83
    Date: 2010
  7. By: Stephen Cecchetti; Ingo Fender; Kostas Patrick McGuire
    Abstract: Global risk maps are unified databases that provide risk exposure data to supervisors and the broader financial market community worldwide. We think of them as giant matrices that track the bilateral (firm-level) exposures of banks, non-bank financial institutions and other relevant market participants. While useful in principle, these giant matrices are unlikely to materialise outside the narrow and targeted efforts currently being pursued in the supervisory domain. This reflects the well known trade-offs between the macro and micro dimensions of data collection and dissemination. It is possible, however, to adapt existing statistical reporting frameworks in ways that would facilitate an analysis of exposures and build-ups of risk over time at the aggregate (sectoral) level. To do so would move us significantly in the direction of constructing the ideal global risk map. It would also help us sidestep the complex legal challenges surrounding the sharing or dissemination of firm-level data, and it would support a two-step approach to systemic risk monitoring. That is, the alarms sounded by the aggregate data would yield the critical pieces of information to inform targeted analysis of more detailed data at the firm- or market-level.
    Keywords: risk map, international banking, financial crises, yen carry trade, funding risk
    Date: 2010–05
  8. By: Kobayashi, Teruyoshi; Muto, Ichiro
    Abstract: This study examines the expectational stability of the rational expectations equilibria (REE) under alternative Taylor rules when trend inflation is non-zero. We find that when trend inflation is high, the REE is likely to be expectationally unstable. This result holds true regardless of the nature of the data (such as contemporaneous data, forecast, and lagged data) introduced in the Taylor rule. Our results suggest that a high macroeconomic volatility during the period of high trend inflation can be well explained by introducing the concept of expectational stability.
    Keywords: adaptive learning, E-stability, Taylor rule, trend inflation
    JEL: D84 E31 E52
    Date: 2010–05–28
  9. By: Hyunsok Kim; Ronald MacDonald
    Abstract: The large appreciation and depreciation of the US dollar in the 1980s stimulated an important debate on the usefulness of unit root tests in the presence of structural breaks. In this paper, we propose a simple model to describe the evolution of the real exchange rate. We then propose a more general smooth transition (STR) function than has hitherto been employed, which is able to capture structural changes along the (long-run) equilibrium path, and show that this is consistent with our economic model. Our framework allows for a gradual adjustment between regimes and allows for under- and/or over-valued exchange rate adjustments. Using monthly and quarterly data for up to twenty OECD countries, we apply our methodology to investigate the univariate time series properties of CPI-based real exchange rates with both the U.S. dollar and German mark as the numeraire currencies. The empirical results show that, for more than half of the quarterly series, the evidence in favour of the stationarity of the real exchange rate was clearer in the sub-sample period post-1980.
    Keywords: Unit root tests, structural breaks, purchasing power parity
    JEL: C16 C22 F31
    Date: 2010–05
  10. By: Nicola Cetorelli; Linda S. Goldberg
    Abstract: Global banks played a significant role in transmitting the 2007-09 financial crisis to emerging-market economies. We examine adverse liquidity shocks on main developed-country banking systems and their relationships to emerging markets across Europe, Asia, and Latin America, isolating loan supply from loan demand effects. Loan supply in emerging markets across Europe, Asia, and Latin America was affected significantly through three separate channels: 1) a contraction in direct, cross-border lending by foreign banks; 2) a contraction in local lending by foreign banks' affiliates in emerging markets; and 3) a contraction in loan supply by domestic banks, resulting from the funding shock to their balance sheets induced by the decline in interbank, cross-border lending. Policy interventions, such as the Vienna Initiative introduced in Europe, influenced the lending-channel effects on emerging markets of shocks to head-office balance sheets.
    Keywords: Capital market ; Emerging markets ; International finance ; International liquidity ; Banks and banking, International ; Banks and banking, Foreign ; Financial crises ; Loans, Foreign
    Date: 2010
  11. By: Mengmeng Guo; Wolfgang Karl Härdle
    Abstract: A good description of the dynamics of interest rates is crucial to price derivatives and to hedge corresponding risk. Interest rate modelling in an unstable macroeconomic context motivates one factor models with time varying parameters. In this paper, the local parameter approach is introduced to adaptively estimate interest rate models. This method can be generally used in time varying coefficient parametric models. It is used not only to detect the jumps and structural breaks, but also to choose the largest time homogeneous interval for each time point, such that in this interval, the coeffcients are statistically constant. We use this adaptive approach and apply it in simulations and real data. Using the three month treasure bill rate as a proxy of the short rate, we nd that our method can detect both structural changes and stable intervals for homogeneous modelling of the interest rate process. In more unstable macroeconomy periods, the time homogeneous interval can not last long. Furthermore, our approach performs well in long horizon forecasting.
    Keywords: CIR model, Interest rate, Local parametric approach, Time homogeneous interval, Adaptive statistical techniques
    JEL: E44 G12 G32 N22
    Date: 2010–05
  12. By: Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Roberto Dieci (Department of Mathematics for Economics and Social Sciences, University of Bologna); Xue-Zhong He (School of Finance and Economics, University of Technology, Sydney)
    Abstract: By taking into account conditional expectations and the dependence of the systematic risk of asset returns on micro- and macro-economic factors, the conditional CAPM with time-varying betas displays superiority in explaining the cross-section of returns and anomalies in a number of empirical studies. Most of the literature on time-varying beta is motivated by econometric estimation rather than explicit modelling of the stochastic behaviour of betas through agents’ behaviour. Within the mean-variance framework of repeated one-period optimisation, we set up a boundedly rational dynamic equilibrium model of a ï¬nancial market with heterogeneous agents and obtain an explicit dynamic CAPM relation between the expectede quilibrium returns and time-varying betas. By incorporating the three most popular types of investors, fundamentalists, chartists and noise traders, into the model, we show that, independent of the fundamentals, there is a systematic change in the market portfolio, risk-return relationships, and time varying betas when investors change their behaviour, such as the chartists acting as momentum traders. In particular, we demonstrate the stochastic nature of time-varying betas and show that the commonly used rolling window estimates of time-varying betas may not be consistent with the ex-ante betas implied by the equilibrium model. The results provide a number of insights into an understanding o ftime-varying beta.
    Keywords: equilibrium asset prices; CAPM; time-varying betas, heterogeneous expectations
    JEL: G12 D84
    Date: 2010–05–01
  13. By: Arend, Mario
    Abstract: The aim of this work is to compare and contrast different ways of modeling financial shocks and financial intermediaries in the Dynamic Stochastic General Equilibrium models (DSGE models) and to discuss the empirical evidence on the importance of modeling financial sector and financial shocks in the economy. The analysis is based on four papers on the matter Jerman and Quiadrini (2009),Christiano, Motto and Rostagno (2006), Goodfriend and McCallum (2007), and Gertler and Kiyotaki (2009)
    Keywords: Financial frictions; Financial Intermediaries; Financial shocks; DSGE models.
    JEL: E5 E44 E4 E3
    Date: 2010–05–27
  14. By: Kathryn M.E. Dominguez (Gerald R. Ford School of Public Policy, University of Michigan); Rasmus Fatum (School of Business, University of Alberta); Pavel Vacek (School of Business, University of Alberta)
    Abstract: Many developing countries have increased their foreign reserve stocks dramatically in recent years, often motivated by the desire for precautionary self-insurance. One of the negative consequences of large accumulations for these countries is the risk of valuation losses. In this paper we examine the implications of systematic reserve decumulation by the Czech authorities aimed at mitigating valuation losses on euro-denominated assets. The policy was explicitly not intended to influence the value of the koruna relative to the euro. Initially the timing and size of reserve sales was not predictable, eventually sales occurred on a daily basis (in three equal installments within the day). This project examines whether these reserve sales, both during the regime of discretionary timing as well as when sales occurred every day, had unintended consequences for the domestic currency. Our findings using intraday exchange rate data and time-stamped reserve sales indicate that when decumulation occurred every day these sales led to significant appreciation of the koruna. Overall, our results suggest that the manner in which reserve sales are carried out matters for whether reserve decumulation influences the relative value of the domestic currency.
    Keywords: foreign exchange reserves; exchange rate determination; high-frequency volatility modeling
    JEL: E58 F31 F32
    Date: 2010–05
  15. By: Ana Beatriz Galvao; Massimiliano Marcellino
    Abstract: This paper contributes to the literature on the changing transmission mechanism of monetary policy by introducing a model whose parameter evolution explicitly depends on the conduct of monetary policy. We find that the model fits the data well, in particular when complemented with an estimated break around 1985 that could be associated with the re-gained credibility of the central bank. The responses of output and inflation to policy shocks change not only because of the break in 1985 but also according to the monetary policy stance: policy shocks have stronger negative e¤ects when policy is tight. There is also evidence in favour of large changes in the volatility of the output equation, but not of inflation. A set of counterfactual experiments indicate that good policy and good luck contributed to the great moderation, but neither of them can fully explain it. A more general variation in the model dynamics underlying the shock transmission mechanism is required.
    Date: 2010
  16. By: Pierre-Daniel G. Sarte
    Abstract: This paper uses sectoral data to study survey-based diffusion indices designed to capture changes in the business cycle in real time. The empirical framework recognizes that when answering survey questions regarding their firm's output, respondents potentially rely on infrequently updated information. The analysis then suggests that their answers reflect considerable information lags, on the order of 16 months on average. Moreover, because information stickiness leads respondents to filter out noisy output fluctuations when answering surveys, it helps explain why diffusion indices successfully track business cycles and their consequent widespread use. Conversely, the analysis shows that in a world populated by fully informed identical firms, as in the standard RBC framework for example, diffusion indices would instead be degenerate. Finally, the data suggest that information regarding changes in aggregate output tends to be sectorally concentrated. The paper, therefore, is able to offer basic guidelines for the design of surveys used to construct diffusion indices.
    Date: 2010
  17. By: Bigio, Saki (Department of Economics, New York University)
    Abstract: This paper studies the properties of an economy subject to random liquidity shocks. As in Kiyotaki and Moore [2008], liquidity shocks affect the ease with which equity can be used as to finance the down-payment for new investment projects. We obtain a liquidity frontier which separates the state-space into two regions (liquidity constrained and unconstrained). In the unconstrained region, the economy behaves according to the dynamics of the standard real business cycle model. Below the frontier, liquidity shocks have the effects of investment shocks. In this region, investment is under-efficient and there is a wedge between the price of equity and the real cost of capital. As with investment shocks, we argue that liquidity shocks are not an important source of business cycle fluctuations in absence of other frictions affecting the labor market.
    Keywords: Business Cycle, Asset Pricing, Liquidity
    JEL: E32 E44 D82
    Date: 2010–05
  18. By: Kishor N. Kundan (University of Wisconsin-Milwaukee)
    Abstract: In this paper, we investigate the role of recessions on the relative forecasting performance of the Fed and the private sector. Romer and Romer (2000) showed that the Fed's forecasts of inflation and output were superior to that of the private sector in the pre-1991 period. D'Agostino and Whelan (2008) found that the information superiority of the Fed deteriorated after 1991. Our results show that the information superiority of the Fed in forecasting real activity did arise from its forecasting dominance during recessions. If recessions are excluded from the pre-1992 period, the informational advantage of the Fed disappears, and in some cases, private sector forecasts perform better. We do not find any systematic effect of recessions on inflation forecasts.
    Keywords: Greenbook Forecasts, Recessions, Business Cycle Turning Points
    JEL: E31 E32 E37
    Date: 2010
  19. By: OKIMOTO, Tatsuyoshi; SHIMOTSU, Katsumi
    Abstract: The paper investigates the possibility of decline in the persistence of real exchange rates, or deviations from PPP. To this end, we test the null hypothesis of no decline in the PPP deviation persistence between two subsamples using a fractional integration framework. In addition, our rolling-window estimates show that the real exchange rate of many countries have experienced a sharp drop in their persistence once we use samples starting from the mid-1980s. Finally, we examine the relationship between the dynamics of PPP deviation persistence and several economic variables and confirm that the speed of convergence of PPP deviations is highly related to economic/financial integration and world economic stabilization.
    Keywords: deviations from PPP, economic stabilization, financial integration
    JEL: C14 C22 F31 F36
    Date: 2010–04
  20. By: Luis M. Viceira (Harvard Business School); Ricardo Gimeno (Banco de España)
    Abstract: In this article, we explore the demand for the euro for risk management purposes, and the evidence of stock market integration in the euro area. We define a reserve currency as one that investors demand either because it helps them hedge real interest risk and inflation risk, or because it helps them reduce the volatility of their portfolio of stocks and bonds because its return is negatively correlated with the returns on those assets. This article re-examines the role of the euro as a reserve currency in the sense of Campbell, Viceira and White (2003), updating their evidence, and reviews the evidence of Campbell, Serfaty-de Medeiros and Viceira (2010) in detail. Consistent with the intuition that an integrated capital market is one in which there is a common discount factor pricing securities, we also investigate whether stocks in the euro area have moved from a regime in which national stock markets were priced with discount rates that were predominantly country specific, to a regime in which national stock markets are predominantly priced by a euro area-wide common discount rate. We adopt the beta decomposition approach of Campbell and Vuolteenaho (2004) and Campbell, Polk and Vuolteenaho (2010) to test for capital market integration, and find robust evidence of increased capital market integration in the euro zone, and consequently improved risk sharing among euro zone economies.
    Keywords: Euro, Reserve Currency, Currency hedging, Market Integration, Beta decomposition
    JEL: G12 G15 F31 F15 E42
    Date: 2010–05
  21. By: Maurice J. Roche (Department of Economics, Ryerson University, Toronto, Canada); Michael J. Moore (School of Management and Economics, The Queen's University of Belfast, Belfast, Northern Ireland)
    Abstract: We present a model that simultaneously explains why uncovered interest parity holds for some pairs of countries and not for others. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with ‘deep’ habits along the lines of the work of Ravn, Schmitt-Grohe and Uribe. By deep habits, we mean habits defined over goods rather than countries. The negative slope in the Fama regression arises when monetary instability is low and the precautionary savings motive dominates the intertemporal substitution motive. When monetary instability is high, the Fama slope is positive in line with uncovered interest parity. The model is simulated using the artificial economy methodology for 34 currencies against the US dollar. We conclude that, given the predominance of precautionary savings, the degree of monetary instability explains whether or not uncovered interest parity holds.
    Keywords: Monetary instability; Uncovered interest parity; Forward biasedness puzzle; Carry trade; Habit persistence
    JEL: F31 F41 G12
    Date: 2010–05
  22. By: Silvia Gabrieli (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: This paper analyses the functioning of the overnight unsecured euro money market during the ongoing crisis in terms of i) operational efficiency of monetary policy implementation, ii) efficient reallocation of banking system’s reserves, iii) developments in the pricing of interbank loans. The results suggest that monetary policy implementation has been hampered by the crisis, particularly after the end of September 2008. A heightened awareness of counterparty credit risk seems to be one key factor behind the downward pressure on unsecured rates, as well as behind the notable increase in their cross-section dispersion. Starting from September 2008, and even more in October 2008, banks perceived as relatively “riskier” pre-turmoil paid significantly higher interest rates to borrow overnight funds. In November, a non-uniform softening of the strains occurred: only the most active (roughly the largest) borrowers experienced a notable price improvement. This is possibly a reflection of the bailouts of “too-big-to-fail” institutions. Heterogeneous developments in banks’ funding costs also suggest a move against the integration of the euro interbank market.
    Keywords: Interbank market; Financial crisis; Monetary policy operational efficiency; Moral hazard; European financial integration
    JEL: E58 G21
    Date: 2010–05–28
  23. By: Yu-chin Chen (University of Washington); Kwok Ping Tsang (Virginia Tech)
    Abstract: The nominal exchange rate is both a macroeconomic variable equilibrating international markets and a financial asset that embodies expectations and prices risks associated with cross border currency holdings. Recognizing this, we adopt a joint macro-finance strategy to model the exchange rate. We incorporate into a monetary exchange rate model macroeconomic stabilization through Taylor-rule monetary policy on one hand, and on the other, market expectations and perceived risks embodied in the cross-country yield curves. Using monthly data between 1985 and 2005 for Canada, Japan, the UK and the US, we employ a state-space system to model the relative yield curves between country-pairs using the Nelson and Siegel (1987) latent factors, and combine them with monetary policy targets (output gap and inflation) into a vector autoregression (VAR) for bilateral exchange rate changes. We find strong evidence that both the financial and macro variables are important for explaining exchange rate dynamics and excess currency returns, especially for the yen and the pound rates relative to the dollar. Moreover, by decomposing the yield curves into expected future yields and bond market term premiums, we show that both expectations about future macroeconomic conditions and perceived risks are priced into the currencies. These findings provide support for the view that the nominal exchange rate is determined by both macroeconomic as well as financial forces.
    Date: 2009–12
  24. By: Sá, F.; Viani, F.
    Abstract: Reversals in capital inflows can have severe economic consequences. This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors. The model has two countries and two asset classes (equities and bonds). It is characterized by imperfect substitutability between assets and allows for endogenous adjustment in interest rates and asset prices. Therefore, it accounts for capital gains arising from equity price movements, in addition to valuation effects caused by changes in the exchange rate. To illustrate the mechanics of the model, we calibrate it to analyse the conse- quences of an increase in the importance of Sovereign Wealth Funds (SWFs). Specifically, we ask what would happen if 'excess' reserves held by Emerging Markets were transferred from central banks to SWFs. We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the 'exorbitant privilege', i.e., the excess return the US receives on its assets over what it pays on its liabilities. The model is applicable to other episodes in which foreign investors change the composition of their portfolios.
    Keywords: portfolio preferences, sudden stops, imperfect substitutability, global imbalances, sovereign wealth funds
    JEL: F32
    Date: 2010–05–29
  25. By: Karsten Staehr
    Abstract: This paper seeks to identify factors driving consumer price inflation in the new EU member countries from Central and Eastern Europe. Different theories are discussed, including some of particular importance to economies experiencing high economic growth and rapid structural change. The explanatory power of the theories is tested using panel data estimations based on annual data from 1997 to 2007. Convergence- related factors, including the Balassa-Samuelson and the Bhagwati capital-deepening effects, are important drivers of inflation. Import inflation and, by implication, exchange rate developments have an important impact, while the exchange rate regime is unimportant. Higher government debt and larger revenues are associated with higher inflation. The cyclical position as measured by unemployment, employment changes or the current account balance is found to affect inflation. Food price shocks have large but short-lived effects, while energy price shocks have longer-lasting effects on the inflation rate. Multicollinearity across the explanatory variables makes it difficult to identify the effect of each individual factor
    Keywords: inflation, inflation theories, real and nominal convergence, inflation determinants
    JEL: E31 E42 E63 P24
    Date: 2010–05–26
  26. By: Hilde Bjørnland (Norwegian School of Management (BI) and Norges Bank (Central Bank of Norway)); Karsten Gerdrup (Norges Bank (Central Bank of Norway)); Christie Smith (Reserve Bank of New Zealand); Anne Sofie Jore (Norges Bank (Central Bank of Norway)); Leif Anders Thorsrud (Norges Bank (Central Bank of Norway))
    Abstract: We apply a suite of models to produce quasi-real-time density forecasts of Norwegian GDP and in ation, and evaluate dfferent combination and selection methods using the Kullback-Leibler information criterion (KLIC). We use linear and logarithmic opinion pools in conjunction with various weighting schemes, and we compare these combinations to two different selection methods. In our application, logarithmic opinion pools were better than linear opinion pools, and score-based weights were generally superior to other weighting schemes. Model selection generally yielded poor density forecasts, as evaluated by KLIC.
    Keywords: Model combination; evaluation; density forecasting; KLIC
    JEL: C32 C52 C53 E52
    Date: 2010–05–19
  27. By: Mustafa Caglayan (Department of Economics, The University of Sheffield Author-Person=pca30); Omar S. Dahi (Hampshire College); Firat Demir (University of Oklahoma)
    Abstract: We investigate the effects of real exchange rate uncertainty and financial depth on manufactures exports from 28 emerging economies to the North and South over 1978-2005. We estimate a dynamic panel model using system GMM approach and show that for the majority of countries in our sample exchange rate uncertainty affects both South-South and South-North trade negatively. Furthermore, for several cases we discover that this effect is unidirectional, that is South-South or South-North. In addition, we find that while financial depth plays a trade-enhancing role, exchange rate shocks can negate this effect. We also show that trade among developing economies is likely to enhance export growth.
    Keywords: Trade flows, Exchange rate uncertainty, South-South trade, Financial depth, Dynamic panel data
    JEL: F15 F31 G15 E44 O14
    Date: 2010–05
  28. By: Janine Aron; John V. Duca; John Muellbauer; Keido Murata; Anthony Murphy
    Abstract: The consumption behaviour of UK, US and Japanese households is examined and compared using a modern Ando-Modigliani style consumption function. The models incorporate income growth expectations, income uncertainty, housing collateral and other credit effects. These models therefore capture important parts of the financial accelerator. The evidence is that credit availability for UK and US but not Japanese households has undergone large shifts since 1980. The average consumption-to-income ratio shifted up in the UK and US as mortgage down-payment constraints eased and as the collateral role of housing wealth was enhanced by financial innovations, such as home equity loans. The estimated housing collateral effect is roughly similar in the US and UK, while land prices in Japan still have a negative effect on consumer spending. Together with evidence for negative real interest rate effects in the UK and US and positive ones in Japan, this suggests important differences in the transmission of monetary and credit shocks between Japan and the US, UK and other credit-liberalized economies.
    Keywords: Consumption, Credit conditions, Housing collateral and housing wealth
    JEL: E21 E32 E44 E51
    Date: 2010
  29. By: Kahn, Charles M. (University of Illinois, Urbana-Champaign)
    Abstract: This paper examines competition between private and public payments settlement systems, and examines the consequences of round-the-clock private payments arrangements on the competitiveness of public systems. Central to the issue is the role of collateral both as a requirement for participation in central bank sponsored payments arrangements and as the backing for private intermediary arrangements. The presence of private systems serves as a check on the ability of a monetary authority to tighten monetary policy. Round-the-clock systems are an example of a collateral saving innovation that further pressures central bank pre-eminence in payments settlement.
    Date: 2009–10
  30. By: Thomas I. Palley (New America Foundation, Washington DC)
    Abstract: This paper explores the macroeconomics of fiscal austerity and deflation in an economy with public debt. A binding budget deficit cap destabilizes the economy by turning the government budget into an automatic destabilizer. Public debt helps maintain AD in the presence of deflation because deflation increases the real value of public interest payments. That makes public debt significantly different from private debt. If the economy is subject to a binding deficit cap, deflation no longer stabilizes output. This is because increased real interest payments must be matched by spending cuts, giving rise to a negative balanced budget multiplier.
    Keywords: fiscal austerity, budget deficit cap, public debt, deflation growth theory
    JEL: E12 E60 E62 H62
    Date: 2010
  31. By: Patnaik, Ila (National Institute of Public Finance and Policy); Shah, Ajay (National Institute of Public Finance and Policy); Sethy, Anmol (National Institute of Public Finance and Policy); Balasubramaniam, Vimal (National Institute of Public Finance and Policy)
    Abstract: Prior to the Asian financial crisis, most Asian exchange rates were de facto pegged to the US Dollar. In the crisis, many economies experienced a brief period of extreme flexibility. A `fear of oating' gave reduced exibility when the crisis subsided, but flexibility after the crisis was greater than that seen prior to the crisis. Contrary to the idea of a durable Bretton Woods II arrangement, Asia then went on to slowly raise flexibility and reduce the role for the US Dollar. When the period from April 2008 to December 2009 is compared against periods of high in flexibility, from January 1991 to November 1991 and October 1995 to March 1997, the increase in flexibility is economically and statistically significant. This paper proposes a new measure of dollar pegging, the "Bretton Woods II score". We find that by this measure Asia has been slowly moving away from a Bretton Woods II arrangement.
    Keywords: Exchange rate regime, Asia, Bretton Woods II hypothesis
    JEL: F31 F33
    Date: 2010–05
  32. By: Burgelman, Robert A. (Stanford University)
    Abstract: Qualitative research in the international business field can benefit from combining grounded theorizing with modern historical methods. Modern historical methods orient qualitative research to studying complex nonlinear organizational dynamics. This provides a basis for differentiating qualitative research from most quantitative social science research. By augmenting historical methods with grounded theorizing qualitative research can develop substantive theory that takes the form of conceptual frameworks. Conceptual frameworks can form a useful bridge between the narratives typically produced by historians and the mathematical and statistical models typically developed by high theorists. This logic, which suggests a somewhat novel role for qualitative research in the hierarchy of theory development, potentially strengthens its raison d'etre.
    Date: 2009–10
  33. By: Bernardo Maggi; Eleonora Cavallaro; Marcella Mulino (Univ. of Rome “La Sapienza”)
    Abstract: The paper presents an open-economy macrodynamical growth model with the aim of giving an endogenous characterisation to the process that leads a small country with a currency-board arrangement to accumulate dangerously high levels of external debt and become vulnerable to macroeconomic instability. The macrodynamics of the model results from the combination of the commitment to maintain the peg - that makes liquidity closely dependent on the dynamics of foreign reserves – and the non-linear real and financial interactions that drives the pro-cyclical behaviour of the economy. Within this context, the external finance ease during an economic upswing leads to debt-supported growth and financial fragility; the consequent deterioration of profitability expectations brings about a capital reversal that, in the absence of monetary stabilization tools, makes the currency arrangement unsustainable. A financial crisis may thus turn into a currency crisis. We run a continuous-time estimation of a non-linear differential equations system for Argentina during the years of the currency-board arrangement. We find that two steady-state solutions exist. The local stability and sensitivity analysis show that both equilibria are unstable and that the qualitative nature of the equilibria depends in particular on lenders’ responsiveness to the degree of leverage. On the contrary, when considering a different currency arrangement with an autonomous monetary policy, the system becomes stable.
    Keywords: Currency Board, Financial Crisis, Monetary policy, Continuous Time Econometrics, Stability, Sensitivity
    JEL: C51 C62 F34 E52
    Date: 2010
  34. By: Eliana González
    Abstract: An application of Bayesian Model Averaging, BMA, is implemented to construct combined forecasts for the colombian inflation for the short and medium run. A model selection algorithm is applied over a set of linear models with a large dataset of potencial predictors using marginal as well as predictive likelihood. The forecasts obtained when using predictive likelihood outperformed the ones obtained when using marginal likelihood. BMA forecasts reduce forecasting error compared to the individual forecasts, equal weighted average, dynamic factors model and random walk forecasts for most horizons. Additionally, the BMA outperformed for some horizons the frequentist Information theoretic model average, ITMA, when the weights of both methodologies are build based on the predictive ability of the models.
    Date: 2010–05–23
  35. By: Monique Reid (Department of Economics, University of Stellenbosch); Stan du Plessis (Department of Economics, University of Stellenbosch)
    Abstract: Inflation targeting is a forward-looking framework for monetary policy that has brought unprecedented transparency to the process of monetary policy. This paper aims to assess the degree to which the South African Reserve Bank’s (SARB) Monetary Policy Committee (MPC) has, since the introduction of inflation targeting, successfully communicated to the public its policy analysis, and, in particular, the expected future policy changes. This paper follows international literature (Rosa and Verga (2007), Ehrmann and Fratszcher (2005)) in constructing a numerical index that is used to reflect the information content of the SARB’s communications, specifically the monetary policy statements that accompanied each of the MPC meetings since 2000. Relating this index to subsequent policy decisions reveals the informativeness of the index and, by implication, the informativeness of the underlying monetary policy statements. This method allows us to judge, systematically, the degree to which the MPC has communicated successfully, and the evolution of that success over the past nine years. We find evidence that the MPC has succeeded in signalling their likely future policy decision with consistency over this period.
    Keywords: South Africa, Inflation targeting, Central bank communication, Effective monetary policy, forward-looking policy framework
    JEL: E42 E52 E58
    Date: 2010
  36. By: Hanif, M. Nadim; Sheikh, Salman
    Abstract: Continuous growth in Islamic finance calls for studying the framework in which the monetary policy maker (i.e., central bank) performs its functions. Central banks in Muslim countries are using various instruments for monetary policy purpose including interest rate. As a result, Islamic financial institutions (IFIs) are facing issues in benchmarking the price of financial instruments. Acceptable solution to benchmarking lies in the presence of a real economic activity in the base of any proposal and its feasibility for business performance when put against conventional banking. This paper presents empirical evidence of statistical equivalence of nominal GDP growth rate and official interest rate for ‘advanced,’ ‘all,’ and some Muslim countries. We propose nominal GDP growth rate as benchmark for pricing domestic financial transactions of IFIs as well as for pricing external bilateral/ multilateral loans. The paper also suggests nominal income targeting as monetary policy regime.
    Keywords: Islamic Finance; Central Bank; Interest Rate; Nominal Income Targeting
    JEL: G12 E58
    Date: 2009–11

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