|
on Central Banking |
| By: | Athanasios Orphanides (Central Bank of Cyprus) |
| Abstract: | This paper provides a policymaker's perspective on some lessons from the recent financial crisis. It focuses on questions in three areas. First, what lessons can be drawn regarding the institutional framework for monetary policy? Has the experience changed the pre-crisis consensus that monetary policy is best performed by an independent central bank focused on achieving and maintaining price stability? Second, what lessons can be drawn regarding the monetary policy strategy that should be followed by a central bank? How activist should a central bank be in dampening macroeconomic fluctuations? Should the "output gap" serve as an important policy guide? Are there lessons regarding the stability-oriented approach followed by the ECB? How activist should a central bank be in tackling perceived asset price misalignments? Does the ECB's monetary analysis pillar help incorporate the pertinent information in formulating policy? Third, is monetary policy pursuing price stability enough to ensure overall stability in the economy? Or is there room for improvement regarding how central banks can contribute to financial stability? Should the role of monetary policy be seen as completely separate from the broader istitutional environment governing financial markets and institutions in our economy? Or would greater central bank involvement in regulation and supervision pertaining to credit and finance allow better management of overall economic stability? |
| Keywords: | Great ¯nancial crisis, activist stabilisation policy, real-time output gap, robust simple rules, stability-oriented monetary policy, asset prices, macro-prudential supervision,financial stability, ECB. |
| JEL: | E50 E52 E58 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:cyb:wpaper:2010-1&r=cba |
| By: | Athanasios Orphanides; John C. Williams |
| Abstract: | What monetary policy framework, if adopted by the Federal Reserve, would have avoided the Great Inflation of the 1960s and 1970s? We use counterfactual simulations of an estimated model of the U.S. economy to evaluate alternative monetary policy strategies. We show that policies constructed using modern optimal control techniques aimed at stabilizing inflation, economic activity, and interest rates would have succeeded in achieving a high degree of economic stability as well as price stability only if the Federal Reserve had possessed excellent information regarding the structure of the economy or if it had acted as if it placed relatively low weight on stabilizing the real economy. Neither condition held true. We document that policymakers at the time both had an overly optimistic view of the natural rate of unemployment and put a high priority on achieving full employment. We show that in the presence of realistic informational imperfections and with an emphasis on stabilizing economic activity, an optimal control approach would have failed to keep inflation expectations well anchored, resulting in highly volatile inflation during the 1970s. Finally, we show that a strategy of following a robust first-difference policy rule would have been highly successful in the presence of informational imperfections. This robust monetary policy rule yields simulated outcomes that are close to those seen during the period of the Great Moderation starting in the mid-1980s. |
| Keywords: | Monetary policy ; Inflation (Finance) |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2010-12&r=cba |
| By: | Athanasios Orphanides (Central Bank of Cyprus); John C. Williams (Federal Reserve Bank of San Francisco) |
| Abstract: | What monetary policy framework, if adopted by the Federal Reserve, would have avoided the Great Inflation of the 1960s and 1970s? We use counterfactual simulations of an estimated model of the U.S. economy to evaluate alternative monetary policy strategies. We show that policies constructed using modern optimal control techniques aimed at stabilizing inflation, economic activity, and interest rates would have succeeded in achieving a high degree of economic stability as well as price stability only if the Federal Reserve had possessed excellent information regarding the structure of the economy or if it had acted as if it placed relatively low weight on stabilizing the real economy. Neither condition held true. We document that policymakers at the time both had an overly optimistic view of the natural rate of unemployment and put a high priority on achieving full employment. We show that in the presence of realistic informational imperfections and with an emphasis on stabilizing economic activity, an optimal control approach would have failed to keep inflation expectations well anchored, resulting in highly volatile inflation during the 1970s. Finally, we show that a strategy of following a robust first-difference policy rule would have been highly successful in the presence of informational imperfections. This robust monetary policy rule yields simulated outcomes that are close to those seen during the period of the Great Moderation starting in the mid-1980s. |
| Keywords: | Great Inflation, rational expectations, robust control, model uncertainty, natural rate of unemployment |
| JEL: | E52 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:cyb:wpaper:2010-2&r=cba |
| By: | Alberto Martin; Jaume Ventura |
| Abstract: | We explore a view of the crisis as a shock to investor sentiment that led to the collapse of a bubble or pyramid scheme in financial markets. We embed this view in a standard model of the financial accelerator and explore its empirical and policy implications. In particular, we show how the model can account for: (i) a gradual and protracted expansionary phase followed by a sudden and sharp recession; (ii) the connection (or lack of connection!) between financial and real economic activity and; (iii) a fast and strong transmission of shocks across sectors and countries. We also use the model to explore the role of fiscal policy. |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1222&r=cba |
| By: | Tommy Sveen (Norges Bank (Central Bank of Norway)); Lutz Weinke (Humboldt-Universität zu Berlin) |
| Abstract: | The Taylor Principle is often used to explain macroeconomic stability (see, e.g., Clarida et al. 2000). The reason is that this simple principle guarantees determinacy, i.e., local uniqueness of rational expectations equilibrium, in many New Keynesian models. However, analyses of determinacy are generally conducted in the context of highly stylized models. In the present paper we use a medium-scale model which combines features that have been shown to explain fairly well postwar U.S. business cycles. Our main result demonstrates that the stability properties of forward-looking interest rate rules are very similar to the corresponding outcomes under current-looking rules. This is in stark contrast with many findings that have been obtained in the context of models whose empirical relevance is limited. |
| Keywords: | Nominal Rigidities, Real Rigidities, Monetary Policy |
| JEL: | E22 E31 |
| Date: | 2010–05–28 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2010_09&r=cba |
| By: | Massimiliano Marcellino; Alberto Musso |
| Abstract: | This paper provides real time evidence on the usefulness of the euro area output gap as a leading indicator for inflation and growth. A genuine real-time data set for the euro area is used, including vintages of several alternative gap estimates. It turns out that, despite some difference across output gap estimates and forecast horizons, the results point clearly to a lack of any usefulness of real-time output gap estimates for inflation forecasting both in the short term (one-quarter and one-year ahead) and the medium term (two-year and three-year ahead). By contrast, we find some evidence that several output gap estimates are useful to forecast real GDP growth, particularly in the short term, and some appear also useful in the medium run. A comparison with the US yields similar conclusions. |
| Keywords: | Output gap, real-time data, euro area, inflation forecasts, real GDP forecasts, data revisions. |
| JEL: | E31 E37 E52 E58 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2010/15&r=cba |
| By: | Betty C. Daniel (University at Albany); Christos Shiamptanis (Central Bank of Cyprus) |
| Abstract: | A country entering a monetary union gives up the right to determine its own monetary policy, thereby relinquishing monetary instruments to assure fiscal solvency. In this paper, we develop a new theoretical model to address fiscal solvency risk. We show that when debt is subject to an upper bound and policy faces stochastic shocks, a government can find itself in a position for which the expected present value of future surpluses under current policy is less than debt. Agents refuse to lend into such a position, and the sudden stop of capital flows defines a fiscal solvency crisis. We model the dynamics of a fiscal solvency crisis in a monetary union under the assumption that the fiscal authority will respond to the crisis using default to reduce the value of debt. We simulate the model to estimate fiscal solvency risk in the European Monetary Union. We find that countries adhering to the Stability and Growth Pack limits are perfectly safe, while countries like Greece and Italy, whose debt relative to GDP has strayed far above the 60 percent limit, are not. |
| Keywords: | European Monetary Union, sovereign default, financial crisis |
| JEL: | E42 E47 E62 F34 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:cyb:wpaper:2010-3&r=cba |
| By: | Sharon G. Harrison (Department of Economics, Barnard College, Columbia University); Mark Weder (School of Economics, University of Adelaide) |
| Abstract: | We examine a general equilibrium model with collateral constraints and increasing returns to scale in production. The utility function is nonseparable, with no income effect on the consumer's choice of leisure. Unlike this model without a collateral constraint, we find that indeterminacy of equilibria is possible. Hence, business cycles can be driven by self-fulfilling expectations. This is the case for more realistic parametrizations than in previous, similar models without these features. |
| Keywords: | Business cycles, Credit markets, Collateral Constraint, Sunspots |
| JEL: | E32 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:adl:wpaper:2010-02&r=cba |
| By: | Krisztina Molnár (Norwegian School of Economics and Business Administration, and Norges Bank (Central Bank of Norway)); Sergio Santoro (Bank of Italy) |
| Abstract: | We derive the optimal monetary policy in a sticky price model when private agents follow adaptive learning. We show that this slight departure from rationality has important implications for policy design. The central bank faces a new intertemporal trade-off, not present under rational expectations: it is optimal to forego stabilizing the economy in the present in order to facilitate private sector learning and thus ease the future intratemporal inflation-output gap trade-offs. The policy recommendation is robust: the welfare loss entailed by the optimal policy under learning if the private sector actually has rational expectations is much smaller than if the central bank mistakenly assumes rational expectations when in fact agents are learning. |
| Keywords: | optimal monetary policy, learning, rational expectations |
| JEL: | C62 D83 D84 E52 |
| Date: | 2010–05–27 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2010_08&r=cba |
| By: | Mandelman, Federico S (Federal Reserve Bank of Atlanta); Zanetti, Francesco (Bank of England) |
| Abstract: | Recent empirical evidence suggests that a positive technology shock leads to a decline in labour inputs. However, the standard real business model fails to account for this empirical regularity. Can the presence of labour market frictions address this problem, without otherwise altering the functioning of the model? We develop and estimate a real business cycle model using Bayesian techniques that allows, but does not require, labour market frictions to generate a negative response of employment to a technology shock. The results of the estimation support the hypothesis that labour market frictions are the factor responsible for the negative response of employment. |
| Keywords: | Technology shocks; employment; labour market frictions |
| JEL: | E32 |
| Date: | 2010–06–03 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0390&r=cba |
| By: | Òscar Jordà; Malte Knüppel; Massimiliano Marcellino |
| 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 con.dence 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 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2010/18&r=cba |
| By: | Faugere, Christophe |
| Abstract: | Economists have argued that a long-term inflation target near 2% is optimal (Summers, 1991; Fischer, 1996; Goodfriend, 2002; Coenen et al., 2003; Bernanke, 2003). However, these arguments are really about why a low positive inflation rate is ideal to avoid a deflationary trap, not explaining why the specific value of 2% (or a value near it) happens to be the optimal long-run inflation rate. In line with the transaction motive literature (Baumol, 1952 and Tobin, 1956), I postulate that new forms of money and technological progress generate cost savings in the transaction technology by comparison to barter. I derive the optimal velocity of money, which depends on real GDP/capita and the net return on depository institutions’ assets. As long as progress is on average biased towards new forms of money, the velocity of money will grow at a pace slower than long-term real GDP/capita growth; i.e. less than 2%. The empirical tests using Johansen’s (1995) VECM approach for the U.S. over the period 1959-2007 confirm that this is indeed the case. Along with a parameter representing the type of bias in the technical progress affecting transactions, the depository institutions’ overall mean leverage ratio also appears as a key parameter in the long-run equilibrium equation describing the behavior of the velocity of narrow money (M1, M1RS and M1S). I show that a ‘naïve’ Friedman k-percent monetary rule that aims at growing the money supply at the same rate as real GDP naturally leads to a rate of inflation equal to the rate of velocity growth. Hence, setting an inflation target near but below 2% makes economic sense. In spite of previously held beliefs, a money growth objective is compatible with an interest-targeting objective; i.e. a derived Taylor (1993) type rule. A Taylor rule that embeds the optimal inflation target defined here is more flexible to account for possible changes in velocity vs. a pure money growth rule. |
| Keywords: | Inflation target; velocity of narrow money; M1; M1RS; M1S; real GDP per capita growth; barter; financial leverage |
| JEL: | E40 |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:23056&r=cba |
| By: | Lundholm, Michael (Dept. of Economics, Stockholm University) |
| Abstract: | Inflation forecasts made 1999-2005 by Sveriges Riksbank and Konjunkturinstitet of Swedish inflation rates 1999-2007 are tested for unbiasedness; i.e., are the mean forecast errors zero? The bias is in the order of -0.1 percentage units for horizons below one year and in the order of 0.1 and 0.6 (depending on inflation measure) above one year. Using the maximum entropy bootstrap for inference bias is significant whereas inference using HAC indicates insignificance. |
| Keywords: | Forecast evaluation; inflation; unbiasedness; maximum entropy bootstrap |
| JEL: | E37 |
| Date: | 2010–06–03 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:sunrpe:2010_0010&r=cba |
| By: | A. Carriero; G. Kapetanios; M. Marcellino |
| Abstract: | We propose a new approach to forecasting the term structure of interest rates, which allows to efficiently extract the information contained in a large panel of yields. In particular, we use a large Bayesian Vector Autoregression (BVAR) with an optimal amount of shrinkage towards univariate AR models. Focusing on the U.S., we provide an extensive study on the forecasting performance of our proposed model relative to most of the existing alternative speci.cations. While most of the existing evidence focuses on statistical measures of forecast accuracy, we also evaluate the performance of the alternative forecasts when used within trading schemes or as a basis for portfolio allocation. We extensively check the robustness of our results via subsample analysis and via a data based Monte Carlo simulation. We .nd that: i) our proposed BVAR approach produces forecasts systematically more accurate than the random walk forecasts, though the gains are small; ii) some models beat the BVAR for a few selected maturities and forecast horizons, but they perform much worse than the BVAR in the remaining cases; iii) predictive gains with respect to the random walk have decreased over time; iv) di¤erent loss functions (i.e., "statistical" vs "economic") lead to di¤erent ranking of speci.c models; v) modelling time variation in term premia is important and useful for forecasting. |
| Keywords: | Bayesian methods, Forecasting, Term Structure. |
| JEL: | C11 C53 E43 E47 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eui:euiwps:eco2010/17&r=cba |
| By: | Marcelle, Chauvet; Insu, Kim |
| Abstract: | This paper proposes a dynamic stochastic general equilibrium model that endogenously generates inflation persistence. We assume that although firms change prices periodically, they face convex costs that preclude optimal adjustment. In essence, the model assumes that price stickiness arises from both the frequency and size of price adjustments. The model is estimated using Bayesian techniques and the results strongly support both sources of price stickiness in the U.S. data. In contrast with traditional sticky price models, the framework yields inflation inertia, delayed effect of monetary policy shocks on inflation, and the observed "reverse dynamic" correlation between inflation and economic activity. |
| Keywords: | In Inflation Persistence; Phillips Curve; Sticky Prices; Convex Costs |
| JEL: | E30 E31 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:23109&r=cba |
| By: | Fang Yao |
| Abstract: | Whelan (2007) found that the generalized Calvo-sticky-price model fails to replicate a typical feature of the empirical reduced-form Phillips curve - the positive dependence of inflation on its own lags. In this paper, I show that it is the 4-period-Taylor-contract hazard function he chose that gives rise to this result. In contrast, an empirically-based aggregate price reset hazard function can generate simulated data that are consistent with inflation gap persistence found in US CPI data. I conclude that a non-constant price reset hazard plays a crucial role for generating realistic inflation dynamics. |
| Keywords: | Inflation gap persistence, Trend inflation, New Keynesian Phillips curve, Hazard function |
| JEL: | E12 E31 |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2010-030&r=cba |
| By: | Hua Xiuping (China Center for Economic Research) |
| Abstract: | We examine determinants of inflation in China. Analyses of both year‐on‐year and month‐on‐month growth data confirm excess liquidity, output gap, housing prices and stock prices positively affecting inflation. Impulse response analyses indicate that most effects occur during the initial five months and disappear after 10 months. Effects of real interest rates and exchange rates on inflation are relatively weak. Our results suggest that output gap is as important as excess liquidity in explaining inflation trajectory. The central bank should closely monitor asset prices given their spillovers to inflation. Currently liquidity measures are still central for controlling inflation, but further liberalization of interest rates and exchange rates are critical. |
| Keywords: | China, inflation, excess liquidity, output gap and asset prices |
| JEL: | E31 E58 G12 R20 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eab:macroe:2196&r=cba |
| By: | Quaas, Georg; Klein, Mathias |
| Abstract: | A preliminary regression analysis of different versions of the Phillips Curve on the basis of yearly data of the German economy from 1952 to 2004 leads to the conclusion that the original finding might still be of empirical relevance. A simple plot of seasonal adjusted quarterly data between the change of nominal wage rates and the unemployment rate shows a picture similar to that by which Phillips was inspired to his famous discovery: A long-term tendency of a negative, non-linear relationship coupled with minor deviations from this tendency forming sometimes so called loops. At fist sight, the Phillips Curve of Germany comprises clusters of data points and movements between these clusters. The clusters can be analysed and – together with the rest of data – dissolved into 12 (left or right turning) loops and 9 movements between these loops during the period from 1971Q1 to 2009Q4. In spite of the striking differences of these phenomena, a model with one regression equation is sufficient to explain the loops, the movements between the loops and the long-term tendency of the German Phillips Curve. This empirical finding contradicts several aspects with the ruling dogma of a Phillips Curve that broke down in the ‘70s and with the allegedly better fit of its replacements by augmented and modified Phillips Curves. |
| Keywords: | Wages; inflation; unemployment; Phillips curve |
| JEL: | E24 E13 |
| Date: | 2010–06–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:23094&r=cba |
| By: | Chia-Lin Chang; Philip Hans Franses; Michael McAleer (University of Canterbury) |
| Abstract: | Macro-economic forecasts are often based on the interaction between econometric models and experts. A forecast that is based only on an econometric model is replicable and may be unbiased, whereas a forecast that is not based only on an econometric model, but also incorporates an expert’s touch, is non-replicable and is typically biased. In this paper we propose a methodology to analyze the qualities of combined non-replicable forecasts. One part of the methodology seeks to retrieve a replicable component from the non-replicable forecasts, and compares this component against the actual data. A second part modifies the estimation routine due to the assumption that the difference between a replicable and a non-replicable forecast involves a measurement error. An empirical example to forecast economic fundamentals for Taiwan shows the relevance of the methodological approach. |
| Keywords: | Combined forecasts; efficient estimation; generated regressors; replicable forecasts; non-replicable forecasts; expert’s intuition |
| JEL: | C53 C22 E27 E37 |
| Date: | 2010–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:cbt:econwp:10/35&r=cba |
| By: | Jörg Bibow |
| Abstract: | This paper investigates the spread of what started as a crisis at the core of the global financial system to emerging economies. While emerging economies had exhibited some resilience through the early stages of the financial turmoil that began in the summer of 2007, they have been hit hard since mid-2008. Their deteriorating fortunes are only partly attributable to the collapse in world trade and sharp drop in commodity prices. Things were made worse by emerging markets' exposure to the turmoil in global finance itself. As "innocent bystanders," even countries that had taken out "self-insurance" proved vulnerable to the global "sudden stop" in capital flows. We critique loanable funds theoretical interpretations of global imbalances and offer an alternative explanation that emphasizes the special status of the U.S. dollar. Instead of taking out even more self-insurance, developing countries should pursue capital account management to enlarge their policy space and reduce external vulnerabilities. |
| Keywords: | Financial Crisis; Capital Flows; Self-insurance; Capital Controls; Bretton Woods II Hypothesis; Global Saving Glut Hypothesis |
| JEL: | E12 E43 E44 F02 F10 F32 F33 F42 |
| Date: | 2010–03 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_591&r=cba |
| By: | Lawrence J. Christiano (Northwestern University, Department of Economics, 2001 Sheridan Road, Evanston, Illinois 60208, USA.); Mathias Trabandt (European Central Bank, Fiscal Policies Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Karl Walentin (Sveriges Riksbank, Research Division, 103 37 Stockholm, Sweden.) |
| Abstract: | We propose a monetary model in which the unemployed satisfy the official US definition of unemployment: they are people without jobs who are (i) currently making concrete efforts to find work and (ii) willing and able to work. In addition, our model has the property that people searching for jobs are better off if they find a job than if they do not (i.e., unemployment is ‘involuntary’). We integrate our model of involuntary unemployment into the simple New Keynesian framework with no capital and use the resulting model to discuss the concept of the ‘non-accelerating inflation rate of unemployment’. We then integrate the model into a medium sized DSGE model with capital and show that the resulting model does as well as existing models at accounting for the response of standard macroeconomic variables to monetary policy shocks and two technology shocks. In addition, the model does well at accounting for the response of the labor force and unemployment rate to the three shocks. JEL Classification: E2, E3, E5, J2, J6. |
| Keywords: | DSGE, unemployment, business cycles, monetary policy, Bayesian estimation. |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20101202&r=cba |
| By: | Barnett, Alina (Bank of England); Groen, Jan J J (Federal Reserve Bank of New York); Mumtaz, Haroon (Bank of England) |
| Abstract: | This paper examines how the interaction between inflation expectations and nominal and real macroeconomic variables has evolved for the United Kingdom over the post-WWII period until 2007. We model time-variation through a Markov-switching structural vector autoregressive framework with variants of the sign restriction identification scheme to back out the time-varying effect of different structural shocks. We investigate the following questions: (i) How has the impact of the mix of real and nominal shocks on the UK economy evolved over time and did this have a specific impact on UK inflation expectations? and (ii) Has there been an autonomous impact of inflation expectations on the UK economy and has it changed over time? Our results suggest that shocks to inflation expectations had important effects on actual inflation in the 1970s, but this impact had significantly declined towards the end of our sample. This seems to be mainly due to a relatively slower response of monetary policy to these shocks in the 1970s compared to later years. Similarly, oil price shocks and real demand shocks led to important changes in macroeconomic variables in the 1970s. Beyond that period and up to the end of our sample oil price shocks became less significant for the dynamics of actual inflation and output growth. However real demand shocks became a relatively more important determinant for fluctuations in those series during the 1990s and the beginning of the 2000s. The changing response of monetary policy to this type of shock appears to be crucial for this result. |
| Keywords: | Inflation expectations; Markov-switching structural VAR |
| JEL: | C10 E50 |
| Date: | 2010–06–03 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0392&r=cba |
| By: | Hogrefe, Jan; Jung, Benjamin; Kohler, Wilhelm |
| Abstract: | We know that euro-area member countries have absorbed asymmetric shocks in ways that are inconsistent with a common nominal anchor. Based on a reformulation of the gravity model that allows for such bilateral misalignment, we disentangle the conventional trade cost channel and trade effects deriving from 'implicit currency misalignment'. Econometric estimation reveals that the currency misalignment channel exerts a significant trade effect on bilateral exports. We retrieve country specific estimates of the euro effect on trade based on misalignment. This reveals asymmetric trade effects and heterogeneous outlooks across countries for the costs and benefits from adopting the euro. -- |
| Keywords: | Euro,gravity model,exchange rates,purchasing power parity,trade imbalances |
| JEL: | F12 F13 F15 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:zewdip:10023&r=cba |
| By: | David Kiefer |
| Abstract: | Carlin and Soskice (2005) advocate a 3-equation model of stabilization policy to replace the conventional IS-LM-AS model. One of their new equations is a monetary reaction rule MR derived by assuming that governments have performance objectives, but are constrained by an augmented Phillips curve PC. They label their replacement model the IS-PC-MR. Central banks achieve the PC-MR solution by setting interest rates along an IS curve. Observing that governments have more tools than just the interest rate, we simplify their model to 2 equations. We develop a state space econometric specification as the solution of these equations, adding a random walk model of the unobserved potential growth. Applying this method to a panel of North Atlantic countries, we find it historically consistent with a few qualifications. For one, governments are more likely to target growth rates, than output gaps. And, inflation expectations are more likely backward looking, than rational, but a two-step estimation based on a forward-looking sticky-price model dramatically improves the empirical fit. Significant interdependence can be seen in the between-country covariance of inflation and growth shocks. |
| Keywords: | new Keynesian, Kalman filtering, open economies |
| JEL: | E61 E63 |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:uta:papers:2010_06&r=cba |
| By: | T. BERGER; B. KEMPA; |
| Abstract: | This paper identifies the Canadian-US equilibrium exchange rate based on a simple structural model of the real exchange rate, in which monetary policy follows a Taylor rule interest rate reaction function. The equilibrium exchange rate is explained by relative output and inflation as observable variables, and by unobserved equilibrium rates as well as unobserved transitory components in output and the exchange rate. Using Canadian data over 1974- 2008 we jointly estimate the unobserved components and the structural parameters using the Kalman filter and Bayesian technique. We find that Canada's equilibrium exchange rate evolves smoothly and follows a trend depreciation. The transitory component is found to be very persistent but much more volatile than the equilibrium rate, resulting in few but prolonged periods of currency misalignments. |
| Keywords: | equilibrium exchange rate, unobserved components, Kalman filter, Bayesian analysis, Importance sampling |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:10/643&r=cba |
| By: | Oscar Bajo-Rubio (Universidad de Castilla-La Mancha); Carmen Díaz-Roldán (Universidad de Castilla-La Mancha); Vicente Esteve (Universidad de Valencia y Universidad de La Laguna) |
| Abstract: | In this paper, we provide a test of the sustainability of the Spanish government deficit over the period 1850-2000, and examine the role played by monetary and fiscal dominance in order to get fiscal solvency. The longer than usual span of the data would allow us to obtain some more robust results on the fulfilling of the intertemporal budget constraint than in most of previous analyses. First, we analyze the relationship between primary surplus and debt, following the recent critique of Bohn (2007), and investigate the possibility of structural changes occurring along the period by means of the new approach of Kejriwal and Perron (2008). The analysis is complemented in two directions: (i) performing Granger-causality tests in order to distinguish properly between a fiscal dominant and a monetary dominant regime; and (ii) presenting the impulse-response functions of debt to innovations in the primary surplus, through the approach of Canzoneri, Cumby and Diba (2001). |
| Keywords: | Fiscal policy, Sustainability, Fiscal Theory of the Price Level, Monetary dominance, Fiscal dominance. |
| JEL: | E62 H62 |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:aee:wpaper:1004&r=cba |
| By: | P. JACOB; |
| Abstract: | Many empirical studies report that .fiscal expansions have a positive effect on private consumption. This paper provides a closer examination of the .deep. habits mechanism used by Ravn, Schmitt-Grohé and Uribe (2006) to generate the positive comovement between public and private consumption. In their set-up, habit-formation at the level of individual varieties makes the demand function facing the price-setting .firm, dynamic. This makes it optimal for the .firms to lower mark-ups of prices over nominal marginal costs when they expand production in response to the .fiscal expansion, leading to an increase in the demand for labor and hence the real wage rises. The consequent intra-temporal substitution of consumption for leisure triggers the positive response of consumption. Here, we show that increasing either price or nominal wage stickiness, reduces the impact of fiscal spending shocks on the mark-up and the real wage. Hence, consumption is still crowded out as in traditional models. |
| Keywords: | Deep Habits, Sticky Prices, Sticky Wages, Fiscal Shocks, Crowding-out. |
| JEL: | E21 E31 E62 |
| Date: | 2010–02 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:10/641&r=cba |
| By: | di Pace, Federico (Department of Economics, Mathematics and Statistics, Birkbeck, University of London); Faccini, Renato (Bank of England) |
| Abstract: | We extend the standard textbook search and matching model by introducing deep habits in consumption. The cyclical fluctuations of vacancies and unemployment in our model can replicate those observed in the US data, with labour market tightness being 20 times more volatile than consumption. Vacancies display a hump-shaped response to technology shocks as well as autocorrelation coefficients that are in line with the empirical evidence. Our model preserves the assumption of fully flexible wages for the new hires and the calibration is consistent with the estimated elasticity of unemployment to unemployment benefits. The numerical simulations generate an artificial Beveridge curve which is in line with the data. |
| Keywords: | Consumption; business cycles; labour market fluctuations; search and matching; wage bargaining |
| JEL: | E21 E24 E32 J41 J64 |
| Date: | 2010–06–03 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:0391&r=cba |
| By: | Oscar Bajo-Rubio (Universidad de Castilla-La Mancha); Carmen Díaz-Roldán (Universidad de Castilla-La Mancha); Vicente Esteve (Universidad de Valencia y Universidad de La Laguna) |
| Abstract: | We provide a test of the sustainability of the Spanish government deficit over the period 1850-2000, from the estimation of a cointegration relationship between government expenditures and revenues derived from the intertemporal budget constraint. The longer than usual span of the data allows us to obtain more robust results on the fulfilment of the intertemporal budget constraint than most of the previous analyses. Two additional robustness checks are provided. First, we investigate the possibility of structural changes occurring along the period analyzed, using the new approach of Kejriwal and Perron (2008, 2010) to testing for multiple structural changes in cointegrated regression models. Second, we investigate whether the behaviour of fiscal authorities has been non-linear, by means of the procedure of Hansen and Seo (2002) based on a threshold cointegration model. Our results show that (i) the government deficit has been strongly sustainable in the long run, (ii) no evidence is found on any significant structural break throughout the whole period, and (iii) fiscal sustainability has been attained due to the non-linear behaviour of fiscal authorities, which have only acted on the budget deficit when it has exceeded around 4.5% of GDP. |
| Keywords: | fiscal policy, sustainability, structural change, threshold cointegration, nonlinearity |
| JEL: | E62 H62 |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:aee:wpaper:1003&r=cba |
| By: | Hyeongwoo Kim |
| Abstract: | Cheung et al. (2004) use a vector error correction model that allows different speeds of convergence for nominal exchange rates and relative prices toward PPP. With the current float monthly data for five countries, they argue that the sluggish PPP reversion is primarily driven by nominal exchange rate adjustment rather than price adjustment, which is at odds with the conventional sticky-price models. Major findings of this paper are twofold. First, we show that it may be inappropriate to use short-horizon high frequency data in vector error correction models, even when both the nominal exchange rate and the relative price are not weakly exogenous. Second, using a long-horizon annual data set for 11 countries vis-à-vis the US, we find a significantly important role of relative prices in real exchange rate dynamics. |
| Keywords: | Purchasing Power Parity, Convergence Rate, Half-Life, Impulse-Response, Variance Decomposition |
| JEL: | C32 F31 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:abn:wpaper:auwp2010-03&r=cba |
| By: | Co-Pierre Georg (Graduate School "Global Financial Markets - Stability and Change", Friedrich-Schiller-Universität Jena); Jenny Poschmann (School of Economics and Business Administration, Friedrich-Schiller-Universität Jena) |
| Abstract: | The breakdown of the interbank money markets in the face of the recent financial crisis has forced central banks and governments to take extraordinary measures to sustain financial stability. In this paper we investigate which influence central bank activity has on interbank markets. In our model, banks optimize a portfolio of risky investments and riskless excess reserves according to their risk and liquidity preferences. They are linked via interbank loans and face a stochastic supply of household deposits. We then introduce a central bank into the model and show that central bank activity enhances financial stability. We model the default of a large bank and analyse the resulting contagion effects. This is compared to a common shock that hits banks who have invested in similiar assets. Our results indicate that common shocks are not subordinate to contagion effects, but are instead the greater threat to systemic stability. |
| Keywords: | systemic risk, interbank markets, monetary policy, contagion, common shocks |
| JEL: | C63 E52 E58 G21 |
| Date: | 2010–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2010-033&r=cba |
| By: | Alexander Popov (European Central Bank, Financial Research Division, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Gregory F. Udell |
| Abstract: | We study the effect of financial distress in foreign parent banks on local SME financing in 14 central and eastern European countries during the early stages of the 2007-2008 financial crisis. We use survey data on applicant and non-applicant firms that enable us to disentangle effects driven by shocks to the banking system from recession-driven demand shocks that may vary across lenders. We find strong evidence that credit tightened in the relatively early stages of the crises caused by the following types of bank financial distress: 1) low equity ratio; 2) low Tier 1 capital ratio; and 3) losses on financial assets. We also find that foreign banks transmit to Main Street a larger portion of similar financial shocks than domestic banks. The observed decline in credit is greater among high-risk firms and firms with fewer tangible assets. JEL Classification: E44, E51, F34, G21. |
| Keywords: | credit crunch, financial crisis, bank lending channel, business lending. |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20101203&r=cba |
| By: | Guglielmo Maria Caporale; Roman Matousek; Chris Stewart |
| Abstract: | We model EU countries' bank ratings using financial variables and allowing for intercept and slope heterogeneity. Our aim is to assess whether "old" and "new" EU countries are rated differently and to determine whether "new" ones are assigned lower ratings, ceteris paribus, than "old" ones. We find that country-specific factors (in the form of heterogeneous intercepts) are a crucial determinant of ratings. Whilst "new" EU countries typically have lower ratings than "old" ones, after controlling for financial variables we also discover that all countries have significantly different intercepts, confirming our prior belief. This intercept heterogeneity suggests that each country's rating is assigned uniquely, after controlling for differences in financial factors, which may reflect differences in country risk and the legal and regulatory framework that banks face (such as foreclosure laws). In addition, we find that ratings may respond differently to the liquidity and operating expenses to operating income variables across countries. Typically ratings are more responsive to the former and less sensitive to the latter for "new" EU countries compared with "old" EU countries. |
| Keywords: | EU countries, banks, ratings, ordered probit models, index of indicator variable |
| JEL: | C25 C51 C52 G21 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1009&r=cba |
| By: | Hubert Gabrisch; L. Orlowski |
| Abstract: | We argue that monetary policies in euro-candidate countries should also aim at mitigating excessive instability of the key target and instrument variables of monetary policy during turbulent market periods. Our empirical tests show a significant degree of leptokurtosis, thus prevalence of tail-risks, in the conditional volatility series of such variables in the euro-candidate countries. Their central banks will be well-advised to use both standard and unorthodox (discretionary) tools of monetary policy to mitigate such extreme risks while steering their economies out of the crisis and through the euroconvergence process. Such policies provide flexibility that is not embedded in the Taylor-type instrument rules, or in the Maastricht convergence criteria. |
| Keywords: | monetary policy rules, tail-risks, convergence to the euro, global financial crisis, equity market risk, interest rate risk, exchange rate risk |
| JEL: | E44 F31 G15 P34 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:iwh:dispap:12-10&r=cba |
| By: | Antonio Colangelo (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Robert Inklaar (University of Groningen, PO Box 800, 9700 AV Groningen, The Netherlands.) |
| Abstract: | Banks do not charge explicit fees for many of the services they provide but the service payment is bundled with the offered interest rates. This output therefore has to be imputed using estimates of the opportunity cost of funds. We argue that rather than using the single short-term, low-risk interest rate as in current official statistics, reference rates should more closely match the risk characteristics of loans and deposits. For the euro area, imputed bank output is, on average, 24 to 40 percent lower than according to current methodology. This implies an average downward adjustment of euro area GDP (at current prices) between 0.16 and 0.27 percent. JEL Classification: E01, E44, O47. |
| Keywords: | Bank output, FISIM, risk, loan interest rates, deposit interest rates. |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20101204&r=cba |
| By: | Uwe Vollmer (University of Leipzig, Economics Department, Institute for Theoretical Economics); Ralf Bebenroth (Research Institute for Economics and Business Administration) |
| Abstract: | We describe the propagation of the recent financial crisis to Japan and compare current monetary policy reactions by the Bank of Japan (BoJ) with actions taken during the 1990s and with current policy reactions by other major central banks. First, we review the recent literature on the origins and propagation mechanisms of financial crises. Then, we ask how the financial crisis was transmitted to Japan and describe the policy responses by BoJ. We proceed and ask what lessons have been learned by other central banks from the financial crisis of the 1990s. |
| Keywords: | Financial crisis · Quantitative/qualitative easing · Exit strategy · Japan |
| JEL: | G21 E42 E52 |
| Date: | 2010–05 |
| URL: | http://d.repec.org/n?u=RePEc:kob:dpaper:dp2010-16&r=cba |
| By: | Domenica Tropeano (University of Macerata) |
| Abstract: | <p>In the paper it is argued that Minsky's theory of financial fragility, interpreted as a the-<br />ory of structural instability, is useful to interpret the current crisis. Structural instability<br />means that a small event can change the qualitative characteristic of a system and thus<br />even its dynamic properties. As Minsky wrote, beyond the uncertainty arising from ex-<br />pected inflows and outflows what matters is the state of markets when people need to take<br />positions in them. Before the financial crisis, though many agents were speculative and<br />Ponzi ones, the extreme liquidity of the markets has allowed them to operate quietly for a<br />long time. When the crisis exploded a tiny increase in the bankruptcy rate of mortgages<br />caused the breakdown of the whole financial system. The qualitative change that followed<br />in this case was the destruction of markets. Monetary policy had to use unusual tools<br />in order to cope with this event. The Federal Reserve however has changed its operating<br />procedures to overcome this problem to overcome this problem only late, as the financial<br />crisis had already propagated to the real sector. Thus the paper concludes that the Federal<br />Reserve did not perceive the potential danger for systemic stability of a huge unregulated<br />short term money market and did not switch promptly enough to the new measures once<br />the crisis started.</p> |
| Date: | 2010–04 |
| URL: | http://d.repec.org/n?u=RePEc:mcr:wpdief:wpaper00060&r=cba |
| By: | Neil Dias Karunaratne; Ramprasad Bhar (School of Economics, The University of Queensland) |
| Abstract: | Australia’s inflation rate and inflation uncertainty during the post-float era 1983Q3-2006Q4 have acted as important barometers of Australia’s macroeconomic performance. The conceptualisation and measurement of the nexus between inflation and inflation uncertainty is subject to complex dynamics. We use Markov regime switching heteroscedasticity (MRSH) model to capture long-run stochastic trend and short-run noisy components. This allows us to conclude that in post-float Australia the results deviate significantly from the mainstream Friedman paradigm on inflation and its uncertainty. We also critically review the plausibility of rival paradigm explaining this paradoxical behaviour. The regime shifts detected in the inflation dynamics appear to be linked to the macroeconomic policies pursued to achieve external and internal balance as implied by Keynesian Mundell-Fleming model. |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:qld:uq2004:405&r=cba |
| By: | ISAKOVA, Asel (CERGE-EI, 11121 Praha 1, Czech Republic) |
| Abstract: | Underdeveloped financial markets and periods of high inflation have stimulated dollarization and currency substitution in the economies of Central Asia. Some authors argue that the latter can pose serious obstacles for the effective conduct of monetary policy and can affect households' welfare. This study uses a model with money-in-the-utility function to estimate the elasticity of substitution between domestic and foreign currencies in three economies of Central Asia - Kazakhstan, the Kyrgyz Republic and Tajikistan. Utility derived from holding money balances is represented by a CES function with money holdings denominated in two currencies. The residents are assumed to diversify their monetary holdings due to instability of the domestic currency. The steady state analysis reveals that though currency substitution decreases governments' seigniorage revenue, holding foreign money can be welfare generating if domestic currency depreciates vis-ˆ-vis the currencies in which households' foreign balances holdings are denominated. De-dollarization can only be achieved through further macroeconomic stabilization that will bring price and exchange rate stability. Financial sector development will also decrease currency substitution through the provision of reliable financial instruments and the gaining of public confidence. |
| Keywords: | currency substitution, dollarization, monetary policy, seigniorage, welfare, transition economies |
| JEL: | E58 P2 E41 |
| Date: | 2010–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2010014&r=cba |