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on Central Banking |
| By: | Joshua Aizenman; Menzie D. Chinna; Hiro Ito (Asian Development Bank Institute) |
| Abstract: | This paper extends our previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, we examine the channels through which the trilemma policy configurations affect output volatility. Secondly, we investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, we look into how trilemma configurations have evolved in the aftermath of economic crises in the past. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of international reserves (IR). Greater financial openness helps reduce real exchange rate volatility. These results indicate that policymakers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. We also find that the “crisis economies” could end up with smaller output losses if they entered the crisis situation with more stable exchange rates or if they continue to hold a high level of IR and maintain greater exchange rate stability during the crisis period. Lastly, we find that developing countries are often found to have decreased the level of monetary independence and financial openness, but increased the level of exchange rate stability in the aftermath of a crisis, especially for the last two decades. This finding indicates how vulnerable developing countries, especially emerging market ones, are to volatile capital flows as a result of global financial liberalization. |
| Keywords: | economic crisis, financial crisis, trilemma, financial openess, exchange rate stability |
| JEL: | F15 F21 F31 F36 F41 O24 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eab:tradew:2249&r=cba |
| By: | Stephen Elias (Reserve Bank of Australia); Mariano Kulish (Reserve Bank of Australia) |
| Abstract: | Now that a number of central banks are faced with short-term nominal interest rates close to or at the zero lower bound, there is a renewed interest in the long-running debate about whether or not changes in the stock of money have direct effects. In particular, do changes in money have additional effects on aggregate demand outside of those induced by changes in short-term nominal interest rates? This paper revisits and reinterprets the empirical evidence based on single equation regressions which is quite mixed, with some results supporting and other results denying the existence of direct effects. We use a structural model with no direct effects of money to show that the finding of positive and statistically significant coefficients on real money growth can be misleading. The model generates data that, when used to estimate analogs of the empirical regressions, produce positive and statistically significant coefficients on real money growth, similar to those often found when using actual data. The problem is that single equation regressions leave out a set of variables, which in turn, gives rise to an omitted variables bias in the estimated coefficients on real money growth. Hence, they are an unreliable guide to calibrate monetary policies, in general, including at the zero lower bound. |
| Keywords: | money; monetary base; direct effects; output gap |
| JEL: | E40 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:rba:rbardp:rdp2010-05&r=cba |
| By: | Luca Sala; Ulf Soderstrom; Antonella Trigari |
| Abstract: | We use a standard quantitative business cycle model with nominal price and wage rigidities to estimate two measures of economic inefficiency in recent U.S. data: the output gap - the gap between the actual and effcient levels of output - and the labor wedge|the wedge between households' marginal rate of substitution and firms' marginal product of labor. We establish three results. (i ) The output gap and the labor wedge are closely related, suggesting that most inefficiencies in output are due to the inecient allocation of labor. (ii ) The estimates are sensitive to the structural interpretation of shocks to the labor market, which is ambiguous in the model. (iii ) Movements in hours worked are essentially exogenous, directly driven by labor market shocks, whereas wage rigidities generate a markup of the real wage over the marginal rate of substitution that is acyclical. We conclude that the model fails in two important respects: it does not give clear guidance concerning the eciency of business cycle fluctations, and it provides an unsatisfactory explanation of labor market and business cycle dynamics. |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:igi:igierp:365&r=cba |
| By: | V. Anton Muscatelli; Piergiovanna Natale; Patrizio Tirelli |
| Abstract: | We use a simple theoretical model of a monetary union where myopic discretionary fiscal policies generate excessive debt accumulation in steady state and inefficiently delayed debt adjustment following a shock. We advocate the adoption of a flexible debt targeting approach. By setting a long-term debt target and by raising the political cost associated to deviations from the optimal pace of debt reversal following a shock¸ institutional design induces the fiscal policymaker to implement unbiased discretionary responses to shocks. Since the power to discipline fiscal policymakers rests in the hands of national voters, this outcome can be achieved by increasing the transparency of the decision-making process, where national voters understand the long-term consequences of fiscal policies. In practice, we call for clearer and more focused supervision tasks for the European Commission and for a more active role of national Parliaments whenever a disagreement arises between the Commission and a national government. |
| JEL: | E52 E61 E63 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:mib:wpaper:195&r=cba |
| By: | Paul Levine (National Institute of Public Finance and Policy) |
| Abstract: | The past forty years or so has seen a remarkable transformation in macro-models used by central banks, policymakers and forecasting bodies. This papers describes this transformation from reduced-form behavioural equations estimated separately, through to contemporary micro-founded dynamic stochastic general equilibrium (DSGE) models estimated by systems methods. In particular by treating DSGE models estimated by Bayesian-Maximum-Likelihood methods I argue that they can be considered as probability models in the sense described by Sims (2007) and be used for risk-assessment and policy design. This is true for any one model, but with a range of models on oer it is possible also to design interest rate rules that are simple and robust across the rival models and across the distribution of parameter estimates for each of these rivals as in Levine et al. (2008). After making models better in a number of important dimensions, a possible road ahead is to consider rival models as being distinguished by the model of expectations. This would avoid becoming `a prisoner of a single system' at least with respect to expectations formation where, as I argue, there is relatively less consensus on the appropriate modelling strategy. |
| Keywords: | structured uncertainty, DSGE models, robustness, Bayesian estimation, interest-rate rules |
| JEL: | E52 E37 E58 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eab:macroe:2224&r=cba |
| By: | Robert Kollmann; Zeno Enders; Gernot J. Müller |
| Abstract: | This paper incorporates a global bank into a two-country business cycle model. The bank collects deposits from households and makes loans to entrepreneurs, in both countries. It has to finance a fraction of loans using equity. We investigate how such a bank capital requirement affects the international transmission of productivity and loan default shocks. Three findings emerge. First, the bank's capital requirement has little effect on the international transmission of productivity shocks. Second, the contribution of loan default shocks to business cycle fluctuations is negligible under normal economic conditions. Third, an exceptionally large loan loss originating in one country induces a sizeable and simultaneous decline in economic activity in both countries. This is particularly noteworthy, as the 2007-09 global financial crisis was characterized by large credit losses in the US and a simultaneous sharp output reduction in the US and the Euro Area. Our results thus suggest that global banks may have played an important role in the international transmission of the crisis. |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:eca:wpaper:2013/60880&r=cba |
| By: | William A. Barnett (Department of Economics, The University of Kansas); Marcelle Chauvet (University of California at Riverside) |
| Abstract: | This paper explores the disconnect of Federal Reserve data from index number theory. A consequence could have been the decreased systemic-risk misperceptions that contributed to excess risk taking prior to the housing bust. We find that most recessions in the past 50 years were preceded by more contractionary monetary policy than indicated by simple-sum monetary data. Divisia monetary aggregate growth rates were generally lower than simple-sum aggregate growth rates in the period preceding the Great Moderation, and higher since the mid 1980s. Monetary policy was more contractionary than likely intended before the 2001 recession and more expansionary than likely intended during the subsequent recovery. |
| Keywords: | Measurement error, monetary aggregation, Divisia index, aggregation, monetary policy, index number theory, financial crisis, great moderation, Federal Reserve. |
| JEL: | E40 E52 E58 C43 E32 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:kan:wpaper:201005&r=cba |
| By: | Barnett, William A.; Chauvet, Marcelle |
| Abstract: | This paper explores the disconnect of Federal Reserve data from index number theory. A consequence could have been the decreased systemic-risk misperceptions that contributed to excess risk taking prior to the housing bust. We find that most recessions in the past 50 years were preceded by more contractionary monetary policy than indicated by simple-sum monetary data. Divisia monetary aggregate growth rates were generally lower than simple-sum aggregate growth rates in the period preceding the Great Moderation, and higher since the mid 1980s. Monetary policy was more contractionary than likely intended before the 2001 recession and more expansionary than likely intended during the subsequent recovery. |
| Keywords: | Measurement error; monetary aggregation; Divisia index; aggregation; monetary policy; index number theory; financial crisis; great moderation; Federal Reserve. |
| JEL: | C43 E32 E58 E52 E40 |
| Date: | 2010–06–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:24721&r=cba |
| By: | Zeng, Zhixiong |
| Abstract: | Policy actions by the Federal Reserve during the recent financial crisis often involve recapitalization of banks. This paper offers a theory of the non-neutrality of money for policy actions taking the form of injecting capital into banks via nominal transfers, in an environment where banking frictions are present in the sense that there exists an agency cost problem between banks and their private-sector creditors. The analysis is conducted within a general equilibrium setting with two-sided financial contracting. We first show that even with perfect nominal flexibility, the recapitalization policy can have real effects on the economy. We then study the design of the optimal long-run recapitalization policy as well as the optimal short-run policy responses to banking riskiness shocks. |
| Keywords: | Banking frictions; two-sided debt contract; money neutrality; unconventional monetary policy; reaction function. |
| JEL: | E52 E44 D82 |
| Date: | 2010–08–25 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:24752&r=cba |
| By: | Kozo Ueda |
| Abstract: | This paper constructs a two-country DSGE model to study the nature of the recent financial crisis and its effects that spread immediately throughout the world owing to the globalization of banking. In the model, financial intermediaries (FIs) enter into chained credit contracts at home and abroad, engaging in cross-border lending to entrepreneurs by undertaking crossborder borrowing from investors. The FIs as well as the entrepreneurs in two countries are credit constrained, so all of their net worths matter. Our model reveals that under FIs' globalization, adverse shocks that hit one country affect the other, yielding business-cycle synchronization on both the real and financial sides. It also suggests that the FIs' globalization, net worth shock, and credit constraints are key to understanding the recent financial crisis. |
| Keywords: | Globalization ; Global financial crisis ; Business cycles ; Financial markets |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:feddgw:58&r=cba |
| By: | Claudio Borio (Bank for International Settlements); Bent Vale (Norges Bank (Central Bank of Norway)); Goetz von Peter (Bank for International Settlements) |
| Abstract: | How does the management and resolution of the current crisis compare with the response of the Nordic countries in the early 1990s, widely regarded as exemplary? We argue that, while intervention has been prompter, the measures taken so far remain less comprehensive and in-depth. In particular, the cleansing of balance sheets has proceeded more slowly, and less attention has been paid to reducing excess capacity and avoiding competitive distortions. In general, policymakers have given higher priority to sustaining aggregate demand in the short term than to encouraging adjustment in the financial sector and containing moral hazard. We argue that three factors largely explain this outcome: the more international nature of the crisis; the complexity of the instruments involved; and, hardly appreciated so far, the effect of accounting practices on the dynamics of the events, reflecting in particular the prominent role of fair value accounting (and mark to market losses) in relation to amortised cost accounting for loan books. There is a risk that the policies followed so far may delay the establishment of the basis for a sustainably profitable and less risk-prone financial sector. |
| Keywords: | Crisis management and resolution, principles for successful resolution, Nordic countries, fair value and amortised cost accounting, mark to market losses |
| JEL: | G21 G28 |
| Date: | 2010–08–31 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2010_17&r=cba |
| By: | Charles Adams (Asian Development Bank Institute) |
| Abstract: | This paper reviews recent state interventions in financial crises and draws lessons for crisis management. A number of areas are identified where crisis management could be strengthened, including with regard to the tools and instruments used to involve the private sector in crisis resolution (with a view to reducing the recent enhanced role of official bailouts and the associated moral hazard), to allow for the orderly resolution of systemically important financial firms (to make these firms “safe to fail”), and with regard to achieving better integration with ex ante macroprudential surveillance. The paper proposes the establishment of high level systemic risk councils (SRCs) in each country with responsibility for overseeing systemic risk in both tranquil times and crisis periods and coordinating the activities of key government ministries, agencies, and the central bank. |
| Keywords: | financial crisis, crisis management, private sector, moral hazard, systemic risk councils |
| JEL: | E58 E01 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eab:macroe:2252&r=cba |
| By: | Sylvia Kaufmann (Economic Studies Division, Oesterreichische Nationalbank); Johann Scharler (Department of Economics, University of Linz) |
| Abstract: | If firms borrow working capital to finance production, then nominal interest rates have a direct influence on in inflation dynamics, which appears to be the case empirically. However, interest rates may only partly mirror the cost of working capital. In this paper we explore the role of bank lending standards as a potential additional cost source and evaluate their empirical importance in explaining in ation dynamics in the US and in the euro area. JEL classification: E40, E50 |
| Keywords: | New Keynesian Phillips Curve, Cost Channel, Bank Lending Standards, Bayesian |
| Date: | 2010–09–08 |
| URL: | http://d.repec.org/n?u=RePEc:onb:oenbwp:164&r=cba |
| By: | Stilianos Fountas (Department of Economics, University of Macedonia) |
| Abstract: | We examine the relationship between inflation uncertainty, inflation and growth using annual historical data on industrial countries covering in many cases more than one century. Proxying inflation uncertainty by the conditional variance of inflation shocks, we obtain the following results. (1) There is significant evidence for the positive effect of inflation uncertainty on inflation supporting the Cukierman-Meltzer hypothesis. (2) There is mixed evidence on the causal effect of inflation on inflation uncertainty. (3) There is strong evidence that inflation uncertainty is not detrimental to output growth. |
| Keywords: | Inflation uncertainty, growth, GARCH models |
| JEL: | E31 O40 |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:mcd:mcddps:2010_12&r=cba |
| By: | Eyler, Robert; Sonora, Robert |
| Abstract: | Monetary policy has differential effects throughout the United States. When setting monetary policy, central banks must consider how national and regional economic goals are being achieved. In this study, the methods and evidence are focused on using structural VAR analysis, assuming that the United States has an interest rate channel of monetary policy. The methods estimate the symmetry and magnitude of monetary shocks on income, unemployment and prices in major metropolitan statistical areas (MSAs) of the United States as compared to the national effects. As in Carlino and Defina (1998) and Florio (2005), differential regional effects connect to optima currency areas (OCA) literature, the advent of the Euro, increased regionalism, and the possibility of more monetary unions forming worldwide. Events in early 2010 concerning the Euro's stability show the importance of monitoring regions and their reactions to policy. |
| Keywords: | E52 ; E61; E37; R12 |
| JEL: | E52 R12 E37 E61 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:24745&r=cba |
| By: | Rasmus Fatum (School of Business, University of Alberta); Jesper Pedersen (Danish Economic Council); Peter Norman Sørensen (Department of Economics, University of Copenhagen) |
| Abstract: | This paper investigates the intraday effects of unannounced foreign exchange intervention on bid-ask exchange rate spreads using official intraday intervention data provided by the Danish central bank. Our starting point is a simple theoretical model of the bid-ask spread which we use to formulate testable hypotheses regarding how unannounced intervention purchases and intervention sales influence the market asymmetrically. To test these hypotheses we estimate weighted least squares (WLS) time-series models of the intraday bid-ask spread. Our main result is that intervention purchases and sales both exert a significant influence on the exchange rate spread, but in opposite directions: intervention purchases of the smaller currency, on average, reduce the spread while intervention sales, on average, increase the spread. We also show that intervention only affects the exchange rate spread when the state of the market is not abnormally volatile. Our results are consistent with the notion that illiquidity arises when traders fear speculative pressure against the smaller currency and confirms the asymmetry hypothesis of our theoretical model. |
| Keywords: | Foreign Exchange Intervention; Exchange Rate Spreads; Intraday Data |
| JEL: | D53 E58 F31 G15 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:1020&r=cba |
| By: | Tri Vi Dang (Yale University, Department of Economics); Hendrik Hakenes (Institute of Financial Economics, Leibniz University Hannover) |
| Abstract: | Disclosure of information triggers immediate price movements, but it mitigates price movements at a later date, when the information would otherwise have become public. Consequently, disclosure shifts risk from later cohorts of investors to earlier cohorts. Hence, disclosure policy can be interpreted as a tool to “control” interim asset price movements, and to allocate risk intertemporally. This paper shows that a policy of partial disclosure (and, hence, of intertemporal risk sharing) can maximize, but surprisingly also minimize, the market value of the firm. Our model also applies to a setting where a central bank chooses the quality and frequency of the disclosure of macroeconomic information, or to the precision of disclosure by (distressed) banks. |
| Keywords: | Financial reporting, disclosure, information policy, asset pricing, intertemporal risk sharing, general equilibrium |
| JEL: | G14 D92 M41 |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:mpg:wpaper:2010_36&r=cba |
| By: | Zhongfang He |
| Abstract: | The author evaluates the effect of the Bank of Canada's conditional commitment regarding the target overnight rate on longer-term market interest rates by taking into account the relationship between interest rates, inflation, and unemployment rates. By using vector autoregressive models of monthly interest rates, month-over-month inflation, and unemployment rates for Canada and the United States, the author finds that the Canadian 1-year treasury bill rates and 1-year forward 3-month rates have generally been lower than their model-implied values since April 2009, while the difference between the U.S. realized rates and their model-implied values has been much smaller. The author also studies the effect of the conditional commitment on longer-term government bond yields with maturities of 2, 5, and 10 years, and finds lower actual Canadian longer-term interest rates than their model-implied values, though their difference diminishes as the maturities become longer. The evidence appears to suggest that the Bank of Canada's conditional commitment likely has produced a persistent effect in lowering Canadian interest rates relative to what their historical relationship with inflation and unemployment rates would imply. However, this finding is not statistically strong and is subject to caveats such as possible in-sample model instability and the dependence of the results on the choice of inflation variable. |
| Keywords: | Interest rates; Monetary policy implementation; Transmission of monetary policy |
| JEL: | E4 E5 E6 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:10-11&r=cba |
| By: | Luca Agnello (University of Palermo); Ricardo M. Sousa (Universidade do Minho - NIPE) |
| Abstract: | We assess the role played by fiscal policy in explaining the dynamics of asset markets. Using a panel of ten industrialized countries, we show that a positive fiscal shock has a negative impact in both stock and housing prices. However, while stock prices immediately adjust to the shock and the effect of fiscal policy is temporary, housing prices gradually and persistently fall. As a result, the attempts of fiscal policy to mitigate stock price developments may severely de-stabilize housing markets. The empirical findings also point to: (i) a contractionary effect of fiscal policy on output in line with the existence of crowding-out effects; (ii) a weakening of the effectiveness of fiscal policy in recent times; (iii) significant fiscal multiplier effects in the context of severe housing busts; and (iv) an increase of the sensitivity of asset prices to fiscal policy shocks following the process of financial deregulation and mortgage liberalization. Finally, the evidence suggests that changes in equity prices may help governments towards consolidation of public finances. |
| Keywords: | fiscal policy, asset prices, panel VAR. |
| JEL: | E62 H30 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:25/2010&r=cba |
| By: | Gunes Kamber; Stephen Millard (Reserve Bank of New Zealand) |
| Abstract: | This paper aims to contribute to our understanding of inflation dynamics in the United Kingdom by estimating two dynamic stochastic general equilibrium models and assessing the role of nominal and real rigidities within them. We first obtain an empirical representation of the monetary transmission mechanism in the United Kingdom and then estimate the models by minimising the difference between this representation and its model equivalents.We find that both models can explain the data reasonably well without relying on undue amounts of price and wage stickiness. |
| JEL: | E31 F52 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:nzb:nzbdps:2010/05&r=cba |
| By: | Richard Ashley; Kwok Ping Tsang; Randal J. Verbrugge |
| Abstract: | We estimate a monetary policy rule allowing for possible frequency dependence - i.e. allowing the central bank to respond di¤erently to persistent innovations than to transitory innovations, in both the real-time unemployment rate and the real-time inflation rate. The method is flexible, and requires no strong a priori assumptions on the pattern of frequency dependence or on the nature of the data-generating process. The data convincingly reject linearity in the monetary policy rule, in the direction suggested by theory. Our two major …ndings are 1) the post-Volcker central bank responds more strongly to unemployment rate fluctuations than previous regimes do and 2) while the post-Volcker central bank reacts more strongly to persistent inflation fluctuations, it actually accommodates inflation at higher frequencies. |
| Keywords: | Taylor rule, frequency dependence, spectral regression, real-time data |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:vpi:wpaper:e07-21&r=cba |
| By: | Ashima Goyal (Indira Gandhi Institute of Development Research); Shruti Tripathi (Indira Gandhi Institute of Development Research) |
| Abstract: | Since consumer prices are a weighted average of the prices of domestic and of imported consumption goods, and producer prices feed into final consumer prices, wholesale price inflation should cause consumer price inflation. Moreover, there should exist a long-term equilibrium relationship between consumer and wholesale price inflation and the exchange rate. But we derive a second relation between the price series from an Indian aggregate supply function, giving reverse causality. The CPI inflation should Granger cause WPI inflation, through the effect of food prices on wages and producer prices. These restrictions on causal relationships are tested using a battery of time series techniques on the indices and their components. We find evidence of reverse causality, when controls are used for other variables affecting the indices. Second, both the identity and the AS hold as long-run cointegrating relationships. There is an important role for supply shocks. Food price inflation is cointegrated with manufacturing inflation. The exchange rate affects consumer prices. The insignificance of the demand variable in short-run adjustment indicates an elastic AS. There is no evidence of a structural break in the time series on inflation. Convergence is slow, and this together with differential shocks on the two series may explain their recent persistent divergence. |
| Keywords: | Consumer and wholesale price inflation, aggregate supply, Granger causality, cointegration, VECM |
| JEL: | E31 E12 C32 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:ind:igiwpp:2010-012&r=cba |
| By: | Shin-ichi Fukuda (Faculty of Economics, University of Tokyo) |
| Abstract: | This paper explores how international money markets reflected credit and liquidity risks during the global financial crisis. After matching the currency denomination, we investigate how the Tokyo Interbank Offered Rate (TIBOR) was synchronized with the London Interbank Offered Rate (LIBOR) denominated in the US dollar and the Japanese yen. Regardless of the currency denomination, TIBOR was highly synchronized with LIBOR in tranquil periods. However, the interbank rates showed substantial deviations in turbulent periods. We find remarkable asymmetric responses in reflecting market-specific and currency-specific risks during the crisis. The regression results suggest that counter-party credit risk increased the difference across the markets, while liquidity risk caused the difference across the currency denominations. They also support the view that a shortage of US dollar as liquidity distorted the international money markets during the crisis. We find that coordinated central bank liquidity provisions were useful in reducing liquidity risk in the US dollar transactions. But their effectiveness was asymmetric across the markets. |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2010cf759&r=cba |
| By: | Vítor Castro (Universidade de Coimbra and NIPE); Ricardo M. Sousa (Universidade do Minho - NIPE) |
| Abstract: | We assess the response of monetary policy to developments in asset markets in the Euro Area, the US and the UK. We estimate the reaction of monetary policy to wealth composition and asset prices using: (i) a linear framework based on a fully simultaneous system approach in a Bayesian environment; and (ii) a nonlinear specification that relies on a smooth transition regression model. The linear framework suggests that wealth composition is indeed important in the formulation of monetary policy. However, the attempts of central banks to mitigate undesirable fluctuations in say, financial wealth, may disrupt housing wealth. A similar result can be found when we assess the reaction of monetary authority to asset prices, although concerns about "price" effects are smaller. The nonlinear model confirms these findings. However, the concerns over the wealth and its components are stronger once inflation is under control, i.e. below a certain target. Some disruptions between financial and housing wealth effects are still present. They can also be found in reaction to asset prices, despite being less intense. |
| Keywords: | monetary policy rules, wealth composition, asset prices. |
| JEL: | E37 E52 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:26/2010&r=cba |
| By: | Yu-chin Chen; Kwok Ping Tsang |
| 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 in‡ ation) 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 …ndings provide support for the view that the nominal exchange rate is determined by both macroeconomic as well as financial forces. |
| Keywords: | Exchange Rate, Term Structure, Latent Factors, Term premiums |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:vpi:wpaper:e07-19&r=cba |
| By: | Fabio C. Bagliano (Department of Economics and Public Finance "G. Prato", University of Torino); Claudio Morana (Department of Economics and Quantitative Methods, University of Eastern Piedmont) |
| Abstract: | As economic and financial integration between the US and the euro area is strong, assessing whether the recent US crisis may affect the process of real and nominal convergence within the euro area is important. The paper addresses this issue in the framework of a large-scale open economy macroeconometric model, featuring 14 euro area member countries, the USA, and 35 advanced and emerging economies. The results point to a likely contribution of US economic and financial crises to real divergence in the euro area, potentially affecting first, second and third moments of the output growth distribution; on the other hand, implications for nominal convergence are less clearcut. |
| Keywords: | Euro area convergence, Great Recession, financial crisis, economic crisis, factor vector autoregressive models |
| JEL: | C22 E32 F36 |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:tur:wpaper:15&r=cba |
| By: | Sonora, Robert |
| Abstract: | Studies of the relationship between national in ation rates and the output gap, as formalized in the New Keynesian Phillips Curve, ignore macroeconomic heterogeneity which exist in dierent parts of the country. This paper investigates dierences in in ation and output across United States cities. The policy implications are dicult to ignore given dierences in production across the country as a whole. Also of interest is identifying the median city-economy in the US. Thus when policy is implemented which city sees the greatest benet of new policy? In addition to considering the standard Phillips relation between inflation and the output gap, I also consider the relationship between inflation and an index of wage costs as suggested in the literature. Preliminary results demonstrate a signicant degree of heterogeneity across cities implying centralized policy prescriptions are helpful for some economies are harmful to others. |
| Keywords: | Inflation Dynamics; New Keynesian Phillips Curve; GMM |
| JEL: | E32 E31 E52 |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:24650&r=cba |
| By: | Marianna Červená; Martin Schneider |
| Abstract: | DSGE models are useful tools for evaluating the impact of policy changes but their use for (short-term) forecasting is still at an infant stage. Besides theory based restrictions, the timeliness of data is an important issue. Since DSGE models are based on quarterly data, they are vulnerable to a publication lag of quarterly national accounts. In this paper we propose a framework for a short-term forecasting of GDP based on a medium-scale DSGE model for a small open economy within a currency area that utilizes the timely information available in monthly conjunctural indicators. To this end we adopt a methodology proposed by Giannone, Monti and Reichlin (2009). Using Austrian data we find that the forecasting performance of the DSGE model can be improved considerably by conjunctural indicators while still maintaining the story-telling capability of the model. JEL classification: |
| Keywords: | DSGE models, nowcasting, short-term forecasting, monthly indicators |
| Date: | 2010–08–25 |
| URL: | http://d.repec.org/n?u=RePEc:onb:oenbwp:163&r=cba |
| By: | Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Patrick Rakotomarolahy (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I) |
| Abstract: | An empirical forecast accuracy comparison of the non-parametric method, known as multivariate Nearest Neighbor method, with parametric VAR modelling is conducted on the euro area GDP. Using both methods for nowcasting and forecasting the GDP, through the estimation of economic indicators plugged in the bridge equations, we get more accurate forecasts when using nearest neighbor method. We prove also the asymptotic normality of the multivariate k-nearest neighbor regression estimator for dependent time series, providing confidence intervals for point forecast in time series. |
| Keywords: | Forecast - Economic indicators - GDP - Euro area - VAR - Multivariate k nearest neighbor regression - Asymptotic normality |
| Date: | 2010–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00511979_v1&r=cba |
| By: | Norbert Christopeit (University of Bonn); Michael Massmann (VU University Amsterdam) |
| Abstract: | In this paper we consider regression models with forecast feedback. Agents' expectations are formed via the recursive estimation of the parameters in an auxiliary model. The learning scheme employed by the agents belongs to the class of stochastic approximation algorithms whose gain sequence is decreasing to zero. Our focus is on the estimation of the parameters in the resulting actual law of motion. For a special case we show that the ordinary least squares estimator is consistent. |
| Keywords: | Adaptive learning; forecast feedback; stochastic approximation; linear regression with stochastic regressors; consistency |
| JEL: | C13 C22 D83 D84 |
| Date: | 2010–08–23 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20100077&r=cba |
| By: | Andrea Terzi |
| Abstract: | With the global crisis, the policy stance around the world has been shaken by massive government and central bank efforts to prevent the meltdown of markets, banks, and the economy. Fiscal packages, in varied sizes, have been adopted throughout the world after years of proclaimed fiscal containment. This change in policy regime, though dubbed the "Keynesian moment," is a "short-run fix" that reflects temporary acceptance of fiscal deficits at a time of political emergency, and contrasts with John Maynard Keynes’s long-run policy propositions. More important, it is doomed to be ineffective if the degree of tolerance of fiscal deficits is too low for full employment. Keynes’s view that outside the gold standard fiscal policies face real, not financial, constraints is illustrated by means of a simple flow-of-funds model. This shows that government deficits do not take financial resources from the private sector, and that demand for net financial savings by the private sector can be met by a rising trade surplus at the cost of reduced consumption, or by a rising government deficit financed by the monopoly supply of central bank credit. Fiscal deficits can thus be considered functional to the objective of supplying the private sector with a provision of financial wealth sufficient to restore demand. By contrast, tax hikes and/or spending cuts aimed at reducing the public deficit lower the available savings of the private sector, and, if adopted too soon, will force the adjustment by way of a reduction of demand and standard of living. This notion, however, is not applicable to the euro area, where constraints have been deliberately created that limit public deficits and the supply of central bank credit, thus introducing national solvency risks. This is a crucial flaw in the institutional structure of Euroland, where monetary sovereignty has been removed from all existing fiscal authorities. Absent a reassessment of its design, the euro area is facing a deflationary tendency that may further erode the economic welfare of the region. |
| Keywords: | Government and the Monetary System; Fiscal Policy; Keynes; Euro Area |
| JEL: | E12 E42 E62 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_614&r=cba |
| By: | Nicoletta Batini; Vasco Gabriel; Paul Levine; Joseph Pearlman (National Institute of Public Finance and Policy) |
| Abstract: | We first develop a two-bloc model of an emerging open economy interacting with the rest of the world calibrated using Indian and US data. The model features a financial accelerator and is suitable for examining the effects of financial stress on the real economy. Three variants of the model are highlighted with increasing degrees of financial frictions. The model is used to compare two monetary interest rate regimes: domestic Inflation targeting with a floating exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both rules are characterized as a Taylor-type interest rate rules. MEX involves a nominal exchange rate target in the rule and a constraint on its volatility. We find that the imposition of a low exchange rate volatility is only achieved at a significant welfare loss if the policymaker is restricted to a simple domestic inflation plus exchange rate targeting rule. If on the other hand the policymaker can implement a complex optimal rule then an almost fixed exchange rate can be achieved at a relatively small welfare cost. This finding suggests that future research should examine alternative simple rules that mimic the fully optimal rule more closely. |
| Keywords: | DSGE model, Indian economy, monetary interest rate rules, floating versus managed exchange rate, financial frictions |
| JEL: | E52 E37 E58 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:eab:macroe:2222&r=cba |