nep-cba New Economics Papers
on Central Banking
Issue of 2010‒09‒25
thirty-six papers chosen by
Alexander Mihailov
University of Reading

  1. Diminished Expectations, Double Dips, and External Shocks: The Decade After the Fall By Reinhart, Carmen; Reinhart, Vincent
  2. Short and long interest rate targets By Bernardino Adão; Isabel Correia; Pedro Teles
  3. The impacts of economic structures on the performance of simple policy rules in a small open economy By Siok Kun, Sek
  4. Money, reserves, and the transmission of monetary policy: does the money multiplier exist? By Seth B. Carpenter; Selva Demiralp
  5. Ambiguity in asset pricing and portfolio choice: a review of the literature By Massimo Guidolin; Francesca Rinaldi
  6. Short-run and Long-run Effects of Banking in a New Keynesian Model By Miguel Casares; Jean-Christophe Poutineauy
  7. Reasonable people did disagree : optimism and pessimism about the U.S. housing market before the crash By Kristopher S. Gerardi; Christopher L. Foote; Paul S. Willen
  8. The information content of high-frequency data for estimating equity return models and forecasting risk By Dobrislav P. Dobrev; Pawel J. Szerszen
  9. Supply, demand and monetary policy shocks in a multi-country New Keynesian Model By Stéphane Dées; M. Hashem Pesaran; L. Vanessa Smith; Ron P. Smith
  10. Monetary Policy, Trend Inflation and the Great Moderation:An Alternative Interpretation By Olivier Coibion; Yuriy Gorodnichenko
  11. Information or Institution? – On the Determinants of Forecast Accuracy By Roland Döhrn; Christoph M. Schmidt
  12. Gathering insights on the forest from the trees: a new metric for financial conditions By Scott Brave; R. Andrew Butters
  13. Asset Price Regulators, Unite: you have Macroeconomic Stability to Win and the Microeconomic Losses are Second-order By G. Menzies; R. Bird; P. Dixon; M. Rimmer
  14. $1.25 Trillion is still real money : some facts about the effects of the Federal Reserve’s mortgage market investments By Andreas Fuster; Paul S. Willen
  15. Major public debt reductions: Lessons from the past, lessons for the future By Christiane Nickel; Philipp Rother; Lilli Zimmermann
  16. The effects of bank capital on lending: what do we know, and what does it mean? By Jose M. Berrospide; Rochelle M. Edge
  17. Exchange Rate Target Zones: A Survey of the Literature By António Portugal Duarte; João Sousa Andrade; Adelaide Duarte
  18. Foreign Currency Loans - Demand or Supply Driven? By Brown, Martin; Kirschenmann, Karolin; Ongena; Steven
  19. Current account determinants and external sustainability in periods of structural change By Sophocles N. Brissimis; George Hondroyiannis; Christos Papazoglou; Nicholas T. Tsaveas; Melina A. Vasardani
  20. Strategic Interaction among Heterogeneous Price-Setters in an Estimated DSGE Model By Olivier Coibion; Yuriy Gorodnichenko
  21. Forecast Combination and Bayesian Model Averaging - A Prior Sensitivity Analysis By Feldkircher, Martin
  22. The Stability and Growth Pact: Past Performance and Future Reforms By Amy K. Filipek; Till Schreiber
  23. Fiscal policy in the United States: automatic stabilizers, discretionary fiscal policy actions, and the economy By Glenn Follette; Byron Lutz
  24. Public and private learning from prices, strategic substitutability and complementarity, and equilibrium multiplicity By Manzano, Carolina; Vives, Xavier
  25. Household money holdings in the euro area: An explorative investigation By Franz Seitz; Julian von Landesberger
  26. Virtual Model Validation for Economics By David K Levine
  27. The endogenous dynamics of markets: price impact and feedback loops By Jean-Philippe Bouchaud
  28. Explaining Inflation Persistence by a Time-Varying Taylor Rule By Conrad, Christian; Eife, Thomas A.
  29. Are the intraday effects of central bank intervention on exchange rate spreads asymmetric and state dependent? By Rasmus Fatum; Jesper Pedersen; Peter Norman Sørensen
  30. What credit card puzzle? Precaution, variable debt limits, and what we can learn from the small debts of poor people By Scott Fulford
  31. Driven by the Markets? ECB Sovereign Bond Purchases and the Securities Markets Programme By Ansgar Belke
  32. Matching frictions, unemployment dynamics and the cost of business cycles By Jean-Olivier Hairault; François Langot; Sophie Osotimehin
  33. A new approach to analyzing convergence and synchronicity in growth and business cycles: cross recurrence plots and quantification analysis By Crowley, Patrick M; Schultz, Aaron
  34. Characterizing the Business Cycles of Emerging Economies By César Calderón; Rodrigo Fuentes.
  35. Correlation Structure between Inflation and Oil Futures Returns: An Equilibrium Approach By Jaime Casassus; Diego Ceballos
  36. Monetary policy, asset prices and consumption in China By Tuuli Koivu

  1. By: Reinhart, Carmen; Reinhart, Vincent
    Abstract: In our recent paper, (Reinhart and Reinhart, 2010) we examine the behavior of real GDP (levels and growth rates), unemployment, inflation, bank credit, and real estate prices in a twenty one-year window surrounding selected adverse global and country-specific shocks or events. In this note, we summarize some of the main findings of that paper, including that economic growth is notably slower in the decade following a macroeconomic disruption. We extend those results to provide evidence of several post-crisis “double dips” in the years following the crisis. A faltering of economic recovery is not uncommon after a severe financial shock, although this can often be ascribed to exogenous events.
    Keywords: recession; unemployment; financial crisis; growth; external shocks
    JEL: N1 F3 E6
    Date: 2010–09
  2. By: Bernardino Adão; Isabel Correia; Pedro Teles
    Abstract: We show that short and long nominal interest rates are independent monetary policy instruments. The pegging of both helps solving the problem of multiplicity that arises when only short rates are used as the instrument of policy. A peg of the nominal returns on assets of different maturities is equivalent to a peg of state-contingent interest rates. These are the rates that should be targeted in order to implement unique equilibria. At the zero bound, while it is still possible to target state-contingent interest rates, that is no longer equivalent to the target of the term structure.
    Date: 2010
  3. By: Siok Kun, Sek
    Abstract: Applying a stochastic dynamic general equilibrium model, the performance of various simple rules is analyzed in a small open economy context. The aspects that are considered in the analysis include the degree of exchange rate pass-through, trade openness, the policy objective and the source and persistency of shocks. The main objective of this analysis is to investigate if the rule reacts to exchange rate performs better than the basic closed economy rule without exchange rate term. Comparison on the performances is also made between the consumer inflation targeting and domestic inflation targeting rules. The results show that adding the exchange rate term to the policy rule enhances improvement especially in the higher pass-through case. The superior rule is the hybrid rule that reacts to the exchange rate term. CPI inflation targeting rules outperform the domestic inflation targeting rules in term of welfare loss. However, more complicated domestic inflation targeting rules generate lower loss in term of relative loss. On the second part of this chapter, comparisons on the performances of different exchange rate regimes are made under different source and persistency of shocks. The floating (pegged) regime is favored under more prominent real (nominal) shocks. The results suggest that emerging countries that experience very large real shocks should float their exchange rate.
    Keywords: simple policy rule; exchange rate pass-through; open economy model
    JEL: E58 N15 E52 H30 N25 F41 E61
    Date: 2009–11
  4. By: Seth B. Carpenter; Selva Demiralp
    Abstract: With the use of nontraditional policy tools, the level of reserve balances has risen significantly in the United States since 2007. Before the financial crisis, reserve balances were roughly $20 billion whereas the level has risen well past $1 trillion. The effect of reserve balances in simple macroeconomic models often comes through the money multiplier, affecting the money supply and the amount of bank lending in the economy. Most models currently used for macroeconomic policy analysis, however, either exclude money or model money demand as entirely endogenous, thus precluding any causal role for reserves and money. Nevertheless, some academic research and many textbooks continue to use the money multiplier concept in discussions of money. We explore the institutional structure of the transmission mechanism beginning with open market operations through to money and loans. We then undertake empirical analysis of the relationship among reserve balances, money, and bank lending. We use aggregate as well as bank-level data in a VAR framework and document that the mechanism does not work through the standard multiplier model or the bank lending channel. In particular, if the level of reserve balances is expected to have an impact on the economy, it seems unlikely that a standard multiplier story will explain the effect.
    Date: 2010
  5. By: Massimo Guidolin; Francesca Rinaldi
    Abstract: A growing body of empirical evidence suggests that investors’ behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the empirical failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs.
    Keywords: Capital assets pricing model ; Investments
    Date: 2010
  6. By: Miguel Casares (Departamento de Economía-UPNA); Jean-Christophe Poutineauy (Faculté des Sciences Economiques, Université de Rennes I, Rennes, France)
    Abstract: This paper introduces both endogenous capital accumulation and deposit-in-advance requirements in the banking model of Goodfriend and McCallum (2007). Impulse response functions from technology and monetary shocks show some attenuation effect due to the procyclical behavior of the marginal finance cost. In addition, an adverse financial shock produces sizeable realistic declines in output, inflation and interest rates. In the long-run analysis, one economy where banking intermediation requires 4% of total labor force suffers from a permanent welfare cost equivalent to 1.96% of output.
    Keywords: financial attenuator, financial shocks, welfare cost of banking.
    JEL: E32 E43 E44
    Date: 2010
  7. By: Kristopher S. Gerardi; Christopher L. Foote; Paul S. Willen
    Abstract: Understanding the evolution of real-time beliefs about house price appreciation is central to understanding the U.S. housing crisis. At the peak of the recent housing cycle, both borrowers and lenders appealed to optimistic house price forecasts to justify undertaking increasingly risky loans. Many observers have argued that these rosy forecasts ignored basic theoretical and empirical evidence that pointed to a massive overvaluation of housing and thus to an inevitable and severe price decline. We revisit the boom years and show that the economics profession provided little such countervailing evidence at the time. Many economists, skeptical that a bubble existed, attempted to justify the historic run-up in housing prices based on housing fundamentals. Other economists were more uncertain, pointing to some evidence of bubble-like behavior in certain regional housing markets. Even these more skeptical economists, however, refused to take a conclusive position on whether a bubble existed. The small number of economists who argued forcefully for a bubble often did so years before the housing market peak, and thus lost a fair amount of credibility, or they make arguments fundamentally at odds with the data even ex post. For example, some economists suggested that cities where new construction was limited by zoning regulations or geography were particularly "bubble-prone," yet the data shows that the cities with the biggest gyrations in house prices were often those at the epicenter of the new construction boom. We conclude by arguing that economic theory provides little guidance as to what should be the "correct" level of asset prices -- including housing prices. Thus, while optimistic forecasts held by many market participants in 2005 turned out to be inaccurate, they were not ex ante unreasonable.
    Keywords: Housing - Prices
    Date: 2010
  8. By: Dobrislav P. Dobrev; Pawel J. Szerszen
    Abstract: We demonstrate that the parameters controlling skewness and kurtosis in popular equity return models estimated at daily frequency can be obtained almost as precisely as if volatility is observable by simply incorporating the strong information content of realized volatility measures extracted from high-frequency data. For this purpose, we introduce asymptotically exact volatility measurement equations in state space form and propose a Bayesian estimation approach. Our highly efficient estimates lead in turn to substantial gains for forecasting various risk measures at horizons ranging from a few days to a few months ahead when taking also into account parameter uncertainty. As a practical rule of thumb, we find that two years of high frequency data often suffice to obtain the same level of precision as twenty years of daily data, thereby making our approach particularly useful in finance applications where only short data samples are available or economically meaningful to use. Moreover, we find that compared to model inference without high-frequency data, our approach largely eliminates underestimation of risk during bad times or overestimation of risk during good times. We assess the attainable improvements in VaR forecast accuracy on simulated data and provide an empirical illustration on stock returns during the financial crisis of 2007-2008.
    Date: 2010
  9. By: Stéphane Dées (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); M. Hashem Pesaran (Cambridge University, Faculty of Economics, Austin Robinson Building, Sidgwick Avenue, Cambridge, CB3 9DD, United Kingdom.); L. Vanessa Smith (Cambridge University, Trumpington Street, Cambridge CB2 1AG, United Kingdom.); Ron P. Smith (Birkbeck College, London, United Kingdom.)
    Abstract: This paper estimates and solves a multi-country version of the standard DSGE New Keynesian (NK) model. The country-specific models include a Phillips curve determining inflation, an IS curve determining output, a Taylor Rule determining interest rates, and a real effective exchange rate equation. The IS equation includes a real exchange rate variable and a countryspecific foreign output variable to capture direct inter-country linkages. In accord with the theory all variables are measured as deviations from their steady states, which are estimated as long-horizon forecasts from a reduced-form cointegrating global vector autoregression. The resulting rational expectations model is then estimated for 33 countries on data for 1980Q1-2006Q4, by inequality constrained IV, using lagged and contemporaneous foreign variables as instruments, subject to the restrictions implied by the NK theory. The multi-country DSGE NK model is then solved to provide estimates of identified supply, demand and monetary policy shocks. Following the literature, we assume that the within country supply, demand and monetary policy shocks are orthogonal, though shocks of the same type (e.g. supply shocks in different countries) can be correlated. We discuss estimation of impulse response functions and variance decompositions in such large systems, and present estimates allowing for both direct channels of international transmission through regression coefficients and indirect channels through error spillover effects. Bootstrapped error bands are also provided for the cross country responses of a shock to the US monetary policy. JEL Classification: C32, E17, F37, F42.
    Keywords: Global VAR (GVAR), New Keynesian DSGE models, supply shocks, demand shocks, monetary policy shocks.
    Date: 2010–09
  10. By: Olivier Coibion (Department of Economics, College of William and Mary); Yuriy Gorodnichenko (Department of Economics, University of California, Berkeley)
    Abstract: With positive trend inflation, the Taylor principle is not enough to guarantee a determinate equilibrium. We provide new theoretical results on restoring determinacy in New Keynesian models with positive trend inflation and combine these with new empirical findings on the Federal Reserve’s reaction function before and after the Volcker disinflation to find that 1) while the Fed likely satisfied the Taylor principle in the pre-Volcker era, the US economy was still subject to self-fulfilling fluctuations in the 1970s, 2) the US economy moved from indeterminacy to determinacy during the Volcker disinflation, and 3) the switch from indeterminacy to determinacy was due to the changes in the Fed’s response to macroeconomic variables and the decline in trend inflation during the Volcker disinflation.
    Keywords: Trend inflation, Determinacy, Great Moderation, Monetary Policy.
    JEL: C22 E3 E43 E5
    Date: 2010–09–15
  11. By: Roland Döhrn; Christoph M. Schmidt
    Abstract: The accuracy of macroeconomic forecast depends on various factors, most importantly the mix of analytical methods used by the individual forecasters, the way that their personal experience is shaping their identifi cation strategies, but also their effi - ciency in translating new information into revised forecasts. In this paper we use a broad sample of forecasts of German GDP and its components to analyze the impact of institutions and information on forecast accuracy. We fi nd that forecast errors are a linear function of the forecast horizon. This result is robust over a variety of diff erent specifi cations. As better information seems to be the key to achieving better forecasts, approaches for acquiring reliable information early seem to be a good investment. By contrast, the institutional factors tend to be small and statistically insignifi cant. It has to remain open, whether this is the consequence of the effi ciency-enhancing competition among German research institutions or rather the refl ection of an abundance of forecast suppliers.
    Keywords: Forecast accuracy, Forecast Revisions, Forecast Horizon, Economic Activity
    JEL: C53 E27 E01
    Date: 2010–09
  12. By: Scott Brave; R. Andrew Butters
    Abstract: By incorporating the Harvey accumulator into the large approximate dynamic factor framework of Doz et al. (2006), we are able to construct a coincident index of financial conditions from a large unbalanced panel of mixed frequency financial indicators. We relate our financial conditions index, or FCI, to the concept of a "financial crisis" using Markov-switching techniques. After demonstrating the ability of the index to capture "crisis" periods in U.S. financial history, we present several policy-geared threshold rules for the FCI using Receiver Operator Characteristics (ROC) curve analysis.
    Keywords: Financial crises ; Financial markets
    Date: 2010
  13. By: G. Menzies; R. Bird; P. Dixon; M. Rimmer
    Abstract: The Global Financial Crisis (GFC) has rekindled debate about the desirability of governmental interference in asset markets - either through the operation of policy levers, or, through the chosen institutional setup. In this paper we quantify economic costs due to mispricing of real assets in the USAGE model of the United States. The microeconomic costs of misallocated capital are second order small. The model suggests that regulators (or central banks) who risk mispricing by influencing asset prices do so without incurring large economic costs.
    Keywords: Capital Misallocation, Financial crises, CGE modeling, real assets
    JEL: C50 F41
    Date: 2010–07
  14. By: Andreas Fuster; Paul S. Willen
    Abstract: This paper measures the effects on the primary U.S. mortgage market of the large-scale asset purchase (LSAP) program in which the Federal Reserve bought $1.25 trillion of mortgage-backed securities in 2009 and 2010. We use an event-study approach and measure the movements in both prices and quantities around the initial announcement of the LSAP and subsequent changes to the program. We use a new dataset to document the changes in the menu of rates and points offered to borrowers and show that there was wide dispersion in the rate changes generated by the announcement of the LSAP program, with some borrowers seeing immediate rate reductions of up to 40 basis points and other borrowers confronting rate increases. We show that the LSAP program led to a substantial boost in market activity, with discontinuous increases in searches, applications and originations for refinance mortgages, but not purchase mortgages. Finally, we show that more creditworthy borrowers were significantly more likely to benefit from the improved credit availability.
    Keywords: Mortgage-backed securities
    Date: 2010
  15. By: Christiane Nickel (European Central Bank, Directorate General Economics, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Philipp Rother (European Central Bank, Directorate General Economics, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Lilli Zimmermann (Center for European Studies (CEUS) at WHU – Otto Beisheim School of Management, Burgplatz 2, D-56179 Vallendar, Germany.)
    Abstract: The financial crisis of 2008/2009 has left European economies with a sizeable public debt stock bringing back the question what factors help to reduce these fiscal imbalances. Using data for the period 1985-2009 this paper identifies factors determining major public debt reductions. On average, the total debt reduction per country amounted to almost 37 percentage points of GDP. We estimate several specifications of a logistic probability model. Our findings suggest that, first, major debt reductions are mainly driven by decisive and lasting (rather than timid and short-lived) fiscal consolidation efforts focused on reducing government expenditure, in particular, cuts in social benefits and public wages. Second, robust real GDP growth also increases the likelihood of a major debt reduction because it helps countries to "grow their way out" of indebtedness. Third, high debt servicing costs play a disciplinary role strengthened by market forces and require governments to set up credible plans to stop and reverse the increasing debt ratios. JEL Classification: C35, E62, H6.
    Keywords: Fiscal policy, public debt, binary choice models.
    Date: 2010–09
  16. By: Jose M. Berrospide; Rochelle M. Edge
    Abstract: The effect of bank capital on lending is a critical determinant of the linkage between financial conditions and real activity, and has received especial attention in the recent financial crisis. We use panel-regression techniques--following Bernanke and Lown (1991) and Hancock and Wilcox (1993, 1994)--to study the lending of large bank holding companies (BHCs) and find small effects of capital on lending. We then consider the effect of capital ratios on lending using a variant of Lown and Morgan's (2006) VAR model, and again find modest effects of bank capital ratio changes on lending. These results are in marked contrast to estimates obtained using simple empirical relations between aggregate commercial-bank assets and leverage growth, which have recently been very influential in shaping forecasters' and policymakers' views regarding the effects of bank capital on loan growth. Our estimated models are then used to understand recent developments in bank lending and, in particular, to consider the role of TARP-related capital injections in affecting these developments.
    Date: 2010
  17. By: António Portugal Duarte (GEMF/Faculdade de Economia, Universidade de Coimbra, Portugal); João Sousa Andrade (GEMF/Faculdade de Economia, Universidade de Coimbra, Portugal); Adelaide Duarte (GEMF/Faculdade de Economia, Universidade de Coimbra, Portugal)
    Abstract: This work selectively reviews the literature on exchange rate target zones and their theoretical and empirical methodologies and examines whether they can be used to clarify to what extent this type of exchange rate regime could contribute to greater exchange rate stability. We discuss the main contributions of the first and second generations of exchange rate target zone models. In an attempt to reconcile the poor empirical performance of the Krugman (1991) model with the reality of exchange rate target zone regimes, this line of research integrates target zones with alternative underlying economic models, such as imperfect credibility, intra-marginal interventions and sticky price models. It was thus possible to understand the correlations observed between the exchange rate, its fundamentals determinants and the interest rate differential, and to explain the fact that the statistical distribution of the exchange rate is hump-shaped rather than U-shaped. This implies that the initial emphasis of target zone models on nonlinearities, “honeymoon effect”, “smooth pasting” and marginal interventions has vanished. Exchange rate target zones are better described as similar to managed floating regimes with intra-marginal interventions, with some marginal interventions when the exchange rate reaches the edges of the floating band.
    Keywords: Exchange rate target zones, imperfect credibility, intra-marginal interventions realignments and sticky prices.
    JEL: F31 F41 G15
    Date: 2010–07
  18. By: Brown, Martin; Kirschenmann, Karolin; Ongena; Steven
    Abstract: Motivated by current concerns over foreign currency exposures in emerging economies, we examine the currency denomination of business loans made in Bulgaria prior to the current crisis. We analyze information on the requested and granted currency for more than hundred thousand loans granted by one bank to sixty thousand different firms during the period 2003- 2007. This unique data set allows us to disentangle demand-side from supply-side determinants of foreign currency loans. We find that the bank in our sample often grants loans in foreign currency even when a firm requests a loan in local currency. The bank lends in foreign currency, not only to less risky firms, but also when the firm requested a large or long-term loan and after the bank itself received more funding in euro. These results suggest that foreign currency borrowing in Eastern Europe is not only be driven by borrowers who try to benefit from lower interest rates but may be partly supply-driven with banks hesitant to lend long-term in local currency and eager to match the currency structure of their assets and liabilities. --
    Keywords: foreign currency debt,banking
    JEL: G21 G30 F34 F37
    Date: 2010
  19. By: Sophocles N. Brissimis (Bank of Greece, Economic Research Department, 21 E. Venizelos Ave., Athens 10250, Greece.); George Hondroyiannis (Bank of Greece, 21 E. Venizelos Ave., Athens 10250, Greece.); Christos Papazoglou (Bank of Greece, 21 E. Venizelos Ave., Athens 10250, Greece.); Nicholas T. Tsaveas (Bank of Greece, 21 E. Venizelos Ave., Athens 10250, Greece.); Melina A. Vasardani (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: The aim of this paper is to study the main macroeconomic, financial and structural factors that shaped current account developments in Greece over the period from 1960 to 2007 and discuss these developments in relation to the issue of external sustainability. Concerns over Greece’s external sustainability have emerged since 1999 when the current account deficit widened substantially and exhibited high persistence. The empirical model used, which theoretically rests on the intertemporal approach, treats the current account as the gap between domestic saving and investment. We examine the behaviour of the current account in the long run and the short run using co-integration analysis and a variety of econometric tests to account for the effect of significant structural changes in the period under review. We find that a stable equilibrium current account model can be derived if the ratio of private sector financing to GDP, as a proxy for financial liberalisation, is included in the specification. Policy options to restore the country’s external sustainability are explored based on the estimated equilibrium model. JEL Classification: F30, F32.
    Keywords: Current account model, external sustainability.
    Date: 2010–09
  20. By: Olivier Coibion (Department of Economics, College of William and Mary); Yuriy Gorodnichenko (Department of Economics, University of California, Berkeley)
    Abstract: We consider a dynamic stochastic general equilibrium (DSGE) model in which firms follow one of four price-setting regimes: sticky prices, sticky-information, rule-of-thumb, or fullinformation flexible prices. The parameters of the model, including the fractions of each type of firm, are estimated by matching the moments of the observed variables of the model to those found in the data. We find that sticky-price firms and sticky-information firms jointly account for over 80% of firms in the model. We compare the performance of our hybrid model to pure sticky-price and sticky-information models along various dimensions, including monetary policy implications.
    Keywords: Heterogeneity, Price-setting, DSGE
    JEL: E3 E5
    Date: 2010–09–15
  21. By: Feldkircher, Martin (Oesterreichische Nationalbank)
    Abstract: In this study the forecast performance of model averaged forecasts is compared to that of alternative single models. Following Eklund and Karlsson (2007) we form posterior model probabilities - the weights for the combined forecast - based on the predictive likelihood. Extending the work of Fernández et al. (2001a) we carry out a prior sensitivity analysis for a key parameter in Bayesian model averaging (BMA): Zellner's g. The main results based on a simulation study are fourfold: First the predictive likelihood does always better than the traditionally employed 'marginal' likelihood in settings where the true model is not part of the model space. Secondly, and more striking, forecast accuracy as measured by the root mean square error (rmse) is maximized for the median probability model put forward by Barbieri and Berger (2003). On the other hand, model averaging excels in predicting direction of changes, a finding that is in line with Crespo Cuaresma (2007). Lastly, our recommendation concerning the prior on g is to choose the prior proposed by Laud and Ibrahim (1995) with a hold-out sample size of 25% to minimize the rmse (median model) and 75% to optimize direction of change forecasts (model averaging). We finally forecast the monthly industrial production output of six Central Eastern and South Eastern European (CESEE) economies for a one step ahead forecasting horizon. Following the aforementioned forecasting recommendations improves the out-of-sample statistics over a 30-period horizon beating for almost all countries the first order autoregressive benchmark model.
    Keywords: Forecast Combination; Bayesian Model Averaging; Median Probability Model; Predictive Likelihood; Industrial Production; Model Uncertainty
    JEL: C11 C15 C53
    Date: 2010–09–15
  22. By: Amy K. Filipek (Department of Economics, The College of William and Mary); Till Schreiber (Department of Economics, The College of William and Mary)
    Abstract: The ‘Stability and Growth Pact’ aims to constrain excessive fiscal deficits by member countries in the European Monetary Union. It identifies and prescribes sanctions for countries that breach the Maastricht deficit and debt ceilings. Under strong criticism for its apparent favoritism of Germany and France, the SGP was reformed in 2005, after which its deficit procedures became more responsive to the economic climate and were individualized to the country’s circumstances. This paper explores the reformed SGP’s performance, especially in light of the recent Greek debt and global financial crises, and proposes further changes to the Pact, while paying special attention to political feasibility. In it we suggest reforms to the SGP that focus on national ownership of fiscal discipline and an extension of Medium Term Objectives to include a consideration of large external imbalances. We show that the latter can provide an early warning signal for potential future difficulties for public finances.
    Keywords: European Monetary Union, fiscal adjustment, external imbalances, global financial crisis
    JEL: F33 H60
    Date: 2010–09–16
  23. By: Glenn Follette; Byron Lutz
    Abstract: We examine the effects of the economy on the government budget as well as the effects of the budget on the economy. First, we provide measures of the effects of automatic stabilizers on budget outcomes at the federal and state and local levels. For the federal government, the deficit increases about 0.35 percent of GDP for each 1 percentage point deviation of actual GDP relative to potential GDP. For state and local governments, the deficit increases by about 0.1 percent of GDP. We then examine the response of the economy to the automatic stabilizers using the FRB/US model by comparing the response to aggregate demand shocks under two scenarios: with the automatic stabilizers in place and without the automatic stabilizers. Second, we provide measures of discretionary fiscal policy actions at the federal and state and local levels. We find that federal policy actions are somewhat counter-cyclical while state and local policy actions have been somewhat pro-cyclical. Finally, we evaluate the impact of the budget, from both automatic stabilizers and discretionary actions, on economic activity in 2008 and 2009.
    Date: 2010
  24. By: Manzano, Carolina (Universitat Rovira i Virgili); Vives, Xavier (IESE Business School)
    Abstract: We study a general static noisy rational expectations model, where investors have private information about asset payoffs, with common and private components, and about their own exposure to an aggregate risk factor, and derive conditions for existence and uniqueness (or multiplicity) of equilibria. We find that a main driver of the characterization of equilibria is whether the actions of investors are strategic substitutes or complements. This latter property in turn is driven by the strength of a private learning channel from prices, arising from the multidimensional sources of asymmetric information, in relation to the usual public learning channel. When the private learning channel is strong (weak) in relation to the public we have strong (weak) strategic complementarity in actions and potentially multiple (unique) equilibria. The results enable a precise characterization of whether information acquisition decisions are strategic substitutes or complements. We find that the strategic substitutability in information acquisition result obtained in Grossman and Stiglitz (1980) is robust.
    Keywords: Rational expectations equilibrium; strategic complementarity; multiplicity of equilibria; asymmetric information; risk exposure; hedging; supply information;
    JEL: D82 D83 G14
    Date: 2010–07–23
  25. By: Franz Seitz (University of Applied Sciences Weiden, Hetzenrichter Weg 15, D-92637 Weiden, Germany.); Julian von Landesberger (European Central Bank, Directorate General Economics, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: In this paper we analyse household holdings of the broad monetary aggregate M3 in the euro area from 1991 until 2009. We develop four models, two in nominal, two in real terms, with satisfactory economic and statistical properties. The main determinants are a transactions variable, wealth considerations, opportunity costs and uncertainty. The models are robust to different estimation strategies, samples considered and a multitude of mis-specification tests. The exercise also provides insights that go beyond the portfolio allocation decision of households. According to our analysis, it is quite apparent that in equilibrium, households jointly determine consumption and broad money holdings both influenced by wealth as well as interest rates. JEL Classification: E41, C23, C32, D21.
    Keywords: money demand, cointegrated VARs, households.
    Date: 2010–09
  26. By: David K Levine
    Date: 2010–09–12
  27. By: Jean-Philippe Bouchaud (CFM)
    Abstract: We review the evidence that the erratic dynamics of markets is to a large extent of endogenous origin, i.e. determined by the trading activity itself and not due to the rational processing of exogenous news. In order to understand why and how prices move, the joint fluctuations of order flow and liquidity - and the way these impact prices - become the key ingredients. Impact is necessary for private information to be reflected in prices, but by the same token, random fluctuations in order flow necessarily contribute to the volatility of markets. Our thesis is that the latter contribution is in fact dominant, resulting in a decoupling between prices and fundamental values, at least on short to medium time scales. We argue that markets operate in a regime of vanishing revealed liquidity, but large latent liquidity, which would explain their hyper-sensitivity to fluctuations. More precisely, we identify a dangerous feedback loop between bid-ask spread and volatility that may lead to micro-liquidity crises and price jumps. We discuss several other unstable feedback loops that should be relevant to account for market crises: imitation, unwarranted quantitative models, pro-cyclical regulation, etc.
    Date: 2010–09
  28. By: Conrad, Christian; Eife, Thomas A.
    Abstract: In a simple New Keynesian model, we derive a closed form solution for the inflation persistence parameter as a function of the policy weights in the central bank’s Taylor rule. By estimating the time-varying weights that the FED attaches to inflation and the output gap, we show that the empirically observed changes in U.S. inflation persistence during the period 1975 to 2010 can be well explained by changes in the conduct of monetary policy. Our findings are in line with Benati’s (2008) view that inflation persistence should not be considered a structural parameter in the sense of Lucas.
    Keywords: inflation persistence; Great Moderation; monetary policy; New Keynesian model; Taylor rule
    Date: 2010–09–16
  29. By: Rasmus Fatum; Jesper Pedersen; Peter Norman Sørensen
    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: Financial markets ; Banks and banking, Central ; Monetary policy ; Foreign exchange rates ; International finance
    Date: 2010
  30. By: Scott Fulford (Boston College)
    Abstract: Many people in the United States have both a revolving credit card balance on which they pay a high rate of interest, and have liquid checking or savings accounts on which they earn little interest. Why would so many people throw so much money away? This paper shows that it may not be much of a puzzle: if credit limits may change unexpectedly, that creates a reason for people to hold on to cash or savings as consumption insurance against the times when they have a high benefit from consumption but cannot borrow. I show that this approach can explain the credit card puzzle with low probabilities of losing access to credit for a wide range of preferences. The approach in this paper offers a novel channel for how financial uncertainty can affect real decisions: if the probability of losing access to credit increases, consumers will increase saving and decrease consumption to add to their insurance, even without "real" shocks to income.
    Keywords: credit, debt, liquidity, credit card puzzle, financial uncertainty
    JEL: E21
    Date: 2010–09–01
  31. By: Ansgar Belke
    Abstract: After the dramatic rescue package for the euro area, the governing council of the European Central Bank decided to purchase European government bonds – to ensure an “orderly monetary policy transmission mechanism”. Many observers argued that, by bond purchases, national fi scal policies could from now on dominate the common monetary policy. This note argues that they are quite right. The ECB has indeed become more dependent in political and fi nancial terms. The ECB has decided to sterilise its bond purchases – compensating those purchases through sales of other bonds or money market instruments to keep the overall money supply unaff ected. This is to counter accusations that the ECB is monetizing government debt. This note addresses how eff ective these sterilisation policies are. One problem inherent in the sterilization approach is that it reshuffl es only the liability side of the ECB’s balance sheet. It is not well-suited to either diminish the bloated ECB balance sheet or to remove the potentially toxic covered or sovereign bonds from it. In addition, the intake of potentially toxic assets as collateral and by outright purchases in the central bank balance sheet artifi cially keeps the asset prices up and does not prevent the (quite intransparent) risk transfer from one group of countries to another to occur. Finally, sterilization takes place in a setting of still ultra-lax monetary policies, i.e. of new liquidity-enhancing operations with unlimited allotment, and, hence, does not appear to be overly irrelevant. A credible strategy to deal with the fi nancial crisis should deal primarily with the asset side of the ECB balance sheet. This note also addresses negative side eff ects of the SMP such as, for instance, the fact that the ECB is currently curbing real returns at the bond markets through its bond purchases. Currently, the real return of Spanish, Portuguese and Italian bonds only amounts to 3 to 3.5 percent. This is almost certainly not enough to attract private capital these countries are heavily dependent on. The most worrisome aspect is that the euro area has stumbled into a perpetuation of unconventional monetary policies by the execution of the SMP. Of course, the intentions are to bail out banks (but not just banks) and to support governments with issuance. What is diffi cult to see at the moment is how, once started, it will be able to stop. Finally, the ECB has been too silent about the following key questions which tends to frighten potential private investors in euro area sovereign bonds: What exactly is the composition of the sovereign bonds the ECB is buying? Which criteria are applied to select bonds to purchase? How is the ECB’s bond purchase strategy characterized in cases and periods of primary issuance? How long is the SMP going to last and what amounts may be spent?
    Keywords: accountability; bail-out; bond purchases; central bank independence; insolvency risk; Securities Markets Programme; transparency
    JEL: G32 E42 E51 E58 E63
    Date: 2010–06
  32. By: Jean-Olivier Hairault (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, IZA - Institute for the Study of Labor); François Langot (IZA - Institute for the Study of Labor, GAINS-TEPP - Université du Mans, CEPREMAP - Centre pour la recherche économique et ses applications); Sophie Osotimehin (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique)
    Abstract: We investigate the welfare cost of business cycles implied by matching frictions. First, using the reduced-form of the matching model, we show that job finding rate fluctuations generate intrinsically a non-linear effect on unemployment: positive shocks reduce unemployment less than negative shocks increase it. For the observed process of the job finding rate in the US economy, this intrinsic asymmetry increases average unemployment, which leads to substantial business cycles costs. Moreover, the structural matching model embeds other non-linearities, which alter the average job finding rate and consequently the welfare cost of business cycles. Our theory suggests to subsidizing employment in order to dampen the impact of the job finding rate fluctuations on welfare.
    Keywords: Business cycle costs; Unemployment dynamics; Matching
    Date: 2010–10–01
  33. By: Crowley, Patrick M (Texas A&M University and Bank of Finland Research); Schultz, Aaron (Athinoula A. Martinos Center for Biomedical Imaging and Massachusetts General Hospital)
    Abstract: Convergence and synchronisation of business and growth cycles are important issues in the efficient formulation of euro area economic policies, and in particular European Central Bank (ECB) monetary policy. Although several studies in the economics literature address the issue of synchronicity of growth within the euro area, this is the first to address the issue using cross recurrence analysis. The main findings are that member state growth rates had largely converged before the introduction of the euro, but there is a wide degree of different synchronisation behaviours which appear to be non-linear in nature. Many of the euro area member states display what is termed here ‘intermittency’ in synchronization, although this is not consistent across countries or members of the euro area. These differences in synchronization behaviors could introduce further challenges in managing the country-specific effects of the common monetary policy in the euro area.
    Keywords: Euro area; business cycles; growth cycles; recurrence plots; non-stationarity; complex systems; surrogate analysis
    JEL: C65 E32 F15
    Date: 2010–09–20
  34. By: César Calderón; Rodrigo Fuentes.
    Abstract: Using the dating algorithm by Harding and Pagan (2002) on a quarterly database for 23 emerging market economies (EMEs) and 12 developed countries over the period 1980.Q1-2006.Q2, we proceed to characterize and compare the business cycle features of these two groups. We first find that recessions are deeper and more frequent among EMEs (especially, among LAC countries) and that expansions are more sizable and longer (especially, among East Asian countries). After this characterization, this paper explores the linkages between the cost of recessions (as measured by the average annual rate of output loss in the peak-to-trough phase of the cycle) and several country-specific factors. Our main findings are: (a) adverse terms of trade shocks raises the cost of recessions in countries with a more open trade regime, deeper financial markets and, surprisingly, a more diversified output structure. (b) U.S. interest rate shocks seem to have a significant impact on the cost of recessions in East Asian countries. (c) Recessions tend to be deeper if they coincide with a sudden stop, but the effect tends to be mitigated in countries with deeper domestic credit markets. (d) Countries with stronger institutions tend to have less costly recessions.
    Keywords: Business cycles, peaks and troughs, emerging markets
    JEL: E32 F41
    Date: 2010
  35. By: Jaime Casassus; Diego Ceballos
    Abstract: We use a general equilibrium model of a monetary economy to understand the economics behind the correlation between in nation and oil futures returns. Oil is used as both, an input to the production of capital and as a consumption good. We estimate our model using maximum likelihood with the following datasets: crude oil futures prices, nominal interest rates, in nation rates and money supply growth rates. We nd that some of the positive correlation found in empirical studies is due to the fact that oil is in the consumption basket; however, this accounts only for a minor part of it. There exist other important sources of correlation related to monetary shocks and output shocks. In particular, we nd that the correlation is extremely sensitive to the reaction of the central bank to output shocks, while the reaction to in nation changes is less signi cant. Our estimates suggest that the monetary authority overreacts to output shocks by increasing the money supply in a more than necessary amount, generating a signi cant source of positive correlation. From a practical perspective, We nd that it is a good strategy to use as a hedge, the futures whose maturity is closer to the hedging horizon. This is particularly true for short-term hedging.
    Keywords: Correlation structure, inflation, futures, hedging, oil, monetary policy
    JEL: E31 G13 Q31 E44 E52 E23 D51
    Date: 2010
  36. By: Tuuli Koivu (Bank of Finland.)
    Abstract: This paper studies the wealth channel in China. Using the structural vector autoregression method, we find that a loosening of China’s monetary policy indeed leads to higher asset prices, which in turn are linked to household consumption. However, the importance of the wealth channel as a part of the monetary policy transmission mechanism in China is still limited. JEL Classification: E52, P24.
    Keywords: China, monetary policy, asset prices.
    Date: 2010–09

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