nep-cba New Economics Papers
on Central Banking
Issue of 2010‒10‒30
35 papers chosen by
Alexander Mihailov
University of Reading

  1. Modeling Inflation After the Crisis By James H. Stock; Mark W. Watson
  2. Equilibrium Price Dispersion and Rigidity: A New Monetarist Approach By Allen Head; Lucy Qian Liu; Guido Menzio; Randall Wright
  3. Liquidity and asset market dynamics By Guillaume Rocheteau; Randall Wright
  4. Monetary Policy Matters: New Evidence Based on a New Shock Measure By Christopher W. Crowe; S. Mahdi Barakchian
  5. Fiscal fragility: what the past may say about the future By Joshua Aizenman; Gurnain Kaur Pasricha
  6. Banks, Credit Market Frictions, and Business Cycles By Ali Dib
  7. Credit risk transfers and the macroeconomy By Ester Faia
  8. The Output Gap, the Labor Wedge, and the Dynamic Behavior of Hours By Sala, Luca; Söderström, Ulf; Trigari, Antonella
  9. How Big (Small?) are Fiscal Multipliers? By Ethan Ilzetzki; Enrique G. Mendoza; Carlos A. Végh
  10. Is there a fiscal free lunch in a liquidity trap? By Christopher J. Erceg; Jesper Linde
  11. A New Keynesian Model with Heterogeneous Price Setting By Paul Middleditch
  12. Imperfect Interbank Markets and the Lender of Last Resort By Tarishi Matsuoka
  13. The Effectiveness of Monetary Policy During the Recent Financial Turmoil By Puriya Abbassi; Tobias Linzert
  14. Unconventional monetary policy and the great recession - Estimating the impact of a compression in the yield spread at the zero lower bound By Christiane Baumeister; Luca Benati
  15. Real-time forecast averaging with ALFRED By Chanont Banternghansa; Michael W. McCracken
  16. MODELLING TIME AND MACROECONOMIC DYNAMICS By Anagnostopoulos, Alexis; Giannitsarou, Chryssi
  17. Density-Conditional Forecasts in Dynamic Multivariate Models By Andersson, Michael K.; Palmqvist, Stefan; Waggoner, Daniel F.
  18. Understanding the effect of productivity changes on international relative prices: the role of news shocks By Deokwoo Nam; Jian Wang
  19. Exchange-Rate Pass Through, Openness, and the Sacrifice Ratio By Daniels, Joseph P; VanHoose, David D
  20. Currency Carry Trades By Travis J. Berge; Òscar Jordà; Alan M. Taylor
  21. A Perspective on Predicting Currency Crises By Juan Yepez; Robert P. Flood; Nancy P. Marion
  22. Real time data, regime shifts, and a simple but effective estimated Fed policy rule, 1969-2009 By Smant, David / D.J.C.
  23. Explaining ECB and FED interest rate correlation: Economic interdependence and optimal monetary policy By Martin Mandler;
  24. Explaining ECB and Fed interest rate correlation: Economic interdependence and optimal monetary policy By Mandler, Martin
  25. Real exchange rate dynamics revisited: a case with financial market imperfections By Ippei Fujiwara; Yuki Teranishi
  26. Dancing together at arm’s length? – The interaction of central banks with governments in the G7 By Cristina Bodea; Stefan Huemer
  27. A DSGE Model from the Old Keynesian Economics: An Empirical Investigation By Paolo Gelain; Marco Guerrazzi
  28. U.S. Monetary and Fiscal Policy in the 1930s By Price V. Fishback
  29. Regular updating By Alain Chateauneuf; Thibault Gajdos; Jean-Yves Jaffray
  30. Approximate and Almost-Exact Aggregation in Dynamic Stochastic Heterogeneous-Agent Models By Reiter, Michael
  31. The US Business Cycle Since 1950: A Post Keynesian Explanation By John Harvey
  32. Credit Crunch in a Small Open Economy By Michał Brzoza-Brzezina; Krzysztof Makarski
  33. Financial Stability and Monetary Policy - The case of Brazil By Benjamin M. Tabak; Marcela T. Laiz; Daniel O. Cajueiro
  34. Bank Lending in Turkey: Effects of Monetary and Fiscal Policies By Deniz Igan; Burcu Aydin
  35. Há assimetria no repasse dos juros bancários de variações na taxa Selic? By Pedro Castro; João Manoel Pinho de Mello

  1. By: James H. Stock; Mark W. Watson
    Abstract: In the United States, the rate of price inflation falls in recessions. Turning this observation into a useful inflation forecasting equation is difficult because of multiple sources of time variation in the inflation process, including changes in Fed policy and credibility. We propose a tightly parameterized model in which the deviation of inflation from a stochastic trend (which we interpret as long-term expected inflation) reacts stably to a new gap measure, which we call the unemployment recession gap. The short-term response of inflation to an increase in this gap is stable, but the long-term response depends on the resilience, or anchoring, of trend inflation. Dynamic simulations (given the path of unemployment) match the paths of inflation during post-1960 downturns, including the current one.
    JEL: C22 E31
    Date: 2010–10
  2. By: Allen Head (Department of Economics, Queen's University); Lucy Qian Liu (International Monetary Fund (IMF)); Guido Menzio (Department of Economics, University of Pennsylvania); Randall Wright (Department of Economics, University of Wisconsin-Madison)
    Abstract: Why do some sellers set prices in nominal terms that do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption. Here it is a result. We use search theory, with two consequences: prices are set in dollars since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When money increases, some sellers keep prices constant, earning less per unit but making it up on volume, so profit is unaffected. The model is consistent with the micro data. But, in contrast with other sticky-price models, money is neutral.
    Keywords: Search, Sticky Prices, Monetary Policy
    JEL: D43 E51 E52
    Date: 2010–09–03
  3. By: Guillaume Rocheteau; Randall Wright
    Abstract: We study economies with an essential role for liquid assets in transactions. The model can generate multiple stationary equilibria, across which asset prices, market participation, capitalization, output and welfare are positively related. It can also generate a variety of nonstationary equilibria, even when fundamentals are deterministic and time invariant, including periodic, chaotic, and stochastic (sunspot) equilibria with recurrent market crashes. Some equilibria have asset price trajectories that resemble bubbles growing and bursting. We also analyze endogenous private and public liquidity provision. Sometimes it is efficient to have enough liquid assets to satiate demand; other times it is not.
    Keywords: Liquidity (Economics) ; Asset pricing
    Date: 2010
  4. By: Christopher W. Crowe; S. Mahdi Barakchian
    Abstract: Conventional VAR and non-VAR methods of identifying the effects of monetary policy shocks on the economy have found a negative output response to monetary tightening using U.S. data over the 1960s-1990s. However, we show that these methods fail to find this contractionary effect when the sample is restricted to the period since the 1980s, apparently due to changes in the policymaking environment that reduce their effectiveness. Identifying policy shocks using Fed Funds futures data, we recover the contractionary effect of monetary tightening on output and find that almost half of output variation over the period appears due to policy shocks.
    Date: 2010–10–14
  5. By: Joshua Aizenman; Gurnain Kaur Pasricha
    Abstract: The end of the great moderation has profound implications on the assessment of fiscal sustainability. The pertinent issue goes beyond the obvious increase in the stock of public debt/GDP induced by the global recession, to include the neglected perspective that the vulnerabilities associated with a given public debt/GDP increase with the future volatility of key economic variables. We evaluate for a given future projected public debt/GDP, the possible distribution of the fiscal burden or the flow cost of funding debt for each OECD country, assuming that this in future decades resembles that in the past four decades. Fiscal projections may be alarmist if one jumps from the priors of great moderation to the prior of permanent high future burden. Prudent adjustment for countries exposed to heightened vulnerability may entail both short term stabilization and forward looking fiscal reforms.
    JEL: E62 E66 F41
    Date: 2010–10
  6. By: Ali Dib
    Abstract: The author proposes a micro-founded framework that incorporates an active banking sector into a dynamic stochastic general-equilibrium model with a financial accelerator. He evaluates the role of the banking sector in the transmission and propagation of the real effects of aggregate shocks, and assesses the importance of financial shocks in U.S. business cycle fluctuations. The banking sector consists of two types of profitmaximizing banks that offer different banking services and transact in an interbank market. Loans are produced using interbank borrowing and bank capital subject to a regulatory capital requirement. Banks have monopoly power, set nominal deposit and prime lending rates, choose their leverage ratio and their portfolio composition, and can endogenously default on a fraction of their interbank borrowing. Because it is costly to raise capital to satisfy the regulatory capital requirement, the banking sector attenuates the real effects of financial shocks, reduces macroeconomic volatilities, and helps stabilize the economy. The model also includes two unconventional monetary policies (quantitative and qualitative easing) that reduce the negative impacts of financial crises.
    Keywords: Economic models; Business fluctuations and cycles; Credit and credit aggregates; Financial stability
    JEL: E32 E44 G1
    Date: 2010
  7. By: Ester Faia (Goethe University Frankfurt, House of Finance, office 3.47, Grueneburgplatz 1, 60323, Frankfurt am Main, Germany.)
    Abstract: The recent financial crisis has highlighted the limits of the "originate to distribute" model of banking, but its nexus with the macroeconomy and monetary policy remains unexplored. I build a DSGE model with banks (along the lines of Holmström and Tirole [28] and Parlour and Plantin [39]) and examine its properties with and without active secondary markets for credit risk transfer. The possibility of transferring credit reduces the impact of liquidity shocks on bank balance sheets, but also reduces the bank incentive to monitor. As a result, secondary markets allow to release bank capital and exacerbate the effect of productivity and other macroeconomic shocks on output and inflation. By offering a possibility of capital recycling and by reducing bank monitoring, secondary credit markets in general equilibrium allow banks to take on more risk. JEL Classification: E3, E5, G3.
    Keywords: credit risk transfer, dual moral hazard, monetary policy, liquidity, welfare.
    Date: 2010–10
  8. By: Sala, Luca (Department of Economics and IGIER); Söderström, Ulf (Research Department, Central Bank of Sweden); Trigari, Antonella (Department of Economics and IGIER)
    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 efficient 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 inefficient 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 efficiency of business cycle fluctuations, and it provides an unsatisfactory explanation of labor market and business cycle dynamics.
    Keywords: Business cycles; Efficiency; Labor markets; Monetary policy
    JEL: E24 E32 E52
    Date: 2010–09–01
  9. By: Ethan Ilzetzki; Enrique G. Mendoza; Carlos A. Végh
    Abstract: We contribute to the intense debate on the real effects of fiscal stimuli by showing that the impact of government expenditure shocks depends crucially on key country characteristics, such as the level of development, exchange rate regime, openness to trade, and public indebtedness. Based on a novel quarterly dataset of government expenditure in 44 countries, we find that (i) the output effect of an increase in government consumption is larger in industrial than in developing countries, (ii) the fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates; (iii) fiscal multipliers in open economies are lower than in closed economies and (iv) fiscal multipliers in high-debt countries are also zero.
    JEL: E2 E6 F41 H5
    Date: 2010–10
  10. By: Christopher J. Erceg; Jesper Linde
    Abstract: This paper uses a DSGE model to examine the effects of an expansion in government spending in a liquidity trap. If the liquidity trap is very prolonged, the spending multiplier can be much larger than in normal circumstances, and the budgetary costs minimal. But given this "fiscal free lunch," it is unclear why policymakers would want to limit the size of fiscal expansion. Our paper addresses this question in a model environment in which the duration of the liquidity trap is determined endogenously, and depends on the size of the fiscal stimulus. We show that even if the multiplier is high for small increases in government spending, it may decrease substantially at higher spending levels; thus, it is crucial to distinguish between the marginal and average responses of output and government debt.
    Date: 2010
  11. By: Paul Middleditch
    Abstract: The Calvo contract pricing mechanism has become the most widely accepted microfoundation to the NK Phillips curve but unfortunately predicts that all firms in the economy face the same probability of price change. To better explain the stylized fact this paper relaxes the homogeneous firm assumption in the Calvo contract, to provide a macroeconomic explanation more consistent with recently available microeconomic evidence that suggests firms face differing probabilities of price change. A simple New Keynesian dynamic stochastic general equilibrium (DSGE) model with nominal rigidities and habit in consumption for the US is estimated using Bayesian techniques and finds evidence of a flexible price sector of around 6% and a sticky price sector of between 55% and 70% depending on model specification.
    Date: 2010
  12. By: Tarishi Matsuoka (Graduate School of Economics, Kyoto University)
    Abstract: This paper presents a monetary model in which interbank markets bear limited commitment to contracts. Limited commitment reduces the proportion of assets that can be used as collateral, and thus banks with high liquidity demands face borrowing constraints in interbank markets. These constraints can be relieved by the central bank (a lender of last resort) through the provision of liquidity loans. I show that the constrained-efficient allocation can be decentralized by controlling only the money growth rate if commitment to interbank contracts is not limited. Otherwise, a proper combination of central bank loans and monetary policy is needed to bring the market equilibrium into a state of constrained efficiency.
    Keywords: Overlapping generations, money, interbank markets, limited commitment, the lender of last resort
    JEL: E42 E51 G21
    Date: 2010–10
  13. By: Puriya Abbassi; Tobias Linzert
    Abstract: The recent financial crisis has deeply affected the marginal cost of funding bank loans and thus the proper functioning of the interest rate channel. We analyze the effectiveness of monetary policy in the euro area with respect to the predictability of money market rates on the basis of monetary policy expectations, and the impact of extraordinary central bank measures on money markets. We find that market’s expectations are less relevant for money market rates up to 12 months after August 2007 compared to the pre-crisis period. At the same time, our results indicate that the ECB’s net increase in outstanding open market operations as of October 2008 accounts for at least a 100 basis point decline in Euribor rates. These findings show that central banks have effective tools at hand to conduct monetary policy in times of crises.
    Keywords: Monetary transmission mechanism; Financial Crisis; Monetary policy implementation; European Central Bank; Money market
    JEL: E43 E52 E58
    Date: 2010–10
  14. By: Christiane Baumeister (Research Department, Bank of Canada, 234 Wellington Street, Ottawa, Ontario, Canada, K1A 0G9.); Luca Benati (Monetary Policy Research Division, Banque de France, 31, Rue Croix des Petits Champs, 75049 Paris CEDEX 01, France.)
    Abstract: We explore the macroeconomic impact of a compression in the long-term bond yield spread within the context of the Great Recession of 2007-2009 via a Bayesian time-varying parameter structural VAR. We identify a ‘pure’ spread shock which, leaving the short-term rate unchanged by construction, allows us to characterise the macroeconomic impact of a compression in the yield spread induced by central banks’ asset purchases within an environment in which the short rate cannot move because it is constrained by the zero lower bound. Two main findings stand out. First, in all the countries we analyse (U.S., Euro area, Japan, and U.K.) a compression in the long-term yield spread exerts a powerful effect on both output growth and inflation. Second, conditional on available estimates of the impact of the FED’s and the Bank of England’s asset purchase programmes on long-term government bond yield spreads, our counterfactual simulations indicate that U.S. and U.K. unconventional monetary policy actions have averted significant risks both of deflation and of output collapses comparable to those that took place during the Great Depression. JEL Classification: E30, E32.
    Keywords: Great Recession, structural VARs, time-varying parameters, Bayesian VARs, stochastic volatility, Monte Carlo integration, policy counterfactuals.
    Date: 2010–10
  15. By: Chanont Banternghansa; Michael W. McCracken
    Abstract: This paper presents empirical evidence on the efficacy of forecast averaging using the ALFRED real-time database. We consider averages taken over a variety of different bivariate VAR models that are distinguished from one another based upon at least one of the following: which variables are used as predictors, the number of lags, using all available data or data after the Great Moderation, the observation window used to estimate the model parameters and construct averaging weights, and for forecast horizons greater than one, whether or not iterated- or direct-multistep methods are used. A variety of averaging methods are considered. Our results indicate that the benefits to model averaging relative to BIC-based model selection are highly dependent upon the class of models being averaged over. We provide a novel decomposition of the forecast improvements that allows us to determine which types of averaging methods and models were most (and least) useful in the averaging process.
    Keywords: Economic forecasting ; Real-time data
    Date: 2010
  16. By: Anagnostopoulos, Alexis; Giannitsarou, Chryssi
    Abstract: In this paper, we analyze the importance of the frequency of decision making for macroeconomic dynamics. We explain how the frequency of decision making (period length) and the unit of time measurement (calibration frequency) differ and study the implications of this difference for macroeconomic modelling. We construct a generic dynamic general equilibrium model that nests a wide range of macroeconomic models and which leaves the period length as an undetermined parameter. We provide a series of examples (variations of the Cass-Koopmans and the New Keynesian models) that fit into this framework and use these to do comparative dynamics with respect to the period length. In particular, we analyze local stability and how this is affected by changes in the period length. We find that in models with endogenous capital accumulation, as the period gets longer, indeterminacy occurs less often. Moreover, as economic agents become less patient and as capital depreciates more, indeterminacy also occurs less often. We also show that, in the case of the New Keynesian model, standard continuous and discrete time versions have entirely different local stability properties due to a discontinuity at zero period length.
    Keywords: depreciation; discounting; local indeterminacy; Macroeconomic dynamics; period length
    JEL: C62 E22 O41
    Date: 2010–10
  17. By: Andersson, Michael K. (Monetary Policy Department, Central Bank of Sweden); Palmqvist, Stefan (Monetary Policy Department, Central Bank of Sweden); Waggoner, Daniel F. (Research Department)
    Abstract: When generating conditional forecasts in dynamic models it is common to impose the conditions as restrictions on future structural shocks. However, these conditional forecasts often ignore that there may be uncertainty about the future development of the restricted variables. Our paper therefore proposes a generalization such that the conditions can be given as the full distribution of the restricted variables. We demonstrate, in two empirical applications, that ignoring the uncertainty about the conditions implies that the distributions of the unrestricted variables are too narrow.
    Keywords: Central Bank; Market Expectation; Restrictions; Uncertainty
    JEL: C53 E37 E52
    Date: 2010–09–01
  18. By: Deokwoo Nam; Jian Wang
    Abstract: The terms of trade and the real exchange rate of the US appreciate when the US labor productivity increases relative to the rest of the world. This finding is at odds with predictions from standard international macroeconomic models. In this paper, we find that incorporating news shocks to total factor productivity (TFP) in an otherwise standard dynamic stochastic general equilibrium (DSGE) model with variable capital utilization can help the model replicate the above empirical finding. Labor productivity increases in our model after a positive news shock to TFP because of an increase in capital utilization. Under some plausible calibrations, the wealth effect of good news about future productivity can increase domestic demand strongly and induce an increase in home prices relative to foreign prices.
    Keywords: Business cycles - Econometric models ; International finance ; International trade - Econometric models ; Labor productivity
    Date: 2010
  19. By: Daniels, Joseph P (Department of Economics Marquette University); VanHoose, David D (Hankamer School of Business Baylor University)
    Abstract: Considerable recent work has reached mixed conclusions about whether and how globalization affects the inflation-output trade-off and suggests that the ultimate effect of openness on the output-inflation relationship is influenced by a variety of factors. In this paper, we consider the impact of exchange-rate pass through and how pass through conditions the effect of openness on the sacrifice ratio. We develop a simple theoretical model showing how both the extent of pass through and openness can interact to influence the output-inflation relationship. Next we empirically explore the nature of these two variables and their interaction. Results indicate that greater pass through increases the sacrifice ratio, that there is significant interaction among pass through and openness, and—once the extent of pass through is taken into account alongside other factors that affect the sacrifice ratio, such as central bank independence—openness exerts an empirically ambiguous effect on the sacrifice ratio.
    Keywords: exchange-rate pass through, openness, sacrifice ratio, Economics
    JEL: F40 F41 F43
    Date: 2010–08
  20. By: Travis J. Berge; Òscar Jordà; Alan M. Taylor
    Abstract: A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and out-of-sample. This holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorable Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of so-called risk factors.
    JEL: C44 F31 F37 G14 G15
    Date: 2010–10
  21. By: Juan Yepez; Robert P. Flood; Nancy P. Marion
    Abstract: Currency crises are difficult to predict. It could be that we are choosing the wrong variables or using the wrong models or adopting measurement techniques not up to the task. We set up a Monte Carlo experiment designed to evaluate the measurement techniques. In our study, the methods are given the right fundamentals and the right models and are evaluated on how closely the estimated predictions match the objectively correct predictions. We find that all methods do reasonably well when fundamentals are explosive and all do badly when fundamentals are merely highly volatile.
    Date: 2010–10–13
  22. By: Smant, David / D.J.C.
    Abstract: Estimates of Taylor rule equations for Federal Reserve policy over periods before the Greenspan period are misleading. Until 1979 Fed policy changed the real funds rate in response to the output gap, with no response to an inflation target. During the Volcker period the policy rule kept the real funds rate at a high but constant level, with no response to the output gap. Taking into account the regime shifts, a simple but effective funds rate equation can be estimated using only inflation and output gap.
    Keywords: Taylor rule; policy regime shifts; real time data
    JEL: E43 E58
    Date: 2010–10–22
  23. By: Martin Mandler (University of Giessen);
    Abstract: This paper studies whether the observed high correlation between monetary policy in the U.S. and the Euro area can be explained by economic fundamentals, i.e. by macroeconomic interdependence between the two regions. We show that an optimal monetary policy reaction function for the ECB that accounts explicitly for economic interrelationships between the two economies reproduces substantial parts of the observed patterns of interest rate correlation and represents a good approximation to the actually observed monetary policy of the ECB. It implies strong reactions to shocks to US variables, particularly to shocks to the Federal Funds Rate.
    Keywords: optimal monetary policy, monetary policy reaction function, vector autoregressions
    JEL: E47 E52 E58
    Date: 2010
  24. By: Mandler, Martin
    Abstract: This paper studies whether the observed high correlation between monetary policy in the U.S. and the Euro area can be explained by economic fundamentals, i.e. by macroeconomic interdependence between the two regions. We show that an optimal monetary policy reaction function for the ECB that accounts explicitly for economic interrelationships between the two economies reproduces substantial parts of the observed patterns of interest rate correlation and represents a good approximation to the actually observed monetary policy of the ECB. It implies strong reactions to shocks to US variables, particularly to shocks to the Federal Funds Rate.
    Keywords: optimal monetary policy; monetary policy reaction function; vector autoregressions
    JEL: E58 E52 E47
    Date: 2010–10
  25. By: Ippei Fujiwara; Yuki Teranishi
    Abstract: In this paper, we investigate the relationship between real exchange rate dynamics and financial market imperfections. For this purpose, we first construct a New Open Economy Macroeconomics (NOEM) model that incorporates staggered loan contracts as a simple form of the financial market imperfections. Our model with such a financial market friction replicates persistent, volatile, and realistic hump-shaped responses of real exchange rates, which have been thought very difficult to materialize in standard NOEM models. Remarkably, these realistic responses can materialize even with both supply and demand shocks, such as cost-push, loan rate and monetary policy shocks. This implies that the financial market developments is a key element for understanding real exchange rate dynamics.
    Keywords: Foreign exchange ; International finance ; Macroeconomics - Econometric models
    Date: 2010
  26. By: Cristina Bodea (Michigan State University); Stefan Huemer (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: Central bank independence is a common feature in advanced economies. Delegation of monetary policy to an independent central bank with a clear mandate for price stability has proven to be successful in keeping a check on inflation and providing a trusted currency. However, it is also a fact that central banks in most countries have regular contacts with the government and cooperate with them on a number of issues. This paper looks into the various forms of cooperation between central banks and governments in the G7. The focus is on those central banks that exercise a monetary policy decision-making function, i.e. the ECB and the central banks of the four G7 countries outside the euro area (the US, UK, Japan and Canada). The paper first reviews the objectives of and arrangements for central bank/government cooperation in the US, UK, Japan and Canada in areas such as monetary policy and its interlink with economic policy; foreign exchange operations and foreign reserve management; international cooperation; payment systems/securities clearing and settlement systems; supervision, regulation and financial stability; banknotes and coins; collection of statistics; and the role of fiscal agent for the government. In parallel the paper looks into the objectives of and arrangements for cooperation between the ECB and relevant European counterparts, reflecting the specific European institutional environment characterised by the absence of a ‘European government’. Following a comprehensive stocktaking of practices, the paper embarks on a comparison of existing arrangements, pointing to the similarities and differences among the five surveyed central banks. The Appendix provides a more in-depth description of central bank/government cooperation per country and topic; it presents the detailed factual background on which the paper builds, serving as a reference for the reader interested in more detail. JEL Classification: E58
    Keywords: Central bank-government cooperation, central bank governance, central bank tasks, G7
    Date: 2010–10
  27. By: Paolo Gelain; Marco Guerrazzi
    Abstract: In this paper we estimate a DSGE model built along the lines of the recent Farmer¡¯s micro-foundation of the General Theory. Estimating a simple demand-driven competitive-search model, we test the ability of this new theoretical proposal to match the behaviour of the US and Euro Area labour markets. We show that within a relatively simple model we are able to fairly replicate their salient features, confirming for instance the conventional wisdom according to which the US labour market is more flexible than its Euro Area counterpart. Moreover, we provide an estimation of the not-yet-measured (unobserved) Euro Area job vacancies time series.
    Keywords: Old Keynesian Economics, Competitive Search, DSGE Model, Bayesian Estimation.
    JEL: E24 E32 E52 J64
    Date: 2010–10–18
  28. By: Price V. Fishback
    Abstract: The paper provides a survey of fiscal and monetary policies during the 1930s under the Hoover and Roosevelt Administrations and how they influenced the policies during the recent Great Recession. The discussion of the causal impacts of monetary policy focuses on papers written in the last decade and the findings of scholars using dynamic structural general equilibrium modeling. The discussion of fiscal policy shows why economists do not see the New Deal as a Keynesian stimulus, describes the significant shift toward excise taxation during the 1930s, and surveys estimates of the impact of federal spending on local economies. The paper concludes with discussion of the lessons for the present from 1930s monetary and fiscal policy.
    JEL: E5 E62 N12 N92
    Date: 2010–10
  29. By: Alain Chateauneuf (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); Thibault Gajdos (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, CERSES - Centre de recherche sens, ethique, société - CNRS : UMR8137 - Université Paris Descartes - Paris V); Jean-Yves Jaffray (LIP6 - Laboratoire d'Informatique de Paris 6 - CNRS : UMR7606 - Université Pierre et Marie Curie - Paris VI)
    Abstract: We study the Full Bayesian Updating rule for convex capacities. Following a route suggested by Jaffray (1992), we define some properties one may want to impose on the updating process, and identify the classes of (convex and strictly positive) capacities that satisfy these properties for the Full Bayesian updating rule.
    Date: 2010–02–11
  30. By: Reiter, Michael (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria)
    Abstract: The paper presents a new method to solve DSGE models with a great number of heterogeneous agents. Using tools from systems and control theory, it is shown how to reduce the dimension of the state and the policy vector so that the reduced model approximates the original model with high precision. The method is illustrated with a stochastic growth model with incomplete markets similar to Krusell and Smith (1998), and with a model of heterogeneous firms with state-dependent pricing. For versions of those models that are nonlinear in individual variables, but linearized in aggregate variables, approximations with 50 to 200 state variables deliver solutions that are precise up to machine precision. The paper also shows how to reduce the state vector even further, with a very small reduction in precision.
    Keywords: Heterogeneous agents, aggregation, model reduction
    JEL: C63 C68 E21
    Date: 2010–10
  31. By: John Harvey (Department of Economics, Texas Christian University)
    Abstract: That the economy goes through periods of expansion and recession is obvious. Whether or not this represents endogenously-generated cycles or simply stochastic variation around a trend is, however, a matter of debate. Among mainstream economists, the latter is the predominant position. For Post Keynesians, however, business cycles are a manifestation of the systemic instability inherent to the capitalist system. Endogenous fluctuations in investment spending lie at the heart of the shift from expansion to recession and while various shocks and government policies can, of course, have an impact, they are unnecessary to create the patterns we see. This paper offers evidence in support of the Post Keynesian position by tracing the US business cycle since 1950. With a combination of quantitative and qualitative evidence, it is demonstrated that, from the Korean War cycle to our current financial crisis, the central factor has been the rise and fall in investment. The complete story cannot be told without reference to fiscal and monetary policy, oil shocks, strikes, and so on–but most of it can.
    Keywords: business cycle, Keynes, Post Keynesian
    JEL: E12 E13 E32
    Date: 2010–08
  32. By: Michał Brzoza-Brzezina (National Bank of Poland, Economic Institute; Warsaw School of Economics); Krzysztof Makarski (National Bank of Poland, Economic Institute; Warsaw School of Economics)
    Abstract: We construct an open-economy DSGE model with a banking sector to analyse the impact of the recent credit crunch on a small open economy. In our model the banking sector operates under monopolistic competition, collects deposits and grants collateralized loans. Collateral effects amplify monetary policy actions, interest rate stickiness dampens the transmission of interest rates, and financial shocks generate non-negligible real and nominal effects. As an application we estimate the model for Poland - a typical small open economy. According to the results, financial shocks had a substantial, though not overwhelming, impact on the Polish economy during the 2008/09 crisis, lowering GDP by approximately 1.5 percent.
    Keywords: credit crunch, monetary policy, DSGE with banking sector
    JEL: E32 E44 E52
    Date: 2010
  33. By: Benjamin M. Tabak; Marcela T. Laiz; Daniel O. Cajueiro
    Abstract: This paper investigates the effects of monetary policy over banks' loans growth and non-performing loans for the recent period in Brazil. We contribute to the literature on bank lending and risk taking channel by showing that during periods of loosening/tightening monetary policy, banks increase/decrease their loans. Moreover, our results illustrate that large, well-capitalized and liquid banks absorb better the effects of monetary policy shocks. We also find that low interest rates lead to an increase in credit risk exposure, supporting the existence of a risk-taking channel. Finally, we show that the impact of monetary policy differs across state-owned, foreign and private domestic banks. These results are important for developing and conducting monetary policy.
    Date: 2010–10
  34. By: Deniz Igan; Burcu Aydin
    Abstract: The period following the 2000-01 crisis was marked by a successful disinflation program sustained through inflation targeting and fiscal discipline in Turkey. This paper studies the impact of monetary and fiscal policies on credit growth during this period. Using quarterly bank-level data covering 2002-08, we find evidence that liquidity-constrained banks have sharper decline in lending during contractionary monetary policies and that crowding-out effect disappears more for banks with a retail-banking focus when fiscal policies are prudent.The results are statistically weak, suggesting that bank lending channel is not strong in Turkey and government finances has limited direct impact on credit.
    Date: 2010–10–18
  35. By: Pedro Castro (SPX Capital); João Manoel Pinho de Mello (Department of Economics PUC-Rio)
    Abstract: This paper tests and find evidence that support the view that credit interest rates respond more to increases than to decreases in the Central Bank basic interest rate (Selic). This asymmetry is robust to an event analysis, in which the availability of a dataset containing daily information is explored in order to isolate monetary policy shocks on interest rates as the cause of the assymetric response of interest rates, as a shift in the basic interest rate is akin to an increase in marginal cost and thus corresponds to a shift in the supply curve of banks. The econometric identification hypothesis is that banks (supply) react faster to monetary shocks than consumers (demand for credit). The empirical evidence of greater rigidity to Selic decreases contributes to the literature of bank behavior in credit markets and the transmission mechanism of monetary policy in Brazil.
    Keywords: Microeconomics of Banking, interest pass-through and Adverse Selection JEL Codes: L11, G21
    Date: 2010–09

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