nep-cba New Economics Papers
on Central Banking
Issue of 2010‒11‒13
39 papers chosen by
Alexander Mihailov
University of Reading

  1. The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma By Joshua Aizenman; Hiro Ito; Menzie D. Chinna
  2. Liquidity Traps: An Interest-Rate-Based Exit Strategy By Stephanie Schmitt-Grohé; Martín Uribe
  3. Japan's Bubble, America's Bubble and China's Bubble By Kazuo Ueda
  4. Japan's Bubble, America's Bubble and China's Bubble By Junko Koeda
  5. Surprising comparative properties of monetary models: Results from a new model database By John B. Taylor; Volker Wieland
  6. Revisiting Overborrowing and Its Policy Implications By Gianluca Benigno; Huigang Chen; Chris Otrok; Alessandro Rebucci; Eric Young
  7. There Will Be Money By Luis Araujo; Bernardo Guimaraes
  8. Imperfect Knowledge, Asset Price Swings and Structural Slumps: A Cointegrated VAR Analysis of Their Interdependence By Katarina Juselius
  9. Monetary Policy Rules and Foreign Currency Positions By Bianca De Paoli; Hande Küçük-Tuger; Jens Søndergaard
  10. On approximating DSGE models by series expansions By Giovanni Lombardo
  11. Optimality criteria of hybrid inflation-price level targeting By László Bokor
  12. Macro expectations, aggregate uncertainty, and expected term premia By Dick, Christian D.; Schmeling, Maik; Schrimpf, Andreas
  13. The euro area interbank market and the liquidity management of the eurosystem in the financial crisis By Hauck, Achim; Neyer, Ulrike
  14. New Keynesian DSGE Models and the IS-LM Paradigm By Ulrich Frische; Ingrid Größl
  15. The Taylor principle and (in-)determinacy in a New Keynesian model with hiring frictions and skill loss By Ansgar Rannenberg
  16. Liquidity Crunch in Late 2008: High-Frequency Differentials between Forward-Implied Funding Costs and Money Market Rates By Matthew S. Yiu; Joseph K. W. Fung; Lu Jin; Wai-Yip Alex Ho
  17. The impact of supply constraints on bank lending in the euro area - crisis induced crunching? By Hannah Sabine Hempell; Christoffer Kok Sørensen
  18. Macroeconomic Shocks and the Business Cycle: Evidence from a Structural Factor Model By Mario Forni; Luca.Gambetti
  19. A decade (and a global financial crisis) after Blinder: The interaction between researchers and policy-makers in central banks By Matthieu Bussière; Livio Stracca
  20. How much does the public know about the ECB's monetary policy? Evidence from a survey of Dutch households By Carin van der Cruijsen; David-Jan Jansen; Jakob de Haan
  21. How Big (Small?) are Fiscal Multipliers? By Ethan Ilzetzki; Enrique G. Mendoza; Carlos A. Végh
  22. Alternative Policies for US Economic Recovery By Byron Ganges
  23. The benefits of fiscal consolidation in uncharted waters By Philipp Rother; Ludger Schuknecht; Jürgen Stark
  24. Public Debt, Distortionary Taxation, and Monetary Policy By Piergallini, Alessandro; Rodano, Giorgio
  25. The monetary policy response to the financial crisis in the Euro area and in the United States: a comparison By Domenica Tropeano
  26. Causes and Remedies of China’s External Imbalances By Huang Yiping; Tao Kunyu
  27. Has the Inclusion of Forward-Looking Statements in Monetary Policy Communications Made the Bank of Canada More Transparent? By Christine Fay; Toni Gravelle
  28. Adaptive Forecasting of Exchange Rates with Panel Data By Leonardo Morales-Arias; Alexander Dross
  29. Squaring the circle in Euroland? Some remarks on the Stability and Convergence Programmes 2010-2013 By Till van Treeck; Silke Tober; Achim Truger; Michael Brecht
  30. The Risk of Sudden Depreciation of the Euro in the Sovereign Debt Crisis of 2009-2010 By Cho-Hoi Hui; Tsz-Kin Chung
  31. Inattentive Consumers and Exchange Rate Volatility By Mehmet Fatih, Ekinci
  32. Monetary Policy Strategies in the Asia and Pacific Region: What Way Forward? By Andrew Filardo; Hans Genberg
  33. Autoregressions in small samples, priors about observables and initial conditions By Marek Jarociński; Albert Marcet
  34. Financial Integration, Monetary Policy and Stock Prices: Empirical Evidence for the New EU Member States By Pirovano M.
  35. The distributional and welfare impact of inflation in Italy. By Alessandra Cepparulo; Francesca Gastaldi; Paolo Liberati; Elena Pisano
  36. Is exchange rate – customer order flow relationship linear? Evidence from the Hungarian FX market By Yuliya Lovcha; Alejandro Perez-Laborda
  37. A New Core Inflation Indicator for Turkey (Turkiye Ekonomisi Icin Yeni Bir Cekirdek Enflasyon Gostergesi) By Necati Tekatli
  38. The Trade Credit Channel of Monetary Policy Transmission: Evidence from Non-Financial Firms in Turkey (Firma Ticari Borclari ve Kredi Aktarim Mekanizmasi: Turkiye Ornegi) By Pinar Ozlu; Cihan Yalcin
  39. Measuring the Impact of Monetary Policy on Asset Prices in Turkey (Turkiye’de Para Politikasinin Finansal Varlik Fiyatlari Uzerine Etkisi) By Murat Duran; Gulserim Ozcan; Pinar Ozlu; Deren Unalmis

  1. By: Joshua Aizenman; Hiro Ito; Menzie D. Chinna
    Abstract: This paper extends their previous paper (Aizenman, Chinn, and Ito 2008) and explores some of the unexplored questions. First, they examine the channels through which the trilemma policy configurations affect output volatility. Secondly, they investigate how trilemma policy configurations affect the output performance of the economies under severe crisis situations. Thirdly, they look into how trilemma configurations have evolved in the aftermath of economic crises in the past. They find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. [ADBI Working Paper 213]
    Keywords: trilemma, policy, performance, economic, finances
    Date: 2010
  2. By: Stephanie Schmitt-Grohé; Martín Uribe
    Abstract: This paper analyzes a potential strategy for escaping liquidity traps. The strategy is based on an augmented Taylor-type interest-rate feedback rule and differs from usual specifications in that when inflation falls below a threshold, the central bank temporarily deviates from the traditional Taylor rule by following a deterministic path for the nominal interest rate. This path reaches the intended target for this policy instrument in finite time. The policy we study is designed to raise inflationary expectations over time while at the same time maintaining all of the desirable local properties of the Taylor principle in a neighborhood of the intended inflation target. Importantly, the effectiveness of the potential exit strategy studied in this paper does not rely on the existence of an accompanying fiscalist (or non-Ricardian) fiscal stance.
    JEL: E31 E52
    Date: 2010–11
  3. By: Kazuo Ueda (Faculty of Economics, University of Tokyo)
    Abstract: This paper compares the three recent episodes of boom and bust cycles in asset prices: Japan in the late 1980s to the 1990s; the U.S. since the mid 1990s; and China during the last decade. Although we have not yet seen a collapse of Chinese property prices, the increases so far are comparable to those in the other two episodes and seem to warrant a careful comparative study. I first examine the behavior of asset prices, especially, property prices in the three cases and point out some similarities. I then go on to discuss some backgrounds for the behavior of asset prices. I emphasize the role played by extremely easy monetary policy for generating bubble like asset price behaviors in the three cases. Monetary policy was shown to be easier than standard policy rules like the Taylor rule indicates. The reason for easy monetary policies is investigated. In the U.S. case the monetary authority was concerned over the risk of deflation in the early to mid 2000s. The experiences of Japan and China are quite similar in that the authorities of both countries were seriously concerned with possible deflationary effects of exchange rate appreciation on the economy. Japan let the exchange rate appreciate, while China has resisted a large scale intervention. It is shown, however, that the behavior of real exchange rates has not been that different. Implications of such a finding for the future of the Chinese economy are also discussed.
    Date: 2010–11
  4. By: Junko Koeda (Faculty of Economics, University of Tokyo)
    Abstract: This note examines the predictability of yield-curve variables for GDP growth by modifying the time-series property of the interest rate process in Ang, Piazessi, and Wei (2006, APW henceforth). When interest rates have a unit root and term spreads are stationary (as in Campbell and Shiller (1987)), the combined information from the short rate and term spread can reveal the relationship between the shift of yield curves and GDP growth. The modified model suggests that, for example, bear-steepening is associated with positive growth, while bear-flattening produces a mixed result. These results are more in line with the practitionerfs views than those based on the original APW model.
    Date: 2010–11
  5. By: John B. Taylor (Herbert Hoover Memorial Building, Stanford University, Stanford, CA 94305, U.S.A.); Volker Wieland (House of Finance, Goethe University of Frankfurt, Grueneburgplatz 1, D-60323 Frankfurt am Main, Germany.)
    Abstract: In this paper we investigate the comparative properties of empirically-estimated monetary models of the U.S. economy. We make use of a new database of models designed for such investigations. We focus on three representative models: the Christiano, Eichenbaum, Evans (2005) model, the Smets and Wouters (2007) model, and the Taylor (1993a) model. Although the three models differ in terms of structure, estimation method, sample period, and data vintage, we find surprisingly similar economic impacts of unanticipated changes in the federal funds rate. However, the optimal monetary policy rules are different in the different models. Simple model-specific policy rules that include the lagged interest rate, inflation and current and lagged output gaps are not robust. Some degree of robustness can be recovered by using rules without interest-rate smoothing or with GDP growth deviations from trend in place of the output gap. However, improvement vis-à-vis other models, comes at the cost of significant performance deterioration in the original model. Model averaging offers a much more effective strategy for improving the robustness of policy rules. JEL Classification: E12, E52, E61.
    Keywords: monetary policy rules, New-Keynesian models, model uncertainty, robustness, monetary policy transmission.
    Date: 2010–11
  6. By: Gianluca Benigno; Huigang Chen; Chris Otrok; Alessandro Rebucci; Eric Young
    Abstract: This paper analyzes quantitatively the extent to which there is overborrowing (i.e., inefficientborrowing) in a business cycle model for emerging market economies with production and anoccasionally binding credit constraint. The main finding of the analysis is that overborrowing is not arobust feature of this class of model economies: it depends on the structure of the economy and itsparametrization. Specifically, we find underborrowing in a production economy with our baselinecalibration, but overborrowing with more impatient agents and more volatile shocks. Endowmenteconomies display overborrowing regardless of parameter values, but they do not allow for policyintervention when the constraint binds (in crisis times). Quantitatively, the welfare gains fromimplementing the constrained-efficient allocation are always larger near crisis times than in normalones. In production economies, they are one order of magnitude larger than in endowment economiesboth i n crisis and normal times. This suggests that the scope for economy-wide macro-prudentialpolicy interventions (e.g. prudential taxation of capital flows and capital controls) is weak in this classof models.
    Keywords: Bailouts, financial frictions, macro prudential policies, overborrowing
    JEL: E52 F37 F41
    Date: 2010–10
  7. By: Luis Araujo; Bernardo Guimaraes
    Abstract: A common belief among monetary theorists is that monetary equilibria are tenuous due to theintrinsic uselessness of fiat money (Wallace (1978)). In this article we argue that thetenuousness of monetary equilibria vanishes as soon as one introduces a small perturbation inan otherwise standard random matching model of money. Precisely, we show that the sheerbelief that fiat money may become intrinsically useful, even if only in an almost unreachablestate, might be enough to rule out nonmonetary equilibria. In a large region of parameters,agents' beliefs and behavior are completely determined by fundamentals.
    Keywords: Fiat money, autarky, equilibrium selection
    JEL: E40 D83
    Date: 2010–09
  8. By: Katarina Juselius (Department of Economics, University of Copenhagen)
    Abstract: This paper is an empirically based discussion of interactions between speculative behavior in the currency markets and aggregate fluctuations in the real economy. It builds on the recent theory of Imperfect Knowledge Economics in Frydman and Goldberg (2007) and combines this with the Structural Slumps theory in Phelps (1994). The paper argues that this is likely to imcrease our understanding of the long recurrent spells of high unemployment that continue to mar our economies.
    Keywords: financial markets; speculation; long swings; imperfect knowledge; CVAR
    JEL: E24 F31 F41
    Date: 2010–11
  9. By: Bianca De Paoli; Hande Küçük-Tuger; Jens Søndergaard
    Abstract: Using an endogenous portfolio choice model, this paper examines how different monetarypolicy regimes can lead to different foreign currency positions by changing the cyclicalproperties of the nominal exchange rate. We find that strict inflation targeting regimes areassociated with a short position in foreign currency, while the opposite is true for noninflationtargeting regimes. We also explore how these different external positions affect theinternational transmission of monetary shocks through the valuation channel. When centralbanks follow inflation targeting Taylor-type rules, valuation effects of monetary expansionsare beggar-thy-self, but they are beggar-thy-neighbour in a money growth targeting regime(or when monetary policy puts weight on output stabilization).
    Keywords: Portfolio choice, international transmission of shocks, monetary policy
    JEL: F31 F41
    Date: 2010–11
  10. By: Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We show how to use a simple perturbation method to solve non-linear rational expectation models. Drawing from the applied mathematics literature we propose a method consisting of series expansions of the non-linear system around a known solution. The variables are represented in terms of their orders of approximation with respect to a perturbation parameter. The final solution, therefore, is the sum of the different orders. This approach links to formal arguments the idea that each order of approximation is solved recursively taking as given the lower order of approximation. Therefore, this method is not subject to the ambiguity concerning the order of the variables in the resulting state-space representation as, for example, has been discussed by Kim et al. (2008). Provided that the model is locally stable, the approximation technique discussed in this paper delivers stable solutions at any order of approximation. JEL Classification: C63, E0.
    Keywords: Solving dynamic stochastic general equilibrium models, Perturbation methods, Series expansions, Non-linear difference equations.
    Date: 2010–11
  11. By: László Bokor (Budapest University of Technology and Economics)
    Abstract: This paper provides a sensitivity analysis of the relative performance of inflation targeting, price level targeting, and hybrid targeting, the combination of these two. A simple, three-period, steady state to steady state economy is presented, where monetary policy is facing various sets of forward and backward looking expectations, social preferences on inflation and output gap stabilization, and degrees of cost push shock persistence. we derive optimal policy mix under the whole spectrum of these economic conditions, reporting also the criteria of the replicability of the theoretically optimal solution. The main intention of the examination is to reveal the nature of each interrelation between economic and policy parameters. The results show that (i) the relative strength of regimes depends heavily on the preconditions, and that (ii) the relationships of parameters related to the performance are non-linear and occasionally non-monotonic as well. our model specification is somewhat restrictive, however, contrary to the related literature, the examination, even in the intermediate cases, can be conducted analytically.
    Keywords: hybrid inflation-price level targeting, hybrid new keynesian Phillips curve, cost push shock persistence
    JEL: E50 E52 E58
    Date: 2010
  12. By: Dick, Christian D.; Schmeling, Maik; Schrimpf, Andreas
    Abstract: Based on individual expectations from the Survey of Professional Forecasters, we construct a real-time proxy for expected term premium changes on long-term bonds. We empirically investigate the relation of these bond term premium expectations with expectations about key macroeconomic variables as well as aggregate macroeconomic uncertainty at the level of individual forecasters. We find that expected term premia are (i) time-varying and reasonably persistent, (ii) strongly related to expectations about future output growth, and (iii) positively affected by uncertainty about future output growth and inflation rates. Expectations about real macroeconomic variables seem to matter more than expectations about nominal factors. Additional findings on term structure factors suggest that the level and slope factor capture information related to uncertainty about real and nominal macroeconomic prospects, and that curvature is related to subjective term premium expectations themselves. Finally, an aggregate measure of forecasters' term premium expectations has predictive power for bond excess returns over horizons of up to one year. --
    JEL: E43 E44 G12
    Date: 2010
  13. By: Hauck, Achim; Neyer, Ulrike
    Abstract: This paper develops a theoretical model which explains several stylized facts observed in the euro area interbank market after the collapse of Lehman Brothers in 2008. The model shows that if costs of participating in the interbank market are high, the central bank assumes an intermediary function between liquidity surplus banks and liquidity deficit banks and thereby replaces the interbank market. From a policy perspective, we argue that possible measures of the Eurosystem to reactivate the interbank market may conflict, inter alia, with monetary policy aims. --
    Keywords: Liquidity,Monetary Policy Instruments,Interbank Market,Financial Crisis
    JEL: E52 E58 G21
    Date: 2010
  14. By: Ulrich Frische (University of Hamburg); Ingrid Größl (University of Hamburg)
    Abstract: New Keynesian DSGE models propose a dynamic and expectational version of the old IS-LM paradigm. Acknowledging that the Taylor rule as a substitute for the LM-curve has its merits we show that standard DSGE models do not model how the central bank achieves its targets. In filling this gap we make evident that models neglecting a store-of-value function of money but still assuming a Taylor rule are inconsistent. Our major point concerns the-so called new Keynesian IS-curve. We prove that DSGE models which typically rest on the assumption of representative agents are unable to derive the IS-curve. This implies that these models lack the capability to analyse the role of savings as a a gap in aggregate demand. By assuming overlapping generations we make evident how this shortcoming can be avoided. We also show how OLG models add a richer dynamics to the standard DSGE approach.
    Date: 2010
  15. By: Ansgar Rannenberg (National Bank of Belgium, Research Department)
    Abstract: We introduce skill decay during unemployment into Blanchard and Gali's (2008) New-Keynesian model with hiring frictions and real-wage rigidity. Plausible values of quarterly skill decay and real-wage rigidity turn the long-run marginal cost-unemployment relationship positive in a "European" labour market with little hiring but not in a fluid "American" one. If the marginal cost-unemployment relationship is positive, determinacy requires a passive response to inflation in the central bank's interest feedback rule if the rule features only inflation. Targeting steady state output or unemployment helps to restore determinacy. Under indeterminacy, an adverse sunspot shock increases unemployment extremely persistently.
    Keywords: Monetary policy rules, Taylor principle, Determinacy, Hysteresis, Skill decay
    JEL: E24 E52 E32 J64
    Date: 2010–11
  16. By: Matthew S. Yiu (Hong Kong Monetary Authority); Joseph K. W. Fung (Hong Kong Baptist University and Hong Kong Institute for Monetary Research); Lu Jin (Hong Kong Monetary Authority); Wai-Yip Alex Ho (Hong Kong Monetary Authority and Boston University)
    Abstract: The US Federal Reserve and the European Central Bank have adopted a number of measures, including aggressive policy rate cuts, to ease the liquidity crunch in the financial markets following the collapse of Lehman Brothers. Using high frequency spot and forward foreign exchange and interest rate quotes that are potentially executable for the period surrounding the 2008 global financial turmoil, this study examines the variations of intraday funding liquidity across the global financial markets that span different time zones. Moreover, the paper also tests how and to what extent policy actions undertaken by central banks affect the dynamics of market liquidity conditions. Similar to Hui et al. (2009), the paper uses the differential between the US dollar interest rate implied by the covered interest rate parity condition and the corresponding US dollar interest rate as a proxy for the liquidity (or the lack of it) in the US dollar money market. The study focuses on the EUR/USD exchange rate and compares the most stressful crisis period with other relatively less stressful periods. The intraday funding liquidity condition during the most tumultuous period shows that the pressures in the demand for US dollars through foreign exchange and forward markets spilled over to the Asian markets. The paper also examines how policy announcements by the central banks affect the dynamics of market liquidity. The study employs autoregressive models to capture the potential effects of monetary policy announcements on both the mean and volatility of the liquidity proxy. The empirical results show that the coordinated cuts of policy rates failed to stimulate lending in the short-term US money market, whereas the uncapped currency swap lines offered by the Federal Reserve to other central banks succeeded in easing the liquidity condition in the market. The policy is more effective and persistent for the very short end of the money market.
    Keywords: Financial Crisis, Intraday Liquidity, CIP Deviation, Monetary Policy
    JEL: G14 G15 E5
    Date: 2010–10
  17. By: Hannah Sabine Hempell (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Christoffer Kok Sørensen (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Aggregate loan development typically hinges on a combination of factors that impact simultaneously on the demand and the supply side of bank lending. The financial turmoil starting in mid-2007 had detrimental consequences for banks’ balance-sheets, cost of funds and profitability, thus weighing negatively on their ability to supply new loans. This paper examines the impact of supply constraints on bank lending in the euro area with a special focus on this turmoil period. The empirical evidence presented suggests that banks’ ability and willingness to supply loans affects overall bank lending activity in general and has done so particularly during the financial crisis. Applying a cross-country panel-econometric approach using a unique confidential data set on results from the Eurosystem’s bank lending survey allows us to disentangle loan supply and demand effects. We find that even when controlling for the effects coming from the demand side loan growth is negatively affected by supply-side constraints. This applies both for loans to households for house purchase and for loans to non-financial corporations. We furthermore provide evidence that the impact of supply-side constraints, especially related to disruptions of banks’ access to wholesale funding and their liquidity positions, was reinforced since the eruption of the financial crisis and corresponding adjustments in banks’ loan portfolios seem to have been geared primarily via prices rather than outright quantity restrictions. JEL Classification: C23, E51, E52, G21.
    Keywords: bank credit, loan supply constraints, euro area, panel data.
    Date: 2010–11
  18. By: Mario Forni; Luca.Gambetti
    Abstract: We use a dynamic factor model to provide a semi-structural representation for 101 quarterly US macroeconomic series. We find that (i) the US economy is well described by a number of structural shocks between two and six. Focusing on the four-shock specification, we identify, using sign re- strictions, two non-policy shocks, demand and supply, and two policy shocks, monetary and fiscal. We obtain the following results. (ii) Both supply and demand shocks are important sources of fluc- tuations; supply prevails for GDP, while demand prevails for employment and inflation. (ii) Policy matters, Both monetary and fiscal policy shocks have sizeable effects on output and prices, with little evidence of crowding out; both monetary and fiscal authorities implement important system- atic countercyclical policies reacting to demand shocks. (iii) Negative demand shocks have a large long-run positive effect on productivity, consistently with the Schumpeterian "cleansing" view of recessions.
    Keywords: structural factor model, sign restrictions, monetary policy, fiscal policy, demand, supply
    JEL: C32 E32 E52 F31
    Date: 2010–03–22
  19. By: Matthieu Bussière (Banque de France, 31 rue Croix des petits champs, 75001 Paris, France.); Livio Stracca (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Periods of economic and financial stress traditionally give rise to profound changes in economic theory and in the way policy decisions are taken. Motivated by the recent interest in renewing macroeconomics after the global financial crisis, we collected the views of senior central bank staff in 32 central banks by means of a special questionnaire on a number of issues related to the interaction between research and policy-making. Thereafter, the paper first surveys the existing literature on the relation between researchers and practitioners and offers some reflections on the fundamental and practical differences between research and policy work. Finally, it delves on the issue of model-based versus judgment-based approaches to economic forecasts and policy simulations, with a special emphasis on the growing role of DSGE models within central banks. We conclude with practical suggestions on how best to integrate models and research into policy making decisions. JEL Classification: A11, C1, D58.
    Keywords: Economic research, policy making, central bank communication, economic crises, DSGE models.
    Date: 2010–11
  20. By: Carin van der Cruijsen (De Nederlandsche Bank.); David-Jan Jansen (De Nederlandsche Bank.); Jakob de Haan (De Nederlandsche Bank.)
    Abstract: Does the general public know what central banks do? Is this kind of knowledge relevant? Using a survey of Dutch households, we investigate these questions for the case of the European Central Bank (ECB). Our findings suggest that knowledge on the ECB's objectives is far from perfect. Both a weak desire to be informed and unawareness of insufficient knowledge are barriers for improving the public's understanding of monetary policy. However, our results also show that more intensive use of information improves understanding, suggesting that the media channel may play an important and constructive role in building knowledge. Finally, we find that knowledge on monetary policy objectives contributes to an individual's ability to form realistic inflation expectations. JEL Classification: D12, D84, E52, E58.
    Keywords: monetary policy, knowledge, transparency, financial literacy, inflation expectations, ECB.
    Date: 2010–11
  21. 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.
    Keywords: government expenditure, macroeconomic policy
    JEL: E2 E6 F41 H5
    Date: 2010–10
  22. By: Byron Ganges (Department of Economics, University of Hawaii at Manoa)
    Abstract: Recovery has begun in the United States and global economies. The US recovery is likely to be anemic by historical standards, raising the possibility that additional stimulus may be desirable. The President and Democrats in Congress have called for a “jobs bill,†and the Federal Reserve has demonstrated that it has a flexible toolkit for providing additional liquidity if deemed appropriate. The possible need for such stimulus will come up against the reality of an expanding public debt on the one hand, and inflationary concerns on the other. In this paper, I use simulations of the IHS Global Insight Model to assess the potential impact on the recovery path of alternative macro policies.
    Keywords: United States (US) recession and recovery; fiscal and monetary policy; econometric model forecast simulation; IHS Global Insight model.
    JEL: E37 E63 C53
    Date: 2010–02
  23. By: Philipp Rother (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Ludger Schuknecht (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Jürgen Stark (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: This paper looks at fiscal sustainability and fiscal risks from a comprehensive, global perspective. It argues that the benefits of consolidation have to be re-assessed given that industrialised countries have entered uncharted waters with unsustainable public debt dynamics and enormous contingent liabilities across sectors and countries coinciding with strong, non-linear and potentially highly adverse fiscal-financial interlinkages. This suggests that there would be significant benefits from fiscal consolidation without delay and that there is a need for caution against excessive faith in fiscal engineering. JEL Classification: E60, D62, H60
    Keywords: Consolidation, deficits, public debt, fiscal sustainability, financial crisis, tail risks, confidence, fiscal engineering.
    Date: 2010–11
  24. By: Piergallini, Alessandro; Rodano, Giorgio
    Abstract: Since Leeper's (1991, Journal of Monetary Economics 27, 129-147) seminal paper, an extensive literature has argued that if fiscal policy is passive, i.e., guarantees public debt stabilization irrespectively of the inflation path, monetary policy can independently be committed to inflation targeting. This can be pursued by following the Taylor principle, i.e., responding to upward perturbations in inflation with a more than one-for-one increase in the nominal interest rate. This paper analyzes an optimizing framework in which the government can only finance public expenditures by levying distortionary taxes. It is demonstrated that households' market participation constraints and Laffer-type effects can render passive fiscal policies unfeasible. For any given target inflation rate, there exists a threshold level of public debt beyond which monetary policy independence is no longer possible. In such circumstances, the dynamics of public debt can be controlled only by means of higher inflation tax revenues: inflation dynamics in line with the fiscal theory of the price level must take place in order for macroeconomic stability to be guaranteed. Otherwise, to preserve inflation control around the steady state by following the Taylor principle, monetary policy must target a higher inflation rate.
    Keywords: Public Debt; Distortionary Taxation; Monetary and Fiscal Policy Rules
    JEL: H31 E63 H63
    Date: 2010–10–30
  25. By: Domenica Tropeano (University of Macerata)
    Abstract: <p>The paper aims at drawing a comparison between the reactions to the recent financial crisis by the European Central Bank and by the Federal Reserve. Though the tools used have been largely the same, the quality and quantity of the interventions has been very different depending on the different structure of financial markets in the two areas. In particular, the ECB has not replaced private markets that did not work any more as the Federal Reserve did. The policy design behind those interventions is di®erent too. The Federal Reserve through the quantitative easing policy aims at lowering both short term and long term interest rates and has recently stated that this policy may continue in the future. The European Central Bank does not justify in this way its own interventions in the market and apparently seems not have given up its traditional goal, fighting inflation. The evolution of financial markets both in the U.S and in Europe after the crisis reflect different initial conditions and expectations for the future. Thus many differences in the structure of markets and in policy design exist. This, however, will not save Europe from the consequences of future disorders in the Us markets. The crisis spread to Europe largely because of the global dimension of the inter-bank market. Given that the interconnections between European and US banks have survived the financial crisis, nothing ensures that the same thing will not happen again.</p>
    Date: 2010–10
  26. By: Huang Yiping; Tao Kunyu (China Center for Economic Research)
    Abstract: China’s large current account surpluses not only destabilize its macroeconomic conditions but also are also at the center of global rebalancing. The literature offered five explanations for such surpluses, most of which are important but fail to account for the recent surge and/or offer actionable policy responses. In this study, we propose an alternative hypothesis for China’s large current account surpluses: asymmetric market liberalization and associated cost distortions. This unique reform approach was the fundamental cause of both extraordinary growth performance and growing structural imbalances during the reform period. Indeed, estimates of cost distortions provide good fits of the current account. Estimated cost distortions rose after 2004 but peaked in 2006 at 12.2 percent of GDP. The worst of the external imbalance problem may be already behind us. We argue that, for rebalancing its economy, China needs a comprehensive package focusing on further liberalization of factor markets. Exchange rate policy should be an important part, but exclusive focus on the currency could be counter‐productive.
    Keywords: China, current account surplus, imbalance, exchange rate, asymmetric market liberalization, cost distortion
    JEL: F40
    Date: 2010
  27. By: Christine Fay; Toni Gravelle
    Abstract: To investigate the extent to which the transparency of the Bank of Canada's monetary policy has improved, the authors examine empirically -- over the period 30 October 2000 to 31 May 2007 -- the reaction of Canadian financial markets to official Bank communications, and in particular their reaction to the recent inclusion of forwardlooking policy-rate guidance in these communications. The authors find evidence that fixed announcement date (FAD) press releases, and, to a lesser extent, speeches by Governing Council members, significantly affect near-term interest rate expectations, indicating that central bank communication conveys important information to market participants. However, the authors' results also show that FAD press releases and speeches do not significantly impact market rates over the more recent period, when forward-looking statements have been used on a regular basis. The authors investigate two explanations for this change in response: (i) market participants better understand the Bank's monetary policy reaction function as they become accustomed to the FAD regime; or, (ii) market participants focus more on the forward-looking statements and less on the Bank's discussion of the economic outlook, and therefore respond less than before to new macroeconomic data releases. The authors find evidence to support the second explanation: forward-looking statements -- even though they have been designed to be conditional -- have made the Bank's decisions on the policy rate more predictable, but not necessarily more transparent.
    Keywords: Interest rates; Central bank research; Transmission of monetary policy
    JEL: E52 E58
    Date: 2010
  28. By: Leonardo Morales-Arias; Alexander Dross
    Abstract: This article investigates the statistical and economic implications of adaptive forecasting of exchange rates with panel data and alternative predictors. The candidate exchange rate predictors are drawn from (i) macroeconomic ‘fundamentals’, (ii) return/volatility of asset markets and (iii) cyclical and confidence indices. Exchange rate forecasts at various horizons are obtained from each of the potential predictors using single market, mean group and pooled estimates by means of rolling window and recursive forecasting schemes. The capabilities of single predictors and of adaptive techniques for combining the generated exchange rate forecasts are subsequently examined by means of statistical and economic performance measures. The forward premium and a predictor based on a Taylor rule yield the most promising forecasting results out of the macro ‘fundamentals’ considered. For recursive forecasting, confidence indices and volatility in-mean yield more accurate forecasts than most of the macro ‘fundamentals’. Adaptive forecast combinations techniques improve forecasting precision and lead to better market timing than most single predictors at higher horizons
    Keywords: Exchange rate forecasting, panel data, forecast combinations, market timing
    JEL: C20 F31 G12
    Date: 2010–10
  29. By: Till van Treeck (Macroeconomic Policy Institute (IMK) in the Hans Boeckler Foundation); Silke Tober (Macroeconomic Policy Institute (IMK) in the Hans Boeckler Foundation); Achim Truger (Macroeconomic Policy Institute (IMK) in the Hans Boeckler Foundation); Michael Brecht
    Abstract: It is generally held, from both a global and a European perspective, that the three most impor-tant objectives for the years to come are 1) the reduction of current account imbalances, 2) the reduction of public deficits, and 3) the reduction of unemployment. This paper argues that the Stability and Convergence Programmes (SCPs) for the period 2010-2013, submitted by the euro area member states to the European Commission in January/February 2010, will not achieve all three objectives. Indeed, under current circumstances, the simultaneous realisation of these objectives would be like "squaring a circle". We show that the SCPs rely on rather optimistic assumptions about private sector demand and GDP growth, given the degree of fiscal consolidation. At the same time, they imply that current account imbalances in EMU would remain quite significant until 2013. Our analysis is mainly based on a few simple accounting identities and places special emphasis on Germany. It leads us to conclude that, in the absence of a drastic deterioration of private financial balances, the only way to achieve the GDP growth rates projected in the SCPs (and, ideally, current account rebalancing) would be for the governments of surplus countries to be prepared to run higher deficits over the next few years. This would be more "fiscally responsible" than the current focus on deficit reduc-tion. Failure to do so may result in persistently high unemployment in the years to come and may threaten the European Monetary Union.
    Date: 2010
  30. By: Cho-Hoi Hui (Hong Kong Monetary Authority and Hong Kong Institute for Monetary Research); Tsz-Kin Chung (Hong Kong Monetary Authority)
    Abstract: The economic-political instability of a country, which is tied to its credit risk, often leads to sharp depreciation and heightened volatility in its currency. This paper shows that not only the creditworthiness of the euro-area countries with weaker fiscal positions but also that of the member countries with more sound fiscal positions are important determinants of the deep out-of-the-money euro put option prices, which embedded information on the euro crash risk during the sovereign debt crisis of 2009-2010. Using information on the option prices under the stochastic-volatility jump-diffusion model, the euro's crash probability of 11% in a year with crash size of 14% is estimated at the end of April 2010. However, during the period of the global financial crisis between the Lehman default and September 2009 before the debt crisis began, the estimated crash size reflects the potential sharp devaluation of the US dollar that might result from quantitative easing in the US.
    Keywords: European Sovereign Debt Crisis, Currency Options, Credit Default Swaps, Currency Crash
    JEL: F31 G13
    Date: 2010–10
  31. By: Mehmet Fatih, Ekinci
    Abstract: We present and study the properties of a sticky information exchange rate model where consumers and producers update their information sets infrequently. We find that introducing inattentive consumers has important implications. Through a mechanism resembling the limited participation models, we can address the exchange rate volatility for reasonable values of risk aversion. We observe more persistence in output, consumption and employment which brings us closer to the data. Impulse responses to monetary shocks are hump shaped consistent with the empirical evidence. Forecast errors of inattentive consumers provide a channel to reduce the correlation of relative consumption and real exchange rate. However, we find that decline in the correlation is quantitatively small.
    Keywords: Sticky Information; Exchange Rate Volatility
    JEL: F3
    Date: 2010–10–31
  32. By: Andrew Filardo; Hans Genberg
    Abstract: Monetary policy frameworks in the Asia and Pacific region have performed well in the past decade as judged by inflation outcomes. We argue that this is due to three principal factors: (i) central banks have focused on price stability as the primary objective of monetary policy, (ii) institutional setups have been put in place that are supportive of the central banks’ abilities to carry out their objectives, and (iii) economic policies in general have been supportive of the pursuit of price stability, in particular the adoption of prudent fiscal policies that have reduced concerns of fiscal dominance. [ADBI Working Paper 195]
    Keywords: Monetary, policy, frameworks, Asia, central banks, institutional
    Date: 2010
  33. By: Marek Jarociński (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Albert Marcet (London School of Economics.)
    Abstract: We propose a benchmark prior for the estimation of vector autoregressions: a prior about initial growth rates of the modeled series. We first show that the Bayesian vs frequentist small sample bias controversy is driven by different default initial conditions. These initial conditions are usually arbitrary and our prior serves to replace them in an intuitive way. To implement this prior we develop a technique for translating priors about observables into priors about parameters. We find that our prior makes a big difference for the estimated persistence of output responses to monetary policy shocks in the United States. JEL Classification: C11, C22, C32.
    Keywords: Vector Autoregression, Initial Condition, Bayesian Estimation, Prior about Growth Rate, Monetary Policy Shocks, Small Sample Distribution, Bias Correction.
    Date: 2010–11
  34. By: Pirovano M.
    Abstract: We provide empirical evidence on the interaction between monetary policy and stock prices in 4 new EU member states of Central and Eastern Europe by estimating a small open economy macroeconometric model (SVAR) identi?ed by means of short-run restrictions. Our modeling choices refl?ect the increasing integration between the NMS and the Euro Area. Our contributions are twofold. We analyze the monetary transmission mechanism through stock prices in the NMS and we determine the extent to which fi?nancial markets in the aforementioned countries are sensitive to euro area monetary policy actions. We conclude that stock prices in the NMS are more sensitive to changes in the Euro Area interest rate than to the domestic one. Only in the Czech Republic and Poland we fi?nd a signi?cant negative effect of contractionary monetary policy on stock prices. Moreover, we fi?nd that the volatility of stock prices in the NMS is mainly due to shocks related to exchange rate and Euro Area monetary policy shocks.
    Date: 2010–10
  35. By: Alessandra Cepparulo; Francesca Gastaldi; Paolo Liberati; Elena Pisano
    Abstract: The entrance of Italy in the Euro area in 2001 has given rise to a wide debate about the perception of inflation on households' well-being. However, most of the debate has involved the measurement of the "correct" consumer price index at national level. Much less analysis has been carried out on the microeconomic consequences of inflation on every household and to the investigation of its distributional impact. This paper addresses this issue by performing a microsimulation analysis of the impact of inflation on Italian households in the period 1997-2007. The extension of the study allows to capture possible structural breaks in correspondence of the adoption of the euro currency in 2001, and to get insightful information on the persistence of either positive or negative impacts. All methods of investigation proposed in this paper show that the impact of inflation has an ambiguous path over the period, yet a large concentration of welfare losses is found in the period surrounding the introduction of the euro currency. In particular, poorer and larger households are found to be severely hurt by inflation and a closer inspection suggests that the prices of gas and gasoline are largely responsible in determining living conditions of Italian households in both the period around the introduction of the euro and over the decade.
    Keywords: Redistribution, Inflation, Households, Welfare.
    JEL: D12 D60 H22 I31
    Date: 2010–07
  36. By: Yuliya Lovcha (University of Alicante); Alejandro Perez-Laborda (University of Alicante)
    Abstract: over the last decade, the microstructure approach to exchange rates has become very popular. The underlying idea of this approach is that the order flows at different levels of aggregation contain valuable information to explain exchange rate movements. The bulk of empirical literature has focused on evaluating this hypothesis in a linear framework. This paper analyzes nonlinearities in the relation between exchange rates and customer order flows. We show that the relationship evolves over time and that it is different under different market conditions defined by exchange rate volatility. Further, we found that the nonlinearity can be captured successfully by the Threshold regression and Markov Switching models, which provide substantial explanatory power beyond the constant coefficients approach.
    Keywords: customer order flows, nonlinear models, microstructure, exchange rate
    JEL: C22 F31 G15
    Date: 2010
  37. By: Necati Tekatli
    Date: 2010
  38. By: Pinar Ozlu; Cihan Yalcin
    Date: 2010
  39. By: Murat Duran; Gulserim Ozcan; Pinar Ozlu; Deren Unalmis
    Date: 2010

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