nep-cba New Economics Papers
on Central Banking
Issue of 2010‒12‒23
thirty papers chosen by
Alexander Mihailov
University of Reading

  1. Openness and optimal monetary policy By Giovanni Lombardo; Federico Ravenna
  2. Epidemics of rules, information aggregation failure and market crashes By Kartik Anand; Alan Kirman; Matteo Marsili
  3. Macroprudential policy - a literature review By Gabriele Galati; Richhild Moessner
  4. The Effectiveness of Government Debt for Demand Management: Sensitivity to Monetary Policy Rules By Guido Ascari; Neil Rankin
  5. Real House Prices in OECD Countries: The Role of Demand Shocks and Structural and Policy Factors By Dan Andrews
  6. Minimising Risks from Imbalances in European Banking By Sebastian Barnes; Philip R. Lane; Artur Radziwill
  7. Loose commitment in medium-scale macroeconomic models: Theory and an application By Davide Debortoli; Junior Maih; Ricardo Nunes
  8. Household inflation expectations and inflation dynamics By Péter Gábriel
  9. Macroeconomic Regimes, Policies, and Outcomes in the World By Klaus Schmidt-Hebbel
  10. The cost channel reconsidered: a comment using an identification-robust approach By Vasco J. Gabriel; Luis F. Martins
  11. Shocking stuff: technology, hours, and factor substitution By Cristiano Cantore; Miguel A. León-Ledesma; Peter McAdam; Alpo Willman
  12. A Transaction Data Study of the Forward Bias Puzzle By Francis Breedon; Dagfinn Rime; Paolo Vital
  13. The Impact of Structural Policies on Saving, Investment and Current Accounts By Clovis Kerdrain; Isabell Koske; Isabelle Wanner
  14. Measuring Monetary Conditions in US Asset Markets - A Market Specific Approach By Drescher, Christian; Herz, Bernhard
  15. Reference-dependent preferences and the transmission of monetary policy By Edoardo GAFFEO; Ivan PETRELLA; Damjan PFAJFAR; Emiliano SANTORO
  16. Suspicious Estimates of Ex Ante Real Interest Rates: Evidence of Macroeconomic Malpractice? By Lee C. Spector; Courtenay C. Stone
  17. Why does the Interest Rate Decline Over the Day? Evidence from the Liquidity Crisis By Angelo Baglioni; Andrea Monticini
  18. Improving Fiscal Performance Through Fiscal Councils By Robert Hagemann
  19. Fiscal-Consolidation Strategies for Canadian Governments By Yvan Guillemette
  20. Fiscal activism and the cost of debt financing By Hans DEWACHTER; Priscilla TOFFANO
  21. Which Parameters Drive Approximation Inaccuracies? By Sebastian Sienknecht
  22. Resolving and Avoiding Unsustainable Imbalances in the Euro Area By Sebastian Barnes
  23. Spatial propagation of macroeconomic shocks in Europe By Hans DEWACHTER; Romain HOUSSA; Priscilla TOFFANO
  24. Current Account Imbalances in the Euro Area: A Comparative Perspective By Sebastian Barnes; Jeremy Lawson; Artur Radziwill
  25. International Financial Integration and the External Positions of Euro Area Countries By Philip R. Lane
  26. Gordon Unbound: The Heresthetic of Central Bank Independence in Britain By Sebastián Dellepiane Avellaneda
  27. A Floating versus Managed Exchange Rate Regime in a DSGE Model of India By Nicoletta Batini; Vasco J. Gabriel; Paul Levine; Joseph Pearlman
  28. An Estimated DSGE Model of the Indian Economy By Vasco J. Gabriel; Paul Levine; Joseph Pearlman; Bo Yang
  29. "Quantitative Easing and Proposals for Reform of Monetary Policy Operations" By Scott Fullwiler; L. Randall Wray
  30. Descomposición Histórica de la Inflación en Perú. Distinguiendo entre choques de demanda y choques de oferta By Guillermo Lavanda; Gabriel Rodriguez

  1. By: Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Federico Ravenna (HEC Montreal.)
    Abstract: We show that the composition of imports has important implications for the optimal volatility of the exchange rate. Using input-output data for 25 countries we document substantial differences in the import and non-tradable content of final demand components, and in the role played by imported inputs in domestic production. We build a business cycle model of a small open economy to discuss how the problem of the optimizing policy-maker changes endogenously as the composition of imports and of final demand is altered. Contrary to models where steady state trade openness is entirely characterized by home bias, we find that trade openness is a very poor proxy of the welfare impact of alternative monetary policies. Finally, we quantify the loss from an exchange rate peg relative to the Ramsey policy conditional on the composition of imports, using parameter values that are estimated from OECD input-output tables data. We find that the main determinant of the losses is the share of non-traded goods in final demand. JEL Classification: E52, E31, F02, F41.
    Keywords: International Trade, Exchange Rate Regimes, Non-tradable Goods, Optimal Policy.
    Date: 2010–12
  2. By: Kartik Anand (The Abdus Salam International Center for Theoretical Physics - The Abdus Salam International Center for Theoretical Physics - Commencez à saisir le nom d'un établissementThe Abdus Salam International Center for Theoretical Physics); Alan Kirman (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Matteo Marsili (The Abdus Salam International Centre for Theoretical Physics - ICTP Trieste)
    Abstract: This short paper argues that rationally motivated coordination between agents is an important ingredient to understand the current economic crisis. We argue that changes in parameters that model the structure of a macro-economy or financial markets are not exogenous but arise as agents adopt rules that appear to be the norm around them. For example, if a rule is adopted by the majority of ones' neighbors it will become acceptable or, alternatively, if agents learn that changing their rule leads to greater gains, they will modified their rules. However, as rules develop and spread they may have consequences at the aggregate level which are not anticipated by individuals. These rules may be adopted by implicit consensus as they turn out to be profitable for individuals, but they may also weaken the constraints imposed by regulators. Indeed, the emergence of new rules or the modification of old ones may render the whole system more fragile, which may then cease to function. To illustrate this we develop a simple model, motivated by the 2007-2008 crisis in credit derivatives markets, to show how coordination on simple and apparently profitable rules may cause a market to collapse.
    Keywords: Coordination; economic crisis; economic rules; information aggregation
    Date: 2010–12–09
  3. By: Gabriele Galati; Richhild Moessner
    Abstract: The recent financial crisis has highlighted the need to go beyond a purely micro approach to financial regulation and supervision. In recent months, the number of policy speeches, research papers and conferences that discuss a macro perspective on financial regulation has grown considerably. The policy debate is focusing in particular on macroprudential tools and their usage, their relationship with monetary policy, their implementation and their effectiveness. Macroprudential policy has recently also attracted considerable attention among researchers. This paper provides an overview of research on this topic. We also identify important future research questions that emerge from both the literature and the current policy debate.
    Keywords: Macroprudential policy
    JEL: E58 G28
    Date: 2010–12
  4. By: Guido Ascari; Neil Rankin
    Abstract: We construct a staggered-price dynamic general equilibrium model with overlapping generations based on uncertain lifetimes. Price stickiness plus lack of Ricardian Equivalence could be expected to make an increase in government debt, with associated changes in lump-sum taxation, effective in raising short-run output. However we find this is very sensitive to the monetary policy rule. A permanent increase in debt under a basic Taylor Rule does not raise output. To make debt effective we need either a temporary nominal interest rate peg; or inertia in the rule; or an exogenous money supply policy; or to make the debt increase temporary.
    Keywords: staggered prices, overlapping generations, government debt, fiscal policy effectiveness, monetary policy rules
    JEL: E62 E63
    Date: 2010–12
  5. By: Dan Andrews
    Abstract: This paper analyses the factors influencing the level and volatility of real house prices in a panel of OECD countries over the period 1980-2005. Results suggest that real house prices tend to rise proportionally with real household incomes, while declines in structural unemployment and real interest rates are associated with higher real house prices. The process of mortgage market deregulation has coincided with a noticeable increase in real house prices in OECD countries, while high rates of leverage are found to amplify house price volatility. Estimates suggest that tax reliefs on mortgage debt financing costs tend to be capitalised into real house prices and may also amplify price volatility, reflecting the tendency for such policies to encourage leverage. While higher transaction costs are associated with lower house price volatility, this effect is modest compared to the impact of banking supervision. Indeed, prudential banking supervision and policies designed to contain the excessive build-up of leverage are shown to significantly reduce the extent of house price volatility, underscoring the importance of ongoing efforts to reform prudential frameworks in OECD countries.<P>Prix réels des logements dans les pays de l’OCDE : Le rôle des chocs sur la demande et des facteurs structurels et politiques<BR>Ce document analyse les facteurs qui influencent le niveau et la volatilité des prix réels des logements dans un panel de pays de l'OCDE sur la période 1980-2005. Les résultats suggèrent que les prix réels des logements ont tendance à augmenter proportionnellement avec les revenus réels des ménages, alors que les baisses du chômage structurel et de taux d'intérêt réels sont associées à la hausse des prix réels des logements. Le processus de déréglementation du marché hypothécaire a coïncidé avec une hausse notable des prix réels des logements dans les pays de l'OCDE, tandis que les taux d'endettement élevés ont amplifié la volatilité des prix. Les estimations suggèrent que les allégements fiscaux sur les coûts de la dette hypothécaire de financement ont tendance à être capitalisées dans les prix réels des logements et peuvent amplifier la volatilité des prix, reflétant la tendance de ces politiques à encourager un effet de levier. Bien que les coûts de transaction plus élevés se sont associés à la volatilité des prix, cet effet est modeste par rapport à l'impact de la supervision bancaire. En effet, un contrôle prudentiel des banques et des politiques visant à contenir l'accumulation excessive de l'effet de levier réduisent d'une façon significative la volatilité des prix des logements, ce qui souligne l'importance des efforts en cours pour réformer les structures prudentielles dans les pays de l'OCDE.
    Keywords: taxation, house prices, mortgage markets, housing market, financial regulation, fiscalité, prix des logements, marchés hypothécaires, réglementation financière, marché des logements
    JEL: G21 H24 R21 R31
    Date: 2010–12–13
  6. By: Sebastian Barnes; Philip R. Lane; Artur Radziwill
    Abstract: The euro area financial system took excessive risks during the global credit boom, which in some countries led to an unsustainable increase in credit, higher asset prices and housing booms. This process helped to fuel large imbalances within the euro area. Banks played a key role in channelling funds from economies with large surpluses to deficit countries, leading in some cases to the accumulation of considerable risks for borrowers and lenders. Weaknesses in the regulatory and supervisory architecture contributed to these problems in the euro area, as in other OECD economies. Gaps in microprudential regulation created an environment prone to excessive risk-taking: capital buffers were too small; the quality of capital was inadequate; banks’ models underestimated risks; and risks were shifted off-balance sheet and beyond supervisory oversight. Liquidity risks were not adequately monitored. Systemic risks were allowed to build up as the authorities largely failed to counter the credit cycle. Some large systemic banks contributed to growing imbalances and vulnerability. The decentralised European supervisory architecture was not sufficiently effective in supervising large cross-border institutions. When the financial crisis hit, the co-ordination of cross-border rescues proved problematic and complicated efficient resolution. Stronger regulations are needed to improve financial stability. Effective microprudential regulation is the first line of defence. This should be upgraded by implementing the Basel III capital accord, as has been announced by the EU authorities, and a range of related measures. Some consideration should be given to an accelerated phasing-in. Macroprudential regulation should be significantly developed to mitigate pro-cyclicality and reduce systemic risks posed by large cross-border banks. The creation of the European Systemic Risk Board is welcome. To improve cross-border supervision, the European Banking Authority should have sufficient powers and resources to ensure that a system based on national supervision leads to coherent regulation and effective supervision. In addition, a cross-border crisis-management framework for Europe is needed. Overall, significant steps have already been taken by the EU authorities to address these issues and further reforms are under way. This working paper relates to the 2010 OECD Economic Survey of the Euro area. (<P>Minimiser les risques de déséquilibre au sein du système bancaire européen<BR>Durant la phase d’explosion du crédit à l'échelle mondiale, le système financier de la zone euro a pris des risques excessifs qui ont abouti, dans quelques pays, à une augmentation insoutenable du crédit et à une flambée des prix des actifs et de l'immobilier. Ce processus a contribué au creusement d'importants déséquilibres au sein de la zone euro. Les banques ont joué un rôle majeur dans la transmission des ressources financières des économies affichant des excédents importants vers les pays déficitaires, ce qui a conduit, dans certains cas, à l'accumulation de risques considérables pour les emprunteurs comme pour les prêteurs. Les lacunes du dispositif de réglementation et de surveillance ont contribué à ces problèmes dans la zone euro, comme dans les autres économies de l’OCDE. Les failles de la réglementation microprudentielle ont favorisé la propension à prendre des risques excessifs : les volants de fonds propres des banques étaient trop faibles, la qualité des capitaux n'était pas adaptée, les modèles utilisés par les banques sous-estimaient les risques et ces risques étaient sortis des bilans et échappaient ainsi à la surveillance des autorités de contrôle. De plus, il n’y a pas eu de suivi convenable des risques de liquidité. Comme les autorités n’ont guère su s’opposer à l’expansion du crédit, des risques systémiques ont pu s'accumuler. Certaines grandes banques d'importance systémique ont contribué à l'aggravation des déséquilibres et de la vulnérabilité du système. Le dispositif européen de surveillance décentralisé n’était pas assez efficace pour contrôler les grandes institutions financières transnationales. Lorsque la crise financière a éclaté, la coordination des différents plans de sauvetage nationaux s'est avérée problématique et a contrarié le règlement efficient des faillites des établissements. Il convient de renforcer la réglementation de façon à améliorer la stabilité financière. La première ligne de défense réside dans une réglementation microprudentielle efficace. Cette réglementation doit être améliorée en appliquant l'Accord de Bâle III sur les fonds propres, comme l’ont annoncé les autorités de l’UE, ainsi qu'une série de mesures connexes. Il conviendrait d’envisager une accélération de leur mise en oeuvre. La réglementation macroprudentielle doit être nettement développée de façon à atténuer le caractère procyclique du dispositif et à réduire les risques systémiques que présentent les grands établissements transnationaux. La création du Comité européen du risque systémique est bienvenue. Pour améliorer la surveillance transnationale, l'Autorité bancaire européenne doit être dotée de prérogatives et de ressources suffisantes pour qu’un système fondé sur une surveillance exercée à l’échelle nationale donne naissance à une réglementation cohérente et un contrôle efficace. En outre, il convient de mettre en place un dispositif transfrontalier de gestion des crises à l'échelle de l'Europe. En résumé, les autorités européennes ont déjà pris des mesures substantielles pour s’attaquer à ces questions, et d’autres réformes sont en cours. Ce document de travail porte sur l'Étude économique du Zone euro. (
    Keywords: euro area, financial stability, zone Euro, stabilité financière
    JEL: G15 G21 G28
    Date: 2010–12–09
  7. By: Davide Debortoli (UC San Diego); Junior Maih (Norges Bank (Central Bank of Norway)); Ricardo Nunes (Federal Reserve Board)
    Abstract: This paper proposes a method and a toolkit for solving optimal policy with imperfect commitment in linear quadratic models. As opposed to the existing literature, our method can be employed in medium- and large-scale models typically used in monetary policy. We apply our method to the Smets and Wouters (2007) model, where we show that imperfect commitment has relevant implications for the interest rate setting, the sources of business cycle fluctuations, and welfare.
    Keywords: Commitment, Discretion, Linear-Quadratic
    JEL: E58 E61
    Date: 2010–12–06
  8. By: Péter Gábriel (Magyar Nemzeti Bank)
    Abstract: Although in modern monetary economics it is usually assumed that inflation expectations play a prominent role when economic agents set prices and wages, the empirical evidence for this link is scarce. This paper aims to identify the effect of changes in inflation expectations on prices and wages in an SVAR framework for three inflation targeting countries (Czech Republic, Hungary and United Kingdom). The results show that in all countries the effect is significant. In comparison with the United Kingdom and the Czech Republic, inflation expectations in Hungary are more volatile and less anchored, which can be an important source of the high volatility of the inflation rate.
    Keywords: inflation expectations, consumer survey
    JEL: D84 E31
    Date: 2010
  9. By: Klaus Schmidt-Hebbel
    Abstract: This paper summarizes a research project focused on the empirical determinants of and interrelations between macroeconomic regimes, policies, and performance in the world. The project’s hypotheses are structured into three related themes. The first aim is analyzing the determinants of the likelihood of adoption of macroeconomic policy regimes. The second project theme focuses on cyclicality of macroeconomic policies and accuracy in attaining inflation targets. Finally, the project tests for the behavior of two key macroeconomic variables - economic growth and inflation – focusing on their sensitivity to different macroeconomic regimes and policies. A large world database was assembled for this project from both publicly available and private databases. Data coverage extends to more than 100 countries, with annual time series extending from 1970 to 2008. A wide spectrum of frontier estimation techniques is applied to the country panel data series, appropriate for discrete-choice and continuous variable estimation. The key research results are the following. Country choice of macroeconomic policy regimes (exchange-rate regimes, money-based targeting, inflation targeting, and rule-based fiscal regimes) is explained by countries’ structural and institutional features, macroeconomic performance, financial development, and international integration. The cyclical behavior of fiscal policy reflects the quality of country institutions, financial openness, and financial development. Central bank accuracy in meeting inflation targets is also a result of domestic institutional strength and macroeconomic credibility. Long-term growth is significantly shaped by the quality of policies, financial development, foreign aid, and exchange-rate misalignment, in addition to standard growth determinants. Growth volatility is a result of domestic macroeconomic policy volatility, external shocks, international integration, and financial development. Country inflation rates are determined by international factors and domestic determinants, including fiscal policy, institutional development, monetary and exchangerate regimes, and financial depth and integration.
    Keywords: Macroeconomic Regimes, Macroeconomic Policies, Inflation, Growth.
    JEL: E58 E62 O47
    Date: 2010
  10. By: Vasco J. Gabriel (Department of Economics, University of Surrey and Universidade do Minho - NIPE); Luis F. Martins (Department of Quantitative Methods and UNIDE, ISCTE-LUI, Portugal)
    Abstract: We re-examine the empirical relevance of the cost channel of monetary policy (e.g. Ravenna and Walsh, 2006), employing recently developed moment-conditions inference methods, including identification-robust procedures. Using US data, our results suggest that the cost channel effect is poorly identified and we are thus unable to corroborate the previous results in the literature.
    Keywords: Cost channel; Phillips curve; GMM; Generalized Empirical Likelihood; Weak Identification.
    JEL: C22 E31 E32
    Date: 2010
  11. By: Cristiano Cantore (Department of Economics, University of Surrey, Surrey GU2 7XH, UK.); Miguel A. León-Ledesma (Department of Economics, University of Kent, Kent CT2 7NP, UK.); Peter McAdam (European Central Bank, Research Dept., Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Alpo Willman (European Central Bank, Research Dept., Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: The reaction of hours worked to technology shocks represents a key controversy between RBC and New Keynesian explanations of the business cycle. It sparked a large empirical literature with contrasting results. We demonstrate that, with a more general and data coherent supply and production framework (“normalized” factor-augmenting CES technology), both models can plausibly generate impacts of either sign. We develop analytical expressions to establish the threshold between positive and negative contemporaneous correlations for both models. These will crucially depend on the factor-augmentation nature of the shock, the elasticity of factor substitution, the capital income share, and the reaction of consumption. The impact of technology on hours can thus hardly be taken as evidence in support of any particular business-cycle model. Our results are also important as: i) we introduce the concept of normalization for DSGE models and, ii) they may help interpret possible time-variation in technology and hours correlations over time. JEL Classification: E32, E23, E25.
    Keywords: Technology Shocks, HoursWorked, RBC and NK models, Normalization, Factor Substitution, Factor Bias.
    Date: 2010–12
  12. By: Francis Breedon (Queen Mary, University of London); Dagfinn Rime (Norges Bank (Central Bank of Norway)); Paolo Vital (University d'Annunzio)
    Abstract: Using ten years of FX transactions data we demonstrate that a large share of the FX forward discount bias can be accounted for by order flow. A simple microstructure-based decomposition suggests that order flow creates a timevarying risk premium that is correlated with the forward discount. The order flow related risk premium is particularly important in currency pairs traditionally associated with carry trade activity, as for these crosses it accounts for more than half of the forward bias (with the rest accounted for by systematic forecasting errors). We also find evidence that order flow is partly driven by carry trade activity, which is itself is driven by expectations of carry trade profits. However, carry trading increases currency-crash risk in that the carry-induced order flow generates negative skewness in FX returns.
    Keywords: Forward Discount Puzzle, FX Microstructure, Carry Trade, Survey Data
    JEL: F31 G14 G15
    Date: 2010–12–13
  13. By: Clovis Kerdrain; Isabell Koske; Isabelle Wanner
    Abstract: This paper explores the impact of structural policies on saving, investment, and current accounts in OECD and non-OECD economies. Since the current account effects of structural reforms are often complex and ambiguous from a theoretical perspective, new OECD empirical analysis is carried out. Reduced-form equations are estimated for a panel of 30 OECD countries as well as for a panel/cross-section of 117 OECD and non-OECD countries that relate saving, investment and current accounts to policy indicators and a set of macroeconomic control variables. This work suggests that structural reforms may influence saving, investment and current accounts through their impact on macroeconomic conditions such as productivity growth or public revenues and expenditures, but also more directly: i) higher social spending (in particular on health care) is found to lower the saving rate and thereby to weaken the current account, most likely reflecting lower precautionary saving; ii) product market liberalisation temporarily boosts investment and thus also weakens the current account; iii) financial market deregulation may lower the saving rate, though only in less developed countries; iv) stricter employment protection may be associated with lower saving rates if unemployment benefits are low, as well as with higher investment rates possibly due to greater substitution of capital for labour. A scenario analysis indicates that fiscal consolidation and structural reforms in the main world economies could significantly reduce current global imbalances, possibly by about a third.<P>L’impact des politiques structurelles sur l’épargne, l’investissement, et la balance courante<BR>Cet article étudie l'impact des politiques structurelles sur l'épargne, l'investissement, et la balance courante de pays membres et non-membres de l'OCDE. Cette nouvelle étude de l'OCDE en présente une analyse empirique, l'impact des réformes structurelles sur la balance courante étant souvent complexe et ambigu d'un point de vue théorique. L'épargne, l'investissement et la balance courante sont reliés à un ensemble de variables de politiques structurelles par des équations de forme réduite, estimées en incluant des variables macroéconomiques de contr“le. Les régressions sont basées d'une part sur des données de 30 pays de l'OCDE disponibles sur une longue période, et d'autre part sur des séries plus courtes pour 117 pays membres et non-membres de l'OCDE. Cette étude suggère que les réformes structurelles peuvent influencer l'épargne, l'investissement et la balance courante via leur impact sur les conditions macroéconomiques telles que la croissance de la productivité, les recettes ou les dépenses publiques. Plus directement, elle indique également que : i) une augmentation des dépenses de protection sociale (en particulier des dépenses de santé) réduit le taux d'épargne, et donc affaiblit la balance courante, reflétant probablement une diminution de l'épargne de précaution ; ii) une libéralisation du marché des biens et services augmente temporairement l'investissement, ce qui affaiblit également la balance courante ; iii) une dérégulation des marchés financiers pourrait réduire le taux d'épargne dans les pays les moins développés ; iv) une protection plus stricte des emplois pourrait conduire à une réduction du taux d'épargne lorsque les allocations-ch“mage sont faibles, ainsi qu'à une élévation du taux d'investissement, peut-être due a une substitution de capital au travail. Les simulations indiquent qu'une consolidation budgetaire et des réformes structurelles dans les principales économies mondiales pourraient réduire significativement les déséquilibres macroéconomiques mondiaux actuels, peut-être d'environ un tiers.
    Keywords: taxation, product market regulation, investment, current account, saving, social welfare system, labour market regulation, financial market regulation, fiscalité, investissement, balance courante, système de protection sociale, épargne, régulation du marché du travail, régulation du marché des biens et services, régulation des marchés financiers
    JEL: E21 E22 F41 G18 H23 H55 K20 K31
    Date: 2010–12–02
  14. By: Drescher, Christian; Herz, Bernhard
    Abstract: We analyze monetary conditions in US asset markets — corporate equity, real estate, Treasury bond and corporate & foreign bond — from a market specific perspective, proposing the concept of market leverage. Market leverage measures the average leverage of all asset holders in a particular asset market. The concept builds on an accounting based network that links balance sheet leverages of asset holders to their corresponding shares of ownership. Our empirical analysis yields the following results. Firstly, market specific monetary conditions can differ considerably among asset markets. Secondly, market specific monetary conditions are positively related to asset prices. Thirdly, US asset markets have experienced a loosening in market specific monetary conditions in the last decades. Fourthly, the loosening of market specific monetary conditions explains long-term increases in US asset prices. Fifthly, the recent convergence of market specific monetary conditions of real asset markets towards those of financial asset markets implies a rise in upside risk to future US asset price inflation.
    Keywords: market leverage; monetary conditions; asset prices
    JEL: G1 E5 E4
    Date: 2010–11
  15. By: Edoardo GAFFEO; Ivan PETRELLA; Damjan PFAJFAR; Emiliano SANTORO
    Abstract: This paper proposes a novel explanation of the vast empirical evidence showing that output and prices react asymmetrically to monetary policy innovations over contractions and expansions in the business cycle. We use VAR techniques to show that monetary policy exerts stronger effects on the U.S. GDP during contractionary phases, as compared to expansionary ones. As to prices, their response is not statistically different across different cyclical stages. We show that these facts are consistent with a New Neoclassical Synthesis model based on the assumption that households. utility partly depends on deviations of their consumption from a reference level below which aversion to loss is displayed. In line with the theory developed by Kahneman and Tversky (1979), losses in consumption utility loom larger than gains. This implies state-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption that generate competing effects on the responses of output and inflation following a monetary innovation. The key predictions of the model are in line with the data. We then explore the state-dependent trade-o¤ between inflation and output stabilization that naturally arises in this context. Greater elasticity of inflation to real activity during expansionary stages of the cycle promotes a stronger degree of policy activism in the response to the expected rate of inflation under discretion, compared to what is otherwise prescribed during contractions.
    Date: 2010–10
  16. By: Lee C. Spector (Department of Economics, Ball State University); Courtenay C. Stone (Department of Economics, Ball State University)
    Abstract: The ex ante real rate of interest is an important concept in economics and finance. These disciplines treat Irving Fischer’s theory of interest as canonical; it is used universally. In the world as we know it, the Fisher theory requires positive ex ante real interest rates. Consequently, empirical estimates of the ex ante real interest rate derived from the Fisher theory of interest should also be positive. Virtually all estimates of the ex ante real interest rate published in economic journals and/or used in macroeconomic models and policy discussions for the past 35 years, however, contain negative values for extended time periods. These negative ex ante real interest rate estimates would thus seem to be theoretically flawed. Moreover, it was shown more than 30 years ago that the procedures generally used to estimate ex ante real interest rates produce biased estimates. We document this problem, explore why it exists, and assess alternative approaches for estimating the ex ante real interest rate.
    Keywords: ex ante real interest rate, estimation problems
    JEL: B4 E0 E3
    Date: 2010–10
  17. By: Angelo Baglioni; Andrea Monticini (Catholic University, Milan, Italy)
    Abstract: We provide a simple model, able to explain why the overnight (ON) rate follows a downward intraday pattern, implicitly creating a positive intraday interest rate. While this normally reflects only some frictions, a liquidity crisis introduces a new component: the chance of an upward jump of the ON rate, which must be compensated by an intraday decline of the ON rate. By analyzing real time data for the e-MID interbank market, we show that the intraday rate has increased from a negligible level to a significant one after the start of the liquidity crisis in August 2007, and even more so since September 2008. The intraday rate is affected by the likelihood of a dry-up of the ON market, proxied by the 3M Euribor - Eonia swap spread. This evidence supports our model and it shows that a liquidity crisis impairs the ability of central banks to curb the market price of intraday liquidity, even by providing free daylight overdrafts. Such results have implications for the efficiency of the money market and of payment systems, as well as for the operational framework of central banks.
    Keywords: : interbank market, intraday interest rate, financial crisis, liquidity risk
    JEL: E4 E5 G21
    Date: 2010–11
  18. By: Robert Hagemann
    Abstract: There is growing interest in the role of independent fiscal institutions, or fiscal councils, in helping to improve fiscal performance. This paper provides some guidance on the scope for improving fiscal performance through fiscal councils based on the available literature and the range of fiscal institutions in the OECD countries. The effectiveness of fiscal councils hinges on several factors, including having full autonomy within the scope of their mandates, active and unfettered dissemination of their analysis and their credibility. Experience and empirical evidence suggest that delegating macroeconomic forecasting to an independent fiscal council can indeed reduce forecasting bias. There is some empirical evidence that independent fiscal institutions can buttress a government’s capacity to comply with a numerical rule. Good fiscal institutions are a necessary condition for achieving disciplined fiscal performance. Experience demonstrates, however, that their existence is not sufficient. Without strong and sustained political commitment to a medium-term fiscal goal and, where relevant, to the mandate of a fiscal council, durable improvements in fiscal performance will remain elusive. This working paper relates to the 2010 OECD Economic Survey of the Euro Area (<P>Améliorer la performance budgétaire à travers des conseils budgétaires<BR>Un intérêt croissant est accordé au rôle des institutions budgétaires indépendantes, ou conseils budgétaires, pour contribuer à l’amélioration des résultats budgétaires. Ce document fournit quelques indications sur la possibilité d’améliorer ces résultats par le biais des conseils budgétaires, en se basant sur la littérature existante et sur la gamme des institutions budgétaires dans les pays de l’OCDE. L’efficacité des conseils budgétaires dépend de plusieurs facteurs, notamment de leur entière indépendance dans l’exercice de leur mandat, d’une communication active et sans restrictions de leurs analyses et de leur crédibilité. L’expérience et les données empiriques montrent que déléguer les prévisions macroéconomiques à un conseil budgétaire indépendant peut effectivement réduire les erreurs de prévision. Selon les données empiriques, les institutions budgétaires indépendantes peuvent étayer la capacité d’un gouvernement à respecter une règle numérique. De bonnes institutions budgétaires sont une condition nécessaire pour la discipline budgétaire. Toutefois, l’expérience montre que leur existence ne suffit pas. Sans un engagement politique fort et durable envers un objectif budgétaire à moyen terme et, le cas échéant, envers le mandat d’un conseil budgétaire, des améliorations pérennes de la performance budgétaire resteront illusoires. Ce document de travail a été réalisé dans le cadre de l'Étude économique de la Zone euro 2010. (
    Keywords: fiscal policy, fiscal councils, fiscal frameworks, politique budgétaire, institution budgétaire, conseil budgétaires
    JEL: H61
    Date: 2010–12–10
  19. By: Yvan Guillemette
    Abstract: Although Canada remains in an advantageous fiscal position relative to many other OECD countries as the global economy recovers from the 2008/09 recession, the deterioration in the country’s public finances has been substantial. Years of spending increases above trend economic growth have led to high structural levels of expenditure, and some Canadian governments are now on unsustainable fiscal paths, a diagnosis made starker when taking an even longer-term view that considers the fiscal implications of demographic change. Evidence shows that successful fiscal consolidations tend to rely on spending restraint rather than tax increases. When focused on restraining less productive expenditure, they can also boost economic growth. Fiscal rules can be useful tools in achieving budgetary consolidation, but also as part of the general fiscal framework to limit deficit bias and counteract the tendency shown by some Canadian governments over the past two decades to run pro-cyclical fiscal policies. Canadian governments with large deficits should announce deficit targets on the way to fiscal balance and should consider supporting these targets with spending growth limits. Other governments should also limit spending growth and target reductions in debt-to-GDP ratios, perhaps supported by budget surplus targets. Temporary fiscal stimulus measures should be allowed to expire as planned. To date, the federal and almost all provincial/territorial governments have committed to return to budget balance over the medium term and outlined plans to do so that focus primarily on expenditure restraint. These plans are broadly in line with the recommendations set forth in this paper and should allow Canada to return to budget balance over the medium term. Of crucial importance for the long-term success of fiscal-consolidation and debt-reduction strategies are public backing and transparency. The federal government should continue to support the Parliamentary Budget Office, and provinces should consider establishing similar independent fiscal agencies that can assess compliance relative to objectives and reinforce accountability. This Working Paper relates to the 2010 OECD Economic Review of Canada (<P>Stratégies d’assainissement budgétaire pour les administrations canadiennes<BR>Bien que la situation budgétaire du Canada demeure plus favorable que celle de beaucoup d’autres pays de l’OCDE au moment où l’économie mondiale se remet de la récession de 2008/09, ses finances publiques se sont sérieusement détériorées. Les dépenses ayant progressé pendant des années à un rythme supérieur à la croissance économique tendancielle, les dépenses structurelles atteignent aujourd’hui un niveau élevé et la trajectoire budgétaire prévisible de certaines administrations canadiennes n’est pas viable, en particulier si l’on se place dans une perspective à long terme tenant compte des conséquences budgétaires de l’évolution démographique. L’expérience nous apprend que les stratégies d’assainissement budgétaire les plus efficaces reposent sur des restrictions de dépenses plutôt que sur des augmentations d’impôts. Lorsqu’elles visent à restreindre les dépenses les moins productives, ces stratégies peuvent aussi stimuler la croissance économique. Des règles budgétaires peuvent non seulement être utiles pour assainir les finances publiques, mais aussi se révéler précieuses dans le cadre des mécanismes budgétaires généraux conçus pour limiter la dérive des déficits et contrecarrer la tendance à mener une politique budgétaire procyclique, observée dans certaines administrations canadiennes au cours des deux dernières décennies. Les administrations dont les finances sont très déficitaires devraient annoncer des objectifs de réduction du déficit dans la perspective d’un retour à l’équilibre budgétaire et envisager parallèlement de plafonner les augmentations de dépenses. Les autres administrations devraient aussi limiter l’augmentation de leurs dépenses et s’efforcer de réduire leur endettement en proportion du PIB, éventuellement en se fixant des objectifs d’excédent budgétaire. Les mesures temporaires de relance budgétaire devront venir à expiration dans les délais prévus. À ce jour, l’administration fédérale et presque toutes les administrations provinciales/territoriales se sont engagées à rétablir l’équilibre budgétaire à moyen terme, et pour ce faire elles ont défini des plans qui mettent l’accent sur le freinage des dépenses. Ces programmes s’accordent globalement avec les recommandations formulées dans la présente étude et devraient permettre au Canada de revenir à l’équilibre budgétaire dans le moyen terme. La mobilisation de l’opinion publique et la transparence revêtent une importance primordiale pour le succès des stratégies d’assainissement des finances publiques et de désendettement. L’administration fédérale devrait continuer d’appuyer l’action du Bureau du Directeur parlementaire du budget, tandis que les provinces devraient envisager de mettre en place des organismes budgétaires indépendants du même type pour jauger le degré de réalisation des objectifs et assurer une plus grande transparence. Ce Document de travail se rapporte à l’Étude économique de l’OCDE du Canada 2010 (
    Keywords: budgets, Canada, deficit, debt, consolidation, federal, provincial, fiscal, budget, Canada, déficit, dette, consolidation, fédéral, provincial, fiscal
    JEL: E62 H68 H77
    Date: 2010–12–06
  20. By: Hans DEWACHTER; Priscilla TOFFANO
    Abstract: In this paper, we estimate the impact of changes in fiscal policy regime on the yield curve. In particular, we differentiate between yield curve responses under active and passive fiscal policy regimes (according to the terminology of Leeper 1991). Analyzing US data in the period 1965-2010, we find a statistically significant impact of fiscal policy only for the active policy regime. A one-percentage-point shock in the primary deficit leads typically to a contemporaneous increase in long-term yields of about 10 basis points, and even stronger cumulative effects. No significant impact of deficits on yields is found in the passive fiscal policy regime.
    Keywords: Fiscal activism, Markov switching and yield curve
    JEL: G12 E62
    Date: 2010–04
  21. By: Sebastian Sienknecht (Department of Economics, Friedrich-Schiller-University Jena)
    Abstract: This paper identifies parameters responsible for welfare reversals when the basic New Keynesian model is approximated. In our setting, a reversal occurs when the Ramsey policy under timeless perspective commitment ceases to be dominant against the Taylor rule after approximating the model. We find that the parameters involved are the degree of persistence in the autoregressive shock process and the labor elasticity of real output.
    Keywords: Optimal Monetary policy, Approximations, Welfare Analysis, Timeless Perspective
    JEL: E30 E52 E61
    Date: 2010–12–16
  22. By: Sebastian Barnes
    Abstract: Some euro area countries accumulated large and persistent external imbalances during the upswing, revealing important weaknesses in the macroeconomic management of the monetary union. Greece, Ireland, Portugal and Spain ran large current account deficits by historical standards, while Finland, Germany and the Netherlands had substantial surpluses. Some of these deficits and surpluses were larger than appear justified by economic fundamentals. The massive debt accumulation made deficit economies vulnerable to shocks, complicated their recovery from the world financial crisis, and has challenged the stability of the euro area. In some countries, fiscal policy in the past decade failed to counter and sometimes aggravated these pressures. External imbalances were driven by underlying domestic economic, financial and sometimes fiscal imbalances. These were the result of a combination of a wide range of country-specific shocks and insufficient macroeconomic and financial stabilisation. Movements in real interest rates in some countries contributed to diverging borrowing and saving patterns, which fuelled credit booms and a weakening of competitiveness in some deficit countries. Weaknesses in financial regulation and over-optimistic growth expectations encouraged excessive risk-taking in both deficit and surplus countries. Harmful imbalances can be characterised by a misallocation of resources and increased vulnerability. When the financial crisis hit, some deficit countries faced the combined problems of a sharp contraction in private demand, an impaired financial system and weak public finances. Unwinding large imbalances, in both deficit and surplus countries, will be a prolonged and difficult process. A new and cross-cutting approach to economic and financial management in the euro area is required to ensure balanced development in the future. While the shocks that led to this build-up of imbalances may not recur, similar pressures are likely to arise within the monetary union in the future. Macroeconomic, financial and fiscal management should be strengthened in an integrated way, alongside structural reforms. This should aim to achieve the differentiation necessary to improve stabilisation of national economies, while ensuring that the euro area as a whole is protected from unsustainable developments in individual countries. Important legislative changes are underway at EU level to improve the surveillance of imbalances and to help ensure that the necessary corrective action is undertaken where risks emerge. This working paper relates to the 2010 OECD Economic Survey of the Euro Area (<P>Résorber et éviter les déséquilibres non soutenables dans la zone euro<BR>Certains pays de la zone euro ont accumulé des déséquilibres extérieurs importants et persistants durant la phase d’expansion, qui ont mis au jour de sérieuses déficiences dans la gestion macroéconomique de l’union monétaire. L’Espagne, la Grèce, l’Irlande et le Portugal ont enregistré des déficits de balance courante élevés par rapport aux périodes passées, alors que l’Allemagne, la Finlande et les Pays-Bas ont affiché des excédents substantiels. Certains de ces déficits et excédents étaient plus prononcés que ne le justifiaient, semble-t-il, les fondamentaux économiques. L’accumulation massive de la dette a rendu les économies déficitaires vulnérables face aux chocs, compliqué leur redressement après la crise financière mondiale et remis en cause la stabilité de la zone euro. Dans certains pays, la politique budgétaire n’a pu contrecarrer et a parfois même aggravé ces tensions. Les déséquilibres extérieurs ont été nourris par des déséquilibres internes sous-jacents, dans les domaines économique, financier et parfois budgétaire, imputables à la fois à une série de chocs par pays et à une stabilisation macroéconomique et financière insuffisante. Les variations des taux d’intérêt réels dans certains pays ont contribué à des profils d’emprunt et d’épargne divergents qui ont alimenté une forte expansion du crédit et suscité un affaiblissement de la compétitivité dans plusieurs pays déficitaires. Les déficiences de la réglementation financière et les anticipations de croissance exagérément optimistes ont encouragé une prise de risques excessifs dans les pays déficitaires comme dans les pays excédentaires. Les déséquilibres néfastes impliquent des distorsions dans l’allocation des ressources et une vulnérabilité accrue. Lorsque la crise financière a frappé, certains pays déficitaires ont été confrontés à une combinaison de problèmes : forte contraction de la demande privée, défaillance du système financier et fragilité des finances publiques. La correction des déséquilibres extérieurs, dans les pays déficitaires comme dans les pays excédentaires, sera longue et difficile. Une nouvelle approche pluridisciplinaire de la gestion économique et financière dans la zone euro s’impose pour assurer un développement équilibré à l’avenir. Les chocs qui ont conduit à cette accumulation de déséquilibres ne se reproduiront pas nécessairement, mais des pressions du même type apparaîtront vraisemblablement au sein de l’union monétaire. La gestion macroéconomique, financière et budgétaire devra être renforcée de façon intégrée, parallèlement à la mise en oeuvre de réformes structurelles. La différenciation nécessaire à une plus grande stabilisation des économies nationales pourra ainsi être assurée, tout en garantissant la protection de la zone euro dans son ensemble contre les évolutions peu viables intervenant dans les différents pays. D’importantes modifications législatives sont engagées au niveau de l’UE pour améliorer la surveillance des déséquilibres et veiller à ce que les mesures correctrices nécessaires soient engagées lorsque des risques se manifestent. Ce document de travail porte sur l'Étude économique du Zone euro. (
    Keywords: euro area, competitiveness, current account, monetary union, imbalances, credit booms, zone Euro, compétitivité, union monétaire, solde extérieur, expansion du crédit, déséquilibres
    JEL: F32 F36 F41
    Date: 2010–12–09
  23. By: Hans DEWACHTER; Romain HOUSSA; Priscilla TOFFANO
    Abstract: This paper develops a Spatial Vector Auto-Regressive (SpVAR) model that takes into account both the time and the spatial dimensions of economic shocks. We apply this framework to analyze the propagation through space and time of macroeconomic (inflation, output gap and interest rate) shocks in Europe. The empirical analysis identifies an economically and statistically significant spatial component in the transmission of macroeconomic shocks in Europe.
    Keywords: Macroeconomics, Spatial Models, VAR
    JEL: E3 E43 E52 C51 C33
    Date: 2010–04
  24. By: Sebastian Barnes; Jeremy Lawson; Artur Radziwill
    Abstract: This paper considers the increase in current account imbalances in euro area countries since the early 1990s. While the euro area as a whole has remained relatively close to external balance, the current account balances of individual countries have diverged: Spain, Greece and Portugal ran large current account deficits by historical norms for industrial economies, while Germany and the Netherlands ran large surpluses. These imbalances are larger and more sustained than those observed in recent decades. While there has been extensive discussion of the US and Chinese external positions in the context of the debate on global imbalances, more attention has been given to the developments in the euro area only in the wake of the recent sovereign debt crisis. This paper uses a period-average model estimated on data for OECD countries since the late 1960s to investigate the determinants of current account imbalances. Fundamental economic factors are found to play an important role, in line with earlier studies, but do not fully explain the extent of imbalances over the past decade. The strength of housing investment appears to capture important effects over this period. This working paper relates to the 2010 OECD Economic Survey of the Euro Area (<P>Les déséquilibres de la balance courante dans la zone euro : une perspective comparative<BR>Ce document analyse l’augmentation des déséquilibres de la balance courante dans les pays de la zone euro depuis le début des années 90. Si le solde extérieur de la zone euro dans son ensemble est resté relativement proche de l’équilibre, les soldes des opérations courantes des pays pris individuellement ont divergé : l’Espagne, la Grèce et le Portugal ont connu d’importants déficits de la balance courante sur la base des normes historiques des économies industrielles, tandis que l’Allemagne et les Pays-Bas ont connu d’amples excédents. Ces déséquilibres sont plus importants et plus marqués que ceux observés ces dernières décennies. Alors qu’il y a eu de nombreuses études sur les positions extérieures des États-Unis et de la Chine dans le contexte du débat sur les déséquilibres globaux, l’attention ne s’est tourné vers l’évolution de la zone euro qu’à la suite de la récente crise sur les dettes souveraines. Ce document utilise un modèle estimé sur des données qui représentent des moyennes temporelles des pays de l’OCDE depuis la fin des années 60, pour rechercher les déterminants des déséquilibres de la balance courante. Il se trouve que les facteurs économiques fondamentaux y jouent un rôle important, conformément aux études antérieures, mais ils n’expliquent pas entièrement l’ampleur des déséquilibres au cours de la dernière décennie. La vigueur de l’investissement en logement semble expliquer des effets importants au cours de cette période. Ce document de travail porte sur l'Étude économique du Zone euro. (
    Keywords: euro area, current account, imbalances, zone Euro, solde extérieur
    JEL: F32 F41
    Date: 2010–12–09
  25. By: Philip R. Lane
    Abstract: This paper describes the dynamics of the external positions of euro area countries since the formation of EMU. While external imbalances have been the main focus in recent times, current account balances can only be properly interpreted in the context of understanding the overall international balance sheet and the dynamics of the net foreign asset. The creation of the euro represented a fundamental financial shock, whose effects then coincided with a reshaping of the international financial system through important financial innovations and the credit boom and securitization boom that followed. The paper builds a profile of the international balance sheets of euro area countries in order to understand the sources and implications of shifts in net positions over the last decade. It is also considers the gross scale of cross-border holdings. To understand the international risk distribution, the overall position is broken down between equity and debt components. The international currency exposures embedded in the international balance sheets are described. In relation to net flows and net positions, the paper tracks the distribution and persistence of current account balances and net foreign asset positions across the member countries. Furthermore, we document that other factors (such as valuation effects) have been important in the dynamics of the net foreign asset positions, in addition to the contribution made by the cumulative current account position. This working paper relates to the 2010 OECD Economic Survey of the Euro Area (<P>L’intégration financière mondiale et les positions extérieures des pays de la zone euro<BR>Ce document décrit la dynamique des positions extérieures des pays de la zone euro depuis la formation de l’Union économique et monétaire. Alors que les déséquilibres externes ont été au centre des intérêts ces derniers temps, l’interprétation des soldes des opérations courantes ne peut se faire qu’à la lumière de la situation financière mondiale et de la dynamique des actifs nets extérieurs. La création de l’euro a représenté un choc financier fondamental, dont les effets ont alors coïncidé avec une réorganisation du système financier international à travers d’importantes innovations financières ainsi que de l’explosion du crédit et de l’envolée de la titrisation qui s’en ont suivies. Ce document établit un profil de la situation financière globale des pays de la zone euro afin de comprendre les origines et implications des positions nettes au cours de la dernière décennie. Il étudie également la forte ampleur des avoirs transnationaux. Pour comprendre la répartition internationale des risques, la situation globale est décomposée en avoirs et dettes. Les risques de change intégrés dans les bilans globaux y sont décrits. Le document retrace la répartition et la persistance des soldes courants et des positions nettes extérieures dans les différents pays membres, en lien avec les flux et positions nets. Par ailleurs, on montre qu’outre l’apport fourni par le cumul des soldes de la balance courante, les autres facteurs (tels que les effets de valorisation) ont été importants dans la dynamique des positions nettes extérieures. Ce document de travail se rapporte à l'Étude économique de la zone euro. (
    Keywords: capital flows, euro area, international investment position, currency exposures, flux de capitaux, zone Euro, position d’investissements internationaux, risque de change
    JEL: F21 F32 F34 F36
    Date: 2010–12–10
  26. By: Sebastián Dellepiane Avellaneda (Institute of Development Policy and Management, University of Antwerp)
    Abstract: This article combines theory and historical narratives to shed new light on the politics surrounding the making of central bank independence in contemporary Britain. Its central argument is that Gordon Brown’s decision to rewrite the British monetary constitution in May 1997 constituted an act of political manipulation in a Rikerian sense. The institutional change involved can be conceptualized as a heresthetic move, that is, structuring the process of the political game so you can win. The incoming government removed a difficult issue from the realm of party politics in order to signal competence and enforce internal discipline in the context of a government that was moving toward the right. But building on Elster’s constraint theory, the paper argues that the institutional reform was not a case of self-binding in an intentional sense. Rather, Brown adopted a precommitment strategy that was aimed at binding others, including members of his government. The reform had dual consequences: it was not only constraining, it was also enabling. The institutionalization of discipline enabled New Labour to achieve key economic and political goals. By revisiting the political rationality of precommitment, this paper questions the dominant credibility story underlying the choice of monetary and fiscal institutions.
    Date: 2010–12–16
  27. By: Nicoletta Batini (IMF and University of Surrey); Vasco J. Gabriel (Department of Economics, University of Surrey and Universidade do Minho - NIPE); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University)
    Abstract: We first develop a two-bloc model of an emerging open economy interacting with the rest of the world calibrated using Indian and US data. The model features a financial accelerator and is suitable for examining the effects of financial stress on the real economy. Three variants of the model are highlighted with increasing degrees of financial frictions. The model is used to compare two monetary interest rate regimes: domestic Inflation targeting with a floating exchange rate (FLEX(D)) and a managed exchange rate (MEX). Both rules are characterized as a Taylor-type interest rate rules. MEX involves a nominal exchange rate target in the rule and a constraint on its volatility. We find that the imposition of a low exchange rate volatility is only achieved at a significant welfare loss if the policymaker is restricted to a simple domestic inflation plus exchange rate targeting rule. If on the other hand the policymaker can implement a complex optimal rule then an almost fixed exchange rate can be achieved at a relatively small welfare cost. This finding suggests that future research should examine alternative simple rules that mimic the fully optimal rule more closely.
    Keywords: DSGE model, Indian economy, monetary interest rate rules, floating versus managed exchange rate, financial frictions
    JEL: E52 E37 E58
    Date: 2010
  28. By: Vasco J. Gabriel (Department of Economics, University of Surrey and Universidade do Minho - NIPE); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University); Bo Yang (University of Surrey and London Metropolitan University)
    Abstract: We develop a closed-economy DSGE model of the Indian economy and estimate it by Bayesian Maximum Likelihood methods using Dynare. We build up in stages to a model with a number of features important for emerging economies in general and the Indian economy in particular: a large proportion of credit-constrained consumers, a financial accelerator facing domestic firms seeking to finance their investment, and an informal sector. The simulation properties of the estimated model are examined under a generalized inflation targeting Taylor-type interest rate rule with forward and backward-looking components. We find that, in terms of model posterior probabilities and standard moments criteria, inclusion of the above financial frictions and an informal sector significantly improves the model fit.
    Keywords: Indian economy, DSGE model, Bayesian estimation, monetary interest rate rules, financial frictions.
    JEL: E52 E37 E58
    Date: 2010
  29. By: Scott Fullwiler; L. Randall Wray
    Abstract: Beyond its original mission to "furnish an elastic currency" as lender of last resort and manager of the payments system, the Federal Reserve has always been responsible (along with the Treasury) for regulating and supervising member banks. After World War II, Congress directed the Fed to pursue a dual mandate, long interpreted to mean full employment with reasonable price stability. The Fed has been left to decide how to achieve these objectives, and it has over time come to view price stability as the more important of the two. In our view, the Fed's focus on inflation fighting diverted its attention from its responsibility to regulate and supervise the financial sector, and its mandate to keep unemployment low. Its shift of priorities contributed to creation of the conditions that led to this crisis. Now in its third phase of responding to the crisis and the accompanying deep recession-so-called "quantitative easing 2," or "QE2'-the Fed is currently in the process of purchasing $600 billion in Treasuries. Like its predecessor, QE1, QE2 is unlikely to seriously impact either of the Fed's dual objectives, however, for the following reasons: (1) additional bank reserves do not enable greater bank lending; (2) the interest rate effects are likely to be small at best given the Fed's tactical approach to QE2, while the private sector is attempting to deleverage at any rate, not borrow more; (3) purchases of Treasuries are simply an asset swap that reduce the maturity and liquidity of private sector assets but do not raise incomes of the private sector; and (4) given the reduced maturity of private sector Treasury portfolios, reduced net interest income could actually be mildly deflationary. The most fundamental shortcoming of QE—or, in fact, of using monetary policy in general to combat the recession-is that it only "works" if it somehow induces the private sector to spend more out of current income. A much more direct approach, particularly given much-needed deleveraging by the private sector, is to target growth in after tax incomes and job creation through appropriate and sufficiently large fiscal actions. Unfortunately, stimulus efforts to date have not met these criteria, and so have mostly kept the recession from being far worse rather than enabling a significant economic recovery. Finally, while there is identical risk to the federal government whether a bailout, a loan, or an asset purchase is undertaken by the Fed or the Treasury, there have been enormous, fundamental differences in democratic accountability for the two institutions when such actions have been taken since the crisis began. Public debates surrounding the wisdom of bailouts for the auto industry, or even continuing to provide benefits to the unemployed, never took place when it came to the Fed committing trillions of dollars to the financial system—even though, again, the federal government is "on the hook" in every instance.
    Keywords: Quantitative Easing; Monetary Policy; Fiscal Policy; Macroeconomic Stabilization; Interest Rates; Central Bank Operations
    JEL: E42 E43 E62 E63
    Date: 2010–12
  30. By: Guillermo Lavanda; Gabriel Rodriguez (Departamento de Economía- Pontificia Universidad Católica del Perú)
    Abstract: This paper analyzes and distinguishes the role and importance of the shocks related to the aggregate demand and aggregate supply on the behavior of the Peruvian inflation during the period 1997:1-2009:2. We use the methodology based on structural vector autoregressive (SVAR) models using a long-run identification based on Blanchard and Quah (1989) which allows to obtain the historical decomposition of the annual inflation. Unlike Salas (2009), this paper uses a simpler model of aggregate demand and aggregate supply, and a larger sample. The results show that the behavior of inflation was largely explained for shocks related to the aggregate demand side in comparison with aggregate supply shocks. Furthermore, the results of the variance decomposition of the prediction error show that in the short and long term, the shocks of the demand side explain around 70% and 60% of the movements of the inflation. The results are robust to the inclusion of different variables in the set of information.
    Keywords: Inflation, Structural VAR, Long-Run Decomposition, Shocks of Aggregate Demand and Aggregate Supply, Variance Decomposition, Historical Decomposition.
    JEL: C32 E31
    Date: 2010

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