nep-cba New Economics Papers
on Central Banking
Issue of 2011‒03‒26
43 papers chosen by
Alexander Mihailov
University of Reading

  1. A Bayesian approach to optimal monetary policy with parameter and model uncertainty By Cogley, Timothy; de Paoli, Bianca; Matthes, Christian; Nikolov, Kalin; Yates, Tony
  2. Money, Financial Stability and Efficiency By Franklin Allen; Elena Carletti; Douglas Gale
  3. The gains from delegation revisited: price-level targeting, speed-limit and interest rate smoothing policies By Blake, Andy; Kirsanova, Tatiana; Yates, Tony
  4. Let’s twist again: a high-frequency event-study analysis of operation twist and its implications for QE2 By Eric T. Swanson
  5. Are Forecast Updates Progressive? By Chia-Lin Chang; Philip Hans Franses; Michael McAleer
  6. The Implementation of Scenarios Using DSGE Models By Igor Vetlov; Ricardo Mourinho Félix; Laure Frey; Tibor Hlédik; Zoltán Jakab; Niki Papadopoulou; Lukas Reiss; Martin Schneider
  7. Central Banks' Voting Records and Future Policy By Roman Horvath; Katerina Smidkova; Jan Zapal
  8. Central bank transparency and the crowding out of private information in an experimental asset market By Menno Middeldorp; Stephanie Rosenkranz
  9. Measuring the systemic importance of interconnected banks By Nikola Tarashev; Mathias Drehmann
  10. Risk Management of Risk under the Basel Accord: Forecasting Value-at-Risk of VIX Futures By Chia-Lin Chang; Juan-Ángel Jiménez-Martín; Michael McAleer; Teodosio Pérez-Amaral
  11. BASEL III: long-term impact on economic performance and fluctuations By Paolo Angelini; Laurent Clerc; Vasco Cúrdia; Leonardo Gambacorta; Andrea Gerali; Alberto Locarno; Roberto Motto; Werner Roeger; Skander Van den Heuvel; Jan Vlcek
  12. The optimal inflation rate revisited By Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola
  13. News, Intermediation Efficiency and Expectations-driven Boom-bust Cycles By Christopher M. Gunn; Alok Johri
  14. A redux of the workhorse NOEM model with capital accumulation and incomplete asset markets By Enrique Martinez-Garcia
  15. The Euro Changeover and Price Adjustments in Italy By Guglielmo Maria Caporale; Alessandro Girardi; Marco Ventura
  16. Inflation expectations, real rates, and risk premia: evidence from inflation swaps By Joseph G. Haubrich; George Pennacchi; Peter Ritchken
  17. Money cycles By Andrew Clausen; Carlo Strub
  18. Extracting deflation probability forecasts from Treasury yields By Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
  19. Labor market imperfections, real wage rigidities and financial shocks By Acocella Nicola; Bisio Laura; Di Bartolomeo Giovanni; Pelloni Alessandra
  20. Price-level targeting versus inflation targeting over the long-term By Hatcher, Michael C.
  21. Flattening of the Phillips Curve and the Role of Oil Price: An Unobserved Components Model for the USA and Australia By Paradiso, Antonio; Rao, B. Bhaskara
  22. How non-Gaussian shocks affect risk premia in non-linear DSGE models By Andreasen, Martin
  23. An efficient method of computing higher-order bond price perturbation approximations By Andreasen , Martin; Zabczyk, Pawel
  24. Leaning Against Boom-Bust Cycles in Credit and Housing Prices By Luisa Lambertini; Caterina Mendicino; Maria Teresa Punzi
  25. Improving forecasting performance by window and model averaging By Prasad S Bhattacharya; Dimitrios D Thomakos
  26. Policymakers' Votes and Predictability of Monetary Policy By Andrei Sirchenko
  27. US Infl ation and infl ation uncertainty in a historical perspective: The impact of recessions By Don Bredin; Stilianos Fountas
  28. A Simple Test of Momentum in Foreing Exchange Markets By Andres Felipe García-Suaza; José E. Gómez González
  29. The macroeconomic effects of large exchange rate appreciations By Kappler, Marcus; Reisen, Helmut; Schularick, Moritz; Turkisch, Edouard
  30. Spatial Propagation of Macroeconomic Shocks in Europe By Romain Houssa
  31. Peripheral Europe’s Debt and German Wages. The Role of Wage Policy in the Euro Area By Engelbert Stockhammer
  32. Do Unit Labor Cost Drive Inflation in the Euro Area? By Sandra Tatierska
  33. "Financial Markets" By Jorg Bibow
  34. Measuring International Risk-Sharing: Theoretical Issues and Empirical Evidence from OECD Countries By Francesca Viani
  35. Trust in Public Institutions over the Business Cycle By Stevenson, Betsey; Wolfers, Justin
  36. On the (non-)equivalence of capital adequacy and monetary policy: A response to Cechetti and Kohler By Stan du Plessis; Gideon du Rand
  37. The Revenge of Baumol’s Cost Disease?: Monetary Union and the Rise of Public Sector Wage Inflation By Alison Johnston
  38. The Revenge of Baumol's Cost Disease?: Monetary Union and the Rise of Public Sector Wage Inflation By Alison Johnston
  39. Does Money Help Predict Inflation? An Empirical Assessment for Central Europe By Roman Horvath; Lubos Komarek; Filip Rozsypal
  40. The Japanese Quantitative Easing Policy under Scrutiny: A Time-Varying Parameter Factor-Augmented VAR Model By Moussa, Zakaria
  41. Comparing China’s GDP Statistics with Coincident Indicators By Mehrotra, Aaron; Paakkonen, Jenni
  42. A New Keynesian Phillips curve for Tunisia : Estimation and analysis of sensitivity By Ben Ali, Samir
  43. Exchange rate pass-through to consumer prices in Ghana: Evidence from structural vector auto-regression By Sanusi, Aliyu Rafindadi

  1. By: Cogley, Timothy (New York University); de Paoli, Bianca (Bank of England); Matthes, Christian (Universitat Pompeu Fabra); Nikolov, Kalin (European Central Bank); Yates, Tony (Bank of England)
    Abstract: This paper undertakes a Bayesian analysis of optimal monetary policy for the United Kingdom. We estimate a suite of monetary policy models that include both forward and backward-looking representations as well as large and small-scale models. We find an optimal simple Taylor-type rule that accounts for both model and parameter uncertainty. For the most part, backward-looking models are highly fault tolerant with respect to policies optimised for forward-looking representations, while forward-looking models have low fault tolerance with respect to policies optimised for backward-looking representations. In addition, backward-looking models often have lower posterior probabilities than forward-looking models. Bayesian policies therefore have characteristics suitable for inflation and output stabilisation in forward-looking models.
    Date: 2011–03–02
  2. By: Franklin Allen; Elena Carletti; Douglas Gale
    Abstract: Most analyses of banking crises assume that banks use real contracts. However, in practice contracts are nominal and this is what is assumed here. We consider a standard banking model with aggregate return risk, aggregate liquidity risk and idiosyncratic liquidity shocks. We show that, with non-contingent nominal deposit contracts, the first-best efficient allocation can be achieved in a decentralized banking system. What is required is that the central bank accommodates the demands of the private sector for fiat money. Variations in the price level allow full sharing of aggregate risks. An interbank market allows the sharing of idiosyncratic liquidity risk. In contrast, idiosyncratic (bank-specific) return risks cannot be shared using monetary policy alone; real transfers are needed.
    Date: 2011
  3. By: Blake, Andy (Bank of England); Kirsanova, Tatiana (University of Exeter); Yates, Tony (Bank of England)
    Abstract: A commonly held view is that the life of a monetary policy maker forced to operate under discretion can be improved by the authorities delegating monetary policy objectives that are different from the social welfare function (including interest rate smoothing, price-level targeting and speed-limit objectives). We show that this holds with much less generality than previously realised. The reason is that in monetary policy models with capital accumulation (or similar variables) there may be multiple equilibria under discretion. Delegating modified objectives to the monetary policy maker does not change this. We find that the best equilbria under delegation are sometimes inferior to the worse ones without delegation. In general the welfare benefits of schemes like price-level targeting must be regarded as ambiguous.
    Date: 2011–03–15
  4. By: Eric T. Swanson
    Abstract: This paper undertakes a modern event-study analysis of Operation Twist and compares its effects to those that should be expected for the recent quantitative policy announced by the Federal Reserve, dubbed "QE2". We first show that Operation Twist and QE2 are similar in magnitude. We identify six significant, discrete announcements in the course of Operation Twist that potentially could have had a major effect on financial markets, and show that four did have statistically significant effects. The cumulative effect of these six announcements on longer-term Treasury yields is highly statistically significant but moderate, amounting to about 15 basis points. This estimate is consistent both with Modigliani and Sutch’s (1966) time series analysis and with the lower end of empirical estimates of Treasury supply effects in the literature.
    Keywords: Monetary policy
    Date: 2011
  5. By: Chia-Lin Chang (Department of Applied Economics, Department of Finance, National Chung Hsing University); Philip Hans Franses (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam); Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, and Institute of Economic Research, Kyoto University)
    Abstract: Many macro-economic forecasts and forecast updates, such as those from the IMF and OECD, typically involve both a model component, which is replicable, as well as intuition (namely, expert knowledge possessed by a forecaster), which is non-replicable. . Learning from previous mistakes can affect both the replicable component of a model as well as intuition. If learning, and hence forecast updates, are progressive, forecast updates should generally become more accurate as the actual value is approached. Otherwise, learning and forecast updates would be neutral. The paper proposes a methodology to test whether macro-economic forecast updates are progressive, where the interaction between model and intuition is explicitly taken into account. The data set for the empirical analysis is for Taiwan, where we have three decades of quarterly data available of forecasts and their updates of two economic fundamentals, namely the inflation rate and real GDP growth rate. The empirical results suggest that the forecast updates for Taiwan are progressive, and that progress can be explained predominantly by improved intuition.
    Keywords: Macro-economic forecasts, econometric models, intuition, learning, progressive forecast updates, forecast errors.
    JEL: C53 C22 E27 E37
    Date: 2011–03
  6. By: Igor Vetlov (Bank of Lithuania); Ricardo Mourinho Félix (Banco de Portugal); Laure Frey (Banque de France); Tibor Hlédik (Czech National Bank); Zoltán Jakab (Office of the Fiscal Council, Republic of Hungary); Niki Papadopoulou (Central Bank of Cyprus); Lukas Reiss (Oesterreichische Nationalbank); Martin Schneider (Oesterreichische Nationalbank)
    Abstract: The new generation of dynamic stochastic general equilibrium (DSGE) models seems particularly suited for conducting scenario analysis. These models formalise the behaviour of economic agents on the basis of explicit micro-foundations. As a result, they appear less prone to the Lucas critique than more traditional macroeconometric models. DSGE models provide researchers with powerful tools, which allow for the designing of a broad range of scenarios and tackling a large range of issues, offering at the same time an appealing structural interpretation of the scenario specification and simulation results. The paper provides illustrations on some of the modelling issues that often arise when implementing scenarios using DSGE models in the context of projection exercises or policy analysis. These issues reflect the sensitivity of DSGE model-based analysis to scenario assumptions, which in more traditional models are apparently less critical, such as, for example, scenario event anticipation and duration, treatment of monetary and fiscal policy rules.
    Keywords: business fluctuations, monetary policy, fiscal policy, forecasting and simulation
    JEL: E32 E52 E62 E37
    Date: 2010–08–25
  7. By: Roman Horvath; Katerina Smidkova; Jan Zapal
    Abstract: We assess whether the voting records of central bank boards are informative about future monetary policy. First, we specify a theoretical model of central bank board decision-making and simulate the voting outcomes. Three different versions of model are estimated with simulated data: 1) democratic, 2) consensual and 3) opportunistic. These versions differ in the extent to which the chairman and other board members exchange information prior to the voting. The model shows that the voting pattern is informative about future monetary policy provided that the signals about the optimal policy rate are noisy and that there is sufficient independence in voting across the board members, which is in line with the democratic version. Next, the model predictions are tested on real data on six countries (the Czech Republic, Hungary, Poland, Sweden, the United Kingdom and the United States). Subject to various sensitivity tests, it is found that the democratic version of the model corresponds best to the real data and that in all countries the voting records are informative about future monetary policy, making a case for publishing the records.
    Keywords: Collective decision-making, monetary policy, transparency, voting record.
    JEL: C78 D78 E52 E58
    Date: 2010–12
  8. By: Menno Middeldorp; Stephanie Rosenkranz
    Abstract: Central banks have become increasingly communicative. An important reason is that democratic societies expect more transparency from public institutions. Central bankers, based on empirical research, also believe that sharing information has economic benefits. Communication is seen as a way to improve the predictability of monetary policy, thereby lowering financial market volatility and contributing to a more stable economy. However, a potential side-effect of providing costless public information is that market participants may be less inclined to invest in private information. Theoretical results suggest that this can hamper the ability of markets to predict future monetary policy. We test this in a laboratory asset market. Crowding out of information acquisition does indeed take place, but only where it is most pronounced does the predictive ability of the market deteriorate. Notable features of the experiment include a complex setup based directly on the theoretical model and the calibration of experimental parameters using empirical measurements.
    Keywords: Banks and banking, Central ; Monetary policy ; Disclosure of information
    Date: 2011
  9. By: Nikola Tarashev; Mathias Drehmann
    Abstract: We develop a measure of systemic importance that accounts for the extent to which a bank propagates shocks across the banking system and is vulnerable to propagated shocks. Based on Shapley values, this measure gauges the contribution of interconnected banks to systemic risk, in contrast to other measures proposed in the literature. An empirical implementation of our measure reveals that systemic importance depends materially on the bank's role in the interbank network, both as a borrower and as a lender. We also find substantial differences between alternative measures, which implies that prudential authorities should be careful in choosing the underlying approach.
    Keywords: Systemic risk, Shapley values, Interbank positions
    Date: 2011–03
  10. By: Chia-Lin Chang (Department of Applied Economics, Department of Finance, National Chung Hsing University); Juan-Ángel Jiménez-Martín (Department of Quantitative Economics, Complutense University of Madrid); Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, and Institute of Economic Research, Kyoto University); Teodosio Pérez-Amaral (Department of Quantitative Economics, Complutense University of Madrid)
    Abstract: The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. McAleer, Jimenez-Martin and Perez- Amaral (2009) proposed a new approach to model selection for predicting VaR, consisting of combining alternative risk models, and comparing conservative and aggressive strategies for choosing between VaR models. This paper addresses the question of risk management of risk, namely VaR of VIX futures prices. We examine how different risk management strategies performed during the 2008-09 global financial crisis (GFC). We find that an aggressive strategy of choosing the Supremum of the single model forecasts is preferred to the other alternatives, and is robust during the GFC. However, this strategy implies relatively high numbers of violations and accumulated losses, though these are admissible under the Basel II Accord.
    Keywords: Median strategy, Value-at-Risk (VaR), daily capital charges, violation penalties, optimizing strategy, aggressive risk management, conservative risk management, Basel II Accord, VIX futures, global financial crisis (GFC).
    JEL: G32 G11 C53 C22
    Date: 2011–03
  11. By: Paolo Angelini; Laurent Clerc; Vasco Cúrdia; Leonardo Gambacorta; Andrea Gerali; Alberto Locarno; Roberto Motto; Werner Roeger; Skander Van den Heuvel; Jan Vlcek
    Abstract: We assess the long-term economic impact of the new regulatory standards (the Basel III reform), answering the following questions: 1) What is the impact of the reform on long-term economic performance? 2) What is the impact of the reform on economic fluctuations? 3) What is the impact of the adoption of countercyclical capital buffers on economic fluctuations? The main results are the following: 1) Each percentage point increase in the capital ratio causes a median 0.09 percent decline in the level of steady-state output, relative to the baseline. The impact of the new liquidity regulation is of a similar order of magnitude, at 0.08 percent. This paper does not estimate the benefits of the new regulation in terms of reduced frequency and severity of financial crisis, analyzed in Basel Committee on Banking Supervision (2010b). 2) The reform should dampen output volatility; the magnitude of the effect is heterogeneous across models; the median effect is modest. 3) The adoption of countercyclical capital buffers could have a more sizable dampening effect on output volatility.
    Keywords: Basel capital accord ; Business cycles ; Economic conditions ; Bank supervision ; Bank capital
    Date: 2011
  12. By: Di Bartolomeo Giovanni; Tirelli Patrizio; Acocella Nicola
    Abstract: We challenge the widely held belief that New Keynesian models cannot predict an optimal positive inflation rate. In fact we find that even for the US economy, characterized by relatively small government size, optimal trend inflation is justified by the Phelps argument that the inflation tax should be part of an optimal (distortionary) taxation scheme. This mainly happens because, unlike standard calibrations of public expenditures that focus on public consumption-to-GDP ratios, we also consider the diverse, highly distortionary effect of public transfers to households. Our prediction of the optimal inflation rate is broadly consistent with recent estimates of the Fed inflation target. We also contradict the view that the Ramsey-optimal policy should minimize inflation volatility over the business cycle and induce near-random walk dynamics of public debt in the long run. In fact optimal fiscal and monetary policies should stabilize long-run debt-to-GDP ratios in order to limit tax (and inflation) distortions in steady state. This latter result is strikingly similar to policy analyses in the aftermath of the 2008 financial crisis.
    Keywords: Trend inflation, monetary and fiscal policy, Ramsey plan
    JEL: E52 E58 J51 E24
    Date: 2011–03
  13. By: Christopher M. Gunn; Alok Johri
    Abstract: The years leading up to the "great recession" were a time of rapid innovation in the financial industry. This period also saw a fall in interest rates, and a boom in liquidity that accompanied the boom in real activity, especially investment. In this paper we argue that these were not unrelated phenomena. The adoption of new financial products and practices led to a fall in the expected costs of intermediation which in turn engendered the flood of liquidity in the financial sector, lowered interest rate spreads and facilitated the boom in economic activity. When the events of 2007-2009 led to a re-evaluation of the effectiveness of these new products, agents revised their expectations regarding the actual efficiency gains available to the financial sector and this led to a withdrawal of liquidity from the financial system, a reversal in interest rates and a bust in real activity. We treat the efficiency of the financial sector as an exogenous process and study the impact of "news shocks" regarding this process. Following the expectations driven business cycle literature, we model the boom and bust cycle in terms of an expected future efficiency gain which is eventually not realized. The build up in liquidity and economic activity in expectation of these efficiency gains is then abruptly reversed when agent's hopes are dashed. The model generates counter-cyclical movements in the spread between lending rates and the risk-free rate which are driven purely by expectations, even in the absence of any exogenous movement in intermediation costs.
    Keywords: externalities; expectations-driven business cycles, intermediation shocks, credit shocks, financial intermediation, financial innovation, news shocks, business cycles.
    JEL: E3
    Date: 2011–03
  14. By: Enrique Martinez-Garcia
    Abstract: I build a symmetric two-country model that incorporates nominal rigidities, local-currency pricing and monopolistic competition distorting the goods markets. The model is similar to the framework developed in Martínez-García and Søndergaard (2008a, 2008b), but it also introduces frictions in the assets markets by restricting the financial assets available to two uncontingent nominal bonds in zero-net supply and by adding quadratic costs on international borrowing (see, e.g., Benigno and Thoenissen (2008) and Benigno (2009). The technical part of the paper contains three basic calculations. First, I derive the equilibrium conditions of the open economy model under local-currency pricing and incomplete asset markets. Second, I compute the zero-inflation (deterministic) steady state and discuss what happens with a non-zero net foreign asset position. Third, I derive the log-linearization of the equilibrium conditions around the deterministic steady state. The quantitative part of the paper aims to give a broad overview of the role that incomplete international asset markets can play in accounting for the persistence and volatility of the real exchange rate. I find that the simulation of the incomplete and complete asset markets models is almost indistinguishable whenever the business cycle is driven primarily by either nonpersistent monetary or persistent productivity (but not permanent) shocks. In turn, asset market incompleteness has more sizeable wealth effects whenever the cycle is driven by persistent (but not permanent) investment-specific technology shocks, resulting in significantly lower real exchange rate volatility.
    Keywords: Foreign exchange ; International finance ; International trade ; Macroeconomics
    Date: 2011
  15. By: Guglielmo Maria Caporale; Alessandro Girardi; Marco Ventura
    Abstract: By estimating a staggered price model over the period 1980q1-2010q2, this paper documents that, after the euro changeover, Italian retailers have increased the number of price adjustments, which has translated into a higher inflation rate, with a detrimental effect on the competitiveness of the Italian economy.
    Keywords: Euro changeover, staggered price adjustments, inflation
    JEL: C22 E31
    Date: 2011
  16. By: Joseph G. Haubrich; George Pennacchi; Peter Ritchken
    Abstract: This paper develops a model of the term structures of nominal and real interest rates driven by state variables representing the short-term real interest rate, expected inflation, inflation’s central tendency, and four volatility factors that follow GARCH processes. We derive analytical solutions for nominal bond yields, yields on inflation-indexed bonds that have an indexation lag, and the term structure of expected inflation. Unlike prior studies, the model’s parameters are estimated using data on inflation swap rates, as well as nominal yields and survey forecasts of inflation. The volatility state variables fully determine bonds’ time-varying risk premia and allow for stochastic volatility and correlation between bond yields, yet they have small effects on the cross section of nominal yields. Allowing for time-varying volatility is particularly important for real interest rate and expected inflation processes, but long-horizon real and inflation risk premia are relatively stable. Comparing our model prices of inflation-indexed bonds to those of Treasury Inflation Protected Securities (TIPS) suggests that TIPS were significantly underpriced prior to 2004 and again during the 2008-2009 financial crisis.
    Keywords: Inflation (Finance) ; Interest rates ; Asset pricing
    Date: 2011
  17. By: Andrew Clausen; Carlo Strub
    Abstract: Classical models of money are typically based on a competitive market without capital or credit. They then impose exogenous timing structures, market participation constraints, or cash-in-advance constraints to make money essential. We present a simple model without credit where money arises from a fixed cost of production. This leads to a rich equilibrium structure. Agents avoid the fixed cost by taking vacations and the trade between workers and vacationers is supported by money. We show that agents acquire and spend money in cycles of finite length. Throughout such a “money cycle,” agents decrease their consumption which we interpret as the hot potato effect of inflation. We give an example where money holdings do not decrease monotonically throughout the money cycle. Optimal monetary policy is given by the Friedman rule, which supports efficient equilibria. Thus, monetary policy provides an alternative to lotteries for smoothing out non-convexities.
    Date: 2011–03
  18. By: Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
    Abstract: We construct probability forecasts for episodes of price deflation (i.e., a falling price level) using yields on nominal and real U.S. Treasury bonds. The deflation probability forecasts identify two "deflation scares" during the past decade: a mild one following the 2001 recession, and a more serious one starting in late 2008 with the deepening of the financial crisis. The estimated deflation probabilities are generally consistent with those from macroeconomic models and surveys of professional forecasters, but they also provide highfrequency insight into the views of financial market participants. The probabilities can also be used to price the deflation option embedded in real Treasury bonds.
    Keywords: Deflation (Finance)
    Date: 2011
  19. By: Acocella Nicola; Bisio Laura; Di Bartolomeo Giovanni; Pelloni Alessandra
    Abstract: By using the recent Gertler and Kiyotaki's (2010) setup, this paper explores the interaction between real distortions stemming from the labor market institutions and financial shocks. We find that neither labor market imperfections nor fiscal institutions determining tax wedges have an impact on the volatility of the real economy induced by a financial shock. By contrast, real wage rigidities matter as they amplify the financial shock effects. Thus, economies with larger imperfections will not systematically observe larger or smaller recessions, unless a causality between imperfections and real wage rigidities is introduced.
    Keywords: Financial accelerator, credit frictions, wage-setters, business cycle, volatility
    JEL: E32 E44
    Date: 2011–03
  20. By: Hatcher, Michael C. (Cardiff Business School)
    Abstract: This paper investigates the long-term impact of price-level targeting on social welfare in an overlapping generations model in which the young save for old age by investing in productive capital and indexed and nominal government bonds. A key feature of the model is that the extent of bond indexation is determined endogenously in response to monetary policy as part of an optimal commitment Ramsey policy. Due to the absence of base-level drift under price-level targeting, long-term inflation risk is reduced by an order of magnitude compared to inflation targeting. Consequently, real bond returns are stabilised somewhat, and consumption volatility for old generations is reduced by around 15 per cent. The baseline welfare gain from price- level targeting is equivalent to a permanent increase in aggregate consumption of only 0.01 per cent, but this estimate is strongly sensitive on the upside.
    Keywords: inflation targeting; price-level targeting; optimal indexation; government bonds
    JEL: E52 E58
    Date: 2011–03
  21. By: Paradiso, Antonio; Rao, B. Bhaskara
    Abstract: We use the unobserved components model of Harvey (1989 and 2011) to estimate the Phillips curve (PC) for the USA and Australia, by augmenting it with oil prices. We found that the level coefficient of inflation and the coefficient of demand pressure have declined and contributed to the flattening of the Phillips curve. But the coefficient of oil prices has increased and has partly offset these effects. Therefore, oil prices are likely to play a significant role in future inflation rates.
    Keywords: Unobserved components; Harvey; USA; Australia; Flattening of the Phillips curve and Oil prices
    JEL: C12 C2 E3
    Date: 2011–03–06
  22. By: Andreasen, Martin (Bank of England)
    Abstract: This paper studies how non-Gaussian shocks affect risk premia in DSGE models approximated to second and third order. Based on an extension of the work by Schmitt-Grohe and Uribe to third order, we derive propositions for how rare disasters, stochastic volatility, and GARCH affect any risk premia in a wide class of DSGE models. To quantify these effects, we then set up a standard New Keynesian DSGE model where total factor productivity includes rare disasters, stochastic volatility, and GARCH. We find that rare disasters increase the mean level of the ten-year nominal term premium, whereas a key effect of stochastic volatility and GARCH is an increase in the variability of this premium.
    Keywords: Epstein-Zin-Weil preferences; GARCH; rare disasters; risk premia; stochastic volatility.
    JEL: C68 E30 E43 E44 G12
    Date: 2011–03–15
  23. By: Andreasen , Martin (Bank of England); Zabczyk, Pawel (Bank of England)
    Abstract: This paper develops a fast method of computing arbitrary order perturbation approximations to bond prices in DSGE models. The procedure is implemented to third order where it can shorten the approximation process by more than 100 times. In a consumption-based endowment model with habits, it is further shown that a third-order perturbation solution is more accurate than the log-normal method and a procedure using consol bonds.
    Keywords: Perturbation method; DSGE models; habit model; higher-order approximation.
    JEL: C63 G12
    Date: 2011–03–15
  24. By: Luisa Lambertini (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland); Caterina Mendicino; Maria Teresa Punzi
    Abstract: This paper studies the potential gains of monetary and macro-prudential policies that lean against news-driven boom-bust cycles in housing prices and credit generated by expectations of future macroeconomic developments. First, we find no trade-off between the traditional goals of monetary policy and leaning against boom-bust cycles. An interest-rate rule that completely stabilizes inflation is not optimal. In contrast, an interest-rate rule that responds to financial variables mitigates macroeconomic and financial cycles and is welfare improving relative to the estimated rule. Second, counter-cyclical Loan-to-Value rules that respond to credit growth do not increase inflation volatility and are more effective in maintaining a stable provision of financial intermediation than interest-rate rules that respond to financial variables. Heterogeneity in the welfare implications for borrowers and savers make it difficult to rank the two policy frameworks.
    Keywords: Expectations-driven cycles, Macro-prudential policy, Monetary policy, Welfare analysis
    JEL: E32 E44 E52
    Date: 2011–03
  25. By: Prasad S Bhattacharya; Dimitrios D Thomakos
    Abstract: This study presents extensive results on the benefits of rolling window and model averaging. Building on the recent work on rolling window averaging by Pesaran et al (2010, 2009) and on exchange rate forecasting by Molodtsova and Papell (2009), we explore whether rolling window averaging can be considered beneficial on a priori grounds. We investigate whether rolling window averaging can improve the performance of model averaging, especially when ‘simpler’ models are used. The analysis provides strong support for rolling window averaging, outperforming the best window forecasts more than 50% of the time across all rolling windows. Furthermore, rolling window averaging smoothes out the forecast path, improves robustness, and minimizes the pitfalls associated with potential structural breaks.
    Keywords: Exchange rate forecasting, inflation forecasting, output growth forecasting, rolling window, model averaging, short horizon, robustness.
    JEL: C22 C53 F31 F47 E31
    Date: 2011–02–21
  26. By: Andrei Sirchenko
    Abstract: The National Bank of Poland does not publish the Monetary Policy Council's voting records before the subsequent policy meeting. Using real-time data, this paper shows that a prompter release of the voting records could improve the predictability of policy decisions. The voting patterns reveal strong and robust predictive content even after controlling for policy bias and responses to in.ation, real activity, exchange rates and financial market information. They contain information not embedded in the spreads and moves in the market interest rates, nor in the explicit forecasts of the next policy decision made by market analysts in Reuters surveys. Moreover, the direction of policymakers' dissent explains the direction of analysts.forecast bias. These findings are based on the voting patterns only, without the knowledge of policymakers' names.
    Keywords: monetary policy; predictability; policy interest rate; voting records; real-time data
    JEL: D70 E52 E58
    Date: 2011
  27. By: Don Bredin (University College Dublin); Stilianos Fountas (University of Macedonia)
    Abstract: We use over two hundred years of US inflation data to examine the impact of inflation uncertainty on inflation. An analysis of the full period without allowing for various regimes shows no impact of uncertainty on inflation. However, once we distinguish between recessions and non recessions, we find that inflation uncertainty has a negative effect on inflation only in recession times, thus providing support to the Holland hypothesis.
    Keywords: asymmetric GARCH, recession, inflation uncertainty
    JEL: C22 E31
    Date: 2011–03–11
  28. By: Andres Felipe García-Suaza; José E. Gómez González
    Abstract: This study proposes a new method for testing for the presence of momentum in nominal exchange rates, using a probabilistic approach. We illustrate our methodology estimating a binary response model using information on local currency / US dollar exchange rates of eight emerging economies. After controlling for important variables a§ecting the behavior of exchange rates in the short-run, we show evidence of exchange rate inertia; in other words, we Önd that exchange rate momentum is a common feature in this group of emerging economies, and thus foreign exchange traders participating in these markets are able to make excess returns by following technical analysis strategies. We Önd that the presence of momentum is asymmetric, being stronger in moments of currency depreciation than of appreciation. This behavior may be associated with central bank intervention.
    Date: 2011–03–13
  29. By: Kappler, Marcus; Reisen, Helmut; Schularick, Moritz; Turkisch, Edouard
    Abstract: In this paper we study the macroeconomic effects of large exchange rate appreciations. Using a sample of 128 countries from 1960-2008, we identify large nominal and real appreciations shocks and study their macroeconomic effects in a dummy-augmented panel autoregressive model. Our results show that an exchange rate appreciation can have strong effects on current account balances. Within three years after the appreciation event, the current account balance on average deteriorates by three percentage points of GDP. This effect occurs through a reduction of savings without a meaningful reduction in investment. Real export growth slows down substantially, while imports remain by and large unaffected. The output costs of appreciation are small and not statistically significant, indicating a shift towards domestic sources of growth. All these effects appear somewhat more pronounced in developing countries. --
    Keywords: Current account adjustment,global imbalances,exchange rate changes
    JEL: F4 F31 F32 N10 O16
    Date: 2011
  30. By: Romain Houssa (Center for Research in the Economics of Development, University of Namur)
    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
  31. By: Engelbert Stockhammer
    Abstract: The paper argues that the Greek debt crisis, as well as those of other Southern European countries and Ireland, has to be seen in macroeconomic context. The sum of the public sector balance, the (domestic) private sector balance and the current account deficit (or equivalently: the capital inflows) has to add up to zero. By implication in a country that has a current account deficit either the private sector or the public sector has to run a deficit. Therefore the peripheral countries can only solve their public debt problems if there is a change in German current account surpluses. The paper explores the implications of this for wage policy in the euro zone.
    Date: 2011
  32. By: Sandra Tatierska (National Bank of Slovakia, Research Departmen)
    Abstract: The purpose of this study is to analyze the relationship between unit labor costs and inflation. We estimate an optimal price path model based on a New Keynesian Phillips Curve for eleven euro area countries individually, under the assumption that unit labor costs are proportional to marginal costs. We seek such a model which minimizes the distance between fitted and actual price level fluctuations, with parameters that satisfy theoretical restrictions. The econometric methodology used is a two-step approach method. Estimates show that in eight of the eleven euro area countries there is a plausible relationship between unit labor costs and price level dynamics. The average time needed to adjust prices in line with movements in unit labor costs is estimated to be around eight months. In the case of Slovakia the results indicate rather flexible prices.
    Keywords: inflation, unit labor costs, NKPC, euro area, VAR
    JEL: C22 E12 E3 J3
    Date: 2010–12
  33. By: Jorg Bibow
    Abstract: This paper provides a brief exposition of financial markets in Post Keynesian economics. Inspired by John Maynard Keynes's path-breaking insights into the role of liquidity and finance in "monetary production economies," Post Keynesian economics offers a refreshing alternative to mainstream (mis)conceptions in this area. We highlight the importance of liquidity-as provided by the financial system—to the proper functioning of real world economies under fundamental uncertainty, contrasting starkly with the fictitious modeling world of neo-Walrasian exchange economies. The mainstream vision of well-behaved financial markets, channeling saving flows from savers to investors while anchored by fundamentals, complements a notion of money as an arbitrary numeraire and mere convenience, facilitating exchange but otherwise "neutral." From a Post Keynesian perspective, money and finance are nonneutral but condition and shape real economic performance. It takes public policy to anchor asset prices and secure financial stability, with the central bank as the key public policy tool.
    Keywords: Financial Markets; Liquidity; Uncertainty; Rate of Interest; Instability; Central Banking
    JEL: B31 E44 E50
    Date: 2011–03
  34. By: Francesca Viani
    Abstract: Whether financial market integration raised global insurance is a crucial, still open issue. All empirical methods to measure cross-border risk-sharing are based on the implicit assumption that international prices do not fluctuate in response to business cycle shocks. This paper shows that these methods can be completely misleading in the presence of large fluctuations in international prices as those observed in the data. I then propose a new empirical method that is immune from this issue. The risk-sharing inefficiency between two countries is measured by the wedge between their Stochastic Discount Factors (SDFs). This measure is a proxy for the welfare losses created by imperfect insurance. Welfare losses can be attributed either to the strength of uninsurable shocks (the extent of risk to be pooled) or to the degree of insurance against different sources of risk. The method is applied to study the evolution of risk-sharing between the US and OECD countries, assuming either constant or time-varying risk-aversion. The degree of insurance is found to have improved over time only for some countries and only if SDFs are estimated assuming time-varying risk-aversion. The results are also informative on the implications of different macro models for international risk. When confronted with the data, standard open-macro models (featuring constant risk-aversion) imply that nominal exchange rate fluctuations do not contain wealth divergences across countries, but rather represent an important source of risk. Time-varying risk-aversion instead implies that limiting welfare losses from imperfect risk-sharing requires reducing the volatility of macro fundamentals.
    Date: 2011
  35. By: Stevenson, Betsey (Wharton School, University of Pennsylvania); Wolfers, Justin (Wharton School, University of Pennsylvania)
    Abstract: We document that trust in public institutions – and particularly trust in banks, business and government – has declined over recent years. U.S. time series evidence suggests that this partly reflects the pro-cyclical nature of trust in institutions. Cross-country comparisons reveal a clear legacy of the Great Recession, and those countries whose unemployment grew the most suffered the biggest loss in confidence in institutions, particularly in trust in government and the financial sector. Finally, analysis of several repeated cross-sections of confidence within U.S. states yields similar qualitative patterns, but much smaller magnitudes in response to state-specific shocks.
    Keywords: trust, institutions, confidence, survey data, congress, banks, big business, media, courts
    JEL: D72 E32 E65 K0 O4 P52 Z13
    Date: 2011–03
  36. By: Stan du Plessis (Department of Economics, University of Stellenbosch); Gideon du Rand (Department of Economics, University of Stellenbosch)
    Abstract: The instrument problem in monetary policy is back on the agenda. Until recently interest rate policy was widely thought to be sufficient for the attainment of appropriate monetary policy goals. No longer. In the wake of the international financial crisis there is much pressure on monetary authorities to incorporate the goal of financial stability more explicitly in policy. This requires an expansion of the instruments typically used by central banks. Cechetti and Kohler (2010) recently considered this new version of the instrument problem in monetary policy by analysing the distinct role and potential for co-ordinating (i) interest rates and (ii) capital adequacy requirements. In this paper we connect this modern debate with an earlier version of the instrument problem, famously discussed by Poole (1970). Then, as now (we claim), the main message of the analysis is the non-equivalence of these instruments and the structural features of the economy on the basis of which one would prefer a particular combination of these instruments. These results are demonstrated with a set of simulations. We also offer a theoretical criticism of the modelling approach used by Cechetti and Kohler (2010).
    Keywords: Monetary policy, Instrument problem, Interest rates, Alternative monetary policy instruments, Balance sheet operations, Policy co-ordination
    JEL: E52 E58 E61
    Date: 2011
  37. By: Alison Johnston
    Abstract: Many political scientists and economists have addressed the implications of the public sector’s sheltered status on their unions’ wage strategies vis-à-vis the government. Since the public sector is a monopoly provider of necessary and price inelastic services, conventional wisdom suggests that public sector unions’ push for wage increases which their productivity does not merit, exacerbating inflation and fiscal deficits. The argument in this paper challenges this conventional view, and maintains that the recent, puzzling rise in public sector wage inflation, relative to that in manufacturing, in Euro-zone countries is an unintended result of the institutional shift towards European Economic and Monetary Union (EMU). During the 1980s and 1990s, differences in wage inflation between the manufacturing and public sector within most EMU candidate-countries were low. After 1999, these differences significantly worsened; wage moderation continued in the manufacturing sector while wage inflation arose in the public sector. It is argued here that monetary union’s predecessors, the European Monetary System and Maastricht regimes, imposed two important constraints on public employers, which enhanced their ability to enforce wage moderation: the commitment to a hard currency policy via participation in the Exchange Rate Mechanism, adopted by some earlier than others and, the Maastricht criteria. Monetary union’s removal of these two constraints weakened public employers’ capability to deny inflationary wage settlements to public sector unions. Panel regressions results outline a statistically significant relationship between monetary union and higher levels of wage inflation in the public sector, relative to manufacturing. The paper concludes with a brief discussion of the implications of monetary union for inter-sectoral dynamics.
    Keywords: employment policy; trade unions; sectoral governance; EMU; EMU
    Date: 2011–03–15
  38. By: Alison Johnston
    Abstract: Many political scientists and economists have addressed the implications of the public sector’s sheltered status on their unions’ wage strategies vis-à-vis the government. Since the public sector is a monopoly provider of necessary and price inelastic services, conventional wisdom suggests that public sector unions’ push for wage increases which their productivity does not merit, exacerbating inflation and fiscal deficits. The argument in this paper challenges this conventional view, and maintains that the recent, puzzling rise in public sector wage inflation, relative to that in manufacturing, in Euro-zone countries is an unintended result of the institutional shift towards European Economic and Monetary Union (EMU). During the 1980s and 1990s, differences in wage inflation between the manufacturing and public sector within most EMU candidate-countries were low. After 1999, these differences significantly worsened; wage moderation continued in the manufacturing sector while wage inflation arose in the public sector. It is argued here that monetary union’s predecessors, the European Monetary System and Maastricht regimes, imposed two important constraints on public employers, which enhanced their ability to enforce wage moderation: the commitment to a hard currency policy via participation in the Exchange Rate Mechanism, adopted by some earlier than others and, the Maastricht criteria. Monetary union’s removal of these two constraints weakened public employers’ capability to deny inflationary wage settlements to public sector unions. Panel regressions results outline a statistically significant relationship between monetary union and higher levels of wage inflation in the public sector, relative to manufacturing. The paper concludes with a brief discussion of the implications of monetary union for inter-sectoral dynamics.
    Keywords: Sectoral Interests, Employers, Trade Unions, European Monetary Union, Institutional Change
    Date: 2011–03
  39. By: Roman Horvath; Lubos Komarek; Filip Rozsypal
    Abstract: This paper investigates the predictive ability of money for future inflation in the Czech Republic, Hungary, Poland, and Slovakia. We construct monetary indicators similar to those the ECB regularly uses for monetary analysis. We find some in-sample evidence that money matters for future inflation at the policy horizons that central banks typically focus on, but our pseudo out-of-sample forecasting exercise shows that money does not in general improve the inflation forecasts vis-à-vis some benchmark models, such as the autoregressive process. Since at least some models containing money improve the inflation forecasts in certain periods, we argue that money still serves as a useful cross-check for monetary policy analysis.
    Keywords: Central Europe, forecasting, inflation, money.
    JEL: E41 E47 E52
    Date: 2010–12
  40. By: Moussa, Zakaria
    Abstract: Interest rates in several countries have recently been decreased to exceptionally low levels and a Quantitative Easing Monetary Policy (QEMP) has been adopted by most major central banks. In this context this paper is very actual, as it sheds some light on the effectiveness of the Japanese use of QEMP, which is the only experience we can learn from. This paper employs a Time Varying Parameters Factor-Augmented VAR (TVP-FAVAR) model to analyse monetary policy shocks in Japan. This model allows us to explore the effect of QEMP on a large number of variables. Our analysis delivers four main results. First, unsurprisingly, our results suggest that the best model to specify the Japanese monetary policy during the two last decades is a model where all of parameters vary over time. Second, the effect of QEMP on activity and prices is stronger than previously found. In particular, we find a significant price reaction to a monetary policy shock. Third, in contrast to previous work, there is a detectable efficiency of the portfolio-rebalancing channel, which could have a role in transmitting the monetary policy shocks. Fourth, while the policy commitment succeeds in controlling private and business expectations, these effects are not transmitted to the long-end of the yield curve.
    Keywords: Time varying parameters; Factor-Augmented VAR; Japan; Quantitative Easing; Transmission channels
    JEL: C32 E5 C11
    Date: 2010–10–05
  41. By: Mehrotra, Aaron (BOFIT); Paakkonen, Jenni (BOFIT)
    Abstract: We use factor analysis to summarize information from various macroeconomic indicators, effectively producing coincident indicators for the Chinese economy. We compare the dynamics of the estimated factors with GDP, and compare our factors with other published indicators for the Chinese economy. The indicator data match the GDP dynamics well and discrepancies are very short. The periods of discrepancies seem to correspond to shocks affecting the growth process as neither autoregressive models for GDP itself nor various coincident indicators are able to forecast them satisfactorily.
    Keywords: factor models; principal component; GDP; China
    JEL: C30 O40 P20
    Date: 2011–02–18
  42. By: Ben Ali, Samir
    Abstract: In this paper, we study some empirical issues in the estimation of a New-Keynesian Phillips curve for Tunisia. In this purpose, we compare the performance of the strict and hybrid forms in the validation of data. In addition, we try to establish the sensitivity of the Phillips curve estimation to some empirical speci…cations. It includes the measures to be used for the output gap variable, as well as the implementation of the generalized method of moments for the estimation of this curve.
    Keywords: monetary policy; New Keynesian Phillips curve; Inflation; sensitivity;Tunisia
    JEL: E31 E52 C22
    Date: 2010–11–10
  43. By: Sanusi, Aliyu Rafindadi
    Abstract: This paper develops a Structural Vector Autoregression (SVAR) model for the Ghanaian economy to estimate the pass-through effects of exchange rate changes to consumer prices. The model incorporates the special features of the Ghanaian economy, especially its dependence on foreign aid and primary commodity exports for foreign exchange earnings. The findings show that the pass-through to consumer prices, although incomplete, is substantially large. This suggests that exchange rate depreciation is a potentially important source of inflation in Ghana. Using variance decomposition analyses, it is found that monetary expansion has been more important in explaining Ghana’s actual inflationary process than the exchange rate depreciation. One policy implication of these findings is that policies that aim at lowering inflation must focus on monetary and exchange rate stability.
    Keywords: Exchange Rate Pass-Through; Inflation; Structural Vector-Autoregression; Foreign Aid; Ghana
    JEL: E31 F41 F31
    Date: 2010–06

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