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on Central Banking |
| By: | William Poole; Robert H. Rasche; David C. Wheelock |
| Abstract: | The Shadow Open Market Committee was formed in 1973 in response to rising inflation and the apparent unwillingness of U.S. policymakers to implement policies necessary to maintain price stability. This paper describes how the Committee’s policy views differed from those of most Federal Reserve officials and many academic economists at the time. The Shadow argued that price stability should be the primary goal of monetary policy and favored gradual adjustment of monetary growth to a rate consistent with price stability. This paper evaluates the Shadow’s policy rule in the context of the New Keynesian macroeconomic model of Clarida, Gali, and Gertler (1999). Simulations of the model suggest that the gradual stabilization of monetary growth favored by the Shadow would have lowered inflation with less impact on output growth and less variability in inflation or output than a one-time reduction in monetary growth. We conclude that the Shadow articulated a policy that would have outperformed the policies actually implemented by the Federal Reserve during the Great Inflation era. |
| JEL: | E31 E32 E37 E41 E52 E58 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16910&r=cba |
| By: | Tatiana Damjanovic; Vladislav Damjanovic; Charles Nolan |
| Abstract: | The unconditional expectation of social welfare is often used to assess alternative macroeconomic policy rules in applied quantitative research. It is shown that it is generally possible to derive a linear-quadratic problem that approximates the exact non-linear problem where the unconditional expectation of the objective is maximised and the steady-state is distorted. Thus, the measure of policy performance is a linear combination of second moments of economic variables which is relatively easy to compute numerically, and can be used to rank alternative policy rules. The approach is applied to a simple Calvo-type model under various monetary policy rules. |
| Keywords: | Linear-quadratic approximation; unconditional expectations;optimal monetary policy; ranking simple policy rules. |
| JEL: | E20 E32 F32 F41 |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:san:wpecon:1102&r=cba |
| By: | Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, and Institute of Economic Research, Kyoto University); Juan-Ángel Jiménez-Martín (Department of Quantitative Economics, Complutense University of Madrid); 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. In this paper we define risk management in terms of choosing sensibly from a variety of risk models, and discuss the selection of optimal risk models. A new approach to model selection for predicting VaR is proposed, consisting of combining alternative risk models, and comparing conservative and aggressive strategies for choosing between VaR models. We then examine how different risk management strategies performed during the 2008-09 financial crisis. These issues are illustrated using Standard and Poor's 500 Index, with an emphasis on how market risk management practices were encouraged by the Basel II Accord regulations during the financial crisis. |
| Keywords: | Value-at-Risk (VaR), daily capital charges, exogenous and endogenous violations, violation penalties, optimizing strategy, risk forecasts, aggressive or conservative risk management strategies, Basel II Accord, global financial crisis. |
| JEL: | G32 G11 C53 C22 |
| Date: | 2011–04 |
| URL: | http://d.repec.org/n?u=RePEc:kyo:wpaper:767&r=cba |
| By: | Giovanni Di Bartolomeo; Patrizio Tirelli; Nicola Acocella |
| Abstract: | We challenge the widely held belief that New-Keynesian models cannot predict optimal positive in‡ ations. We finnd that these are justified by the Phelps argument. This mainly happens because we also consider distortionary expects of public transfers. Our predictions are broadly consistent with recent estimates of the Fed inflation targets. We also contradict theview that the Ramsey policy should minimize inflation volatility and induce near-random walk dynamics of public debt in the long-run. It should instead stabilize debt-to-GDP ratios to mitigate steady-state distortions. This latter result is strikingly similar to policy analyses in the aftermath of the 2008 crisis. |
| Keywords: | trend inflation, monetary and fiscal policy, Ramsey plan. |
| JEL: | E52 E58 J51 E24 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:mib:wpaper:208&r=cba |
| By: | Xiaoshan Chen; Ronald MacDonald |
| Abstract: | This paper conducts a systematic investigation of parameter instability in a small open economy DSGE model of the UK economy over the past thirty-five years. Using Bayesian analysis, we find a number of Markov-switching versions of the model provide a better fit for the UK data than a model with time-invariant parameters. The Markov-switching DSGE model that has two independent Markov-chains - one governing the shifts in UK monetary policy and nominal price rigidity and one governing the standard deviations of shocks - is selected as the best fitting model. The preferred model is then used to evaluate and design monetary policy. For the latter, we use the Markov-Jump-Linear-Quadratic (MJLQ) model, as it incorporates abrupt changes in structural parameters into derivations of the optimal and arbitrary policy rules. It also reveals the entire forecasting distribution of the targeted variables. To our knowledge, this is the first paper that attempts to evaluate and design UK monetary policy based on an estimated open economy Markov-switching DSGE model. |
| Keywords: | DSGE models; Markov-switching; Bayesian analysis |
| JEL: | C11 C32 C51 C52 |
| Date: | 2011–01 |
| URL: | http://d.repec.org/n?u=RePEc:gla:glaewp:2011_04&r=cba |
| By: | Noussair, C.N.; Pfajfar, D.; Zsiros, J. (Tilburg University, Center for Economic Research) |
| Abstract: | New Keynesian dynamic stochastic general equilibrium models are the principal paradigm currently employed for central bank policymaking. In this paper, we construct experimental economies, populated with human subjects, with the structure of a New Keynesian DSGE model. We give individuals monetary incentives to maximize the objective functions in the model, but allow scope for agents' boundedly rational behavior and expectations to influence outcomes. Subjects participate in the roles of consumer/workers, producers, or central bankers. Our objective is twofold. The first objective is general, and is to create an experimental environment for the analysis of macroeconomic policy questions. The second objective is more focused and is to consider several specific research questions relating to the persistence of shocks, the behavior of human central bankers, and the pricing behavior of firms, using our methodology. We find that the presence of menu costs is not necessary to generate persistence of output shocks, but rather that monopolistic competition in the output market is sufficient. Interest rate policies of human discretionary central bankers are characterized by persistence in interest rate shocks, the use of the Taylor principle, and lower output and welfare than under an automated instrumental rule. Pattens in price changes conform closely to stylized empirical facts. |
| Keywords: | Experimental Economics;DSGE economy;Monetary Policy;Menu costs. |
| JEL: | C91 C92 E31 E32 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:2011030&r=cba |
| By: | Carolin E. Pflueger; Luis M. Viceira |
| Abstract: | This paper empirically analyzes the Expectations Hypothesis (EH) in inflation-indexed (or real) bonds and in nominal bonds in the US and in the UK. We strongly reject the EH in inflation-indexed bonds, and also confirm and update the existing evidence rejecting the EH in nominal bonds. This rejection implies that the risk premium on both real and nominal bonds varies predictably over time. We also find strong evidence that the spread between the nominal and the real bond risk premium, or the break-even inflation risk premium, also varies over time. We argue that the time variation in real bond risk premia mostly likely reflects both a changing real interest rate risk premium and a changing liquidity risk premium, and that the variability in the nominal bond risk premia reflects a changing inflation risk premium. We estimate significant time series variability in the magnitude and sign of bond risk premia. |
| JEL: | G12 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:16903&r=cba |
| By: | Mario Forni; Luca Gambetti; Luca Sala |
| Abstract: | This paper uses a structural, large dimensional factor model to evaluate the role of `news' shocks (shocks with a delayed effect on productivity) in generating the business cycle. We find that (i) existing small-scale VECM models are affected by `non-fundamentalness' and therefore fail to recover the correct shock and impulse response functions; (ii) news shocks have a limited role in explaining the business cycle; (iii) their effects are in line with what predicted by standard neoclassical theory; (iv) the bulk of business cycle fluctuations are explained by shocks unrelated to technology. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:igi:igierp:383&r=cba |
| By: | Dunne, Peter (Central Bank of Ireland); Fleming, Michael J. (Federal Reserve Bank of New York); Zholos, Andrey (Queen’s University Management School) |
| Abstract: | The financial turmoil that began in mid-2007 produced severe stress in interbank markets and prompted significant changes in central banks’ funding operations. We examine the changing characteristics of ECB official interventions through the crisis and assess how they affected the efficiency and reliability of the secondary repo market as a mechanism for the distribution of interbank funding. The limit orderbook from the BrokerTec electronic repo trading platform is reconstructed to provide a range of indicators of participating banks’ aversion to the risk of failing to fund their liquidity needs. These indicators anticipate similar variables from ECB reverse repo auctions and are also affected by surprise outcomes of auctions. |
| Keywords: | Repo, Financial crisis, liquidity, market microstructure, monetary policy operations |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:cbi:wpaper:8/rt/11&r=cba |
| By: | Paolo Zagaglia (Department of Economics, University of Bologna) |
| Abstract: | This paper studies the forecasting performance of the general equilibrium model of bond yields of Marzo, Söderström and Zagaglia (2008), where long-term interest rates are an integral part of the monetary transmission mechanism. The model is estimated with Bayesian methods on Euro area data. I compare the out-of-sample predictive performance of the model against a variety of competing specifications, including that of De Graeve, Emiris and Wouters (2009). Forecast accuracy is evaluated through both univariate and multivariate measures. I also control the statistical significance of the forecast differences using the tests of Diebold and Mariano (1995), Hansen (2005) and White (1980). I show that taking into account the impact of the term structure of interest rates on the macroeconomy generates superior out-of-sample forecasts for both real variables, such as output, and inflation, and for bond yields. |
| Keywords: | Yield curve, general equilibrium models, Bayesian estimation, forecasting |
| JEL: | E43 E44 E52 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:19_11&r=cba |
| By: | kevin dowd; john cotter |
| Abstract: | This paper proposes the use of wavelet methods to estimate U.S. core inflation. It explains wavelet methods and suggests they are ideally suited to this task. Comparisons are made with traditional CPI-based and regression-based measures for their performance in following trend inflation and predicting future inflation. Results suggest that wavelet-based measures perform better, and sometimes much better, than the traditional approaches. These results suggest that wavelet methods are a promising avenue for future research on core inflation. |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1103.5659&r=cba |
| By: | Nutahara, Kengo |
| Abstract: | Carlstrom and Fuerst (2007) [``Asset prices, nominal rigidities, and monetary policy,'' Review of Economic Dynamics 10, 256--275] find that monetary policy response to share prices is a source of equilibrium indeterminacy because an increase in inflation implies a high real marginal cost and low share prices in a sticky-price economy. We find that if the New Keynesian Phillips curve has a lagged inflation term caused by price indexation, this effect is weakened. Moreover, equilibrium indeterminacy caused by monetary policy response to share prices never arises if all the firms that cannot re-optimize their prices follow price indexation. |
| Keywords: | asset prices; monetary policy; equilibrium determinacy; price indexation |
| JEL: | E32 E31 E52 E44 |
| Date: | 2011–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:29859&r=cba |
| By: | Rodrigo Cerda; Rolf Lüders |
| Abstract: | We study the relation between inflation rate and relative price variability using data of prices on 23 disaggregated food items since 1960 to 2003 in Chile. The behavior of inflation rate is quite variable in that country during that time span and more interestingly, there are periods of time in which prices were determined (fixed) by the economic authorities. We find consistent evidence that a larger inflation rate causes a larger relative price variability and this effect is much larger in periods in which prices were fixed. We interpret that result as firms over-reacting to inflation when setting their relative prices if they assume that it is unlikely to reset their prices in the near future. That result holds even if we follow different econometric approaches and it holds for all the food products considered. |
| Keywords: | Wage premium, Skill Upgrading, Trade Openness, Skill Biased Technical Change, Chile, Latin America. |
| JEL: | E3 N1 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:ioe:doctra:395&r=cba |
| By: | Huixin Bi |
| Abstract: | We develop a closed economy model to study the interactions among sovereign risk premia, fiscal limits, and fiscal policy. The stochastic fiscal limits, which measure the ability and willingness of the government to service its debt, arise endogenously from a dynamic Laffer curve. The distribution of fiscal limits is country-specific, depending on the size of the government, the degree of countercyclical policy responses, economic diversity, and political uncertainty, among other characteristics. The model rationalizes different sovereign ratings across developed countries. A nonlinear relationship between sovereign risk premia and the level of government debt, which emerges in equilibrium, is consistent with the empirical evidence that once risk premia begin to rise, they do so rapidly. Movements in default risk premia for long-term bonds precede those for shortterm bonds, providing early warnings of increasing probabilities of sovereign defaults. |
| Keywords: | Fiscal policy; International topics |
| JEL: | E62 H30 H60 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:11-10&r=cba |
| By: | Lanne, Markku; Luoto, Jani |
| Abstract: | We propose an estimation method of the new Keynesian Phillips curve (NKPC) based on a univariate noncausal autoregressive model for the inflation rate. By construction, our approach avoids a number of problems related to the GMM estimation of the NKPC. We estimate the hybrid NKPC with quarterly U.S. data (1955:1-2010:3), and both expected future inflation and lagged inflation are found important in determining the inflation rate, with the former clearly dominating. Moreover, inflation persistence turns out to be intrinsic rather than inherited from a persistent driving process. |
| Keywords: | Noncausal time series; Non-Gaussian time series; inflation; Phillips curve |
| JEL: | C51 E31 C22 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:29801&r=cba |
| By: | Martin Brown; Karolin Kirschenmann; Steven Ongena |
| Abstract: | Motivated by concerns over foreign currency exposures of banks in Emerging Europe, we examine the currency denomination of business loans made in Bulgaria during the period 2003-2007. We analyze a unique dataset including information on the requested and granted currency for more than hundred thousand loans granted by one bank to sixty thousand different firms. This data set allows us to disentangle demand-side from supply-side determinants of foreign currency loans. We find that 32% of the foreign currency loans disbursed in our sample were actually requested in local currency by the firm. Our analysis suggests that the bank lends in foreign currency, not only to less risky firms, but also when the firm requests a long-term loan and when the bank itself has more funding in euro. These results imply that foreign currency borrowing in Eastern Europe is not only driven by borrowers who try to benefit from lower interest rates but also by banks hesitant to lend longterm in local currency and eager to match the currency structure of their assets and liabilities. |
| Keywords: | foreign currency debt, banking |
| JEL: | G21 G30 F34 F37 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:snb:snbwpa:2011-02&r=cba |
| By: | Matthias Gubler (Faculty of Business and Economics, University of Basel, Switzerland); Matthias S. Hertweck (Department of Economics, University of Konstanz, Germany) |
| Abstract: | This paper develops a 9-dimensional SVAR to investigate the sources of the U.S. business cycle. We extend the standard set of identified shocks to include unexpected changes in commodity prices. Our main result is that commodity price shocks are a very important driving force of macroeconomic fluctuations, second only to investment-specific technology shocks. In particular, we find that commodity price shocks explain a large share of cyclical movements in inflation. Neutral technology shocks and monetary policy shocks seem less relevant at business cycle frequencies. The impulse response dynamics provide support for medium-scale DSGE models, but not for strong price rigidities. |
| Keywords: | business cycles, commodity price shocks, structural VAR |
| JEL: | C32 E32 E52 Q43 |
| Date: | 2011–03–25 |
| URL: | http://d.repec.org/n?u=RePEc:knz:dpteco:1103&r=cba |
| By: | Stéphane Auray (EQUIPPE - ECONOMIE QUANTITATIVE, INTEGRATION, POLITIQUES PUBLIQUES ET ECONOMETRIE - Université des Sciences et Technologies de Lille - Lille I); Aurélien Eyquem (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure de Lyon) |
| Abstract: | This paper examines if taking into account changes in the number of producers, or equivalently changes in the product variety space over the business cycle, helps to understand and replicate international business cycle facts. To this end, we develop a two-country model in which the economy is driven by real and monetary policy shocks. If it is characterized by an endogenous number of firms and varieties, sticky prices and financial markets incompleteness. We show that these features are crucial to reproduce international business cycle statistics. We also evaluate the welfare implications of various monetary policies and highlight the importance for monetary policymakers to respond moderately to output fluctuations. |
| Keywords: | International business cycles; Endogenous entry; Financial markets incompleteness; Sticky prices; Monetary policy; Welfare |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00581165&r=cba |
| By: | Stéphane Auray (CNRS, THEMA, EQUIPPE, Universités Lille Nord de France (ULCO),Université de Sherbrooke (GREDI) and CIRPEE, Canada.); Aurélien Eyquem (Université de Lyon, Lyon, F-69003, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France) |
| Abstract: | This paper examines if taking into account changes in the number of producers, or equivalently changes in the product variety space over the business cycle, helps to understand and replicate international business cycle facts. To this end, we develop a two-country model in which the economy is driven by real and monetary policy shocks. If it is characterized by an endogenous number of firms and varieties, sticky prices and financial markets incompleteness. We show that these features are crucial to reproduce international business cycle statistics. We also evaluate the welfare implications of various monetary policies and highlight the importance for monetary policymakers to respond moderately to output fluctuations. |
| Keywords: | International business cycles, Endogenous entry, Financial markets incompleteness, Sticky prices, Monetary policy, Welfare |
| JEL: | C92 D62 D63 D64 D74 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:1114&r=cba |
| By: | Stéphane Auray (EQUIPPE - ECONOMIE QUANTITATIVE, INTEGRATION, POLITIQUES PUBLIQUES ET ECONOMETRIE - Université des Sciences et Technologies de Lille - Lille I); Beatriz De Blaz (Departamento de Teoría Económica e Historia Económica - Universidad Autónoma de Madrid); Aurélien Eyquem (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure de Lyon) |
| Abstract: | This paper analyzes jointly optimal fiscal and monetary policies in a small open economy with capital and sticky prices. We allow for trade in consumption goods under perfect international risk sharing. We consider balanced-budget fiscal policies where authorities use distortionary taxes on labor and capital together with monetary policy using the nominal interest rate. First, as long as a symmetric equilibrium is considered, the steady state in an open economy is isomorphic to that of a closed economy. second, whereas sticky prices allocations are almost indistinguishable from flexible prices allocations, the open economydimension delivers results that are qualitatively similar to those of a closed economy but with significant quantitative changes. Fluctuations in terms of trade implied by complete international financial markets affect (i) consumption through changes in the consumption price index (CPI), (ii) hours through changes in the CPI-based real wage and (iii) capital accumulation through the relative price of capital goods. These wedges affect the volatility and persistence of optimal tax rates, and resulting allocations are quite different, as compared to a closed economy. |
| Keywords: | small open economy; sticky prices; optimal monetary and fiscal policies |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00581173&r=cba |
| By: | Vilmi, Lauri (Department of Economics) |
| Abstract: | We explore the implications of endogenous firm entry and exit for business cycle dynamics and optimal fiscal policy. We first show that when the firm exit rate is endogenous, negative technology shocks lead to reductions in the number of firms. Technology shocks therefore have additional effects on household welfare relative to an economy with only endogenous entry. Second, endogenous firm exit creates a new channel for monetary policy when debt contracts are written in nominal terms, as monetary shocks affect the rate of firm defaults. Monetary shocks therefore have real effects also when prices and wages are flexible. Third, we show that endogenous firm exit creates a new role for fiscal policy to increase efficiency and welfare by subsidizing firms and decreasing the number of defaults. Finally, we demonstrate that endogenous firm exit implies that non-persistent shocks to technology and money supply have persistent effects on labor productivity. This has implications for the estimated persistence of technology shocks. |
| Keywords: | firm defaults; money supply shock; labor productivity |
| JEL: | E32 E52 |
| Date: | 2011–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:rbnkwp:0250&r=cba |
| By: | Andres Felipe Garcia-Suaza; Jose Eduardo Gómez |
| 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 affecting the behavior of exchange rates in the short-run, we show evidence of exchange rate inertia; in other words, we find 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 find 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: | 2011–03–28 |
| URL: | http://d.repec.org/n?u=RePEc:col:000094:008230&r=cba |
| By: | Fan, Jingwen (Cardiff Business School); Arghyrou, Michael G (Cardiff Business School) |
| Abstract: | We test for fiscal policy sustainability in the UK for the period 1955-2006. We find evidence of sustainability with three structural breaks, respectively occurring in the early 1970s, early 1980s and late 1990s. UK fiscal policy has been sustainable throughout the sample period except from 1973-1981 when a non-Ricardian regime applied. For the remaining periods correction of fiscal disequilibrium occurs through adjustments in public revenue rather than expenditure. Finally, we find evidence of non-linear fiscal adjustment, with UK authorities not reacting to relatively small deficits; but correcting exceedingly large deficits and any temporary surpluses relatively fast. |
| Keywords: | Fiscal policy; Sustainability; UK; Structural breaks; Non-linear adjustment |
| JEL: | E62 H60 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2011/9&r=cba |
| By: | Hongfei Sun (Queen's University) |
| Abstract: | I construct a unified macroeconomic framework by incorporating frictional markets in a neoclassical environment. This framework formalizes a theory that the variety and the functioning of markets reflect the status of national income. In the model, households have free access to markets with and without trading frictions. Uninsurable income risks generate money distributions and price dispersions. In equilibrium, the frictionless markets are generically used to smooth consumption and the frictional markets are only used when households have sufficiently high expected real income. Income inequality critically determines the equilibrium trading protocols across frictional markets. The optimal policy program consists of money growth, proportional income taxes and sales subsidies. Policy coordination is critical. It can be welfare-improving for the government to alleviate income taxes when the monetary authority is running deflation and to elevate income taxes under inflation. |
| Keywords: | markets, frictions, income, policy, competitive search |
| JEL: | E0 E4 E5 E6 H2 H3 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1262&r=cba |
| By: | Sushanta K. Mallick (Queen Mary University of London); Ricardo M. Sousa (Universidade do Minho - NIPE) |
| Abstract: | Using two identification strategies based on a Bayesian Structural VAR and a Sign-Restriction VAR, we examine the real effects of financial stress in the Eurozone. In particular, we assess the macroeconomic impact of: (i) a monetary policy shock; and (ii ) a financial stress shock. We find that a monetary policy contraction strongly deteriorates financial stress conditions. In addition, unexpected variation in the Financial Stress Index (FSI) plays an important role in explaining output fluctuations, and also demands an aggressive response by the monetary authority to stabilise output indicating a preference shift from targeting inflation as it is currently happening in major economies. Therefore, our paper reveals the importance of adopting a vigilant posture towards financial stress conditions, as well as the urgency of macro-prudential risk management. |
| Keywords: | monetary policy, financial stress, Bayesian Structural VAR, Sign-Restrictions, Euro-zone. |
| JEL: | E37 E52 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:nip:nipewp:12/2011&r=cba |
| By: | Massimiliano Marzo (Department of Economics, Università di Bologna); Paolo Zagaglia (Department of Economics, Università di Bologna) |
| Abstract: | We investigate the relation between aggregate trading imbalances and interest rates in the Euro money market. We use data for OTC contracts as well as information from the major electronic trading platform in Europe to study the presence of cointegration between trading pressures and money market rates. We report strong evidence of a long-term linear relation between trading imbalances and liquidity prices for Euro interbank deposits. |
| Keywords: | Euro money market, order flow, interest rates |
| JEL: | G14 E52 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:20_11&r=cba |
| By: | Theoharry Grammatikos; Robert Vermeulen |
| Abstract: | This paper tests for the transmission of the 2007-2010 financial and sovereign debt crises to fifteen EMU countries. We use daily data from 2003 to 2010 on country financial and non-financial stock market indexes. First, we find strong evidence of crisis transmission to European non-financials from US non-financials, whereas the increase in dependence of European financials on US financials is rather limited. Second, in order to test how the sovereign debt crisis affected stock market developments we split the crisis in pre- and post-Lehman sub periods. Results show that financials become significantly more dependent on changes in Greek CDS spreads after Lehman’s collapse, compared to the pre-Lehman sub period. However, this increase is not present for non-financials. Third, before the crisis euro appreciations are associated with European stock market decreases, whereas during the crisis this is reversed. Finally, the reversal in the relationship between the Eurodollar exchange rate and stock prices seems to have been triggered by Lehman’s collapse. |
| Keywords: | financial crisis; euro exchange rate; EMU; equity markets; sovereign debt |
| JEL: | F31 G15 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:287&r=cba |
| By: | Agnes Benassy-Quere; Jean Pisani-Ferry |
| Abstract: | Though the renminbi is not yet convertible, the international monetary regime has already started to move towards a 'multipolar' system, with the dollar, the Chinese currency and the euro as its key likely pillars. This shift corresponds to the long-term evolution of the balance of economic weight in the world economy. Such an evolution may mitigate some flaws of the present (non-) system, such as the rigidity of key exchange rates, the asymmetry of balanceof- payments adjustments or what remains of the Triffin dilemma. However it may exacerbate other problems, such as short-run exchange rate volatility or the scope for ‘currency wars’, while leaving key questions unresolved, such as the response to capital flows global liquidity provision. Hence, in itself, a multipolar regime can be both the best and the worst of all regimes. Which of these alternatives will materialise depends on the degree of cooperation within a multilateral framework. |
| Keywords: | International monetary system; capital controls |
| JEL: | F33 F32 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:cii:cepidt:2011-04&r=cba |
| By: | Marc Flandreau (Graduate Institute of International and Development Studies, Geneva); Stefano Ugolini (Scuola Normale Superiore, Pisa) |
| Abstract: | The National Monetary Commission was deeply concerned with importing best practice. One important focus was the connection between the money market and international trade. It was said that Britain’s lead in the market for “acceptances” originating in international trade was the basis of its sterling predominance. In this article, we use a so-far unexplored source to document the portfolio of bills that was brought up to the Bank of England for discount and study the behavior of the Bank of England during the crisis of 1866 (the so-called Overend-Gurney panic) when the Bank began adopting lending of last resort policies (Bignon, Flandreau and Ugolini 2011). We compare 1865 (a “normal” year) to 1866. Important findings include: (a) the statistical predominance of foreign bills in the material brought to the Bank of England; (b) the correlation between the geography of bills and British trade patterns; (c) a marked contrast between normal times lending and crisis lending in that main financial intermediaries and the “shadow banking system” only showed up at the Bank’s window during crises; (d) the importance of money market investors (bills brokers) as chief conduit of liquidity provision in crisis; (e) the importance of Bank of England’s supervisory policies in ensuring lending-of-last-resort operations without enhancing moral hazard. An implication of our findings is that Bank of England’s ability to control moral hazard for financial intermediaries involved in acceptances was another reason for the rise of sterling as an international currency. |
| Keywords: | Financial crises, lending of last resort, history of monetary policy, shadow banking system, banking supervision. |
| JEL: | E42 E58 N13 |
| Date: | 2011–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2011_03&r=cba |
| By: | L. Randall Wray |
| Abstract: | The world's worst economic crisis since the 1930s is now well into its third year. All sorts of explanations have been proffered for the causes of the crisis, from lax regulation and oversight to excessive global liquidity. Unfortunately, these narratives do not take into account the systemic nature of the global crisis. This is why so many observers are misled into pronouncing that recovery is on the way-or even under way already. I believe they are incorrect. We are, perhaps, in round three of a nine-round bout. It is still conceivable that Minsky's "it"-a full-fledged debt deflation with failure of most of the largest financial institutions-could happen again. Indeed, Minsky's work has enjoyed unprecedented interest, with many calling this a "Minsky moment" or "Minsky crisis." However, most of those who channel Minsky locate the beginnings of the crisis in the 2000s. I argue that we should not view this as a "moment" that can be traced to recent developments. Rather, as Minsky argued for nearly 50 years, we have seen a slow realignment of the global financial system toward "money manager capitalism." Minsky's analysis correctly links postwar developments with the prewar "finance capitalism" analyzed by Rudolf Hilferding, Thorstein Veblen, and John Maynard Keynes-and later by John Kenneth Galbraith. In an important sense, over the past quarter century we created conditions similar to those that existed in the run-up to the Great Depression, with a similar outcome. Getting out of this mess will require radical policy changes no less significant than those adopted in the New Deal. |
| Keywords: | Hyman Minsky; Hilferding; Veblen; Keynes; John Kenneth Galbraith; Financial Crisis; Minsky Crisis; Minsky Moment; Finance Capitalism; Money Manager Capitalism; Debt Deflation; Can It Happen Again? |
| JEL: | B22 B25 B52 E11 E12 E44 G18 G20 G21 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:lev:wrkpap:wp_661&r=cba |
| By: | Bank, Alexander |
| Abstract: | This paper analyses the effects of discretionary fiscal policy by presenting new empirical evidence for Germany within a structural vector autoregression (SVAR) framework. Following Blanchard and Perotti (2002), the SVAR model is identified by applying institutional information. We find no compelling evidence for the effectiveness of discretionary fiscal policy. Cutting taxes does not tend to stabilise the business cycle. Increasing government expenditure has an ambiguous effect on GDP for the basic specification. However, by controlling for the influence of inflation, higher government expenditure does not either tend to stabilise economic activity. The results are robust to various modifications. |
| Keywords: | Discretionary fiscal policy, Germany, structural vector autoregression |
| JEL: | C32 E62 H30 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:han:dpaper:dp-470&r=cba |
| By: | Kitov, Oleg; Kitov, Ivan |
| Abstract: | The Lucas critique has exposed the problem of the trade-off between changes in monetary policy and structural breaks in economic time series. The search for and characterisation of such breaks has been a major econometric task ever since. We have developed an integral technique similar to CUSUM using an empirical model quantitatively linking the rate of inflation and unemployment to the change in the level of labour force in Canada. Inherently, our model belongs to the class of Phillips curve models, and the link between the involved variables is a linear one with all coefficients of individual and generalized models obtained by empirical calibration. To achieve the best LSQ fit between measured and predicted time series cumulative curves are used as a simplified version of the 1-D boundary elements (integral) method. The distance between the cumulative curves (in L2 metrics) is very sensitive to structural breaks since it accumulates true differences and suppresses uncorrelated noise and systematic errors. Our previous model of inflation and unemployment in Canada is enhanced by the introduction of structural breaks and is validated by new data in the past and future. The most exiting finding is that the introduction of inflation targeting as a new monetary policy in 1991 resulted in a structural break manifested in a lowered rate of price inflation accompanied by a substantial fall in the rate of unemployment. Therefore, the new monetary policy in Canada is a win-win one. |
| Keywords: | structural break; inflation; unemployment; labour force; modelling; Canada; monetary policy |
| JEL: | E31 J21 E61 |
| Date: | 2011–03–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:29975&r=cba |
| By: | Oleg Kitov; Ivan Kitov |
| Abstract: | The Lucas critique has exposed the problem of the trade-off between changes in monetary policy and structural breaks in economic time series. The search for and characterisation of such breaks has been a major econometric task ever since. We have developed an integral technique similar to CUSUM using an empirical model quantitatively linking the rate of inflation and unemployment to the change in the level of labour force in Canada. Inherently, our model belongs to the class of Phillips curve models, and the link between the involved variables is a linear one with all coefficients of individual and generalized models obtained by empirical calibration. To achieve the best LSQ fit between measured and predicted time series cumulative curves are used as a simplified version of the 1-D boundary elements (integral) method. The distance between the cumulative curves (in L2 metrics) is very sensitive to structural breaks since it accumulates true differences and suppresses uncorrelated noise and systematic errors. Our previous model of inflation and unemployment in Canada is enhanced by the introduction of structural breaks and is validated by new data in the past and future. The most exiting finding is that the introduction of inflation targeting as a new monetary policy in 1991 resulted in a structural break manifested in a lowered rate of price inflation accompanied by a substantial fall in the rate of unemployment. Therefore, the new monetary policy in Canada is a win-win one. |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1103.5994&r=cba |
| By: | Sébastien Kraenzlin; Thomas Nellen |
| Abstract: | Based on real-time trade data from the Swiss franc overnight interbank repo market and SIX Interbank Clearing (SIC) - the Swiss real-time gross settlement (RTGS) system - we are able to gain valuable insights on the daytime value of money and its determinants: First, an implicit hourly interbank interest rate can be derived from the intraday term structure of the overnight rate. We thereby provide evidence that an implicit intraday money market exists. Second, we show that after the introduction of the foreign exchange settlement system CLS the value of intraday liquidity has increased during the hours of the CLS settlement cycle. Third, the turnover as well as the liquidity in SIC influence the intraday rate correspondingly. These facts provide evidence for the cost of immediacy. Features like RTGS, delivery-versus-payment and payment-versus-payment substitute credit risk with liquidity risk which in turn increases the value of intraday liquidity. The analysis is central bank policy relevant insofar as different designs of intraday liquidity facilities and different collateral policies result in different intraday term structures for the overnight money market. |
| Keywords: | interbank money market, intraday credit, term structure |
| JEL: | E58 G21 G28 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:snb:snbwpa:2010-06&r=cba |
| By: | Basil Guggenheim; Sébastien Philippe Kraenzlin; Silvio Schumacher |
| Abstract: | To date, various central banks have lacked detailed statistical evidence on developments in the unsecured interbank money market. Furfine (1999) introduced the idea of calculating unsecured overnight interbank lending by using data of a RTGS system. Based on data from the Swiss payment system (SIC) we developed an algorithm to identify unsecured interbank loans in Swiss francs. In contrast to Furfine (1999) we also identify longer-term transactions. We thereby gain a deeper insight on the size and structure of the unsecured interbank money market in Swiss francs. This is the first time that SIC data have been used to identify transactions and market rates in the unsecured Swiss franc money market. Overall, the estimates show that after the collapse of Lehman Brothers loss of confidence led to a freezing-up of the market for several months and a decrease in daily turnover. |
| Keywords: | unsecured interbank money market, development,money market turmoil, financial stability, Switzerland |
| JEL: | E40 E42 E44 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:snb:snbwpa:2011-05&r=cba |
| By: | Philipp Maier |
| Abstract: | We evaluate different approaches for using monthly indicators to predict Chinese GDP for the current and the next quarter (‘nowcasts’ and ‘forecasts’, respectively). We use three types of mixed-frequency models, one based on an economic activity indicator (Liu et al., 2007), one based on averaging over indicator models (Stock and Watson, 2004), and a static factor model (Stock and Watson, 2002). Evaluating all models’ out-of-sample projections, we find that all the approaches can yield considerable improvements over naïve AR benchmarks. We also analyze pooling across forecasting methodologies. We find that the most accurate nowcast is given by a combination of a factor model and an indicator model. The most accurate forecast is given by a factor model. Overall, we conclude that these models, or combinations of these models, can yield improvements in terms of RMSE’s of up to 60 per cent over simple AR benchmarks. |
| Keywords: | Econometric and statistical methods; International topics |
| JEL: | C50 C53 E37 E47 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:11-11&r=cba |