nep-cba New Economics Papers
on Central Banking
Issue of 2011‒06‒11
47 papers chosen by
Alexander Mihailov
University of Reading

  1. Theoretical notes on bubbles and the current crisis By Alberto Martin; Jaume Ventura
  2. Stock Prices and Monetary Policy Shocks: A General Equilibrium Approach By Challe, Edouard; Giannitsarou, Chryssi
  3. Financial Crises and Macro-Prudential Policies By Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
  4. Macroprudential Approach to Regulation-Scope and Issues By Gopinath, Shyamala
  5. Dissent in Monetary Policy Decisions By Alessandro Riboni; Francisco J. Ruge-Murcia
  6. Modeling Exchange Rates with Incomplete Information By Philippe Bacchetta; Eric van Wincoop
  7. Estimates of Fundamental Equilibrium Exchange Rates, May 2011 By William R. Cline; John Williamson
  8. Forecasting Financial Stress By Jan Willem Slingenberg; Jakob de Haan
  9. Potential Output in DSGE Models By Igor Vetlov; Tibor Hlédik; Magnus Jonsson; Henrik Kucsera; Massimiliano Pisani
  10. Predicting Severe Simultaneous Recessions Using Yield Spreads as Leading Indicators By Charlotte Christiansen
  11. Banks, Market Organization, and Macroeconomic Performance: An Agent-Based Computational Analysis By Quamrul Ashraf; Boris Gershman; Peter Howitt
  12. Banks, Market Organization, and Macroeconomic Performance: An Agent-Based Computational Analysis By Quamrul Ashraf; Boris Gershman; Peter Howitt
  13. Credit Conditions and the Real Economy: The Elephant in the Room By Muellbauer, John; Williams, David M
  14. The Dynamics of UK and US Inflation Expectations* By Deborah Gefang; Gary Koop; Simon Potter
  15. Inflation Perception and Anticipation Gaps in the Eurozone By Svatopluk Kapounek; Lubor Lacina
  16. Forecasting In?ation Using Dynamic Model Averaging* By Gary Koop; Dimitris Korobilis
  17. UK Macroeconomic Forecasting with Many Predictors: Which Models Forecast Best and When Do They Do So?* By Gary Koop; Dimitris Korobilis
  18. Bank Bailouts, International Linkages and Cooperation By Friederike Niepmann; Tim Schmidt-Eisenlohr
  19. Understanding Liquidity and Credit Risks in the Financial Crisis* By Deborah Gefang; Gary Koop; Simon Potter
  20. Banks’ responses to funding liquidity shocks: lending adjustment, liquidity hoarding and fire sales By Leo de Haan; Jan Willem van den End
  21. The great moderation under the microscope: decomposition of macroeconomic cycles in US and UK aggregate demand By Crowley , Patrick M; Hughes Hallett, Andrew
  22. Monetary Policy Delegation and Transparency of Policy Targets: A Positive Analysis By Hielscher, Kai
  23. Is there a trade-off between inflation and output stabilization? By Justiniano, Alejandro; Primiceri, Giorgio E; Tambalotti, Andrea
  24. Public versus Private Information By Maria Demertzis
  25. Limited asset market participation: does it really matter for monetary policy? By Ascari, Guido; Colciago , Andrea; Rossi, Lorenza
  26. Evaluating microfoundations for aggregate price rigidities: evidence from matched firm-level data on product prices and unit labor cost By Carlsson, Mikael; Nordström Skans, Oskar
  27. Estimating Phillips Curves in Turbulent Times using the ECBs Survey of Professional Forecasters* By Gary Koop; Luca Onorante
  28. The effect of inflation on real commodity prices By Dennis Wesselbaum
  29. Improving Real-time Estimates of Output Gaps and Inflation Trends with Multiple-vintage Models By Michael P. Clements; Ana Beatriz Galvão
  30. Forecasting the intraday market price of money By Andrea Monticini; Francesco Ravazzolo
  31. Forecasting with Medium and Large Bayesian VARs By Gary Koop
  32. A comparison of Forecasting Procedures for Macroeconomic Series: The Contribution of Structural Break Models By Luc Bauwens; Gary Koop; Dimitris Korobilis; Jeroen Rombouts
  33. On Identification of Bayesian DSGE Models* By Gary Koop; M. Hashem Pesaran; Ron Smith
  34. Joint estimates of automatic and discretionary fiscal policy for the OECD By Julia Darby; Jacques Melitz
  35. News Shocks or Correlated Sunspots? An Observational Equivalence Result in Linear Rational Expectations Model By Marco M. Sorge
  36. Hyperbolic Discounting and Positive Optimal Inflation By Graham, Liam; Snower, Dennis J.
  37. Forecasting the Price of Oil By Alquist, Ron; Kilian, Lutz; Vigfusson, Robert J.
  38. Real-Time Forecasts of the Real Price of Oil By Baumeister, Christiane; Kilian, Lutz
  39. Inference on Impulse Response Functions in Structural VAR Models By Inoue, Atsushi; Kilian, Lutz
  40. System-wide liquidity risk in the United Kingdom’s large-value payment system: an empirical analysis By Perlin, Marcelo; Schanz, Jochen
  41. Rent-Seeking Origins of Central Banks: The Case of the Federal Reserve System By Tomáš Otáhal
  42. A Time-varying Indicator of Effective Monetary Policy Conservatism By Berlemann, Michael; Hielscher, Kai
  43. Macro-econometric Models and the Outline of the MEAD-RIETI Model (Japanese) By FUKUYAMA Mitsuhiro; OIKAWA Keita; YOSHIHARA Masayoshi; NAKAZONO Yoshiyuki
  44. Canadian Monetary Policy and Real and Nominal Exchange Rates By John Earl Floyd
  45. Lack of Credibility, Inflation Persistence and Disinflation in Colombia By Andrés González G.; Franz Hamann
  46. Determinants of the Dinar-Euro Nominal Exchange Rate By Milan Nedeljkovic; Branko Urosevic
  47. Dynamic Effects of Monetary Policy Shocks in Malawi By Harold Ngalawa; Nicola Viegi

  1. By: Alberto Martin (CREI and Universitat Pompeu Fabra, Ramon Trias Fargas 25-27, 08005-Barcelona, Spain.); Jaume Ventura (CREI and Universitat Pompeu Fabra, Ramon Trias Fargas 25-27, 08005-Barcelona, Spain.)
    Abstract: We explore a view of the crisis as a shock to investor sentiment that led to the collapse of a bubble or pyramid scheme in financial markets. We embed this view in a standard model of the financial accelerator and explore its empirical and policy implications. In particular, we show how the model can account for: (i) a gradual and protracted expansionary phase followed by a sudden and sharp recession; (ii) the connection (or lack of connection!) between financial and real economic activity and; (iii) a fast and strong transmission of shocks across countries. We also use the model to explore the role of fiscal policy. JEL Classification: E32, E44, G01, O40.
    Keywords: bubbles, financial accelerator, credit constraints, financial crisis, pyramid schemes.
    Date: 2011–06
  2. By: Challe, Edouard; Giannitsarou, Chryssi
    Abstract: Recent empirical literature documents that unexpected changes in the nominal interest rates have a significant effect on stock prices: a 25-basis point increase in the Fed funds rate is associated with an immediate decrease in broad stock indices that may range from 0.5 to 2.3 percent, followed by a gradual decay as stock prices revert towards their long-run expected value. In this paper, we assess the ability of a general equilibrium New Keynesian asset-pricing model to account for these facts. The model we consider allows for staggered price and wage setting, as well as time-varying risk aversion through habit formation. We find that the model predicts a stock market response to policy shocks that matches empirical estimates, both qualitatively and quantitatively. Our findings are robust to a range of variations and parameterizations of the model.
    Keywords: Asset prices; Monetary policy; New Keynesian general equilibrium model
    JEL: E31 E52 G12
    Date: 2011–05
  3. By: Gianluca Benigno; Huigang Chen; Christopher Otrok; Alessandro Rebucci; Eric R. Young
    Abstract: Stochastic general equilibrium models of small open economies with occasionally binding financial frictions are capable of mimicking both the business cycles and the crisis events associated with the sudden stop in access to credit markets (Mendoza, 2010). In this paper we study the inefficiencies associated with borrowing decisions in a two-sector small open production economy. We find that this economy is much more likely to display "under-borrowing" rather than "over-borrowing" in normal times. As a result, macro-prudential policies (i.e. Tobin taxes or economy-wide controls on capital inflows) are costly in welfare terms in our economy. Moreover, we show that macro-prudential policies aimed at minimizing the probability of the crisis event might be welfare-reducing in production economies. Our analysis shows that there is a much larger scope for welfare gains from policy interventions during financial crises. That is to say that, within our modeling approach, ex post or crisis-management policies dominate ex ante or macro-prudential ones.
    Keywords: Capital controls, crises, financial frictions, macro prudential policies, bailouts,overborrowing
    JEL: E52 F37 F41
    Date: 2010–12
  4. By: Gopinath, Shyamala (Asian Development Bank Institute)
    Abstract: This paper provides an overview of the Reserve Bank of India's approach to macroprudential regulation and systemic risk management, and reviews lessons drawn from the Indian experience. It emphasizes the need for harmonization of monetary policy and prudential objectives, which may not be possible if banking supervision is separated from central banks. It also notes that supervisors need to have the necessary independence and flexibility to act in a timely manner on the basis of available information. Macroprudential regulation is an inexact science with limitations and needs to be used in conjunction with other policies to be effective.
    Keywords: macroprudential regulation; systemic risk management; monetary policy; banking supervision; central banks
    JEL: E52 E58 G28
    Date: 2011–06–06
  5. By: Alessandro Riboni (Department of Economics, University of Montreal); Francisco J. Ruge-Murcia (Department of Economics, University of Montreal and Rimini Centre for Economic Analysis (RCEA))
    Abstract: Voting records indicate that dissents in monetary policy committees are frequent and predictability regressions show that they help forecast future policy decisions. In order to study whether the latter relation is causal, we construct a model of committee decision making and dissent where members' decisions are not a function of past dissents. The model is estimated using voting data from the Bank of England and the Riksbank. Stochastic simulations show that the decision-making frictions in our model help account for the predictive power of current dissents. The eect of institutional characteristics and structural parameters on dissent rates is examined using simulations as well.
    Keywords: Committees, voting models, political economy of central banking
    JEL: D7 E5
    Date: 2011–05
  6. By: Philippe Bacchetta; Eric van Wincoop
    Abstract: Recent research has shown that relaxing the assumptions of complete information and common knowledge in exchange rate models can shed light on a wide range of important exchange rate puzzles. In this chapter, we review a number of models we have developed in previous work that relax the strong assumptions on information. We also review some related literature.
    Keywords: information heterogeneity; learning; infrequent decisions
    JEL: F31 F37 F47
    Date: 2011–05
  7. By: William R. Cline (Peterson Institute for International Economics); John Williamson (Peterson Institute for International Economics)
    Abstract: This policy brief updates Cline and Williamson's estimates of fundamental equilibrium exchange rates (FEERs) to April 2011. Most currencies appear to have been reasonably close to their FEERs in April 2011. The most important exceptions are China, on the weak side, and the United States, on the strong side. The countries that need to seek weaker effective rates are those with large current account deficits: Australia and New Zealand, South Africa, Turkey, (marginally) Poland and Hungary, and the United States and Brazil. These are countries with floating exchange rates that have been pushed to an overvalued level by (in most cases) capital mobility and the carry trade, reinforced in the case of the United States by the dollar's role as the currency to which many other countries peg combined with the decision of some other countries to peg their rates at an undervalued level. The countries that need to revalue their effective rates are primarily Asian: China and countries that make it a priority to avoid losing competitiveness versus China (Hong Kong, Malaysia, Singapore, and Taiwan). The authors' calculations show the need for a slightly larger effective revaluation of the Chinese currency, the renminbi, this year (17.6 percent) than last (15.3 percent) and a larger appreciation of the renminbi in terms of the dollar (28.5 percent rather than 24.2 percent).
    Date: 2011–05
  8. By: Jan Willem Slingenberg; Jakob de Haan
    Abstract: This paper uses a Financial Stress Index (FSI) for 13 OECD countries to examine which variables can help predicting financial stress. A stress index measures the current state of stress in the financial system and summarizes it in a single statistic. We employ three criteria for indicators to be used in constructing a multi-country FSI (the index covers the entire financial system, indicators used are available at a high frequency for many countries for a long period, and are comparable) to come up with our FSI. Our results suggest that financial stress is hard to predict. Only credit growth has predictive power for most countries. Several other variables have predictive power for some countries, but not for others.
    Keywords: financial stress index; predicting financial stress
    JEL: E5 G10
    Date: 2011–04
  9. By: Igor Vetlov (Bank of Lithuania); Tibor Hlédik (Czech National Bank); Magnus Jonsson (Sveriges Riksbank); Henrik Kucsera (Magyar Nemzeti Bank); Massimiliano Pisani (Banca d'Italia)
    Abstract: In view of the increasing use of Dynamic Stochastic General Equilibrium (DSGE) models in the macroeconomic projections and the policy process, this paper examines, both conceptually and empirically, alternative notions of potential output within DSGE models. Furthermore, it provides historical estimates of potential output/output gaps on the basis of selected DSGE models developed by the European System of Central Banks’ staff. These estimates are compared to the corresponding estimates obtained applying more traditional methods. Finally, the paper assesses the usefulness of the DSGE model-based output gaps for gauging inflationary pressures.
    Keywords: potential output, simulation and forecasting models, monetary policy
    JEL: E32 E37 E52
    Date: 2011–06–03
  10. By: Charlotte Christiansen (Aarhus University, Business and Social Sciences and CREATES)
    Abstract: Severe simultaneous recessions are de?ned to occur when at least half of the countries under investigation (Australia, Canada, Germany, Japan, United Kingdom, and United States) are in recession simultaneously. I pose two new research questions that extend upon stylized facts for US recessions. One, are the occurrences of simultaneous recessions predictable? Two, does the yield spread predict future occurrences of simultaneous recessions? I use the indicator for severe simultaneous recessions as the explained variable in probit models. The lagged yield spread is an important explanatory variable, where decreasing yield spreads are a leading indicator for severe simultaneous recessions.
    Keywords: Business cycle, Recessions, Yield spread, Probit model
    JEL: C25 E32 E43 G15
    Date: 2011–05–31
  11. By: Quamrul Ashraf; Boris Gershman; Peter Howitt
    Abstract: This paper is an exploratory analysis of the role that banks play in supporting the mechanism of exchange. It considers a model economy in which exchange activities are facilitated and coordinated by a self-organizing network of entrepreneurial trading firms. Collectively, these firms play the part of the Walrasian auctioneer, matching buyers with sellers and helping the economy to approximate equilibrium prices that no individual is able to calculate. Banks affect macroeconomic performance in this economy because their lending activities facilitate entry of trading firms and also influence their exit decisions. Both entry and exit have conflicting effects on performance, and we resort to computational analysis to understand how they are resolved. Our analysis sheds new light on the conflict between micro-prudential bank regulation and macroeconomic stability. Specifically, it draws an important distinction between "normal" performance of the economy and "worst-case" scenarios, and shows that micro prudence conflicts with macro stability only in bad times. The analysis also shows that banks provide a "financial stabilizer" that in some respects can more than counteract the more familiar financial accelerator.
    JEL: C63 E0 E44 G20 G28
    Date: 2011–06
  12. By: Quamrul Ashraf (Williams College); Boris Gershman (Brown University); Peter Howitt (Brown University)
    Abstract: This paper is an exploratory analysis of the role that banks play in supporting what Jevons called the mechanism of exchange. It considers a model economy in which exchange activities are facilitated and coordinated by a self-organizing network of entrepreneurial trading firms. Collectively, these firms play the part of the Walrasian auctioneer, matching buyers with sellers and helping the economy to approximate equilibrium prices that no individual is able to calculate. Banks affect macroeconomic performance in this economy because their lending activities facilitate entry of trading firms and also influence their exit decisions. Both entry and exit have conflicting effects on performance, and we resort to computational analysis to understand how they are resolved. Our analysis sheds new light on the conflict between micro-prudential bank regulation and macroeconomic stability. Specifically, it draws an important difference between "normal" performance of the economy and "worst-case" scenarios, and shows that micro prudence conflicts with macro stability only in bad times. The analysis also shows that banks provide a "financial stabilizer" that in some respects can more than counteract the more familiar financial accelerator.
    Keywords: Agent-based computational model, Market organization, Bank regulation, Macroeconomic stability, Financial stabilizer
    JEL: C63 E00 E63 G20 G28
    Date: 2011–05
  13. By: Muellbauer, John; Williams, David M
    Abstract: Changes in credit market architecture are an important but unobservable structural influence on economic activity. For Australian data, we model non-price credit supply conditions within equilibrium correction models of consumption, house prices, mortgage credit and housing equity withdrawal. Our "latent interactive variable equation system" (LIVES) employs a single latent variable to capture evolutionary shifts (in credit conditions) that affect not only the intercept of each equation, but also interact with key economic variables. We show that credit conditions impact on consumption by: (i) lowering the mortgage downpayment constraint facing young households; (ii) introducing a housing collateral channel from house prices to real activity; and (iii) facilitating intertemporal consumption smoothing.
    Keywords: Consumption; credit conditions; house prices; wealth
    JEL: E21 E44 G21 R31
    Date: 2011–05
  14. By: Deborah Gefang (Department of Economics, University of Lan~~#badcaster); Gary Koop (Department of Economics, University of Strathclyde); Simon Potter (Research and Statistics Group, Federal Reserve Bank of New York)
    Abstract: This paper investigates the relationship between short term and long term inflation expectations in the US and the UK with a focus on inflation pass through (i.e. how changes in short term expectations affect long term expectations). An econometric methodology is used which allows us to uncover the relationship between in?ation pass through and various explanatory variables. We relate our empirical results to theoretical models of anchored, contained and unmoored inflation expectations. For neither country do we find anchored or unmoored inflation expectations. For the US, contained inflation expectations are found. For the UK, our findings are not consistent with the specific model of contained in?ation expectations presented here, but are consistent with a more broad view of expectations being constrained by the existence of an inflation target.
    Keywords: smoothly mixing regression, inflation pass through, Bayesian
    JEL: C11 C24 E37
    Date: 2011–04
  15. By: Svatopluk Kapounek (Department of Finance, FBE MENDELU in Brno); Lubor Lacina (Department of Finance, FBE MENDELU in Brno)
    Abstract: There is significant empirical evidence that the introduction of the euro led to a significant increase of perceived inflation in most countries. Such an increase and persistence in the perceived inflation might then have an impact on inflation expectations and other macroeconomic variables. The authors have used the short-term Phillips curve to describe the difference between inflation expectations and its current values, subsequently to identify the impact of this difference on other economic indicators. The paper is structured as follows: Section 1 provides an overview of the theory and empiricism on the gap between measured and perceived inflation. Section 2 then builds up the theoretical framework based on the short–term Phillips curve approach and derives two hypotheses, to be tested subsequently. Section 3 provides the methodology. Section 4 presents the modelling and results of the empirical analysis. In section 5 authors compare its results and used methodology with papers and studies on a similar topic. Finally, Section 6 concludes and provides recommendations for the economic policy.
    Keywords: monetary integration, perceived and anticipated inflation, adaptive and rational expectations hypothesis, expectations-augmented Phillips curve, stationarity, ADF test
    JEL: E42
    Date: 2011–04
  16. By: Gary Koop (Department of Economics, University of Strathclyde); Dimitris Korobilis (Center for Operations Research & Econometrics (CORE), Universite Catholique de Louvain)
    Abstract: We forecast quarterly US inflation based on the generalized Phillips curve using econometric methods which incorporate dynamic model averaging. These methods not only allow for coe¢ cients to change over time, but also allow for the entire forecasting model to change over time. We find that dynamic model averaging leads to substantial forecasting improvements over simple benchmark regressions and more sophisticated approaches such as those using time varying coefficient models. We also provide evidence on which sets of predictors are relevant for forecasting in each period.
    Keywords: Bayesian, State space model, Phillips curve
    JEL: E31 E37 C11 C53
    Date: 2011–04
  17. By: Gary Koop (Department of Economics, University of Strathclyde); Dimitris Korobilis (Center for Operations Research & Econometrics (CORE), Universite Catholique de Louvain)
    Abstract: Block factor methods offer an attractive approach to forecasting with many predictors. These extract the information in these predictors into factors reflecting different blocks of variables (e.g. a price block, a housing block, a financial block, etc.). However, a forecasting model which simply includes all blocks as predictors risks being over-parameterized. Thus, it is desirable to use a methodology which allows for different parsimonious forecasting models to hold at di¤erent points in time. In this paper, we use dynamic model averaging and dynamic model selection to achieve this goal. These methods automatically alter the weights attached to different forecasting model as evidence comes in about which has forecast well in the recent past. In an empirical study involving forecasting output and inflation using 139 UK monthly time series variables, we find that the set of predictors changes substantially over time. Furthermore, our results show that dynamic model averaging and model selection can greatly improve forecast performance relative to traditional forecasting methods.
    Keywords: Bayesian, state space model, factor model, dynamic model averaging
    JEL: E31 E37 C11 C53
    Date: 2011–04
  18. By: Friederike Niepmann; Tim Schmidt-Eisenlohr
    Abstract: Financial institutions are increasingly linked internationally. As a result, financial crisis and government intervention have stronger effects beyond borders. We provide a model of international contagion allowing for bank bailouts. While a social planner trades off tax distortions, liquidation losses and intra- and intercountry income inequality, in the noncooperative game between governments there are inefficiencies due to externalities, no burden sharing and free-riding. We show that, in absence of cooperation, stronger interbank linkages make government interests diverge, whereas cross-border asset holdings tend to align them. We analyze different forms of cooperation and their effects on global and national welfare.
    Keywords: Portfolio choice, international transmission of shocks, monetary policy
    JEL: F31 F41
    Date: 2010–11
  19. By: Deborah Gefang (Department of Economics, University of Lan~~#badcaster); Gary Koop (Department of Economics, University of Strathclyde); Simon Potter (Research and Statistics Group, Federal Reserve Bank of New York)
    Abstract: This paper develops a structured dynamic factor model for the spreads between London Interbank O¤ered Rate (LIBOR) and overnight index swap (OIS) rates for a panel of banks. Our model involves latent factors which relect liquidity and credit risk. Our empirical results show that surges in the short term LIBOR-OIS spreads during the 2007-2009 financial crisis were largely driven by liquidity risk. However, credit risk played a more significant role in the longer term (twelve-month) LIBOR-OIS spread. The liquidity risk factors are more volatile than the credit risk factor. Most of the familiar events in the financial crisis are linked more to movements in liquidity risk than credit risk.
    Keywords: LIBOR-OIS spread, factor model, credit default swap, Bayesian
    JEL: C11 C22 G21
    Date: 2011–04
  20. By: Leo de Haan; Jan Willem van den End
    Abstract: The crisis of 2007-2009 has shown that financial market turbulence can lead to huge funding liquidity problems for banks. This paper provides empirical evidence on banks’ responses to wholesale funding shocks, using data of seventeen of the largest Dutch banks over the period January 2004 to April 2010. The dynamic interrelations among instruments of bank liquidity management are modelled in a panel Vector Autoregressive (p-VAR) framework. Orthogonalized impulse responses reveal that banks respond to a negative funding liquidity shock in a number of ways. First, banks reduce lending, especially wholesale lending. Second, banks hoard liquidity in the form of liquid bonds and central bank reserves. Third, banks conduct fire sales of securities, especially equity. We also find that fire sales are triggered by liquidity constraints rather than by solvency constraints.
    Keywords: Banks; Funding; Liquidity; Banking crisis
    JEL: G21 G32
    Date: 2011–04
  21. By: Crowley , Patrick M (College of Business, Texas A&M University); Hughes Hallett, Andrew (George Mason University – School of Public Policy)
    Abstract: In this paper the relationship between the growth of real GDP components is explored in the frequency domain using both static and dynamic wavelet analysis. This analysis is carried out separately for the US and UK using quarterly data, and the results are found to be substantially different for the two countries. One of the key findings of this research is that the ‘great moderation’ shows up only at certain frequencies, and not in all components of real GDP. We use these results to explain why the incidence of the great moderation has been so patchy across GDP components, countries and time periods. This also explains why it has been so hard to detect periods of moderation (or other periods) reliably in the aggregate data. We argue this cannot be done without separating the GDP components into their frequency components over time. Our results show why: the predictions of traditional real business cycle theory often appear not to be upheld in the data.
    Keywords: business cycles; growth cycles; discrete wavelet analysis; US real GDP; UK real GDP
    JEL: C49 E20 E32
    Date: 2011–05–23
  22. By: Hielscher, Kai (Helmut Schmidt University, Hamburg)
    Abstract: We show that, in a two-stage model of monetary policy with stochastic policy targets and asymmetric information, the transparency regime chosen by the central bank does never coincide with the regime preferred by society. Independent of society’s endogenous choice of delegation, the central bank reveals its inflation target and conceals its output target. In contrast, society would prefer either transparency or opacity of both targets. As a conclusion, the choice of the transparency regime should be part of the optimal delegation solution.
    Keywords: central banking; monetary policy; communication; delegation; positive analysis
    JEL: E52 E58
    Date: 2011–06–01
  23. By: Justiniano, Alejandro; Primiceri, Giorgio E; Tambalotti, Andrea
    Abstract: Not in an estimated DSGE model of the US economy, once we account for the fact that most of the high-frequency volatility in wages appears to be due to noise, rather than to variation in workers' preferences or market power.
    Keywords: optimal policy; output gap; potential output
    JEL: E30 E52
    Date: 2011–06
  24. By: Maria Demertzis
    Abstract: Using the model by Morris and Shin (2002), we distinguish between how people perceive a state and how they act upon it. We show than even for perceptions, where the coordination motive plays no role, improving the quality of public information does not always reduce the forecasting error. The reason why this happens is because better information is always more relevant information. But if improvements in information attract more attention than they deserve, the overall effect may be detrimental to the accuracy of perceptions. Increases in private information quality, on the other hand, are always beneficial to the decisions. Moreover, the assumption of no private information error on average implies that agents would do better collectively if there was no public information signal.
    Keywords: Signal extraction; Public and Private information; Actions vs Perceptions
    JEL: D82 E52 E58
    Date: 2011–04
  25. By: Ascari, Guido (Department of Economics and Quantitative Methods, University of Pavia); Colciago , Andrea (University of Milano-Bicocca. Department of Economics); Rossi, Lorenza (University of Pavia)
    Abstract: We study the design of monetary policy in an economy characterized by staggered wage and price contracts together with limited asset market participation (LAMP). Contrary to previous results, we find that once nominal wage stickiness, an incontrovertible empirical fact, is considered: i) the Taylor Principle is restored as a necessary condition for equilibrium determinacy for any empirically plausible degree of LAMP; ii) the implications of LAMP for the design of optimal monetary policy are minor; iii) optimal interest rate rules become active no matter the degree of asset market participation. For these reasons we argue that LAMP is not particularly important for monetary policy.
    Keywords: optimal monetary policy; sticky wages; non-Ricardian household; determinacy; optimal simple rules
    JEL: E50 E52
    Date: 2011–05–31
  26. By: Carlsson, Mikael (Sveriges Riksbank); Nordström Skans, Oskar (IFAU - Institute for Labour Market Policy Evaluation)
    Abstract: Using data on product-level prices matched to the producing firm's unit labor cost, we reject the hyptothesis of a full and immediate pass-through of marginal cost. Since we focus on idiosyncratic variation, this does not fit the predictions of the Makowiak and Wiederholt (2009) version of the Rational inattention model. Neither do we find that firms react strongly to predictable marginal cost changes, as expected from the Mankiw and Reis (2002) Sticky information model. We find that, in line with Staggered contracts models, firms consider both the current and future expected marginal cost when setting prices with a sum of coefficients not significantly different from unity.
    Keywords: Price setting; business cycles; information; micro data
    JEL: L16
    Date: 2011–04–06
  27. By: Gary Koop (Department of Economics, University of Strathclyde); Luca Onorante (European Central Bank)
    Abstract: This paper uses forecasts from the European Central Bank?s Survey of Professional Forecasters to investigate the relationship between inflation and inflation expectations in the euro area. We use theoretical structures based on the New Keynesian and Neoclassical Phillips curves to inform our empirical work. Given the relatively short data span of the Survey of Professional Forecasters and the need to control for many explanatory variables,we use dynamic model averaging in order to ensure a parsimonious econometric specification. We use both regression-based and VAR-based methods. We find no support for the backward looking behavior embedded in the Neo-classical Phillips curve. Much more support is found for the forward looking behavior of the New Keynesian Phillips curve, but most of this support is found after the beginning of the financial crisis.
    Keywords: inflation expectations, survey of professional forecasters,Phillips curve, Bayesian
    JEL: E31 C53 C11
    Date: 2011–03
  28. By: Dennis Wesselbaum
    Abstract: Recent research has shown that economic conditions have an important effect on real commodity prices. We quantify the contribution of fluctuations in inflation to this particular link. In the data, a temporary rise in inflation causes real commodity prices to rise, as does a rise in trend inflation. We find that a simple dynamic equilibrium model of commodity supply and demand gives a realistic response of real commodity prices to inflation. Based on historical simulations, shocks to inflation played an important role in commodity price dynamics during the 1970s, but they have contributed negligibly to commodity price movements since then
    Keywords: Commodity prices, monetary policy, inflation, the 1970s
    JEL: E31 E52 E65 Q00
    Date: 2011–05
  29. By: Michael P. Clements (University of Warwick); Ana Beatriz Galvão (Queen Mary, University of London)
    Abstract: Real-time estimates of output gaps and inflation trends differ from the values that are obtained using data available long after the event. Part of the problem is that the data on which the real-time estimates are based is subsequently revised. We show that vector-autoregressive models of data vintages provide forecasts of post-revision values of future observations and of already-released observations capable of improving real-time output gap and inflation trend estimates. Our findings indicate that annual revisions to output and inflation data are in part predictable based on their past vintages.
    Keywords: Revisions, Real-time forecasting, Output gap, Inflation trend
    JEL: C53
    Date: 2011–06
  30. By: Andrea Monticini (Universita Cattolica - Milano); Francesco Ravazzolo (Norges Bank (Central Bank of Norway))
    Abstract: Market efficiency hypothesis suggests a zero level for the intraday interest rate. However, a liquidity crisis introduces frictions related to news, which can cause an upward jump of the intraday rate. This paper documents that these dynamics can be partially predicted during turbulent times. A long memory approach outperforms random walk and autoregressive benchmarks in terms of point and density forecasting. The gains are particular high when the full distribution is predicted and probabilistic assessments of future movements of the interest rate derived by the model can be used as a policy tool for central banks to plan supplementary market operations during turbulent times. Adding exogenous variables to proxy funding liquidity and counterparty risks does not improve forecast accuracy and the predictability seems to derive from the econometric properties of the series more than from news available to financial markets in realtime.
    Keywords: Interbank market, Intraday interest rate, Forecasting, Density forecasting, Policy tools.
    JEL: C22 C53 E4 E5
    Date: 2011–06–06
  31. By: Gary Koop (Department of Economics, University of Strathclyde)
    Abstract: This paper is motivated by the recent interest in the use of Bayesian VARs for forecasting, even in cases where the number of dependent variables is large. In such cases, factor methods have been traditionally used but recent work using a particular prior suggests that Bayesian VAR methods can forecast better. In this paper, we consider a range of alternative priors which have been used with small VARs, discuss the issues which arise when they are used with medium and large VARs and examine their forecast performance using a US macroeconomic data set containing 168 variables. We ?nd that Bayesian VARs do tend to forecast better than factor methods and provide an extensive comparison of the strengths and weaknesses of various approaches. Our empirical results show the importance of using forecast metrics which use the entire predictive density, instead of using only point forecasts.
    Keywords: Bayesian, Minnesota prior, stochastic search variable selection, predictive likelihood
    JEL: C11 C32 C53
    Date: 2011–04
  32. By: Luc Bauwens (Université catholique de Louvain); Gary Koop (Department of Economics, University of Strathclyde); Dimitris Korobilis (Universite Catholique de Louvain); Jeroen Rombouts (HEC Montréal (École des Hautes Études Commerciales) (Business School) and Center for Operations Research and Econometrics (CORE) ECORE)
    Abstract: This paper compares the forecasting performance of different models which have been proposed for forecasting in the presence of structural breaks. These models differ in their treatment of the break process, the parameters defining the model which applies in each regime and the out-of-sample probability of a break occurring. In an extensive empirical evaluation involving many important macroeconomic time series, we demonstrate the presence of structural breaks and their importance for forecasting in the vast majority of cases. However, we find no single forecasting model consistently works best in the presence of structural breaks. In many cases, the formal modeling of the break process is important in achieving good forecast performance. However, there are also many cases where simple, rolling OLS forecasts perform well.
    Keywords: Forecasting, change-points, Markov switching, Bayesian inference.
    JEL: C11 C22 C53
    Date: 2011–04
  33. By: Gary Koop (Department of Economics, University of Strathclyde); M. Hashem Pesaran (Faculty of Economics, University of Cambridge); Ron Smith (Department of Economics, Mathematics and Statistics, University of Birkbeck)
    Abstract: In recent years there has been increasing concern about the identification of parameters in dynamic stochastic general equilibrium (DSGE) models. Given the structure of DSGE models it may be di¢ cult to deter- mine whether a parameter is identi?ed. For the researcher using Bayesian methods, a lack of identi?cation may not be evident since the posterior of a parameter of interest may di¤er from its prior even if the parameter is unidentified. We show that this can even be the case even if the priors assumed on the structural parameters are independent. We suggest two Bayesian identification indicators that do not su¤er from this difficulty and are relatively easy to compute. The first applies to DSGE models where the parameters can be partitioned into those that are known to be identified and the rest where it is not known whether they are identi?ed. In such cases the marginal posterior of an unidenti?ed parameter will equal the posterior expectation of the prior for that parameter conditional on the identified parameters. The second indicator is more generally applicable and considers the rate at which the posterior precision gets updated as the sample size (T) is increased. For identi?ed parameters the posterior precision rises with T, whilst for an unidentified parameter its posterior precision may be updated but its rate of update will be slower than T. This result assumes that the identified parameters are pT-consistent, but similar differential rates of updates for identified and unidentified parameters can be established in the case of super consistent estimators. These results are illustrated by means of simple DSGE models.
    Keywords: Bayesian identification, DSGE models, posterior updating, New Keynesian Phillips Curve.
    JEL: C11 C15 E17
    Date: 2011–03
  34. By: Julia Darby (Department of Economics, University of Strathclyde); Jacques Melitz (Department of Economics, School of Management and Languages, Heriot-Watt University, Edinburgh.)
    Abstract: Official calculations of automatic stabilizers are seriously flawed since they rest on the assumption that the only element of social spending that reacts automatically to the cycle is unemployment compensation. This puts into question many estimates of discretionary fiscal policy. In response, we propose a simultaneous estimate of automatic and discretionary fiscal policy. This leads us, quite naturally, to a tripartite decomposition of the budget balance between revenues, social spending and other spending as a bare minimum. Our headline results for a panel of 20 OECD countries in 1981-2003 are .59 automatic stabilization in percentage-points of primary surplus balances. All of this stabilization remains following discretionary responses during contractions, but arguably only about 3/5 of it remains so in expansions while discretionary behavior cancels the rest. We pay a lot of attention to the impact of the Maastricht Treaty and the SGP on the EU members of our sample and to real time data.
    Keywords: Fiscal stabilization, automatic stabilizers, discretionary policy.
    JEL: E62 H53 H62
    Date: 2011–04
  35. By: Marco M. Sorge
    Abstract: This paper studies identification of linear rational expectations models under news shocks. Exploiting the general martingale difference solution approach, we show that news shocks models are observationally equivalent to a class of indeterminate equilibrium frameworks which are subject only, though arbitrarily, to i.i.d. fundamental shocks. The equivalent models are characterized by a lagged expectations structure, which arises typically when choice variables are predetermined or rather based on past information with respect to current observables. This particular feature creates room for serially correlated sunspot variables to arise in equilibrium reduced forms, whose dynamics can be equivalently induced by news shocks processes. This finding, which is inherent to the rational expectations theoretical construct, calls for carefully designing empirical investigations of news shocks in estimated DSGE models.
    Keywords: Rational expectations; News shocks; Indeterminacy; Observational equivalence.
    JEL: C1 E3
    Date: 2011–05–09
  36. By: Graham, Liam; Snower, Dennis J.
    Abstract: The Friedman rule states that steady-state welfare is maximized when there is deflation at the real rate of interest. Recent work by Khan et al. (2003) uses a richer model but still finds deflation optimal. In an otherwise standard new Keynesian model we show that, if households have hyperbolic discounting, small positive rates of inflation can be optimal. In our baseline calibration, the optimal rate of inflation is 2.1% and remains positive across a wide range of calibrations.
    Keywords: inflation targeting; monetary policy; nominal inertia; optimal monetary policy; Phillips curve; unemployment
    JEL: E20 E40 E50
    Date: 2011–05
  37. By: Alquist, Ron; Kilian, Lutz; Vigfusson, Robert J.
    Abstract: We address some of the key questions that arise in forecasting the price of crude oil. What do applied forecasters need to know about the choice of sample period and about the tradeoffs between alternative oil price series and model specifications? Are real or nominal oil prices predictable based on macroeconomic aggregates? Does this predictability translate into gains in out-of-sample forecast accuracy compared with conventional no-change forecasts? How useful are oil futures markets in forecasting the price of oil? How useful are survey forecasts? How does one evaluate the sensitivity of a baseline oil price forecast to alternative assumptions about future demand and supply conditions? How does one quantify risks associated with oil price forecasts? Can joint forecasts of the price of oil and of U.S. real GDP growth be improved upon by allowing for asymmetries?
    Keywords: Asymmetries; Demand and supply; Forecasting; Oil price; Predictability
    JEL: C53 Q43
    Date: 2011–05
  38. By: Baumeister, Christiane; Kilian, Lutz
    Abstract: We construct a monthly real-time data set consisting of vintages for 1991.1-2010.12 that is suitable for generating forecasts of the real price of oil from a variety of models. We document that revisions of the data typically represent news, and we introduce backcasting and nowcasting techniques to fill gaps in the real-time data. We show that real-time forecasts of the real price of oil can be more accurate than the no-change forecast at horizons up to one year. In some cases real-time MSPE reductions may be as high as 25 percent one month ahead and 24 percent three months ahead. This result is in striking contrast to related results in the literature for asset prices. In particular, recursive vector autoregressive (VAR) forecasts based on global oil market variables tend to have lower MSPE at short horizons than forecasts based on oil futures prices, forecasts based on AR and ARMA models, and the no-change forecast. In addition, these VAR models have consistently higher directional accuracy. We demonstrate how with additional identifying assumptions such VAR models may be used not only to understand historical fluctuations in the real price of oil, but to construct conditional forecasts that reflect hypothetical scenarios about future demand and supply conditions in the market for crude oil. These tools are designed to allow forecasters to interpret their oil price forecast in light of economic models and to evaluate its sensitivity to alternative assumptions.
    Keywords: Forecast; Oil price; Real time; Scenario analysis
    JEL: C53 E32 Q43
    Date: 2011–06
  39. By: Inoue, Atsushi; Kilian, Lutz
    Abstract: Skepticism toward traditional identifying assumptions based on exclusion restrictions has led to a surge in the use of structural VAR models in which structural shocks are identified by restricting the sign of the responses of selected macroeconomic aggregates to these shocks. Researchers commonly report the vector of pointwise posterior medians of the impulse responses as a measure of central tendency of the estimated response functions, along with pointwise 68 percent posterior error bands. It can be shown that this approach cannot be used to characterize the central tendency of the structural impulse response functions. We propose an alternative method of summarizing the evidence from sign-identified VAR models designed to enhance their practical usefulness. Our objective is to characterize the most likely admissible model(s) within the set of structural VAR models that satisfy the sign restrictions. We show how the set of most likely structural response functions can be computed from the posterior mode of the joint distribution of admissible models both in the fully identified and in the partially identified case, and we propose a highest-posterior density credible set that characterizes the joint uncertainty about this set. Our approach can also be used to resolve the long-standing problem of how to conduct joint inference on sets of structural impulse response functions in exactly identified VAR models. We illustrate the differences between our approach and the traditional approach for the analysis of the effects of monetary policy shocks and of the effects of oil demand and oil supply shocks.
    Keywords: Credible Set; Impulse responses; Median; Mode; Sign restrictions; Simultaneous inference; Vector autoregression
    JEL: C32 C52 E37 Q43
    Date: 2011–06
  40. By: Perlin, Marcelo (Professor Adjunto - Escola de Administração (Federal University of Rio Grande do Sul, Brazil)); Schanz, Jochen (Bank of England)
    Abstract: When settling their own liabilities and those of their clients, settlement banks rely on incoming payments to fund a part of their outgoing payments. We investigate their behaviour in CHAPS, the United Kingdom’s large-value payment system. Our estimates suggest that in normal times, banks increase their payment outflows when their liquidity is above target and immediately following the receipt of payments. We use these estimates to determine the robustness of this payment system to two hypothetical behavioural changes. In the first, a single bank stops sending payments, perhaps because of an operational problem. In the second, it pays out exactly what it previously received, relying exclusively on the liquidity provided by other system members. Using the observed uncertainty around our estimated behavioural equations, we derive probabilistic statements about the time at which the bank’s counterparties would run out of liquidity if they followed their estimated normal-time behaviour.
    Keywords: Payment systems; banks; network models; contagion; systemic risk; liquidity risk
    JEL: G21
    Date: 2011–05–31
  41. By: Tomáš Otáhal (Department of Economics, FBE MENDELU in Brno)
    Abstract: What were the purposes for establishment of central banks? Central banks are historically relatively young organizations. Their main purposes are to regulate money supply through interest rates, regulate the banking sector and act as a lender of last resort to banking sector during the time of financial crises. Historical evidence suggests that in the second half of 19th century in the USA private clearing houses were able to provide the banking sector with similar services. In this paper, we follow such evidence and provide Public Choice explanation for establishment of central banks. On the historical example of establishment of the Federal Reserve System we show that the motivation for establishment of the Federal Reserve System might be rather political instead of economic. More precisely, we argue that the Federal Reserve System was established to allow the American Federal Government to control rent- distribution through money supply control and banking sector regulation.
    Keywords: Federal Reserve System, financial markets institutions, historical example, rent-seeking
    JEL: D72 D73 N21 E42 E58
    Date: 2011–04
  42. By: Berlemann, Michael (Helmut Schmidt University, Hamburg); Hielscher, Kai (Helmut Schmidt University, Hamburg)
    Abstract: Based on an extended version of a time-inconsistency model of monetary policy we show that the degree of effective monetary policy conservatism can be uncovered by studying to what extent central banks react to real disturbances. By estimating central bank reaction functions in moving and overlapping intervals for the period of 1985 to 2007 using an ordered logit approach in a panel setting we derive a time-varying indicator of effective monetary policy conservatism for Canada, Sweden, the UK and the US. Employing this indicator we show that increasing effective conservatism tends to lower inflation without increasing the output gap. However, while a higher degree of effective conservatism does not result in lower inflation uncertainty the variance of the output gap tends to decrease.
    Keywords: central banking; monetary policy; conservatism; central bank independence; inflation
    JEL: E31 E58
    Date: 2011–06–01
  43. By: FUKUYAMA Mitsuhiro; OIKAWA Keita; YOSHIHARA Masayoshi; NAKAZONO Yoshiyuki
    Abstract: The global financial crisis, triggered by the subprime mortgage problem and resulting in the collapse of a major American investment bank in September 2008, has seriously affected the Japanese economy. The Japanese government has instigated certain policies in response to the global economic recession and volatility in financial markets. In formulating policies, it has become increasingly necessary to forecast different economic scenarios by taking into account the possible impact of policies and risks, including contributing factors from abroad. Using macro-econometric models is one way to respond to this. In recent years, the governments, central banks and international organizations of many nations have placed more emphasis on aligning their macro-econometric models with macroeconomic theory, in order to better respond with the "Lucas Critique." This paper will attempt to achieve two things: 1) to illustrate the macro-econometric models of foreign countries and Japan and the macroeconomic theory behind those models, and 2) to explain the "MEAD-RIETI Model" (MRM) which we have constructed. While the aim of the MRM is to evaluate quantitatively the risks and impacts of policy decisions, it is a hybrid model which attaches a high degree of importance to how it fits with empirical data considering the consistency of the model with macroeconomic theory. Although MRM comprehensively covers SNA and other key economic variables, MRM prefers simplicity over complexity with regards to model specification and avoids the use of too many variables.
    Date: 2010–07
  44. By: John Earl Floyd
    Abstract: This paper analyzes the relationship between Canadian Monetary Policy and the movements of Canada\'s real and nominal exchange rates with respect to the U.S. A broad-based theory is developed to form the basis for subsequent empirical analysis. The main empirical result is that the Canadian real exchange rate has been determined in large part by capital movements into and out of Canada as compared to the U.S. and world energy prices. Additional important determinants were world commodity prices and Canadian and U.S. real GDPs and employment rates. No evidence of effects of unanticipated money supply shocks on the nominal and real exchange rates is found. Under conditions where exchange rate overshooting is likely to occur in response to monetary demand or supply shocks, this suggests that the Bank of Canada follows an orderly-markets style of monetary policy and the conclusion is that this is the best approach under normal conditions. Finally, it is shown that in response to a domestic inflation rate that has become permanently too high or a catastrophic situation in the U.S., the Bank of Canada can induce a one-percent short-run change in the unemployment rate by pushing the nominal and real exchange rates in the appropriate direction by between five and six percent.
    Keywords: Real Exchange Rate Canadian Monetary Policy
    JEL: A E F G
    Date: 2011–05–16
  45. By: Andrés González G.; Franz Hamann
    Abstract: This paper measures inflation persistence in Colombia for the period 1990-2010 and estimates the implied speed at which agents learn about the central bank’s inflation target. We estimate Erceg and Levin’s (2003) imperfect credibility model using Bayesian techniques and compare the posterior odds of this model against a conventional Neokeynesian model with ad-hoc price indexation. The odds are strongly in favor of the imperfect credibility model, suggesting that lack of credibility on the inflation target is an important source of inflation persistence. We use the model to compute the sacrifice ratio associated to 100 basis points inflation target shocks and find that it is (0.83%) in line with previous estimates for Colombia. We also find that the speed at which agents learn in the model has increased, albeit marginally, since the central bank implemented its inflation targeting strategy. Although during this period macroeconomic volatility has fallen, inflation persistence has remained roughly constant suggesting that so far, the impact of those credibility gains has been modest.
    Date: 2011–05–26
  46. By: Milan Nedeljkovic (National Bank of Serbia); Branko Urosevic (National Bank of Serbia)
    Abstract: This paper studies drivers of daily dynamics of the nominal dinar-euro exchange rate from September 2006 to June 2010. Using a novel semiparametric approach we are able to incorporate the evidence of nonlinearities under very weak assumptions on the underlying data generating process. We identify several factors influencing daily exchange rate returns whose importance varies over time. In the period preceeding the financial crisis, information in past returns, changes in households’ foreign currency savings and banks' net purchases of foreign currency are the most significant factors. From September 2008 onwards other factors related to changes in country's risk and the information processing in the market gain importance. NBS interventions are found to be effective with a time delay.
    Keywords: Foreign exchange market, Partially linear model, Kernel estimation
    JEL: F31 C14 G18
    Date: 2011–05
  47. By: Harold Ngalawa (School of Economics and Finance, University of KwaZulu-Natal); Nicola Viegi (Department of Economics, University of Pretoria)
    Abstract: This paper sets out to investigate the process through which monetary policy affects economic activity in Malawi. Using innovation accounting in a structural vector autoregressive model, it is established that monetary authorities in Malawi employ hybrid operating procedures and pursue both price stability and high growth and employment objectives. Two operating targets of monetary policy are identified, viz., bank rate and reserve money, and it is demonstrated that the former is a more effective measure of monetary policy than the latter. The study also illustrates that bank lending, exchange rates and aggregate money supply contain important additional information in the transmission process of monetary policy shocks in Malawi. Furthermore, it is shown that the floatation of the Malawi Kwacha in February 1994 had considerable effects on the country’s monetary transmission process. In the post-1994 period, the role of exchange rates became more conspicuous than before although its impact was weakened; and the importance of aggregate money supply and bank lending in transmitting monetary policy impulses was enhanced. Overall, the monetary transmission process evolved from a weak, blurred process to a somewhat strong, less ambiguous mechanism.
    JEL: E52 E58
    Date: 2011–05

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