nep-cba New Economics Papers
on Central Banking
Issue of 2011‒06‒18
forty papers chosen by
Alexander Mihailov
University of Reading

  1. The Real Exchange Rate, Real Interest Rates, and the Risk Premium By Charles Engel
  2. Consumer confidence as a predictor of consumption spending: evidence for the United States and the euro area By Stéphane Dées; Pedro Soares Brinca
  3. A note on bank lending in times of large bank reserves By Antoine Martin; James McAndrews; David Skeie
  4. The coordination value of monetary exchange: Experimental evidence By G. Camera; M. Casari
  5. Monetary Policy and Asset Price Volatility: Should We Refill the Bernanke-Gertler Prescription? By Kenneth Kuttner
  6. Should central banks lean against changes in asset prices? By Sylvain Leduc; Jean-Marc Natal
  8. Sticky Prices vs. Sticky Information – A Cross-Country Study of Inflation Dynamics By Christian Bredemeier; Henry Goecke
  9. Central Bank Forecasts as a Coordination Device By Jan Filacek; Branislav Saxa
  10. Exchange Rate Policy in Small Rich Economies By Francis Breedon; Thórarinn G. Pétursson; Andrew K. Rose
  11. Financial Integration at Times of Financial Instability By Jan Babecky; Lubos Komarek; Zlatuse Komarkova
  12. The optimal width of the central bank standing facilities corridor and banks' day-to-day liquidity management By Ulrich Bindseil; Juliusz Jabłecki
  13. Bank relationships, business cycles, and financial crisis By Galina Hale
  14. Nonlinear Expectations in Speculative Markets - Evidence from the ECB Survey of Professional Forecasters By Stefan Reitz; Jan-Christoph Rülke; Georg Stadtmann
  15. Welfare and excess volatility of exchange rates By M. Salto; T. Pietra
  16. Potential output in DSGE models By Igor Vetlov; Tibor Hlédik; Magnus Jonsson; Henrik Kucsera; Massimiliano Pisani
  17. Oil Price Shocks and Cyclical Dynamics in an Asymmetric Monetary Union By Volker Clausen; Hans-Werner Wohltmann
  18. Dating U.S. Business Cycles with Macro Factors By Fossati, Sebastian
  19. The Effects of Monetary Policy "News" and "Surprises" By Fabio Milani; John Treadwell
  20. Fiscal Stimulus and Distortionary Taxation By Thorsten Drautzburg; Harald Uhlig
  21. Joint Estimates of Automatic and Discretionary Fiscal Policy: the OECD 1981-2003 By Julia Darby; Jacques Melitz
  22. Financial Frictions and Credit Spreads By Ke Pang; Pierre L. Siklos
  23. The Optimal Inflation Tax in the Presence of Imperfect Deposit – Currency Substitution By Eduardo Olaberría
  24. An Experiment on Consumption Responses to Future Prices and Interest Rates By Wolfgang J. Luhan; Michael W.M. Roos; Johann Scharler
  25. Central bank transparency, the accuracy of professional forecasts, and interest rate volatility By Menno Middeldorp
  26. Introducing Financial Assets into Structural Models By Jorge Fornero
  27. Does Monetary Policy Affect Stock Market Uncertainty? – Empirical Evidence from the United States By Mario Jovanovic
  28. Do Government Purchases Affect Unemployment? By Holden, Steinar; Sparrman, Victoria
  29. Fiscal Multipliers and Policy Coordination By Gauti B. Eggertsson
  30. Has the Financial Crisis eroded Citizens’ Trust in the European Central Bank? - Evidence from 1999-2010 By Felix Roth; Daniel Gros; Felicitas Nowak-Lehmann
  31. Cross-section Dependence and the Monetary Exchange Rate Mode – A Panel Analysis By Joscha Beckmann; Ansgar Belke; Frauke Dobnik
  32. Paradigm shift? A critique of the IMF’s new approach to capital controls By Daniela Gabor
  33. Jaque Mate a las Proyecciones de Consenso By Pablo Pincheira B.; Nicolás Fernández
  34. Estimating Central Bank preferences in a small open economy: Sweden 1995-2009 By Gaetano D’Adamo
  35. The information content of central bank interest rate projections: Evidence from New Zealand By Gunda-Alexandra Detmers; Dieter Nautz
  36. Assessment of Consensus Forecasts Accuracy: The Czech National Bank Perspective By Filip Novotny; Marie Rakova
  37. Un Test Conjunto de Superioridad Predictiva para los Pronósticos de Inflación Chilena. By Pablo Pincheira B.
  38. Chile’s Fiscal Rule as Social Insurance By Eduardo Engel; Christopher Neilson; Rodrigo Valdés
  39. Short-Term GDP Forecasting Using Bridge Models: a Case for Chile By Marcus Cobb; Gonzalo Echavarría; Pablo Filippi; Macarena García; Carolina Godoy; Wildo González; Carlos Medel; Marcela Urrutia
  40. A comparative analysis of alternative univariate time series models in forecasting Turkish inflation By Catik, A. Nazif; Karaçuka, Mehmet

  1. By: Charles Engel
    Abstract: The well-known uncovered interest parity puzzle arises from the empirical regularity that, among developed country pairs, the high interest rate country tends to have high expected returns on its short term assets. At the same time, another strand of the literature has documented that high real interest rate countries tend to have currencies that are strong in real terms – indeed, stronger than can be accounted for by the path of expected real interest differentials under uncovered interest parity. These two strands – one concerning short-run expected changes and the other concerning the level of the real exchange rate – have apparently contradictory implications for the relationship of the foreign exchange risk premium and interest-rate differentials. This paper documents the puzzle, and shows that existing models appear unable to account for both empirical findings. The features of a model that might reconcile the findings are discussed.
    JEL: F30 F31 G12
    Date: 2011–06
  2. By: Stéphane Dées (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Pedro Soares Brinca (Stockholm University, Sweden.)
    Abstract: For most academics and policy makers, the depth of the 2007-09 financial crisis, its longevity and its impacts on the real economy resulted from an erosion of confidence. This paper proposes to assess empirically the link between consumer sentiment and consumption expenditures for the United States and the euro area. It shows under which circumstances confidence indicators can be a good predictor of household consumption even after controlling for information in economic fundamentals. Overall, the results show that the consumer confidence index can be in certain circumstances a good predictor of consumption. In particular, out-of-sample evidence shows that the contribution of confidence in explaining consumption expenditures increases when household survey indicators feature large changes, so that confidence indicators can have some increasing predictive power during such episodes. Moreover, there is some evidence of a "confidence channel" in the international transmission of shocks, as U.S. confidence indices lead consumer sentiment in the euro area. JEL Classification: C32, E17, F37, F42.
    Keywords: Consumer Confidence, Consumption, International Linkages, Non-linear modeling.
    Date: 2011–06
  3. By: Antoine Martin; James McAndrews; David Skeie
    Abstract: The amount of reserves held by the U.S. banking system reached $1.5 trillion in April 2011. Some economists argue that such a large quantity of bank reserves could lead to overly expansive bank lending as the economy recovers, regardless of the Federal Reserve’s interest rate policy. In contrast, we show that the size of bank reserves has no effect on bank lending in a frictionless model of the current banking system, in which interest is paid on reserves and there are no binding reserve requirements. We also examine the potential for balance-sheet cost frictions to distort banks’ lending decisions. We find that large reserve balances do not lead to excessive bank credit and may instead be contractionary.
    Date: 2011
  4. By: G. Camera; M. Casari
    Abstract: Under what conditions can cooperation be sustained in a network of strangers? Here we study the role of institutions and uncover a new behavioral foundation for the use of monetary systems. In an experiment, anonymous subjects could cooperate or defect in bilateral random encounters. This sequence of encounters was indefinite; hence multiple equilibria were possible, including full intertemporal cooperation supported by a social norm based on community punishment of defectors. We report that such social norm did not emerge. Instead, the availability of intrinsically worthless tokens favored the coordination on intertemporal cooperation in ways that networks of strangers were unable to achieve through social norms.
    JEL: C90 C70 D80
    Date: 2011–05
  5. By: Kenneth Kuttner (Williams College)
    Abstract: Bernanke and Gertler’s influential 1999 article "Asset Price Bubbles and Monetary Policy" made the case that monetary policy should respond to asset prices only to the extent that they have implications for future inflation. This paper revisits that prescription in light of the 2007– 09 financial crisis. After reviewing the Bernanke-Gertler logic, the paper surveys the recent evolution of views on the appropriate policy response to asset price fluctuations, and discusses the conditions under which a proactive policy would be justified. There is almost no discernible relationship between interest rates and stock and property prices across countries during the years leading up to the crisis, however. While a theoretical case could be made to give some weight to financial stability in setting monetary policy, the evidence presented in the paper suggests that incremental interest rate adjustments are unlikely to be effective in restraining excessive asset price appreciation.
    JEL: E52 E58 E44 G12
    Date: 2011–05
  6. By: Sylvain Leduc; Jean-Marc Natal
    Abstract: How should monetary policy be conducted in the presence of endogenous feedback loops between asset prices, firms’ financial health, and economic activity? We reconsider this question in the context of the financial accelerator model and show that, when the level of natural output is inefficient, the optimal monetary policy under commitment leans considerably against movements in asset prices and risk premia. We demonstrate that an endogenous feedback loop is crucial for this result and that price stability is otherwise quasi-optimal absent this feature. We also show that the optimal policy can be closely approximated and implemented using a speed-limit rule that places a substantial weight on the growth of financial variables.
    Keywords: Monetary policy ; Asset pricing
    Date: 2011
  7. By: Bill Russell; Anindya Banerjee; Issam Malki; Natalia Ponomareva
    Abstract: Phillips curves are often estimated without due attention being paid to the underlying time series properties of the data. In particular, the consequences of inflation having discrete breaks in mean have not been studied adequately. We show by means of simulations and a detailed empirical example based on United States data that not taking account of breaks may lead to biased, and therefore spurious, estimates of Phillips curves. We suggest a method to account for the breaks in mean inflation and obtain meaningful and unbiased estimates of the short- and long-run Phillips curves in the United States.
    Keywords: Phillips curve, inflation, panel data, non-stationary data, breaks
    JEL: C22 C23 E31
    Date: 2011–06
  8. By: Christian Bredemeier; Henry Goecke
    Abstract: This paper empirically compares sticky-price and sticky-information Phillips curves considering inflation dynamics in six countries (US, UK, Germany, France, Canada, and Japan). We evaluate the models‘ abilities to match empirical second moments of inflation. Under baseline calibrations, the two models perform similarly in almost all countries. Under estimated parametrizations, sticky information performs better in France while sticky prices dominate in the UK and Germany. Sticky prices match unconditional moments of inflation dynamics better while sticky information is more successful in matching co-movement of inflation with demand. Both models‘ performances worsen where inflation dynamics diff er from the US benchmark.
    Keywords: Phillips curve; sticky information; sticky prices
    JEL: E31 E32 E37
    Date: 2011–04
  9. By: Jan Filacek; Branislav Saxa
    Abstract: Do private analysts coordinate their forecasts via central bank forecasts? In this paper, we examine private and central bank forecasts for the Czech Republic. The evolution of the standard deviation of private forecasts as well as the distance from the central bank’s forecasts are used to study whether a coordination effect exists, how it is influenced by uncertainty, and the effects of changes in central bank communication. The results suggest that private analysts coordinate their forecasts for the interest rate and inflation, while no or limited evidence exists for the exchange rate and GDP growth.
    Keywords: Central bank, coordination, forecast.
    JEL: E27 E37 E47 E58
    Date: 2010–12
  10. By: Francis Breedon; Thórarinn G. Pétursson; Andrew K. Rose
    Abstract: We look at the exchange rate policy choices and outcomes for small rich economies. Small rich economies face significant policy challenges due to proportionately greater economic volatility than larger economies. These economies usually choose some form of fixed exchange rate regime, particularly in the very small economies where the per capita cost of independent monetary policy is relatively high. When such countries do choose a free or managed floating regime, they appear to derive no benefit from those regimes; their exchange rate volatility seems to rise without any significant change in fundamental economic volatility. Thus, for these countries, floating exchange rates seem to create problems for policy makers without solving any.
    Date: 2011–06
  11. By: Jan Babecky; Lubos Komarek; Zlatuse Komarkova
    Abstract: This article analyzes the phenomenon of financial integration on both the theoretical and empirical levels, focusing primarily on assessing the impacts of the current financial crisis. In the theoretical section we first look at the definition of financial integration and summarize the benefits and costs associated with this process. We go on to examine the relationship between financial integration and financial instability, emphasizing the priority role of financial innovation. The subsequent empirical section provides an analysis of the speed and level of integration of the Czech financial market and the markets of selected inflation-targeting Central European economies (Hungary and Poland) and advanced Western European economies (Sweden and the United Kingdom) with the euro area. The results for the Czech Republic reveal that a process of increasing financial integration has been going on steadily since the end of the 1990s and also that the financial crisis caused only temporary price divergence of the Czech financial market from the euro area market.
    Keywords: Beta-convergence, financial crisis, financial integration, gamma-convergence, new EU Member States, propagation of shocks, sigma-convergence.
    JEL: C23 G12 G15
    Date: 2010–12
  12. By: Ulrich Bindseil (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Juliusz Jabłecki (National Bank of Poland and Faculty of Economic Sciences, Warsaw University.)
    Abstract: Containing short-term volatility of the overnight interest rate is normally considered the main objective of central bank standing facilities. This paper develops a simple stochastic model to show how the width of the central bank standing facilities corridor affects banks’ day-to-day liquidity management and the volatility of the overnight rate. It is shown that the wider the corridor, the greater the interbank turnover, the leaner the central bank’s balance sheet (i.e. the lower the average recourse to standing facilities) and the greater short-term interest rate volatility. The obtained relationships are matched with central bank preferences to obtain an optimal corridor width. The model is tested against euro area and Hungarian daily data encompassing the financial crisis that began in 2007. JEL Classification: E4, E5.
    Keywords: standing facilities, money market, liquidity management.
    Date: 2011–06
  13. By: Galina Hale
    Abstract: Recent literature argues that the structure of a banking network is important for its stability. We use network analysis to formally describe bank relationships in the global banking network between 1980 and 2009 and analyze the effects of recessions and banking crises on these relationships. We construct a novel data set that builds a bank-level global network from loan-level data on syndicated loans to financial institutions. Our network consists of 7938 banking institutions from 141 countries. We find that the network became more interconnected and more asymmetric, and therefore potentially more fragile, prior to 2008, and that its expansion slowed in recent years, dramatically so during the 2008-09 crisis. We use a stylized model to describe potential effects of banking crises and recessions on bank relationships. Empirically, we find that the structure of a global banking network is not invariant to banking crises nor to recessions, especially those in the United States. While recessions appear to encourage banks to make new connections, especially on the periphery of the network, the global financial crisis of 2008-09 made banks very cautious in their lending, meaning that almost no new connections were made during the crisis, particularly in 2009. We also find that during country-specific recessions or banking crises past relationships become more important as few new relationships are formed.
    Keywords: Banks and banking ; Financial crises
    Date: 2011
  14. By: Stefan Reitz; Jan-Christoph Rülke; Georg Stadtmann
    Abstract: Chartist and fundamentalist models have proven to be capable of replicating stylized facts on speculative markets. In general, this is achieved by specifying nonlinear interactions of otherwise linear asset price expectations of the respective trader groups. This paper investigates whether or not regressive and extrapolative expectations themselves exhibit significant nonlinear dynamics. The empirical results are based on a new data set from the European Central Bank Survey of Professional Forecasters on oil price expectations. In particular, we find that forecasters form destabilizing expectations in the neighborhood of the fundamental value, whereas expectations tend to be stabilizing in the presence of substantial oil price misalignment
    Keywords: agent based models, nonlinear expectations, survey data
    JEL: F31 D84 C33
    Date: 2011–06
  15. By: M. Salto; T. Pietra
    Abstract: We study the properties of a GEI model with nominal assets, outside money (injected into the economy as in Magill and Quinzii), and multiple currencies. We analyze the existence of monetary equilibria and the structure of the equilibrium set under two different assumptions on the determination of the exchange rates. If currencies are perfect substitutes, equilibrium allocations are indeterminate and, generically, sunspot equilibria exist. Generically, given a nonsunspot equilibrium, there are Pareto improving (and Pareto worsening) sunspot equilibria associated with an increase in the volatility of the future exchange rates. We interpret this property as showing that, in general, there is no clear-cut effect on welfare of the excess volatility of exchange rates, even when due to purely extrinsic phenomena.
    JEL: D52
    Date: 2011–06
  16. By: Igor Vetlov (Bank of Lithuania, Department of Economics, Economic Research Division, Gedimino pr. 6, LT-01103 Vilnius, 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. JEL Classification: E32, E37, E52.
    Keywords: potential output, simulation and forecasting models, monetary policy.
    Date: 2011–06
  17. By: Volker Clausen; Hans-Werner Wohltmann
    Abstract: This paper analyzes the dynamic effects of anticipated and unanticipated oil price increases in a small two-country monetary union, which is simultaneously characterized by asymmetric wage adjustments and asymmetric interest rate sensitivities of private absorption. Common external oil price disturbances lead in this asymmetric macroeconomic setup to temporary divergences in output developments across the monetary union. In the case of anticipated oil price increases the relative cyclical position is reversed in the course of the adjustment process. Complete stabilization of the output variables throughout the overall adjustment process requires a restrictive monetary policy being time inconsistent from a quantitative but time consistent from a qualitative point of view. That means that the central bank credibly announces a future reduction in the growth rate of the nominal money stock but actually implements a reduction, which is less restrictive than the original announcement.
    Keywords: EMU; international policy transmission; oil price shock; time inconsistency; monetary policy
    JEL: E63 F41
    Date: 2011–03
  18. By: Fossati, Sebastian (University of Alberta, Department of Economics)
    Abstract: A probit model is used to show that latent common factors estimated by principal components from a large number of macroeconomic time series have important predictive power for NBER recession dates. A pseudo out-of-sample forecasting exercise shows that predicted recession probabilities consistently rise during subsequently declared NBER recession dates. The latent variable in the factor-augmented probit model is interpreted as an index of real business conditions which can be used to assess the strength of an expansion or the depth of a recession.
    Keywords: business cycle; forecasting; factors; probit model; Bayesian methods
    JEL: C01 C22 C25 E32 E37
    Date: 2011–05–01
  19. By: Fabio Milani (Department of Economics, University of California-Irvine); John Treadwell (Department of Economics, University of California-Irvine)
    Abstract: There is substantial agreement in the monetary policy literature over the effects of exogenous monetary policy shocks. The shocks that are investigated, however, almost exclusively represent unanticipated changes in policy, which surprise the private sector and which are typically found to have a delayed and sluggish effect on output. In this paper, we estimate a New Keynesian model that incorporates news about future policies to try to disentangle the anticipated and unanticipated components of policy shocks. The paper shows that the conventional estimates confound two distinct effects on output: an effect due to unanticipated or “surprise” shocks, which is smaller and more short-lived than the response usually obtained in the literature, and a large, delayed, and persistent effect due to anticipated policy shocks or "news." News shocks play a larger role in influencing the business cycle than unanticipated policy shocks, although the overall fraction of economic fluctuations that can be attributed to monetary policy remains limited.
    Keywords: Anticipated and unanticipated monetary policy shocks; News shocks; New Keynesian model with news shocks; Effects of monetary policy onoutput
    JEL: E32 E52 E58
    Date: 2011–05
  20. By: Thorsten Drautzburg; Harald Uhlig
    Abstract: We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. We extend the benchmark Smets-Wouters (2007) New Keynesian model, allowing for credit-constrained households, the zero lower bound, government capital and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42. The multiplier is sensitive to the fraction of transfers given to credit-constrained households, the duration of the zero lower bound and the capital. The stimulus results in negative welfare effects for unconstrained agents. The constrained agents gain, if they discount the future substantially.
    JEL: E62 E63 E65 H20 H62
    Date: 2011–06
  21. By: Julia Darby; Jacques Melitz
    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: Automatic stabilization; discretionary fiscal policy; government social and health spending; Maastricht Treaty; Stability and Growth Pact; real time reaction functions
    JEL: E62 E63
    Date: 2011–05
  22. By: Ke Pang; Pierre L. Siklos
    Abstract: This paper uses the credit-friction model developed by Curdia and Woodford, in a series of papers, as the basis for attempting to mimic the behavior of credit spreads in moderate as well as crisis times. We are able to generate movements in representative credit spreads that are, at times, both sharp and volatile. We then study the impact of quantitative easing and credit easing. Credit easing is found to reduce spreads, unlike quantitative easing, which has opposite effects. The relative advantage of credit easing becomes even clearer when we allow borrowers to default on their loans. Since increases in default offset the beneficial effects of credit easing on spreads, the policy implication is that, in times of financial stress, the central bank should be aggressive when applying credit easing policies.
    Keywords: Credit easing, credit spread, financial friction, quantitative easing.
    JEL: E43 E44 E51 E58
    Date: 2010–12
  23. By: Eduardo Olaberría
    Abstract: During the last decades, technological innovation has generated a major transformation in payment systems, stimulating a widespread use of different forms of electronic money and increasing substitutability between deposits and currency in transactions. A big advantage of deposits is that, unlike currency, they can pay nominal interest on the average balance at a very low cost. As a result, in most developed countries an increasing number of people chose debit cards to make transactions. Despite the huge impact that these cards have had on everyday life, little is known about their consequences for the optimal conduct of monetary policy. This paper contributes to the literature on optimal monetary and fiscal policy by analyzing how the presence of imperfect deposit-currency substitution affects inflationary taxation in a public finance framework. The paper presents a model where financial intermediaries supply deposits that can be used to buy goods and services. In order to produce deposits, financial intermediaries must incur a cost. It is shown that if this cost is zero, the optimal inflation tax is zero. However, in the more realistic case in which this cost is positive, the optimal inflation tax is positive whenever there are revenue needs. Furthermore, the higher the cost of producing deposits, the higher is the optimal inflation tax. These results suggest that central banks in countries with less productive financial intermediaries (implying a higher cost of producing deposits), should optimally choose to have higher inflation rates.
    Date: 2011–03
  24. By: Wolfgang J. Luhan; Michael W.M. Roos; Johann Scharler
    Abstract: We design an experiment to investigate the influence of announced future variations in interest rates and prices on consumption decisions. In an experimental implementation of the discounted utility model, the subjects learn the entire paths of inflation and interest rates prior to deciding on a consumption path. We decompose the total change in consumption that results from changes in either interest rates or inflation rates into anticipation and impact effects. While impact effects are of similar orders of magnitude as in the model, future changes in inflation or interest rates exert substantially smaller effects on current consumption than predicted by the model.
    Keywords: Consumption; saving; intertemporal utility maximization; macroeconomic experiment
    JEL: D91 E21 C91
    Date: 2011–04
  25. By: Menno Middeldorp
    Abstract: Central banks worldwide have become more transparent. An important reason is that democratic societies expect more openness from public institutions. Policymakers also see transparency as a way to improve the predictability of monetary policy, thereby lowering interest rate volatility and contributing to economic stability. Most empirical studies support this view. However, there are three reasons why more research is needed. First, some (mostly theoretical) work suggests that transparency has an adverse effect on predictability. Second, empirical studies have mostly focused on average predictability before and after specific reforms in a small set of advanced economies. Third, less is known about the effect on interest rate volatility. To extend the literature, I use the Dincer and Eichengreen (2007) transparency index for twenty-four economies of varying income and examine the impact of transparency on both predictability and market volatility. I find that higher transparency improves the accuracy of interest rate forecasts for three months ahead and reduces rate volatility.
    Date: 2011
  26. By: Jorge Fornero
    Abstract: This paper reviews extensively the literature on asset pricing and builds a structural dynamic general equilibrium model with financial assets. We obtain the policy function of the calibrated model and approximate it up to third order. We derive asset pricing and various premiums conditions up to the third order, meaning that returns depend on the first three conditional moments. We obtain a hypothetic yield curve whose curvature increases with the order of approximation because of premiums. In addition, impulse responses of various fundamental shocks illustrate the effects on the level and slope of bond yields with several maturities and on break-even inflation. Important shocks are technology and inflation target shocks.
    Date: 2011–05
  27. By: Mario Jovanovic
    Abstract: This paper investigates the response of US stock market uncertainty to monetary policy of the Federal Reserve Bank. It can be shown that monetary policy significantly Granger-causes stock market confidence. By using monthly closing prices of the VIX as a stock market uncertainty proxy and a copula-based Markov approach the stable nonlinear relation between confidence and uncertainty is demonstrated. The monetary policy effect on stock market uncertainty is therefore separable into a linear and nonlinear part.
    Keywords: Stock market confi dence; temporal dependence; copula
    JEL: C12 C22 E43 E52
    Date: 2011–01
  28. By: Holden, Steinar (Dept. of Economics, University of Oslo); Sparrman, Victoria (Dept. of Economics, University of Oslo)
    Abstract: We investigate empirically the effect of government purchases on unemployment in 20 OECD countries, for the period 1960-2007. Compared to earlier studies we use a data set with more variation in unemployment, and which allows for controlling for a host of factors that influence the effect of government purchases. We find that increased government purchases lead to lower unemployment; an increase equal to one percent of GDP reduces unemployment by 0.2 percentage point in the same year. The effect is greater in downturns than in booms, and also greater under a fixed exchange rate regime than under a floating regime.
    Keywords: Fiscal policy; unemployment
    JEL: E62 H30
    Date: 2011–05–23
  29. By: Gauti B. Eggertsson
    Abstract: This paper analyzes the effectiveness of fiscal policy at zero nominal interest rates. I solve a stochastic general equilibrium model with sticky prices assuming that the government cannot commit to future policy. Real government spending increases demand by boosting public consumption. Deficit spending increases demand by generating inflation expectations. I compute multipliers of government spending that calculate by how much each dollar of spending increases output. Both the deficit and the real spending multipliers can be large, but the multiplier of deficit spending depends critically on monetary and fiscal cooperation: it can be large with cooperation and zero without it. The theory suggests one interesting interpretation of why recovery measures–such as fiscal spending, exchange interventions, and large increases in the money supply–had a smaller effect on nominal demand in Japan during the Great Recession (1992-2006) than during the US's Great Depression (1929-1941). In both episodes, the short-term nominal interest rate was close to zero. The theory suggests that part of the difference can be explained by the fact that, while monetary and fiscal policy were coordinated in the US during the Great Depression, they were not in Japan during the Great Recession. The overall conclusion of the paper is that the effect of given policy actions depends crucially on the institutional setup in the economy.
    Date: 2011–05
  30. By: Felix Roth; Daniel Gros; Felicitas Nowak-Lehmann
    Abstract: Trust in the ECB has fallen to unprecedented lows in the aftermath of the financial crisis. Up to the start of the recession in 2008, trust levels in the ECB were moderately high and trust in the ECB was not affected by business cycle variables such as growth and inflation. This changed radically with the recession, with trust in the ECB becoming correlated quite closely with growth. After a relatively short recovery in 2009 trust in the ECB has fallen again at the start of the Eurozone crisis. Our findings first imply that European citizens seem to have placed a heavy share of the blame on the European Central Bank for the real economic downturn caused by the financial crisis in early 2009 and secondly an increase of debt over GDP and inflation have caused the new fall in May 2010.
    Keywords: Trust, financial crisis, European Central Bank
    JEL: E58 G21 Z13
    Date: 2011–05–20
  31. By: Joscha Beckmann; Ansgar Belke; Frauke Dobnik
    Abstract: This paper tackles the issue of cross-section dependence for the monetary exchange rate model in the presence of unobserved common factors using panel data from 1973 until 2007 for 19 OECD countries. Applying a principal component analysis we distinguish between common factors and idiosyncratic components and determine whether non-stationarity stems from international or national stochastic trends. We find evidence for a cross-section cointegration relationship between the exchange rates and fundamentals which is driven by those common international trends. In addition, the estimated coefficients of income and money are in line with the suggestions of the monetary model.
    Keywords: Monetary exchange rate model; common factors; panel data; cointegration; vector error-correction models
    JEL: C32 C23 F31 F41
    Date: 2011–04
  32. By: Daniela Gabor (University of the West of England)
    Abstract: The global financial crisis forcefully highlighted the importance of developing mechanisms to curb the effects of large and volatile capital inflows on growth and financial stability in developing countries. It led the IMF to reconsider its long-standing rejection of capital controls. This paper explores the analytical framework underlying the IMF’s new position, arguing that its sequencing strategy offers a formulaic solution that neglects the institutional make-up of money and currency markets, is asymmetric in its emphasis on the upturn of the liquidity cycle and sanctions capital-controls only as a last-resort solution. The new approach can have perverse impacts, increasing vulnerability where banks play an important role in the intermediation of capital inflows. The paper offers alternative policy solutions that focus on realigning bank incentives towards longer horizons and sustainable growth models, combining carefully designed central bank liquidity strategies and institutional changes in the banking sector.
    Keywords: IMF, capital controls, financial crisis, global liquidity, shadow banks, sterilizations, central banks.
    JEL: E58 E63 F3 G1 O11 O2
    Date: 2011–06
  33. By: Pablo Pincheira B.; Nicolás Fernández
    Abstract: In this article we analyze bias and autocorrelation properties of inflation forecast errors coming from the surveys carried out by Consensus Economics. We consider monthly forecasts for Chile, México and Brazil as well as quarterly forecasts for the US, Canada, Sweden and Japan. Our sample spans the period from March 2002 to June 2008. We consider forecasts at several predictive horizons. Our results indicate the existence of excessive autocorrelation and bias in forecast errors, which is not consistent with optimality under quadratic loss. We also explore whether these findings of excessive autocorrelation and bias enable us to build new and more accurate inflation forecasts. We evaluate these new forecasts in an out-of sample exercise and find that they are more accurate in the cases of Chile, Mexico, Brazil and the US. For Canada, our results are mixed depending on the forecasting horizon. For Sweden and Japan, however, the new forecasts display lower accuracy. It is worth mentioning that in the best case, our new forecasts display a 45% reduction in the Mean Squared Prediction Error.
    Date: 2011–05
  34. By: Gaetano D’Adamo (Department of Economics, University of Bologna)
    Abstract: Interest Rate rules are often estimated as simple reaction functions linking the policy interest rate to variables such as (forecasted) inflation and the output gap; however, the coefficients estimated with this approach are convolutions of structural and preference parameters. I propose an approach to estimate Central Bank preferences starting from the Central Bank's optimization problem within a small open economy. When we consider open economies in a regime of Inflation Targeting, the issue of the role of the exchange rate in the Monetary Policy rule becomes relevant. The empirical analysis is conducted on Sweden, to verify whether the recent stabilization of the Krona/Euro exchange rate was due to “Fear of Floating”; the results show that the exchange rate might not have played a role in monetary policy, suggesting that the stabilization probably occurred as a result of increased economic integration and business cycle convergence.
    Keywords: Interest Rate Rules, Inflation Targeting, Central Bank Preferences, Fear of Floating.
    JEL: E42 E52 F31
    Date: 2011–05
  35. By: Gunda-Alexandra Detmers; Dieter Nautz
    Abstract: The Reserve Bank of New Zealand (RBNZ) has been the first central bank that began to publish interest rate projections in order to improve its guidance of monetary policy. This paper provides new evidence on the role of interest rate projections for market expectations about future shortterm rates and the behavior of long-term interest rates in New Zealand. We find that interest rate projections up to four quarters ahead play a significant role for the RBNZs expectations management before the crisis, while their empirical relevance has decreased ever since. For interest rate projections at longer horizons, the information content seems to be only weak and partially destabilizing.
    Keywords: Central bank interest rate projections, central bank communication, expectations management of central banks
    JEL: E52 E58
    Date: 2011–06
  36. By: Filip Novotny; Marie Rakova
    Abstract: Consensus Economics forecasts for euro-area GDP growth, consumer and producer price inflation and the USD/EUR exchange rate are used by the Czech National Bank to make assumptions about future external economic developments. This paper compares the accuracy of the aforementioned Consensus forecasts to those of the European Commission, International Monetary Fund and Organization for Economic Co-operation and Development, and also to the naïve forecast and the forecast implied by the forward exchange rate. In the period from 1994 to 2009 Consensus forecasts for effective euro-area consumer price inflation and GDP growth beat the alternatives by a difference which is typically statistically significant. The results are more diverse for the pre-crisis sample (1994–2007). The Consensus forecast for euro-area producer price inflation significantly outperforms the naïve forecast in the short-term. Finally, the Consensus forecast for the USD/EUR exchange rate during the period from 2002 to 2009 is more precise than the naïve forecast and the forecast implied by the forward rate.
    Keywords: Forecasting accuracy, prediction process, survey forecasts.
    JEL: E37 E58
    Date: 2010–12
  37. By: Pablo Pincheira B.
    Abstract: Optimality under quadratic loss implies that forecasts built using a large information set should perform al least as well as forecasts built using a more restricted and nested information set. In this article we use a joint test of superior predictive ability to test this optimality condition for the term structure of several Chilean inflation forecasts coming from the following sources: Bloomberg, Consensus Economics, the Survey of Professional Forecasters and an average of selected seasonal univariate models. We do this by taking advantage of the fact that these sets of forecasts are built at different moments in time and, more importantly, using different and nested information sets. Our results indicate that the null hypothesis of optimality under quadratic loss cannot be rejected when Mean Squared Error is used to evaluate the term structure of the forecasts. Nevertheless, when the joint test is carried out to evaluate the term structure of the Mean Squared Forecasts, as suggested by Patton and Timmermann (2010), the joint test rejects the null hypothesis of optimality. Further analysis of our results reveals that this rejection is associated with a violation of an orthogonality condition that should be satisfied when forecasts are optimal. Moreover, this violation seems to stand both across different sources of forecasts and across different forecasting horizons. This suggests that there is room for improvement in the term structure of Chilean inflation forecasts.
    Date: 2011–02
  38. By: Eduardo Engel; Christopher Neilson; Rodrigo Valdés
    Abstract: We explore the role of fiscal policy over the business cycle from a normative perspective, for a government with a highly volatile and exogenous revenue source. Instead of resorting to Keynesian mechanisms, in our framework fiscal policy plays a role because the government provides transfers to heterogeneous households facing volatile income, albeit with an imperfect transfer technology (a fraction of transfers leak to richer households). We calibrate the model to Chile’s highly volatile government revenues derived from copper, and characterize the optimal fiscal reaction. We quantify the welfare gains vis-à-vis a balanced budget rule, and the degree of adequate fiscal countercyclicality. We also analyze simpler rules, such as the structural balance rule in place in Chile during the last decade, more general linear rules, and linear rules with an escape clause. We find that the optimal rule leads to the same welfare gain as doubling the government’s copper revenues under a balanced budget rule. Chile’s structural balance rule achieves 18% of these gains, while a linear rule with an escape clause achieves 83% of the gains. The degrees of countercyclicality of the optimal rule and the linear rule with an escape clause are similar, and much larger than those of the structural balance rule.
    Date: 2011–05
  39. By: Marcus Cobb; Gonzalo Echavarría; Pablo Filippi; Macarena García; Carolina Godoy; Wildo González; Carlos Medel; Marcela Urrutia
    Abstract: The aim of this document is to provide a forecasting tool that facilitates understanding economic developments in a timely manner. This is pursued through the Bridge Model approach by using it to relate a large set of monthly indicators to Chilean GDP and its main components. The outcome is a set of simple equations that characterize reasonably well total GDP and the feasible supply- and demand-side components based on a small set of relevant indicators. The selected equations generally provide better short-term forecasts than simple autoregressive models. However, if needed, the equation selection methodology is straightforward enough to update the equations easily making it an attractive tool for real-time forecasting.
    Date: 2011–05
  40. By: Catik, A. Nazif; Karaçuka, Mehmet
    Abstract: This paper analyses inflation forecasting power of artificial neural networks with alternative univariate time series models for Turkey. The forecasting accuracy of the models is compared in terms of both static and dynamic forecasts for the period between 1982:1 and 2009:12. We find that at earlier forecast horizons conventional models, especially ARFIMA and ARIMA, provide better one-step ahead forecasting performance. However, unobserved components model turns out to be the best performer in terms of dynamic forecasts. The superiority of the unobserved components model suggests that inflation in Turkey has time varying pattern and conventional models are not able to track underlying trend of inflation in the long run. --
    Keywords: Inflation forecasting,Neural networks,Unobserved components model
    JEL: C45 C53 E31 E37
    Date: 2011

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