nep-cba New Economics Papers
on Central Banking
Issue of 2011‒07‒13
sixty-four papers chosen by
Alexander Mihailov
University of Reading

  1. Global Liquidity Trap By Ippei Fujiwara; Tomoyuki Nakajima; Nao Sudo; Yuki Teranishi
  2. Clashing Theories of Unemployment By Robert E. Hall
  3. Towards a Political Economy of Macroeconomic Thinking By Saint-Paul, Gilles
  4. The possibility of ideological bias in structural macroeconomics models By Saint-Paul, Gilles
  5. Booms and Busts in Asset Prices By Klaus Adam; Albert Marcet
  6. Equilibrium in a market with intermediation is Walrasian. By Wooders, John
  7. Bailout Uncertainty in a Microfounded General Equilibrium Model of the Financial System By Cukierman, Alex; Izhakian, Yehuda
  8. The more we know on the fundamental, the less we agree on the price By Kondor, Péter
  9. How to get the Blanchard-Kahn form from a general linear rational expectations model. By Boucekkine, Raouf; Le Van, Cuong; Schubert, Katheline
  10. Taking Multi-Sector Dynamic General Equilibrium Models to the Data By Huw Dixon; Engin Kara
  11. The Euro-project at risk By Hankel, Wilhelm; Hauskrecht, Andreas; Stuart, Bryan
  12. Policymaking in the Eurozone and the Core Vs. Perifphery Problem By Stergios Skaperdas
  13. ECB Reaction Functions and the Crisis of 2008 By Gerlach, Stefan; Lewis, John
  14. An Historical Walk Through Recent Financial Crises By Tadeusz Kowalski; Yochanan Shachmurove
  15. The international propagation of the financial crisis of 2008 and a comparison with 1931 By William A. Allen; Richhild Moessner
  16. Learning, Capital-Embodied Technology and Aggregate Fluctuations By Christoph Görtz; John Tsoukalas
  17. Policy Risk and the Business Cycle By Benjamin Born; Johannes Peifer
  18. Optimal monetary policy and default By Lizarazo, Sandra; Da-Rocha, Jose-Maria
  19. Asset Prices, Monetary Policy, and Aggregate Fluctuations: An Empirical Investigation By Lichao Cheng; Yi Jin; Zhixiong Zeng
  20. A Repayment Model of House Prices By Jakob B Madsen
  21. Regime Changes and Financial Markets By Andrew Ang; Allan Timmermann
  22. The Financial and Macroeconomic Implications of Banking Frictions and Banking Riskiness By Yi Jin; Zhixiong Zeng
  23. No news in business cycles By Mario Forni; Luca Gambetti; Luca Sala
  24. News-driven Business Cycles in SVARs By Patrick Bunk
  25. Sufficient information in structural VARs By Mario Forni; Luca Gambetti
  26. Inflation persistence, Price Indexation and Optimal Simple Interest Rate Rules By Guido Ascari; Nicola Branzoli
  27. House Price, Mortgage Premium, and Business Fluctuations By Nan-Kuang Chen; Han-Liang Cheng; Ching-Sheng Mao
  28. How Well Does Sticky Information Explain the Dynamics of Inflation, Output, and Real Wages? By J. A. CARRILLO
  29. Equilibrium Selection in a Cashless Economy with Transaction Frictions in the Bond Market By M. Marzo; P. Zagaglia
  30. U.S. Core Inflation: A Wavelet Analysis By Kevin Dowd; John Cotter
  31. Individual Expectations and Aggregate Macro Behavior By Tiziana Assenza; Peter Heemeijer; Cars Hommes; Domenica Massaro
  32. The Effectiveness of Government Debt for Demand Management: Sensitivity to Monetary Policy Rules By Guido Ascari; Neil Rankin
  33. Financial intermediation and the international business cycle: The case of small countries with big banks By Gunes Kamber; Christoph Thoenissen
  34. Price setting in a leading Swiss online supermarket By Martin Berka; Michael B. Devereux; Thomas Rudolph
  35. The Microstructure of Currency Markets By Martin Evans
  36. Liquidity, Assets and Business Cycles By Shouyong Shi
  37. Idiosyncratic uncertainty, capacity utilization and the business cycle. By Fagnart, Jean-Francois; Licandro, Omar; Portier, Franck
  38. Micro approaches to Foreign Exchange Determination By Martin Evans and Dagfinn Rime
  39. Fiscal Calculus in a New Keynesian Model with Labor Market Frictions By Alessia Campolmi; Ester Faia; Roland Winkler
  40. Public Sector Debt Dynamics: The Persistence and Sources of Shocks to Debt in Ten EU Countries By Massimo Antonini; Kevin Lee; Jacinta Pires
  41. The Impact of Financial Market Frictions on Trade Flows, Capital Flows and Economic Development By Kevin Lee; James Morley; Kalvinder Shields
  42. Monetary Policy and Automatic Stabilizers: the Role of Progressive Taxation By Fabrizio Mattesini; Lorenza Rossi
  43. Diversification and Financial Stability By Paolo Tasca; Stefano Battiston
  44. Transparency of banking supervisors By Carin van der Cruijsen; Jakob de Haan; Franka Liedorp; Robert Mosch
  45. Monetary Policy Trade-Offs in a Portfolio Model with Endogenous Asset Supply By Stefan Schüder
  46. Monetary policy trade-offs in a portfolio model with endogenous asset supply By Schüder, Stefan
  47. Small Lessons from the Recent Euro-Dollar Skirmishes By Dino Martellato
  48. Solving Exchange Rate Puzzles with neither Sticky Prices nor Trade Costs By Maurice J. Roche; Michael J. Moore
  49. Unveiling the monetary policy rule in euro area By Thanassis Kazanas; Elias Tzavalis
  50. What Might Central Banks Lose or Gain in Case of Euro Adoption – A GARCH-Analysis of Money Market Rates for Sweden, Denmark and the UK By Herbert Buscher; Hubert Gabrisch
  51. TARGET2 Unlimited: Monetary Policy Implications of Asymmetric Liquidity Management within the Euro Area By Abad, José M; Loeffler, Axel; Zemanek, Holger
  52. Testing for Parameter Stability in DSGE Models. The Cases of France, Germany and Spain By Jerger, Jürgen; Röhe, Oke
  53. Mattresses versus Banks - The Effect of Trust on Portfolio Composition By Tom Coupe
  54. Labor Market Participation, Unemployment and Monetary Policy By Alessia Campolmi; Stefano Gnocchi
  55. Cycle Extraction: A Comparison of the Phase-Average Trend Method, the Hodrick-Prescott and Christiano-Fitzgerald Filters By Ronny Nilsson; Gyorgy Gyomai
  56. Testing for Weak Identification in Possibly Nonlinear Models By Barbara Rossi; Atsushi Inoue
  57. Error Reduction strategies for the 1998-2005 USAGE Forecast By Peter Mavromatis; Marnie Griffith
  58. Testing the asset pricing model of exchange rates with survey data By Anna Naszódi
  59. Beating the Random Walk in Central and Eastern Europe by Survey Forecasts By Anna Naszódi
  60. Understanding the macroeconomic effects of working capital in the United Kingdom By Fernandez-Corugedo, Emilio; McMahon, Michael; Millard, Stephen; Rachel, Lukasz
  61. Canadian Monetary Policy and Real and Nominal Exchange Rates [Revised] By John E. Floyd
  62. The Role of Asset Prices in Forecasting Inflation and Output in South Africa By Rangan Gupta; Faaiqa Hartley
  63. The trend of the real exchange rate overvaluation in open emerging economies: the case of Brazil By André Nassif; Carmem Feijó; Eliane Araújo
  64. Foreign exchange reserve management in the 19th century: The National Bank of Belgium in the 1850s By Stefano Ugolini

  1. By: Ippei Fujiwara (Bank of Japan); Tomoyuki Nakajima (Kyoto University); Nao Sudo (Bank of Japan); Yuki Teranishi (Bank of Japan)
    Abstract: Using a two-country New Open Economy Macroeconomics model, we analyze how monetary policy should respond to a "global liquidity trap," where the two countries may fall into a liquidity trap simultaneously. We first characterize optimal monetary policy, and show that the optimal rate of infl ation in one country is affected by whether or not the other country is in a liquidity trap. We next examine how well the optimal monetary policy is approximated by relatively simple monetary policy rules. We find that the interest-rate rule targeting the producer price index performs very well in this respect.
    Keywords: Zero interest rate policy; two-country model; international spillover; monetary policy coordination
    JEL: E52 E58 F41
    Date: 2011–06
  2. By: Robert E. Hall
    Abstract: General-equilibrium models for studying monetary influences in general and the zero lower bound on the nominal interest rate in particular contain implicit theories of unemployment. In some cases, the theory is explicit. When the nominal rate is above the level that clears the current market for output, the excess supply shows up as diminished output, lower employment, and higher unemployment. Quite separately, the Diamond-Mortensen-Pissarides model is a widely accepted and well-developed account of turnover, wage determination, and unemployment. The DMP model is a clashing theory of unemployment, in the sense that its determinants of unemployment do not include any variables that signal an excess supply of current output. In consequence, a general-equilibrium monetary model with a DMP labor market generally has no equilibrium. After demonstrating the clash in a minimal but adequate setting, I consider modifications of the DMP model that permit the complete model to have an equilibrium. No fully satisfactory modification has yet appeared.
    JEL: E12 E22 E32
    Date: 2011–06
  3. By: Saint-Paul, Gilles
    Abstract: This paper investigates, in a simplified macro context, the joint determination of the (incorrect) perceived model and the equilibrium. I assume that the model is designed by a self-interested economist who knows the true structural model, but reports a distorted one so as to influence outcomes. This model influences both the people and the government; the latter tries to stabilize an unobserved demand shock and will make different inferences about that shock depending on the model it uses. The model’s choice is constrained by a set of autocoherence conditions that state that, in equilibrium, if everybody uses the model then it must correctly predict the moments of the observables. I then study, in particular, how the models devised by the economists vary depending on whether they are "progressive" vs. "conservative". The predictions depend greatly on the specifics of the economy being considered. But in many cases, they are plausible. For example, conservative economists will tend to report a lower keynesian multiplier, and a greater long-term inflationary impact of output expansions. On the other hand, the economists’ margin of manoeuver is constrained by the autocoherence conditions. Here, a "progressive" economist who promotes a Keynesian multiplier larger than it really is, must, to remain consistent, also claim that demand shocks are more volatile than they really are. Otherwise, people will be disappointed by the stabilization performance of fiscal policy and reject the hypothesized value of the multiplier. In some cases, autocoherence induces the experts to make, loosely speaking, ideological concessions on some parameter values. The analysis is illustrated by empirical evidence from the Survey of Professional Forecasters
    Keywords: Autocoherence; Bias; Experts; Ideology; Macroeconomic modelling; Political Economy
    JEL: A11 E6
    Date: 2011–06
  4. By: Saint-Paul, Gilles
    Abstract: This paper studies the trade-offs that an expert with ideological biases faces in designing his model. I assume the perceived model must be autocoherent, in that its use by all agents delivers a self-concerming equilibrium. The exercise is carried in the context of a simplified AS-AD model, where in principle the expert can influence policy by manipulation six key parameters: the Keynesian multiplier, the interest elasticity of aggregate demand, the response of output to actual and expected inflation in the Phillips curve, and the variances of supply and demand shocks. Typically, a larger reported Keynesian multiplier is favored by more left-wing economists, as is a flatter inflation output trade-off. But an important aspect of the analysis is that autocoherence conditions imply constraints and trade-offs between parameters. For example a larger reported Keynesian multiplier must be associated with a lower interest elasticity of aggregate demand for the economists’s model to match the data. Also, some parameters or some combinations of parameters must be truthfully revealed for the expert to remain autocoherent. These are the parameters that are "identified" from the empirical moments of the distribution of observables. This illustrates the tight link between parameter identification and the scope for bias that is generated by the autocoherence conditions.
    Keywords: Autocoherence; Bias; Experts; Ideology; Macroeconomic modelling; Political Economy
    JEL: A11 E6
    Date: 2011–07
  5. By: Klaus Adam; Albert Marcet
    Abstract: We show how low-frequency boom and bust cycles in asset prices can emerge from Bayesian learning by investors. Investors rationally maximize infinite horizon utility but hold subjective priors about the asset return process that we allow to differ infinitesimally from the rational expectations prior. Bayesian updating of return beliefs then gives rise to selfreinforcing return optimism that results in an asset price boom. The boom endogenously comes to an end because return optimism causes investors to make optimistic plans about future consumption. The latter reduces the demand for assets that allow to intertemporally transfer resources. Once returns fall short of expectations, investors revise return expectations downward and set in motion a self-reinforcing price bust. In line with available survey data, the learning model predicts return optimism to comove positively with market valuation. In addition, the learning model replicates the low frequency behavior of the U.S. price dividend ratio over the period 1926-2006.
    Keywords: asset price fluctuations, boom and bust cycles
    JEL: G12 D84
    Date: 2011–07
  6. By: Wooders, John
    Abstract: We show that a profit maximizing monopolistic intermediary may behave approximately like a Walrasian auctioneer setting bid and ask prices nearly equal to Walrasian equilibrium prices. In the model agents trade either through the intermediary or privately. Buyers (sellers) choosing to trade through the intermediary potentially trade immediately at the ask (bid) price, but sacrifice the spread as potential gains. Agents trading privately capture all of the gains to trade, but risk costly delay in finding a partner. We show that when the cost of delay is small, the intermediary sets bid and ask prices nearly equal to Walrasian equilibrium prices. As the cost of delay vanishes, the equilibrium bid and ask prices converge to the Walrasian equilibrium prices. If the possibility of trading through the intermediary is removed, and therefore all trade takes place in the private trading market, then prices are not close to Walrasian equilibrium prices even as the cost of delay vanishes.
    Keywords: Intermediation; Walrasian equilibrium; Matching; Bargaining;
  7. By: Cukierman, Alex; Izhakian, Yehuda
    Abstract: This paper develops a micro-founded general equilibrium model of the financial system composed of ultimate borrowers, ultimate lenders and financial intermediaries. The model is used to investigate the impact of uncertainty about the likelihood of governmental bailouts on leverage, interest rates, the volume of defaults and the real economy. The distinction between risk and uncertainty is implemented by applying the Gilboa-Schmeidler maxmin with multiple priors framework to lenders' beliefs about the probability of bailout. Events like Lehman's collapse are conceived of as 'black swan' events that led lenders to put a positive mass on bailout probabilities that were previously assigned zero mass. Results of the analysis include: (i) An unanticipated increase in bailout uncertainty raises interest rates, the volume of defaults in both the real and financial sectors and may lead to a total drying up of credit markets. (ii) Lower exante bailout uncertainty is conducive to higher leverage - which raises moral hazard and makes the economy more vulnerable to expost increases in bailout uncertainty. (iii) Bailout uncertainty raises the likelihood of bubbles, the amplitude of booms and busts as well as the banking and the credit spreads. (iv) Bailout uncertainty is associated with higher returns’ variability in diversified portfolios and systemic risks, (v) Expansionary monetary policy reinforces those effects by inducing higher aggregate leverage levels.
    Keywords: Ambiguity Aversion; Bailouts; Duration mismatches; Financial intermediaries; Lehman's Collapse; Leverage; Risk; Uncertainty
    JEL: D81 D83 E3 E4 E5 E6 G11 G18 G2
    Date: 2011–06
  8. By: Kondor, Péter
    Abstract: I allow heterogenity in trading horizons across groups in a standard differential information model of a financial market. This can explain the empirical facts that after public announcements trading volume increases, more private information is incorporated into prices and volatility increases. Public information, in such environments, has the important secondary role of helping agents to learn about the information of other agents. As a consequence, whenever the correlation between private information across groups is sufficiently low, a public announcement increases disagreement among short horizon traders on the expected selling price, even if it decreases disagreement about the fundamental value of the asset. Additional testable implications are also suggested.
    Keywords: higher-order expectations; public announcement; trading volume
    JEL: D82 D84 G11 G12
    Date: 2011–06
  9. By: Boucekkine, Raouf; Le Van, Cuong; Schubert, Katheline
    Abstract: In this paper, we prove that every linear model with rational expectations can be transformed by the means of an one-to-one mapping into another model which has one of the following properties: i) it is degenerated, ii) it is backward, ii) it has the Blanchard-Kahn form. In addition to sorne simple illustrations, we provide two applications on two nonlinear forward-looking economic models in order to show how to use our theoretical analysis for local stability assessment.
    Keywords: Rational Expectations; Blanchard-Kahn Form; Reduction Algorithms;
  10. By: Huw Dixon; Engin Kara
    Abstract: We estimate and compare two models, the Generalized Taylor Economy (GTE) and the Multiple Calvo model (MC) that have been built to model the distributions of contract lengths observed in the data. We compare the performances of these models to those of the standard models such as the Calvo and its popular variant, using the ad hoc device of indexation. The estimations are made with Bayesian techniques for the US data. The results indicate that the data strongly favour the GTE.
    Keywords: DSGE models, Calvo, Taylor, price-setting
    JEL: E32 E52 E58
    Date: 2011–07
  11. By: Hankel, Wilhelm; Hauskrecht, Andreas; Stuart, Bryan
    Abstract: In contrast to Robert Mundell's Optimum Currency Area theory and his recommendation of forming a monetary union, the economic fundamentals of Euro area member countries have not harmonized. The opposite holds: the Euro core countries - most of all Germany, but also the Netherlands and Finland - increased productivity growth while limiting nominal wage growth. However, Mediterranean countries - particularly Greece, but also Spain, Portugal, and Italy - have dramatically lost international competitiveness. Although the overall balance of payments for the Euro area at large is almost balanced, internal disequilibria are skyrocketing and default risk premiums and tensions within the Euro area are rising, thus jeopardizing the stability of the monetary union. The findings confirm that a common currency without fiscal union is inherently unstable. The international financial and economic crisis has merely triggered events which highlight this instability. The paper discusses three possible scenarios for the future of the Euro: a laissez faire approach, a bailout, and finally an exit strategy for the Mediterranean countries, or an organized exit by a group of core countries led by Germany, forming their own smaller monetary union. --
    Keywords: Optimum currency areas,monetary union,risk spreads,central banking,exchange rates,fiscal policy
    JEL: E42 E63 F15 F33 F34
    Date: 2010
  12. By: Stergios Skaperdas (Department of Economics, University of California-Irvine)
    Abstract: I argue that the eurozone’s current problems are primarily structural: A weak central bank; the absence of fiscal coordination; fragmented bank supervision with individual countries having the ultimate responsibility for supporting banks but without the ability to print their own currency. At the same time, European elites of the core have been driven by very short-term objectives whereas the Greek and Irish governments have shown no appetite to represent their own citizens in negotiations. In the absence of any moves towards political integration and to avoid a probable disorderly exit, it is critical to formally establish an opt-out clause for exit from the eurozone and, in the meantime, rapidly prepare procedures for such an exit.
    Date: 2011–05
  13. By: Gerlach, Stefan; Lewis, John
    Abstract: We study ECB’s interest rate setting in 1999-2010 using a reaction function in which forecasts of future economic growth and inflation enter as regressors. Allowing for a gradual switch between two reaction functions, we detect a shift after Lehman Brothers failed in September 2008 when the pre-crisis reaction function first indicates that interest rates may become constrained by the zero lower bound. Furthermore, the interest rate cuts in late 2008 were more aggressive than forecast by the pre-crisis reaction function. These findings are compatible with the literature on optimal monetary policy in the presence of a zero lower bound.
    Keywords: ECB; reaction functions; smooth transition; zero lower bound
    JEL: C2 E52
    Date: 2011–07
  14. By: Tadeusz Kowalski (Poznan University of Economics); Yochanan Shachmurove (Department of Economics, University of Pennsyslvania and The City College of The City University of New York)
    Abstract: This paper analyzes the causes and implications of recent financial crises. Financial crises in general lead to changes in both theory and practice of economics. The paper takes an historical overview. The global consensus of economic theory during the 20th century is discussed. The paper describes the Bretton Woods regime after World War II, details the era of adaptive expectations and motivates the emerging of the rational expectations school of thoughts. Various perspectives on the causes of the financial crisis are incorporated. The paper provides some policy suggestions and remarks on the consequences of ever-changing capital markets.
    Keywords: Financial crises; The United States Financial Crisis Inquiry Commission; The 2010 Economic Report of the United States President; Keynsian Theory; Adaptive Expectations; Rational Expectations; Monetary and Fiscal Policies; Business Cycles; Regulations; General Agreement on Tariffs and Trade (GATT); World Trade Organization (WTO); Trade Liberalization; United States; China; Euro; Econometric Policy Evaluation
    JEL: B0 E0 E3 E4 E5 E6 F0 F3 F4 G0 H3 H6 K2 O51 P1 R3
    Date: 2011–07–06
  15. By: William A. Allen; Richhild Moessner
    Abstract: We examine the international propagation of the financial crisis of 2008, and compare it with that of the crisis of 1931. We argue that the collateral squeeze in the United States, which became intense after the failure of Lehman Brothers created doubts about the stability of other financial companies, was an important propagator in 2008. We identify some common features in the propagation of the two crises, the most important being the flight to liquidity and safety. In both crises, deposit outflows were not the only important sources of liquidity pressure on banks: in 1931, the central European acceptances of the London merchant banks were a serious problem, as, in 2008, were the liquidity commitments that commercial banks had provided to shadow banks. And in both crises, the behaviour of creditors towards debtors, and the valuation of assets by creditors, were very important. However, there was a very important difference between the two crises in the range and nature of assets that were regarded as liquid and safe. Central banks in 2008, with no gold standard constraint, could liquefy illiquid assets on a much greater scale.
    Keywords: financial crisis, liquidity, international monetary system, Great Depression
    Date: 2011–07
  16. By: Christoph Görtz; John Tsoukalas
    Abstract: Recent evidence suggests that agents’ expectations may have played a role in several cycli¬cal episodes such as the U.S. "new economy" boom in the late 1990s, the real estate boom in Japan in the 1980s and the real estate boom in the U.S. which ended in 2008. One chal¬lenge in the expectations driven view of fluctuations has been to develop simple one sector models that can give rise to such fluctuations without a compromise on other dimensions. In this paper we propose a simple generalization of the Greenwood et al. (1988) one sec¬tor model and show it can generate fluctuations that arise as a result of agents difficulty to forecast productivity embodied in new capital. The two key assumptions in the model are: (1) the vintage view of capital productivity, whereby each successive vintage has (po¬tentially) different productivity and (2) agents’ imperfect information and learning about this productivity. The model is consistent with second and third moments from U.S. data. Simulations of the model suggest that, (a) noise amplifies fluctuations and (b) pure noise can trigger recessions that mimic in magnitude, duration and depth the typical post WW II U.S. recession.
    Keywords: News shocks, expectations, growth asymmetry, Bayesian learning, business cy¬cles.
  17. By: Benjamin Born; Johannes Peifer
    Abstract: The argument that policy risk, i.e. uncertainty about monetary and fiscal policy, has been holding back the economic recovery in the U.S. during the Great Recession has a large popular appeal. We analyze the role of policy risk in explaining business cycle fluctuations by using an estimated New Keynesian model featuring policy risk as well as uncertainty about technology. We directly measure uncertainty from aggregate time series using Sequential Monte Carlo Methods. While we find considerable evidence of policy risk in the data, we show that the "pure uncertainty"-effect of policy risk is unlikely to play a major role in business cycle fluctuations. With the estimated model, output effects are relatively small due to i) dampening general equilibrium effects that imply a low amplification and ii) counteracting partial effects of uncertainty. Finally, we show that policy risk has effects that are an order of magnitude larger than the ones of uncertainty about aggregate TFP.
    Keywords: Policy Risk; Uncertainty; Aggregate Fluctuations; Particle Filter; General Equilibrium.
    JEL: E32 E63 C11
    Date: 2011–06
  18. By: Lizarazo, Sandra; Da-Rocha, Jose-Maria
    Abstract: In a context in which individuals might default on their debts and subsequently be excluded from credit markets, holding money helps agents smooth their consumption during periods in which they cannot borrow. Therefore holding money makes the punishment to default less severe. In this context, by affecting money demand, monetary policy can affect incentives to default; determining optimal monetary policy can then be thought of as equivalent to choosing the optimal default rate. Since each economy might have a different optimal default rate, each economy might have a different optimal monetary policy different from the Friedman rule. Specifically, we compare the US to Colombia, using a model with idiosyncratic labor income risk and fiat money. Given differences in enforcement of debt contracts, and differences in income variability and persistence, we find that high inflation is costlier for developing countries compared to developed countries.
    Keywords: Default; Inflation; Fiat Money; Friedman rule; Endogenous Borrowing Constraints; Precautionary Savings.
    JEL: E52 E44 E21 E41
    Date: 2011–06–29
  19. By: Lichao Cheng; Yi Jin; Zhixiong Zeng
    Abstract: This paper studies empirically the dynamic interactions between asset prices, monetary policy, and aggregate fluctuations during the Volcker-Greenspan period. Using a simple structural vector autoregression framework, we investigate the effects of monetary policy on output, inflation and asset prices, the interactions of asset prices with the aggregate economy, as well as the relationship between stock price and house price. Several robust findings emerge. The systematic response of monetary policy to output and inflation is also found to play an important role in stabilizing the aggregate economy. In addition, the results call for special attention to be paid to house price when studying the dynamic relationships between asset prices and macroeconomic fluctuations.
    Keywords: House prices; stock prices; systematic monetary policy; structural vector autoregressions.
    JEL: E31 E32 E44 E52
    Date: 2011–06
  20. By: Jakob B Madsen
    Abstract: This paper proposes a model in which house prices are determined by housing affordability in the short run, while being determined by acquisition costs in the long run. Housing affordability is, in turn, determined by nominal income and nominal mortgage payments. The model explains the recent housing market run-up in the OECD countries by lower housing repayments, decreasing nominal interest rates, and a large inflow of migrants. Empirical estimates give strong support for the model and suggest that it explains house prices in the OECD better than the mainstream models.
    Keywords: house prices, institutions, affordability, financial innovations, Tobin’s q.
    JEL: E13 E22 G12
    Date: 2011–06
  21. By: Andrew Ang; Allan Timmermann
    Abstract: Regime switching models can match the tendency of financial markets to often change their behavior abruptly and the phenomenon that the new behavior of financial variables often persists for several periods after such a change. While the regimes captured by regime switching models are identified by an econometric procedure, they often correspond to different periods in regulation, policy, and other secular changes. In empirical estimates, the regime switching means, volatilities, autocorrelations, and cross-covariances of asset returns often differ across regimes, which allow regime switching models to capture the stylized behavior of many financial series including fat tails, heteroskedasticity, skewness, and time-varying correlations. In equilibrium models, regimes in fundamental processes, like consumption or dividend growth, strongly affect the dynamic properties of equilibrium asset prices and can induce non-linear risk-return trade-offs. Regime switches also lead to potentially large consequences for investors' optimal portfolio choice.
    JEL: G11 G12
    Date: 2011–06
  22. By: Yi Jin; Zhixiong Zeng
    Abstract: This paper develops a model of banking frictions and banking riskiness, the importance of which is highlighted by the recent Global Financial Crisis (GFC). We propose a model-based approach to decompose the effect of a banking riskiness shock into a pure default effect and a risk effect when risk sharing among the depositors is imperfect. Although the default effect is quantitatively more important, the risk effect is not to be neglected. When the shock generates a bank spread similar in value to the peak during the GFC, the overall effect is a decline in employment by 6:57 percent. The pure default effect leads to a 4:76 percent employment decline by a “within-model” measure, and a 5:05 decline by a “between-model” measure. The remaining is attributed to the risk effect.
    Keywords: Banking riskiness shocks; two-sided debt contract; default effects; risk effects; financial crisis.
    JEL: E44 E32 D82 D86
    Date: 2011–06
  23. By: Mario Forni; Luca Gambetti; Luca Sala
    Abstract: This paper uses a structural, large dimensional factor model to evaluate the role of `news' shocks (shocks with a delayed effect on productivity) in generating the business cycle. We find that (i) existing small-scale VECM models are affected by `non-fundamentalness' and therefore fail to recover the correct shock and impulse response functions; (ii) news shocks have a limited role in explaining the business cycle; (iii) their effects are in line with what predicted by standard neoclassical theory; (iv) the bulk of business cycle flucuations is explained by shocks unrelated to technology.
    Keywords: structural factor model; news shocks; invertibility; fundamentalness
    JEL: C32 E32 E62
    Date: 2011–06
  24. By: Patrick Bunk
    Abstract: Recent studies proposed news about future technology growth as the main driver of macroeconomic fluctuations. The identification of these news through stock prices in SVARs has been criticized in the past. Therefore, I propose a series of experiments to test that hypothesis by examining its implications. If business cycles are mainly driven by news then these shocks should be captured by other time series as well. I find that news shocks identified through S&P 500 prices exhibit the same dynamics as news identified through a broader stock price index, patent applications, the relative price of investment or shocks to the real interest rate. The common theme among these identifications is a technological change in productivity that demands time to build, economic activity and natural resources to come into effect.
    Keywords: Business Cycles, News Shocks, Technological Progress
    JEL: E30 E32
    Date: 2011–07
  25. By: Mario Forni; Luca Gambetti
    Abstract: We derive necessary and sufficient conditions under which a set of variables is information-ally sufficient, i.e. contains enough information to estimate the structural shocks with a VAR model. Based on such conditions, we provide a procedure to test for informational sufficiency. If sufficiency is rejected, we propose a strategy to amend the VAR. Our method can be applied to FAVAR models and can be used to determine how many factors to include in such models. We apply our procedure to a VAR including TFP, unemployment and per-capita hours worked. We find that the three variables are not informationally sucient. When adding missing information, the effects of technology shocks change dramatically.
    Keywords: Structural VAR; non-fundamentalness; information; FAVAR models; technology shocks
    JEL: C32 E32 E62
    Date: 2011–06
  26. By: Guido Ascari (Department of Economics and Quantitative Methods, University of Pavia); Nicola Branzoli (University of Wisconsin Madison)
    Abstract: We study the properties of the optimal nominal interest rate policy under different levels of price indexation. In our model indexation regulates the sources of inflation persistence. When indexation is zero, the inflation gap is purely forward- looking and inflation persistence depends only on the level of trend inflation, while full indexation makes the inflation gap persistent and it eliminates the effects of trend inflation. We show that in the former case the optimal policy is inertial and targets inflation stability while in the latter the optimal policy has no inertia and targets the real interest rate. We compare our results with empirical estimates of the FED's policy in the post-WWII era.
    Keywords: Inflation Persistence, Taylor Rule, New Keynesian model, Indexation
    JEL: E31 E52
    Date: 2010–11
  27. By: Nan-Kuang Chen (National Taiwan University and Hong Kong Institute for Monetary Research); Han-Liang Cheng (Chung-Hua Institution for Economic Research); Ching-Sheng Mao (National Taiwan University)
    Abstract: This paper investigates the transmission mechanism of mortgage premium to characterize the relationship between the housing market and the business cycle for the U.S. economy. The model matches the main features of the U.S. housing market and business cycles well. The mortgage premium is crucial for the amplification and propagation of the model to match the data. If the Federal Reserve had exercised pre-emptive monetary policy in 2002Q1, the counterfactual analysis suggests that a higher interest rate would have stabilized house price and housing investment volatilities, but would have taken a big toll on real GDP: its volatility remains approximately the same, but the level of GDP contracts dramatically.
    Keywords: Mortgage Premium, House Price, DSGE
    JEL: E3 E4 E5 G1
    Date: 2011–06
  28. By: J. A. CARRILLO
    Abstract: This paper finds that a model with pervasive information frictions is less successful than a standard model featuring nominal rigidities, inflation indexation, and habit persistence in generating the dynamics triggered by technology shocks, as estimated by a vector autoregression using key U.S. macroeconomic time series. The real wage responses after a permanent increase in productivity tilt the balance clearly in favor of the standard model. The sticky information model overestimates the speed of adjustment in the real wage and is hence particularly unsuccessful in replicating its inertial response, whereas the standard model relies on inflation indexation in wage-setting to achieve a better fit. The two models are, however, statistically equivalent in mimicking the responses of output, inflation, the real wage and the federal funds rate after a shock in monetary policy.
    Keywords: Sticky prices, sticky information, inflation indexation, monetary and technology shocks
    JEL: E31 E52 C15
    Date: 2011–06
  29. By: M. Marzo; P. Zagaglia
    Abstract: The present paper introduces two bonds in a standard New-Keynesian model to study the role of segmentation in bond markets for the determinacy of rational expectations equilibria. We use a strongly-separable utility function to model ‘liquid’ bonds that provide transaction services for the purchase of consumption goods. ‘Illiquid’ bonds, instead, provide the standard services of store of value. We interpret liquid bonds as mimicking short-term instruments, and illiquid bonds to represent long-dated instruments. In this simple setting, the expectation hypothesis holds after log-linearizing the model and after pricing the bonds according to an affine scheme. We assume that monetary policy follows a standard Taylor rule. In this context, the inflation targeting parameter should be higher than one for determinacy of rational expectations equilibria to be achieved. We compute an analytical solution for the bond pricing kernel. We also show that the possibility of obtaining this analytical solution depends on the type of utility function. When utility is weakly separable between consumption and liquid bonds, the Taylor principle holds conditional to the output and inflation coefficients in the Taylor rule. Achieving solution determinacy requires constraining these coefficients within bounds that depend on the structural parameters of the model, like the intertemporal elasticity of consumption substitution.
    JEL: E43 E63
    Date: 2011–07
  30. By: Kevin Dowd (The University of Nottingham, UK); John Cotter (University College Dublin, Ireland)
    Abstract: This paper proposes the use of wavelet methods to estimate U.S. core inflation. It explains wavelet methods and suggests they are ideally suited to this task. Comparisons are made with traditional CPI-based and regression-based measures for their performance in following trend inflation and predicting future inflation. Results suggest that wavelet-based measures perform better, and sometimes much better, than the traditional approaches. These results suggest that wavelet methods are a promising avenue for future research on core inflation.
    Keywords: core inflation, wavelets, trend inflation, inflation prediction
    Date: 2011–06–24
  31. By: Tiziana Assenza; Peter Heemeijer; Cars Hommes; Domenica Massaro
    Abstract: The way in which individual expectations shape aggregate macroeconomic variables is crucial for the transmission and effectiveness of monetary policy. We study the individual expectations formation process and the interaction with monetary policy, within a standard New Keynesian model, by means of laboratory experiments with human subjects. We find that a more aggressive monetary policy that sets the interest rate more than point for point in response to inflation stabilizes inflation in our experimental economies. We use a simple model of individual learning, with a performance-based evolutionary selection among heterogeneous forecasting heuristics, to explain coordination of individual expectations and aggregate macro behavior observed in the laboratory experiments. Three aggregate outcomes are observed: convergence to some equilibrium level, persistent oscillatory behaviour and oscillatory convergence. A simple heterogeneous expectations switching model fits individual learning as well as aggregate outcomes and outperforms homogeneous expectations benchmarks.
    Keywords: Experiments; Monetary Policy; Expectations; Heterogeneity
    JEL: C91 C92 E52
    Date: 2011–05
  32. By: Guido Ascari (Department of Economics and Quantitative Methods, University of Pavia); Neil Rankin (Department of Economics and Related Studies, University of York)
    Abstract: We construct a staggered-price dynamic general equilibrium model with overlapping generations based on uncertain lifetimes. Price stickiness plus lack of Ricardian Equivalence could be expected to make an increase in government debt, with associated changes in lumpsum taxation, effective in raising short-run output. However we find this is very sensitive to the monetary policy rule. A permanent increase in debt under a basic Taylor Rule does not raise output. To make debt effective we need either a temporary nominal interest rate peg; or inertia in the rule; or an exogenous money supply policy; or to make the debt increase temporary.
    Keywords: staggered prices, overlapping generations, government debt, fiscal policy effectiveness, monetary policy rules
    JEL: E62 E63
    Date: 2010–11
  33. By: Gunes Kamber; Christoph Thoenissen
    Abstract: We examine the transmission mechanism of banking sector shocks in a two-country DSGE model. Assuming that the home country is small relative to the rest of world, we find that spillovers from foreign banking sector shocks are modest unless banks in the small country hold foreign banking assets. The correlation between home and foreign GDP rises with the exposure of the of the domestic banking sector to foreign bank assets.
    Date: 2011–06–21
  34. By: Martin Berka; Michael B. Devereux; Thomas Rudolph
    Abstract: We study a newly released data set of scanner prices for food products in a large Swiss online supermarket. We find that average prices change about every two months, but when we exclude temporary sales, prices are extremely sticky, changing on average once every three years. Non-sale price behavior is broadly consistent with menu cost models of sticky prices. When we focus specifically on the behavior of sale prices, however, we find that the characteristics of price adjustment seems to be substantially at odds with standard theory.
    Date: 2011–07
  35. By: Martin Evans (Department of Economics, Georgetown University)
    Abstract: This article summarizes exchange-rate research using microstructure models. It first lays out the key features of the foreign exchange market and describes how they are incorporated into a canonical model of currency trading. The empirical implications of the model are then examined. The article also discusses how currency trading links spot rate dynamics to macroeconomic conditions, and how this link sheds light on some long-standing puzzles concerning the behavior of exchange rates. Classification-JEL Codes:
    Keywords: Currency Trading, Exchange Rates, Exchange Rate Puzzles, Exchange Rate Fundamentals, Foreign Exchange Market, Microstructure, Order Flow, Risk Premium
    Date: 2010–07–10
  36. By: Shouyong Shi
    Abstract: Equity price is cyclical and often leads the business cycle by one or two quarters. These observations lead to the hypothesis that shocks to equity market liquidity are an independent source of the business cycle. In this paper I construct a model to evaluate this hypothesis. The model is easy for aggregation and for the construction of the recursive competitive equilibrium. After calibrating the model to the US data, I find that a negative liquidity shock in the equity market can generate large drops in investment and output but, contrary to what one may conjecture, the shock generates an equity price boom. This response of equity price occurs as long as a negative liquidity shock tightens firms' financing constraints on investment. Thus, liquidity shocks to the equity market cannot be the primary driving force of the business cycle. For equity price to fall as it typically does in a recession, a negative liquidity shock must be accompanied or caused by other shocks that reduce the need for investment sufficiently and relax firms' financing constraints on investment. I illustrate that a strong negative productivity shock is a good candidate of such concurrent shocks.
    Keywords: Liquidity; Asset prices; Business cycle
    JEL: E32 E5 G1
    Date: 2011–06–14
  37. By: Fagnart, Jean-Francois; Licandro, Omar; Portier, Franck
    Abstract: In a stochastic dynamic general equilibrium framework, we introduce the concept of variable capacity utilization (as opposed to the concept of capital utilization). We consider an economy where imperfectly competitive firms use a putty-clay technology and decide on their productive capacity level under uncertainty. An idiosyncratic uncertainty about the exact position of the demand curve facedby each firm explains why sorne productive capacities may remain idle in the sequel and why individual capacity utilization rates differ across firms. The capacity underutilization at the aggregate level thus hides a diversity of microeconomic situations. The variability of the capacity utilization allows for a good description of sorne of the main stylized facts of the business cycle, propagates and magnifies aggregate technological shocks and generates endogenous persistence (Le., the output growth rate displays positive serial correlation).
    Keywords: Business Cycle; Capacity Utilization; Idiosyncratic shocks; Mark-ups; Propagation Mecanism;
  38. By: Martin Evans and Dagfinn Rime (Department of Economics, Georgetown University)
    Abstract: Classification-JEL Codes: F3, F4, G1
    Keywords: Exchange Rate Dynamics, Microstructure, Order Flow
    Date: 2010–07–10
  39. By: Alessia Campolmi (Central European University; Magyar Nemzeti Bank (central bank of Hungary)); Ester Faia (Goethe University Frankfurt; Kiel Institute for the World Economy (IfW); CEPREMAP); Roland Winkler (Goethe University Frankfurt; Kiel Institute for the World Economy (IfW))
    Abstract: During the Great Recession following the recent financial crisis large fiscal stimuli were implemented to counteract labor market sclerosis. We explore the effectiveness of various fiscal packages in a matching model featuring inefficient unemployment and a rich fiscal sector employing distortionary taxation and government debt. Results show that only stimuli directed toward the labor market, such as hiring subsidies, deliver large multipliers. Those policies can, indeed, abate the congestion externality, pervasive in the labor market. Various robustness checks confirm the results. The results obtained in the calibrated model are also confirmed through Bayesian estimation.
    Keywords: fiscal calculus, taxation, matching frictions, bayesian estimation
    JEL: E62 E63 E24
    Date: 2011
  40. By: Massimo Antonini; Kevin Lee; Jacinta Pires
    Abstract: We document that, at business cycle frequencies, fluctuations in nominal variables, such as aggregate price levels and nominal interest rates, are substantially more synchronized across countries than fluctuations in real output. To the extent that domestic nominal variables are largely determined by domestic monetary policy, this might seem surprising. We ask if a parsimonious international business cycle model can account for this aspect of cross-country aggregate fluctuations. It can. Due to spillovers of technology shocks across countries, expected future responses of national central banks to fluctuations in domestic output and inflation generate movements in current prices and interest rates that are synchronized across countries even when output is not. Even modest spillovers produce cross-country correlations such as those in the data.
    Keywords: International business cycles, prices, interest rates.
  41. By: Kevin Lee; James Morley; Kalvinder Shields
    Abstract: This paper provides a characterisation of U.S. monetary policy within a generalized Tay¬lor rule framework that accommodates uncertainties about the duration of policy regimes and the speciÞcation of the rule, in addition to the standard parameter and stochastic un¬certainties inherent in traditional Taylor rule analysis. Our approach involves estimation and inference based on Taylor rules obtained through standard linear regression methods, but combined using Bayesian model averaging techniques. Employing data that were available in real time, the estimated version of the ‘meta’ Taylor rule provides a ßexible but compelling characterisation of monetary policy in the United States over the last forty years.
    Keywords: Taylor rule, real-time policy, model uncertainty, US interest rates.
  42. By: Fabrizio Mattesini (University of Rome "Tor Vergata"); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia)
    Abstract: We study the e¤ects of progressive labor income taxation in an otherwise standard NK model. We show that progressive taxation (i) introduces a trade-o¤ between output and in?ation stabilization and a¤ects the slope of the Phillips Curve; (ii) acts as automatic stabilizer changing the responses of the economy to technology shocks and demand shocks (iii) alters the prescription for the optimal discretionary interest rate rule. We also show that the welfare gains from commitment decrease as labor income taxes become more progressive. Quantitatively, the model is able to reproduce the observed negative correlation between the volatility of output, hours and in?ation and the degree of progressivity of labor income taxation.
    JEL: E50 E52 E58
    Date: 2010–11
  43. By: Paolo Tasca; Stefano Battiston
    Abstract: The recent credit crisis of 2007/08 has raised a debate about the so-called knife-edge properties of financial markets. The paper contributes to the debate shedding light on the controversial relation between risk-diversification and financial stability. We model a financial network where assets held by borrowers to meet their obligations, include claims against other borrowers and securities exogenous to the network. The balance-sheet approach is conjugated with a stochastic setting and by a mean-field approximation the law of motion of the system's fragility is derived. We show that diversification has an ambiguous effect and beyond a certain levels elicits financial instability. Moreover, we find that risk-sharing restrictions create a socially preferable outcome. Our findings have significant implications for future policy recommendation.
    Keywords: Systemic Risk, Financial Crisis, Diversification, Default Probability
  44. By: Carin van der Cruijsen; Jakob de Haan; Franka Liedorp; Robert Mosch
    Abstract: Following Eijffinger and Geraats (2006), we construct an index of transparency of banking supervisors that takes political, economic, procedural, policy and operational transparency into account. Based on a survey, we construct the index for 24 banking supervisors. There are large differences among transparency of supervisors. The average total score is 9.2 points (out of 15), whereas the minimum is 6.25 points and the maximum 12.75 points. The average of economic transparency is the highest, while the average score for policy transparency is the lowest. Our analysis suggests that it is very hard to identify factors that can explain these differences.
    Keywords: G28
    Date: 2011–05
  45. By: Stefan Schüder
    Abstract: This paper develops an open economy portfolio balance model with en¬dogenous asset supply. Domestic producers finance capital goods through credit and bonds in accordance with debt capital costs as well as through equity assets. Private households hold a portfolio of domestic and foreign assets, shift balances depending on risk-return considerations, and maximise real consumption in accordance with the real exchange rate. Within this general equilibrium model, it can be shown that expansive monetary interventions, being applied throughout the course of economic crises, stabilise the real amount of domestic investments at the cost of inflation, currency devaluation, distortions of interest rates, and risk clusters on the central bank’s balance sheet. Furthermore, through exchange rate stabilising interventions, the central bank is able to stabilise the real amount of domestic investments and in turn the main goal of exchange rate stabilisation is also achieved. However, either risk clusters on central bank’s balance sheet or changes in the domestic price level emerge. This consequently results in both types of central bank interventions promoting an inefficient international allocation of real capital investments.
    Keywords: portfolio balance, monetary policy, macroeconomic risk, exchange rate, real capital investments
    JEL: E10 E44 E52
    Date: 2011–06–27
  46. By: Schüder, Stefan
    Abstract: This paper develops an open economy portfolio balance model with endogenous asset supply. Domestic producers finance capital goods through credit and bonds in accordance with debt capital costs as well as through equity assets. Private households hold a portfolio of domestic and foreign assets, shift balances depending on risk-return considerations, and maximise real consumption in accordance with the real exchange rate. Within this general equilibrium model, it can be shown that expansive monetary interventions, being applied throughout the course of economic crises, stabilise the real amount of domestic investments at the cost of inflation, currency devaluation, distortions of interest rates, and risk clusters on the central bank’s balance sheet. Furthermore, through exchange rate stabilising interventions, the central bank is able to stabilise the real amount of domestic investments and in turn the main goal of exchange rate stabilisation is also achieved. However, either risk clusters on central bank’s balance sheet or changes in the domestic price level emerge. This consequently results in both types of central bank interventions promoting an inefficient international allocation of real capital investments.
    Keywords: portfolio balance; monetary policy; macroeconomic risk; exchange rate; real capital investments
    JEL: E52 E44 E10
    Date: 2011–06–25
  47. By: Dino Martellato (Department of Economics, University Of Venice Cà Foscari)
    Abstract: We investigate in this paper the skirmishes that the US dollar and the euro had from 2007 to 2011 and, in particular, the two distinct sharp falls that the single currency had in 2008 and 2010. We basically consider how impulses coming from domestic money markets impact on the USD/EUR exchange rate through the Eurocurrency market. Our findings show that the cycles in the spreads in the LIBOR rates have a bearing on the direction of change in the spot exchange rate in a way which is different from that predicted by the interest rate parity. The exposure of the value of reserve currencies to the vagaries of the outside circulation in the Eurocurrency and FX markets is only one of the many different policy implications of the current arrangement of the international monetary system. In the final part of the paper we also discuss some of those tied to the very existence of the international money market and to competition among old and emerging global currencies and financial centres.
    Keywords: Exchange rates, LIBOR rates, reserve currencies, financial centres.
    JEL: F31 F33 F36
    Date: 2011
  48. By: Maurice J. Roche (Department of Economics, Ryerson University, Toronto, Canada); Michael J. Moore (School of Management and Economics, The Queen's University of Belfast, Belfast, Northern Ireland)
    Abstract: We present a simple framework in which both the exchange rates disconnect and forward bias puzzles are simultaneously resolved. The flexible-price two-country monetary model is extended to include a consumption externality with habit persistence. Habit persistence is modeled using Campbell Cochrane preferences with „deep? habits. By deep habits, we mean habits defined over goods rather than countries. The model is simulated using the artificial economy methodology. It offers a neo-classical explanation of the Meese-Rogoff puzzle and mimics the failure of fundamentals to explain nominal exchange rates in a linear setting. Finally, the model naturally generates the negative slope in the standard forward market regression.
    Keywords: Exchange Rate Puzzles; Forward Foreign Exchange; Habit Persistence
    JEL: F31 F41 G12
    Date: 2009–10
  49. By: Thanassis Kazanas (Athens University of Economics and Business); Elias Tzavalis (Athens University of Economics and Business)
    Abstract: This paper provides evidence that, since the sign of Maastricht Treaty, euro-area monetary authorities mainly follow a strong anti-inflationary policy. This policy can be described by a threshold monetary policy rule model which allows for distinct inflation policy regimes: a low and high. The paper finds that these authorities react more strongly to positive deviations of inflation and/or output from their target levels rather than to the negative. They do not seem to react at all to negative deviations of output from its target level in the low-inflation regime. We argue that this behaviour can be attributed to the attitude of the monetary authorities to build up credibility on stabilizing inflationary expectations. To evaluate the policy implications of the above euro-area monetary policy rule behaviour, the paper simulates a small New Keynesian model. This exercise clearly indicates that the absence of reaction of the euro-area monetary authorities to negative output gap when inflation is very low reduces their efficiency on dampening the effects of negative demand shocks on the economy.
    Keywords: Monetary policy, threshold models; regime-switching; generalized method of moments; New Keynesian model
    JEL: E52 C13 C30
    Date: 2011–05
  50. By: Herbert Buscher; Hubert Gabrisch
    Abstract: This study deals with the question whether the central banks of Sweden, Denmark and the UK can really influence short-term money markets and thus, would lose this influence in case of Euro adoption. We use a GARCH-M-GED model with daily money market rates. The model reveals the co-movement between the Euribor and the shortterm interest rates in these three countries. A high degree of co-movement might be seen as an argument for a weak impact of the central bank on its money markets. But this argument might only hold for tranquil times. Our approach reveals, in addition, whether there is a specific reaction of the money markets in turbulent times. Our finding is that the policy of the European Central Bank (ECB) has indeed a significant impact on the three money market rates, and there is no specific benefit for these countries to stay outside the Euro area. However, the GARCH-M-GED model further reveals risk divergence and unstable volatilities of risk in the case of adverse monetary shocks to the economy for Sweden and Denmark, compared to the Euro area. We conclude that the danger of adverse monetary developments cannot be addressed by a common monetary policy for these both countries, and this can be seen as an argument to stay outside the Euro area
    Keywords: Euro adoption, EMS, money markets, interest rates, GARCH-M-GED models, international financial markets
    JEL: E42 E43 F36 G15
    Date: 2011–07
  51. By: Abad, José M; Loeffler, Axel; Zemanek, Holger
    Abstract: This paper analyses the implications of a continued divergence of TARGET2 balances for monetary policy in the euro area. The accumulation of TARGET2 claims (liabilities) would make ECB’s liquidity management asymmetric once the TARGET2 claims in core countries have crowded out central bank credit in those regions. Then while providing scarce liquidity to banks in countries with TARGET2 liabilities, the ECB will need to absorb excess liquidity in countries with TARGET2 claims. We discuss three alternatives and its implications to absorb excess liquidity in core regions: (1) Using market based measures might accelerate the capital flight from periphery to core countries and would add to the accumulation of risky assets by the ECB. (2) Conducting non-market based measures such as imposing differential (unremunerated) reserve requirements would distort banking markets and would support the development of shadow banking. (3) Staying passive would lead to decreasing interest rates in core Europe entailing inflationary pressure and overinvestment in those regions and possibly future instability of the banking system.
    Keywords: TARGET2 balances; monetary policy; euro area; Eurosystem; excess liquidity
    JEL: F32 E42 E58 E52 F36
    Date: 2011–07–02
  52. By: Jerger, Jürgen; Röhe, Oke
    Abstract: We estimate a New Keynesian DSGE model on French, German and Spanish data. The main aim of this paper is to check for the respective sets of parameters that are stable over time, making use of the ESS procedure ( ”Estimate of Set of Stable parameters“) developed by Inoue and Rossi (2011). This new econometric technique allows to address the stability properties of each single parameter in a DSGE model separately. In the case of France and Germany our results point to structural breaks after the beginning of the second stage of EMU in the mid-nineties, while the estimates for Spain show a significant break just before the start of the third stage in 1998. Specifically, there are significant changes in monetary policy behavior for France and Spain, while monetary policy in Germany seems to be stable over time.
    Keywords: DSGE; EMU; Monetary Policy; Structural Breaks
    JEL: E31 E32 E52
    Date: 2009–10–01
  53. By: Tom Coupe (Kyiv School of Economics, Kyiv Economic Institute)
    Abstract: This paper adds to the growing literature that studies whether trust affects the financial decisions of people. More specifically, we investigate whether lack of trust in banks can explain why people save their savings in cash, ‘under the mattress’, rather than deposit their savings at the bank. We find a significant effect of lack of trust on the likelihood that a person saves money in cash but also that lack of trust can only provide part of the explanation for the ‘money under the mattress’ phenomenon. Other factors that matter are the financial awareness and access to bank services.
    Keywords: trust, bank deposits, cash savings, financial awareness
    JEL: G21 O16
    Date: 2011–06
  54. By: Alessia Campolmi (Central European University; Magyar Nemzeti Bank (central bank of Hungary)); Stefano Gnocchi (Universitat Autonoma de Barcelona)
    Abstract: In the present paper we examine how the introduction of endogenous participation in an otherwise standard DSGE model with matching frictions and nominal rigidities affects business cycle dynamics and monetary policy. The contribution of the paper is threefold: first, we show that the model provides a good fit for employment and unemployment volatility, as well as participation volatility and its correlation with output for US data. Second, we show that in such a model, and contrary to a model with exogenous participation, a monetary authority that becomes more aggressive in fighting inflation decreases the volatility of employment and unemployment. Finally, we show the role of search costs in shaping those results.
    Keywords: matching frictions, endogenous participation, monetary policy
    JEL: E24 E32 E52
    Date: 2011
  55. By: Ronny Nilsson; Gyorgy Gyomai
    Abstract: This paper reports on revision properties of different de-trending and smoothing methods (cycle estimation methods), including PAT with MCD smoothing, a double Hodrick-Prescott (HP) filter and the Christiano-Fitzgerald (CF) filter. The different cycle estimation methods are rated on their revision performance in a simulated real time experiment. Our goal is to find a robust method that gives early turning point signals and steady turning point signals. The revision performance of the methods has been evaluated according to bias, overall revision size and signal stability measures. In a second phase, we investigate if revision performance is improved using stabilizing forecasts or by changing the cycle estimation window from the baseline 6 and 96 months (i.e. filtering out high frequency noise with a cycle length shorter than 6 months and removing trend components with cycle length longer than 96 months) to 12 and 120 months. The results show that, for all tested time series, the PAT de-trending method is outperformed by both the HP or CF filter. In addition, the results indicate that the HP filter outperforms the CF filter in turning point signal stability but has a weaker performance in absolute numerical precision. Short horizon stabilizing forecasts tend to improve revision characteristics of both methods and the changed filter window also delivers more robust turning point estimates.<BR>Ce document présente l’impact des révisions dû à différentes méthodes de lissage et de correction de la tendance (méthodes d'estimation du cycle), comme la méthode PAT avec lissage en utilisant le mois de dominance cyclique (MCD), le double filtre de Hodrick-Prescott (HP) et le filtre Christiano-Fitzgerald (CF). Les différentes méthodes d'estimation du cycle sont évaluées sur leur performance de révision faite à partir d’une simulation en temps réel. Notre objectif est de trouver une méthode robuste qui donne des signaux de point de retournement tôt et stable á la fois. La performance de révisions de ces méthodes a été évaluée en fonction du biais, de la grandeur de la révision et de la stabilité du signal. Nous examinerons ensuite si la performance de la révision peut être améliorée en utilisant des prévisions de stabilisation ou en changeant la fenêtre d'estimation du cycle de base de 6 et 96 mois à une fenêtre de 12 et 120 mois. La fenêtre d’estimation de base correspond à un filtre pour éliminer le bruit (hautes fréquences) avec une longueur de cycle de moins de 6 mois et supprimer la tendance avec une longueur de cycle supérieure à 96 mois. Les résultats montrent que, pour toutes les séries testées, la méthode PAT est moins performante que les deux filtres HP ou CF. En outre, les résultats indiquent que le filtre HP surpasse le filtre CF du point de vue de la stabilité du signal du point de retournement mais sa performance est plus faible quant à la précision numérique absolue. Des prévisions à court terme ont la tendance à améliorer les caractéristiques des révisions des deux méthodes et la modification de la fenêtre de base offre aussi des estimations plus robustes des points de retournement.
    Date: 2011–05–27
  56. By: Barbara Rossi; Atsushi Inoue
    Abstract: In this paper we propose a chi-square test for identification. Our proposed test statistic is based on the distance between two shrinkage extremum estimators. The two estimators converge in probability to the same limit when identification is strong, and their asymptotic distributions are different when identification is weak. The proposed test is consistent not only for the alternative hypothesis of no identification but also for the alternative of weak identification, which is confirmed by our Monte Carlo results. We apply the proposed technique to test whether the structural parameters of a representative Taylor-rule monetary policy reaction function are identified.
    Keywords: GMM, Shrinkage, Weak Identification
    JEL: C12
    Date: 2010
  57. By: Peter Mavromatis; Marnie Griffith
    Abstract: This paper examines methods aimed at improving baseline economic forecasts using a dynamic CGE model. Forecasting can be used to test the validity of such models, as well as to highlight possible improvements, by investigating the discrepancies between the forecast and actual outcomes. The model employed here is USAGE - a recursive dynamic, 500-industry CGE model of the U.S. USAGE generates baseline forecasts by incorporating expert forecasts for certain macro variables and extrapolating historical trends in technology, consumer preferences, positions of foreign demand curves for U.S. products, and numerous other naturally exogenous variables. In instances where important trends either dissipate or reverse, large forecast errors can arise. This paper seeks to provide explanations and guidance as to whether these various trends from the period 1992 to 1998 would continue for the 1998 to 2005 USAGE forecast. The twenty largest errors on a relative and/or absolute basis are examined. It is found that for some commodities, had all publicly available information by 1998 been appropriately utilised, certain important trends should not have been expected to continue. Hence, a better forecast could have been generated had the projection of certain trends been nullified. More generally, the findings suggest that there is a case to be argued against projecting forward large values relating to import-domestic preference twist factors in particular. It is also shown that for commodities in the trade-exposed textile, clothing and footwear industries moderately better results could have been produced by implementing import price forecasts in a way that is more in line with historical trade policy. This was achieved by projecting forward real basic import prices. However, the key drivers behind these errors were usually the significant underestimation of the impact of import-domestic preference twist factors, as well as the overestimation of factor input cost savings. In relation to forecasts for commodities in the oil and mining sectors as well as industries that service these cyclical industries, it is concluded that these typically could not have been improved in the absence of strong convictions (by 1998) about an impending mining "super-cycle" or extended boom. For the construction-related commodities demand was fuelled by virtually unprecedented low borrowing costs. In these instances, it is difficult to conclusively argue that the modeller could have produced a better forecast. Moreover, while large improvements in forecast accuracy can be obtained for some industries and sectors, the overall economy-wide forecast error does not fall greatly due to the sheer volume of commodities. While it is disappointing that the error is not very reducible, it is also reassuring because it implies that the default implementation of the model is quite powerful. In all about 4% of all commodities were specifically examined to assess the potential for error reduction. After due consideration about 7.5% of commodities were in some way directly re-projected. To generate a large reduction in the forecast error would require an extensive amount of work and probably call for the input of numerous industry specialists.
    Keywords: CGE, forecasting, validation
    JEL: C68 D58
    Date: 2011–04
  58. By: Anna Naszódi (Magyar Nemzeti Bank (central bank of Hungary))
    Abstract: This paper proposes a new test for the asset pricing model of the exchange rate. It examines whether the way market analysts generate their forecasts is closer to the one implied by the asset pricing model, or to any of those implied by some alternative models. The asset pricing model is supported by the test since it has significantly better out-of-sample fit on survey data than simpler models including the random walk. The traditional test based on forecasting ability is applied as well. The asset pricing model proves to have better forecast accuracy in case of some exchange rates and forecast horizons than the random walk.
    Keywords: asset pricing exchange rate model, present value model of exchange rate, survey data
    JEL: F31 F36 G13
    Date: 2011
  59. By: Anna Naszódi (Magyar Nemzeti Bank (central bank of Hungary))
    Abstract: This paper investigates the forecasting ability of survey data on exchange rate expectations with multiple forecast horizons. The survey forecasts are on the exchange rates of five Central and Eastern European currencies: Czech Koruna, Hungarian Forint, Polish Zloty, Romanian Leu and Slovakian Koruna. First, different term-structure models are fitted on the survey forecasts. Then, the forecasting performances of the fitted forecasts are compared. The fitted forecasts for the 5 months horizon and beyond are proved to be significantly better than the random walk on the pooled data of the five currencies. The best performing term-structure model is the one that assumes an exponential relationship between the forecast and the forecast horizon, and has time-varying parameters.
    Keywords: evaluating forecasts, exchange rate, survey forecast, time-varying parameter, term-structure of forecasts
    JEL: F31 F36 G13
    Date: 2011
  60. By: Fernandez-Corugedo, Emilio (Bank of England); McMahon, Michael (University of warwick and Centre for Economic Performance, LSE); Millard, Stephen (Bank of England); Rachel, Lukasz (Bank of England)
    Abstract: In this paper we first document the behaviour of working capital over the business cycle stressing the large negative effect of the recent credit contraction on UK firms working capital positions. In order to understand the effects of working capital on macroeconomic variables, we solve and calibrate an otherwise standard flexibleprice DSGE model that introduces an explicit role for the components of working capital as well as a banking sector which intermediates credit. We find that financial intermediation shocks, similar to those experienced post-2007, have persistent negative effects on economic activity ; these effects are reinforced by reductions in trade credit. Our model admits a crucial role for monetary policy to offset such shocks. Key words: Working capital ; business cycle model ; spreads ; financial crisis. JEL classification: E20 ; E51 ; E52
    Date: 2011
  61. By: John E. Floyd
    Abstract: 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: Canadian Monetary Policy Real Exchange Rates
    JEL: E F
    Date: 2011–06–15
  62. By: Rangan Gupta (Department of Economics, University of Pretoria); Faaiqa Hartley (Department of Economics, University of Pretoria)
    Abstract: This paper assesses the predictive ability of asset prices relative to other variables in forecasting inflation and real GDP growth in South Africa. A total of 42 asset and non-asset predictor variables are considered. Forecasts of inflation and real GDP growth are computed using both individual predictor autoregressive distributed lag (ARDL) models, forecast combination approaches, as well as, large scale models. The large scale data models considered include Bayesian vector autoregressive models, and classical and Bayesian univariate and multivariate factor augmented vector autoregressive models. The models are estimated for an in-sample of 1980:Q2 to 1999:Q4, and then one- to eight step-ahead forecasts for inflation and real GDP growth are evaluated over the 2000:Q1 to 2010:Q2 out-of-sample period. Principle Component forecast combination models are found to produce the most accurate out-of-sample forecasts of inflation and real GDP growth relative to the other combination and more sophisticated models considered. Asset prices are found to contain particularly useful information for forecasting inflation and real GDP growth at certain horizons. Asset prices are however found to be stronger predictors of inflation, particularly in the long run.
    Keywords: Asset Prices, Combination Forecasts, BVAR, FAVAR
    JEL: C32 R31
    Date: 2011–07
  63. By: André Nassif (Universidade Federal Fluminense e BNDES); Carmem Feijó (Universidade Federal Fluminense); Eliane Araújo (Universidade Estadual de Maringá)
    Abstract: We present a Structuralist-Keynesian theoretical approach on the determining factors of the real exchange rate for open emerging economies. Instead of macroeconomic fundamentals, the long-term trend of the real exchange rate level is better determined not only by structural forces and long-term economic policies, but also by both short-term macroeconomic policies and their indirect effects on other short-term economic variables. In our theoretical model, the actual real exchange rate is broken down into long-term structural and short-term components, and both of which may be responsible for deviations of that actual variable from its long-term trend level. The econometric model for the Brazilian economy in the 1999-2010 period shows that the terms of trade and the short-term interest rate differential are the most significant variables that explain the long-term trend of the real exchange rate overvaluation in Brazil. We also propose an index of overvaluation and an original definition of a long-term “optimal” real exchange rate for open emerging economies. The econometric results show two basic conclusions: first the Brazilian currency was persistently overvalued throughout almost all of the period under analysis; and second, the long-term “optimal” real exchange rate was reached in 2004. In January 2011, the average nominal exchange rate should be around 2.91 Brazilian reais per US dollar for reaching that “optimal” level, against an observed average nominal exchange rate of 1.67 Brazilian reais per US dollar. According to this estimation, in January 2011, the real overvaluation of the Brazilian currency in relation to the long-term ¨optimal¨ level was around 74 per cent. These findings lead us to suggest in the conclusion that a mix of policy instruments should be used in order to reverse the overvaluation trend of the Brazilian real exchange rate, including a target for reaching the “optimal” real exchange rate in the medium and the long-run.
    Keywords: real exchange rate, real overvaluation, economic policy dilemmas, Brazil
    JEL: F30 F31 F39
    Date: 2011
  64. By: Stefano Ugolini (Scuola Normale Superiore, Pisa)
    Abstract: As well as the current one, the wave of globalization culminated in 1913 was marked by increasing accumulation of foreign exchange reserves. But what did ‘reserves’ mean in the past, how were they managed, and how much relevant are the differences between then and now? This paper is the first attempt to investigate 19th-century reserve management from central banks’ perspective. Building on a significant case study (the National Bank of Belgium, i.e. the ‘inventor’ of foreign exchange policy, in the 1850s), it shows that risk management practices in the past differed considerably from nowadays. The structure of the international monetary system allowed central banks to minimize financial risk, while poor institutional design enhanced operational risk: this is in stark contrast with the present situation, in which operational risk has been minimized and financial risk has considerably increased. Yet 19th-century reserve management was apparently not conducive to major losses for central banks, while the opposite seems to have been the case in the 21st century.
    Keywords: Foreign exchange reserves, international monetary systems, central banking, risk management
    JEL: E42 E58 G11 N23
    Date: 2011–07–05

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