nep-cba New Economics Papers
on Central Banking
Issue of 2011‒07‒27
35 papers chosen by
Alexander Mihailov
University of Reading

  1. Cycles, Gaps, and the Social Value of Information By George-Marios Angeletos; Luigi Iovino; Jennifer La'O
  2. Tranching, CDS and Asset Prices: How Financial Innovation Can Cause Bubbles and Crashes By Ana Fostel; John Geanakoplos
  3. International Recessions By Perri, Fabrizio; Quadrini, Vincenzo
  4. A Gains from Trade Perspective on Macroeconomic Fluctuations By Beaudry, Paul; Portier, Franck
  5. Quo vadis, Euroland? European Monetary Union between Crisis and Reform By Martin Hellwig
  6. "The Global Crisis and the Remedial Actions: A Nonmainstream Perspective" By Sunanda Sen
  7. Bank Overleverage and Macroeconomic Fragility By Ryo Kato; Takayuki Tsuruga
  8. Sources of Entropy in Representative Agent Models By David Backus; Mikhail Chernov; Stanley E. Zin
  9. Sources of entropy in representative agent models By Backus, David; Chernov, Mikhail; Zin, Stanley E.
  10. Informality, Frictions and Monetary Policy By Nicoletta Batini; Paul Levine; Emanuela Lotti; Bo Yang
  11. House Price Booms and the Current Account By Klaus Adam; Pei Kuang; Albert Marcet
  12. The theoretical framework of monetary policy revisited By Balfoussia, Hiona; Brissimis, Sophocles; Delis, Manthos D
  13. Monetary policy under myopia By Gaël Giraud; Nguenamadji Orntangar
  14. How do inflation expectations form? New insights from a high-frequency survey By Gabriele Galati; Peter Heemeijer; Richhild Moessner
  15. Does the Box-Cox transformation help in forecasting macroeconomic time series? By Tommaso, Proietti; Helmut, Luetkepohl
  16. Asymmetric Phase Shifts in the U.S. Industrial Production Cycles By Yongsung Chang; Sunoong Hwang
  17. Forecasting in the presence of recent structural change By Jana Eklund; George Kapetanios; Simon Price
  18. Central Bank Transparency, the Accuracy of Professional Forecasts, and Interest Rate Volatility By Menno Middeldorp
  19. FOMC Communication Policy and the Accuracy of Fed Funds Futures By Menno Middeldorp
  20. Identification of Monetary Policy in SVAR Models: A Data-Oriented Perspective By Matteo Fragetta; Giovanni Melina
  21. Identifying the effects of government spending shocks with and without expected reversal - an approach based on U.S. real-time data By Jacopo Cimadomo; Sebastian Hauptmeier; Sergio Sola
  22. Risk Management of Risk Under the Basel Accord: A Bayesian Approach to Forecasting Value-at-Risk of VIX Futures By Michael McAleer; Roberto Casarin; Chia-Lin Chang; Juan-Ángel Jiménez-Martín; Teodosio Pérez-Amaral
  23. The Euro-Sting revisited: PMI versus ESI to obtain euro area GDP forecasts By Maximo Camacho; Agustin Garcia-Serrador
  24. GFC-Robust Risk Management Under the Basel Accord Using Extreme Value Methodologies By Paulo Araújo Santos; Juan-Ángel Jiménez-Martín; Michael McAleer; Teodosio Pérez Amaral
  25. Marking-to-Market Government Guarantees to Financial Systems.Theory and Evidence for Europe By Angelo Baglioni; Umberto Cherubini
  26. Fiscal and Monetary Institutions in Central, Eastern and South-Eastern European Countries By Zsolt Darvas; Valentina Kostyleva
  27. Fiscal News and Macroeconomic Volatility By Benjamin Born; Alexandra Peter; Johannes Pfeifer
  28. How to Solve the Price Puzzle? A Meta-Analysis By Marek Rusnák; Tomáš Havránek; Roman Horváth
  29. Tail Behaviour of the Euro By John Cotter
  30. Towards a micro-founded theory of aggregate labor supply By Andrés Erosa; Luisa Fuster; Gueorgui Kambourov
  31. How Experts Decide: Identifying Preferences versus Signals from Policy Decisions By Stephen Hansen; Michael McMahon
  32. Employment Growth, Inflation and Output Growth: Was Phillips Right?: Evidence from a Dynamic Panel By Guglielmo Maria Caporale; Marinko Skare
  33. Keynesian Economics After All By A. Johansen; I. Simonsen
  34. How flexible are real wages in EU countries? A panel investigation By Frigyes Ferdinand Heinz; Desislava Rusinova
  35. Accounting for the Decline in the Velocity of Money in the Japanese Economy By Nao Sudo

  1. By: George-Marios Angeletos; Luigi Iovino; Jennifer La'O
    Abstract: What are the welfare effects of the information contained in macroeconomic statistics, central-bank communications, or news in the media? We address this question in a business-cycle framework that nests the neoclassical core of modern DSGE models. Earlier lessons that were based on “beauty contests” (Morris and Shin, 2002) are found to be inapplicable. Instead, the social value of information is shown to hinge on essentially the same conditions as the optimality of output stabilization policies. More precise information is unambiguously welfare-improving as long as the business cycle is driven primarily by technology and preference shocks—but can be detrimental when shocks to markups and wedges cause sufficient volatility in “output gaps.” A numerical exploration suggests that the first scenario is more plausible.
    JEL: C7 D6 D8
    Date: 2011–07
  2. By: Ana Fostel (Dept. of Economics, George Washington University); John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: We study the effect of leverage, tranching, securitization and CDS on asset prices in a general equilibrium model with collateral. We show how the timing of financial innovation might have contributed to the mortgage boom and to the bust of 2007-2009. We show why tranching and leverage tend to raise asset prices and why CDS tend to lower them. This may seem puzzling, since it implies that creating a derivative tranche in the securitization whose payoffs are identical to the CDS will raise the underlying asset price while the CDS outside the securitization lowers it. The resolution of the puzzle is that the CDS lowers the value of the underlying asset since it is equivalent to tranching cash.
    Keywords: Endogenous leverage, Collateral equilibrium, CDS, Tranching, Asset prices
    JEL: D52 D53 E44 G10 G12
    Date: 2011–07
  3. By: Perri, Fabrizio; Quadrini, Vincenzo
    Abstract: The 2008-2009 crisis was characterized by an unprecedented degree of international synchronization as all major industrialized countries experienced large macroeconomic contractions around the date of Lehman bankruptcy. At the same time countries also experienced large and synchronized tightening of credit conditions. We present a two-country model with financial market frictions where a credit tightening can emerge as a self-fulfilling equilibrium caused by pessimistic but fully rational expectations. As a result of the credit tightening, countries experience large and endogenously synchronized declines in asset prices and economic activity (international recessions). The model suggests that these recessions are more severe if they happen after a prolonged period of credit expansion.
    Keywords: credit tightness; international crisis
    JEL: E32 F3
    Date: 2011–07
  4. By: Beaudry, Paul; Portier, Franck
    Abstract: Business cycles reflect changes over time in the amount of trade between individuals. In this paper we show that incorporating explicitly intra-temporal gains from trade between individuals into a macroeconomic model can provide new insight into the potential mechanisms driving economic fluctuations as well as modify key policy implications. We first show how a "gains from trade" approach can easily explain why changes in perceptions about the future (including \news" about the future) can cause booms and bust. We then turn to fiscal policy, and discuss under what conditions fiscal multipliers can be observed. While much of our analysis is conducted in a fl exible price environment, we also present implications of our model for a sticky price environments, as it allows to understand stable-in ation boom-bust cycles. The source of the explicit gains from trade in our setup derives from simply assuming that in the short run workers are not perfect mobile across all sectors of the economy. We provide evidence from the PSID in support of this modeling assumption.
    Keywords: Business Cycle; Fiscal Policy; Heterogeneous Agents; Investment; Monetary Policy
    JEL: E32
    Date: 2011–07
  5. By: Martin Hellwig (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This lecture discusses the 2010 crisis of the European Monetary Union and draws some lessons for reform. Crisis resolution has been difficult because the sovereign debt crisis of countries like Greece and Portugal has come together with real-estate and banking crises in countries like Ireland and Spain and bank vulnerability in countries like Germany and France. Failure to disentangle and resolve the different crises prevents a satisfactory approach to the long-term reform of governance of sovereign borrowing and banking. Any such reform must find a substitute for the discipline that exchange rate mechanisms impose on sovereign borrowers and their lenders when the currency is national. Any mechanism for imposing discipline on sovereign borrowers and their lenders must be designed so that enforcement is credible even in a crisis. Recommendations for reform include (i) an inclusion of sovereign exposure from too-big-to-fail concerns in banking in monitoring of fiscal stance, (ii) independence of bank supervisors from their respective political authorities, and (iii) a strengthening of the powers of the European Supervisory Authorities over the national supervisors.
    Keywords: European Monetary Union, sovereign debt crisis, bank supervision
    JEL: G28 F53 F33 F36
    Date: 2011–06
  6. By: Sunanda Sen
    Abstract: The global financial crisis has now spread across multiple countries and sectors, affecting both financial and real spheres in the advanced as well as the developing economies. This has been caused by policies based on "rational expectation" models that advocate deregulated finance, with facilities for easy credit and derivatives, along with globalized exposures for financial institutions. The financial crisis has combined with long-term structural changes in the real economy that trend toward underconsumption, generating contractionary effects therein and contributing to further instabilities in the financial sector. The responses so far from US monetary authorities have not been effective, especially in dealing with issues of unemployment and low real growth in the United States, or in other countries. Nor have these been of much use in the context of the lost monetary and fiscal autonomy in both developing countries and the eurozone, especially with the debt-related distress in the latter. Solutions to the current maladies in the global economy include strict control of financial speculation and the institution of an "employer of last resort" policy, both at the initiative of the state.
    Keywords: Global Crisis; Expectations; Underconsumption; Ponzi; Labor Flexibility
    JEL: E2 E4 E5 E6 J2 J3 J6
    Date: 2011–07
  7. By: Ryo Kato (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Takayuki Tsuruga (Associate Professor, Graduate School of Economics, Kyoto University, (E-mail:
    Abstract: This paper develops a dynamic general equilibrium model that explicitly includes a banking sector with a maturity mismatch. We demonstrate that, despite the perfect competition in the banking sector, rational banks take on excessive risks systemically, resulting in overleverage and inefficiently high crisis probabilities. The model accounts for the banks' rational over-optimism regarding future capital prices which arises from pecuniary externalities on their own solvency. Using the model as an example, we introduce MSR (marginal systemic risk) as a general measure to assess the macroeconomic exposure to systemic risks.
    Keywords: Financial crisis, Liquidity shortage, Maturity mismatch, Pecuniary externalities
    JEL: E3 G21
    Date: 2011–07
  8. By: David Backus; Mikhail Chernov; Stanley E. Zin
    Abstract: We propose two metrics for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The metrics describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (time dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and time dependence and compare their magnitudes to estimates derived from asset returns. This exercise — and transparent loglinear approximations — clarifies the mechanisms underlying these models. It also reveals, in some cases, tension between entropy, which should be large enough to account for observed excess returns, and time dependence, which should be small enough to account for mean yield spreads.
    JEL: E44 G12
    Date: 2011–07
  9. By: Backus, David; Chernov, Mikhail; Zin, Stanley E.
    Abstract: We propose two metrics for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The metrics describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (time dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and time dependence and compare their magnitudes to estimates derived from asset returns. This exercise--and transparent loglinear approximations--clarifies the mechanisms underlying these models. It also reveals, in some cases, tension between entropy, which should be large enough to account for observed excess returns, and time dependence, which should be small enough to account for mean yield spreads.
    Keywords: asset returns; bond yields; disasters; habits; jumps; pricing kernel; recursive preferences
    JEL: E44 G12
    Date: 2011–07
  10. By: Nicoletta Batini (University of Surrey and IMF); Paul Levine (University of Surrey); Emanuela Lotti (University of Southampton and University of Surrey); Bo Yang (University of Surrey)
    Abstract: How does informality in emerging economies affect the conduct of monetary policy? To answer this question we construct a two-sector, formal-informal new Keynesian closed-economy. The informal sector is more labour intensive, is untaxed, has a classical labour market, faces high credit constraints in financing investment and is less visible in terms of observed output. We compare outcomes under welfare-optimal monetary policy, discretion and welfare-optimized interest-rate Taylor rules building the model in stages; first with no frictions in these two markets, then with frictions in only the formal labour market and finally with frictions on both credit markets and the formal labour market. Our main conclusions are first, labour and financial market frictions, the latter assumed to be stronger in the informal sector, cause the time-inconsistency problem to worsen. The importance of commitment therefore in- creases in economies characterized by a large informal sector with the features we have highlighted. Simple implementable optimized rules that respond only to observed aggregate inflation and formal-sector output can be significantly worse in welfare terms than their optimal counterpart, but are still far better than discretion. Simple rules that respond, if possible, to the risk premium in the formal sector result in a significant welfare improvement.
    Keywords: Informal economy, emerging economies, labour market, credit market, tax policy, interest rate rules
    JEL: J65 E24 E26 E32
    Date: 2011–07
  11. By: Klaus Adam; Pei Kuang; Albert Marcet
    Abstract: A simple open economy asset pricing model can account for the house price and current account dynamics in the G7 over the years 2001-2008. The model features rational households, but assumes that households entertain subjective beliefs about price behavior and update these using Bayes' rule. The resulting beliefs dynamics considerably propagate economic shocks and crucially contribute to replicating the empirical evidence. Belief dynamics can temporarily delink house prices from fundamentals, so that low interest rates can fuel a house price boom. House price booms, however, are not necessarily synchronized across countries and the model is consistent with the heterogeneous response of house prices across the G7 following the reduction in real interest rates at the beginning of the millennium. The response to interest rates depends sensitively on agents' beliefs at the time of the interest rate reduction, which in turn are a function of the country specific history prior to the year 2000. According to the model, the US house price boom could have been largely avoided, if real interest rates had decreased by less after the year 2000.
    JEL: E44 F32 F41
    Date: 2011–07
  12. By: Balfoussia, Hiona; Brissimis, Sophocles; Delis, Manthos D
    Abstract: The three-equation New-Keynesian model advocated by Woodford (2003) as a self-contained system on which to base monetary policy analysis is shown to be inconsistent in the sense that its long-run static equilibrium solution implies that the interest rate is determined from two of the system’s equations, while the price level is left undetermined. The inconsistency is remedied by replacing the Taylor rule with a standard money demand equation. The modified system is seen to possess the key properties of monetarist theory for the long run, i.e. monetary neutrality with respect to real output and the real interest rate and proportionality between money and prices. Both the modified and the original New-Keynesian models are estimated on US data and their dynamic properties are examined by impulse response analysis. Our research suggests that the economic and monetary analysis of the European Central Bank could be unified into a single framework.
    Keywords: Monetary theory; Central banking; New-Keynesian model; Impulse response analysis
    JEL: E58 E52 E40 E47
    Date: 2011–07–13
  13. By: Gaël Giraud (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, ESCP-Europe - Campus de Paris); Nguenamadji Orntangar (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This paper provides a new framework for monetary macro-policy, where the Central Bank potentially intervenes both on short-term and long-term loans markets, and can do this alternatively by manipulating interest rates or money supply. Following Bonnisseau and Orntangar (2010) and Giraud and Tsomokos (2010), we develop a discrete-time out-of-equilibrium dynamics with real trades, performed by myopic heterogeneous households in a cash-in-advance economy with several goods. Positive value and non-neutrality of fiat money are shown to be compatible with a local quantity theory of money. Every monetary policy induces a globally unique trade path, both for real and nominal variables.Thus, monetary policy and myopia suffice to pin down the absolute level of prices. However, a minimal money growth rate is exhibited, which depends upon the level of households' long-term debt and current gains-to-trade. Below this growth rate, the economy falls into a local liquidity trap ; above it, the economy eventually converges towards a Pareto-optimal rest-point while inflation raises in an unbounded fashion. As a consequence, a literal application of Taylor's rule leads the economy to a local liquidity trap. These findings provide insight into recent non-conventional monetary policies led by Central Banks.
    Keywords: Central Bank, gains to trade, Taylor rule, myopia, liquidity trap.
    Date: 2011–02
  14. By: Gabriele Galati; Peter Heemeijer; Richhild Moessner
    Abstract: We provide new insights on the formation of inflation expectations - in particular at a time of great financial and economic turmoil - by evaluating results from a survey conducted from July 2009 through July 2010. Participants in this survey answered a weekly questionnaire about their short-, medium- and long-term inflation expectations. Participants received common information sets with data relevant to euro area inflation. Our analysis of survey responses reveals several interesting results. First, our evidence is consistent with long-term expectations having remained well anchored to the ECB's definition of price stability, which acted as a focal point for long-term expectations. Second, the turmoil in euro area bond markets triggered by the Greek fiscal crisis influenced short- and medium-term inflation expectations but had only a very small impact on long-term expectations. By contrast, longterm expectations did not react to developments of the euro area wide fiscal burden. Third, participants changed their expectations fairly frequently. The longer the horizon, the less frequent but larger these changes were. Fourth, expectations exhibit a large degree of timevariant non-normality. Fifth, inflation expectations appear fairly homogenous across groups of agents at the shorter horizon but less so at the medium- and long-term horizons.
    Keywords: inflation expectations, monetary policy, crisis
    Date: 2011–07
  15. By: Tommaso, Proietti; Helmut, Luetkepohl
    Abstract: The paper investigates whether transforming a time series leads to an improvement in forecasting accuracy. The class of transformations that is considered is the Box-Cox power transformation, which applies to series measured on a ratio scale. We propose a nonparametric approach for estimating the optimal transformation parameter based on the frequency domain estimation of the prediction error variance, and also conduct an extensive recursive forecast experiment on a large set of seasonal monthly macroeconomic time series related to industrial production and retail turnover. In about one fifth of the series considered the Box-Cox transformation produces forecasts significantly better than the untransformed data at one-step-ahead horizon; in most of the cases the logarithmic transformation is the relevant one. As the forecast horizon increases, the evidence in favour of a transformation becomes less strong. Typically, the na¨ıve predictor that just reverses the transformation leads to a lower mean square error than the optimal predictor at short forecast leads. We also discuss whether the preliminary in-sample frequency domain assessment conducted provides a reliable guidance which series should be transformed for improving significantly the predictive performance.
    Keywords: Forecasts comparisons; Multi-step forecasting; Rolling forecasts; Nonparametric estimation of prediction error variance.
    JEL: C53 C14 C52 C22
    Date: 2011–07–18
  16. By: Yongsung Chang (University of Rochester); Sunoong Hwang (Korea Institute for Industrial Economics & Trade)
    Abstract: We identify the cyclical turning points of 74 U.S. manufacturing industries and uncover new empirical regularities: (i) Cyclical phase shifts are highly concentrated around the aggregate turning points; (ii) In contrast to the conventional notion of a Ôsudden stop and slow recovery,Õ troughs are much more concentrated than peaks; (iii) Occurrences of phase shifts across industries support the spillovers through input-output linkages; (iv) The common macroeconomic shocks, such as exogenous changes in the federal funds rate, government spending, and oil prices, are significant drivers of industrial phase shifts; (v) Both monetary and fiscal policy shocks are more effective in recessions.
    Keywords: Business cycles; Comovement; Turning points; Asymmetries
    JEL: C14 C33 C35 E23 E32
    Date: 2011–07
  17. By: Jana Eklund; George Kapetanios; Simon Price
    Abstract: We examine how to forecast after a recent break. We consider monitoring for change and then combining forecasts from models that do and do not use data before the change; and robust methods, namely rolling regressions, forecast averaging over different windows and exponentially weighted moving average (EWMA) forecasting. We derive analytical results for the performance of the robust methods relative to a full-sample recursive benchmark. For a location model subject to stochastic breaks the relative MSFE ranking is EWMA < rolling regression < forecast averaging. No clear ranking emerges under deterministic breaks. In Monte Carlo experiments forecast averaging improves performance in many cases with little penalty where there are small or infrequent changes. Similar results emerge when we examine a large number of UK and US macroeconomic series.
    JEL: C10 C59
    Date: 2011–07
  18. 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.
    Keywords: Central bank communication, interest rate forecasts, central bank transparency, financial market efficiency
    JEL: D83 E47 E58 G14
    Date: 2011–07
  19. By: Menno Middeldorp
    Abstract: Over the last two decades, the Federal Open Market Committee (FOMC), the rate-setting body of the United States Federal Reserve System, has become increasingly communicative and transparent. According to policymakers, one of the goals of this shift has been to improve monetary policy predictability. Previous academic research has found that the FOMC has indeed become more predictable. Here, I contribute to the literature in two ways. First, instead of simply looking at predictability before and after the Fed's communication reforms in the 1990s, I identify three distinct periods of reform and measure their separate contributions. Second, I correct the interest rate forecasts embedded in fed funds futures contracts for risk premiums, in order to obtain a less biased measure of predictability. My results suggest that the communication reforms of the early 1990s and the 'guidance' provided from 2003 significantly improved predictability, while the release of the FOMC's policy bias in 1999 had no measurable impact. Finally, I find that FOMC speeches and testimonies significantly lower short-term forecasting errors.
    Keywords: central bank communication, central bank transparency, futures pricing, financial market efficiency
    JEL: D83 E58 G13 G14
    Date: 2011–07
  20. By: Matteo Fragetta (University of Salerno); Giovanni Melina (University of Surrey)
    Abstract: This paper applies graphical modelling theory to recover identifying restrictions for the analysis of monetary policy shocks in a VAR of the US economy. Results are in line with the view that only high-frequency data should be assumed to be in the information set of the monetary authority when the interest rate decision is taken.
    Keywords: Monetary policy; SVAR; Graphical modelling
    JEL: E43 E52
    Date: 2011–07
  21. By: Jacopo Cimadomo (European Central Bank, Directorate General Economics, Fiscal Policies Division, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Sebastian Hauptmeier (European Central Bank, Directorate General Economics, Fiscal Policies Division, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Sergio Sola (Graduate Institute of International Studies, Department of Economics, 11A Avenue de La Paix, 1201 Genève, Switzerland.)
    Abstract: This paper investigates how expectations about future government spending affect the transmission of fiscal policy shocks. We study the effects of two different types of government spending shocks in the United States: (i) spending shocks that are accompanied by an expected reversal of public spending growth below trend; (ii) spending shocks that are accompanied by expectations of future spending growth above trend. We use the Ramey (2011)’s time series of military build-ups to measure exogenous spending shocks, and deviations of forecasts of public spending with respect to past trends, evaluated in real-time, to distinguish shocks into these two categories. Based on a structural VAR analysis, our results suggest that shocks associated with an expected spending reversal exert expansionary effects on the economy and accelerate the correction of the initial increase in public debt. Shocks associated with expected spending growth above trend, instead, are characterized by a contraction in aggregate demand and a more persistent increase in public debt. The main channel of transmission seems to run through agents’ perception of the future macroeconomic environment. JEL Classification: E62, E65, H20.
    Keywords: Government spending shocks, Survey of Professional Forecasters, Real-time data, Spending reversal, Fiscal multipliers.
    Date: 2011–07
  22. By: Michael McAleer (Erasmus University Rotterdam, Tinbergen Institute, The Netherlands, Complutense University of Madrid, and Institute of Economic Research, Kyoto University); Roberto Casarin (Department of Economics Ca’Foscari University of Venice); Chia-Lin Chang (Department of Applied Economics Department of Finance National Chung Hsing University Taichung, Taiwan); Juan-Ángel Jiménez-Martín (Department of Quantitative Economics Complutense University of Madrid); Teodosio Pérez-Amaral (Department of Quantitative Economics Complutense University of Madrid)
    Abstract: It is well known that the Basel II Accord requires banks and other Authorized Deposit-taking Institutions (ADIs) to communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models, whether individually or as combinations, to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. McAleer et al. (2009) proposed a new approach to model selection for predicting VaR, consisting of combining alternative risk models, and comparing conservative and aggressive strategies for choosing between VaR models. This paper addresses the question of risk management of risk, namely VaR of VIX futures prices, and extends the approaches given in McAleer et al. (2009) and Chang et al. (2011) to examine how different risk management strategies performed during the 2008-09 global financial crisis (GFC). The empirical results suggest that an aggressive strategy of choosing the Supremum of single model forecasts, as compared with Bayesian and non-Bayesian combinations of models, is preferred to other alternatives, and is robust during the GFC. However, this strategy implies relatively high numbers of violations and accumulated losses, which are admissible under the Basel II Accord.
    Keywords: Median strategy, Value-at-Risk, daily capital charges, violation penalties, aggressive risk management, conservative risk management, Basel Accord, VIX futures, Bayesian strategy, quantiles, forecast densities.
    JEL: G32 C53 C22 C11
    Date: 2011–07
  23. By: Maximo Camacho; Agustin Garcia-Serrador
    Abstract: This paper uses an extension of the Euro-Sting single-index dynamic factor model to construct short-term forecasts of quarterly GDP growth for the euro area, as also including financial variables as leading indicators. From a simulated real-time exercise, the model is used to investigate the forecasting accuracy across the different phases of the business cycle. In addition, the model is used to evaluate the relative forecasting ability of the two most watched business cycle surveys for the eurozone, the PMI and the ESI. We show that the latter produces more accurate GDP forecasts than the former. Finally, the proposed model is also characterized by its great ability to capture the European business cycle, as well as the probabilities of expansion and/or contraction periods.
    Keywords: Real-time forecasting, dynamic factor model, eurozone GDP, business cycle
    JEL: E32 C22 E27
    Date: 2011–06
  24. By: Paulo Araújo Santos (Escola Superior de Gestão e Tecnologia de Santarém and Center of Statistics and Applications, University of Lisbon); Juan-Ángel Jiménez-Martín (Departamento de Economía Cuantitativa (Department of Quantitative Economics), Facultad de Ciencias Económicas y Empresariales (Faculty of Economics and Business), Universidad Complutense de Madrid); Michael McAleer (Econometrisch Instituut (Econometric Institute), Faculteit der Economische Wetenschappen (Erasmus School of Economics), Erasmus Universiteit, Tinbergen Instituut (Tinbergen Institute).); Teodosio Pérez Amaral (Departamento de Economía Cuantitativa (Department of Quantitative Economics), Facultad de Ciencias Económicas y Empresariales (Faculty of Economics and Business), Universidad Complutense de Madrid)
    Abstract: In McAleer et al. (2010b), a robust risk management strategy to the Global Financial Crisis (GFC) was proposed under the Basel II Accord by selecting a Value-at-Risk (VaR) forecast that combines the forecasts of different VaR models. The robust forecast was based on the median of the point VaR forecasts of a set of conditional volatility models. In this paper we provide further evidence on the suitability of the median as a GFC-robust strategy by using an additional set of new extreme value forecasting models and by extending the sample period for comparison. These extreme value models include DPOT and Conditional EVT. Such models might be expected to be useful in explaining financial data, especially in the presence of extreme shocks that arise during a GFC. Our empirical results confirm that the median remains GFC-robust even in the presence of these new extreme value models. This is illustrated by using the S&P500 index before, during and after the 2008-09 GFC. We investigate the performance of a variety of single and combined VaR forecasts in terms of daily capital requirements and violation penalties under the Basel II Accord, as well as other criteria, including several tests for independence of the violations. The strategy based on the median, or more generally, on combined forecasts of single models, is straightforward to incorporate into existing computer software packages that are used by banks and other financial institutions.
    Keywords: Value-at-Risk (VaR), DPOT, daily capital charges, robust forecasts, violation penalties, optimizing strategy, aggressive risk management, conservative risk management, Basel, global financial crisis.
    JEL: G32 G11 C53 C22
    Date: 2011
  25. By: Angelo Baglioni (DISCE, Università Cattolica); Umberto Cherubini
    Abstract: We propose a new index for measuring the systemic risk of default of the banking sector, which is based on a homogeneous version of multivariate intensity based models (Cuadras – Augé distribution). We compute the index for 10 European countries, exploiting the information incorporated in the CDS premia of 44 large banks over the period January 2007 – September 2010. In this way, we provide a market based measure of the liability incurred by the Governments, due to the implicit bail-out guarantees they provide to the financial sector. We find that during the financial crisis the systemic component of the default risk in the banking sector has significantly increased in all countries, with the exception of Germany and the Netherlands. As a consequence, the Governments’ liability implicit in the bail out guarantee amounts to a quite relevant share of GDP in several countries: it is huge for Ireland, lower but still important for the other PIIGS (Italy is the least affected within this group) and for the UK. Finally, our estimate is very close to the overall amount of money already committed in the rescue plans adopted in Europe between Octo ber 2008 and March 2010, despite strong cross-country differences: in particular, Germany and Ireland seem to have committed an amount of resources much larger than needed; to the contrary, the Italian Government has committed much less than it should.
    Keywords: bank bail out, Government budget, systemic risk, financial crisis
    JEL: G21 H63
    Date: 2011–07
  26. By: Zsolt Darvas (Bruegel, Institute of Economics - Hungarian Academy of Sciences); Valentina Kostyleva (OECD Public Governance and Territorial Development Directorate)
    Abstract: This paper studies the role of fiscal and monetary institutions in macroeconomic stability and budgetary control in central, eastern and south-eastern European countries (CESEE) in comparison with other OECD countries. CESEE countries tend to grow faster and have more volatile output than non-CESEE OECD countries, which has implications for macroeconomic management: better fiscal and monetary institutions are needed to avoid pro-cyclical policies. The paper develops a Budgetary Discipline Index to assess whether good fiscal institutions underpin good fiscal outcomes. Even though most CESEE countries have low scores, the debt/GDP ratios declined before the crisis. This was largely the consequence of a very favourable relationship between the economic growth rate and the interest rate, but such a favourable relationship is not expected in the future. Econometric estimations confirm that better monetary institutions reduce macroeconomic volatility and that countries with better budgetary procedures have better fiscal outcomes. All these factors call for improved monetary institutions, stronger fiscal rules and better budgetary procedures in CESEE countries.
    Keywords: CESEE countries; Budgetary Discipline Index; budget process; fiscal institutions; budgetary institutions; monetary institutions; macroeconomic stability; econometric analysis; budgetary procedures; fiscal outcomes; fiscal rules.
    JEL: E32 E50 H11 H60
    Date: 2011–06
  27. By: Benjamin Born; Alexandra Peter; Johannes Pfeifer
    Abstract: This paper analyzes the contribution of anticipated capital and labor tax shocks to business cycle volatility in an estimated New Keynesian DSGE model. While fiscal policy accounts for 12 to 20 percent of output variance at business cycle frequencies, the anticipated component hardly matters for explaining fluctuations of real variables. Anticipated capital tax shocks do explain a sizable part of inflation and interest rate fluctuations, accounting for between 5 and 15 percent of total variance. In line with earlier studies, news shocks in total account for 20 percent of output variance. Further decomposing this news effect, we find that it is mostly driven by stationary TFP and non-stationary investment-specific technology.
    Keywords: Anticipated Tax Shocks; Sources of Aggregate Fluctuations; Bayesian Estimation
    JEL: E32 E62 C11
    Date: 2011–07
  28. By: Marek Rusnák (CERGE-EI); Tomáš Havránek (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic); Roman Horváth (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: The short-run increase in prices following an unexpected tightening of monetary policy represents a frequently reported puzzle. Yet the puzzle is easy to explain away when all published models are quantitatively reviewed. We collect and examine about 1,000 point estimates of impulse responses from 70 articles using vector autoregressive models to study monetary transmission in various countries. We find some evidence of publication selection against the price puzzle in the literature, but our results also suggest that the reported puzzle is mostly caused by model misspecifications. Finally, the long-run response of prices to monetary policy shocks depends on the characteristics of the economy.
    Keywords: Monetary policy transmission; Price puzzle; Meta-analysis; Publication selection bias
    JEL: E52
    Date: 2011–07
  29. By: John Cotter (University College Dublin)
    Abstract: This paper empirically analyses risk in the Euro relative to other currencies. Comparisons are made between a sub period encompassing the final transitional stage to full monetary union with a sub period prior to this. Stability in the face of speculative attack is examined using Extreme Value Theory to obtain estimates of tail exchange rate changes. The findings are encouraging. The Euro’s common risk measures do not deviate substantially from other currencies. Also, the Euro is stable in the face of speculative pressure. For example, the findings consistently show the Euro being less risky than the Yen, and having similar inherent risk to the Deutsche Mark, the currency that it is essentially replacing.
    Keywords: Extreme Value Theory; Tail Behaviour; GARCH; The Euro
    JEL: G15 F31
    Date: 2011–07–21
  30. By: Andrés Erosa (IMDEA Social Sciences Institute); Luisa Fuster (IMDEA Social Sciences Institute); Gueorgui Kambourov (University of Toronto)
    Abstract: We document various facts about the labor supply decisions of male workers in the US over their life cycle. We then build a neoclassical model of labor markets with non-linear wages and heterogeneous agents. The key model feature for delivering periods of non-participation is the non-linear mapping between hours of work and earnings. We show that our model can go a long way towards capturing salient features of individual labor supply over the life cycle. Moreover, the aggregate response of labor supply to a one time unanticipated wage shock is much larger than predicted by the Frisch elasticity of labor supply.
    Keywords: aggregate labor supply; intensive margin; extensive margin; heterogeneous agents; life cycle
    JEL: D9 E2 E13 E62 J22
    Date: 2011–07–13
  31. By: Stephen Hansen; Michael McMahon
    Abstract: A large theoretical literature assumes that experts di ffer in terms of preferences and the distribution of their private signals, but the empirical literature to date has not separately identi ed them. This paper proposes a novel way of doing so by relating the probability a member chooses a particular policy decision to the prior belief that it is correct. We then apply this methodology to study diff erences between internal and external members on the Bank of England's Monetary Policy Committee. Using a variety of proxies for the prior, we provide evidence that they di ffer significantly on both dimensions.
    Keywords: Bayesian decision making, committees, monetary policy
    JEL: D81 D82 E52
    Date: 2011–07
  32. By: Guglielmo Maria Caporale; Marinko Skare
    Abstract: In this paper we analyse the short- and long-run relationship between employment growth, inflation and output growth in Phillips' tradition. For this purpose we apply FMOLS, DOLS, PMGE, MGE, DFE, and VECM methods to a nonstationary heterogeneous dynamic panel including annual data for 119 countries over the period 1970-2010, and also carry out multivariate Granger causality tests. The empirical results strongly support the existence of a single cointegrating relationship between employment growth, inflation and output growth with bidirectional causality between employment growth and inflation as well as output growth, giving support to Phillips' Golden Triangle theory.
    Keywords: Employment growth, inflation, output growth, Golden Triangle theory
    JEL: C23 E24 E31 E60
    Date: 2011
  33. By: A. Johansen; I. Simonsen
    Abstract: It is demonstrated that the US economy has on the long-term in reality been governed by the Keynesian approach to economics independent of the current official economical policy. This is done by calculating the two-point correlation function between the fluctuations of the DJIA and the US public debt. We find that the origin of this condition is mainly related to the wars that the USA has fought during the time period investigated. Wars mean a large influx of public money into the economy, thus as a consequence creating a significant economical upturn in the DJIA. A reason for this straight-cut result of our analysis, is that very few wars have been fought on US-territory and those that have, were in the 18th century, when the partial destruction of cities, factories, railways and so on, was more limited and with less effect on the over-all economy.
    Date: 2011–07
  34. By: Frigyes Ferdinand Heinz (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Desislava Rusinova (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: In this paper we estimate the degree of real wage flexibility in 19 EU countries in a wage Phillips curve panel framework. We find evidence for a reaction of wage growth to unemployment and productivity growth. However, due to unemployment persistence, over time the real wage response weakens substantially. Our results suggest that the degree of real wage flexibility tends to be larger in the central and eastern European (CEE) countries than in the euro area; weaker in downturns than during upswings. Moreover, there exists an inflation threshold, below which real wage flexibility seems to decrease. Finally, we find that part of the heterogeneity in real wage flexibility and unemployment might be related to differences in the wage bargaining institutions and more specifically the extent of labour market regulation in different country groups within the EU. JEL Classification: J31, J38, P5.
    Keywords: real wage flexibility, bargaining institutions, central and eastern Europe, euro area, panel heterogeneity.
    Date: 2011–07
  35. By: Nao Sudo (Deputy Director, Institute for Monetary and Economic Studies (currently Research and Statistics Department), Bank of Japan (E-mail:
    Abstract: A notable feature of the Japanese economy following the banking crisis of the late 1990s is the drastic decline in the velocity of money and the consequent decline in the price level. Based on the inventory model of money demand a la Alvarez, Atkeson, and Edmond (2009), we explore how macroeconomic shocks affect the velocity. Households in the model are subject to a multiple-period cash-in-advance constraint in which the portion of the payment in cash, which we call the liquidity requirement, varies according to the credit service supply in the economy. Extracting various shocks underlying the velocity variations from 1990 to 2010, we find that an increase in the liquidity requirement is the key driver of the decline in velocity. Particularly important is the channel stemming from householdsf expectations about the future liquidity requirement. During the Japanese banking crisis and the global financial crisis, credit service is disrupted and households expect the disruption to last long. Since they demand additional money for a higher liquidity requirement for current and future transactions, the velocity and the price level decrease, even though the growth rate of money stock then exceeds that of consumption.
    Keywords: Velocity of Money, Liquidity Requirement, Financial Crises
    JEL: E4 E5
    Date: 2011–07

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