nep-cba New Economics Papers
on Central Banking
Issue of 2011‒10‒01
33 papers chosen by
Alexander Mihailov
University of Reading

  1. How Flexible Can Inflation Targeting Be and Still Work? By Kenneth N. Kuttner; Adam S. Posen
  2. How Flexible Can Inflation Targeting Be and Still Work? By Kenneth Kuttner; Adam Posen
  3. International Recessions By Fabrizio Perri; Vincenzo Quadrini
  4. The Role of Default in Macroeconomics By Charles A. E. Goodhart; Dimitrios P. Tsomocos
  5. Fiscal Policy in Debt Constrained Economies By Mark A. Aguiar; Manuel Amador
  6. Fiscal Multipliers in Recession and Expansion By Alan J. Auerbach; Yuriy Gorodnichenko
  7. Collateral Crises By Gary Gorton; Guillermo Ordonez
  8. Clearing Up the Fiscal Multiplier Morass By Eric M. Leeper; Nora Traum; Todd B. Walker
  9. Eurozone inflation differentials and the ECB By Pirovano M.; Van Poeck A.
  10. How to Restore Sustainability of the Euro? By Kari E.O. Alho
  11. Stock Market Volatility and Learning By Klaus Adam; Albert Marcet; Juan Pablo Nicolini
  12. Bubbles, Banks, and Financial Stability By Kosuke Aoki; Kalin Nikolov
  13. Estimating US persistent and transitory monetary shocks: implications for monetary policy By Juan Angel Lafuente; Rafaela Pérez; Jesús Ruiz
  14. Mapping the state of financial stability By Peter Sarlin; Tuomas A. Peltonen
  15. Optimal Monetary Policy with Endogenous Entry and Product Variety By Florin O. Bilbiie; Ippei Fujiwara; Fabio Ghironi
  16. Monetary policy in a non-representative agent economy: A survey By Michał Brzoza-Brzezina; Marcin Kolasa; Grzegorz Koloch; Krzysztof Makarski; Michal Rubaszek
  17. Fiscal disciplining effect of central bank opacity: Stackelberg versus Nash equilibrium. By Meixing Dai; Moïse Sidiropoulos
  18. Expectations, Employment and Prices: A Suggested Interpretation of the New ‘Farmerian’ Economics By Marco Guerrazzi
  19. Labor-Market Heterogeneity, Aggregation, and the Policy-(In)variance of DSGE Model Parameters By Yongsung Chang; Sun-Bin Kim; Frank Schorfheide
  20. Low-Income Countries Vulnerabilities and the Need for an SDR-Based International Monetary System By Pietro Alessandrini; Andrea Filippo Presbitero
  21. Financial-Friction Macroeconomics with Highly Leveraged Financial Institutions By Luk, Sheung Kan; Vines, David
  22. DSGE model estimation on base of second order approximation By Sergey Ivashchenko
  23. Precautionary price stickiness By James Costain; Anton Nakov
  24. Endogenous Credit Cycles By Chao Gu; Joseph Haslag
  25. The Stability and Growth Pact: crisis and reform By Ludger Schuknecht; Philippe Moutot; Philipp Rother; Jürgen Stark
  26. Asymmetric Information and the Foreign-Exchange Trades of Global Custody Banks By Carol Osler; Thang Nguyen; Tanseli Savaser
  27. Monetary policy and sunspot fluctuation in the U.S. and the Euro area By Hirose, Yasuo
  28. Forecasting with Approximate Dynamic Factor Models: the Role of Non-Pervasive Shocks By Mattéo Luciani
  29. Learning by Devaluating: A Supply-Side Effect of Competitive Devaluation By Juha Tervala
  30. Driving Forces of the Swiss Output Gap By Stefan Leist
  31. Floating against the tide : Spanish monetary policy, 1870-1931 By Pablo Martín-Aceña; Elena Martínez Ruiz; Pilar Noguer Marco
  32. Political Pressure on the National Bank of Slovakia By Peter Kukuk; Adam Gersl
  33. Overview of the Evolution of China's Central Bank and Monetary Policy: Correlation to the European Union By Skold, Alida S.

  1. By: Kenneth N. Kuttner (Oberlin College, Department of Economics); Adam S. Posen (Peterson Institute for International Economics)
    Abstract: This paper takes up the issue of the flexibility of inflation targeting regimes, with the specific goal of determining whether the monetary policy of the Bank of England, which has a formal inflation target, has been any less flexible than that of the Federal Reserve, which does not have such a target. The empirical analysis uses the speed of inflation forecast convergence, estimated from professional forecasters' predictions at successive forecast horizons, to gauge the perceived flexibility of the central bank's response to macroeconomic shocks. Based on this criterion, there is no evidence to suggest that the Bank of England's inflation target has compelled it to be more aggressive in pursuit of low inflation than the Federal Reserve.
    Keywords: Inflation targeting, inflation expectations, monetary policy
    JEL: E42 E58 E65
    Date: 2011–09
  2. By: Kenneth Kuttner (Williams College); Adam Posen
    Abstract: This paper takes up the issue of the flexibility of inflation targeting regimes, with the specific goal of determining whether the monetary policy of the Bank of England, which has a formal inflation target, has been any less flexible than that of the Federal Reserve, which does not have such a target. The empirical analysis uses the speed of inflation forecast convergence, estimated from professional forecasters’ predictions at successive forecast horizons, to gauge the perceived flexibility of the central bank’s response to macroeconomic shocks. Based on this criterion, there is no evidence to suggest that the Bank of England’s inflation target has compelled it to be more aggressive in pursuit of low inflation than the Federal Reserve.
    JEL: E42 E58 E65
    Date: 2011–09
  3. By: Fabrizio Perri (University of Minnesota and Federal Reserve Bank of Minneapolis (email:; Vincenzo Quadrini (University of Southern California)
    Abstract: The 2008-2009 crisis was characterized by an unprecedented degree of international synchronization as all major industrialized countries experienced large macroeconomic contractions. Countries also experienced large and synchronized contractions in the growth of financial flows. In this paper we present a two-country model with financial markets frictions where credit-driven recessions can explain these features of the recent crisis. A credit contraction can emerge as a self-fulling equilibrium caused by pessi- mistic but fully rational expectations. As a result of the credit contraction, in a financially integrated world, countries experience large and, endogenously synchronized, declines in asset prices and economic activity ( international recessions).
    Date: 2011–09
  4. By: Charles A. E. Goodhart (Norman Sosnow Professor of Banking and Finance, London School of Economics (email:; Dimitrios P. Tsomocos (Said Business School, University of Oxford (email:
    Abstract: What is the main limitation of much modern macro-economic theory, among the failings pointed out by William R. White at the 2010 Mayekawa Lecture? We argue that the main deficiency is a failure to incorporate the possibility of default, including that of banks, into the core of the analysis. With default assumed away, there can be no role for financial intermediaries, for financial disturbances, or even for money. Models incorporating defaults are, however, harder to construct, in part because the representative agent fiction must be abandoned. Moreover, financial crises are hard to predict and to resolve. All of the previously available alternatives for handling failing systemically important financial institutions (SIFIs) are problematical. We end by discussing a variety of current proposals for improving the resolution of failed SIFIs.
    Keywords: Default, Transversality, Money, Bankruptcy cost, Asset bubbles, Resolution mechanisms
    JEL: B40 E12 E30 E40 E44 G18 G20 G28 P10
    Date: 2011–09
  5. By: Mark A. Aguiar; Manuel Amador
    Abstract: We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero, reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the private agents are impatient relative to the international interest rate and the economy is subject to sovereign debt constraints. The front loading of labor taxes allows the economy to build a large (aggregate) debt position in the presence of limited commitment. We show that a similar result holds in a closed economy with imperfect inter-generational altruism.
    JEL: E62 F41 H63
    Date: 2011–09
  6. By: Alan J. Auerbach; Yuriy Gorodnichenko
    Abstract: In this paper, we estimate government purchase multipliers for a large number of OECD countries, allowing these multipliers to vary smoothly according to the state of the economy and using real-time forecast data to purge policy innovations of their predictable components. We adapt our previous methodology (Auerbach and Gorodnichenko, 2011) to use direct projections rather than the SVAR approach to estimate multipliers, to economize on degrees of freedom and to relax the assumptions on impulse response functions imposed by the SVAR method. Our findings confirm those of our earlier paper. In particular, GDP multipliers of government purchases are larger in recession, and controlling for real-time predictions of government purchases tends to increase the estimated multipliers of government purchases in recession. We also consider the responses of other key macroeconomic variables and find that these responses generally vary over the cycle as well, in a pattern consistent with the varying impact on GDP.
    JEL: E32 E62
    Date: 2011–09
  7. By: Gary Gorton (Yale University and NBER (e-mail:; Guillermo Ordonez (Yale University (e-mail:
    Abstract: How can a small shock sometimes cause a large crisis when it does not at other times? Financial fragility builds up over time because it is not optimal to always produce costly information about counterparties. Short-term, collateralized, debt (e.g., demand deposits, money market instruments) -private money- is efficient if agents are willing to lend without producing costly information about the value of the collateral backing the debt. But, when the economy relies on this informationally-insensitive debt, information is not renewed over time, generating a credit boom during which firms with low quality collateral start borrowing. During the credit boom output and consumption go up, but there is increased fragility. A small shock can trigger a large change in the information environment; agents suddenly produce information about all collateral and find that much of the collateral is low quality, leading to a decline in output and consumption. A social planner would produce more information than private agents, but would not always want to eliminate fragility.
    Date: 2011–09
  8. By: Eric M. Leeper; Nora Traum; Todd B. Walker
    Abstract: Bayesian prior predictive analysis of five nested DSGE models suggests that model specifications and prior distributions tightly circumscribe the range of possible government spending multipliers. Multipliers are decomposed into wealth and substitution effects, yielding uniform comparisons across models. By constraining the multiplier to tight ranges, model and prior selections bias results, revealing less about fiscal effects in data than about the lenses through which researchers choose to interpret data. When monetary policy actively targets inflation, output multipliers can exceed one, but investment multipliers are likely to be negative. Passive monetary policy produces consistently strong multipliers for output, consumption, and investment.
    JEL: C11 E62 E63
    Date: 2011–09
  9. By: Pirovano M.; Van Poeck A.
    Abstract: This paper presents new evidence on inflation differentials in the Euro Area from different perspectives, and extending the sample including the recent financial crisis. First, we give an informal analysis of the evolution of inflation dispersion and inflation differentials since the start of EMU. Second, we perform formal statistical analyses of the stability properties of inflation differentials in the period 1999-2010. Univariate and multivariate tests reject the null of stability of inflation differentials when conducted over the entire sample period. However, when the financial crisis is excluded, the null of stability is not rejected for the large majority of countries. This finding implies the beginning of a new tendency since the global financial turmoil, and new challenges for the common monetary policy. Finally, we analyze the determinants of inflation differentials, empirically testing a number of theories including price level equalization, productivity differentials, differences in cyclical positions, labor and product market rigidities. We conclude that inflation differentials are not the result of equilibrating, transitory forces, but rather of persistent structural and country-specific factors. This calls for structural reforms in labor and product markets, and countercyclical fiscal policy measures at the individual country level. As inflation differentials pose a serious challenge for the monetary policy of the ECB, we further believe that the ECB should be equipped with additional policy instruments to cope with them in a more direct way.
    Date: 2011–09
  10. By: Kari E.O. Alho
    Abstract: We reassess the result of unsustainability of the euro with respect to inflation differentials claimed by Wickens (2007) by specifying an open-economy version of a two-region New Keynesian model for EMU and demonstrate that the result by Wickens does not hold in general. We are able to derive a result that the model is determinate for a wide range of policy rules so that the sustainability of the euro area and the member countries is reached over time with respect to supply and demand shocks and emerged imbalances in price levels and competitiveness. We then enlarge the numerical analysis to consider EMU and sustainability in the case, prevailing currently, where a high debt country should both restore its competitiveness and its fiscal balance, and the policies re-quired from the single monetary policy and the national fiscal policies. Strong fiscal consolidation and far-reaching successful structural reforms are needed to reach sustainability in the sense that emerged imbalances in competitiveness and price levels and the threat of ever mounting debt levels could be eliminated over the medium run. We also illustrate how the current deflationary adjustment involves a major polarisation in economic developments within the euro area.
    JEL: E43 E52 E62
    Date: 2011–09–21
  11. By: Klaus Adam; Albert Marcet; Juan Pablo Nicolini
    Abstract: We study a standard consumption based asset pricing model with rationally investing agents but allow agents' prior beliefs about price and dividend behavior to deviate slightly from rational expectations priors. Learning about stock price behavior then causes the model to become quantitatively consistent with a range of basic asset prizing 'puzzles': stock returns display momentum and mean reversion, asset prices become volatile, the price-dividend ratio displays persistence, long-horizon returns become predictable and a risk premium emerges. Comparing the moments of the model with those in the data using confidence bands from the method of simulated moments, we show that our findings are robust to different assumptions on the system of beliefs and other model features. We depart from previous studies of asset prices under learning in that agents form expectations about future stock prices using past price observations.
    Keywords: asset pricing, learning, near-rational price forecasts
    JEL: G12 D84
    Date: 2011–09
  12. By: Kosuke Aoki (University of Tokyo (email:; Kalin Nikolov (European Central Bank(email:
    Abstract: This paper asks two main questions: (1) What makes some asset price bubbles more costly for the real economy than others? and (2)When do costly bubbles occur? We construct a model of rational bubbles under credit frictions and show that when bubbles held by banks burst this is followed by a costly financial crisis. In contrast, bubbles held by ordinary savers have relatively muted effects. Banks tend to invest in bubbles when financial liberalisation decreases their profitability.
    Keywords: Rational bubbles, Financial Frictions, Financial Stability
    JEL: E32 E44
    Date: 2011–09
  13. By: Juan Angel Lafuente; Rafaela Pérez; Jesús Ruiz
    Abstract: This paper proposes an estimation method for persistent and transitory monetary shocks using the monetary policy modeling proposed in Andolfatto et al, [Journal of Monetary Economics, 55 (2008), pp.: 406-422]. The contribution of the paper is threefold: a) to deal with non-Gaussian innovations, we consider a convenient reformulation of the state-space representation that enables us to use the Kalman filter as an optimal estimation algorithm. Now the state equation allows expectations play a significant role in explaining the future time evolution of monetary shocks; b) it offers the possibility to perform maximum likelihood estimation for all the parameters involved in the monetary policy, and c) as a consequence, we can estimate the conditional probability that a regime change has occurred in the current period given an observed monetary shock. Empirical evidence on US monetary policy making is provided through the lens of a Taylor rule, suggesting that the Fed’s policy was implemented accordingly with the macroeconomic conditions after the Great Moderation. The use of the particle filter produces similar quantitative and qualitative findings. However, our procedure has much less computational cost.
    Keywords: Kalman filter, Non-normality, Particle filter, Monetary policy
    JEL: C4 F3
    Date: 2011–09
  14. By: Peter Sarlin (Åbo Akademi University, Turku Centre for Computer Science, Joukahaisenkatu 3–5, 20520 Turku, Finland.); Tuomas A. Peltonen (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: The paper uses the Self-Organizing Map for mapping the state of financial stability and visualizing the sources of systemic risks as well as for predicting systemic financial crises. The Self-Organizing Financial Stability Map (SOFSM) enables a two-dimensional representation of a multidimensional financial stability space that allows disentangling the individual sources impacting on systemic risks. The SOFSM can be used to monitor macro-financial vulnerabilities by locating a country in the financial stability cycle: being it either in the pre-crisis, crisis, post-crisis or tranquil state. In addition, the SOFSM performs better than or equally well as a logit model in classifying in-sample data and predicting out-of-sample the global financial crisis that started in 2007. Model robustness is tested by varying the thresholds of the models, the policymaker’s preferences, and the forecasting horizons. JEL Classification: E44, E58, F01, F37, G01.
    Keywords: Systemic financial crisis, systemic risk, Self-Organizing Map (SOM), visualization, prediction, macroprudential supervision.
    Date: 2011–09
  15. By: Florin O. Bilbiie (Assistant Professor, Centre d'Economie de la Sorbonne, Maison des Sciences Economiques and CEPR (E-mail:; Ippei Fujiwara (Director and Senior Economist, Financial Markets Department, Bank of Japan (E-mail:; Fabio Ghironi (Associate Professor, Boston College and NBER (E-mail:
    Abstract: We show that deviations from long-run stability of product prices are optimal in the presence of endogenous producer entry and product variety in a sticky-price model with monopolistic competition in which price stability would be optimal in the absence of entry. Specifically, a long-run positive (negative) rate of inflation is optimal when the benefit of variety to consumers falls short of (exceeds) the market incentives for creating that variety under flexible prices, governed by the desired markup. Plausible preference specifications and parameter values justify a long-run inflation rate of two percent or higher. Price indexation implies even larger deviations from long-run price stability. However, price stability (around this non-zero trend) is close to optimal in the short run, even in the presence of time-varying flexible-price markups that distort the allocation of resources across time and states. The central bank uses its leverage over real activity in the long run, but not in the short run. Our results point to the need for continued empirical research on the determinants of markups and investigation of the benefit of product variety to consumers.
    Keywords: Entry, Optimal Inflation Rate, Price Stability, Product Variety, Ramsey-Optimal Monetary Policy
    JEL: E31 F32 E52
    Date: 2011–09
  16. By: Michał Brzoza-Brzezina (National Bank of Poland, Economic Institute; Warsaw School of Economics); Marcin Kolasa (National Bank of Poland, Economic Institute; Warsaw School of Economics); Grzegorz Koloch (National Bank of Poland, Economic Institute); Krzysztof Makarski (National Bank of Poland, Economic Institute; Warsaw School of Economics); Michal Rubaszek (National Bank of Poland, Economic Institute; Warsaw School of Economics)
    Abstract: It is well-known that central bank policies affect not only macroeconomic aggregates, but also their distribution across economic agents. Similarly, a number of papers demonstrated that heterogeneity of agents may matter for the transmission of monetary policy on macro variables. Despite this, the mainstream monetary economics literature has so far been dominated by dynamic stochastic general equilibrium (DSGE) models with representative agents. This article aims to tilt this imbalance towards heterogeneous agents setups by surveying the main positive and normative findings of this line of the literature, and suggesting areas in which these models could be implemented. In particular, we review studies that analyze the heterogeneity of (i) households’ income, (ii) households’ preferences, (iii) consumers’ age, (iv) expectations, and (v) firms’ productivity and financial position. We highlight the results on issues that, by construction, cannot be investigated in a representative agent framework and discuss important papers modifying the findings from the representative agent literature.
    Keywords: Heterogeneous Agents; Monetary Policy
    JEL: E31 E32 E43 E44 E52
    Date: 2011
  17. By: Meixing Dai; Moïse Sidiropoulos
    Abstract: Several recent studies have shown that, when fiscal and monetary authorities play a Stackelberg game, central bank opacity has a fiscal disciplining effect in the sense that it induces the government to reduce taxes and public expenditures, leading hence to lower inflation and output distortions, and lower macroeconomic variability. We show in this paper that, in a Nash equilibrium, the government is still disciplined by central bank opacity. However, the disciplining effect on the level and variability of inflation and the output gap is dominated by the direct effect of opacity.
    Keywords: Distortionary taxes, output distortions, central bank transparency (opacity), fiscal disciplining effect.
    JEL: E52 E58 E62 E63 H30
    Date: 2011
  18. By: Marco Guerrazzi
    Abstract: This paper aims at providing a critical assessment of the new ‘Farmerian’ economics, i.e. the recent Farmer’s attempt to provide a new micro-foundation of the General Theory grounded on modern search and business cycle theories. Specifically, I develop a theoretical model that summarizes the main arguments of the suggested approach by showing that a special importance has to be attached to the search mechanism, the choice of units and ‘animal spirits’ modelling. Thereafter, referring to self-made real-business-cycle experiments, I discuss the main empirical implications of the resulting framework. Finally, I consider its policy implications by stressing the problematic nature of demand management interventions and the advisability of extending the role of the central bank in preventing financial bubbles and crashes.
    Keywords: New ‘Farmerian’ Economics, Search Theory, Demand Constrained Equilibrium, Bubbles and Crashes.
    JEL: E12 E24
    Date: 2011–01–05
  19. By: Yongsung Chang (University of Rochester); Sun-Bin Kim (Yonsei University); Frank Schorfheide (University of Pennsylvania)
    Abstract: Data from a heterogeneous-agents economy with incomplete asset markets and indivisible labor supply are simulated under various fiscal policy regimes and an approximating representative-agent model is estimated. Preference and technology parameter estimates of the representative-agent model are not invariant to policy changes and the bias in the representative-agent model’s policy predictions is large compared to predictive intervals that reflect parameter uncertainty. Since it is not always feasible to account for heterogeneity explicitly, it is important to recognize the possibility that the parameters of a highly aggregated model may not be invariant with respect to policy changes.
    Keywords: Aggregation, DSGE Models, Fiscal Policy, Heterogeneous-Agents Economy, Policy Predictions, Representative-Agent Models
    JEL: C11 C32 E32 E62
    Date: 2011–09
  20. By: Pietro Alessandrini (Universit… Politecnica delle Marche, Department of Economics, MoFiR); Andrea Filippo Presbitero (Universit… Politecnica delle Marche, Department of Economics, MoFiR)
    Abstract: The global financial crisis, the weakening role of the dollar and the increasing importance of China in the global arena are calling for a reform of the international monetary system (IMS) in the direction of a greater multilateralism. We agree with the necessity to reform the IMS and we advance a proposal based on a greater role of the Special Drawing Rights (SDRs), focusing on the potential benefits that a new monetary order could brings to Low-Income Countries (LICs). Given their extreme vulnerability to external shocks and their dependence on the exchange rate vis-vis the US dollar, poor countries would benefit from the creation of a more stable multi-currency monetary system. The new SDRs will created exogenously - with a disproportionate allocation to LICs -, but also endogenously, through the substitution account and the overdraft facility. Finally, we discuss the superiority of this proposal in the context of the current foreign assistance framework.
    Keywords: International Mometary System, Key Currency, Low-Income Countries, Reserves, SDR
    JEL: F33 F35 O11 O19
    Date: 2011–09
  21. By: Luk, Sheung Kan; Vines, David
    Abstract: This paper adds a highly-leveraged financial sector to the Ramsey model of economic growth and shows that this causes the economy to behave in a highly volatile manner: doing this strongly augments the macroeconomic effects of aggregate productivity shocks. Our model is built on the financial accelerator approach of Bernanke, Gertler and Gilchrist (BGG), in which leveraged goods-producers, subject to idiosyncratic productivity shocks, borrow from a competitive financial sector. In the present paper, by contrast, it is the financial institutions which are leveraged and subject to idiosyncratic productivity shocks. Financial institutions can only obtain their funds by paying an interest rate above the risk-free rate, and this risk premium is anti-cyclical, and so augments the effects of shocks. Our parameterisation, based on US data, is one in which the leverage of the financial sector is two and a half times that of the goods-producers in the BGG model. This causes a much more significant augmentation of aggregate productivity shocks than that which is found in the BGG model.
    Keywords: financial accelerator; highly leveraged financial institutions; leverage; volatility
    JEL: E22 E32 E44
    Date: 2011–09
  22. By: Sergey Ivashchenko
    Abstract: This article compares properties of different non-linear Kalman filters: well-known Unscented Kalman filter (UKF), Central Difference Kalman Filter (CDKF) and unknown Quadratic Kalman filter (QKF). Small financial DSGE model is repeatedly estimated by maximum quasi-likelihood methods with different filters for data generated by the model. Errors of parameters estimation are measure of filters quality. The result is that QKF has reasonable advantage in quality over CDKF and UKF with some loose in speed.
    Keywords: DSGE, QKF, CDKF, UKF, quadratic approximation, Kalman filtering
    JEL: C13 C32 E32
    Date: 2011–09–20
  23. By: James Costain (Banco de España); Anton Nakov (Banco de España)
    Abstract: This paper proposes two models in which price stickiness arises endogenously even though fi rms are free to change their prices at zero physical cost. Firms are subject to idiosyncratic and aggregate shocks, and they also face a risk of making errors when they set their prices. In our fi rst specifi cation, fi rms are assumed to play a dynamic logit equilibrium, which implies that big mistakes are less likely than small ones. The second specifi cation derives logit behavior from an assumption that precision is costly. The empirical implications of the two versions of our model are very similar. Since fi rms making suffi ciently large errors choose to adjust, both versions generate a strong “selection effect” in response to a nominal shock that eliminates most of the monetary nonneutrality found in the Calvo model. Thus the model implies that money shocks have little impact on the real economy, as in Golosov and Lucas (2007), but fi ts microdata better than their specifi cation.
    Keywords: Nominal rigidity, logit equilibrium, state-dependent pricing, (S,s) adjustment, near-rational behavior
    JEL: E31 D81 C72
    Date: 2011–09
  24. By: Chao Gu (Department of Economics, University of Missouri-Columbia); Joseph Haslag (Department of Economics, University of Missouri-Columbia)
    Abstract: We build a model in which verifiability of private debts, timing mismatch in debt settlements and borrowing leverage lead to liquidity crisis in the financial market. Central bank can respond to the liquidity crisis by adopting an unconventional monetary policy that resembles repurchase agreements between the central bank and the lenders. This policy is effective if the timing mismatch is nominal (i.e., a settlement participation risk). It is ineffective if the timing mismatch is driven by a real shock (i.e., preference shock).
    Keywords: liquidity problem, timing mismatch, leveraging, liquidity shock, settlement risk, repurchase agreement, consumption shock
    JEL: E44 E52
    Date: 2011–09–22
  25. By: Ludger Schuknecht (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Philippe Moutot (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Philipp Rother (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main); Jürgen Stark (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main)
    Abstract: The sovereign debt crisis in the euro area is a symptom of policy failures and deficiencies in – among other things – fiscal policy coordination. The first nine years of the euro were not used effectively in order to improve public finances, while the Stability and Growth Pact was watered down. Spillovers from the financial and economic crisis compounded fiscal difficulties in the euro area, especially in certain member countries. This paper looks back at the history of fiscal policies and rules in Economic and Monetary Union (EMU). It makes proposals to strengthen fiscal policy governance that go well beyond the legislation set to be adopted in autumn 2011. The authors consider these additional governance measures to be essential for effective policy coordination and sound public finances in the future. JEL Classification: H6, E6
    Keywords: fiscal rules, Stability and Growth Pact, fiscal deficits, public debt, EU institutional reform
    Date: 2011–09
  26. By: Carol Osler (Brandeis International Business School); Thang Nguyen (Brandeis International Business School); Tanseli Savaser (Williams College)
    Abstract: This paper provides the first rigorous empirical analysis of markups on custodial foreign exchange trades. It finds that they substantially exceed relevant benchmarks such as interbank half-spreads. We trace this to an information asymmetry -- custodial bank dealers know more about their prices and bid-ask spreads than their client funds. We also examine the asset managers’ continued heavy reliance on this high-cost approach to trading when alternatives are available with lower markups. We provide evidence that this choice does not reflect ignorance of the cost differential. Analysis relies on the complete foreign exchange trading record of a mid-sized global custody bank during calendar year 2006.
    Date: 2011–06
  27. By: Hirose, Yasuo
    Abstract: We estimate a two-country open economy version of the New Keynesian DSGE model for the U.S. and the Euro area, using Bayesian techniques that allow for both determinacy and indeterminacy of the equilibrium. Our empirical analysis shows that the worldwide equilibrium is indeterminate due to a passive monetary policy in the Euro area, even if U.S. policy is aggressive enough. We demonstrate that the impulse responses under indeterminacy exhibit different dynamics than those under determinacy and that sunspot shocks affect the Euro economy to a substantial degree, while the transmission of sunspots to the U.S. is limited.
    Keywords: Monetary Policy; Indeterminacy; Sunspot Shock; Open Economy Model; Bayesian Analysis
    JEL: E52 F41 C11 C62
    Date: 2010–11
  28. By: Mattéo Luciani
    Abstract: In this paper we investigate whether accounting for non-pervasive shocks improves the forecast of a factor model. We compare four models on a large panel of US quarterly data: factor models, factor models estimated on selected variables, Bayesian shrinkage, and factor models together with Bayesian shrinkage for the idiosyncratic component. The results of the forecasting exercise show that the four approaches considered perform equally well and produce highly correlated forecasts, meaning that non-pervasive shocks are of no helps in forecasting. We conclude that comovements captured by factor models are informative enough to make accurate forecasts.
    JEL: C13 C32 C33 C52 C53
    Date: 2011–07
  29. By: Juha Tervala
    Abstract: This study shows that the learning by doing (LBD) effect has substantial, both quantitative and qualitative, consequences for the international transmission of monetary policy. LDB implies that a country can increase its productivity-increasing skill level, at the expense of the neighbour, by competitive devaluation engineered through low interest rates. If measured by the cumulative change in output after 12 quarters, LBD increases the harmful effect of competitive devaluation on foreign output by 85Ð125%, when compared to the case without it. If LBD is sufficiently strong and the cross-country substitutability is high (low), it reverses the effect of monetary policy on foreign (domestic) welfare into negative (positive). Moreover, a combination of a high crosscountry substitutability and a sufficiently strong LDB effect implies that competitive devaluation increases both domestic output and welfare, at the expense of foreign output and welfare.
    Keywords: Beggar-thyself, beggar-thy-neighbour, competitive devaluation, learning by doing, open economy macroeconomics
    JEL: E52 F30 F41
    Date: 2011–09
  30. By: Stefan Leist
    Abstract: Contrary to standard agnostic statistical approaches an output gap estimate based on a New Keynesian Small Open Economy model provides the possibility to analyze the driving forces of the variation in GDP caused by nominal rigidities. This paper makes use of this and provides an estimate of a model based output gap that corresponds well with conventional measures. The results confirm conventional wisdom that most of the variation is due to foreign shocks. But the risk premium shock in the uncovered interest rate parity equation also plays an important role. It has a procyclical effect on the output gap except for the last recession.
    Keywords: DSGE models; output gap; natural level of output; small open economy; business cycle; recessions
    JEL: C11 C51 E32 F41
    Date: 2011–09
  31. By: Pablo Martín-Aceña; Elena Martínez Ruiz; Pilar Noguer Marco
    Abstract: The gold standard began to emerge as a universal monetary system in the late 1870s, and it had spread throughout the world economy by 1900. It was unusual for nations to be off the gold standard, and it meant that they were detached from the international financial community. Spain never joined the gold standard club in any of its varieties, either before or after 1914. Unlike the vast majority of the European currencies, the peseta’s exchange rate fluctuated, sometimes widely, against gold and gold currencies. Gold convertibility was suspended in 1883 and never resumed. Nevertheless, the monetary authorities were aware that the Spanish economy, off the gold standard, was an outlier in the international economy and made plans to put the peseta on gold both before and after 1914.Why Spain never adopted the gold standard is a complex issue, and our paper offers a possible answer by examining the behaviour of an issuing bank that refused to accept, or resisted, its role as a central bank. Our study also provides a basis for a comparison between the Bank of Spain, some of its features and policies, with other peripheral issuing institutions. Moreover, our paper encompasses both the pre-war and the post-war periods, which allows us to present both the similarities and the differences in the exchange and monetary policies of the Spanish authorities during the era of the classical gold standard and the years of the gold exchange standard
    Keywords: Gold standard, Monetary policy, Bank of Spain
    JEL: E42 E58 N10
    Date: 2011–09
  32. By: Peter Kukuk (UniCredit Bank, Prague); Adam Gersl (Czech National Bank; Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: This paper analyzes political pressure on the National Bank of Slovakia, using the Havrilesky (1993) methodology based on media signalling. This methodology allows the pressure on the Central Bank of Slovakia to be compared with the pressure on the central banks to which the methodology was already applied, namely – the U.S. Federal Reserve, the Deutsche Bundesbank and the Czech National Bank. The analysis and the comparison reveals a relatively weak signalling of pressure in media in Slovakia and prevailance of financial sector representatives as the main commentaries on monetary policy of the National Bank of Slovakia in the period before euro adoption.
    Keywords: political economy, central banks, monetary policy
    JEL: E52 D78
    Date: 2011–09
  33. By: Skold, Alida S.
    Abstract: As an innovator in the financial system, China was the first to use paper currency. Eventually the form of currency was held responsible for devastating inflation and was abandoned during the Ming Dynasty. Going forward in time, uprisings and discontent have emphasized the importance of controlling inflation. The central bank is pivotal in issuing monetary policy to control inflation and to maintain financial stability as the government transforms itself from a planned economy to a mixed market economy. The transforming economy is moving toward a free market system through series of economic reforms. The correlation between China’s structure and the European Union’s structure provides opportunities for further study to determine next steps for both.
    Keywords: China; central bank; monetary policy; inflation; economy
    JEL: E0 H60 E5
    Date: 2011–07–17

This nep-cba issue is ©2011 by Alexander Mihailov. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.