nep-cba New Economics Papers
on Central Banking
Issue of 2011‒11‒07
forty-six papers chosen by
Alexander Mihailov
University of Reading

  1. A Theory of Asset Pricing Based on Heterogeneous Information By Elias Albagli; Christian Hellwig; Aleh Tsyvinski
  2. In Search of a Theory of Debt Management By Elisa Faraglia; Albert Marcet; Andrew Scott
  3. The international role of the dollar: Does it matter if this changes? By Linda Goldberg
  4. Can Oil Prices Forecast Exchange Rates? By Ferraro, Domenico; Rogoff, Kenneth; Rossi, Barbara
  5. The international monetary system is changing: What opportunities and risks for the euro? By Ignazio Angeloni; André Sapir
  6. Supply-Side Policies and the Zero Lower Bound By Jesús Fernández-Villaverde; Pablo A. Guerrón-Quintana; Juan Rubio-Ramírez
  7. Supply-side policies and the zero lower bound By Jesús Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez
  8. Modifying Gaussian term structure models when interest rates are near the zero lower bound By Leo Krippner
  9. The great escape? A quantitative evaluation of the Fed’s liquidity facilities By Marco Del Negro; Gauti Eggertsson; Andrea Ferrero; Nobuhiro Kiyotaki
  10. Optimal Forecasts in the Presence of Structural Breaks By Pesaran, M.H.; Pick, A.; Pranovich, M.
  11. A medium scale forecasting model for monetary policy By Kenneth Beauchemin; Saeed Zaman
  12. Forecasting inflation with consumer survey data – application of multi-group confirmatory factor analysis to elimination of the general sentiment factor By Piotr Białowolski
  13. The Signalling Channel of Central Bank Interventions: Modelling the Yen/US Dollar Exchange Rate By Yu-Fu Chen; Michael Funke; Nicole Glanemann
  14. Do experts incorporate statistical model forecasts and should they? By Legerstee, R.; Franses, Ph.H.B.F.; Paap, R.
  15. Forecasting and tracking real-time data revisions in inflation persistence By Tierney, Heather L.R.
  16. Liquidity and the threat of fraudulent assets By Yiting Li; Guillaume Rocheteau; Pierre-Olivier Weill
  17. Measuring the level and uncertainty of trend inflation By Elmar Mertens
  18. Market- and Book-Based Models of Probability of Default for Developing Macroprudential Policy Tools By Xisong Jin; Francisco Nadal de Simone
  19. A New-Keynesian model of the yield curve with learning dynamics: A Bayesian evaluation By Dewachter, Hans; Iania, Leonardo; Lyrio, Marco
  20. Divergent competitiveness in the eurozone and the optimum currency area theory By João Rebelo Barbosa; Rui Henrique Alves
  21. U.S. monetary-policy evolution and U.S. intervention By Michael D Bordo; Owen F Humpage; Anna J Schwartz
  22. UK Macroeconomic Volatility and the Welfare Costs of Inflation By Polito, Vito; Spencer, Peter
  23. How to Solve the Price Puzzle? A Meta-Analysis By Marek Rusnak; Tomas Havranek; Roman Horvath
  24. Expectations versus fundamentals: does the cause of banking panics matter for prudential policy? By Todd Keister; Vijay Narasiman
  25. A Taylor Rule for Fiscal Policy By David A. Kendrick; Hans M. Amman
  26. Real-Time Data and Fiscal Policy Analysis: a Survey of the Literature By Jacopo Cimadomo
  27. Direct vs bottom-up approach when forecasting GDP: reconciling literature results with institutional practice By Paulo Soares Esteves
  28. Optimal Fiscal Policy in a Small Open Economy with Limited Commitment By Sofia Bauducco; Francesco Caprioli
  29. State-Dependent Probability Distributions in Non Linear Rational Expectations Models By Barthélemy, J.; Marx, M.
  30. How do individual UK consumer prices behave? By Bunn, Philip; Ellis, Colin
  31. Estimating the impact of the volatility of shocks: a structural VAR approach By Mumtaz, Haroon
  32. A SVECM Model of the UK Economy and The Term Premium By Dungey, Mardi; Tugrul Vehbi, M
  33. Core, What is it Good For? Why the Bank of Canada Should Focus on Headline Inflation By Philippe Bergevin; Colin Busby
  34. How do joint supervisors examine financial institutions? the case of state banks By Marcelo Rezende
  35. Is there a role for funding in explaining recent US bank failures? By Pierluigi Bologna
  36. Money and Price Posting under Private Information By Mei Dong; Janet Hua Jiang
  37. Oil and Gold Prices: Correlation or Causation? By Thai-Ha LE; Youngho CHANG
  38. Moment matching versus Bayesian estimation: Backward-looking behaviour in the new-Keynesian three-equations model By Franke, Reiner; Jang, Tae-Seok; Sacht, Stephen
  39. "Reducing Economic Imbalances in the Euro Area: Some Remarks on the Current Stability Programs, 2011–14" By Gregor Semieniuk; Till van Treeck; Achim Truger
  40. Time-varying volatility, precautionary saving and monetary policy By Hatcher, Michael
  41. Dimensions of centralbank transparency and monetary policy By José Simão Filho; Helder Ferreira deMendonça
  42. A further view on current account, capital account and Target2 balances: Assessing the effect on capital structure and economic welfare By Sell, Friedrich L.; Sauer, Beate
  43. Stability Analysis ofDifferent Monetary Policy Rules for a Macroeconomic Model withEndogenous Money and Credit Channel By Flávio Augusto Corrêa Basilio; JoséLuis da Costa Oreiro
  44. Monetary Policy,Fundamentals and Risk in Brazil By Alex Luiz Ferreira
  45. Real Wage Rigidity andthe New Phillips Curve: the Brazilian Case By Antonio Alberto Mazali; José Angelo Divino
  46. Crédito, Exceso de toma de Riesgo, Costo de Crédito y ciclo Económico en Chile By Carlos J. García; Andrés Sagner

  1. By: Elias Albagli; Christian Hellwig; Aleh Tsyvinski
    Abstract: We propose a theory of asset prices that emphasizes heterogeneous information as the main element determining prices of different securities. Our main analytical innovation is in formulating a model of noisy information aggregation through asset prices, which is parsimonious and tractable, yet flexible in the specification of cash flow risks. We show that the noisy aggregation of heterogeneous investor beliefs drives a systematic wedge between the impact of fundamentals on an asset price, and the corresponding impact on cash flow expectations. The key intuition behind the wedge is that the identity of the marginal trader has to shift for different realization of the underlying shocks to satisfy the market-clearing condition. This identity shift amplifies the impact of price on the marginal trader's expectations. We derive tight characterization for both the conditional and the unconditional expected wedges. Our first main theorem shows how the sign of the expected wedge (that is, the difference between the expected price and the dividends) depends on the shape of the dividend payoff function and on the degree of informational frictions. Our second main theorem provides conditions under which the variability of prices exceeds the variability for realized dividends. We conclude with two applications of our theory. First, we highlight how heterogeneous information can lead to systematic departures from the Modigliani-Miller theorem. Second, in a dynamic extension of our model we provide conditions under which bubbles arise.
    JEL: E44 G12 G14 G30
    Date: 2011–10
  2. By: Elisa Faraglia; Albert Marcet; Andrew Scott
    Abstract: A growing literature integrates debt management into models of optimal fiscal policy. One promising theory argues the composition of government debt should be chosen so that fluctuations in its market value offsets changes in expected future deficits. This complete market approach to debt management is valid even when governments only issue non-contingent bonds. Because bond returns are highly correlated it is known this approach implies asset positions which are large multiples of GDP. We show, analytically and numerically, across a wide range of model specifications (habits, productivity shocks, capital accumulation, persistent shocks, etc) that this is only one of the weaknesses of this approach. We find evidence of large fluctuations in positions, enormous changes in portfolios for minor changes in maturities issued and no presumption it is always optimal to issue long term debt and invest in short term assets. We show these extreme, volatile and unstable features are undesirable from a practical perspective for two reasons. Firstly the fragility of the optimal portfolio to small changes in model specification means it is frequently better for fear of model misspecification to follow a balanced budget rather than issue the optimal debt structure. Secondly we show for even miniscule levels of transaction costs governments would prefer a balanced budget rather than the large and volatile positions the complete market approach recommends. We conclude it is difficult to insulate fiscal policy from shocks using the complete markets approach. Due to the yield curve's limited variability maturities are a poor way to substitute for state contingent debt. As a result the recommendations of this approach conflict with a number of features we believe are integral to bond market incompleteness e.g. allowing for transaction costs, liquidity effects, robustness etc. Our belief is that market imperfections need to be explicitly introduced into the model and incorporated into the portfolio problem. Failure to do so means that the complete market approach applied in an incomplete market setting can be seriously misleading.
    Keywords: Complete markets, debt management, government debt, maturity structure, yield curve
    JEL: E43 E62
    Date: 2011–10
  3. By: Linda Goldberg
    Abstract: There is often speculation that the international roles of currencies may be changing. This paper presents the current status of these roles. The U.S. dollar continues to be the dominant currency across various uses. Yet, such a role may change over time. If this occurs, there could be consequences for seignorage returns, U.S. funding costs, the dollar’s value, U.S. insulation from foreign shocks, and U.S. global influence. The paper concludes with a discussion of recent research on related themes and questions for future study.
    Keywords: Dollar, American ; Foreign exchange
    Date: 2011
  4. By: Ferraro, Domenico; Rogoff, Kenneth; Rossi, Barbara
    Abstract: This paper investigates whether oil prices have a reliable and stable out-of-sample relationship with the Canadian/U.S dollar nominal exchange rate. Despite state-of-the-art methodologies, we find little systematic relation between oil prices and the exchange rate at the monthly and quarterly frequencies. In contrast, the main contribution is to show the existence of a very short-term relationship at the daily frequency, which is rather robust and holds no matter whether we use contemporaneous (realized) or lagged oil prices in our regression. However, in the latter case the predictive ability is ephemeral, mostly appearing after instabilities have been appropriately taken into account.
    Keywords: exchange rates
    JEL: C22 C53 F31 F37
    Date: 2011–11
  5. By: Ignazio Angeloni; André Sapir
    Abstract: After a thirty-year pause, discussions on the future of the international monetary system (IMS) have restarted. This is partly due to the fact that the IMS has facilitated, or at least not prevented, the economic and financial imbalances that led to the recent crisis. This paper argues that the international position of the US dollar is likely to erode in the coming years, though the speed of the process is uncertain. This will create a demand for other currencies to be used internationally as means of payment and store of value. The most likely candidates for filling the partial vacuum created by the dollarâ??s decline are the euro and the Chinese renminbi. The probability that the renminbi will eventually become one of the worldâ??s key currencies is very high, but the speed of the process is uncertain. As far as the euro is concerned, much will depend on if and how the sovereign debt crisis is resolved. Our view is that the crisis will be dealt with and that it will result in radical steps towards fiscal and financial integration. If such steps are taken, the euro will secure both internal stabilisation and a growing international role.
    Date: 2011–11
  6. By: Jesús Fernández-Villaverde; Pablo A. Guerrón-Quintana; Juan Rubio-Ramírez
    Abstract: This paper examines how supply-side policies may play a role in fighting a low aggregate demand that traps an economy at the zero lower bound (ZLB) of nominal interest rates. Future increases in productivity or reductions in mark-ups triggered by supply-side policies generate a wealth effect that pulls current consumption and output up. Since the economy is at the ZLB, increases in the interest rates do not undo this wealth effect, as we will have in the case outside the ZLB. We illustrate this mechanism with a simple two-period New Keynesian model. We discuss possible objections to this set of policies and the relation of supply-side policies with more conventional monetary and fiscal policies.
    JEL: E3 E4 E52
    Date: 2011–10
  7. By: Jesús Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez
    Abstract: This paper examines how supply-side policies may play a role in fighting a low aggregate demand that traps an economy at the zero lower bound (ZLB) of nominal interest rates. Future increases in productivity or reductions in mark-ups triggered by supply-side policies generate a wealth effect that pulls current consumption and output up. Since the economy is at the ZLB, increases in the interest rates do not undo this wealth effect, as we will have in the case outside the ZLB. The authors illustrate this mechanism with a simple two-period New Keynesian model. They discuss possible objections to this set of policies and the relation of supply-side policies with more conventional monetary and fiscal policies.
    Keywords: Supply-side economics ; Keynesian economics
    Date: 2011
  8. By: Leo Krippner
    Abstract: With nominal interest rates currently at or near their zero lower bound (ZLB) in many major economies, it has become untenable to apply Gaussian affine term structure models (GATSMs) while ignoring their inherent non-zero probabilities of negative interest rates. In this article I modify GATSMs by representing physical currency as call options on bonds to establish the ZLB. The result- ing ZLB-GATSM framework remains tractable, producing a simple closed-form analytic expression for forward rates and requiring only elementary univariate numerical integration (over time to maturity) to obtain interest rates and bond prices. I demonstrate the salient features of the ZLB-GATSM framework using a two-factor model. An illustrative application to U.S. term structure data in- dicates that movements in the model state variables have been consistent with unconventional monetary policy easings undertaken after the U.S. policy rate reached the ZLB in late 2008.
    JEL: E43 G12 G13
    Date: 2011–10
  9. By: Marco Del Negro; Gauti Eggertsson; Andrea Ferrero; Nobuhiro Kiyotaki
    Abstract: We introduce liquidity frictions into an otherwise standard DSGE model with nominal and real rigidities, explicitly incorporating the zero bound on the short-term nominal interest rate. Within this framework, we ask: Can a shock to the liquidity of private paper lead to a collapse in short-term nominal interest rates and a recession like the one associated with the 2008 U.S. financial crisis? Once the nominal interest rate reaches the zero bound, what are the effects of interventions in which the government exchanges liquid government assets for illiquid private paper? We find that the effects of the liquidity shock can be large, and we show some numerical examples in which the liquidity facilities prevented a repeat of the Great Depression in 2008-09.
    Keywords: Federal Reserve System ; Interest rates ; Liquidity (Economics) ; Private equity
    Date: 2011
  10. By: Pesaran, M.H.; Pick, A.; Pranovich, M.
    Abstract: This paper considers the problem of forecasting under continuous and discrete structural breaks and proposes weighting observations to obtain optimal forecasts in the MSFE sense. We derive optimal weights for continuous and discrete break processes. Under continuous breaks, our approach recovers exponential smoothing weights. Under discrete breaks, we provide analytical expressions for the weights in models with a single regressor and asympotically for larger models. It is shown that in these cases the value of the optimal weight is the same across observations within a given regime and differs only across regimes. In practice, where information on structural breaks is uncertain a forecasting procedure based on robust weights is proposed. Monte Carlo experiments and an empirical application to the predictive power of the yield curve analyze the performance of our approach relative to other forecasting methods.
    JEL: C22 C53
    Date: 2011–10–31
  11. By: Kenneth Beauchemin; Saeed Zaman
    Abstract: This paper presents a 16-variable Bayesian VAR forecasting model of the U.S. economy for use in a monetary policy setting. The variables that comprise the model are selected not only for their effectiveness in forecasting the primary variables of interest, but also for their relevance to the monetary policy process. In particular, the variables largely coincide with those of an augmented New-Keynesian DSGE model. We provide out-of sample forecast evaluations and illustrate the computation and use of predictive densities and fan charts. Although the reduced form model is the focus of the paper, we also provide an example of structural analysis to illustrate the macroeconomic response of a monetary policy shock.
    Keywords: Forecasting ; Monetary policy
    Date: 2011
  12. By: Piotr Białowolski (Warsaw School of Economics)
    Abstract: This paper (1) examines the properties of survey based households’ inflation expectations and investigates their forecasting performance. With application of the individual data from the State of the Households’ Survey (50 quarters between 1997Q4 and 2010Q1) it was shown that inflation expectations were affected by the consumer sentiment. Multi-Group Confirmatory Factor Analysis (MGCFA) was employed to verify whether a set of proxies provides a reliable basis for measurement of two latent phenomena – consumer sentiment and inflation expectations. Following the steps proposed by Davidov (2008) and Steenkamp and Baumgartner (1998), it appeared that it was possible to specify and estimate a MGCFA model with partial measurement invariance. Thus it was possible to eliminate the influence of consumer sentiment on inflation expectations and at the same time to obtain individually corrected answers concerning the inflation expectations. Additionally, it was shown that the linear relation between consumer sentiment and inflation expectations was stable over time. As a by-product of analysis, it was possible to show that respondents during the financial crisis were much less consistent in their answers to the questions of the consumer questionnaire. In the next step of the analysis, data on inflation expectations were applied to modelling and forecasting inflation. It was shown that with respect to standard ARIMA processes, inclusion of the information on the inflation expectations significantly improved the in-sample and out-of-sample forecasting performance of the time-series models. Especially out-of-sample performance was significantly better as the average absolute error in forecasts of headline and core inflation was reduced by half. It was also shown that models with inflation expectations based on the CFA method (after elimination of the consumer sentiment factor) provided better in-sample forecasts of inflation. Nevertheless, it was not confirmed for the out-of-sample forecasts. (1) Project financed by the National Bank of Poland. Polish title of the project: "Prognozowanie inflacji na podstawie danych koniunktury gospodarstw domowych. Zastosowanie konfirmacyjnej analizy czynnikowej dla wielu grup do oczyszczenia prognoz inflacji z czynnika ogólnego nastroju gospodarczego."
    Keywords: Inflation expectations, Inflation forecasts, Confirmatory Factor Analysis
    JEL: C32 E31 E37
    Date: 2011
  13. By: Yu-Fu Chen; Michael Funke; Nicole Glanemann
    Abstract: This paper presents a theoretical framework analysing the signalling channel of exchange rate interventions as an informational trigger. We develop an implicit target zone framework with learning in order to model the signalling channel. The theoretical premise of the model is that interventions convey signals that communicate information about the exchange rate objectives of central bank. The model is used to analyse the impact of Japanese FX interventions during the period 1999 -2011 on the yen/US dollar dynamics.
    Keywords: Exchange rates, interventions, Japan
    JEL: C61 E58 F31
    Date: 2011–10
  14. By: Legerstee, R.; Franses, Ph.H.B.F.; Paap, R.
    Abstract: Experts can rely on statistical model forecasts when creating their own forecasts.Usually it is not known what experts actually do. In this paper we focus on threequestions, which we try to answer given the availability of expert forecasts andmodel forecasts. First, is the expert forecast related to the model forecast andhow? Second, how is this potential relation influenced by other factors? Third,how does this relation influence forecast accuracy?We propose a new and innovative two-level Hierarchical Bayes model to answerthese questions. We apply our proposed methodology to a large data set offorecasts and realizations of SKU-level sales data from a pharmaceutical company.We find that expert forecasts can depend on model forecasts in a variety ofways. Average sales levels, sales volatility, and the forecast horizon influence thisdependence. We also demonstrate that theoretical implications of expert behavioron forecast accuracy are reflected in the empirical data.
    Keywords: endogeneity;Bayesian analysis;expert forecasts;model forecasts;forecast adjustment
    Date: 2011–09–30
  15. By: Tierney, Heather L.R.
    Abstract: This paper presents three local nonparametric forecasting methods that are able to utilize the isolated periods of revised real-time PCE and core PCE for 62 vintages within a historic framework with respect to the nonparametric exclusion-from-core inflation persistence model. The flexibility, provided by the kernel and window width, permits the incorporation of the forecasted value into the appropriate time frame. For instance, a low inflation measure can be included in other low inflation time periods in order to form more optimal forecasts by combining values that are similar in terms of metric distance as opposed to chronological time. The most efficient nonparametric forecasting method is the third model, which uses the flexibility of nonparametrics to its utmost by making forecasts conditional on the forecasted value.
    Keywords: Inflation Persistence; Real-Time Data; Monetary Policy; Nonparametrics; Forecasting
    JEL: C53 C14 E52
    Date: 2011–11–01
  16. By: Yiting Li; Guillaume Rocheteau; Pierre-Olivier Weill
    Abstract: We study an over-the-counter (OTC) market with bilateral meetings and bargaining where the usefulness of assets, as means of payment or collateral, is limited by the threat of fraudulent practices. We assume that agents can produce fraudulent assets at a positive cost, which generates endogenous upper bounds on the quantity of each asset that can be sold, or posted as collateral in the OTC market. Each endogenous, asset-specific, resalability constraint depends on the vulnerability of the asset to fraud, on the frequency of trade, and on the current and future prices of the asset. In equilibrium, the set of assets can be partitioned into three liquidity tiers, which differ in their resalability, their prices, their sensitivity to shocks, and their responses to policy interventions. The dependence of an asset’s resalability on its price creates a pecuniary externality, which leads to the result that some policies commonly thought to improve liquidity can be welfare reducing.
    Keywords: Liquidity (Economics) ; Fraud ; Asset pricing
    Date: 2011
  17. By: Elmar Mertens
    Abstract: Firmly-anchored inflation expectations are widely viewed as playing a central role in the successful conduct of monetary policy. This paper presents estimates of trend inflation, based on information contained in survey expectations, the term structure of interest rates, and realized inflation rates. My application combines a variety of data sources at the monthly frequency and it can flexibly handle missing data arising from infrequent observations and limited data availability. In order to assess whether inflation expectations are anchored, uncertainty surrounding future changes in trend inflation--measured by a time-varying volatility of trend shocks--is estimated as well. ; Not surprisingly, the estimates suggest that trend inflation in the U.S. rose and fell again over the 1970s and 1980s, accompanied by increases in uncertainty. Considering the recent crisis, full-sample estimates of trend inflation fell quite a bit, but not too dramatically. In contrast, real-time estimates recorded sizeable increases of trend uncertainty during the crisis of 2007/2008, which have abated since then.
    Keywords: Inflation (Finance) - United States
    Date: 2011
  18. By: Xisong Jin; Francisco Nadal de Simone
    Abstract: The recent financial crisis raised awareness of the need for a framework for conducting macroprudential policy. Identifying as early as possible and addressing the buildup of endogenous imbalances, exogenous shocks, and contagion from financial markets, market infrastructures, and financial institutions are key elements of a sound macroprudential framework. This paper contributes to this literature by estimating several models of default probability, two of which relax two key assumptions of the Merton model: the assumption of constant asset volatility and the assumption of a single debt maturity. The study uses market and banks? balance sheet data. It finds that systemic risk in Luxembourg banks, while mildly correlated with that of European banking groups, did not increase as dramatically as it did for the European banking groups during the heights of the financial crisis. In addition, it finds that systemic risk has declined during the second half of 2010, both for the banking groups as well as for the Luxembourg banks. Finally, this study illustrates how models of default probability can be used for event-study purposes, for simulation exercises, and for ranking default probabilities during a period of distress according to banks? business lines. As such, this study is a stepping stone toward developing an operational framework to produce quantitative judgments on systemic risk and financial stability in Luxembourg.
    Keywords: financial stability; credit risk; structured products; default probability, GARCH
    JEL: C30 E44 G1
    Date: 2011–10
  19. By: Dewachter, Hans; Iania, Leonardo; Lyrio, Marco
    Abstract: We estimate a New-Keynesian macro-finance model of the yield curve incorporating learning by private agents with respect to the long-run expectation of inflation and the equilibrium real interest rate. A preliminary analysis shows that some liquidity premia, expressed as some degree of mispricing relative to no-arbitrage restrictions, and time variation in the prices of risk are important features of the data. These features are, therefore, included in our learning model. The model is estimated on U.S. data using Bayesian techniques. The learning model succeeds in explaining the yield curve movements in terms of macroeconomic shocks. The results also show that the introduction of a learning dynamics is not sufficient to explain the rejection of the extended expectations hypothesis. The learning mechanism, however, reveals some interesting points. We observe an important difference between the estimated inflation target of the central bank and the perceived long-run inflation expectation of private agents, implying the latter were weakly anchored. This is especially the case for the period from mid-1970s to mid-1990s. The learning model also allows a new interpretation of the standard level, slope, and curvature factors based on macroeconomic variables. In line with standard macro-finance models, the slope and curvature factors are mainly driven by exogenous monetary policy shocks. Most of the variation in the level factor, however, is due to shocks to the output-neutral real rate, in contrast to the mentioned literature which attributes most of its variation to long-run inflation expectations.
    Keywords: New-Keynesian model; Affine yield curve model; Learning; Bayesian estimation
    JEL: E43 E52 E44
    Date: 2011–09
  20. By: João Rebelo Barbosa (Faculdade de Economia, Universidade do Porto); Rui Henrique Alves (CEF.UP, Faculdade de Economia, Universidade do Porto)
    Abstract: As the euro is on its second decade, the European sovereign debt crisis and the ever more evident disparities in competitiveness among member states are prompting many to question whether monetary union is bringing more benefits than costs. The optimum currency area (OCA) theory provides a framework with several criteria for such analysis. Most literature focuses either or on OCA individual criteria or on an aggregate analysis of these criteria, using meta-properties. Differently, we start by a descriptive analysis of the first twelve euro countries under six criteria between 1999 and 2009. We detect signs of labour geographic mobility. However, nominal wages growth largely outpaced productivity growth in some periphery countries, resulting in losses of competitiveness. Financial markets seem to be deeply integrated. Total intra-EMU trade increased, though core countries seem to have benefited more, as their relative competitiveness improved. We detect no increased homogeneity of exports structures of EMU countries. Inflation rates alternated between periods of convergence and of divergence, though prices levels consistently converged between EMU countries. Finally, budgetary indiscipline was frequent preventing several countries from having fiscal room to face asymmetrical shocks.We conclude by estimating the impact of five OCA criteria on countries’ relative competitiveness, using real effective exchange rates as a proxy. Differences in the growth of unit labour costs, the dissimilarity of trade and the differences in output growth were found to be significant. With a higher confidence level, bilateral trade is significant and points towards the specialization paradigm. Thus, we identify some causes of the divergent competitiveness between some EMU countries that contributed to weaker economic growth in parts of the euro area.
    Keywords: Optimum currency area, Euro Area; Economic and Monetary Union (EMU), Competitiveness
    JEL: E42 E63 F15 F33 F41
    Date: 2011–11
  21. By: Michael D Bordo; Owen F Humpage; Anna J Schwartz
    Abstract: The United States all but abandoned its foreign-exchange-market intervention operations in late 1995, when they proved corrosive to the credibility of the Federal Reserve?s commitment to price stability. We view this decision as the culmination of the evolution of U.S. monetary policy over the past century from a gold standard to a fiat money regime. The abandonment of intervention was necessary to secure monetary policy credibility.
    Keywords: Foreign exchange market ; Monetary policy - United States ; Federal Open Market Committee
    Date: 2011
  22. By: Polito, Vito (Cardiff Business School); Spencer, Peter
    Abstract: This paper explores the implications of time varying volatility for optimal monetary policy and the measurement of welfare costs. We show how macroeconomic models with linear and quadratic state dependence in their variance structure can be used for the analysis of optimal policy within the framework of an optimal linear regulator problem. We use this framework to study optimal monetary policy under inflation conditional volatility and Find that the quadratic component of the variance makes policy more responsive to inflation shocks in the same way that an increase in the welfare weight attached to inflation does, while the linear component reduces the steady state rate of inflation. Empirical results for the period 1979-2010 underline the statistical significance of inflation-dependent UK macroeconomic volatility. Analysis of the welfare losses associated with inflation and macroeconomic volatility shows that the conventional homoskedastic model seriously underestimates both the welfare costs of inflation and the potential gains from policy optimization.
    Keywords: Monetary policy; Macroeconomic volatility; Optimal control; Welfare costs of inflation
    JEL: C32 C61 E52
    Date: 2011–09
  23. By: Marek Rusnak; Tomas Havranek; Roman Horvath
    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: 2011–09
  24. By: Todd Keister; Vijay Narasiman
    Abstract: There is a longstanding debate about whether banking panics and other financial crises always have fundamental causes or are sometimes the result of self-fulfilling beliefs. Disagreement on this point would seem to present a serious obstacle to designing policies that promote financial stability. However, we show that the appropriate choice of policy is invariant to the underlying cause of banking panics in some situations. In our model, the anticipation of being bailed out in the event of a crisis distorts the incentives of financial institutions and their investors. Two policies that aim to correct this distortion are compared: restricting policymakers from engaging in bailouts, and allowing bailouts but taxing the short-term liabilities of financial institutions. We find that the latter policy yields higher equilibrium welfare regardless of whether panics are sometimes caused by self-fulfilling beliefs.
    Keywords: Financial crises ; Financial stability ; Monetary policy ; Economic policy
    Date: 2011
  25. By: David A. Kendrick; Hans M. Amman
    Abstract: In times of rapid macroeconomic change it would seem useful for both fiscal and monetary policy to be modified frequently. This is true for monetary policy with monthly meetings of the Open Market Committee. It is not true for fiscal policy which mostly varies with the annual Congressional budget cycle. This paper proposes a feedback framework for analyzing the question of whether or not movement from annual to quarterly fiscal policy changes would improve the performance of stabilization policy. More broadly the paper considers a complementary rather than competitive framework in which monetary policy in the form of the Taylor rule is joined by a similar fiscal policy rule. This framework is then used to consider methodological improvements in the Taylor and the fiscal policy rule to include lags, uncertainty in parameters and measurement errors.
    Keywords: design of fiscal policy, optimal experimentation, stochastic optimization, time-varying parameters, numerical experiments
    JEL: C63 E61 E62
    Date: 2011–10
  26. By: Jacopo Cimadomo
    Keywords: Fiscal policy, real-time data, data revisions, cyclical sensitivity
    JEL: E62 H68 A
    Date: 2011–10
  27. By: Paulo Soares Esteves
    Abstract: How should we forecast GDP? Should we forecast directly the overall GDP or aggregate the forecasts for each of its components using some level of disaggregation? The search for the answer continues to motivate several horse races between these two approaches. Nevertheless, independently of the results, institutions producing shortterm forecasts usually opt for a bottom-up approach. This paper uses an application for the euro area to show that the option between direct and bottom-up approaches as the level of disaggregation chosen by forecasters is not determined by the results of those races.
    JEL: C32 C53 E27
    Date: 2011
  28. By: Sofia Bauducco; Francesco Caprioli
    Abstract: We introduce limited commitment into a standard optimal fiscal policy model in small open economies. We consider the problem of a benevolent government that signs a risk-sharing contract with the rest of the world, and that has to choose optimally distortionary taxes on labor income, domestic debt and international debt. Both the home country and the rest of the world may have limited commitment, which means that they can leave the contract if they find it convenient. The contract is designed so that, at any point in time, neither party has incentives to exit. We define a small open emerging economy as one where the limited commitment problem is active in equilibrium. Conversely, a small open developed economy is an economy with full commitment. Our model is able to rationalize two stylized facts about fiscal policy in emerging economies: i) the volatility of tax revenues over GDP is higher in emerging economies than in developed ones; ii) the volatility of tax revenues over GDP is positively correlated with sovereign default risk.
    Date: 2011–09
  29. By: Barthélemy, J.; Marx, M.
    Abstract: In this paper, we provide solution methods for non-linear rational expectations models in which regime-switching or the shocks themselves may be "endogenous", i.e. follow state-dependent probability distributions. We use the perturbation approach to find determinacy conditions, i.e. conditions for the existence of a unique stable equilibrium. We show that these conditions directly follow from the corresponding conditions in the exogenous regime-switching model. Whereas these conditions are difficult to check in the general case, we provide for easily verifiable and sufficient determinacy conditions and first-order approximation of the solution for purely forward-looking models. Finally, we illustrate our results with a Fisherian model of inflation determination in which the monetary policy rule may change across regimes according to a state-dependent transition probability matrix.
    Keywords: Perturbation methods, monetary policy, indeterminacy, regime switching, DSGE.
    JEL: E32 E43
    Date: 2011
  30. By: Bunn, Philip (Bank of England); Ellis, Colin (BVCA and University of Birmingham)
    Abstract: This paper examines the behaviour of individual consumer prices in the United Kingdom, and uncovers a number of stylised facts about pricing behaviour. First, on average 19% of prices change each month, although this falls to 15% if sales are excluded. Second, the probability of price changes is not constant over time. Third, goods prices change more frequently than services prices. Fourth, the distribution of price changes is wide, although a significant number of changes are relatively small and close to zero. Fifth, prices that change more frequently tend to do so by less. We find that conventional pricing theories struggle to match these results, particularly the marked heterogeneity, which argues against the use of ‘representative agent’ models.
    Keywords: Consumer prices; price-setting behaviour.
    JEL: D40 E31
    Date: 2011–10–31
  31. By: Mumtaz, Haroon (Bank of England)
    Abstract: A large empirical literature has examined the transmission mechanism of structural shocks in great detail. The possible role played by changes in the volatility of shocks has largely been overlooked in vector autoregression based applications. This paper proposes an extended vector autoregression where the volatility of structural shocks is allowed to be time-varying and to have a direct impact on the endogenous variables included in the model. The proposed model is applied to US data to consider the potential impact of changes in the volatility of monetary policy shocks. The results suggest that while an increase in this volatility has a statistically significant impact on GDP growth and inflation, the relative contribution of these shocks to the forecast error variance of these variables is estimated to be small.
    Keywords: Vector autoregression; stochastic volatility; particle filter.
    JEL: E30 E32
    Date: 2011–10–31
  32. By: Dungey, Mardi; Tugrul Vehbi, M (School of Economics and Finance, University of Tasmania)
    Abstract: The term premium is estimated from an empirically coherent open economy VAR model of the UK economy where the model speci?cally accounts for the mixed nature of the data and cointegration between some variables. Using this framework the estimated negative term premia for 1980-2007 is decomposed into its contributing shocks, where the role of in?ation and monetary policy shocks are shown to be dominant in the evolution of the term premium. Projecting into the 2008 crisis period reveals the extent of the shocks to the UK economy, and also shows the similarities in term premia behaviour with those experienced during the 1998 Russian crisis.
    Keywords: Consumer Economics: Theory, Consumer Economics: Empirical Analysis, Demographic Economics
    Date: 2011–05
  33. By: Philippe Bergevin (C.D. Howe Institute); Colin Busby (C.D. Howe Institute)
    Abstract: With inflation as measured by the Consumer Price Index (CPI) growing faster than the Bank of Canada’s 2 percent target, the Bank has pointed out that core CPI, which excludes items whose prices are especially volatile, is at or below target and, further, that the Bank anticipates total CPI eventually will converge with the core measure. While the Bank is certainly justified in using core CPI as one of many imperfect measures of underlying inflation, our results suggest that the Bank should, at a minimum, revisit the role of core within its inflation-targeting framework and consider de-emphasizing core CPI in its communications or as an operational guide.
    Keywords: Monetary Policy, Bank of Canada, inflation, Consumer Price Index (CPI), core CPI
    JEL: E52 E58 E31
    Date: 2011–09
  34. By: Marcelo Rezende
    Abstract: This paper studies what determines whether federal and state supervisors examine state banks independently or together. The results suggest that supervisors coordinate examinations in order to support states with lower budgets and capabilities and more banks to supervise. I find that states with larger budgets examine more banks independently, that they accommodate changes in the number of banks mostly through the number of examinations with a federal supervisor and that, when examining banks together, state banking departments that have earned quality accreditation are more likely to write conclusion reports separately from federal supervisors. The results also indicate that regulation impacts supervision by changing the characteristics of banks. Independent examinations decrease with branch deregulation, which is consistent with the facts that this reform consolidated banks within fewer independent firms and that state and federal supervisors are more likely to examine large and complex institutions together.
    Keywords: Bank examination - United States ; Bank supervision - United States
    Date: 2011
  35. By: Pierluigi Bologna (Banca d'Italia)
    Abstract: This paper tests the role of different banks’ liquidity funding structures in explaining the bank failures that occurred in the United States between 2007 and 2009. The results highlight that funding is indeed a significant factor in explaining banks’ probability of default. By confirming the role of funding as a driver of banking crisis, the paper also recognizes that the new liquidity framework proposed by the Basel Committee on Banking Supervision appears to have the features needed to strengthen banks’ liquidity conditions and improve financial stability. Its correct implementation, together with closer supervision of banks’ liquidity and funding conditions, appear decisive, however, if such improvements are to be achieved.
    Keywords: banks, default, crises, liquidity, funding, brokered deposits, liquidity regulation, deposit insurance, United States
    JEL: G20 G21 G28
    Date: 2011–10
  36. By: Mei Dong; Janet Hua Jiang
    Abstract: We study price posting with undirected search in a search-theoretic monetary model with divisible money and divisible goods. Ex ante homogeneous buyers experience match specific preference shocks in bilateral trades. The shocks follow a continuous distribution and the realization of the shocks is private information. We show that generically there exists a unique price posting monetary equilibrium. In equilibrium, each seller posts a continuous pricing schedule that exhibits quantity discounts. Buyers spend only when they have high enough preferences. As their preferences are higher, they spend more till they become cash constrained. Since inflation reduces the future purchasing power of money and the value of retaining money, buyers tend to spend their money faster in response to higher inflation. In particular, more buyers choose to spend money and buyers spend on average a higher fraction of their money. The model naturally captures the hot potato effect of inflation along both the intensive margin and the extensive margin.
    Keywords: Economic models; Inflation and prices
    JEL: D82 D83 E31
    Date: 2011
  37. By: Thai-Ha LE (Division of Economics, Nanyang Technological University, Singapore 639798, Singapore); Youngho CHANG (Division of Economics, Nanyang Technological University, Singapore 639798, Singapore)
    Abstract: This paper uses the monthly data spanning from Jan-1986 to April-2011 to investigate the relationship between the prices of two strategic commodities: gold and oil. We examine this relationship through the inflation channel and their interaction with the index of the US dollar. We use different oil price proxies in our investigation and find that the impact of oil price on gold price is not asymmetric but non-linear. Our results show that there is a long-run relationship existing between the prices of oil and gold. Our findings imply that the oil price can be used to predict the gold price.
    Keywords: oil price, gold price, inflation, US dollar index, cointegration
    JEL: E3
    Date: 2011–02
  38. By: Franke, Reiner; Jang, Tae-Seok; Sacht, Stephen
    Abstract: The paper considers an elementary New-Keynesian three-equations model and contrasts its Bayesian estimation with the results from the method of moments (MM), which seeks to match the model-generated second moments of inflation, output and the interest rate to their empirical counterparts. Special emphasis is placed on the degree of backward-looking behaviour in the Phillips curve. While, in line with much of the literature, it only plays a marginal role in the Bayesian estimations, MM yields values of the price indexation parameter close to or even at its maximal value of one. These results are worth noticing since the matching thus achieved is entirely satisfactory. The matching of some special (and even better) versions of the model is econometrically evaluated by a model comparison test. --
    Keywords: inflation persistence,autocovariance profiles,goodness-of-fit,model comparison
    JEL: C52 E32 E37
    Date: 2011
  39. By: Gregor Semieniuk; Till van Treeck; Achim Truger
    Abstract: This paper evaluates whether the 2011 national stability programs (SPs) of the euro area countries are instrumental in achieving economic stability in the European Monetary Union (EMU). In particular, we analyze how the SPs address the double challenge of public deficits and external imbalances. Our analysis rests, first, on the accounting identities of the public, private, and foreign financial balances; and second, on the consideration of all SPs at once rather than separately. We find that conclusions are optimistic regarding GDP growth and fiscal consolidation, while current account rebalancing is neglected. The current SPs reach these conclusions by assuming strong global export markets, entrenched current account imbalances within the EMU as well as the deterioration of private financial balances in the current account deficit countries. By means of our simulations we conclude, on the one hand, that the failure of favorable global macroeconomic developments to materialize may lead to the opposite of the desired stability by exacerbating imbalances in the euro area. On the other hand, given symmetric efforts at rebalancing, the simulation suggests that for surplus countries that reduce their current account, a more expansionary fiscal policy will likely be required to maintain growth rates.
    Keywords: Euro Area; Stability Programs; Current Account Imbalances; Fiscal Policy; Stability and Growth Pact
    JEL: E10 E17 E62 F42
    Date: 2011–10
  40. By: Hatcher, Michael (Cardiff University)
    Abstract: This paper analyses the conduct of monetary policy in an environment where households’ desire to amass precautionary savings is influenced by fluctuations in the volatilities of disturbances that hit the economy. It uses a simple New Keynesian model with external habit formation that is augmented with demand and supply disturbances whose volatilities vary over time. If volatility fluctuations are ignored by policy, interest rates are set at a suboptimal level. The extent of ‘policy bias’ is relatively small but of greater importance the higher the degree of habit formation. The reason is that habit-forming preferences raise risk aversion, increasing the importance of the precautionary savings channel through which volatility fluctuations impact upon inflation and output.
    Keywords: Time-varying volatility; precautionary saving; monetary policy; DSGE models.
    JEL: E21 E32 E58 G12
    Date: 2011–10–31
  41. By: José Simão Filho; Helder Ferreira deMendonça
    Date: 2011
  42. By: Sell, Friedrich L.; Sauer, Beate
    Abstract: In this paper, we first present the state and the development of the European capital and current account imbalances. We demonstrate how large the heterogeneity among European countries is and that clustering here different types of countries is possible, but that it leads to different groupings than what has been labeled the PIGS or better GIPS countries on the one side and the GLNF countries on the other side. The same applies when it comes to cluster countries according to the debt ratio criterion. Hereafter, we put forward our own description of the mentioned ECB implicit financing scheme(s), among other things extending and complementing the recent base money market (supply and demand) analysis given by H.-W. Sinn and T. Wollmershäuser (2011). The core of the paper consists in a modified model of the New Austrian School of Economics - in the tradition of F. A. v. Hayek (1929, 1931) and in the vein of R. M. Garrison (2002) - which enables us to discuss the current distortions introduced by the Target2 credit channel into the capital markets of selected EMU countries and to detect its most important economic consequences. This part of the paper ends with a static welfare evaluation. Finally, we come up with some conclusions and suggestions for economic policy. --
    Keywords: Target2 balances,current account deficits,ECB monetary policy,New Austrian Economics
    JEL: D61 E52 E58 F32 F34
    Date: 2011
  43. By: Flávio Augusto Corrêa Basilio; JoséLuis da Costa Oreiro
    Date: 2011
  44. By: Alex Luiz Ferreira
    Date: 2011
  45. By: Antonio Alberto Mazali; José Angelo Divino
    Date: 2011
  46. By: Carlos J. García; Andrés Sagner
    Abstract: This paper studies the interaction between the business cycle and the credit market. A first result is that the business cycle has procyclical effects on different types of credit (i.e., consumer, commercial and mortgage loans). The results area obtained through the identification of structural shocks of VAR models that empirically replicate the standard transmission mechanism of monetary policy that has been found in previous work on the Chilean economy. However, our evidence points to new results. Periods of economic expansion trigger in the medium term, first, an increase in non– performing loans, and then, a decline in credit. We interpret this phenomenon as excessive risktaking. Similarly, periods of economic contraction and high interest rates are followed by a drop in non–performing loans in the medium term and then by a credit expansion. Finally, unexpected increases in non–performing loans can also produce contractionary effects, a rise in inflation by increasing credit risk and financial costs for firms.
    Date: 2011–09

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