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on Central Banking |
| By: | Levine, Paul; Pearlman, Joseph |
| Abstract: | This paper describes a series of algorithms that are used to compute optimal policy under full and imperfect information. Firstly we describe how to obtain linear quadratic (LQ) approximations to a nonlinear optimal policy problem. We develop novel algorithms that are required as a result of having agents with forward-looking expectations, that go beyond the scope of those that are used when all equations are backward-looking; these are utilised to generate impulse response functions and second moments for the case of imperfect information. We describe algorithms for reducing a system to minimal form that are based on conventional approaches, and that are necessary to ensure that a solution for fully optimal policy can be computed. Finally we outline a computational algorithm that is used to generate solutions when there is a zero lower bound constraint for the nominal interest rate. |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:dynare:010&r=cba |
| By: | Torben G. Andersen (Northwestern University and CREATES); Tim Bollerslev (Duke University and CREATES); Peter F. Christoffersen (University of Toronto and CREATES); Francis X. Diebold (University of Pennsylvania) |
| Abstract: | Current practice largely follows restrictive approaches to market risk measurement, such as historical simulation or RiskMetrics. In contrast, we propose exible methods that exploit recent developments in nancial econometrics and are likely to produce more accurate risk assessments, treating both portfoliolevel and asset-level analysis. Asset-level analysis is particularly challenging because the demands of real-world risk management in nancial institutions - in particular, real-time risk tracking in very high-dimensional situations - impose strict limits on model complexity. Hence we stress powerful yet parsimonious models that are easily estimated. In addition, we emphasize the need for deeper understanding of the links between market risk and macroeconomic fundamentals, focusing primarily on links among equity return volatilities, real growth, and real growth volatilities. Throughout, we strive not only to deepen our scientic understanding of market risk, but also cross-fertilize the academic and practitioner communities, promoting improved market risk measurement technologies that draw on the best of both. |
| Keywords: | Risk measurement, risk management, volatility, conditionality, dimensionality reduction, high-frequency data, macro fundamentals |
| JEL: | C22 C32 G32 |
| Date: | 2011–11–02 |
| URL: | http://d.repec.org/n?u=RePEc:aah:create:2011-37&r=cba |
| By: | Anton Nakov (Banco de España and ECB); Carlos Thomas (Banco de España) |
| Abstract: | We study optimal monetary policy from the timeless perspective in a general state-dependent pricing framework. Firms are monopolistic competitors and are subject to idiosyncratic menu cost shocks. We find that, under isoelastic preferences and no government spending, strict price stability is optimal both in the long run and in response to aggregate shocks. Key to this finding is an “envelope” property: at zero inflation, a marginal increase in the rate of inflation has no effect on firms’ profits and therefore has no effect on the rate of price adjustment. We offer an analytic solution which does not rely on local approximation or efficiency of the steady-state. |
| Keywords: | monetary policy, state-dependent pricing, monopolistic competition |
| JEL: | E31 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:bde:wpaper:1130&r=cba |
| By: | Anton Nakov; Carlos Thomas |
| Abstract: | In an abstract economic model, we study optimal monetary policy from the timeless perspective under a general state-dependent pricing framework. We find that when firms are monopolistic competitors subject to idiosyncratic menu cost shocks, households have isoelastic preferences, and there is no government spending, strict price stability is optimal both in the long run and in response to aggregate shocks. Key to this finding is an "envelope" property: At zero inflation, a marginal increase in the rate of inflation has no effect on firms' profits and therefore it has no effect on the probability of price adjustment. Our results lend support to more informal statements about the suitability of the Calvo model for studying optimal monetary policy despite its apparent conflict with the Lucas critique. We offer an analytic solution that does not require local approximation or efficiency of the steady state. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2011-48&r=cba |
| By: | James Costain; Anton Nakov |
| Abstract: | Starting from the assumption that firms are more likely to adjust their prices when doing so is more valuable, this paper analyzes monetary policy shocks in a DSGE model with firm-level heterogeneity. The model is calibrated to retail price microdata, and inflation responses are decomposed into "intensive", "extensive", and "selection" margins. Money growth and Taylor rule shocks both have nontrivial real effects, because the low state dependence implied by the data rules out the strong selection effect associated with fixed menu costs. The response to sector-specific shocks is gradual, but inappropriate econometrics might make it appear immediate. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2011-50&r=cba |
| By: | Hatcher, Michael C. (Cardiff Business School) |
| Abstract: | Using a version of the Smets-Wouters model of the US economy augmented to include both New Keynesian and New Classical sectors, this paper investigates the performance of inflation targeting and price-level targeting when the zero lower bound on nominal interest rates is occasionally-binding. Several notable results emerge. First, the unconditional probability of hitting the lower bound is lower under price-level targeting than inflation targeting, with 'lower bound episodes' being less frequent and lasting for shorter periods of time. Second, the volatilities of key macroeconomic variables are lower under price-level targeting than inflation targeting. Third, the lower frequency and severity of lower bound episodes under price-level targeting appears to have a first-order impact on consumption, investment and output, raising their mean values. Intuitively, price-level targeting performs well because inflation expectations act as automatic stabilisers, reducing the chance of hitting or remaining at the lower bound whilst also providing stability when the economy is away from the lower bound. |
| Keywords: | Zero lower bound; occasionally-binding constraint; price-level targeting; inflation targeting |
| JEL: | E52 E58 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2011/24&r=cba |
| By: | Dixon, Huw (Cardiff Business School); Bihan, Hervé Le |
| Abstract: | The Generalized Calvo and the Generalized Taylor models of price and wage-setting are, unlike the standard Calvo and Taylor counterparts, exactly consistent with the distribution of durations observed in the data. Using price and wage micro-data from a major euro-area economy (France), we develop calibrated versions of these models. We assess the consequences for monetary policy transmission by embedding these calibrated models in a standard DSGE model. The Generalized Taylor model is found to help rationalizing the humpshaped and persistent response of inflation, without resorting to the counterfactual assumption of systematic wage and price indexation. |
| Keywords: | Contract length; steady state; hazard rate; Calvo; Taylor; wage-setting; price-setting |
| JEL: | E31 E32 E52 J30 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:cdf:wpaper:2011/25&r=cba |
| By: | Sheri Markose; Amadeo Alentorn; Stephen Millard; Jing Yang |
| Abstract: | The purpose of this paper is to show how agent-based simulations of payment systems can be used to aid central bankers and payment system operators in thinking about the appropriate design of payment settlement systems to minimise risk and increase their efficiency. Banks, which we model as the ‘agents’, are capable of a degree of autonomy with which to respond to payment system rules and adopt a strategy that determines how much collateral to post with the central bank at the start of the day (equivalently how much liquidity to borrow intraday from the central bank) and when to send payment orders to the central processor. An interbank payment system with costly liquidity requires banks to solve an intraday cash management problem, minimising their liquidity and delay costs subject to their beliefs about what the other banks are doing. Some preliminary results are given on how banks learn to endogenously determine how much liquidity to post in the interbank liquidity management game. |
| Date: | 2011–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:700&r=cba |
| By: | Antonio De Socio (Bank of Italy) |
| Abstract: | After August 2007 the plumbing system that supplied banks with wholesale funding, the interbank market, failed because toxic assets obstructed the pipes. Banks were forced to squeeze liquidity in a “lemons market” or to ask for liquidity “on tap” from central banks. This paper disentangles the two components of the three-month Euribor-Eonia swap spread, credit and liquidity risk and then evaluates the decomposition. The main finding is that credit risk increased before the key events of the crisis, while liquidity risk was mainly responsible for the subsequent increases in the Euribor spread and then reacted to the systemic responses of the central banks, especially in October 2008. Moreover, the level of the spread between May 2009 and February 2010 was influenced mainly by credit risk, suggesting that European banks were still in a “lemons market” and relied on liquidity “on tap”. |
| Keywords: | interbank markets, credit risk, liquidity risk, financial crisis, Euribor spread. |
| JEL: | E43 E44 E58 G21 |
| Date: | 2011–09 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_819_11&r=cba |
| By: | Charles A. Fleischman; John M. Roberts |
| Abstract: | We construct new estimates of potential output and the output gap using a multivariate approach that allows for an explicit role for measurement errors in the decomposition of real output. Because we include data on hours, output, employment, and the labor force, we are able to decompose our estimate of potential output into separate trends in labor productivity, labor-force participation, weekly hours, and the NAIRU. We find that labor-market variables—especially the unemployment rate—are the most informative individual indicators of the state of the business cycle. Conditional on including these measures, inflation is also very informative. Among measures of output, we find that although they add little to the identification for the cycle, the income-side measures of output are about as informative as the traditional product-side measures about the level of structural productivity and potential output. We also find that the output gap resulting from the recent financial crisis was very large, reaching -7 percent of output in the second half of 2009. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2011-46&r=cba |
| By: | Adam Elbourne; Coen Teulings |
| Abstract: | <p>This CPB Discussion Paper highlights potential uses of simple, small models where large traditional models are less flexible.</p><p>We run a number of experiments with a small two variable VAR model of GDP growth and unemployment with both quarterly and yearly data. We compare the forecasts of these simple models with the published forecasts of the CPB and we conclude that there is not much di erence. We then show how easy it is to evaluate the usefulness of a given variable for forecasting by extending the model to include world trade. Perfect knowledge of future world trade growth would help considerably but is obviously not available at the time the forecasts were made. The available world trade data doesn't improve the forecasts. Finally we also show how quick and exible measures of the output gap can be constructed.</p> |
| JEL: | C0 E0 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpb:discus:193&r=cba |
| By: | Stefan Avdjiev |
| Abstract: | The existing literature on estimated structural News Driven Business Cycle (NDBC) models has focused almost exclusively on macroeconomic data and has largely ignored asset prices. In this paper, we present evidence that including data on asset prices in the estimation of a structural NDBC model dramatically affects inference about the main sources of business cycle fluctuations. Combined with the large body of evidence that asset price movements reflect changes in expectations of future developments in the economy, our results imply that data on asset prices should always be used in the estimation of structural NDBC models because they contain information that cannot be obtained by using solely macroeconomic data. |
| Keywords: | News Driven Business Cycles, Asset Prices, Estimated DSGE Models, Bayesian MCMC Methods |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:358&r=cba |
| By: | Sandra Gomes (Bank of Portugal); Pascal Jacquinot (European Central Bank); Matthias Mohr (European Central Bank); Massimiliano Pisani (Bank of Italy) |
| Abstract: | We quantitatively assess the macroeconomic effects of country-specific supply-side reforms in the euro area by simulating EAGLE, a multi-country dynamic general equilibrium model. We consider reforms in the labor and services markets of Germany (or, alternatively, Portugal) and the rest of the euro area. Our main results are as follows. First, a unilateral markup reduction by 15 percentage points in the German (Portuguese) labor and services market would induce an increase in the long-run German (Portuguese) output equal to 8.8 (7.8) percent. Second, cross-country coordination of reforms would add extra benefits to each region, by limiting the deterioration of relative prices and purchasing power that a country faces when implementing reforms unilaterally. In the long run German (Portuguese) output would increase by 9.2 (8.6) percent. Third, cross-country coordination would make the macroeconomic performance of the different regions more homogeneous, in terms of price competitiveness and real activity. Overall, our results suggest that while reforms implemented individually by each country in the euro area will produce positive effects, cross-country coordination produces larger and more evenly distributed (positive) effects. |
| Keywords: | economic policy, structural reforms, dynamic general equilibrium modeling, competition, markups. |
| JEL: | C53 E52 F47 |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_830_11&r=cba |
| By: | Gabriel Desgranges (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise); Stéphane Gauthier (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris) |
| Abstract: | We study how asymmetric information affects market volatility in a linear setup where the outcome is determined by forecasts about this same outcome. The unique rational expectations equilibrium will be stable when it is the only rationalizable solution. It has been established in the literature that stability is obtained when the sensitivity of the outcome to agents' forecasts is less than 1, provided that this sensitivity is common knowledge. Relaxing this common knowledge assumption, instability is obtained when the proportion of agents who a priori know the sensitivity is large, and the uninformed agents believe it is possible that the sensitivity is greater than 1. |
| Keywords: | Asymmetric information, common knowledge, eductive learning, rational expectations, rationalizability, volatility. |
| Date: | 2011–10 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00639813&r=cba |
| By: | Alessio Anzuini (Bank of Italy); Fabio Fornari (European Central Bank) |
| Abstract: | From a financial standpoint, the mechanics of the carry trade has been recently examined in Brunnermeier et al. (2009). They showed that shocks to interest rate differentials lead to carry trade activity and to significant reactions in the bilateral exchange rates vis-a-vis the US dollar that they analyse. Starting from their paper, we take a more macroeconomic standpoint and aim to identify what kind of structural shock can generate the implications of their interest rate differential shock. To this aim we add two macroeconomic variables and two indicators of confidence to the 4-variable financial VAR of Brunnermeier et al. (2009) and use sign restrictions on the impulse responses of the resulting larger VAR to identify four macroeconomic shocks. We evidence that demand shocks and confidence shocks are associated with longer-term gains from carry trade activity, relative to supply and monetary policy shocks. This finding also supports the widely reported idea that sentiment boosts position taking. |
| Keywords: | carry trade, speculative activity, sign restriction. |
| JEL: | G12 G13 G14 |
| Date: | 2011–09 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_817_11&r=cba |
| By: | David Jamieson Bolder; Simon Deeley |
| Abstract: | As part of managing a debt portfolio, debt managers face the challenging task of choosing a strategy that minimizes the cost of debt, subject to limitations on risk. The Bank of Canada provides debt-management analysis and advice to the Government of Canada to assist in this task, with the Canadian debt-strategy model being developed to help in this regard. The authors outline the main elements of the model, which include: cost and risk measures, inflation-linked debt, optimization techniques, the framework used to model the government’s funding requirement, the sensitivity of results to the choice of joint stochastic macroeconomic term-structure model, the effects of shocks to macroeconomic and term-structure variables and changes to their long-term values, and the relationship between issuance yield and issuance amount. Emphasis is placed on the degree to which changes to the formulation of model elements impact key results. The model is an important part of the decision-making process for the determination of the government’s debt strategy. However, it remains one of many tools that are available to debt managers and is to be used in conjunction with the judgment of an experienced debt manager. |
| Keywords: | Debt management; Econometric and statistical methods; Financial markets; Fiscal policy |
| JEL: | C0 G11 H63 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:11-3&r=cba |
| By: | Horvath, Roman; Rusnak, Marek; Smidkova, Katerina; Zapal, Jan |
| Abstract: | Abstract We examine the determinants of the dissent in central bank boards’ voting records about monetary policy rates in the Czech Republic, Hungary, Sweden, the U.K. and the U.S. In contrast to previous studies, we consider about 25 different macroeconomic, financial, institutional, psychological or preference-related factors jointly and deal formally with the attendant model uncertainty using Bayesian model averaging. We find that the rate of dissent is between 5% and 20% in these central banks. Our results suggest that most regressors, including those capturing the effect of inflation and output, are not robust determinants of voting dissent. The difference in central bankers’ preferences is likely to drive the dissent in the U.S. Fed and the Bank of England. For the Czech and Hungarian central banks, average dissent tends to be larger when policy rates are changed. Some evidence is also found that food price volatility tends to increase the voting dissent in the U.S. Fed and in Riksbank. |
| Keywords: | monetary policy; voting record; dissent |
| JEL: | E58 E52 |
| Date: | 2011–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34638&r=cba |
| By: | Michael Brei; Leonardo Gambacorta; Goetz von Peter |
| Abstract: | This paper examines whether the rescue measures adopted during the global financial crisis helped to sustain the supply of bank lending. The analysis proposes a setup that allows testing for structural shifts in the bank lending equation, and employs a novel dataset covering large international banks headquartered in 14 major advanced economies for the period 1995-2010. While stronger capitalisation sustains loan growth in normal times, banks during a crisis can turn additional capital into greater lending only once their capitalisation exceeds a critical threshold. This suggests that recapitalisations may not translate into greater credit supply until bank balance sheets are sufficiently strengthened. |
| Keywords: | bank lending channel, monetary policy, financial crisis, rescue packages, recapitalisation |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:357&r=cba |
| By: | Veronica Guerrieri; Guido Lorenzoni |
| Abstract: | We study the effects of a credit crunch on consumer spending in a heterogeneous-agent incomplete-market model. After an unexpected permanent tightening in consumers’ borrowing capacity, some consumers are forced to deleverage and others increase their precautionary savings. This depresses interest rates, especially in the short run, and generates an output drop, even with flexible prices. The output drop is larger with nominal rigidities, if the zero lower bound prevents the interest rate from adjusting downwards. Adding durable goods to the model, households take larger debt positions and the output response may be larger. |
| JEL: | E2 E4 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17583&r=cba |
| By: | Horvath, B.L.; Huizinga, H.P. (Tilburg University, Center for Economic Research) |
| Abstract: | On May 9, 2010 euro zone countries announced the creation of the European Financial Stability Facility as a response to the sovereign debt crisis. This paper investigates the impact of this announcement on bank share prices, bank CDS spreads and sovereign CDS spreads. The main private beneficiaries were bank creditors, especially of banks heavily exposed to southern Europe and Ireland and located in countries characterized by weak public finances. Furthermore, countries with weak public finances and banking systems heavily exposed to southern Europe and Ireland benefited, as evidenced by lower sovereign CDS spreads. The combined gains of bank debt holders and shareholders exceed the increase in the value of their sovereign debt exposures, suggesting that banks saw their contingent claim on the financial safety net increase in value. |
| Keywords: | Bailout;Banking;CDS spreads;Sovereign debt. |
| JEL: | G21 G28 H63 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:2011118&r=cba |
| By: | Hanna Samaryna; Jakob de Haan |
| Abstract: | This paper examines which economic, fiscal, external, financial, and institutional characteristics of countries affect the likelihood that they adopt inflation targeting as their monetary policy strategy. We estimate a panel binary response transition model for 60 countries and two subsamples consisting of OECD and non-OECD countries over the period 1985-2008. The findings suggest that past macroeconomic performance of a country, its fiscal discipline, exchange rate arrangements, as well as the structure and development of its financial system have a significant impact on the likelihood to adopt inflation targeting. However, the determinants of inflation targeting differ between OECD and non-OECD countries. |
| Keywords: | inflation targeting; monetary policy strategy |
| JEL: | E42 E52 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:321&r=cba |
| By: | Leonardo Gambacorta; Paolo Emilio Mistrulli |
| Abstract: | A substantial literature has investigated the role of relationship lending in shielding borrowers from idiosyncratic shocks. Much less is known about how lending relationships and bank-specific characteristics affect the functioning of the credit market in an economy-wide crisis, when banks may find it difficult to perform the role of shock absorbers. We investigate how bank-specific characteristics (size, liquidity, capitalization, funding structure) and the bank-firm relationship have influenced interest rate setting since the collapse of Lehman Brothers. Unlike the existing literature, which has focused chiefly on the amount of credit granted during the crisis, we look at its cost. The data on a large sample of loans from Italian banks to non-financial firms suggest that close lending relationships kept firms more insulated from the financial crisis. Further, spreads increased by less for the customers of well-capitalized, liquid banks and those engaged mainly in traditional lending business. |
| Keywords: | bank interest rate setting, lending relationship, bank lending channel, financial crisis |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:359&r=cba |
| By: | Laine, Tatu (Bank of Finland); Nummelin, Tuomas (Bank of Finland); Snellman, Heli (Bank of Finland) |
| Abstract: | This study utilises payment system data to analyse market participants’ liquidity usage and to trace interest rates paid on overnight loans. Our aim is to examine how liquidity usage has changed during the years 2006–2/2011 and to combine this information with data on overnight lending rates between market participants. It turns out that the Furfine algorithm used in the analysis produces overnight interest rates that correlate very closely with the EONIA curve. Based on Finnish payment system data, we identify four separate time periods: normal, start of turmoil, acute crisis and stabilizing period. The results show that, during the acute crisis period, TARGET2 participants holding an account with the Bank of Finland paid, on average, lower overnight interest rates than other banks in the euro area. However, the results reveal there has been some lack of confidence between Finnish participants since the onset of the financial crisis. A new indicator – the Grid – which we present here shows this very clearly. We suggest that this new indicator could be a highly useful tool for overseers in supporting financial stability analysis. |
| Keywords: | liquidity; interest rates; overnight loans; payment systems; indicators |
| JEL: | C81 E42 E43 E58 |
| Date: | 2011–11–11 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2011_023&r=cba |
| By: | Ron Alquist; Olivier Gervais |
| Abstract: | Over the past 10 years, financial firms have increased the size of their positions in the oil futures market. At the same time, oil prices have increased dramatically. The conjunction of these developments has led some observers to argue that financial speculation caused the run-up in oil prices. Yet several arguments cast doubt on the validity of this claim. First, although the stock of open futures contracts is many times larger than the flow of oil consumption in the United States, comparing these two statistics is misleading. Stocks are not measured with respect to a specific unit of time but flows are, so the two are not directly comparable. Second, empirical analysis shows that changes in financial firms’ positions do not predict oil-price changes, but that oil-price changes predict changes in positions. Third, the evidence indicates that financial firms’ positions did not cause the market to expect persistent price increases during 2007/08. Other explanations for the increase in oil prices include macroeconomic fundamentals, such as interest rates and increased demand from emerging Asia. Of these two explanations, the one that seems most consistent with the facts explains oil-price fluctuations in terms of large and persistent demand shocks related to growth in global real activity in the presence of supply constraints. |
| Keywords: | International topics |
| JEL: | Q41 G12 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:11-6&r=cba |
| By: | Mitra , Kaushik (School of Economics & Finance, University of St Andrews); Evans , George W. (University of Oregon and University of St Andrews); Honkapohja , Seppo (Bank of Finland) |
| Abstract: | What is the impact of surprise and anticipated policy changes when agents form expectations using adaptive learning rather than rational expectations? We examine this issue using the standard stochastic real business cycle model with lump-sum taxes. Agents combine knowledge about future policy with econometric forecasts of future wages and interest rates. Both permanent and temporary policy changes are analyzed. Dynamics under learning can have large impact effects and a gradual hump-shaped response, and tend to be prominently characterized by oscillations not present under rational expectations. These fluctuations reflect periods of excessive optimism or pessimism, followed by subsequent corrections. |
| Keywords: | taxation; government spending; expectations; permanent and temporary policy changes |
| JEL: | D84 E21 E43 E62 |
| Date: | 2011–11–10 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofrdp:2011_022&r=cba |
| By: | Guy Mayraz |
| Abstract: | An experiment tested whether and in what circumstances people are more likely to believe an event simply because it makes them better off. Subjects observed a financial asset's historical price chart, and received both an accuracy bonus for predicting the price at some future point, and an unconditional award that was either increasing or decreasing in this price. Despite incentives for hedging, subjects gaining from high prices made significantly higher predictions than those gaining from low prices. The magnitude of the bias was smaller in charts with less subjective uncertainty, but was independent of the amount paid for accurate predictions. |
| Keywords: | Wishful-thinking, optimal expectations, priors and desires, payoff-dependent beliefs, asset prices |
| JEL: | D01 D81 D84 G11 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp1092&r=cba |
| By: | Shepherd, Ben |
| Abstract: | This note presents a simple generalization of the adaptive expectations mechanism in which the learning parameter is time variant. It is shown that expectations generated in this way are rational in the sense of producing minimum mean squared forecast errors for a broad class of time series models, namely any process that can be written in linear state space form. |
| Keywords: | Adaptive Expectations; Rational Expectations; Kalman Filter |
| JEL: | C53 C22 |
| Date: | 2011–10–25 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:34644&r=cba |
| By: | Flint Brayton |
| Abstract: | This paper describes the E-Newton and E-QNewton algorithms for solving rational expectations (RE) models. Both algorithms treat a model's RE terms as exogenous variables whose values are iteratively updated until they (hopefully) satisfy the RE requirement. In E-Newton, the updates are based on Newton's method; E-QNewton uses an efficient form of Broyden's quasi-Newton method. The paper shows that the algorithms are reliable, fast enough for practical use on a mid-range PC, and simple enough that their implementation does not require highly specialized software. The evaluation of the algorithms is based on experiments with three well-known macro models--the Smets-Wouters (SW) model, EDO, and FRB/US--using code written in EViews, a general-purpose, easy-to-use software package. The models are either linear (SW and EDO) or mildly nonlinear (FRB/US). A test of the robustness of the algorithms in the presence of substantial nonlinearity is based on modified versions of each model that include a smoothed form of the constraint that the short-term rate of interest cannot fall below zero. In two single-simulation experiments with the standard and modified versions of the models, E-QNewton is found to be faster than E-Newton, except for solutions of small-to-medium sized linear models. In a multi-simulation experiment using the standard versions of the models, E-Newton dominates E-QNewton. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2011-44&r=cba |
| By: | Guonan Ma; Yan Xiandong; Kostas Liu Xi |
| Abstract: | This paper examines the evolving role of reserve requirements as a policy tool in China. Since 2007, the Chinese central bank (PBC) has relied more on this tool to withdraw domestic liquidity surpluses, as a cheaper substitute for open-market operation instruments in this period of rapid FX accumulation. China's reserve requirement system has also become more complex and been used to address a range of other policy objectives, not least being macroeconomic management, financial stability and credit policy. The preference for using reserve requirements reflects the size of China's FX sterilisation task and the associated cost considerations, a quantity-oriented monetary policy framework challenged to reconcile policy dilemmas and tactical considerations. The PBC often finds it easier to reach consensus over reserve requirement decisions than interest rate decisions and enjoys greater discretion in applying this tool. The monetary effects of reserve requirements need to be explored in conjunction with other policy actions and not in isolation. Depending on the policy mix, higher reserve requirements tend to signal a tightening bias, to squeeze excess reserves of banks, to push market interest rates higher, and to help widen net interest spreads, thus tightening domestic monetary conditions. There are, however, costs to using this policy tool, as it imposes a tax burden on Chinese banks that in turn appear to have passed a significant portion of this cost onto their customers, mostly depositors and SMEs. However, the pass-through onto bank customers appears to be partial. |
| Keywords: | reserve requirements, sterilisation tools, monetary policy, net interest margin and spread, tax incidence, Chinese economy |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:360&r=cba |
| By: | Olivier Gervais; Lawrence Schembri; Lena Suchanek |
| Abstract: | In emerging-market economies, real exchange rate adjustment is critical for maintaining a sustainable current account position and thereby for helping to reduce macroeconomic and financial instability. The authors examine empirically two related hypotheses: (i) that real exchange rate flexibility and adjustment promotes external stability, and (ii) that a flexible nominal exchange rate facilitates real exchange rate adjustment. Based on an event-study analysis for a large set of emerging-market economies over the period 1975–2008, the authors find that real exchange rate adjustment has contributed significantly to reducing current account imbalances. The adjustment of current account deficits in countries with a fixed exchange rate regime does not typically occur through the classical adjustment mechanism, but as a consequence of exchange rate crises, where the nominal exchange rate collapses and there are substantial costs in terms of forgone output. Vector-error-correction results support the findings of the event study; namely, in the long run the real exchange rate movements facilitate current account adjustment. |
| Keywords: | Development economics; Exchange rate regimes; International topics |
| JEL: | F31 F32 F41 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:11-5&r=cba |
| By: | Carlos Vieira (CEFAGE-UE, Universidade de Évora, Portugal); Isabel Vieira (CEFAGE-UE, Universidade de Évora, Portugal) |
| Abstract: | The academic and political discussion about which countries met the conditions for joining EMU was decisively influenced by the Frankel and Rose (1997) hypothesis concerning endogenous OCA properties. The answer to their question "Is EMU more justifiable ex post than ex ante?" was a definite yes in their ex ante analysis. Our ex post examination of the euro's first decade, however suggests that the hypothesis does not hold for some countries. This paper utilizes panel data estimation techniques to compute OCA indices that help assess the OCA endogeneity hypothesis and signal current external and fiscal imbalances. |
| Keywords: | optimum currency areas, OCA index, monetary union |
| JEL: | F15 F36 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:mde:wpaper:0042&r=cba |
| By: | Frank A.G. den Butter (VU University Amsterdam); Harro B.J.B. Maas (Utrecht University) |
| Abstract: | This paper investigates the history of the shift from expert to model based monetary policy analysis at the Dutch Central Bank (DNB) in the postwar period up to the middle of the nineteen-eighties. For reasons that will become clear expert based reasoning at DNB was referred to as normative impulse analysis. Our focus is on two aspects of this shift: (i) from an expert based monetary analysis to a model based analysis of channels of monetary transmission, and (ii) from the top down way of monetary analysis where the president of DNB acted as the monetary expert that was in line with the hierarchical organisation of DNB to the bottom up modelling approach that was set up by a group of newly hired young academic outsiders and destabilized DNB's organisation. The resulting econometric model enabled DNB to regain some of its argumentative strength in the Dutch policy arena that had become dominated by the econometric model of the Dutch Planning Bureau (of wh ich Tinbergen was the first director), but also led to tensions within DNB's organisation. In spite of efforts to incorporate the main aspects of Holtrop's monetary analysis within the model, its concomitant new research group appeared difficult to integrate within the hierarchical organisation of DNB. The model analysis resulted in the MORKMON model which replaced Holtrop's analysis in the mid 1980s and was regularly used in policy analysis and forecasting of DNB until 2011, when the model was replaced by the DELFI model. |
| Keywords: | Dutch monetarism; history of economic modelling; monetary policy |
| JEL: | B23 C52 E58 |
| Date: | 2011–11–15 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20110161&r=cba |
| By: | Douglas A. Irwin |
| Abstract: | The Recession of 1937-38 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery. Yet our understanding of this severe downturn is incomplete: existing studies find that changes in fiscal policy were small in comparison to the magnitude of the downturn and that higher reserve requirements were not binding on banks. This paper focuses on a neglected change in monetary policy, the sterilization of gold inflows during 1937, and finds that it exerted a powerful contractionary force during this period. The transmission of this monetary shock to the real economy appears to have worked through lower asset (equity) prices and higher interest rates. |
| JEL: | E5 N12 |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17595&r=cba |
| By: | David Laidler (University of Western Ontario) |
| Abstract: | Irving Fisher's encounter with the Quantity theory of Money began in the 1890s, during the debate about bimetallism, and reached its high point in 1911 with the publication of The Purchasing Power of Money. His most important refinement of the theory, derived from his recognition of bank deposits as means of exchange, was to treat their out of equilibrium recursive interaction with inflation as integral to it. This treatment underlay both his 1920s work on the business cycle as a "dance of the dollar" and his advocacy of subjecting monetary policy to a legislated price stability rule, initially to be based on his "compensated dollar" scheme. Fisher's failure to recognize the onset of the Great Depression even as it was happening was directly related to his faith in the quantity theory's seeming implication that price level stability in and of itself guaranteed the continuation of prosperity, while his subsequent work on the debt deflation theory of great depressions initially failed to repair the damage that this failure did to his reputation, and to that of the quantity theory. In the 1930s Fisher nevertheless remained an active supporter of various schemes to reflate and then stabilize the price level. His subsequent influence on the quantity theory based Monetarist counter-revolution that began in the 1950s lay, directly, in its deployment of his analysis of expected inflation on nominal interest rates, and, indirectly, in its espousal of the case for subjecting monetary policy to a legislated rule. |
| Keywords: | Quantity theory; Price level; Inflation; Deflation; Business cycle; Depression; Money; Interest; Fisher effect |
| JEL: | B1 B2 B3 E3 E4 E5 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:uwo:uwowop:20111&r=cba |
| By: | Andrew Filardo |
| Abstract: | The international financial crisis of the late 2000s has revived interest in asset price bubble research. For some, the event confirmed the enduring relevance of studying asset price bubbles in our economies. For others, it was a realisation that asset price bubbles are of much greater significance than previously thought. The financial and policy preconditions that foster "frothy" asset prices which characterise bubbles have been the focus of considerable attention. While doubtless important, it is not the only aspect that requires greater understanding. We also need to develop a better understanding of the whole life-cycle of asset price bubbles, from their origins, to their expansion and spread, the inevitable collapse, and the aftermath that has to be cleaned up. It is increasingly recognised that researchers must not treat bubbles as one-off, exogenous events. The challenge is to develop a more holistic approach, and then build into our policy models endogenous bubble behavior. Such behavior may indeed be rare but nonetheless has its origins in a number of avoidable factors, not least being some combination of financial fragility, flawed policy frameworks, and poor risk management decisions. This paper contributes to our understanding of asset price bubbles by looking at assets when they are severely underpriced, i.e., when there are negative asset price bubbles. Generally, negative asset price bubbles are an underrepresented protagonist in most crisis stories, and this has certainly been the case in the recent international financial crisis. The particular illustration for this paper comes from an examination of the financial market spillovers from the West to Asia and the Pacific. Where did the spillovers come from and how will the crisis end? While there are many different ways to conceptualise the spillovers, this paper will show how cross-border spillovers led to the severe underpricing of various types of assets in Asia and the Pacific. And, just as the policy response to the bursting of the dot-com bubble in the United States may have contributed to the housing problems in the 2000s, there are concerns that accommodative monetary policy in response to the negative asset price bubble and associated macroeconomic fallout may be laying the foundation for a round of positive asset price bubbles. The paper begins with a brief discussion of a negative asset price bubble and a narrative of the international financial crisis in Asia and the Pacific. Prior to September 2008, the international financial crisis had had a limited impact on Asia-Pacific markets. To be sure there were periods of unusual stress but, by and large, the region was more focused on macroeconomic policy issues throughout much of the year. That all changed in late 2008 as the region, despite its strong economic and financial fundamentals, entered what was to become a sharp V-shaped business cycle. Through the lens of a negative asset price bubble perspective, this paper helps to shed new light on the unusual dynamics as well as the policy trade-offs faced during the crisis and afterward. Asia and the Pacific economies are particularly useful "laboratories" to examine these phenomena because of the diverse economic, financial, and policy frameworks in place. The paper also presents a simple model of endogenous asset price bubbles to clarify some of the policy issues. The model assumes there are two regions of the world that are susceptible to domestic asset price bubbles. This type of model emphasises the highly persistent nature of financial shocks associated with boom-bust dynamics and the potential spillovers across geographic borders. An asset price bubble in one economy can influence the likelihood of an asset price bubble in the other economy. Possibly most important, the actions of the policymaker in one region can affect not only the occurrence of a bubble in its domestic market but also the occurrence of a bubble in the other region. This type of model also elevates the importance of tail risk considerations for policymakers, opening up consideration of more complex monetary policy trade-offs than in conventional macroeconomic models. The paper then explores the implications, combining both the narrative from the crisis and the implications of the theoretical model to understand better the regional policy trade-offs that occurred during the international financial crisis. In addition to emphasising the critical importance of having strong economic and financial fundamentals going into a crisis period, it also highlights the value of monetary policymakers adopting state-dependent policy frameworks. During normal times, monetary policy focused on price stability makes sense. During crisis times, the priorities of a central bank may need to be adjusted by putting more weight on financial stability than on short-term inflation stability. This comes down to placing more weight on tail risks when making policy decisions. Practically, this means that short-term deviations from (implicit and explicit) inflation targets may be appropriate, if not optimal, when coming out of a crisis. The paper proceeds as follows. Section 2 lays out the basic intuition of a negative asset price bubble. Section 3 reviews the Asia-Pacific experience during the recent international financial crisis, highlighting aspects of this new bubble perspective. Section 4 then presents a simple international monetary policy model with negative asset price bubbles to explore the theoretical channels of spillovers and the policy trade-offs. Section 5 describes results. Section 6 draws on historical narrative and theoretical findings to evaluate the policy implications. Section 7 offers some conclusions. |
| Keywords: | Financial crisis, monetary policy, asset price bubble, central banking |
| Date: | 2011–11 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:356&r=cba |
| By: | Gordon Wilkinson |
| Abstract: | Measures of core inflation enable a central bank to distinguish price movements that are transitory and generated by non-monetary events from those that are more permanent and related to prior monetary policy decisions. The author uses standard statistical measures to assess the behaviour of consumer prices across provinces and identify price components with more divergent price patterns. The results indicate that energy, shelter and tobacco prices are the most volatile across provinces. Very large price movements restricted to one or a few provinces suggest that the forces or events triggering those movements may be province specific and unrelated to national demand pressures. Such results suggest that constructing a type of core inflation measure called the “trimmed mean” that excludes components with exceptionally large price changes at the provincial level may offer an alternative means of assessing underlying inflationary pressures. |
| Keywords: | Inflation and prices |
| JEL: | E31 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocadp:11-2&r=cba |
| By: | Yavuz Arslan; Evren Ceritoglu |
| Abstract: | We estimate average quality growth and upward inflation bias for a set of 51 goods in Turkey by using 7 waves of Household Budget Survey from 2003 to 2009 and TURKSTAT prices. We employ instrumental variables approach introduced by Bils and Klenow (2001). We find that average quality growth in Turkey is 3.93 percent. Of this 3.93 percent, 2.28 percent is not netted out by TURKSTAT. Consequently, for the set of goods that we study, the estimated inflation bias is 2.28 percentage points. |
| Keywords: | Quality bias, Inflation rates |
| JEL: | D12 E31 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:tcb:wpaper:1121&r=cba |