nep-cba New Economics Papers
on Central Banking
Issue of 2011‒11‒28
39 papers chosen by
Alexander Mihailov
University of Reading

  1. The Current Currency Situation By William R. Cline; John Williamson
  2. Does the European Financial Stability Facility bail out sovereigns or banks? An event study By Horvath, Balint; Huizinga, Harry
  3. Learning by Disinflating By Alina Barnett; Martin Ellison
  4. Financial Risk Measurement for Financial Risk Management By Torben G. Andersen; Tim Bollerslev; Peter F. Christoffersen; Francis X. Diebold
  5. Predicting Recessions: A New Approach For Identifying Leading Indicators and Forecast Combinations By Turgut Kisinbay; Chikako Baba
  6. Monetary Policy, Bank Leverage, and Financial Stability By Fabian Valencia
  7. Early Warning Indicators of Crisis Incidence: Evidence from a Panel of 40 Developed Countries By Jan Babecký; Tomáš Havránek; Jakub Matìjù; Marek Rusnák; Kateøina Šmídková; Boøek Vašíèek
  8. Negative nominal interest rates: History and current proposals By Ilgmann, Cordelius; Menner, Martin
  9. Firms entry, monetary policy and the international business cycle By Cavallari Lilia
  10. Towards Effective Macroprudential Policy Frameworks: An Assessment of Stylized Institutional Models By Luis Ignacio Jácome; Erlend Nier; Jacek Osinski; Pamela Madrid
  11. Macroprudential Policy: What Instruments and How to Use Them? Lessons from Country Experiences By Cheng Hoon Lim; Alejo Costa; Torsten Wezel; Akira Otani; Francesco Columba; Mustafa Saiyid; X. Wu; Piyabha Kongsamut
  12. Sovereign CDS and Bond Pricing Dynamics in the Euro-area By Palladini, Giorgia; Portes, Richard
  13. Restrictive Fiscal Policies in Europe: What are the Likely Effects? By C. KERDRAIN; V. LAPÈGUE
  14. A Tale of Five PIIGS: Soft Budget Constraints and the EMU Sovereign Debt Crises By Thushyanthan Baskaran; Zohal Hessami
  15. The Eurozone Crisis: Institutional Setting, Structural Vulnerability, and Policies By Bruno Dallago; Chiara Guglielmetti
  16. Sovereign spreads in the Euro Area. Which prospects for a Eurobond? By Carlo Favero; Alessandro Missale
  17. Fiscal Policy Discretion, Private Spending, and Crisis Episodes By Luca Agnello; Davide Furceri; Ricardo M. Sousa
  18. Rules-based economic governance in the European Union: A reappraisal of national fiscal rules By Benczes, Istvan
  19. The "Austerity Myth": Gain without Pain? By Perotti, Roberto
  20. The New Version of the Model MZE, Macroeconometric Model for the Eurozone By M. BARLET; M.-É. CLERC; M. GARNERO; V. LAPÈGUE; V. MARCUS
  21. The theoretical framework of monetary policy revisited By Hiona Balfoussia; Sophocles N. Brissimis; Manthos D. Delis
  22. Macroeconomic implications of downward wage rigidities By Fahr Stephen
  23. Rapid Credit Growth: Boon or Boom-Bust? By Selim Elekdag; Yiqun Wu
  24. Persistent Liquidity Effects and Long Run Money Demand By Alvarez, Fernando E; Lippi, Francesco
  25. Niurong as the target for NGDP targeting: Mario Draghi's nightmare? By Belgodere, Antoine
  26. Rethinking equilibrium conditions in macromonetary theory: A conceptually rigorous approach By Piet-Hein Van Eeghen
  27. G-20 Reforms of the International Monetary System: An Evaluation By Edwin M. Truman
  28. Individual exchange rate forecasts and expected fundamentals By Dick, Christian D.; MacDonald, Ronald; Menkhoff, Lukas
  29. European exchange rates volatility and its asymmetrical components during the financial crisis By Daniel Stavárek
  30. Do Policy-Related Shocks Affect Real Exchange Rates? An Empirical Analysis Using Sign Restrictions and a Penalty-Function Approach By Taya Dumrongrittikul
  31. Exchange Rates and Individual Good’s Price Misalignment: Some Preliminary Evidence of Long-Horizon Predictability By Wei Dong; Deokwoo Nam
  32. Making Banks Safer: Can Volcker and Vickers Do It? By Jay Surti; Julian T. S. Chow
  33. A Dynamic General Equilibrium Analysis of Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk By Blommestein, Hans J.; Eijffinger, Sylvester C W; Qian, Zongxin
  34. What do we really know about the long-term evolution of central banking? Evidence from the past, insights for the present By Stefano Ugolini
  35. Exchange rates and prices in the Netherlands and Britain over the past four centuries By James R. Lothian; John Devereux
  36. A Cost-Benefit Analysis of Basel III: Some Evidence from the UK By Meilin Yan; Maximilian J. B. Hall; Paul Turner
  37. Financial stress and economic activity in Germany and the Euro Area By Björn van Roye
  38. Industry Effects of Bank Lending in Germany By Ivo Arnold; Clemens Kool; Katharina Raabe
  39. Talking to the inattentive public: How the media translates the Reserve Bank’s communications By Monique Reid; Stan Du Plessis

  1. By: William R. Cline (Peterson Institute for International Economics); John Williamson (Peterson Institute for International Economics)
    Abstract: The currency markets have been extremely disturbed for the last three months. The period witnessed a major strengthening of the US dollar in September, then the European currency crisis, a recovery of the euro when the markets believed that the crisis was being controlled, and then a rebound of the dollar. In view of these developments, those who follow currency movements need a new guide as to how the current values of currencies compare to our estimates of fundamental equilibrium exchange rates (FEERs). The first section is devoted to a brief exposition of the main changes that have occurred since April, which our previous publication used as the benchmark. The second section updates information on the levels of effective exchange rates consistent with the FEER targets identified in our most recent estimates (Cline and Williamson 2011), as well as the FEER-consistent dollar rates as of late October. The third section steps outside our normal frame of reference in order to make some comments about the situation within Europe in view of the sovereign debt crisis currently raging there.
    Date: 2011–11
  2. By: Horvath, Balint; Huizinga, Harry
    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: 2011–11
  3. By: Alina Barnett; Martin Ellison
    Abstract: Disinflationary episodes are a valuable source of information for economic agents trying to learn about the economy. This paper is especially interested in how a policymaker can themselves learn by disinflating. The approach differs from the existing literature, which typically focuses on the learning of private agents during a disinflation. We build a model where both the policymaker and private agents learn, and ask what happens if the poicymaker has to disinflate to satisfy a new central bank mandate specifying greater emphasis on inflation stabilisation. In this case, our results show that inflation may fall dramatically before it gradually rises to its new long run level. The potential for inflation to undershoot its long run level during a disinflationary episode suggests that caution should be exercised when assessing the success of any change in the policymaker’s mandate.
    Keywords: Disinflation, Escape dynamics, Learning, Monetary policy
    JEL: D83 E52 E58
    Date: 2011
  4. By: Torben G. Andersen (Kellogg School of Management, Northwestern University); Tim Bollerslev (Department of Economics, Duke University); Peter F. Christoffersen (Rotman School of Management, University of Toronto); Francis X. Diebold (Department of Economics, University of Pennsylvania)
    Abstract: Current practice largely follows restrictive approaches to market risk measurement, such as historical simulation or RiskMetrics. In contrast, we propose flexible methods that exploit recent developments in financial econometrics and are likely to produce more accurate risk assessments, treating both portfolio-level and asset-level analysis. Asset-level analysis is particularly challenging because the demands of real-world risk management in financial 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 scientific 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: Market risk, volatility, GARCH
    JEL: C1 G1
    Date: 2011–11–02
  5. By: Turgut Kisinbay; Chikako Baba
    Abstract: This study proposes a data-based algorithm to select a subset of indicators from a large data set with a focus on forecasting recessions. The algorithm selects leading indicators of recessions based on the forecast encompassing principle and combines the forecasts. An application to U.S. data shows that forecasts obtained from the algorithm are consistently among the best in a large comparative forecasting exercise at various forecasting horizons. In addition, the selected indicators are reasonable and consistent with the standard leading indicators followed by many observers of business cycles. The suggested algorithm has several advantages, including wide applicability and objective variable selection.
    Keywords: Business cycles , Economic forecasting , Economic indicators , Economic recession , Forecasting models , United States ,
    Date: 2011–10–13
  6. By: Fabian Valencia
    Abstract: This paper develops a model to assess how monetary policy rates affect bank risk-taking. In the model, a reduction in the risk-free rate increases lending profitability by reducing funding costs and increasing the surplus the monopolistic bank extracts from borrowers. Under limited liability, this increased profitability affects only upside returns, inducing the bank to take excessive leverage and hence risk. Excessive risk-taking increases as the interest rate decreases. At a broader level, the model illustrates how a benign macroeconomic environment can lead to excessive risk-taking, and thus it highlights a role for macroprudential regulation.
    Keywords: Monetary policy , Bank rates , Profits , Interest rates on loans , Interest rates on deposits , Credit risk , Bank supervision ,
    Date: 2011–10–25
  7. By: Jan Babecký (Czech National Bank); Tomáš Havránek (Czech National Bank); Jakub Matìjù (Czech National Bank); Marek Rusnák (Czech National Bank); Kateøina Šmídková (Czech National Bank); Boøek Vašíèek (Czech National Bank)
    Abstract: We provide a critical review of the literature on early warning indicators of economics crises and propose methods to overcome several pitfalls of the previous contributions. We use a quarterly panel of 40 EU and OECD countries for the period 1970–2010. As the response variable, we construct a continuous index of crisis incidence capturing the real costs for the economy. As the potential warning indicators, we evaluate a wide range of variables, selected according to the previous literature and our own considerations. For each potential indicator we determine the optimal lead employing panel vector autoregression, then we select useful indicators employing Bayesian model averaging. We re-estimate the resulting specification by system GMM to account for potential endogeneity of some indicators. Subsequently, to allow for country heterogeneity, we evaluate the random coefficients estimator and illustrate the stability among endogenous clusters. Our results suggest that global variables rank among the most useful early warning indicators. In addition, housing prices emerge consistently as an important domestic source of risk.
    Keywords: Early warning indicators, Bayesian model averaging, panel VAR, dynamic panel, macro-prudential policies.
    JEL: C33 E44 E58 F47
    Date: 2011–11
  8. By: Ilgmann, Cordelius; Menner, Martin
    Abstract: Given the renewed interest in negative interest rates as a means for overcoming the zero bound on nominal interest rates, this article reviews the history of negative nominal interest rates and gives a brief survey over the current proposals that received popular attention in the wake of the financial crisis of 2007/08. It is demonstrated that taxing money proposals have a long intellectual history and that instead of being the conjecture of a monetary crank, they are a serious policy proposal. In a second step the article points out that, besides the more popular debate on a Gesell tax as a means to remove the zero bound on nominal interest rates, there is a class of neoclassical search-models that advocates a negative tax on money as efficiency enhancing. This strand of the literature has so far been largely ignored by the policy debate on negative interest rates. --
    Keywords: negative interest rates,history of economic thought,Silvio Gesell,zero bound,search-theoretical models,monetary policy
    Date: 2011
  9. By: Cavallari Lilia
    Abstract: This paper provides a novel theory of the international business cycle grounded on firms entry and sticky prices. It shows that under simple monetary rules pro-cyclical entry can generate fluctuations in consumption, output and investment as large as those observed in the data while at the same time providing positive international comovements and highly volatile terms of trade. The capacity to capture these stylized facts of the international business cycle overcomes the well-known difficulties of the standard open economy real business cycle model in this regard. Numerical simulations show that floating regimes exacerbate counter-cyclical markup movements. Fixed regimes, on the other hand, lead to an increase in the volatility of?firm entry.
    Keywords: product variety, firm entry, international business cycle, monetary policy, interest rate rules, exchange rate regimes
    JEL: E31 E32 E52
    Date: 2011–11
  10. By: Luis Ignacio Jácome; Erlend Nier; Jacek Osinski; Pamela Madrid
    Abstract: A number of countries are reviewing their institutional arrangements for financial stability to support the development of a macroprudential policy function. In some cases, this involves a rethink of the appropriate institutional boundaries between central banks and financial regulatory agencies, or the setting up of dedicated policymaking committees. In others, efforts are underway to enhance cooperation within the existing institutional structure. Against this background, this paper provides basic guidance for the design of effective arrangements, in a manner that can provide a framework for country-specific advice. After reviewing briefly the main institutional elements of existing and emerging macroprudential policy frameworks across countries, the paper identifies stylized institutional models based on key features that distinguish institutional arrangements. It develops criteria to assess the effectiveness of models, examines the strengths and weaknesses of models against these criteria, and explores ways to improve existing setups. The paper finally distills lessons and sets out desired principles for effective macroprudential policy arrangements.
    Keywords: Cross country analysis , Economic models , Fiscal policy , Governance , Monetary policy ,
    Date: 2011–10–31
  11. By: Cheng Hoon Lim; Alejo Costa; Torsten Wezel; Akira Otani; Francesco Columba; Mustafa Saiyid; X. Wu; Piyabha Kongsamut
    Abstract: This paper provides the most comprehensive empirical study of the effectiveness of macroprudential instruments to date. Using data from 49 countries, the paper evaluates the effectiveness of macroprudential instruments in reducing systemic risk over time and across institutions and markets. The analysis suggests that many of the most frequently used instruments are effective in reducing pro-cyclicality and the effectiveness is sensitive to the type of shock facing the financial sector. Based on these findings, the paper identifies conditions under which macroprudential policy is most likely to be effective, as well as conditions under which it may have little impact.
    Keywords: Banks , Capital inflows , Credit risk , Cross country analysis , Developed countries , Emerging markets , Exchange rate regimes , Financial risk , Financial sector , Fiscal policy , Liquidity , Monetary policy ,
    Date: 2011–10–19
  12. By: Palladini, Giorgia; Portes, Richard
    Abstract: This analysis tests the price discovery relationship between sovereign CDS premia and bond yield spreads on the same reference entity. The theoretical no-arbitrage relationship between the two credit spreads is confronted with daily data from six Euro-area countries over the period 2004-2011. As a first step, the supposed non stationarity of the two series is verified. Then, we examine whether the non-stationary CDS and bond spreads series are bound by a cointegration relationship. Overall the cointegration analysis confirms that the two prices should be equal to each other in equilibrium, as theory predicts. Nonetheless the theoretical value [1, -1] for the cointegrating vector is rejected, meaning that in the short run the cash and synthetic market's valuation of credit risk differ to various degrees. The VECM analysis suggests that the CDS market moves ahead of the bond market in terms of price discovery. These findings are further supported by the Granger Causality Test: for most sovereigns in the sample, past values of CDS spreads help to forecast bond yield spreads. Short-run deviations from the equilibrium persist longer than it would take for participants in one market to observe the price in the other. That is consistent with the hypothesis of imperfections in the arbitrage relationship between the two markets.
    Keywords: asset pricing; CDS; euro area; international finance; sovereign bonds
    JEL: F34 G12 G15
    Date: 2011–11
  13. By: C. KERDRAIN (Insee); V. LAPÈGUE (Insee)
    Abstract: In Europe, fiscal policy will be distinctly more restrictive from 2011 onwards. The fiscal consolidation efforts scheduled for 2011 represent 1.2 percentage points of GDP in the eurozone and 1.8 percentage points in the UK. Such adjustments hit short-term demand and depress activity by Keynesian effects. However, non-Keynesian mechanisms can attenuate them, not least through expectations and supply effects. The impact of fiscal consolidation is also related to the economic background: in line with the recent developments on sovereign bond markets, fiscal variables are found to have a significant impact on interest rate spreads on euro area public bonds. According to our main result, when debt exceeds 100 percentage points of GDP, the marginal effect on the spread of one additional point of debt would be about 7 to 8 basis points. Accordingly, fiscal consolidation is likely to weigh down on euro area sovereign risk premiums. In this light, the NiGEM international macroeconomic model is used to assess the GDP impact of European fiscal consolidation plans. Overall, euro area's GDP in 2011 is estimated to have been 0.6% lower than in a scenario without fiscal consolidation. This impact may however be an upper bound: these simulations do not take account of the possibility of a sudden increase of financial distress following a major loss of confidence in the sovereign bonds of some euro area countries.
    Keywords: Fiscal consolidation, sovereign risk spread, eurozone
    JEL: E6 H6
    Date: 2011
  14. By: Thushyanthan Baskaran (Department of Economics, University of Göttingen, Germany); Zohal Hessami (Department of Economics, University of Konstanz, Germany)
    Abstract: Why are so many EU countries currently in dire fiscal straits? A popular explanation is that monetary unification led to bailout expectations, which in turn resulted in soft budget constraints and over-borrowing. This paper investigates the validity of this explanation by studying the effects of the Maastricht treaty and the introduction of the Euro on public deficits. To identify the causal effects of these last two stages of EMU, we apply the difference- in-difference methodology to a dataset that covers 26 OECD countries (including all EU-15 countries) over the 1975-2009 period. The estimations suggest that the effect of the EMU on deficits is limited to the so-called PIIGS countries. The signing of the Maastricht treaty triggered a reduction of deficits in this group of countries. Once the Euro had been introduced, the PIIGS expanded their deficits – but only to pre Maastricht levels. In other words, the Euro led to soft budget constraints, and the PIIGS exploited these soft budget constraints to some extent (but not excessively). From a policy perspective, our findings favor reforms in the direction of administrative rather than fiscal centralization for the EU.
    Keywords: EMU, PIIGS, monetary union, budget deficits, soft budget constraints
    Date: 2011–11–13
  15. By: Bruno Dallago; Chiara Guglielmetti
    Abstract: The unfolding of the crisis in the Eurozone can be explained by the interaction of institutional features and policy failures, and by their interconnection with real and financial imbalances. The crisis has shown that internal divergence in the EZ is based on important structural components which are unsustainable in the long run. Indeed, the crisis has magnified the gap between the vulnerable peripheral member countries and a more resilient core. The paper analyses those factors that opened the way to the diffusion of the financial and economic crisis in the Eurozone. It also discusses the structural consequences of these events and critically analyses the institutional and political reforms which the Eurozone is facing in order to enhance its capability to cope with external shocks.
    Keywords: Eurozone; European Union; European Monetary Union; euro; Common fiscal parameters; Real convergence; Productivity
    JEL: P16 O10 E60
    Date: 2011
  16. By: Carlo Favero; Alessandro Missale
    Abstract: In this paper, we provide new evidence on the determinants of sovereign yield spreads and contagion effects in the euro area in order to evaluate the rationale for a common Eurobond jointly guaranteed by euro-area Member States. We find that default risk is the main driver of yield spreads, suggesting small gains from greater liquidity. Fiscal fundamentals matter in the pricing of default risk but only as they interact with other countries’ yield spreads; i.e. with the global risk that the market perceives. More important, the impact of this global risk variable is not constant over time, a clear sign of contagion driven by shifts in market sentiment. This evidence points to a discontinuity in the disciplinary role of financial markets. If markets can stay irrational longer than a country can stay solvent, then the role of yield spreads on national bonds as a fiscal discipline device is considerably weakened, and issuing Eurobonds can be economically justified.
    Date: 2011
  17. By: Luca Agnello (Banque de France); Davide Furceri (International Monetary Fund); Ricardo M. Sousa (Universidade do Minho - NIPE)
    Abstract: In this paper, we assess the impact of fiscal policy discretion on economic activity in the short and medium-term. Using a panel of 132 countries from 1960 to 2008, we find that fiscal policy discretion provides a net stimulus to the economy in the short-run and crowding-in effects are amplified once crisis episodes are controlled for– in particular, banking crises - giving a great scope for fiscal policy stimulus packages. However, crowding-out effects take over in the long-run – especially, in the case of debt crises -, in line with the concerns about long-term debt sustainability.
    Keywords: Fiscal policy discretion, GDP growth, private consumption, private investment, crowding-in, crowding-out
    JEL: E0 E6
    Date: 2011
  18. By: Benczes, Istvan
    Abstract: The economic and financial crisis of 2007/2009 has posed unexpected challenges on both the global and the regional level. Besides the US, the EU has been the most severely hit by the current economic crisis. The financial and banking crisis on the one hand and the sovereign debt crisis on the other hand have clearly shown that without a bold, constructive and systematic change of the economic governance structure of the Union, not just the sustainability of the monetary zone but also the viability of the whole European integration process can be seriously undermined. The current crisis is, however, only a symptom, which made all those contradictions overt that were already heavily embedded in the system. Right from the very beginning, the deficit and the debt rules of the Maastricht Treaty and the Stability and Growth Pact have proved to be controversial cornerstones in the fiscal governance framework of the European Economic and Monetary Union (EMU). Yet, member states of the EU (both within and outside of the EMU) have shown an immense interest in adopting numerical constraints on the domestic level without hesitation. The main argument for the introduction of national fiscal rules was mostly to strengthen the accountability and credibility of national fiscal policy-making. The paper, however, claims that a relatively large portion of national rules were adopted only after the start of deceleration of the debt-to-GDP ratios. Accordingly, national rules were hardly the sole triggering factors of maintaining fiscal discipline; rather, they served as the key elements of a comprehensive reform package of public budgeting. It can be safely argued, therefore, that countries decide to adopt fiscal rules because they want to explicitly signal their strong commitment to fiscal discipline. In other words, it is not fiscal rules per se what matter in delivering fiscal stability but a strong political commitment.
    Keywords: fiscal governance; fiscal consolidation; fiscal rules; European Union
    JEL: E62 H50 H60
    Date: 2011–07–05
  19. By: Perotti, Roberto
    Abstract: As governments around the world contemplate slashing budget deficits, the "expansionary fiscal consolidation hypothesis" is back in vogue. I argue that, as a statement about the short run, it should be taken with caution. Alesina and Perotti (1995) and Alesina and Ardagna (2010) (AAP) show that fiscal consolidations may be expansionary if implemented mainly by cutting government spending. IMF (2010) criticizes the data and methodology used by AAP, and reach opposite conclusions. I argue that because of the multi-year nature of the large fiscal consolidations, which are precisely the most informative ones, using yearly panels of fiscal policy is limiting. I present four detailed case studies, two -- Denmark and Ireland -- undertaken under fixed exchange rates (the most relevant case for many Eurozone countries today) and two -- Finland and Sweden -- after floating the currency. All four episodes were associated with an expansion; but only in Denmark the driver of growth was internal demand. However, after three years a long slump set in as the economy lost competitiveness. In all the others for a long time the main driver of growth was exports. In Ireland this occurred because the sterling coincidentally appreciated. In Finland and Sweden the currency experienced an extremely large depreciation after floating. In all consolidations interest rate fell fast, and wage moderation played a key role in generating a gain in competitiveness and a decline in interest rates. Wage moderation was facilitated by the direct intervention of the government in the wage negotiation process. In Finland and Sweden, the adoption of inflation targeting at the same time of the consolidation helped the decline in interest rates. These results cast doubt on at least some versions of the expansionary fiscal consolidations hypothesis, and on its applicability to many countries in the present circumstances. A depreciation is not available to EMU members today (except vis à vis countries outside the Eurozone). A net export boom is not feasible for the world as a whole. A further decline in interest rates is unlikely in the current situation. And incomes policies are not popular nowadays; moreover, international experience, and the Danish case, suggest that they are ineffective after a few years.
    Keywords: expansionary fiscal consolidations
    JEL: E62 E65 F32
    Date: 2011–11
  20. By: M. BARLET (Drees); M.-É. CLERC (Insee); M. GARNERO (Drees); V. LAPÈGUE (Insee); V. MARCUS (SGDD)
    Abstract: This paper presents the main improvements carried out to the macroeconometric model MZE since its creation in 2003. We have back-calculated the series over the period 1980-1995, in order to make the model more stable. To our knowledge, this paper is the first application of Kllians (1998) method to estimate coefficients and centered confidence intervals for an operational macroeconometric model. The new coefficients enable to get less inflationary responses to macroeconomic shocks than the previous version of MZE. The study is more nuanced and rigorous thanks to the confidence intervals around the main scenarios. It is thus possible to check the significance of the results at any horizon. At last, the new version of MZE enables to find conventional responses to international shocks, like the inflationary effect of a rise in oil prices or the delayed impact of a depreciation of the euro on the improvement of the trade balance.
    Keywords: Macroeconometric modelling, Forecasting, Confidence interval, Bootstrap
    JEL: C3 C5 E1 E2
    Date: 2011
  21. By: Hiona Balfoussia (Bank of Greece); Sophocles N. Brissimis; Manthos D. Delis (City University)
    Abstract: The three-equation New-Keynesian model advocated by Woodford (2003) as a self-contained system on which to base monetary policy analysis is shown to be inconsistent in the sense that its long-run static equilibrium solution implies that the interest rate is determined from two of the system’s equations, while the price level is left undetermined. The inconsistency is remedied by replacing the Taylor rule with a standard money demand equation. The modified system is seen to possess the key properties of monetarist theory for the long run, i.e. monetary neutrality with respect to real output and the real interest rate and proportionality between money and prices. Both the modified and the original New-Keynesian models are estimated on US data and their dynamic properties are examined by impulse response analysis. Our research suggests that the economic and monetary analysis of the European Central Bank could be unified into a single framework.
    Keywords: Monetary theory; Central banking; New-Keynesian model; Impulse response analysis
    JEL: E40 E47 E52 E58
    Date: 2011–09
  22. By: Fahr Stephen
    Abstract: Growth of wages, unemployment, employment and vacancies exhibit strong asymmetries between expansionary and contractionary phases. In this paper we analyze to what degree downward wage rigidities in the bargaining process aect other variables of the economy. We introduce asymmetric wage adjustment costs in a New-Keynesian DSGE model with search and matching frictions in the labor market. We nd that the presence of downward wage rigidities strongly improves the t of the model to the skewness of variables and the relative length of expansionary and contractionary phases even when detrending the data. Due to the asymmetry, wages increase more easily in expansions, which limits vacancy posting and employment creation, similar to the exible wage case. During contractions nominal wages decrease slowly, shifting the main burden of adjustment to employment and hours worked. The asymmetry also explains the diering transmission of positive and negative demand shocks from wages to ination. Downward wage rigidities help explaining the asymmetric business cycle of many OECD countries where long and smooth expansions with low growth rates are followed by sharp but short recessions with large negative growth rates.
    Keywords: labor market, unemployment, downward wage rigidity, asymmetric adjustment costs, non—linear dynamics
    JEL: E31 E52 C61
    Date: 2011–11
  23. By: Selim Elekdag; Yiqun Wu
    Abstract: Episodes of rapid credit growth, especially credit booms, tend to end abruptly, typically in the form of financial crises. This paper presents the findings of a comprehensive event study focusing on 99 credit booms. Loose monetary policy stances seem to have contributed to the build-up of credit booms across both advanced and emerging economies. In particular, domestic policy rates were below trend during the pre-peak phase of credit booms and likely fuelled macroeconomic and financial imbalances. For emerging economies, while credit booms are associated with episodes of large capital inflows, international interest rates (a proxy for global liquidity) are virtually flat during these periods. Therefore, although external factors such as global liquidity conditions matter, and possibly increasingly so over time, domestic factors (especially monetary policy) also appear to be important drivers of real credit growth across emerging economies.
    Keywords: Asia , Credit expansion , Monetary policy , Liquidity , Capital inflows , Financial crisis , Interest rates , Bank soundness , Corporate sector , International liquidity ,
    Date: 2011–10–20
  24. By: Alvarez, Fernando E; Lippi, Francesco
    Abstract: We present a monetary model in the presence of segmented asset markets that im- plies a persistent fall in interest rates after a once and for all increase in liquidity. The gradual propagation mechanism produced by our model is novel in the literature. We provide an analytical characterization of this mechanism, showing that the magnitude of the liquidity effect on impact, and its persistence, depend on the ratio of two parameters: the long-run interest rate elasticity of money demand and the intertemporal substitution elasticity. At the same time, the model has completely classical long-run predictions, featuring quantity theoretic and Fisherian properties. The model simultaneously explains the short-run "instability" of money demand estimates as-well-as the stability of long-run interest-elastic money demand.
    Keywords: money demand
    JEL: E5
    Date: 2011–11
  25. By: Belgodere, Antoine
    Abstract: NGDP targeting is presented by some macroeconomists as a good practice for central banks. But what should be the target value? I propose a relevant measure: the Non Increasing Unemployment Rate Of Nominal Growth (NIURONG). I use NIURONG to show how difficult would have been for European Central Bank to implement a relevant monetary policy for each Euro Area country in front of post-2008 economic downturn.
    Keywords: NDGP targeting; monetary policy; Optimal Currency Areas
    JEL: E58
    Date: 2011–11–20
  26. By: Piet-Hein Van Eeghen
    Abstract: Although still very much a minority view, there is a growing sense of unease about the high degree of abstraction involved in contemporary macro-monetary theory, in particular concerning its representative-agent microfoundation (see e.g. Colander et al., 2008; Goodhart, 2005, 2008; Buiter, 2009; Caballero, 2010; Hoover, 2010; Du Plessis, 2010; Meeusen, 2010). The paper shares this unease but questions another aspect of contemporary theory: its equilibrium conditions as consisting of its market coordination conditions and budget equation. The paper derives, from scratch, an alternative set of such conditions which it rigorously grounds in the nature of monetary exchange. This alternative set has implications for a wide variety of issues, including the aptness of MIU and CIA modelling, the nature of real and monetary disturbances, and the linkage between the financial and real sectors. The paper also assesses the conceptual soundness of commonly used constructs like Keynes’s income-spending (saving-investment) equation of IS analysis, Hicks’s wealth constraint, Fisher’s quantity equation, Walras’s Law, and the budget constraint of contemporary DSGE modelling.
    Keywords: monetary exchange, equilibrium condition, budget equation, market coordination, market price
    JEL: E11 E12 E40
    Date: 2011
  27. By: Edwin M. Truman (Peterson Institute for International Economics)
    Abstract: At the recent Cannes G-20 summit, the international monetary system (IMS) reform agenda, along with a number of other important issues, was hijacked by the European crisis. Nevertheless, the G-20 countries and various international institutions conducted an intensive process of review and discussion of the IMS via conferences, working groups, and reports. A year ago French President Sarkozy and other French government officials set the agenda for IMS reform to include five elements: surveillance of the global economy and financial system, the international lender-of-last-resort mechanisms (global financial safety nets), the management of global capital flows, reserve assets and reserve currencies, and IMS governance. Little progress was made on most of these topics. On surveillance there was only one surprise in the form of commitments by a few countries to allow their automatic stabilizers to operate in the current slowdown; on the lender-of-last-resort issues, there will only be marginal steps forward; and on the management of capital flows, the progress that has been achieved over the past several years has been loosely codified, which is a substantive achievement. Overall, the G-20 summit at Cannes resulted in some useful mutual education but not much in terms of concrete accomplishments.
    Date: 2011–11
  28. By: Dick, Christian D.; MacDonald, Ronald; Menkhoff, Lukas
    Abstract: This paper suggests that exchange rates are related to economic fundamentals over medium-term horizons, such as a month or longer. We find from a large panel of individual professionals' forecasts that good exchange rate forecasts benefit from the proper understanding of fundamentals, specifically good interest rate forecasts. This relation is robust to individual fixed effects and further controls. Reassuringly, this relation is stronger during obvious fundamental misalignment. This occurs when exchange rates substantially deviate from their PPP values, when interest rate differentials are high and when exchange rates are less influenced by strong momentum. --
    Keywords: Exchange Rate Determination,Individual Expectations,Macroeconomic Fundamentals
    JEL: F31 F37 E44
    Date: 2011
  29. By: Daniel Stavárek (Silesian University, School of Business Administration)
    Abstract: Two forms of asymmetry in the exchange rate volatility are examined in this paper. We analyze four currencies of new EU member states, two currencies of non euro area old EU members, US dollar and Swiss franc against the euro during the period financial crisis. We apply a modified TARCH model on data grouped into four phases of the financial crises differing in intensity and market sentiment. The results suggest that the exchange rates usually shared a similar trend in volatility. The presence of asymmetric attributes of the exchange rate volatility was relatively common. Similar symptoms of asymmetry were registered mainly in the new EU member states and Sweden. Appreciation movements seem to have significantly different effects on volatility than the depreciation movements of equal size (first form of asymmetry) particularly during the phases of crisis initialization and culmination. By contrast, a significant impact of divergence from the target exchange rate on the volatility (second form of asymmetry) was revealed principally during the crisis stabilization.
    Keywords: exchange rate volatility, asymmetry, TARCH model, financial crisis
    JEL: F31
    Date: 2011–11
  30. By: Taya Dumrongrittikul
    Abstract: We examine the response of real exchange rates to shocks in real exchange rate determinants, a monetary policy shock, and a fiscal policy shock in 30 countries over the period 1970-2008. The country set is divided into 4 groups - European, developed-country, Asian developing-country, and non Asian developing-country groups. We propose and apply a new approach, i.e. we employ a panel Bayesian structural vector error correction model, and we impose sign restrictions with a penalty-function approach to identify the shocks. We find that most of our impulse response analysis is in line with economic theories. Specifically, there is strong evidence that trade liberalization generates a real depreciation and an increase in government spending leads to a real appreciation over the long run. We also find that a contractionary monetary policy shock has only short-run impacts on real exchange rates, corresponding to the long-run neutrality of monetary policy. The responses to a productivity shock are interesting, i.e. productivity growth in traded sectors has no effect on the real exchange rate of the Asian developing-country group, and it leads to a long-run real appreciation in the non Asian developing-country group. In contrast, this shock causes a real depreciation in the European country group over the long run. Variance decomposition suggests that international trade policy contributes the most to real exchange rate movements in most country groups, with the exception of the non Asian developing-country group, for which fiscal policy via government spending seems to be the most important.
    Keywords: Real exchange rate, Vector error correction model, Monetary policy shocks, Sign restriction, Penalty function, Identification
    JEL: C33 C51 E52 F31
    Date: 2011–11–10
  31. By: Wei Dong; Deokwoo Nam
    Abstract: When prices are sticky, movements in the nominal exchange rate have a direct impact on international relative prices. A relative price misalignment would trigger an adjustment in consumption and employment, and may help to predict future movements in the exchange rate. Although purchasing-power-parity fundamentals, in general, have only weak predictability, currency misalignment may be indicated by price differentials for some goods, which could then have predictive power for subsequent re-evaluation of the nominal exchange rate. The authors collect good-level price data to construct deviations from the law of one price and examine the resulting price-misalignment model’s predictive power for the nominal exchange rates between the U.S. dollar and two other currencies: the Japanese yen and the U.K. pound. To account for small-sample bias and data-mining issues, inference is drawn from bootstrap distributions and tests of superior predictive ability (SPA) are performed. The slope coefficients and R-squares increase with the forecast horizon for the bilateral exchange rates between the U.S. dollar and the Japanese yen and the U.S. dollar and the U.K. pound. The out-of-sample SPA tests suggest that the authors’ price-misalignment model outperforms random walks either with or without drift for the U.S. dollar vis-à-vis the Japanese yen at the 5 per cent level of significance over long horizons.
    Keywords: Exchange rates; International topics
    JEL: F31 F47
    Date: 2011
  32. By: Jay Surti; Julian T. S. Chow
    Abstract: This paper assesses proposals to redefine the scope of activities of systemically important financial institutions. Alongside reform of prudential regulation and oversight, these have been offered as solutions to the too-important-to-fail problem. It is argued that while the more radical of these proposals such as narrow utility banking do not adequately address key policy objectives, two concrete policy measures - the Volcker Rule in the United States and retail ring-fencing in the United Kingdom - are more promising while still entailing significant implementation challenges. A risk factor common to all the measures is the potential for activities identified as too risky for retail banks to migrate to the unregulated parts of the financial system. Since this could lead to accumulation of systemic risk if left unchecked, it appears unlikely that any structural engineering will lessen the policing burden on prudential authorities and on the banks.
    Keywords: Bank regulations , Bank supervision , Banking , Commercial banks , Fiscal risk , Risk management , Securities markets , United Kingdom , United States ,
    Date: 2011–10–13
  33. By: Blommestein, Hans J.; Eijffinger, Sylvester C W; Qian, Zongxin
    Abstract: This paper builds a dynamic general equilibrium macro-finance model with two types of borrowers: entrepreneurs who want to produce and gamblers who want to play a lottery. It links central bank's interest rate policy to expected cash flows of both types. This link enables us to study how the interactions between various shocks and different monetary policy rules affect the borrower pool faced by financial intermediaries. We find that when the economy is hit by an expansionary monetary policy shock, the proportion of entrepreneurs in the borrower pool will be persistently lower than the steady state level after a short period. It is lowest when the central bank does not react to output fluctuations. Quite differently, not reacting to output fluctuations avoids a persistent worsening of the borrower pool in the long run if the shock is a bad productivity shock.
    Keywords: Adverse Selection; Financial Crisis; Monetary Policy
    JEL: E44 E52
    Date: 2011–11
  34. By: Stefano Ugolini (Scuola Normale Superiore, Pisa)
    Abstract: The ongoing financial crisis is shaking central bankers’ certainties about their mission, and a rethinking of such mission can greatly benefit from a non-finalistic reassessment of how central banking has evolved over the centuries. This paper does so by taking a functional, instead of an institutional approach. The survey covers the provision of both microeconomic (financial stability) and macroeconomic (monetary stability) central banking functions in the West since the Middle Ages. The existence of a number of important trends (some unidirectional, some cyclical) is underlined. The findings have implications for the current debate on the institutional design of central banking, both in the U.S. and in the eurozone. Historical evidence suggests that neither changes in the organizational model of central banks nor government deficit monetization should necessarily be seen as evil; what is crucial to the success of any solution, is that the institutional agreement backing the existence of money-issuing organizations must be credible. The appendix provides a case study on Norway.
    Keywords: Central banking, monetary policy, financial stability, institutional design
    JEL: E42 E50 G21 N10 N20
    Date: 2011–11–21
  35. By: James R. Lothian (Fordham University); John Devereux (Queens College, CUNY)
    Abstract: This paper examines exchange-rate and price-level data for the long period 1590-2009 for the Netherlands and the United Kingdom (earlier the Dutch Republic and England), countries that at various times over this near four century span have differed substantially in terms of the pace at which their economies were developing, have operated under a variety of exchange rate regimes, and have been subjected to an extremely wide variety of real shocks. The principal conclusion of this study is the resiliency of the simple purchasing-power-parity model and of the law of one price at the microeconomic level. Both take some heavy blows during this close to four-century long sample period. In the end, however, they emerge surprisingly unscathed. Real factors at times appear to have had substantial effects on real exchange rates and hence PPP, but such effects ultimately dissipate. As a long-run equilibrium condition, PPP holds up remarkably well.
    Date: 2011–07
  36. By: Meilin Yan (School of Business and Economics, Loughborough University, UK); Maximilian J. B. Hall (School of Business and Economics, Loughborough University, UK); Paul Turner (School of Business and Economics, Loughborough University, UK)
    Abstract: This paper provides a long-term cost-benefit analysis for the United Kingdom of the Basel III capital and liquidity requirements proposed by the Basel Committee on Banking Supervision (BCBS, 2010a). We provide evidence that the Basel III reforms will have a significant net positive long-term effect on the United Kingdom economy. The estimated optimal tangible common equity capital ratio is 10% of risk-weighted assets, which is larger than the Basel III target of 7%. We also estimate the maximum net benefit when banks meet the Basel III longterm liquidity requirements. Our estimated permanent net benefit is larger than the average estimates of the BCBS. This significant marginal benenfit suggests that UK banks need to increase their reliance on common equity in their capital base beyond the level required by Basel III as well as boosting customer deposits as a funding source.
    Keywords: Basel III, Cost-Benefit analysis, Tangible Common Equity Capital, Liquidity
    JEL: C32 C53 G21 G28
    Date: 2011–11
  37. By: Björn van Roye
    Abstract: The financial crisis 2008-2009 and the European sovereign debt crisis have shown that stress on financial markets is important for analyzing and forecasting economic activity. Since financial stress is not directly observable but is presumably reflected in many financial market variables, it is useful to derive an indicator summarizing the stress component of these variables. Therefore, I derive a financial market stress indicator (FMSI) for Germany and the Euro Area using a dynamic approximate factor model. Subsequently, applying these indicators, I analyse the effects of financial stress on economic activity in a small Bayesian VAR model. An increase in financial stress leads to a significant dampening of GDP growth and the inflation rate. Additionally, there is a substantial and persistent decline in short-term nominal interest rates. I find that about fifteen percent of variation in real GDP growth can be accounted for variations in financial stress for Germany and about 30 percent in the Euro Area. I show that the inclusion of the indicator significantly improves out-of-sample forecasting accuracy for real GDP growth in Germany compared to a model without the indicator and other forecast benchmarks
    Keywords: Forecasting, Financial stress indicator, Financial Systems, Recessions, Slowdowns, Financial Crises
    JEL: E5 E6 F3 G2 G14
    Date: 2011–11
  38. By: Ivo Arnold; Clemens Kool; Katharina Raabe
    Abstract: We investigate the industry dimension of bank lending and its role in the monetary transmission mechanism in Germany. We use dynamic panel methods to estimate bank lending functions for eight industries for the period 1992-2002. Our evidence shows that bank lending growth predominantly depends on the industry composition of bank loan portfolios, both through the underlying cyclical fluctuations in industry-specific bank credit demand and through industry-specific credit supply effects.
    Keywords: Monetary policy transmission, credit channel, industry structure, dynamic panel data
    JEL: C23 E52 G21 L16
    Date: 2011–11
  39. By: Monique Reid; Stan Du Plessis
    Abstract: Central bank communication is widely recognised as crucial to the implementation of monetary policy. This communication should enhance a central bank’s management of the inflation expectations of the financial markets as well as the general public — the latter being a part of the central bank’s audience that has received relatively little research attention. In this paper, the role of the media in transmitting the SARB’s communication to the general public is explored, with the aim of improving our understanding of its impact on the expectations channel of the monetary policy transmission mechanism. A deliberate evaluation of this channel could aid the design of future strategies to communicate with the general public.
    Keywords: South Africa, central bank communication, consistency, monetary policy transmission mechanism, transparent monetary policy.
    JEL: E42 E52 E58
    Date: 2011

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