nep-cba New Economics Papers
on Central Banking
Issue of 2011‒12‒19
forty-one papers chosen by
Alexander Mihailov
University of Reading

  1. Optimal disinflation under learning By Timothy Cogley; Christian Matthes; Argia M. Sbordone
  2. The role of expectations in U. S. inflation dynamics By Jeffrey C. Fuhrer
  3. International recessions By Fabrizio Perri; Vincenzo Quadrini
  4. Japanfs Deleveraging since the 1990s and the Bank of Japanfs Monetary Policy: Some Comparisons with the U.S. Experience since 2007 By Kazuo Ueda
  5. Do mood swings drive business cycles and is it rational? By Paul Beaudry; Deokwoo Nam; Jian Wang
  6. Do Mood Swings Drive Business Cycles and is it Rational? By Paul Beaudry; Deokwoo Nam; Jian Wang
  7. The financial accelerator and monetary policy rules By Gunes Kamber; Christoph Thoenissen
  8. The International Monetary System: Living with Asymmetry By Obstfeld, Maurice
  9. News Shocks and Asset Price Volatility in General Equilibrium By Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
  10. When credit bites back: leverage, business cycles, and crises By Òscar Jordà; Moritz Schularick; Alan M. Taylor
  11. A Quantitative Model of Sovereign Debt, Bailouts and Conditionality By Fabian Fink; Almuth Scholl
  12. Bank of Japan’s Monetary Easing Measures: Are They Powerful and Comprehensive? By W. Raphael Lam
  13. Are recoveries from banking and financial crises really so different? By Greg Howard; Robert Martin; Beth Anne Wilson
  14. Policy Response to External Shocks: Lessons from the Crisis By Carlos Capistrán; Gabriel Cuadra; Manuel Ramos Francia
  15. Bank Leverage Regulation and Macroeconomic Dynamics By Ian Christensen; Césaire Meh; Kevin Moran
  16. How does the FOMC learn about economic revolutions? evidence from the New Economy Era, 1994-2001 By Richard G. Anderson; Kevin L. Kliesen
  17. Output sensitivity of inflation in the euro area: Indirect evidence from disaggregated consumer prices By Fröhling, Annette; Lommatzsch, Kirsten
  18. Price-Level Targeting - A Real Alternative to Inflation Targeting? By Jiri Bohm; Jan Filacek; Ivana Kubicova; Romana Zamazalova
  19. Monetary regime switches and unstable objectives By Davide Debortoli; Ricardo Nunes
  20. A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets By Acharya, Viral V.; Skeie, David
  21. Detecting multiple breaks in long memory: The case of US inflation By Hassler, Uwe; Meller, Barbara
  22. Monetary Policy Rules, Adverse Selection and Long-Run Financial Risk By Blommestein, H.J.; Eijffinger, S.C.W.; Qian, Z.
  23. Data Revisions in the Estimation of DSGE models By Miguel Casares; Jesús Vázquez
  24. Fiscal Policy Discretion, Private Spending, and Crisis Episodes By Agnello, L.; Furceri, D.; R.M, Sousa.
  25. International transmission of shocks, money illusion and the velocity of money By Sousa, Teresa
  26. Loose commitment in medium-scale macroeconomic models: theory and applications By Davide Debortoli; Junior Maih; Ricardo Nunes
  28. Technology news and the U.S. economy: Time variation and structural changes By Berg, Tim Oliver
  29. Political Business Cycles and Monetary Policy Revisited – An Application of a Two-Dimensional Asymmetric Taylor Reaction Function By Jens Klose
  30. Real-Time Analysis of Oil Price Risks Using Forecast Scenarios By Baumeister, Christiane; Kilian, Lutz
  31. External Shocks and Monetary Policy in a Small Open Oil Exporting Economy By Jean Pierre Allegret; Mohamed Tahar Benkhodja
  32. Monetary Credibility Effects on Inflation Dynamics: A Macrohistorical Case Study. By Claude Diebolt; Mamoudou Toure; Jamel Trabelsi
  33. Skew-normal shocks in the linear state space form DSGE model By Grzegorz Grabek; Bohdan Klos; Grzegorz Koloch
  34. Inflation Dynamics in Asia: Causes, Changes, and Spillovers from China By D. Filiz Unsal; Carolina Osorio
  35. Can Emerging Market Central Banks Bail Out Banks? A Cautionary Tale from Latin America By Luis Ignacio Jácome; Tahsin Saadi Sedik; Simon Townsend
  36. What Can Low-Income Countries Expect from Adopting Inflation Targeting? By Edward R. Gemayel; Sarwat Jahan; Alexandra Peter
  37. Testing the Monetary Model for Exchange Rate Determination in South Africa: Evidence from 101 Years of Data By Riane de Bruyn; Rangan Gupta; Lardo Stander
  38. Monetary Policy and Risk-Premium Shocks in Hungary: Results from a Large Bayesian VAR By Alina Carare; Adina Popescu
  39. Does Money Matter for Inflation in Ghana? By Arto Kovanen
  40. Monetary Policy Transmission in Ghana: Does the Interest Rate Channel Work? By Arto Kovanen
  41. On the Stability of Money Demand in Ghana: A Bounds Testing Approach By Jihad Dagher; Arto Kovanen

  1. By: Timothy Cogley; Christian Matthes; Argia M. Sbordone
    Abstract: We model transitional dynamics that emerge after the adoption of a new monetary policy rule. We assume that private agents learn about the new policy via Bayesian updating, and we study how learning affects the nature of the transition and the choice of a new rule. Temporarily explosive dynamics can emerge when there is substantial disagreement between actual and perceived policies. These dynamics make the transition highly volatile and dominate expected loss. The emergence of temporarily explosive paths depends more on uncertainty about policy-feedback parameters than about the long-run inflation target. For that reason, the central bank can at least achieve low average inflation. Its ability to move feedback parameters away from initial beliefs, however, is more constrained.
    Keywords: Monetary policy ; Bayesian statistical decision theory ; Inflation (Finance)
    Date: 2011
  2. By: Jeffrey C. Fuhrer
    Abstract: A growing body of literature examines alternatives to the rational expectations hypothesis in applied macroeconomics. This paper continues this strand of research by examining the role survey expectations play in the inflation process and reports three principal findings. One, short-run inflation expectations appear to play a significant role in explaining U.S. inflation over the past 20–25 years. Two, long-run expectations generally do not appear to have a direct influence on U.S. inflation over the same period, although these longer expectations enter indirectly as a key determinant of the short-run expectations. The restrictions implied by "trend inflation" models of inflation are generally rejected in the data. Three, by employing a "survey operator," this paper develops a first pass at a structural model that incorporates the features discussed above and assesses its performance in explaining inflation in the postwar period.
    Keywords: Inflation (Finance) ; Rational expectations (Economic theory)
    Date: 2011
  3. By: Fabrizio Perri; Vincenzo Quadrini
    Abstract: The 2007–2009 crisis was characterized by an unprecedented degree of international synchronization as all major industrialized countries experienced large macroeconomic contractions around the date of Lehman bankruptcy. At the same time countries also experienced large and synchronized tightening of credit conditions. We present a two-country model with financial market frictions where a credit tightening can emerge as a self-fulfilling equilibrium caused by pessimistic but fully rational expectations. As a result of the credit tightening, countries experience large and endogenously synchronized declines in asset prices and economic activity (international recessions). The model suggests that these recessions are more severe if they happen after a prolonged period of credit expansion.
    Date: 2011
  4. By: Kazuo Ueda (Faculty of Economics, University of Tokyo)
    Abstract: This paper discusses the backgrounds for the stagnant behavior of the Japanese economy during the last two decades and the failure of the Bank of Japan (BOJ) to turn the economy around. I argue that the policy authorities did not act quickly enough to mitigate the pain of the deleveraging process in the aftermath of the burst of land and stock price bubble in the early 1990s. Thus, the process became overly severe and protracted. The economy increasingly became vulnerable to negative external shocks and the decline in its population. Use of non-conventional monetary policy measures after deflationary expectations became entrenched substantially weakened their power to stimulate the economy. The U.S. economy since 2007 has exhibited many of the features seen for the Japanese economy during the last two decades; hence, the talk of the Japanization of the U.S. economy. There are, however, many dissimilarities as well as similarities between the two episodes. These are also discussed along with the analysis of Japanfs two lost decades.Popular discussions of Japanfs stagnation often focus on persistent deflation. Figure 1 shows core CPI inflation and a representative property price index for Japan and the U.S. since the peak of property prices, with the peak (T=0) assumed to be 1990 for Japan and 2006 for the U.S. In addition, it also plots investment in structures relative to GDP in Japan. Inflation in Japan has been in negative territory since 1998.1 There has been, however, no tendency for the deflation to accelerate. The cumulative decrease in the index since the late 1990s has been only about 5%. Thus, the classic debt-deflation type dynamic has not been a major cause of economic stagnation. In contrast, declines in property prices in Japan since the peak has been large and protracted-cumulating in a 60% decline at the time of writing. They led to significant deleveraging by financial institutions and non-financial corporations, which put downward pressure on aggregate demand for goods and services, especially, investment in structures, the component of aggregate demand most sensitive to property prices. The figure shows that its movements have been highly correlated with those of property prices.2 As may be seen from the figure, this component of aggregate demand alone subtracted about 0.4% per year from GDP growth during the 1990s. Such a negative feedback loop among asset prices, economic activity and, as we discuss below, financial instability has been the key feature of Japanfs stagnation. It is also interesting to note that both CPI inflation and property prices in the U.S. since the recent financial crisis have followed closely that of Japan in the 1990s, but inflation has so far avoided plunging into negative territory. Adjustment in asset prices and real investment were to some extent inevitable given the extent of the excesses created during the bubble period. The deleveraging process, however, became extremely protracted as a result of a forbearance game played by policymakers and financial institutions. Banks kept lending for a while to zombie companies in order to avoid recognition of losses on their balance sheets, and the authority stayed away for years from making the tough decision to recapitalize the banks. This resulted in a huge buildup of bad loans and eventually in a serious credit crunch in the late 1990s, which aggravated the declines in asset prices and deleveraging by banks and nonfinancial corporations. Banks increasingly became risk averse and stopped lending to risky, but promising projects. The economy slowly, but steadily lost momentum and could not grow out of the negative shocks generated by external financial crises in the late 1990s and 2000s, and the declines in its population that started in the 2000s. Deflation of the general price level did play a part in this process as well. It has hindered the effectiveness of monetary easing. This is ironic because monetary policy normally is a tool for avoiding deflation. Either the deleveraging forces outweighed the capacity of monetary policy to stimulate the economy or the BOJ easing came a bit too late. The BOJ tried to reverse the disinflation trend with fairly aggressive rate cuts - a conventional monetary policy tool-- and brought the policy rate to near zero by late 1995, effectively hitting the zero lower bound (ZLB) constraint on interest rates. Deflation, however, developed in response to economic weakness. The real interest rate has stayed at higher levels than desirable, and undermined the power of a zero interest rate to stimulate the economy, although it did not throw the economy into a deflationary spiral. Since the late 1990s, the BOJ has adopted a variety of non-conventional monetary policy measures. They have supported the financial system and prevented deflation from becoming worse, but have not turned the economy around. As I argue below, non-conventional measures work by reducing risk premiums and long-short interest rate spreads. The long period of economic stagnation had lowered these spreads to minimum levels and limited the effectiveness of such measures as was the case for conventional measures. In the following I will describe in more detail the deleveraging experience in Japan and then turn to discussing the experience of the BOJ to turn the economy around. Comparisons with the U.S. experience since 2007 are offered at each stage of the discussion
    Date: 2011–12
  5. By: Paul Beaudry; Deokwoo Nam; Jian Wang
    Abstract: This paper provides new evidence in support of the idea that bouts of optimism and pessimism drive much of US business cycles. In particular, we begin by using sign-restriction based identification schemes to isolate innovations in optimism or pessimism and we document the extent to which such episodes explain macroeconomic fluctuations. We then examine the link between these identified mood shocks and subsequent developments in fundamentals using alternative identification schemes (i.e., variants of the maximum forecast error variance approach).> ; We find that there is a very close link between the two, suggesting that agents' feelings of optimism and pessimism are at least partially rational as total factor productivity (TFP) is observed to rise 8–10 quarters after an initial bout of optimism. While this later finding is consistent with some previous findings in the news shock literature, we cannot rule out that such episodes reflect self-fulfilling beliefs. Overall, we argue that mood swings account for over 50 percent of business-cycle fluctuations in hours and output.
    Keywords: Macroeconomics
    Date: 2011
  6. By: Paul Beaudry; Deokwoo Nam; Jian Wang
    Abstract: This paper provides new evidence in support of the idea that bouts of optimism and pessimism drive much of US business cycles. In particular, we begin by using sign-restriction based identification schemes to isolate innovations in optimism or pessimism and we document the extent to which such episodes explain macroeconomic fluctuations. We then examine the link between these identified mood shocks and subsequent developments in fundamentals using alternative identification schemes (i.e., variants of the maximum forecast error variance approach). We find that there is a very close link between the two, suggesting that agents' feelings of optimism and pessimism are at least partially rational as total factor productivity (TFP) is observed to rise 8-10 quarters after an initial bout of optimism. While this later finding is consistent with some previous findings in the news shock literature, we cannot rule out that such episodes reflect self-fulfilling beliefs. Overall, we argue that mood swings account for over 50% of business cycle fluctuations in hours and output.
    JEL: E1 E2 E32
    Date: 2011–12
  7. By: Gunes Kamber; Christoph Thoenissen
    Abstract: The ability of financial frictions to amplify the output response of monetary policy, as in the financial accelerator model of Bernanke et al. (1999), is analyzed for a wider class of policy rules where the policy interest rate responds to both inflation and the output gap. When policy makers respond to the output gap as well as inflation, the standard financial accelerator model reacts less to an interest rate shock than does a comparable model without an operational financial accelerator mechanism. In recessions, when firm-speci fic volatility rises, financial acceleration due to financial frictions is further reduced, even under pure inflation targeting.
    Date: 2011–12
  8. By: Obstfeld, Maurice
    Abstract: This paper analyzes current stresses in the two key areas that concerned the architects of the original Bretton Woods system: international liquidity and exchange rate management. Despite radical changes since World War II in the market context for liquidity and exchange rate concerns, they remain central to discussions of international macroeconomic policy coordination. To take two prominent examples of specific (and related) coordination problems, liquidity issues are paramount in strategies of national self-insurance through foreign reserve accumulation, while recent attempts by emerging market economies (EMEs) to limit real currency appreciation have relied heavily on nominal exchange rate management. A central message is that a diverse set of potential asymmetries among sovereign member states provides fertile ground for a variety of coordination failures. The paper goes on to discuss institutions and policies that might mitigate some of these inefficiencies.
    Keywords: currency wars; exchange rates; global imbalances; international monetary system; liquidity; Triffin dilemma
    JEL: F32 F33 F36 F42 G15
    Date: 2011–12
  9. By: Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
    Abstract: This paper studies equity price volatility in general equilibrium with news shocks about future productivity and monetary policy. As West (1998) shows, in a partial equilibrium present discounted value model, news about the future cash flow reduces asset price volatility. This paper shows that introducing news shocks in canonical dynamic stochastic general equilibrium model may not reduce asset price volatility under plausible parameter assumptions. This is because, in general equilibrium, the asset cash flow itself may be affected by the introduction of new shocks. In addition, it is shown that neglecting to account for policy news shocks (e. g. , policy announcements) can potentially bias empirical estimates of the impact of monetary policy shocks on asset prices.
    JEL: E32 F30 F40 G11
    Date: 2011–06
  10. By: Òscar Jordà; Moritz Schularick; Alan M. Taylor
    Abstract: This paper studies the role of leverage in the business cycle. Based on a study of nearly 200 recession episodes in 14 advanced countries between 1870 and 2008, we document a new stylized fact of the modern business cycle: more credit-intensive booms tend to be followed by deeper recessions and slower recoveries. We find a close relationship between the rate of credit growth relative to GDP in the expansion phase and the severity of the subsequent recession. We use local projection methods to study how leverage impacts the behavior of key macroeconomic variables such as investment, lending, interest rates, and inflation. The effects of leverage are particularly pronounced in recessions that coincide with financial crises, but are also distinctly present in normal cycles. The stylized facts we uncover lend support to the idea that financial factors play an important role in the modern business cycle.
    Keywords: Business cycles ; Financial crises
    Date: 2011
  11. By: Fabian Fink (Department of Economics, University of Konstanz, Germany); Almuth Scholl (Department of Economics, University of Konstanz, Germany)
    Abstract: International Financial Institutions provide temporary balance-of-payment support contingent on the implementation of specific macroeconomic policies. While several emerging markets repeatedly used conditional assistance, sovereign defaults occurred. This paper develops a dynamic stochastic model of a small open economy with endogenous default risk and endogenous participation rates in bailout programs. Conditionality enters as a constraint on fiscal policy. In a quantitative application to Argentina the model mimics the empirical duration and frequency of bailout programs. In equilibrium, conditional bailouts generate high and volatile interest spreads. A Laffer-curve in conditionality reflects the trade-off between fostering fiscal reform and creating incentives for non-compliance.
    Keywords: sovereign debt, sovereign default, interest rate spread, fiscal policy, bailouts, conditionality
    JEL: E44 E62 F34
    Date: 2011–11–30
  12. By: W. Raphael Lam
    Abstract: With policy rates near the zero bound, the Bank of Japan (BoJ) has introduced a series of unconventional monetary easing measures since late 2009 in response to lingering deflation and a weakening economy. These measures culminated in a new Asset Purchase Program under the Comprehensive Monetary Easing (CME) which differs from typical quantitative easing in other central banks by including purchases of risky asset in an effort to reduce term and risk premia. This note assesses the impact of monetary easing measures on financial markets using an event study approach. It finds that the BoJ’s monetary easing measures has had a statistically significant impact on lowering bond yields and improving equity prices, but no notable impact on inflation expectations.
    Keywords: Capital markets , Central banks , Financial assets , Monetary policy , Private sector ,
    Date: 2011–11–15
  13. By: Greg Howard; Robert Martin; Beth Anne Wilson
    Abstract: This paper studies the behavior of recoveries from recessions across 59 advanced and emerging market economies over the past 40 years. Focusing specifically on the performance of output after the recession trough, we find little or no difference in the pace of output growth across types of recessions. In particular, banking and financial crisis do not affect the strength of the economic rebound, although these recessions are more severe, implying a sizable output loss. However, recovery does change with some characteristics of recession. Recoveries tend to be faster following deeper recessions, especially in emerging markets, and tend to be slower following long recessions. Most recessions are associated with a slowing, if not outright decline in house prices, but recessions with large declines in house prices also tend to have slower recoveries. Long recessions and those associated with poor housing-market outcomes can lead to sustained output losses relative to pre-crisis trends. Consistent with microeconomic studies showing permanent income loss to job-losing workers during recessions, we find that the sustained deviation in output from trend is associated with a reduction in labor input, especially linked to declines in employment and labor-force participation following recessions. On net, our results imply that the output/employment gap following a severe, long recessions is considerably smaller than is typically assumed by standard macro models, which in turn may have substantial implications for macroeconomic policy during recoveries.
    Date: 2011
  14. By: Carlos Capistrán; Gabriel Cuadra; Manuel Ramos Francia
    Abstract: Emerging economies have been subject to abrupt reversals in capital inflows, which have adverse consequences for economic activity and financial stability. An important question for policymakers is how to respond to a sudden loss of external financing and its negative effects on the domestic economy. The experience of emerging economies through the recent financial crisis shows that those economies with relatively better economic fundamentals were able to implement countercyclical policies. This paper provides a simple analytical framework to rationalize this evidence. In particular, it addresses this issue by developing a small-scale macroeconomic model of the New Keynesian type. Numerical exercises illustrate how both credible monetary and fiscal policies increase policymakers’ degrees of freedom to respond to adverse external shocks.
    Keywords: Reversals in capital flows, emerging economies, monetary policy, fiscal policy.
    JEL: E52 E62 F32 F41
    Date: 2011–12
  15. By: Ian Christensen; Césaire Meh; Kevin Moran
    Abstract: This paper assesses the merits of countercyclical bank balance sheet regulation for the stabilization of financial and economic cycles and examines its interaction with monetary policy. The framework used is a dynamic stochastic general equilibrium model with banks and bank capital, in which bank capital solves an asymmetric information problem between banks and their creditors. In this economy, the lending decisions of individual banks affect the riskiness of the whole banking sector, though banks do not internalize this impact. Regulation, in the form of a constraint on bank leverage, can mitigate the impact of this externality by inducing banks to alter the intensity of their monitoring efforts. We find that countercyclical bank leverage regulation can have desirable stabilization properties, particularly when financial shocks are an important source of economic fluctuations. However, the appropriate contribution of countercyclical capital requirements to stabilization after a technology shock depends on the size of the externality and on the conduct of the monetary authority.
    Keywords: Moral hazard, bank capital, countercyclical capital requirements, leverage, monetary policy
    JEL: E44 E52 G21
    Date: 2011
  16. By: Richard G. Anderson; Kevin L. Kliesen
    Abstract: Forecasting is a daunting challenge for business economists and policymakers, often made more difficult by pervasive uncertainty. No such uncertainty is more difficult than projecting the reaction of policymakers to major shifts in the economy. We explore the process by which the FOMC came to recognize, and react to, the productivity acceleration of the 1990s. Initial impressions were formed importantly by anecdotal evidence. Then, policymakers—and chiefly Alan Greenspan—came to mistrust the data and the forecasts. Eventually, revisions to published data confirmed initial impressions. Our main conclusion is that the productivity-driven positive supply side shocks of the 1990s were initially viewed favorably. However, over time they came to be viewed as posing a threat to the economy, chiefly through unsustainable increases in aggregate demand growth that threatened to increase inflation pressures. Perhaps nothing so complicates business planning and forecasting as policymakers who initially embrace an unanticipated shift and, later, come to abhor the same shift.
    Keywords: Federal Open Market Committee ; Financial crises ; Productivity
    Date: 2011
  17. By: Fröhling, Annette; Lommatzsch, Kirsten
    Abstract: We investigate output sensitivity of inflation in the euro area through a disaggregated analysis using price indices at the COICOP 4-digit level and compare cyclical sensitivity of a newly created index of cyclically sensitive items (ICSP) with that of headline HICP and core price indices. We also relate the ICSP to the first common factor extracted from the disaggregated prices, which best reflects the common dynamics of the underlying price indices. Our results indicate that two thirds of the items in the euro area HICP are cyclically sensitive. Categories most robustly related to the business cycle are food items (processed and unprocessed), non-durable industrial goods and services related to recreation. Output sensitivity of the ICSP is significantly higher than that of headline inflation. The difference in output sensitivity is most striking between the ICSP and core inflation because of the rather strong cyclical sensitivity of processed and unprocessed food prices (both in prevalence and the estimated parameter of output sensitivity). The index of cyclically sensitive prices is highly correlated with the first common factor. Given the weak factor structure of disaggregated prices, however, we conclude that the domestic business cycle is an important determinant of inflation but it is only one among a number of nearly equally important factors. --
    Keywords: Output sensitivity,inflation,disaggregated price indices,heterogeneity,euro area,factor analysis
    JEL: E31
    Date: 2011
  18. By: Jiri Bohm; Jan Filacek; Ivana Kubicova; Romana Zamazalova
    Abstract: This paper reviews price-level targeting in the light of current theoretical knowledge and past practical experience. We discuss progress in the economic debate on this issue, starting with the traditional arguments discussed in the early 1990s, moving to Svensson’s seminal paper in the late 1990s and ending with the most recent literature from the beginning of the new millennium. We devote special attention to the issues of the zero interest rate bound, time consistency and communication. Practical experience from Sweden in the 1930s and Czechoslovakia in the first few years after WWI is used to illustrate the advantages and disadvantages of price-level targeting. Finally, the similarities of price-level and inflation developments with hypothetical outcomes under price-level targeting are investigated in selected inflation-targeting countries.
    Keywords: Communication, deflation, price-level targeting, time inconsistency, zero bound.
    JEL: E31 E52 E58
    Date: 2011–10
  19. By: Davide Debortoli; Ricardo Nunes
    Abstract: Monetary policy objectives and targets are not necessarily stable over time. The regime switching literature has typically analyzed and interpreted changes in policymakers' behavior through simple interest rate rules. This paper analyzes policy regime switches explicitly modeling policymakers' behavior and objectives. We show how current monetary policy is affected and should optimally respond to alternative regimes. We also show that changes in the parameters of simple rules do not necessarily correspond to changes in policymakers' preferences. In fact, capturing and interpreting regime changes in preferences through interest rate rules can lead to misleading results.
    Date: 2011
  20. By: Acharya, Viral V.; Skeie, David
    Abstract: Financial crises are associated with reduced volumes and extreme levels of rates for term inter-bank transactions, such as in one-month and three-month LIBOR markets. We provide an explanation of such stress in term lending by modelling leveraged banks’ precautionary demand for liquidity. When adverse asset shocks materialize, a bank’s ability to roll over debt is impaired because of agency problems associated with high leverage. In turn, a bank’s propensity to hoard liquidity is increasing, or conversely its willingness to provide term lending is decreasing, in its rollover risk over the term of the loan. High levels of short-term leverage and illiquidity of assets can thus lead to low volumes and high rates for term borrowing, even for banks with profitable lending opportunities. In extremis, there can be a complete freeze in inter-bank markets.
    Keywords: bank liquidity; bank loans; debt; financial leverage; interbank market; risk management
    JEL: E43 G01 G21
    Date: 2011–12
  21. By: Hassler, Uwe; Meller, Barbara
    Abstract: Multiple structural change tests by Bei and Perron (1998) are applied to the regression by Demetrescu, Kuzin and Hassler (2008) in order to detect breaks in the order of fractional integration. With this instrument we tackle time-varying inflation persistence as an important issue for monetary policy. We determine not only the location and significance of breaks in persistence, but also the number of breaks. Only one significant break in U.S. inflation persistence (measured by the long-memory parameter) is found to have taken place in 1973, while a second break in 1980 is not significant. --
    Keywords: Fractional integration,break in persistence,unknown break point,inflation dynamics
    JEL: C22 E31
    Date: 2011
  22. By: Blommestein, H.J.; Eijffinger, S.C.W.; Qian, Z. (Tilburg University, Center for Economic Research)
    Abstract: This paper constructs a macro-finance model with two types of borrowers: entrepreneurs who engage in productive activities and gamblers who play in lotteries. It links a central bank's interest rate policy to expected cash ows of both types of borrowers. Via this link we study how the interactions between various shocks and different monetary policy rules affect the quality of the borrower pool faced by financial intermediaries. We find that if the economy is hit by an expansionary monetary policy shock, in the long run the proportion of entrepreneurs in the borrower pool will be persistently lower than the steady state level. This worsening of the borrower pool is more serious if the central bank does not react to output uctuations. By contrast, not reacting to output uctuations in case of a negative productivity shock avoids a persistent worsening of the borrower pool in the long run.
    Keywords: Monetary Policy;Adverse Selection;Financial Crisis
    JEL: E44 E52 G01
    Date: 2011
  23. By: Miguel Casares (Departamento de Economía-UPNA); Jesús Vázquez (Department FAE II, Universidad del País Vasco)
    Abstract: Revisions of US macroeconomic data are not white-noise. They are persistent, correlated with real-time data, and with high variability (around 80% of volatility observed in US real-time data). Their business cycle effects are examined in an estimated DSGE model that distinguishes real-time data from final data. Both the consumption habit formation and the price indexation to lagged inflation fall significantly in the estimation. The model also shows that revision shocks of both output and inflation are expansionary because they occur when real-time published data are too low and the Fed reacts by cutting interest rates. Consumption revisions, by contrast, are countercyclical as consumption habits mirror the observed reduction in real-time consumption. Finally, revisions of the three variables explain 9.3% of changes of output in its long-run variance decomposition.
    Keywords: data revisions, DSGE models, business cycles.
    JEL: C32 E30
    Date: 2011
  24. By: Agnello, L.; Furceri, D.; R.M, Sousa.
    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
  25. By: Sousa, Teresa
    Abstract: Money illusion is frequently invoked and frequently resisted by economists. Resisted as it contradicts the maximizing paradigm of microeconomic theory and invoked since a tendency to think in nominal rather than real terms becomes evident in the behavior of agents. This paper rationalizes money illusion in an stylized open economy model considering that private agents learn nominal aggregate demand at a level different from the one imposed by rationality. We find that the welfare effects of a productivity shock are increasing in the degree of money illusion and decreasing in the degree of openness of the economy. Furthermore we introduce a velocity of money shock revisiting the Quantity Theory of Money within the open economy micro-founded framework. An incomplete information game between Home and Foreign policymakers with monetary policy rules is developed, where sudden unstable financial conditions arise in one country, to find that allowing for velocity shocks reinforces the need for optimal monetary policy rules and to open the economies in order to avoid welfare costs. --
    Keywords: Optimal monetary policy,open economy,international transmission mechanism,money illusion,velocity of money,nominal rigidities
    JEL: E31 E52 F42
    Date: 2011
  26. By: Davide Debortoli; Junior Maih; Ricardo Nunes
    Abstract: This paper proposes a method and a toolkit for solving optimal policy with imperfect commitment. As opposed to the existing literature, our method can be employed in medium- and large-scale models typically used in monetary policy. We apply our method to the Smets and Wouters (2007) model, where we show that imperfect commitment has relevant implications for interest rate setting, the sources of business cycle fluctuations, and welfare.
    Date: 2011
  27. By: Stefano D'Addona (University of Roma Tre); Ilaria Musumeci (University of Roma Tre)
    Abstract: We analyze the current state of the monetary integration in Europe focusing on the UK position regarding the European Monetary Union. The interest rates decisions of the European Central Bank and the Bank of England are compared through different specifications of the Taylor Rule. The comparison of the monetary conducts provides a useful feedback when looking for the differences claimed by the British government as motivating the UK refusal to join the European Monetary Union. Testing for a forward looking behavior and possible asymmetries in the policy responses, we show evidence supporting the opt-out by the UK monetary authorities.
    Keywords: Taylor rule; European monetary integration; Regime switching models; Interest rate smoothing.
    JEL: E32 E52
    Date: 2011
  28. By: Berg, Tim Oliver
    Abstract: This paper examines the time varying impact of technology news shocks on the U.S. economy during the Post-World War II era using a structural time varying parameter vector autoregressive (TVP-VAR) model. The identification restrictions are derived froma standard new Keynesian dynamic stochastic general equilibrium (DSGE) model and hold for a wide range of parameter constellations. In addition, the set of restrictions is sufficient to discriminate technology news shocks from other supply and demand side disturbances - technology surprise shocks among them. Overall, there is little evidence that the variance of technology news shocks or their transmission to real activity and inflation has changed over time. However, I detect significant time variation in the endogenous monetary policy reaction to technology news shocks; responding strongly to inflation most of the time, but less during the Great Inflation period. The evidence of this paper thus supports the hypothesis that the high inflation rates of the mid and late 1970s were the result of bad policy rather than bad luck.
    Keywords: technology news shocks; business cycles; monetary policy; DSGE models; structural time varying parameter VARs
    JEL: E32 E52 C11
    Date: 2011
  29. By: Jens Klose
    Abstract: This paper uses two-dimensional asymmetric Taylor reaction functions for 16 OECD-countries to account for different reactions to the inflation rate and output by central banks before or after an election of the fiscal authorities in the respective country. Important for such an investigation is not only the period before or after an election takes place but also whether the inflation rate and output are below or above their target or potential value because this information shows whether the central bank systematically deviates from the Taylor rule. Using a Panel-GMM we observe that in the OECD-countries there are political business cycles in monetary policy with respect to the inflation and output response. However, the supporting time horizon differs between both exogenous indicators and state of variables.
    Keywords: Political business cycle; monetary policy; Taylor rule; asymmetries; Panel- GMM
    JEL: E32 E43 E52 E58
    Date: 2011–10
  30. By: Baumeister, Christiane; Kilian, Lutz
    Abstract: Recently, there has been increased interest in real-time forecasts of the real price of crude oil. Standard oil price forecasts based on reduced-form regressions or based on oil futures prices do not allow consumers of forecasts to explore how much the forecast would change relative to the baseline forecast under alternative scenarios about future oil demand and oil supply conditions. Such scenario analysis is of central importance for end-users of oil price forecasts interested in evaluating the risks underlying these forecasts. We show how policy-relevant forecast scenarios can be constructed from recently proposed structural vector autoregressive models of the global oil market and how changes in the probability weights attached to these scenarios affect the upside and downside risks embodied in the baseline real-time oil price forecast. Such risk analysis helps forecast users understand what assumptions are driving the forecast. An application to real-time data for December 2010 illustrates the use of these tools in conjunction with reduced-form vector autoregressive forecasts of the real price of oil, the superior real-time forecast accuracy of which has recently been established.
    Keywords: Forecast; Oil price; Predictive density; Real time; Risk; Scenario analysis; VAR
    JEL: C53 E32 Q43
    Date: 2011–12
  31. By: Jean Pierre Allegret; Mohamed Tahar Benkhodja
    Abstract: To investigate the dynamic effect of external shocks on an oil exporting economy, we estimate, using Bayesian approach, a DSGE model based on the features of the Algerian economy. The main purpose is to investigate the dynamic effect of four external shocks (oil price shock, USD/EUR exchange rate shock, international inflation shock and international interest rate shock) and to examine the appropriate monetary policy strategy for Algerian economy, given its structural characteristics and the pattern of the external shocks. We analyze the impulse response functions of our external shocks according to alternative monetary rules. The welfare cost associated with each monetary policy rule has been considered. Our main findings show that, over the period 1990Q1-2010Q4, core inflation monetary rule allows better to stabilize both output and inflation. This rule also appears to be the best way to improve a social welfare.
    Keywords: Monetary policy, external shocks, oil exporting economy, Algeria, DSGE model.
    JEL: E3 E5 F4
    Date: 2011
  32. By: Claude Diebolt (BETA/CNRS, Université de Strasbourg & Humboldt-Universität zu Berlin.); Mamoudou Toure (BETA/CNRS, Université de Strasbourg.); Jamel Trabelsi (BETA/CNRS, Université de Strasbourg.)
    Date: 2012
  33. By: Grzegorz Grabek (National Bank of Poland, Economic Institute); Bohdan Klos (National Bank of Poland, Economic Institute); Grzegorz Koloch (National Bank of Poland, Economic Institute)
    Abstract: Observed macroeconomic data – notably GDP growth rate, inflation and interest rates – can be, and usually are skewed. Economists attempt to fit models to data by matching first and second moments or co-moments, but skewness is usually neglected. It is so probably because skewness cannot appear in linear (or linearized) models with Gaussian shocks, and shocks are usually assumed to be Gaussian. Skewness requires non-linearities or non-Gaussian shocks. In this paper we introduce skewness into the DSGE framework assuming skewed normal distribution for shocks while keeping the model linear (or linearized). We argue that such a skewness can be perceived as structural, since it concerns the nature of structural shocks. Importantly, the skewed normal distribution nests the normal one, so that skewness is not assumed, but only allowed for. We derive elementary facts about skewness propagation in the state space model and, using the well-known Lubik-Schorfheide model, we run simulations to investigate how skewness propagates from shocks to observables in a standard DSGE model. We also assess properties of an ad hoc two-steps estimator of models’ parameters, shocks’ skewness parameters among them.
    JEL: C12 C13 C16 D58 E32
    Date: 2011
  34. By: D. Filiz Unsal; Carolina Osorio
    Abstract: The perception that Asia’s inflation dynamics is driven by idiosyncratic supply shocks implies, as a corollary, that there is little scope for a policy reaction to a build-up of inflationary pressures. However, Asia’s fast growth and integration over the last two decades suggest that the drivers of inflation may have changed, and that domestic demand pressures may now play a larger role than in the past. This paper presents a quantitative analysis of inflation dynamics in Asia using a Global VAR (GVAR) model, which explicitly incorporates the role of regional and global spillovers in driving Asia’s inflation. Our results suggest that over the past two decades the main drivers of inflation in Asia have been monetary and supply shocks, but also that, in recent years, the contribution of these shocks has fallen, whereas demand-side pressures have started to emerge as an important contributor to inflation in Asia.
    Keywords: Asia , China , Commodity prices , Cross country analysis , Demand , Economic models , Inflation , Spillovers ,
    Date: 2011–11–08
  35. By: Luis Ignacio Jácome; Tahsin Saadi Sedik; Simon Townsend
    Abstract: This paper investigates whether developing and emerging market countries can implement monetary policies similar to those used by advanced countries during the recent global crisis - injecting significant amounts of money into the financial system without facing major short-run adverse macroeconomic repercussions. Using panel data techniques, the paper analyzes episodes of financial turmoil in 16 Latin America during 1995-2007. The results show that developing and emerging market countries should be cautious because injecting money on a large scale into the financial system may fuel further macroeconomic instability, increasing the chances of simultaneous currency crises.
    Keywords: Banking sector , Cross country analysis , Developing countries , Emerging markets , Financial crisis , Financial systems , Latin America , Monetary policy ,
    Date: 2011–11–08
  36. By: Edward R. Gemayel; Sarwat Jahan; Alexandra Peter
    Abstract: Inflation targeting (IT) is a relatively new monetary policy framework for low-income countries (LICs). The limited number of LICs with an IT framework and the short time that has elapsed since the adoption of this framework explains why there are no previous empirical studies on the performance of IT in LICs. This paper has made a first attempt at filling this gap. It finds that inflation targeting appears to be associated with lower inflation and inflation volatility. At the same time, there is no robust evidence of an adverse impact on output. This may explain the appeal of IT for many LICs, where building credibility of monetary policy is difficult and minimizing output costs of reducing inflation is imperative for social and political reasons.
    Keywords: Albania , Armenia , Cross country analysis , Developed countries , Emerging markets , Ghana , Inflation targeting , Low-income developing countries , Monetary policy ,
    Date: 2011–11–30
  37. By: Riane de Bruyn (Department of Economics, University of Pretoria); Rangan Gupta (Department of Economics, University of Pretoria); Lardo Stander (Department of Economics, University of Pretoria)
    Abstract: Evidence in favour of the monetary model of exchange rate determination for the South African Rand is at best mixed. A co-integrating relationship between the nominal exchange rate and fundamentals forms the basis of the monetary model. With the econometric literature suggesting that it is the span of the data, and not the frequency, that determines the power of the co-integration tests, and all the studies on South Africa using short-span data of the post-Bretton Woods era, we decided to test the long-run monetary model of exchange rate determination for the South African Rand relative to the US Dollar, using annual data from 1910 – 2010. The results provide some support for the monetary model in the sense that long-run co-integration is found between the nominal exchange rate and the output and money supply deviations. However, the theoretical restrictions required by the monetary model are rejected. A vector errorcorrection model identifies both the nominal exchange rate and the monetary fundamentals as the channel for the adjustment process of deviations from the long-run equilibrium exchange rate. A subsequent comparison of nominal exchange rate forecasts based on the monetary model with those of the random walk model, suggests that the forecasting performance of the monetary model is superior.
    Keywords: Nominal exchange rate, monetary model, long-span data, forecasting
    JEL: C22 C32 C53 F31 F47
    Date: 2011–12
  38. By: Alina Carare; Adina Popescu
    Abstract: We document the transmission of monetary policy and risk-premium shocks in Hungary, by applying recent advances in the Bayesian estimation of large VAR models. The method allows extracting information from over 100 series, opening the "black box" of the transmission mechanism to provide the most comprehensive description to date of the impact of these two shocks on the economy under the inflation-targeting regime. We find novel evidence that most of the channels of transmission are operational in Hungary, in spite of large liability euroization and high foreign ownership of banks and corporations. Due to financial stability concerns, monetary policy responds procyclically to risk-premium shocks. We also find that the use of such a large panel of data improves inflation forecasting performance over smaller models and renders this model suitable for policy purposes.
    Keywords: Central banks , External shocks , Hungary , Inflation targeting , Monetary policy , Monetary transmission mechanism , Risk premium ,
    Date: 2011–11–08
  39. By: Arto Kovanen
    Abstract: Money has only limited information value for future inflation in Ghana over a typical monetary policy implementation horizon (four to eight quarters). On the other hand, currency depreciation and demand pressures (as measured by the output gap) are shown to be important predictors of future price changes. Inflation inertia is high and inflation expectations are largely based on backward-looking information, suggesting that inflation expectations are not well anchored and hence more is needed to strengthen the credibility of Ghana’s inflation-targeting regime.1
    Keywords: Capital markets , Cross country analysis , Demand for money , Economic models , Emerging markets , Inflation targeting , Interest rates , Monetary policy ,
    Date: 2011–11–22
  40. By: Arto Kovanen
    Abstract: This paper analyzes interest rate pass-through in Ghana. Time series and bank-specific data are utilized to highlight linkages between policy, wholesale market, and retail market interest rates. Our analysis shows that responses to changes in the policy interest rate are gradual in the wholesale market. Prolonged deviation in the interbank interest rate from the prime rate illustrate the challenges the Bank of Ghana faces when targeting a short-term money market interest rate. Asymmetries in the wholesale market adjustment possibly relate to monetary policy signaling, weak policy credibility, and liquidity management. In the retail market, pass-through to deposit and lending interest rates is protracted and incomplete.1
    Keywords: Banks , Central bank policy , Financial systems , Interest rates , Monetary policy ,
    Date: 2011–11–23
  41. By: Jihad Dagher; Arto Kovanen
    Abstract: This paper adopts the bounds testing procedure developed by Pesaran et al. (2001) to test the stability of the long-run money demand for Ghana. The results provide strong evidence for the presence of a stable, well-identified long-run money demand during a period of substantial changes in the financial markets. The empirical evidence points to complex dynamics between money demand and its determinants while suggesting that deviations from the equilibrium are rather short-lived.1
    Keywords: Capital markets , Demand for money , Inflation targeting , Monetary policy ,
    Date: 2011–11–22

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