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on Central Banking |
| By: | Philip Bond; Alex Edmans; Itay Goldstein |
| Abstract: | A large amount of activity in the financial sector occurs in secondary financial markets, where securities are traded among investors without capital flowing to firms. The stock market is the archetypal example, which in most developed economies captures a lot of attention and resources. Is the stock market just a side show or does it affect real economic activity? In this article, we discuss the potential real effects of financial markets that stem from the informational role of market prices. We review the theoretical literature and show that accounting for the feedback effect from market prices to the real economy significantly changes our understanding of the price formation process, the informativeness of the price, and speculators’ trading behavior. We make two main points. First, we argue that a new definition of price efficiency is needed to account for the extent to which prices reflect information useful for the efficiency of real decisions (rather than the extent to which they forecast future cash flows). Second, incorporating the feedback effect into models of financial markets can explain various market phenomena that otherwise seem puzzling. Finally, we review empirical evidence on the real effects of secondary financial markets. |
| JEL: | G12 G14 G31 G34 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17719&r=cba |
| By: | Kenneth Kuttner (Williams College) |
| Abstract: | This paper revisits the relationship between interest rates and house prices. Surveying a number of recent studies and bringing to bear some new evidence on the question, this paper argues that in the data, the impact of interest rates on house prices appears to be quite modest. Specifically, the estimated effects are uniformly smaller than those implied by the conventional user cost theory of house prices, and they are too small to explain the previous decade’s real estate boom in the U.S. and elsewhere. However in some countries, there does appear to have been a link between the rapid expansion of the monetary base and growth in house prices and housing credit. |
| JEL: | E52 E44 E65 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2012-01&r=cba |
| By: | Tom Krebs; Moritz Kuhn; Mark L. J. Wright |
| Abstract: | We develop a macroeconomic model with physical and human capital, human capital risk, and limited contract enforcement. We show analytically that young (high-return) households are the most exposed to human capital risk and are also the least insured. We document this risk-insurance pattern in data on life-insurance drawn from the Survey of Consumer Finance. A calibrated version of the model can quantitatively account for the life-cycle variation of insurance observed in the US data and implies welfare costs of under-insurance for young households that are equivalent to a 4 percent reduction in lifetime consumption. A policy reform that makes consumer bankruptcy more costly leads to a substantial increase in the volume of credit and insurance. |
| JEL: | D52 E21 E24 J24 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17714&r=cba |
| By: | Cabrales, Antonio; Serrano, Roberto |
| Abstract: | We study the classic implementation problem under the behavioral assumption that agents myopically adjust their actions in the direction of better-responses or bestresponses. First, we show that a necessary condition for recurrent implementation in better-response dynamics (BRD) is a small variation of Maskin monotonicity, which we call quasimonotonicity. We also provide a mechanism for implementation in BRD if the rule is quasimonotonic and excludes worst alternatives – no worst alternative (NWA). Quasimonotonicity and NWA are both necessary and sufficient for absorbing implementation in BRD. Moreover, they characterize implementation in strict Nash equilibria. Under incomplete information, incentive compatibility is necessary for any kind of stable implementation in our sense, while Bayesian quasimonotonicity is necessary for recurrent implementation in interim BRD. Both conditions are also essentially sufficient for recurrent implementation, together with a Bayesian NWA. A characterization of implementation in strict Bayesian equilibria is also provided. Partial implementation results are also obtained. |
| Keywords: | Robust implementation; Bounded rationality; Evolutionary dynamics; Mechanisms; |
| JEL: | C72 D70 D78 |
| Date: | 2011–03–21 |
| URL: | http://d.repec.org/n?u=RePEc:ner:carlos:info:hdl:10016/12895&r=cba |
| By: | Giancarlo Corsetti; Gernot J. Müller |
| Abstract: | During the global financial crisis 2007–2009 fiscal policy was widely used as a stabilization tool. Policymakers allowed a large build-up of public debt resulting from both automatic and discretionary expansionary measures. At the same time, calls for policy coordination stressed that international spillovers of fiscal policy might be sizeable. We reconsider the case for fiscal coordination by providing new evidence on the cross-border effects of discretionary fiscal measures. We rely on a vector autoregression model as well as on a quantitative business cycle model. We find that i) large spillover effects cannot be ruled out and, in contrast to conventional wisdom, ii) financial factors rather than trade flows lie at the heart of the international transmission mechanism. We discuss the implications of these results for policy coordination when markets price sovereign default risk, and put pressure on governments for implementing budget consolidation measures. |
| JEL: | E62 F42 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17708&r=cba |
| By: | Kubota, Megumi |
| Abstract: | There is a renewed debate on the role of exchange rate policies as an industrial policy tool in both academic and policy circles. Policy practitioners usually examine real exchange rate misalignments to monitor the behavior of this key relative price and, if possible, exploit distortions in the traded and non-traded relative price to promote growth. Anecdotal evidence shows that some countries have pursued very active exchange rate policies to promote the export sector and enhance growth by undervaluing their currencies. The main goal of this paper is to provide a systematic characterization of real exchange rate undervaluations. The long-run real exchange rate equation is estimated using: (a) Johansen time series cointegration estimates, and (b) pooled mean group estimates for non-stationary panel data. The paper constructs a dataset of real undervaluation episodes. It first evaluates whether (and if so, to what extent) economic policies can be used to either cause or sustain real undervaluations. In this context the paper empirically models the likelihood and magnitude of sustaining real exchange rate undervaluations by examining their link to policy instruments (such as exchange rate regimes and capital controls, among other policies) using probit and Tobit models. Finally, it investigates whether foreign exchange intervention can generate persistent real exchange rate deviations from equilibrium. In general, it finds that intervention can lead to greater persistence in the incidence and magnitude of real exchange rate undervaluations. |
| Keywords: | Currencies and Exchange Rates,Debt Markets,Economic Theory&Research,Economic Stabilization,Emerging Markets |
| Date: | 2011–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:wbk:wbrwps:5925&r=cba |
| By: | Bertay, Ata Can; Demirguc-Kunt, Asli; Huizinga, Harry |
| Abstract: | A bank’s interest expenses are found to increase with its degree of internationalization as proxied by its share of foreign liabilities in total liabilities or a Herfindahl index of international liability concentration, especially if the bank is performing badly. Our benchmark estimation suggests that an international bank’s cost of funds raised through a foreign subsidiary is between 1.5% and 2.4% higher than the cost of funds for a purely domestic bank, which is a sizeable difference given an overall mean cost of funds of 3.3%. These results are consistent with limited incentives for national authorities to bail out an international bank, but also with an international bank recovery and resolution process that is inefficient. In any event, the operation of the financial safety net appears to be a barrier to cross-border banking. |
| Keywords: | Bank bailouts; Cross-border banking; International burden sharing |
| JEL: | F36 G21 G28 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8712&r=cba |
| By: | Vipin Arora; Pedro Gomis-Porqueras; Shuping Shi |
| Abstract: | In this paper we test for large deviations in headline measures of the price level relative to core measures using the recently proposed test of Phillips et al. (2011a). We find evidence of explosive behaviour in the headline price index of personal consumption expenditures (PCE) relative to the core PCE (less food and energy prices) on three occasions from 1982-2010. Two of these episodes correspond to energy supply shocks (OPEC price collapse of 1986 and Hurricane Katrina). The third one is during March 2008 through September 2008 which seems to be driven by both food and energy prices as these indices exhibit explosive behaviour. We also find evidence suggesting that inflation expectations behave differently under normal and explosive periods. In particular, unemployment and interest rates also help predict inflation expectations during explosive episodes relative to normal times. Furthermore, explosive episodes in the relative measure between headline and core inflation is found to be more important than the relative volatile periods implied by a Markov-switching model when studying inflation expectations. The findings of this paper suggest that explosive behaviour of headline versus core PCE should be taken into account when conducting monetary policy as it is a key determinant in consumers’ inflation expectations. |
| Keywords: | Explosive behaviour, core inflation, relative measure, inflation expectations |
| JEL: | C5 E31 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2011-37&r=cba |
| By: | Ales Bulír; Martin Cihák; David-Jan Jansen |
| Abstract: | This paper examines whether the clarity of central bank communication about inflation has changed with the economic environment. We use readability statistics and content analysis to study the clarity of communication on the inflation outlook by seven central banks between 1997 and 2010. Overall, we find no strong indications that central banks were less clear in explaining their policies when faced with higher uncertainty or a less favorable inflation outlook. The global financial crisis, however, did have a negative impact on clarity of central bank communication. |
| Keywords: | monetary policy; communication; inflation; clarity; transparency |
| JEL: | E52 E58 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:333&r=cba |
| By: | Gondo, Rocio (University of Maryland); Orrego, Fabrizio (Central Bank of Peru) |
| Abstract: | This paper evaluates the qualitative and quantitative implications of financial dedollarization of firms' liabilities on real aggregates in a small open economy model. We extend the standard Cespedes, Chang, and Velasco (2004) model by allowing entrepreneurs borrow in both foreign and domestic currency so as to finance firms' capital needs. A real depreciation reduces the value of firms' net worth whenever there is a currency mismatch in their balance sheets. Under flexible exchange rates, a lower degree of dollarization lessens the negative impact on output and investment, since there is a smaller increase in the cost of external borrowing. The quantitative results show that the balance sheet channel accounts for about 70 percent of the output and investment drop in Peru following the Russian Crisis, and a reduction in debt dollarization would have reduced output drop in 0.9 percentage points of GDP. |
| Keywords: | Small open economy, balance sheet eects, dollarization |
| JEL: | F31 F41 G32 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:rbp:wpaper:2011-022&r=cba |
| By: | Wilko Bolt; Sujit Chakravorti |
| Abstract: | The provision of retail payment services is complex with many participants engaging in a series of interrelated bilateral transactions and subject to large economies of scale and scope along with strong adoption, usage and network externalities. This makes sound public policy difficult. We focus on three types of market interventions for various countries. We argue that intervention into payment markets should concentrate on the removal of entry barriers in payment markets and providing greater incentives to adopt efficient payment instruments without stifling private sector investment in more efficient payment technologies over the long term. While the theoretical literature on the economics of payment cards is growing, the empirical literature is yet too limited to provide much guidance to public authorities. Eventually, the outcomes from different types of market interventions will provide a useful “natural experiment” to refute or validate the various theories of the economics of payments. |
| Keywords: | Retail payments; market interventions; pricing; public policy |
| JEL: | L11 G21 D53 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:331&r=cba |
| By: | Alessandro Spelta; Tanya Ara\'ujo |
| Abstract: | The recent financial crisis has stressed the need to understand financial systems as networks of interdependent countries, where cross-border financial linkages play the fundamental role. It has also been emphasized that the relevance of these networks relies on the representation of changes follow-on the occurrence of stress events. Adopting a topological approach we are able to address the role that network structures play in the spread of shocks and conversely, the effectiveness of stress events and its impact on the structure of the networks. Here, from series of interbank liabilities and claims over different time periods, we have developed networks of positions (net claims) between countries. Besides the Minimal Spanning Tree analysis of the time-constrained networks, a coefficient of residuality is defined to capture the structural evolution of the network of cross-border financial linkages. Because some structural changes seem to be related to the role that countries play in the financial context, networks of debtor and creditor countries are also developed. Empirical results allows to relate the network structure that emerges in the last years to the globally turbulent period that has characterized financial systems since the latest nineties. The residuality coefficient highlights an important modification acting in the financial linkages across countries in the period 1997-2011, and situates the recent financial crises as replica of a larger structural change going on since 1997. |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1112.5711&r=cba |
| By: | Matthias Gubler; Christoph Sax (University of Basel) |
| Keywords: | Real Exchange Rate, Balassa-Samuelson Hypothesis, Panel Data Estimation, Terms of Trade |
| JEL: | F14 F31 F41 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:bsl:wpaper:2011/09&r=cba |
| By: | Lambrias, Kyriacos |
| Abstract: | We extend the empirical SVAR literature on real exchange rates by extracting a common stochastic trend in productivity, interpreted as a permanent world technology shock. Overall, we find that innovations to world technology constitute an important, albeit not the dominant, source of movements in the real euro-dollar exchange rate. First, the dollar appreciates significantly in response to such an impulse. Second, the world technology shock accounts for approximately one-fifth of the variance of the forecast error in the real euro-dollar rate at business-cycle frequencies. Our results are in line with previous studies who find that demand or nominal shocks are the dominant sources of fluctuations in relative prices and provides limited support to productivity-based models of real exchange rate determination. |
| Keywords: | Euro-Dollar Real Exchange Rate, World Technology Shocks, Structural VAR |
| JEL: | C32 F41 E32 |
| Date: | 2011–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:25315&r=cba |
| By: | Scott J. Colby; Timothy A. Graciano; Jeffrey T. LaFrance; Rulon D. Pope |
| Abstract: | Any demand equation satisfying Lau’s (1982) Fundamental Theorem of Exact Aggregation and 0° homogeneity in prices and income will have a Gorman (1981) functional form for each income term. This property does not depend on symmetry or adding up. The implications of this result are illustrated by an extensive example. |
| Keywords: | Demand, exact aggregation, functional form, homogeneity |
| JEL: | C1 C5 D1 D3 D6 |
| Date: | 2011–12 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2011-30&r=cba |
| By: | Ponomarenko, Alexey (BOFIT); Solovyeva, Alexandra (BOFIT); Vasilieva, Elena (BOFIT) |
| Abstract: | We review some aspects of financial dollarization in Russia, applying the main relevant theories to analyze the dynamics of several dollarization indicators. An econometric model of the short run dynamics of deposit and loan dollarization is estimated for the last decade. We find that ruble appreciation was the main driver of the de-dollarization that occurred then and of the later episode of renewed dollarization. We estimate the overall (and sectoral) currency mismatches of the Russian economy. The results show a gradual improvement of the net foreign currency position of the public sector, where we have seen significant accumulation of international reserves by the Bank of Russia and repayment of government debt. Evidence is also presented for the significant currency risk vulnerability of the nonbanking private sector. Several existing empirical studies are examined in order to assess the growth losses of the Russian economy following the crisis of 2008, which was linked with the financial dollarization. |
| Keywords: | financial dollarization; currency mismatch; balance sheet effects; Russia |
| JEL: | E44 F34 G32 |
| Date: | 2012–01–02 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:bofitp:2011_036&r=cba |
| By: | Rangan Gupta (Department of Economics, University of Pretoria) |
| Abstract: | Empirical evidence on the whether the inflation-targeting South African Reserve Bank (SARB) should also consider responding to exchange rate fluctuations, are contradictory. Against this backdrop of contradictory evidence, we revisit the issue by questioning if the inflation rate is more volatile than it would have been had South Africa not moved to a flexible exchange rate regime in 1995, using the cosine-squared cepstrum. We find that the CPI inflation in South Africa has become more volatile since the second quarter of 1995, post a flexible exchange rate regime, than it would have been had the country continued to pursue a fixed exchange rate policy. Based on this result, we can conclude that the SARB should perhaps respond to exchange rate fluctuations, however, we also warn against the cost of increased volatility in output that is likely to result from targeting exchange rate variability. |
| Keywords: | Cosine-Squared Cepstrum, Exchange Rate Regime, Inflation Targeting, Inflation Volatility, Output Volatility, Saphe Cracking |
| JEL: | C65 E42 E52 E64 F31 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:201201&r=cba |