nep-cba New Economics Papers
on Central Banking
Issue of 2012‒02‒27
35 papers chosen by
Alexander Mihailov
University of Reading

  1. Central Banking for the 21st Century: An American Perspective By Paul Wachtel
  2. Financial market frictions in a model of the euro area By Giovanni Lombardo; Peter McAdam
  3. Uncertain Fiscal Consolidations By Huixin Bi; Eric M. Leeper; Campbell B. Leith
  4. Uncertain Fiscal Consolidations By Huixin Bi; Eric M. Leeper; Campbell Leith
  5. Fiscal Consolidation: Part 2. Fiscal Multipliers and Fiscal Consolidations By Ray Barrell; Dawn Holland; Ian Hurst
  6. Fiscal Policy in a Financial Crisis: Standard Policy vs. Bank Rescue Measure By Robert Kollmann; Werner Roeger; Jan in'tVeld
  7. Income Distribution, Credit and Fiscal Policies in an Agent-Based Keynesian Model By Giovanni Dosi; Giorgio Fagiolo; Mauro Napoletano; Andrea Roventini
  8. The relationship between the objectives and tools of macroprudential and monetary policy By David Green
  9. Optimal Monetary Policy and Stock-Prices Dynamics in a Non-Ricardian DSGE Model By Salvatore Nistico'
  10. Monetary Policy and Stock-Price Dynamics in a DSGE Framework By Salvatore Nisticò
  11. Default Risk on Government Bonds, Deflation, and Inflation By Oguro, Kazumasa; Sato, Motohiro
  12. Regional and Global Monetary Cooperation By Lamberte, Mario; Morgan , Peter J.
  13. The Political Economy of European Monetary Union By A. R. Nobay
  14. Efficiency of monetary and fiscal policy in open economies By Chan Wang; Heng-fu Zou
  15. Learning generates Long Memory By Chevillon, Guillaume; Mavroeidis, Sophocles
  16. Did the Fed and ECB react asymmetrically with respect to asset market developments? By Hoffmann, Andreas
  17. Can the Fed talk the Hind Legs off the Stock Market? (replaces CentER DP 2011-072) By Eijffinger, S.C.W.; Mahieu, R.J.; Raes, L.B.D.
  18. Using Survey Data on Inflation Expectations in the Estimation of Learning and Rational Expectations Models By Ormeño, Arturo
  19. A Fiscal Stimulus with Deep Habits and Optimal Monetary Policy By Cristiano Cantore; Paul Levine; Giovanni Melina; Bo Yang
  20. The case for higher frequency inflation expectations By Guzman, Giselle C.
  21. Fiscal Dominance and the Long-Term Interest Rate By Philip Turner
  22. Public Debt, Distortionary Taxation, and Monetary Policy By Alessandro Piergallini; Giorgio Rodano
  23. Macroeconomic effects of loss aversion in a signal extraction model By Giuseppe Ciccarone; Enrico Marchetti
  24. Minsky’s Financial Instability Hypothesis and the Leverage Cycle By Sudipto Bhattacharya; Charles Goodhart; Dimitrios Tsomocos; Alexandros Vardoulakis
  25. The relationship between central bank transparency and the quality of inflation forecasts: is it U-shaped? By Emna Trabelsi
  26. The Household Effects of Government Spending By Francesco Giavazzi; Michael McMahon
  27. The effects of monetary policy shocks in credit and labor markets with search and matching frictions By Giuseppe Ciccarone; Francesco Giuli; Danilo Liberati
  28. ECB Policy Response to the Euro/US Dollar Exchange Rate By Demir, Ishak
  29. Essais sur la modélisation de la dynamique du taux de change à travers les enseignements de la finance comportementale. By Di Filippo, Gabriele
  30. Combinación de Proyecciones para el Precio del Petróleo: Aplicación y Evaluación de Metodologías By Ercio Muñoz; Miguel Ricaurte; Mariel Siravegna
  31. Are Forecast Combinations Efficient? By Pablo Pincheira
  32. Forecasting inflation in Asian economies By Liew, Freddy
  33. Lessons of the European Crisis for Regional Monetary and Financial Integration in East Asia By Volz, Ulrich
  34. Non-Ricardian Aspects of Fiscal Policy in Chile By Luis Felipe Céspedes; Jorge Fornero; Jordi Galí
  35. Two Exercises of Inflation Modelling and Forecasting for Azerbaijan By Alexander Chubrik; Przemyslaw Wozniak; Gulnar Hajiyeva

  1. By: Paul Wachtel
    Date: 2011
  2. By: Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Peter McAdam (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We build a model of the euro area incorporating financial market frictions at the level of firms and households. Entrepreneurs borrow from financial intermediaries in order to purchase business capital, in the spirit of the "financial accelerator" literature. We also introduce two types of households that differ in their degree of time preference. All households have preferences for housing services. The impatient households are faced with a collateral constraint that is a function of the value of their housing stock. Our aim is to provide a unified framework for policy analysis that emphasizes financial market frictions alongside the more traditional model channels. The model is estimated by Bayesian methods using euro area aggregate data and model properties are illustrated with simulation and conditional variance and historical shock decomposition. JEL Classification: C11, C32, E32, E37.
    Keywords: Financial Frictions, euro area, DSGE modeling, Bayesian estimation, simulation, decompositions.
    Date: 2012–02
  3. By: Huixin Bi; Eric M. Leeper; Campbell B. Leith
    Abstract: The paper explores the macroeconomic consequences of fiscal consolidations whose timing and composition are uncertain. Drawing on the evidence in Alesina and Ardagna (2010), we emphasize whether or not the fiscal consolidation is driven by tax rises or expenditure cuts. We find that the composition of the fiscal consolidation, its duration, the monetary policy stance, the level of government debt and expectations over the likelihood and composition of fiscal consolidations all matter in determining the extent to which a given consolidation is expansionary and/or successful in stabilizing government debt.
    JEL: E3 E31 E52 E62
    Date: 2012–02
  4. By: Huixin Bi; Eric M. Leeper; Campbell Leith
    Abstract: The paper explores the macroeconomic consequences of fiscal consolidations whose timing and composition are uncertain. Drawing on the evidence in Alesina and Ardagna (2010), we emphasize whether or not the fiscal consolidation is driven by tax rises or expenditure cuts. We find that the composition of the fiscal consolidation, its duration, the monetary policy stance, the level of government debt and expectations over the likelihood and composition of fiscal consolidations all matter in determining the extent to which a given consolidation is expansionary and/or successful in stabilizing government debt.
    Keywords: government debt, budget reform, monetary-fiscal policy interactions
    JEL: H60 E62 E63 H30
    Date: 2012–01
  5. By: Ray Barrell; Dawn Holland; Ian Hurst
    Abstract: This paper looks at various aspects of fiscal consolidation in 18 OECD economies. The prospects for fiscal consolidation depend upon the problems the country may face with its debt stock, the political will to deal with these problems and on the costs of consolidation. The analysis is based on a series of simulations using the National Institute Global Econometric Model, NiGEM. The properties of the NiGEM model are discussed first. Although the model is estimated it has a strong role for expectations and can be run under different modes of expectations formation. This allows a decomposition of the factors that might affect the results. Temporary and permanent shifts in fiscal policy are assessed as well as the potential impact of fiscal consolidation plans under different monetary and fiscal feedback rules and different modes of expectations formation. If fiscal policy is expected to be tightened in the future, then long rates will fall now, and perhaps even induce a short-term expansion of output. Expansionary fiscal contractions of this sort are rare, however, and none are anticipated with the programmes that are investigated.<P>Consolidation budgétaire : Partie 2. Multiplicateurs budgétaires et assainissement des finances publiques<BR>Ce document examine divers aspects de l’assainissement des finances publiques dans 18 pays de l’OCDE. Le potentiel de consolidation budgétaire dépend du montant de la dette d’un pays et des problèmes qui peuvent en résulter, de la volonté politique de traiter ces problèmes et des coûts du redressement. L’analyse s’appuie sur un ensemble de simulations fondées sur le modèle économétrique mondial de l'Institut de recherche économique et sociale du Royaume-Uni (NiGEM). Les auteurs examinent en premier lieu les caractéristiques du modèle NiGEM. Même si ce modèle procède par estimation, il conditionne fortement les anticipations et peut être appliqué à différents modes de formation des anticipations. Cela permet de décomposer les facteurs susceptibles d’influer sur les résultats. Les auteurs évaluent ensuite les modifications temporaires et permanentes de la politique budgétaire, ainsi que l’impact potentiel des plans de redressement budgétaire selon différentes règles de rétroaction budgétaire et monétaire et différents modes de formation des anticipations. Si l’on s’attend à un durcissement de la politique budgétaire à l’avenir, les taux longs baisseront immédiatement, ce qui pourrait même induire une expansion à court terme de la production. Néanmoins, les contractions budgétaires expansionnistes de ce type sont exceptionnellement rares, et les programmes étudiés n’en prévoient aucune.
    JEL: E17 E37 E62
    Date: 2012–02–22
  6. By: Robert Kollmann; Werner Roeger; Jan in'tVeld
    Abstract: A key dimension of fiscal policy during the financial crisis was massive government support for the banking system. The macroeconomic effects of that support have, so far, received little attention in the literature. This paper fills this gap, using a quantitative dynamic model with a banking sector. Our results suggest that state aid for banks may have a strong positive effect on real activity. Bank state aid multipliers are in the same range as conventional fiscal spending multipliers. Support for banks has a positive effect on investment, while a rise in government purchases crowds out investment.
    Keywords: state support for banks; financial crisis; financial stimulus; real activity
    JEL: E62 E63 G21 G28 H25
    Date: 2012–02
  7. By: Giovanni Dosi (Sant'Anna School of Advanced Studies); Giorgio Fagiolo (Sant'Anna School of Advanced Studies); Mauro Napoletano (Observatoire Francais des Conjonctures Economiques); Andrea Roventini (Department of Economics, University of Verona)
    Abstract: This work studies the interactions between income distribution and monetary and fiscal policies in terms of ensuing dynamics of macro variables (GDP growth, unemployment, etc.) on the grounds of an agent-based Keynesian model. The direct ancestor of this work is the "Keynes meeting Schumpeter" formalism presented in Dosi et al. (2010). To that model, we add a banking sector and a monetary authority setting interest rates and credit lending conditions. The model combines Keynesian mechanisms of demand generation, a "Schumpeterian" innovation-fueled process of growth and Minskian credit dynamics. The robustness of the model is checked against its capability to jointly account for a large set of empirical regularities both at the micro level and at the macro one. The model is able to catch salient features underlying the current as well as previous recessions, the impact of financial factors and the role in them of income distribution. We find that different income distribution regimes heavily affect macroeconomic performance: more unequal economies are exposed to more severe business cycles fluctuations, higher unemployment rates, and higher probability of crises. On the policy side, fiscal policies do not only dampen business cycles, reduce unemployment and the likelihood of experiencing a huge crisis. In some circumstances they also affect positively long-term growth. Further, the more income distribution is skewed toward profits, the greater the effects of fiscal policies. About monetary policy, we find a strong non-linearity in the way interest rates affect macroeconomic dynamics: in one "regime" with low rates, changes in interest rates are ineffective up to a threshold beyond which increasing the interest rate implies smaller output growth rates and larger output volatility, unemployment and likelihood of crises.
    Keywords: agent-based Keynesian models, multiple equilibria, fiscal and monetary policies, income distribution, transmission mechanisms, credit constraints
    JEL: E32 E44 E51 E52 E62
    Date: 2012–02
  8. By: David Green
    Abstract: No Abstract is available.
    Date: 2011–05
  9. By: Salvatore Nistico' (University of Rome La Sapienza and LUISS Guido Carli University)
    Abstract: In a DSGE model with non-ricardian agents, a' la Blanchard-Yaari, stock-price fluctuations affect the dynamics of aggregate consumption through wealth effects. This wealth effects can be characterized as an additional dynamic distortion with respect to the social planner allocation, related to the cross sectional consumption dispersion that the decentralized allocation implies. By exploiting the specific cross-sectional distribution that the model implies for individual financial wealth, this paper derives the welfare criterion consistent with this economy, and shows that it features an additional target besides output-gap and price stability: financial stability. The ultimate implication is that price stability is no longer necessarily optimal, even absent cost push shocks. Given the quadratic form of the welfare criterion, some fluctuations in output and inflation will be optimal as long as they reduce the volatility of financial wealth.
    Keywords: Monetary Policy, DSGE Models, Stock Prices, Wealth Effects.
    JEL: E12 E44 E52
    Date: 2011
  10. By: Salvatore Nisticò (Università degli Studi di Roma “La Sapienza" and LUISS Guido Carli)
    Abstract: This paper analyzes the role of stock prices in driving Monetary Policy for price stability in a Non-Ricardian DSGE model. It shows that the dynamics of the interest rate consistent with price stability requires a response to stock-price changes that depends on the shock driving them: a supply shock (e.g. productivity) does not require an additional, dedicated response relative to the standard Representative-Agent framework, while a demand shock does. Moreover, we show that implementing the exible-price allocation by means of an interest-rate rule that reacts to deviations of the stock-price level from the exible-price equilibrium incurs risks of endogenous instability that are the higher the less profitable on average equity shares. On the other hand, reacting to the stock-price growth rate is risk-free from the perspective of equilibrium determinacy, and can be beneficial from an overall real stability perspective.
    Keywords: Monetary Policy, DSGE Models, Stock Prices, Wealth Effects.
    JEL: E12 E44 E52
    Date: 2012–02–10
  11. By: Oguro, Kazumasa; Sato, Motohiro
    Abstract: This paper analyzes the impact of deflation and inflation on the real interest rates of GBs using an overlapping generations model with the relationship between the real interest rate of GBs and the fiscal consolidation rule. We find that deflation may lower the real interest rate of GBs to the same level of public debt to capital, even if the fiscal consolidation rule is the same, as opposed to the conventional view that the real interest rate of GBs is determined independent of deflation if the Fisher equation holds. Our results are consistent with how the real interest rates of Japanese GBs react in periods of deflation. This paper also addresses the impact of fiscal inflation (i.e., monetizing all parts of the GB’s default using monetary policy). We calculate the expected fiscal inflation when the default rate in the event of fiscal consolidation is raised. The fiscal inflation may be extremely high if the extent of the required tax increase in fiscal consolidation is low. Initial inflation accelerates the expected fiscal inflation, but initial deflation suppresses it.
    Keywords: Overlapping generations model, real interest rate, fiscal consolidation rule, default risk, fiscal inflation
    JEL: E17 H30 H5 H60 E62 H63
    Date: 2012–02
  12. By: Lamberte, Mario (Asian Development Bank Institute); Morgan , Peter J. (Asian Development Bank Institute)
    Abstract: The increasing occurrence of national, regional, and global financial crises, together with their rising costs and complexity, have increased calls for greater regional and global monetary cooperation. This is particularly necessary in light of volatile capital flow movements that can quickly transmit crisis developments in individual countries to other countries around the world. Global financial safety nets (GFSNs) are one important area for monetary cooperation. This paper reviews the current situation of regional and global monetary cooperation, focusing on financial safety nets, with a view toward developing recommendations for more effective cooperation, especially between the International Monetary Fund (IMF) and regional financial arrangements (RFAs).
    Keywords: monetary cooperation; regional monetary cooperation; global monetary cooperation; regional financial arrangements; financial safety nets; global financial crises
    JEL: F33 F34 F36 F53 F55
    Date: 2012–02–23
  13. By: A. R. Nobay
    Abstract: Issues of European monetary union and international commercial policy share the centre stage of very current deliberations. This paper addresses the broader political economy perspective of monetary union rather than the specifics of this or that proposal, so as to abstract from the somewhat fluid nature of the discussions. I consider in turn, the background to the quest for monetary union, the conventional economic wisdom of such issues and finally, and more speculatively, the political economy aspects of European monetary arrangements in the world economy.
    Date: 2011–12
  14. By: Chan Wang (CEMA, Central University of Finance and Economics); Heng-fu Zou (CEMA, Central University of Finance and Economics)
    Abstract: This paper investigates the efficiency of monetary and fiscal policy in two-country general equilibrium model with monopolistic competition and price stickiness. Comparing the efficiency of global monetary policy that replicates the real allocations with flexible wages before and after introducing stochastic government spending, we conclude that stochastic government spending is vital, the global monetary policy replicating the real allocations with flexible wages will turn from being efficient to being inefficient when some conditions are satisfied. When the stochastic government spending is present, we also find that the monopoly distortions are essential for the efficiency of the global monetary policy that replicates the real allocations with flexible wages. Complete removal of the monopoly distortions will cause the efficient global monetary policy replicating the real allocations with flexible wages to be inefficient when some conditions are satisfied. Fiscal policy is found to be unable to replicate the real allocations with flexible wages.
    Keywords: New open-economy macroeconomics, Efficiency of monetary policy, Stochastic government spending, Monopoly distortions
    Date: 2012–02–13
  15. By: Chevillon, Guillaume (ESSEC Business School); Mavroeidis, Sophocles (University of Oxford)
    Abstract: We consider a prototypical representative-agent forward-looking model, and study the low frequency variability of the data when the agent's beliefs about the model are updated through linear learning algorithms. We nd that learning in this context can generate strong persistence. The degree of persistence depends on the weights agents place on past observations when they update their beliefs, and on the magnitude of the feedback from expectations to the endogenous variable. When the learning algorithm is recursive least squares, long memory arises when the coefficient on expectations is sufficiently large. In algorithms with discounting, long memory provides a very good approximation to the low-frequency variability of the data. Hence long memory arises endogenously, due to the self-referential nature of the model, without any persistence in the exogenous shocks. This is distinctly dierent from the case of rational expectations, where the memory of the endogenous variable is determined exogenously. Finally, this property of learning is used to shed light on some well-known empirical puzzles.
    Keywords: Learning; Long Memory; Persistence; Present-Value Models
    Date: 2011–11–24
  16. By: Hoffmann, Andreas
    Abstract: This paper studies the monetary policy of the Federal Reserve (Fed) and the Bundesbank / European Central Bank (ECB) with respect to stock or/and foreign exchange markets from 1979 to 2009. I find that Fed policy changed over time, dependent on the chairman of the Fed. During the Greenspan era stock markets mattered for the Fed. In this period, the Fed lowered interest rates when stock prices fell, but did not raise interest rates in the boom. This asymmetry potentially put a downward pressure on interest rates. For the ECB, the exchange rate to the dollar played a role in monetary policy decisions until 2006. While I do not find evidence of asymmetric monetary policy with respect to the stock market, the ECB may be argued to indirectly have followed asymmetric US monetary policy via the exchange rate channel. --
    Keywords: monetary policy,Taylor rule,asset prices
    JEL: E52 E61
    Date: 2012
  17. By: Eijffinger, S.C.W.; Mahieu, R.J.; Raes, L.B.D. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: Central banks in fluence financial markets' expectations of its future policy. By providing its stance on the prospects of the economy, rationalizing past decisions or announcing future actions, central banks affect financial markets' forecasts. In bad times monetary policy communication inducing an upward revision of the path of future policy is good news for stocks. During an expansion the effect is weak and on average negative. The response of equities to central bank talk depends critically on the business cycle. There are strong industry specific effects of monetary policy actions and communication. These industry effects relate to the variation in cyclicality of different industries. Firmspecific effects of monetary policy relate to the leverage, the size and the price-earnings ratio of firms.
    Keywords: Monetary policy;Federal Reserve Communication;Credit channel;Business cycle;Stock market.
    JEL: G14 E44 E52 E58
    Date: 2012
  18. By: Ormeño, Arturo (Department of Economics, University of Amsterdam (UvA))
    Abstract: Do survey data on inflation expectations contain useful information for estimating macroeconomic models? I address this question by using survey data in the New Keynesian model by Smets and Wouters (2007) to estimate and compare its performance when solved under the assumptions of Rational Expectations and learning. This information serves as an additional moment restriction and helps to determine the forecasting model for inflation that agents use under learning. My results reveal that the predictive power of this model is improved when using both survey data and an admissible learning rule for the formation of inflation expectations.
    Keywords: Survey data; Learning models; Inflation expectations; Bayesian econometrics
    JEL: C11 D84 E30 E52
    Date: 2012–02
  19. By: Cristiano Cantore (University of Surrey); Paul Levine (University of Surrey); Giovanni Melina (University of Surrey); Bo Yang (University of Surrey)
    Abstract: A New-Keynesian model with deep habits and optimal monetary policy delivers a fiscal multiplier above one and the crowding-in effect on private consumption obtainable in a Real Business Cycle model à la Ravn et al. (2006). Optimized Taylor-type or price-level interest rate rules yield results close to optimal policy and dominate a conventional Taylor interest rate rule. Private consumption is crowded out only if the Taylor rule is sub-optimal and then negates the fiscal stimulus by responding strongly to the output gap, or if the ability to commit is absent. At the zero lower bound private consumption is always crowded in across simple rules.
    Keywords: Deep habits, Optimal monetary policy, Price-level rule, Zero lower bound
    JEL: E30 E62
    Date: 2012–02
  20. By: Guzman, Giselle C.
    Abstract: I present evidence that higher frequency measures of inflation expectations outperform lower frequency measures of inflation expectations in tests of accuracy, predictive power, and rationality. For decades, the academic literature has focused on three survey measures of expected inflation: the Livingston Survey, the Survey of Professional Forecasters, and the Michigan Surveys of Consumers. While these measures have been useful in developing models of forecasting inflation, the data are low frequency measures that are anachronistic in the modern era of high frequency and real-time data. I present a collection of 37 different measures of inflation expectations, including many previously unexploited monthly and real-time measures of inflation expectations. These higher frequency measures tend to outperform the standard three low frequency survey measures in tests of accuracy, predictive power, and rationality, indicating that there are benefits to using higher frequency measures of inflation expectations. Out of sample forecasts confirm the findings.
    Keywords: inflation; expectations; sentiment; TIPS; surveys; forecasting; Michigan; SPF; Livingston; time-series; econometrics; inflation; predictive power; out-of-sample forecasts; high frequency; Rational Expectations Hypothesis; Efficient Markets Hypothesis; hypothesis testing; inflation forecasting
    JEL: C51 C52 C12 G00 E47 D84 E58 E30 C02 G14 C82 E31 E44 C32 C13 D03 C53 C20 C22 C42 D83 C81 G10 E37 C01
    Date: 2011–06–29
  21. By: Philip Turner
    Abstract: Very high government debt/GDP ratios will increase uncertainty about inflation and the future path of real interest rates. This will reduce substitutability across the yield curve. In such circumstances, changes in the short-term/long-term mix of government debt held by the public will become more effective in achieving macroeconomic objectives. In circumstances of imperfect substitutability, central bank purchases or sales of government bonds have been seen historically as a key tool of monetary policy. Since the mid-1990s, however, responsibility for government debt management has been assigned to other bodies. The mandates of the government debt manager could have the unintended consequence of making their actions endogenous to macroeconomic policies. There is evidence that decisions on the maturity of debt have in the past been linked to both fiscal and monetary policy. Recent Quantitative Easing (QE) by the central bank must be analysed from the perspective of the consolidated balance sheet of government and central bank.
    Date: 2011–05
  22. By: Alessandro Piergallini (Faculty of Economics, University of Rome "Tor Vergata"); Giorgio Rodano (University of Rome “La Sapienza”)
    Abstract: Since Leeper’s (1991, Journal of Monetary Economics 27, 129-147) seminal paper, an extensive literature has argued that if fiscal policy is passive, i.e., guarantees public debt stabilization irrespectively of the inflation path, monetary policy can independently be committed to inflation targeting. This can be pursued by following the Taylor principle, i.e., responding to upward perturbations in inflation with a more than one-for-one increase in the nominal interest rate. This paper analyzes an optimizing framework in which the government can only finance public expenditures by levying distortionary taxes. It is demonstrated that households’ market participation constraints and Laffer-type effects can render passive fiscal policies unfeasible. For any given target inflation rate, there exists a threshold level of public debt beyond which monetary policy independence is no longer possible. In such circumstances, the dynamics of public debt can be controlled only by means of higher inflation tax revenues: inflation dynamics in line with the fiscal theory of the price level must take place in order for macroeconomic stability to be guaranteed. Otherwise, to preserve inflation control around the steady state by following the Taylor principle, monetary policy must target a higher inflation rate.
    Keywords: Public Debt; Distortionary Taxation; Monetary and Fiscal Policy Rules.
    JEL: E63 H31 H63
    Date: 2012–02–07
  23. By: Giuseppe Ciccarone; Enrico Marchetti
    Abstract: We add some elements of prospect theory to an analytically tractable version of Lucas’s “islands†model and show that the inclusion of reference dependence, declining sensitivity and loss aversion into the agents’ utility function leads to three main results. First, the equilibrium labor supply and the natural level of output are negatively affected by the presence of behavioral elements, whereas the cyclical response of output to a monetary shock remains unaltered. Second, the expected utility of a representative agent is generally lower than that obtained when loss aversion is absent. Third, the presence of loss aversion eliminates the paradoxical increase in expected utility that may be generated, in the standard model, by an increase in monetary policy uncertainty.
    Keywords: Prospect Theory, Behavioral economics, Signal extraction.
    JEL: E32 E52 D81
    Date: 2011–10
  24. By: Sudipto Bhattacharya; Charles Goodhart; Dimitrios Tsomocos; Alexandros Vardoulakis
    Abstract: Busts after periods of prolonged prosperity have been found to be catastrophic. Financial institutions increase their leverage and shift their portfolios towards projects that were previously considered too risky. This results from institutions rationally updating their expectations and becoming more optimistic about the future prospects of the economy. Default is inevitably harsher when a bad shock occurs after periods of good news. Commonly used measures to forecast risk in the system, such as VIX, fail to capture this phenomenon, as they are also biased by optimistic expectations. Competition among financial institutions for better relative performance exacerbates the boom-bust cycle. We explore the relative advantages of alternative regulations in reducing financial fragility, and suggest a novel criterion for improvement of aggregate welfare.
    Date: 2011–09
  25. By: Emna Trabelsi
    Abstract: A recent theoretical literature highlighted the potential dangers of further increasing information disclosure by central banks. This paper gives a continuous empirical investigation of the existence of an optimal degree of transparency in the lines of van der Cruijsen et al. We test a quadratic relationship between central bank transparency and the inflation persistence by introducing some technical and economic modifications. Particularly, we used three new measures of transparency. An appropriate U shape test that was made through a Stata routine, recently developed by Lind and Mehlum, indicates a robust optimal intermediate degree of transparency, but its level is not. These results were obtained using a panel of 11 OECD central banks under the period 1999-2009. The estimations were run using a bias corrected LSDVC, a newly recent technique developed by Bruno for short dynamic panels with fixed effects, extended to accommodate unbalanced data.
    Keywords: Intermediate optimal transparency degree, inflation forecasts, inflation persistence, u-shaped relationship, non linear modeling, LSDVC, Principal Component Analysis.
    JEL: C23 E58
    Date: 2012–01–02
  26. By: Francesco Giavazzi; Michael McMahon
    Abstract: This paper provides new evidence on the effects of fiscal policy by studying, using household-level data, how households respond to shifts in government spending. Our identification strategy allows us to control for time-specific aggregate effects, such as the stance of monetary policy or the U.S.-wide business cycle. However, it potentially prevents us from estimating the wealth effects associated with a shift in spending. We find significant heterogeneity in households' response to a spending shock; the effects appear vary over time depending, among other factors, on the state of business cycle and, at a lower frequency, on the composition of employment (such as the share of workers in part-time jobs). Shifts in spending could also have important distributional effects that are lost when estimating an aggregate multiplier. Heads of households working relatively few (weekly) hours, for instance, suffer from a spending shock of the type we analyzed: their consumption falls, their hours increase and their real wages fall.
    Keywords: Fiscal policy, PSID, household consumption, labor supply
    JEL: E62 E21 E24 D12
    Date: 2012–02
  27. By: Giuseppe Ciccarone; Francesco Giuli; Danilo Liberati
    Abstract: By introducing search and matching frictions in both the labor and the credit markets into a cash in advance New Keynesian DSGE model, we provide a novel explanation of the incomplete pass-through from policy rates to loan rates. We show that this phenomenon is ineradicable if banks possess some power in the bargaining over the loan rate of interest, if the cost of posting job vacancies is positive and if firms and bank sustain costs when searching for lines of credit and when posting credit vacancies, respectively. We also show that the presence of credit market frictions moderates the reactions of output and wages to a monetary shock, and that the transmission of monetary policy shocks to output and inflation is more relevant than suggested by the recent literature.
    Keywords: interest rate pass-through,search and matching, credit market frictions.
    JEL: E43 E13 E24 E44
    Date: 2012–01
  28. By: Demir, Ishak
    Abstract: The exchange rate is an important part of transmission mechanism in the determination of monetary policy because movements in the exchange rate have significant effect on the macroeconomy. Measuring the reaction of monetary policy to the movements in exchange rate has some difficulties due to the simultaneous response of monetary policy on the exchange rate and the possibility that both variables respond several other variables. This study will use an identification method based on the heteroscedasticity in the high-frequency data. In particular, shifts in the importance of exchange rate relative to monetary policy shocks, and the estimated changes in the covariance between the shocks that result, allow us to measure the reaction of interest rates to changes in exchange rates. This study comes up with unbiased estimates with heteroscedasticity based identification approach and results of this paper suggest that ECB systematically respond to the exchange rate movements but that quantitative effects are small. The empirical results indicate that a 1 point rise (fall) in the exchange rate tends to decrease (increase) the three-month interest rate by around 20 basis points. Small and negative reaction coefficient implies that ECB may respond to the movements in exchange rate only to the extent warranted by their impact on the macroeconomy, since it affects the expected inflation and future output path.
    Keywords: Monetary Policy; Exchange Rates; Identi…cation through Heteroscedasticity; European Central Bank; Monetary Policy Reaction
    JEL: G12 E58 E5 E52 E44 E40
    Date: 2012–02–17
  29. By: Di Filippo, Gabriele
    Abstract: La thèse tire des leçons de la finance comportementale et de l’économétrie non-linéaire pour trouver un modèle fournissant de meilleurs pouvoirs explicatifs des taux de change que les modèles traditionnels. Le premier article justifie l’échec des modèles traditionnels par l’échec de leurs hypothèses et suggère que l’unique considération de fondamentaux macroéconomiques est insuffisante pour expliquer les taux de change. Le deuxième article analyse le succès des modèles à flux d’ordre et montre la nécessité de considérer le comportement des agents pour construire un modèle robuste de change. Le troisième article montre qu’une règle basée sur les comportements hétérogènes des agents fournit de meilleures prévisions des taux de change que la marche aléatoire. Le quatrième article propose un modèle de change basé sur les conventions de marché. Ce modèle fournit de meilleures performances prédictives que les modèles traditionnels. Le message principal de la thèse est que les fondamentaux macroéconomiques et les comportements des agents sont des déterminants essentiels pour expliquer et prévoir la dynamique des taux de change.
    Abstract: The thesis draws lessons from behavioural finance and nonlinear econometrics to build models that provide better explanatory and predictive powers of exchange rate dynamics than traditional models. The first article justifies the failure of traditional models by the failure of their underlying hypotheses and claims that the unique consideration of macroeconomic fundamentals is not sufficient to explain exchange rate dynamics. The second article analyses the success of order flows models and shows the necessity of considering agents’ behaviours to find a robust exchange rate model. The third article considers heterogeneous behaviours to explain exchange rate dynamics. It shows that a rule based on stylised facts about agents’ behaviours provides better exchange rate forecasts than the random walk. The fourth article proposes an exchange rate model based on conventions that prevail in the market. The convention model significantly beats the forecasting power of traditional models. The main message of the thesis is that macroeconomic fundamentals and agents’ behaviours are both essential components to explain and forecast exchange rate dynamics.
    Keywords: Taux de Change; Finance Comportementale; Econométrie Non-Linéaire; Exchange Rate; Behavioural Finance; Nonlinear Econometrics;
    JEL: C51 F31 G19
    Date: 2011–11
  30. By: Ercio Muñoz; Miguel Ricaurte; Mariel Siravegna
    Abstract: This paper conducts an exhaustive out-of-sample forecasting evaluation exercise for the monthly price of crude oil between 1992 and 2011. The idea is to identify the forecasting strategy that results in the “best” forecasts in terms of mean forecasting error. To this end, a wide variety of econometric models as well as future prices are tested for different forecasting horizons in an individual manner, as well as combined. We find that for short horizons (1 and 3 months), an ARIMA specification results in smaller forecasting errors, but for longer horizons (6-24 months), future prices outperform other models. All models are found to underestimate the true price of oil, on average. The combination of these individual models only yields smaller forecasting errors when compared to the “best” individual strategy in a restricted sample ending in 2005. Nevertheless, when we tabulate the number of times one strategy yields the largest forecasting error compared to other alternatives, combinations of forecasts never yields the highest absolute error except one month ahead. These results are robust to the sample selection.
    Date: 2012–01
  31. By: Pablo Pincheira
    Abstract: It is well known that weighted averages of two competing forecasts may reduce Mean Squared Prediction Errors (MSPE) and may also introduce certain inefficiencies. In this paper we take an in-depth view of one particular type of inefficiency stemming from simple combination schemes. We identify testable conditions under which every linear convex combination of two forecasts displays this type of inefficiency. In particular, we show that the process of taking averages of forecasts may induce inefficiencies in the combination, even when the individual forecasts are efficient. Furthermore, we show that the so-called "optimal weighted average" traditionally presented in the literature may indeed be suboptimal. We propose a simple testable condition to detect if this traditional weighted factor is optimal in a broader sense. An optimal "recombination weight" is introduced. Finally, we illustrate our findings with simulations and an empirical application in the context of the combination of inflation forecasts.
    Date: 2012–01
  32. By: Liew, Freddy
    Abstract: This paper surveys the recent literature on inflation forecasting and conducts an extensive empirical analysis on forecasting inflation in Singapore, Japan, South Korea and Hong Kong paying particular attention to whether the inflation-markup theory can help to forecast inflation. We first review the relative performance of different predictors in forecasting h-quarter ahead inflation using single equations. These models include the autoregressive model and bivariate Philips curve models. The predictors are selected from business activity, financial activity, trade activity, labour market, interest rate market, money market, exchange rate market and global commodity market variables. We then evaluate a vector autoregressive inflation-markup model against the single equation models to understand whether there is any gain in forecasting using the inflation-markup theory. The paper subsequently analyses the robustness of these results by examining different forecasting procedures in the presence of structural breaks. Empirical results suggest that inflation in Singapore, Hong Kong and South Korea is best predicted by financial and business activity variables. For Japan, global commodity variables provide the most predictive content for inflation. In general, monetary variables tend to perform poorly. These results hold even when structural break is taken into consideration. The vector autoregressive inflation-markup model does improve on single equation models as forecasting horizon increases and these gains are found to be significant for Japan and Korea.
    Keywords: Inflation; Markup; Forecasting; Asia; Structural Break
    JEL: C32 C53 E31
    Date: 2012–01–01
  33. By: Volz, Ulrich (Asian Development Bank Institute)
    Abstract: The debt crisis in several member states of the euro area has raised doubts on the viability of European Economic and Monetary Union (EMU) and the future of the euro. While the launch of the euro in 1999 stirred a lot of interest in regional monetary integration and even monetary unification in various parts of the world, including East Asia, the current crisis has had the opposite effect, even raising expectations of a break-up of the euro area. Indeed, the crisis has highlighted the problems and tensions that will inevitably arise within a monetary union when imbalances build up and become unsustainable. This note discusses the causes of the current European crisis and the challenges that EMU countries face in solving it. Based on this analysis, it derives five lessons for regional financial and monetary cooperation and integration in East Asia.
    Keywords: european crisis; euro area; european monetary union; financial integration; east asia
    JEL: E42 F33 F36 G01
    Date: 2012–02–23
  34. By: Luis Felipe Céspedes; Jorge Fornero; Jordi Galí
    Abstract: This paper examines non-Ricardian effects of government spending shocks in the Chilean economy. We first provide evidence on those effects based on vector autoregressions. We then show that such evidence can be accounted for by a model that features: (i) a sizeable share of non-Ricardian households (i.e. households which do not make use of financial markets and just consume their current labor income); (ii) nominal price and wage rigidities; (iii) an inflation targeting scheme, and (iv) a structural balance fiscal rule that represents the particular Chilean fiscal rule. The model is estimated employing Bayesian techniques. Finally, we use model simulations to demonstrate the countercyclical effects of the Chilean fiscal rule as compared with a zero-deficit rule.
    Date: 2012–02
  35. By: Alexander Chubrik; Przemyslaw Wozniak; Gulnar Hajiyeva
    Abstract: The paper proposes two econometric models of inflation for Azerbaijan: one based on monthly data and eclectic, another based on quarterly data and takes into account disequilibrium at the money market. Inflation regression based on monthly data showed that consumer prices dynamics is explained by money growth (the more money, the higher the inflation), exchange rate behaviour (appreciation drives disinflation), commodities price dynamics (“imported” inflation) and administrative changes in regulated prices. For the quarterly model, nominal money demand equation (with inflation, real non-oil GDP and nominal interest rate on foreign currency deposits as predictors) and money supply equation were estimated, and error-correction mechanism from money demand equation was included into inflation equation. It is shown that disequilibrium at the money market (supply higher than demand) drives inflation together with money supply growth and nominal exchange rate depreciation and administrative changes in prices. No cost-push variables appeared to be significant in this equation specification. Both models give similar inflation projections, but sudden changes in money demand (2012) lead to significant differences between the projections. It is shown that money is the most important inflation determinant that explains up to 97.8% of CPI growth between 2012 and 2015, and that in order to keep inflation under control the Central Bank of Azerbaijan should link money supply to real non-oil GDP growth.
    Keywords: Inflation modelling, Inflation forecasting, Money demand, Money supply, Azerbaijan
    JEL: C32 E31 E41 O52
    Date: 2012

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