nep-cba New Economics Papers
on Central Banking
Issue of 2012‒07‒14
seven papers chosen by
Maria Semenova
Higher School of Economics

  1. Central bank credibility and the persistence of inflation and inflation expectations By J. Scott Davis
  2. Global Banks and Crisis Transmission By Sebnem Kalemli-Ozcan; Elias Papaioannou; Fabrizio Perri
  3. Do good institutions promote counter-cyclical macroeconomic policies? By César Calderón; Roberto Duncan; Klaus Schmidt-Hebbel
  4. Social Trust and Central-Bank Independence By Berggren, Niclas; Daunfeldt, Sven-Olof; Hellström, Jörgen
  5. Interest rates and business cycles in emerging economies: The role of financial frictions By Fernández, Andrés; Gulan, Adam
  6. Too-Systemic-To-Fail: What Option Markets Imply About Sector-wide Government Guarantees By Kelly, Bryan; Lustig, Hanno; van Nieuwerburgh, Stijn
  7. The Signaling Effect of Exchange Rates: pass-through under dispersed information By Waldyr Areosa; Marta Areosa

  1. By: J. Scott Davis
    Abstract: This paper introduces a model where agents are unsure about the central bank's inflation target. They believe that the central bank's inflation target could lie between two extremes, and their beliefs vary depending on the central bank's stock of credibility. They form the expectations used in price and wage setting using this perceived inflation target, and they use past observations of inflation to update their beliefs about the credibility of the central bank. Thus a series of high inflation observations can lead them to believe (incorrectly) that the central bank has adopted a high target. High inflation expectations are incorporated into price and wage setting decisions, and a transitory shock to inflation can become very persistent. The model with endogenous credibility can match the volatility and persistence of both inflation and measures of long-term inflation expectations that we see in the data. The model is then calibrated to match the observed levels of Federal Reserve credibility in the 1980s and the 2000s. By simply changing the level of credibility, holding all else fixed, the model can explain nearly all of the observed changes in the volatility and persistence of inflation and inflation expectations in the U.S. from the 1980s to today.
    Keywords: Price levels
    Date: 2012
  2. By: Sebnem Kalemli-Ozcan; Elias Papaioannou; Fabrizio Perri
    Abstract: We study the effect of financial integration (through banks) on the transmission of international business cycles. In a sample of 20 developed countries between 1978 and 2009 we find that, in periods without financial crises, increases in bilateral banking linkages are associated with more divergent output cycles.This relation is significantly weaker during financial turmoil periods, suggesting that financial crises induce co-movement among more financially integrated countries. We also show that countries with stronger, direct and indirect, financial ties to the U.S. experienced more synchronized cycles with the U.S. during the recent 2007-2009 crisis. We then interpret these findings using a simple general equilibrium model of international business cycles with banks and shocks to banking activity. The model suggests that the relation between integration and synchronization depends on the type of shocks hitting the world economy, and that shocks to global banks played an important role in triggering and spreading the 2007-2009 crisis.
    JEL: E32 F15 F36
    Date: 2012–07
  3. By: César Calderón; Roberto Duncan; Klaus Schmidt-Hebbel
    Abstract: The literature has argued that developing countries are unable to adopt counter-cyclical monetary and fiscal policies due to financial imperfections and unfavorable politicaleconomy conditions. Using a world sample of 115 industrial and developing countries for 1984-2008, we find that the level of institutional quality plays a key role in countries' ability to implement counter-cyclical macroeconomic policies. The results show that countries with strong (weak) institutions adopt counter- (pro-) cyclical macroeconomic policies, reflected in extended monetary policy and fiscal policy rules. The threshold level of institutional quality at which monetary and fiscal policies are a-cyclical is found to be similar.
    Keywords: Interest rates ; Monetary policy ; Fiscal policy
    Date: 2012
  4. By: Berggren, Niclas (Research Institute of Industrial Economics (IFN)); Daunfeldt, Sven-Olof (HUI Research AB); Hellström, Jörgen (Umeå School of Business and Economics)
    Abstract: Central banks have been made more independent in many countries. A common rationale has been the existence of a credibility (or lack-of-trust) problem for monetary policy. This indicates a possible and until now unexplored link between social trust and central-bank independence. Our empirical findings, based on data from 149 countries, confirm that there is such a link, in the form of a u-shaped relationship. We suggest that two factors help explain this finding: the need for this kind of reform and the ability with which it can be implemented. At low trust levels, the need for central-bank independence is strong enough to dominate the low ability; at high trust levels the ability for reform is high and dominates the low need; at intermediate trust levels there is neither need nor ability strong enough to generate very independent central banks.
    Keywords: Trust; Credibility; Reforms; Monetary Policy; Inflation; Central Bank; Time Inconsistency
    JEL: E52 E58 P48 Z13
    Date: 2012–05–23
  5. By: Fernández, Andrés (Research Department, Inter-American Development Bank); Gulan, Adam (Bank of Finland Research)
    Abstract: Countercyclical country interest rates have been shown to be both a distinctive characteristic and an important driving force of business cycles in emerging market economies. In order to account for this, most business cycle models of emerging market economies have relied on ad hoc and exogenous countercyclical interest rate processes. We embed a financial contract à la Bernanke et al. (1999) into a standard small open economy business cycle model that endogenously delivers countercyclical interest rates. We then take the model to the data. For this purpose we build a novel panel dataset for emerging economies that includes financial data, namely sovereign and corporate interest rates as well as leverage. We show that the model accounts well not only for countercyclical interest rates, but also for other stylized facts of emerging economies' business cycles, including the dynamics of leverage.
    Keywords: business cycle models; emerging economies; financial frictions
    JEL: E32 E44 F41
    Date: 2012–06–18
  6. By: Kelly, Bryan; Lustig, Hanno; van Nieuwerburgh, Stijn
    Abstract: We examine the pricing of financial crash insurance during the 2007-2009 financial crisis in U.S. option markets. A large amount of aggregate tail risk is missing from the price of financial sector crash insurance during the financial crisis. The difference in costs of out-of-the-money put options for individual banks, and puts on the financial sector index, increases fourfold from its pre-crisis 2003-2007 level. We provide evidence that a collective government guarantee for the financial sector, which lowers index put prices far more than those of individual banks, explains the divergence in the basket-index put spread.
    Keywords: financial crisis; government bailout; option pricing models; systemic risk; too-big-to-fail
    JEL: E44 E60 G12 G13 G18 G21 G28 H23
    Date: 2012–06
  7. By: Waldyr Areosa; Marta Areosa
    Abstract: We examine exchange-rate pass-through (ERPT) to prices in a model of dispersed information in which the nominal exchange rate imperfectly conveys information about the underlying fundamentals. If the information is complete, ERPT is also complete. Under dispersed information, we derive conditions under which our model displays three properties that are consistent with the stylized facts of pass-through. First, ERPT lies between 0 and 1 (incomplete ERPT). Second, ERPT is usually higher for imported goods prices than for consumer prices (exchange rate-consumer price puzzle). Third, there is a link between ERPT and macroeconomic stability.
    Date: 2012–06

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