nep-cba New Economics Papers
on Central Banking
Issue of 2013‒02‒16
sixteen papers chosen by
Maria Semenova
Higher School of Economics

  1. "Arresting Financial Crises: The Fed versus the Classicals" By Thomas M. Humphrey
  2. Monetary Policy, Inflation Illusion and the Taylor Principle: An Experimental Study By Wolfgang Luhan; Johann Scharler
  3. Monetary regime change and business cycles By Vasco Cúrdia; Daria Finocchiaro
  4. Hot Money Flows, Commodity Price Cycles, and Financial Repression in the US and the People’s Republic of China: The Consequences of Near Zero US Interest Rates By McKinnon, Ronald; Liu, Zhao
  5. Reserve Options Mechanism and FX Volatility By Arif Oduncu; Yasin Akcelik; Ergun Ermisoglu
  6. Financial markets and the response of monetary policy to uncertainty in South Africa By Ruthira Naraidoo; Leroi Raputsoane
  7. Chinese monetary policy – from theory to practice By Körner, Finn Marten; Ehnts, Dirk H.
  8. National Banking's Role in U.S. Industrialization, 1850-1900 By Matthew S. Jaremski
  9. Explaining interest rate decisions when the MPC members believe in different stories By Carl Andreas Claussen; Øistein Røisland
  10. Macroprudential policy and imbalances in the euro area By Michał Brzoza-Brzezina; Marcin Kolasa; Krzysztof Makarski
  11. Forecasting annual inflation with power transformations: the case of inflation targeting countries By Héctor Manuel Záarte Solano; Angélica Rengifo Gómez
  12. Forecasting Exchange Rates Out-of-Sample with Panel Methods and Real-Time Data By Onur Ince
  13. "Lessons from an Unconventional Central Banker" By Thorvald Grung Moe
  14. Imperfect Information and Inflation Expectations: Evidence from Microdata By Michael J. Lamla; Lena Dräger
  15. Equilibrium credit : the reference point for macroprudential supervisors By Buncic, Daniel; Melecky, Martin
  16. Inflation expectations in Spain: The Spanish PwC Survey By María del Carmen Ramos-Herrera; Simon Sosvilla-Rivero

  1. By: Thomas M. Humphrey
    Abstract: Nineteenth-century British economists Henry Thornton and Walter Bagehot established the classical rules of behavior for a central bank, acting as lender of last resort, seeking to avert panics and crises: Lend freely (to temporarily illiquid but solvent borrowers only) against the security of sound collateral and at above-market, penalty interest rates. Deny aid to unsound, insolvent borrowers. Preannounce your commitment to lend freely in all future panics. Also lend for short periods only, and have a clear, simple, certain exit strategy. The purpose is to prevent bank runs and money-stock collapses--collapses that, by reducing spending and prices, will, in the face of downward inflexibility of nominal wages, produce falls in output and employment. In the financial crisis of 2008-09 the Federal Reserve adhered to some of the classical rules--albeit using a credit-easing rather than a money stock–protection rationale--while deviating from others. Consistent with the classicals, the Fed filled the market with liquidity while lending to a wide variety of borrowers on an extended array of assets. But it departed from the classical prescription in charging subsidy rather than penalty rates, in lending against tarnished collateral and/or purchasing assets of questionable value, in bailing out insolvent borrowers, in extending its lending deadlines beyond intervals approved by classicals, and in failing both to precommit to avert all future crises and to articulate an unambiguous exit strategy. Given that classicals demonstrated that satiating panic-induced demands for cash are sufficient to end crises, the Fed might think of abandoning its costly and arguably inessential deviations from the classical model and, instead, return to it.
    Keywords: Lender of Last Resort; Financial Crises; Bank Panics; Bank Runs; Bailouts; Penalty Rates; Collateral; High-powered Monetary Base; Broad Money Stock; Multiplier; Federal Reserve Policy; Liquidity; Insolvency; Emergency Lending; Credit Risk Spreads; Systemic Risks; Classical Economists
    JEL: E44 E51 E58
    Date: 2013–02
  2. By: Wolfgang Luhan; Johann Scharler
    Abstract: We develop a simple experimental setting to evaluate the role of the Taylor principle, which holds that the nominal interest rate has to respond more than one-for-one to fluctuations in the inflation rate. In our setting, the average inflation rate fluctuates around the inflation target if the computerized central bank obeys the Taylor principle. If the Taylor principle is violated, then the average inflation rate persistently deviates from the target. We find that these deviations from the target are less pronounced, if inflation rates cannot be as readily observed as nominal interest rates. This result is consistent with the interpretation that subjects underestimate the influence of inflation on the real return to savings if the inflation rate is only observed ex post.
    Keywords: Taylor principle, Interest Rate Rule, Inflation Illusion, Laboratory Experiment
    JEL: E30 E52 C90
    Date: 2013–01
  3. By: Vasco Cúrdia; Daria Finocchiaro
    Abstract: This paper proposes a simple method to structurally estimate a model over a period of time containing a regime shift. It then evaluates to which degree it is relevant to explicitly acknowledge the break in the estimation procedure. We apply our method on Swedish data, and estimate a DSGE model explicitly taking into account the monetary regime change in 1993, from exchange rate targeting to inflation targeting. We show that ignoring the break in the estimation leads to spurious estimates of model parameters including parameters in both policy and non-policy economic relations. Accounting for the regime change suggests that monetary policy reacted strongly to exchange rate movements in the first regime, and mostly to inflation in the second. The sources of business cycle fluctuations and their transmission mechanism are significantly affected by the exchange rate regime.
    Date: 2013
  4. By: McKinnon, Ronald (Stanford University); Liu, Zhao (Stanford University)
    Abstract: Under near zero United States (US) interest rates, the international dollar standard malfunctions. Emerging markets with naturally higher interest rates are swamped with "hot money" inflows. Emerging market central banks intervene to prevent their currencies from rising precipitously. They subsequently lose monetary control and begin inflating. Primary commodity prices rise worldwide unless interrupted by an international banking crisis. This cyclical inflation on the dollar’s periphery only registers in the US core consumer price index (CPI) with a long lag. The zero interest rate policy also fails to stimulate the US economy as domestic financial intermediation by banks and money market mutual funds is repressed. Because the People’s Republic of China (PRC) is forced to keep its interest rates below market-clearing levels, it also suffers from "financial repression," although in a form differing from that in the US.
    Keywords: Dollar standard; carry trades; commodity price inflation
    JEL: F31 F32
    Date: 2013–01–01
  5. By: Arif Oduncu; Yasin Akcelik; Ergun Ermisoglu
    Abstract: Reserve Options Mechanism (ROM), which is the option to hold FX or gold reserves in increasing tranches in place of Turkish Lira reserve requirements of Turkish banks, was designed and launched by the Central Bank of the Republic of Turkey (CBRT). ROM is a tool unique to the CBRT and it is aimed to support the FX reserve management of the banking system and to limit the adverse effects of excess capital flow volatility on the macroeconomic and financial stability of Turkey. In this paper, we study the effectiveness of ROM on the volatility of Turkish Lira, and to the best of our knowledge, it is the first analytical paper on investigating the effects of the ROM. The results suggest that ROM is an effective policy tool in decreasing the volatility of Turkish lira in the sample period.
    Keywords: Reserve Options Mechanism, Volatility of Turkish Lira, Central Bank of the Republic of Turkey’s Policy Mix, GARCH
    JEL: C12 C58 E58 G10
    Date: 2013
  6. By: Ruthira Naraidoo (Department of Economics, University of Pretoria); Leroi Raputsoane (South African Reserve Bank)
    Abstract: This paper assesses the impact of uncertainty about the true state of the economy on monetary policy in South Africa since the adoption of inflation targeting. The paper also analyses the impact of uncertainty about the conditions in financial markets on the interest rate setting behavior that describes the South African Reserve Bank’s monetary policy decisions over and above using inflation and output as indicator variables. The results indicate that the effect of uncertainty on the interest rates has led to a more cautious monetary policy stance by the monetary authorities consistent with a large body of literature that recognizes that an excessively activist policy can increase economic instability. The results further show that uncertainty about the state of the economy clusters around the financial crisis periods in 2003 and from 2007 to 2009. The uncertainty about inflation was important to the interest rate setting behavior in 2003, while the uncertainty about the conditions in financial markets was important to the interest rate setting behavior between 2007 and 2009.
    Keywords: Monetary policy, Uncertainty, Financial market conditions
    JEL: C51 E43 E44 E58
    Date: 2013–02
  7. By: Körner, Finn Marten; Ehnts, Dirk H.
    Abstract: Chinese monetary policy constitutes a marked example of a clash between theory and practice. In theory, a fixed exchange rate regime with capital mobility turns the money supply into an endogenous variable while expansionary pressure can be alleviated by the central bank by foreign currency transactions. For China, this standard view is contended by the 'compensation thesis' as proposed by Lavoie and Wang (2012) according to which the central bank maintains discretion over money supply by using alternative balance sheet instruments. In this paper we show that the People's Bank of China's (PBoC) activities can be better characterized by the 'compensation thesis' view of alternative money supply operations. In addition, we can thus characterize the PBoC's policy stance as being directed at targeting inflation and exchange rate stability via a five-phase policy mix using sterilization bonds and reserve requirements according to macroeconomic conditions. After downgrading the loans-to-deposits ratio of 75% to the status of an indicator and given the rise in lending despite a high reserve ratio, the quantity-driven approach to monetary policy of the PBoC faces an uncertain future.
    Keywords: Chineses monetary policy; Nominal exchange rate; Money supply; Mundell-Fleming; Compensation thesis; Modern Money Theory; Sterilization; Loans-to-deposit ratio; Reserve requirement ratio; Credit and money suppply growth
    JEL: E58 E31 E5 F31 G21
    Date: 2013–02–07
  8. By: Matthew S. Jaremski
    Abstract: The passage of the National Banking Acts stabilized the existing financial system and encouraged the entry of 729 banks between 1863 and 1866. The national banks not only attracted more deposits than previous state banks, but also concentrated in the area that would eventually become the Manufacturing Belt. Using a new bank census, the paper shows that these changes to the financial system were a major determinant of the geographic distribution of manufacturing. The sudden entry not only resulted in more manufacturing capital and output at the county-level, but also more steam engines and value added at the establishment-level.
    JEL: G21 N21 O43
    Date: 2013–02
  9. By: Carl Andreas Claussen (Sveriges Riksbank (Central Bank of Sweden)); Øistein Røisland (Norges Bank (Central Bank of Norway))
    Abstract: Modern central banks do not only announce the interest rate decision, they also communicate a "story" that explains why they reached the particular decision. When decisions are made by a committee, it could be difficult to find a story that is both consistent with the decision and representative for the committee. Two alternatives that give a unique and consistent story are: (i) vote on the interest rate and let the winner decide the story, (ii) vote on the elements of the story and let the interest rate follow from the story. The two procedures tend to give different interest rate decisions and different stories due to an aggregation inconsistency called the "discursive dilemma". We investigate the quality of the stories under the two approaches, and find that alternative (ii) gives stories that tend to be closer to the true (but unobservable) story. Thus, our results give an argument in favour of premise-based, as opposed to conclusion-based, decisionmaking.
    Keywords: Monetary policy committees, Communication, Judgment aggregation, Discursive dilemma
    JEL: E52 E58 D71
    Date: 2013–02–08
  10. By: Michał Brzoza-Brzezina (National Bank of Poland, Warsaw School of Economics); Marcin Kolasa (National Bank of Poland, Warsaw School of Economics); Krzysztof Makarski (National Bank of Poland, Warsaw School of Economics)
    Abstract: Since its creation the euro area suffered from imbalances between its core and peripheral members. This paper checks whether macroprudential policy applied to the peripheral countries could contribute to providing more macroeconomic stability in this region. To this end we build a twoeconomy macrofinancial DSGE model and simulate the effects of macroprudential policies under the assumption of asymmetric shocks hitting the core and the periphery. We find that macroprudential policy is able to partly make up for the loss of independent monetary policy in the periphery. Moreover, LTV policy seems more efficient than regulating capital adequacy ratios. However, for the policies to be effective, they must be set individually for each region. Area-wide policy is almost ineffective in this respect.
    Keywords: euro-area imbalances, macroprudential policy, DSGE with banking sector
    JEL: E32 E44 E58
    Date: 2013
  11. By: Héctor Manuel Záarte Solano; Angélica Rengifo Gómez
    Abstract: This paper investigates whether transforming the Consumer Price Index with a class of power transformations lead to an improvement of inflation forecasting accuracy. We use one of the prototypical models to forecast short run inflation which is known as the univariate time series ARIMA . This model is based on past inflation which is traditionally approximated by the difference of logarithms of the underlying consumer price index. The common practice of applying the logarithm could damage the forecast precision if this transformation does not stabilize the variance adequately. In this paper we investigate the benefits of incorporating these transformations using a sample of 28 countries that has adopted the inflation targeting framework. An appropriate transformation reduces problems with estimation, prediction and inference. The choice of the parameter is done by bayesian grounds.
    Date: 2013–02–05
  12. By: Onur Ince
    Abstract: This paper evaluates out-of-sample exchange rate forecasting with Purchasing Power Parity (PPP) and Taylor rule fundamentals for 9 OECD countries vis-à-vis the U.S. dollar over the period from 1973:Q1 to 2009:Q1 at short and long horizons. In contrast with previous work, which reports “forecasts” using revised data, I construct a quarterly real-time dataset that incorporates only the information available to market participants when the forecasts are made. Using bootstrapped out-of-sample test statistics, the exchange rate model with Taylor rule fundamentals performs better at the one-quarter horizon and panel estimation is not able to improve its performance. The PPP model, however, forecasts better at the 16-quarter horizon and its performance increases in panel framework. The results are in accord with previous research on long-run PPP and Taylor rule models. Key Words: Exchange Rate Forecasting, Taylor Rules, Real-Time Data, Out-of-Sample Test Statistics
    JEL: C23 C53 E32 E52 F31 F47
    Date: 2013
  13. By: Thorvald Grung Moe
    Abstract: The global financial crisis has generated renewed interest in the 1951 Treasury - Federal Reserve Accord and its lessons for central bank independence. A broader interpretation of the Accord and of Marriner S. Eccles's role at the Federal Reserve should teach central bankers that independence can be crucial for fighting inflation, but also encourage them to be more supportive of government efforts to fight deflation and mass unemployment.
    Date: 2013–01
  14. By: Michael J. Lamla (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Lena Dräger (University of Hamburg, Hamburg, Germany)
    Abstract: We investigate the updating behavior of individual consumers regarding their short and long-run inflation expectations. Utilizing the University of Michigan Survey of Consumer’s rotating panel microstructure, we can identify whether individuals adjust their inflation expectations over a period of six months. We find evidence that the updating frequency has been underestimated. Furthermore, looking at the possible determinants of an update we find support for imperfect information models. Moreover, individual expectations are found to be more accurate after an update and forecast accuracy is affected by inflation volatility measures and news regarding inflation. Finally, the updating frequency is found to significantly move spreads in bond markets.
    Keywords: Rational Inattention, updating inflation expectations, microdata, news
    JEL: D84 E31
    Date: 2013–02
  15. By: Buncic, Daniel; Melecky, Martin
    Abstract: Equilibrium credit is an important concept because it helps identify excessive credit provision. This paper proposes a two-stage approach to determine equilibrium credit. It uses two stages to study changes in the demand for credit due to varying levels of economic, financial and institutional development of a country. Using a panel of high and middle-income countries over the period 1980-2010, this paper provides empirical evidence that the credit-to-GDP ratio is inappropriate to measure equilibrium credit. The reason for this is that such an approach ignores heterogeneity in the parameters that determine equilibrium credit across countries due to different stages of economic development. The main drivers of this heterogeneity are financial depth, access to financial services, use of capital markets, efficiency and funding of domestic banks, central bank independence, the degree of supervisory integration, and experience of a financial crisis. Countries in Europe and Central Asia show a slower adjustment of credit to its long-run equilibrium compared with other regions of the world.
    Keywords: Economic Theory&Research,Access to Finance,Currencies and Exchange Rates,Banks&Banking Reform,Debt Markets
    Date: 2013–02–01
  16. By: María del Carmen Ramos-Herrera (Universidad Complutense de Madrid. Instituto Complutense de Estudios Internacionales (ICEI)); Simon Sosvilla-Rivero (Departamento de Economía Cuantitativa (Department of Quantitative Economics), Facultad de Ciencias Económicas y Empresariales (Faculty of Economics and Business), Universidad Complutense de Madrid (Complutense University of Madrid),)
    Abstract: We examine the predictive ability, the consistency properties and the possible driving forces of inflation expectations, using a survey conducted in Spain by PwC among a panel of experts and entrepreneurs. When analysing the headline inflation rate, our results suggest that the PwC panel has some forecasting ability for time horizons from 3 to 9, improving when it comes to predict the core inflation rate. Nevertheless, the results indicate that predictions made by survey participants are neither unbiased nor efficient predictors of future inflation rates, regardless of the measures of inflation used. As for the consistency properties of the inflation expectations formation process, we find that panel members form stabilising expectations in the case of the headline inflation rate, both in the short and in the long-run, although in the case of the core inflation rate, consistency remains indeterminate. Finally, we find that inflation expectations are very persistent and that they appear to incorporate the information content of some macroeconomic variables (current core inflation and growth rate, the USD/EUR exchange rate, the ECB inflation target and changes in the ECB official short-term interest rate).
    Keywords: Inflation, Forecasting, Expectations, Panel data, Econometric models.
    JEL: E31 D84 C33
    Date: 2013–01

This nep-cba issue is ©2013 by Maria Semenova. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.