nep-cba New Economics Papers
on Central Banking
Issue of 2013‒09‒24
28 papers chosen by
Maria Semenova
Higher School of Economics

  1. The Macroprudential Framework: Policy Responsiveness and Institutional Arrangements By Cheng Hoon Lim; Ivo Krznar; Fabian Lipinsky; Akira Otani; Xiaoyong Wu
  2. Institutional Arrangements for Macroprudential Policy in Asia By Cheng Hoon Lim; Rishi S Ramchand; Hong Wang; Xiaoyong Wu
  3. The Global Financial Crisis and the Language of Central Banking: Central Bank Guidance in Good Times and in Bad By Pierre L. Siklos
  4. Central Bank Screening, Moral Hazard, and the Lender of Last Resort Policy By Mei Li; Frank Milne; Junfen Qiu
  5. Information Management in Banking Crises By Shapiro, Joel; Skeie, David
  6. How Monetary Policy is Made: Two Canadian Tales By Matthias Neuenkirch; Pierre Siklos
  7. Creating a Safer Financial System: Will the Volcker, Vickers, and Liikanen Structural Measures Help? By José Vinãls; Ceyla Pazarbasioglu; Jay Surti; Aditya Narain; Michaela Erbenova; Julian T. S. Chow
  8. Towards deeper financial integration in Europe: What the Banking Union can contribute By Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
  9. Optimal versus realized bank credit risk and monetary policy By Delis, Manthos; Karavias, Yiannis
  10. Collateral and Monetary Policy By Manmohan Singh
  11. Price Indexation, Habit Formation, and the Generalized Taylor Principle By Saroj Bhattarai; Jae Won Lee; Woong Yong Park
  12. How Effective are Macroprudential Policies in China? By Bin Wang; Tao Sun
  13. Banks’ Liquidity Buffers and the Role of Liquidity Regulation By Clemens Bonner; Iman van Lelyveld; Robert Zymek
  14. Market-Based Bank Capital Regulation By Bulow, Jeremy I.; Klemperer, Paul
  15. Competition Policy for Modern Banks By Lev Ratnovski
  16. Semiparametric Estimates of Monetary Policy Effects: String Theory Revisited By Joshua D. Angrist; Òscar Jordà; Guido Kuersteiner
  17. A Framework for Macroprudential Bank Solvency Stress Testing: Application to S-25 and Other G-20 Country FSAPs By Andreas A. Jobst; Li L. Ong; Christian Schmieder
  18. Market-Based Structural Top-Down Stress Tests of the Banking System By Jorge A. Chan-Lau
  19. International monetary transmission to the Euro area: Evidence from the U.S., Japan and China By Vespignani, Joaquin L.; Ratti, Ronald A.
  20. Is Inflation Targeting Operative in an Open Economy Setting? By Esteban Pérez Caldentey; Matías Vernengo
  21. Monetary Policy and Hysteresis in Potential Output By Daniel Kienzler; Kai Daniel Schmid
  22. A Tale of Two Deficits: Public Budget Balance of Reserve Currency Countries By Andreas Steiner
  23. Factors Influencing Emerging Market Central Banks’ Decision to Intervene in Foreign Exchange Markets By Matthew S Malloy
  24. Which Fundamentals Drive Exchange Rates? A Cross-Sectional Perspective By Sarno, Lucio; Schmeling, Maik
  25. Capital Flows in the Euro Area By Lane, Philip R.
  26. Monetary Shocks with Observation and Menu Costs By Alvarez, Fernando E; Lippi, Francesco; Paciello, Luigi
  27. Does the European Semester deliver the right policy advice? By Zsolt Darvas; Erkki Vihriälä
  28. Why do governments default, and why don't they default more often? By Buiter, Willem H.; Rahbari, Ebrahim

  1. By: Cheng Hoon Lim; Ivo Krznar; Fabian Lipinsky; Akira Otani; Xiaoyong Wu
    Abstract: This paper gauges if, and how, institutional arrangements are correlated with the use of macroprudential policy instruments. Using data from 39 countries, the paper evaluates policy response time in various types of institutional arrangements for macroprudential policy and finds that the macroprudential framework that gives the central bank an important role is associated with more timely use of macroprudential policy instruments. Policymakers may also tend to use macroprudential instruments more quickly if the ability to conduct monetary policy is somehow constrained. This finding points to the importance of coordination between macroprudential and monetary policy.
    Keywords: Macroprudential Policy;Financial stability;Central banks;Monetary policy;Central bank role;macroprudential, institutions, instruments, systemic risk, credit, interest rate.
    Date: 2013–07–17
  2. By: Cheng Hoon Lim; Rishi S Ramchand; Hong Wang; Xiaoyong Wu
    Abstract: This paper surveys institutional arrangements for macroprudential policy in Asia. Central banks in Asia typically have a financial stability mandate, and play a key role in the macroprudential framework. Smaller and more open economies with prudential regulation inside the central bank tend to have institutional arrangements that give the central bank a leading role. In larger and more complex economies where prudential regulation is outside the central bank, the financial stability mandate is usually shared with other agencies and the government tends to play a leading role. Domestic policy coordination is typically performed by a financial stability committee/other coordination body while cross-border cooperation is largely governed by Memoranda of Understanding.
    Keywords: Macroprudential Policy;Asia;Central banks;Financial stability;Central bank role;banking, financial stability, institutional arrangements, macroprudential, regulation
    Date: 2013–07–17
  3. By: Pierre L. Siklos
    Abstract: Words are critical in how the public perceives the work of central banks and the quality of monetary policy. Press releases that accompany policy rate decisions and, where available, the minutes of central bank committee meetings, are focal points for the media in public discussions about the conduct of monetary policy. Using data from five countries, I examine whether the language used by central banks has changed since the global financial crisis (GFC) began. Briefly, I find that concerns about financial stability peaked just as the global financial crisis reached its zenith. However, concerns over uncertainty about the current and anticipated state of the economy have also risen over time. More generally, central bank speak became more aggressive throughout the crisis years. More conventional expressions about the current stance of monetary policy took a back seat to other concerns in central bank policy statements and minutes.
    Keywords: central bank communication, financial stability, language analysis
    JEL: E52 E58 E61 E69
    Date: 2013–09
  4. By: Mei Li (University of Guelph); Frank Milne (Queen's University); Junfen Qiu (Central University of Finance and Economics)
    Abstract: This paper establishes a theoretical model to examine the LOLR policy when a central bank cannot distinguish between solvent and insolvent banks. We study two cases: a case where the central bank cannot screen insolvent banks and a case where the central bank can only imperfectly screen insolvent banks. The major results that our model produces are as follows: (1) It is impossible for any separating equilibrium to exist because insolvent banks always have an incentive to mimic solvent banks to gamble for resurrection. (2) The pooling equilibria in which, on one hand, all the banks borrow from the central bank and, on the other hand, all the banks do not borrow from the central bank, could exist given certain market beliefs off the equilibrium path. However, neither of the equilibria is socially efficient because insolvent banks will continue to hold their unproductive assets, rather than efficiently liquidating them. (3) When the central bank can screen banks imperfectly, the pooling equilibrium where all the banks borrow from the central bank becomes more likely, and the pooling equilibrium where all the banks do not borrow from the central bank becomes less likely. (4) Higher precision in central bank screening will improve social welfare not only by identifying insolvent banks and forcing them to efficiently liquidate their assets, but also by reducing moral hazard and deterring banks from choosing risky assets in the first place. (5) If a central bank can commit to a specific precision level before the banks choose their assets, rather than conducting a discretionary LOLR policy, it will choose a higher precision level to reduce moral hazard and will attain higher social welfare.
    Keywords: Central Bank Screening, Moral Hazard, Lender of Last Resort
    JEL: D82 G2
    Date: 2013–09
  5. By: Shapiro, Joel; Skeie, David
    Abstract: A regulator resolving a bank faces two audiences: depositors, who may run if they believe the regulator will not provide capital, and banks, which may take excess risk if they believe the regulator will provide capital. When the regulator's cost of injecting capital is private information, it manages expectations by using costly signals: (i) A regulator with a low cost of injecting capital may forbear on bad banks to signal toughness and reduce risk taking, and (ii) A regulator with a high cost of injecting capital may bail out bad banks to increase confidence and prevent runs. Regulators perform more informative stress tests when the market is pessimistic.
    Keywords: bank regulation; financial crisis; reputation; sovereign debt crisis; stress tests
    JEL: G01 G21 G28
    Date: 2013–08
  6. By: Matthias Neuenkirch (University of Aachen); Pierre Siklos (Wilfrid Laurier University)
    Abstract: This paper examines the policy rate recommendations of the Bank of Canada's Governing Council (GC) and the C.D. Howe Institute's Monetary Policy Council (MPC)since 2003. We find, first, that differences in the median recommendations between the MPC and the GC are persistent but small (i.e., 25 bps). The median MPC recommendation is based on a higher steady state real interest rate. However, the response of the MPC and the GC to output and inflation shocks are, for the most part, comparable. Second, we are also able to examine the individual recommendations for the MPC. Estimates of the determinants of consensus inside the MPC or disagreement with the GC yield some useful insights. For example, disagreements are more likely when rates are proposed to rise than at other times. Equally interesting is the finding that the Bank of Canada conditional commitment on the overnightrate in 2009-10 has a relatively larger restricting impact on the MPC's median recommendation than the GC'starget rate.
    Keywords: Bank of Canada, central bank communication, committee behaviour, monetary policy committees,shadow councils, Taylorrules.
    JEL: E43 E52 E58 E61 E69
    Date: 2013
  7. By: José Vinãls; Ceyla Pazarbasioglu; Jay Surti; Aditya Narain; Michaela Erbenova; Julian T. S. Chow
    Abstract: The U.S., the U.K., and more recently, the E.U., have proposed policy measures directly targeting complexity and business structures of banks. Unlike other, price-based reforms (e.g., Basel 3 and G-SIFI surcharges), these proposals have been developed unilaterally with material differences in scope, design and implementation schedules. This may exacerbate cross-border regulatory arbitrage and put a further burden on consolidated supervision and cross-border resolution. This paper provides an analysis of the potential implications of implementing different structural policy measures. It proposes a pragmatic and coordinated approach to development of these policies to reduce risk of regulatory arbitrage and minimize unintended consequences. In doing so, it also aims to identify a set of common policy measures that countries could adopt to re-scope bank business models and corporate structures.
    Keywords: Banking sector;Bank resolution;Bank supervision;Bank reforms;Risk management;International financial system;Bank business models, capital, least cost resolution, risk reduction, structural measures
    Date: 2013–05–14
  8. By: Buch, Claudia M.; Körner, Tobias; Weigert, Benjamin
    Abstract: The agreement to establish a Single Supervisory Mechanism in Europe is a major step towards a Banking Union, consisting of centralized powers for the supervision of banks, the restructuring and resolution of distressed banks, and a common deposit insurance system. In this paper, we argue that the Banking Union is a necessary complement to the common currency and the Internal Market for capital. However, due care needs to be taken that steps towards a Banking Union are taken in the right sequence and that liability and control remain at the same level throughout. The following elements are important. First, establishing a Single Supervisory Mechanism under the roof of the ECB and within the framework of the current EU treaties does not ensure a sufficient degree of independence of supervision and monetary policy. Second, a European institution for the restructuring and resolution of banks should be established and equipped with sufficient powers. Third, a fiscal backstop for bank restructuring is needed. The ESM can play a role but additional fiscal burden sharing agreements are needed. Direct recapitalization of banks through the ESM should not be possible until legacy assets on banks' balance sheets have been cleaned up. Fourth, introducing European-wide deposit insurance in the current situation would entail the mutualisation of legacy assets, thus contributing to moral hazard. --
    Keywords: Banking Union,Europe,Single Supervisory Mechanism,Risk Sharing
    JEL: E02 E42 G18
    Date: 2013
  9. By: Delis, Manthos; Karavias, Yiannis
    Abstract: Standard banking theory suggests that there exists an optimal level of credit risk that yields maximum bank profit. We identify the optimal level of risk-weighted assets that maximizes banks’ returns in the full sample of US banks over the period 1996–2011. We find that this optimal level is cyclical, being higher than the realized credit risk in relatively stable periods with high profit opportunities for banks but quickly decreasing below the realized in periods of turmoil. We place this cyclicality into the nexus between bank risk and monetary policy. We show that a contractionary monetary policy in stable periods, where the optimal credit risk is higher than the realized credit risk, increases the gap between them. An increase in this gap also comes as a result of an expansionary monetary policy in bad economic periods, where the realized risk is higher than the optimal risk.
    Keywords: Banks; Optimal credit risk; Profit maximization; Monetary policy
    JEL: C13 E5 G21
    Date: 2013–09–13
  10. By: Manmohan Singh
    Abstract: Financial lubrication in markets is indifferent to margin posting via money or collateral; the relative price(s) of money and collateral matter. Some central banks are now a major player in the collateral markets. Analogous to a coiled spring, the larger the quantitative easing (QE) efforts, the longer the central banks will impact the collateral market and associated repo rate. This may have monetary policy and financial stability implications since the repo rates map the financial landscape that straddles the bank/nonbank nexus.
    Keywords: Monetary policy;Money markets;Central banks;velocity of collateral; IS/LM; quantitative easing; central banks; repo rate
    Date: 2013–08–28
  11. By: Saroj Bhattarai; Jae Won Lee; Woong Yong Park
    Abstract: We prove that the Generalized Taylor Principle, under which the nominal interest rate reacts more than one-for-one to inflation in the long run, is a necessary and (under some extra mild restrictions on parameters) sufficient condition for determinacy in a sticky price model with positive steady-state inflation, interest rate smoothing in monetary policy, partial dynamic price indexation, and habit formation in consumption.
    Keywords: Determinacy; Generalized Taylor Principle; Sticky prices; Price indexation; Habit formation; Steady-state inflation
    JEL: E31 E52 E58
    Date: 2013–09
  12. By: Bin Wang; Tao Sun
    Abstract: This paper investigates macroprudential policies and their role in containing systemic risk in China. It shows that China faces systemic risk in both the time (procyclicality) and cross-sectional (contagion) dimensions. The former is reflected as credit and asset price risks, while the latter is reflected as the links between the banking sector and informal financing and local government financing platforms. Empirical analysis based on 171 banks shows that some macroprudential policy tools (e.g., the reserve requirement ratio and house-related policies) are useful, but they cannot guarantee protection against systemic risk in the current economic and financial environment. Nevertheless, better-targeted macroprudential policies have greater potential to contain systemic risk pertaining to the different sizes of the banks and their location in regions with different levels of economic development. Complementing macroprudential policies with further reforms, including further commercialization of large banks, would help improve the effectiveness of those policies in containing systemic risk in China.
    Keywords: Macroprudential Policy;China;Financial risk;Banking sector;Systemic risk, Macroprudential policies, Effectiveness
    Date: 2013–03–27
  13. By: Clemens Bonner; Iman van Lelyveld; Robert Zymek
    Abstract: We assess the determinants of banks’ liquidity holdings using balance sheet data for nearly 7000 banks from 30 OECD countries over a ten-year period. We highlight the role of several bank-specific, institutional and policy variables in shaping banks’ liquidity risk management. Our main question is whether the presence of liquidity regulation substitutes or complements banks’ incentives to hold liquid assets. Our results reveal that in the absence of liquidity regulation, the determinants of banks’ liquidity buffers are a combination of bank-specific (business model, profitability, deposit holdings, size) and country-specific (disclosure requirements, concentration of the banking sector) variables. While most incentives are substituted by liquidity regulation, a bank’s disclosure requirement and size remain significant. A key takeaway from our analysis is that the complementary nature of disclosure and liquidity requirements provides a strong rationale for considering them jointly in the design of regulation.
    Keywords: Liquidity; Regulation; Disclosure; Business Models
    JEL: G20 G21 G28
    Date: 2013–09
  14. By: Bulow, Jeremy I.; Klemperer, Paul
    Abstract: Today’s regulatory rules, especially the easily-manipulated measures of regulatory capital, have led to costly bank failures. We design a robust regulatory system such that (i) bank losses are credibly borne by the private sector (ii) systemically important institutions cannot collapse suddenly; (iii) bank investment is counter-cyclical; and (iv) regulatory actions depend upon market signals (because the simplicity and clarity of such rules prevents gaming by firms, and forbearance by regulators, as well as because of the efficiency role of prices). One key innovation is “ERNs” (equity recourse notes--superficially similar to, but importantly distinct from, “cocos”) which gradually "bail in" equity when needed. Importantly, although our system uses market information, it does not rely on markets being “right”.
    Keywords: bail-in; bank; bank capital; bank crisis; capital requirements; contingent capital; contingent convertible bond; debt overhang; deposit insurance; living wills; regulatory capital; regulatory forbearance; SIFI; systemically important financial institution; too-big-to-fail
    JEL: G10 G21 G28 G32
    Date: 2013–08
  15. By: Lev Ratnovski
    Abstract: Traditional bank competition policy seeks to balance efficiency with incentives to take risk. The main tools are rules guiding entry/exit and consolidation of banks. This paper seeks to refine this view in light of recent changes to financial services provision. Modern banking is largely market-based and contestable. Consequently, banks in advanced economies today have structurally low charter values and high incentives to take risk. In such an environment, traditional policies that seek to affect the degree of competition by focusing on market structure (i.e. concentration) may have limited effect. We argue that bank competition policy should be reoriented to deal with the too-big-to-fail (TBTF) problem. It should also focus on the permissible scope of activities rather than on market structure of banks. And following a crisis, competition policy should facilitate resolution by temporarily allowing higher concentration and government control of banks.
    Keywords: Banking;Banks;Competition;Risk management;Banks, Competition Policy, Macroprudential Policy, Systemic Risk.
    Date: 2013–05–23
  16. By: Joshua D. Angrist; Òscar Jordà; Guido Kuersteiner
    Abstract: We develop a flexible semiparametric time series estimator that is then used to assess the causal effect of monetary policy interventions on macroeconomic aggregates. Our estimator captures the average causal response to discrete policy interventions in a macro-dynamic setting, without the need for assumptions about the process generating macroeconomic outcomes. The proposed procedure, based on propensity score weighting, easily accommodates asymmetric and nonlinear responses. Application of this estimator to the effects of monetary restraint suggest contractionary policy slows real economic activity. By contrast, the Federal Reserve's ability to stimulate real economic activity through monetary expansion appears to be much more limited. Estimates for recent financial crisis years are similar to those for the earlier, pre-crisis period.
    JEL: C32 C54 E52 E58 E65
    Date: 2013–08
  17. By: Andreas A. Jobst; Li L. Ong; Christian Schmieder
    Abstract: The global financial crisis has placed the spotlight squarely on bank stress tests. Stress tests conducted in the lead-up to the crisis, including those by IMF staff, were not always able to identify the right risks and vulnerabilities. Since then, IMF staff has developed more robust stress testing methods and models and adopted a more coherent and consistent approach. This paper articulates the solvency stress testing framework that is being applied in the IMF’s surveillance of member countries’ banking systems, and discusses examples of its actual implementation in FSAPs to 18 countries which are in the group comprising the 25 most systemically important financial systems (“S-25â€) plus other G-20 countries. In doing so, the paper also offers useful guidance for readers seeking to develop their own stress testing frameworks and country authorities preparing for FSAPs. A detailed Stress Test Matrix (STeM) comparing the stress test parameters applie in each of these major country FSAPs is provided, together with our stress test output templates.
    Keywords: Banking sector;Stress testing;Financial systems;Group of Twenty;Economic models;Risk management;Financial Sector Assessment Program;Basel III, Financial Sector Assessment Plan (FSAP), G-20, macroprudential, S-25, satellite models, solvency, stress testing, surveillance.
    Date: 2013–03–13
  18. By: Jorge A. Chan-Lau
    Abstract: Despite increased need for top-down stress tests of financial institutions, performing them is challenging owing to the absence of granular information on banks’ trading and loan portfolios. To deal with these data shortcomings, this paper presents a market-based structural top-down stress testing methodology that relies in market-based measures of a bank's probability of default and structural models of default risk to infer the capital losses they could experience in stress scenarios. As an illustration, the methodology is applied to a set of banks in an advanced emerging market economy.
    Keywords: Stress testing;Banking systems;Financial institutions;Emerging markets;Financial sector;Economic models;Stress tests, banks, default risk, systemic risk, structural models, market prices
    Date: 2013–04–10
  19. By: Vespignani, Joaquin L.; Ratti, Ronald A.
    Abstract: There are marked differences in the effect of increases in monetary aggregates ‎in China, Japan ‎and the U.S. on Euro area economic and financial variables over 1999-2012. Increases in ‎monetary aggregates ‎in China are associated with significant increases in the world price of ‎commodities and with increases in Euro area inflation, industrial production and exports. ‎Results are consistent with shocks to China’s M2 facilitating domestic growth with ‎expansionary consequences for the Euro area economy. In contrast, increases in monetary ‎aggregates in Japan are associated with significant appreciation of the Euro and decreases in ‎Euro area industrial production and exports. Production of goods highly competitive with ‎European goods in Japan and expenditure switching in Japan are consistent with the results. ‎U.S. monetary expansion has relatively small effects on the Euro area over this period ‎compared to results reported in the literature for earlier sample periods.‎
    Keywords: International monetary transmission, China’s monetary aggregates, Euro area Commodity prices
    JEL: E52 E58 F31 F42
    Date: 2013–09–10
  20. By: Esteban Pérez Caldentey; Matías Vernengo
    Abstract: The justification for inflation targeting rests on three core propositions. The first is called ‘lean against the wind’, which refers to fact that the monetary authority contracts (expands) aggregate demand below capacity when the actual rate of inflation is above (below) target. The second is ‘the divine coincidence’, which means that stabilizing the rate of inflation around its target is tantamount to stabilizing output around its full employment level. The third proposition is that of stability. This means that the inflation target is part of an equilibrium configuration which generates convergence following any small disturbance to its initial conditions. These propositions are derived from a closed economy setting which is not representative of the countries that actually have adopted inflation targeting frameworks. Currently there are 27 countries, 9 of which are classified as industrialized and 18 as developing countries that have explicitly implemented a fully fledged inflation targeting regime (FFIT). These countries are open economies and are concerned by the evolution of the external sector and the exchange rate as proven by their interventions in the foreign exchange markets. We show that these three core propositions and the practice of inflation targeting are inoperative in an open economy context.
    Keywords: Inflation Targeting, Open Economies, Exchange Rate
    JEL: E42 E58 F41
    Date: 2013
  21. By: Daniel Kienzler; Kai Daniel Schmid
    Abstract: We show that actively stabilizing economic activity plays a more prominent role in the conduct of monetary policy when potential output is subject to hysteresis. We augment a basic NewKeynesian model by hysteresis in potential output and contrast simulation outcomes of this extended model to the standard model. We find that considering hysteresis allows for a more realistic propagation of macroeconomic shocks and persistent movements in output after monetary shocks. Our central policy implication of active output gap stabilization arises from stability analyses and welfare considerations.
    Keywords: Monetary Policy, Hysteresis, Potential Output, Output Gap Mismeasurement
    JEL: E32 E50 E52
    Date: 2013
  22. By: Andreas Steiner (Universitaet Osnabrueck)
    Abstract: Central banks invest their foreign exchange reserves predominantly in government bonds. The global accumulation of reserves therefore affects the equilibrium in the market for government bonds of reserve currency countries. By means of a panel data analysis we examine the relationship between reserve currency status and public budget balance during different constellations of the international monetary system: the sterling period (1890-1935) and the dollar dominance (since World War II). We show for both periods that reserve currency status significantly lowers the fiscal balance. Any additional dollar of reserves lowers the center's balance by 0.7-1.4 dollars. These novel findings show that reserve currency status increases sovereign debt of the center country.
    Keywords: Reserve Currency, Public Balance, International Monetary System
    JEL: F31 F33 F41 H62 E62 C23
    Date: 2013–09–13
  23. By: Matthew S Malloy
    Abstract: Using panel data for 15 economies from 2001-12, I identify determinants of central bank foreign exchange intervention in emerging markets (“EMsâ€) with flexible to moderately managed exchange rates. Similar to other studies, I find that central banks tend to “lean against the wind,†buying/selling more foreign exchange in response to greater short-run and medium-run appreciation/depreciation pressures. The panel structure provides a framework to test whether other macroeconomic variables influence the different rates of reserve accumulation between economies. In testing other variables, I find evidence of both precautionary and external competitiveness motives for reserve accumulation.
    Keywords: Central banks;Emerging markets;Exchange markets;Intervention;Reserves accumulation;Cross country analysis;Economic models;foreign exchange intervention, international reserves
    Date: 2013–03–15
  24. By: Sarno, Lucio; Schmeling, Maik
    Abstract: Standard present-value models suggest that exchange rates are driven by expected future fundamentals, implying that exchange rates contain information about future fundamentals. We test this key empirical prediction of present-value models in a sample of 35 currency pairs ranging from 1900 to 2009. Employing a variety of tests, we find that exchange rates have strong and significant predictive power for nominal fundamentals (inflation, money balances, nominal GDP), whereas predictability of real fundamentals and risk premia is much weaker and largely confined to the post-Bretton Woods era. Overall, we uncover ample evidence that future macro fundamentals drive current exchange rates.
    Keywords: economic fundamentals; Exchange rates; forecasting; present value model
    JEL: F31 G10
    Date: 2013–05
  25. By: Lane, Philip R.
    Abstract: We investigate the behaviour of gross capital flows and net capital flows for euro area member countries. We highlight the extraordinary boom-bust cycles in both gross flows and net flows since 2003. We also show that the reversal in net capital flows during the crisis has been very costly in terms of macroeconomic and financial outcomes for the high-deficit countries. Finally, we describe the reforms that can improve macro-financial stability across the euro area.
    Keywords: capital flows; euro; imbalances
    JEL: E42 F32 F41
    Date: 2013–05
  26. By: Alvarez, Fernando E; Lippi, Francesco; Paciello, Luigi
    Abstract: We compute the impulse response of output to an aggregate monetary shock in a general equilibrium when firms set prices subject to a costly observation of the state and a menu cost. We study how the aggregate effects of a monetary shock depend on the relative size of these costs. We find that empirically reasonable observations costs increase the impact and the persistence of the output response to monetary shocks compared to models with menu cost only, flattening the shape of the impulse response function. Moreover we show that if the shocks are not large the results are independent of the assumption of whether firms know the realization of the monetary shock on impact.
    Keywords: impulse responses; inattentiveness; monetary shocks; sticky prices
    JEL: E5
    Date: 2013–05
  27. By: Zsolt Darvas; Erkki Vihriälä
    Abstract: This paper was prepared at the request of the Economic and Monetary Affairs Commitee of the European Parliament. The July 2013 European Council recommendations to the euro area recognise a number of fiscal and macrostructural challenges, but do not fully exploit the options made possible by the European economic governance framework. There are particular problems with the Council's suggestions for the euro area as whole, which are not (or not adequately) reflected by the country-specific recommendations. A major drawback is that the Council recommendations do not give sufficient importance to symmetric intra-euro area adjustments. Reference to the euro area's â??aggregate fiscal stanceâ?? is empty rhetoric. Insufficient attention is paid to demand management.The most comprehensive recommendations are made on structural reforms. The July/August 2013 Article IV IMF recommendations on macroeconomic policies could also have been more ambitious, but they correspond better to the economic situation of the euro area than the Councilâ??s recommendations. The President of the Eurogroup should continue discussions on the completion of the economic governance framework, including completion of the banking union and the setting-up of a euro-area institution responsible for managing the euro areaâ??s aggregate fiscal stance.
    Date: 2013–09
  28. By: Buiter, Willem H.; Rahbari, Ebrahim
    Abstract: This paper considers the economic and political drivers of sovereign default, focusing on countries rich enough to render sovereign default a ‘won’t pay’ rather than a ‘can’t pay’ phenomenon. Unlike many private contracts, sovereign debt contracts rely almost exclusively on self-enforcement rather than on third-party enforcement. Among the social costs of sovereign default are contagion and concentration risk, both within and outside the jurisdiction of the sovereign, and ‘rule of law externalities’. We consider illiquidity as a separate trigger for sovereign default and emphasize the role of lenders of last resort for the sovereign. Not only do political economy factors drive sovereign insolvency, they also influence the debt sustainability analyses performed by national and international agencies. We consider it likely that the absence of sovereign defaults in the advanced economies since the (West) German defaults of 1948 and 1953 until the Greek defaults of 2012 was a historical aberration that is unlikely to be a reliable guide to the future.
    Keywords: fiscal sustainability; intertemporal budget constraint; political economy.; solvency; sovereign default; strategic default
    JEL: E62 E63 F34 F41 G01 G18 H26 H63
    Date: 2013–05

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