nep-cba New Economics Papers
on Central Banking
Issue of 2014‒07‒05
twenty-two papers chosen by
Maria Semenova
Higher School of Economics

  1. Inflation Targeters Do Not Care (Enough) about Financial Stability: A Myth? By Armand Fouejieu Azangue
  2. The art of central banks' forward guidance at the zero lower bound By Bennani, Hamza
  3. Navigating Constraints: The Evolution of Federal Reserve Monetary Policy, 1935-59 By Carlson, Mark A.; Wheelock, David C.
  4. U.S. Unconventional Monetary Policy and Transmission to Emerging Market Economies By Bowman, David; Londono, Juan M.; Sapriza, Horacio
  5. Exchange Rate Pass-through in Russia By Yuri Ponomarev; Pavel Trunin; Alexei Uluykaev
  6. Excess reserves, interbank markets and domestic money market intervention By Willmott, Bryony
  7. Globalisation, Pass-through and the Optimal Policy Response to Exchange Rates By Michael B. Devereux; James Yetman
  8. External Debt Profile of Chilean Companies By Nelson Loo; Valeria Orellana
  9. Accommodative monetary policy: savior or saboteur? By Williams, John C.
  10. Unconventional Monetary Policy and Money Demand By Christian Dreger; Jürgen Wolters
  11. The inflation bias under Calvo and Rotemberg pricing By Campbell Leith; Ding Liu
  12. ECB Policy and Eurozone Fragility: Was De Grauwe Right? By Fuertes, Ana-Maria; Kalotychou, Elena; Saka, Orkun
  13. Quantifying and Explaining Implicit Public Guarantees for European Banks By Oana Toader
  14. The Determinants of Inflation in Egypt: An Empirical Study (1991-2012) By El Baz, Osama
  15. Optimal Monetary Policy in the Presence of Human Capital Depreciation during Unemployment By Lien Laureys
  16. Using Survey Data of Inflation Expectations in the Estimation of Learning and Rational Expectations Models. By Ormeno, Arturo; Molnar, Krisztina
  17. Increase in Home Bias and the Eurozone Sovereign Debt Crisis By Camille Cornand; Pauline Gandré; Céline Gimet
  18. Sovereign bond yields in emerging Asia: New evidence By Thi-Hong-Hanh Pham
  19. On the Nominal Interest Rate Yield Response to Net Government Borrowing in the U.S.: An Empirical Analysis with Robustness Tests By Alexander, Gigi; Foley, Maggie
  20. The Real Exchange Rate in the Long Run: Balassa-Samuelson Effects Reconsidered By Michael D. Bordo; Ehsan U. Choudhri; Giorgio Fazio; Ronald MacDonald
  21. The Liquidity Premium of Near-Money Assets By Stefan Nagel
  22. Does nominal rigidity mislead our perception of the exchange rate pass-through? By Olivier de Bandt; Tovonony Razafindrabe

  1. By: Armand Fouejieu Azangue (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR7322 - Université d'Orléans)
    Abstract: The 2008/2009 financial crisis raised issues related to the monetary policy doctrine of the last two decades. Inflation targeting has been criticized as its main objective of inflation stabilisation might have diverted central banks from other concerns such as financial stability. As a first attempt in the literature on emerging countries, this study aims at investigating (i) whether inflation targeting is associated to higher financial instability, and (ii) whether inflation targeting central banks are less responsive to financial imbalances relative to non-targeters. To this end, we build a composite index in order to get a more complete and comprehensive view of the financial conditions in emerging countries. The paper concludes that, in spite of a stronger central banks' response to financial imbalances, inflation targeters are facing more financial instability than others. These findings suggest that, even if inflation targeting might be associated to higher financial fragility, this can hardly be attributed to the central banks 'carelessness' about developments in the financial sector. For emerging market economies, especially those implementing inflation targeting, this highlights the need for a broader and more integrated framework such as macro-prudential policies to tackle the issue of financial stability.
    Keywords: Inflation targeting ; financial stabiity ; central banks' reaction function
    Date: 2014–06–25
  2. By: Bennani, Hamza
    Abstract: This paper proposes to assess the usefulness of central banks forward guidance since the start of the global economic crisis. Using a novel approach, the Wordscores methodology, we reveal that since 2009, central banks do provide a temporal guidance of their accommodative policy that can be relied on and expected. Central banks communication thus gives important insights to financial markets about the persistence of their unconventional measures and in particular about the occurrence of an exit strategy.
    Keywords: central bank communication, monetary policy, forward guidance
    JEL: E52 E58
    Date: 2014–05–29
  3. By: Carlson, Mark A. (Board of Governors of the Federal Reserve System (U.S.)); Wheelock, David C. (Federal Reserve Bank of St. Louis)
    Abstract: The 1950s are often pointed to as a decade in which the Federal Reserve operated a particularly successful monetary policy. The present paper examines the evolution of Federal Reserve monetary policy from the mid-1930s through the 1950s in an effort to understand better the apparent success of policy in the 1950s. Whereas others have debated whether the Fed had a sophisticated understanding of how to implement policy, our focus is on how the constraints on the Fed changed over time. Roosevelt Administration gold policies and New Deal legislation limited the Fed's ability to conduct an independent monetary policy. The Fed was forced to cooperate with the Treasury in the 1930s, and fully ceded monetary policy to Treasury financing requirements during World War II. Nonetheless, the Fed retained a policy tool in the form of reserve requirements, and from the mid-1930s to 1951, changes in required reserve ratios were the primary means by which the Fed responded to expected inflation. The inability of the Fed to maintain a credible commitment to low interest rates in the face of increased government spending and rising inflation led to the Fed-Treasury Accord of March 1951. Following the Accord, the external pressures on the Fed diminished significantly, which enabled the Fed to focus primarily on macroeconomic objectives. We conclude that a successful outcome requires not only a good understanding of how to conduct policy, but also a conducive environment in which to operate.
    Keywords: Federal Reserve; monetary policy; reserve requirements; Fed-Treasury Accord; inflation
    JEL: E52 E58 N12
    Date: 2014–06–09
  4. By: Bowman, David (Board of Governors of the Federal Reserve System (U.S.)); Londono, Juan M. (Board of Governors of the Federal Reserve System (U.S.)); Sapriza, Horacio (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: We investigate the effects of U.S. unconventional monetary policies on sovereign yields, foreign exchange rates, and stock prices in emerging market economies (EMEs), and we analyze how these effects depend on country-specifc characteristics. We find that, although EME asset prices, mainly those of sovereign bonds, responded strongly to unconventional monetary policy announcements, these responses were not outsized with respect to a model that takes into account each country's time-varying vulnerability to U.S. interest rates affected by monetary policy shocks.
    Keywords: Unconventional monetary policy; emerging markets; large-scale asset purchase program; quantitative easing; Federal Reserve
    JEL: E58 F42 G15
    Date: 2014–06–23
  5. By: Yuri Ponomarev (Gaidar Institute for Economic Policy); Pavel Trunin (Gaidar Institute for Economic Policy); Alexei Uluykaev (Ministry of Economic Development)
    Abstract: In The article provides estimates of short-run and medium-run exchange rate pass-through into domestic prices in Russia during the period of 2000–2012 using vector error correction model. Exchange rate pass-through asymmetry estimates, its assessments on different sub-periods and exchange rate volatility effect on pass-through are also provided.
    Keywords: exchange rate pass-through, asymmetry of exchange rate pass-through, exchange rate volatility, inflation, monetary policy, vector error correction model. exchange rate pass-through, asymmetry of exchange rate pass-through, exchange rate volatility, inflation, monetary policy, vector error correction model.
    JEL: C32 E31 E52 F31 F41
    Date: 2014
  6. By: Willmott, Bryony
    Abstract: This paper considers whether relationships exist between the daily weighted average 7-day interbank rate, the change in the daily 7-day interbank rate, the daily level of commercial banks excess reserves and the change in the daily level of excess reserves, which may guide domestic money market intervention. Monetary survey data for the period 1st June 2011 – 13th September 2013 (i.e. inflation targeting lite period) is used. Results show no correlation between excess reserves and interbank rate movements, even though a Granger causality test shows that in the absence of money market intervention, the level of excess reserves may determine both the level of and changes in the interbank rate. There is also highly significant causality from Central Bank intervention to the target interbank rate, but no correlation between the two. Furthermore, there is no evidence of correlation or causation between excess reserves and interbank rates when the interbank rate falls outside of the target. In conclusion, the relatively shallow nature of the Ugandan financial system prevents a distinct relationship between the interbank money market interest rate and commercial banks excess reserves, as a result a rules-based intervention policy is not suitable to Uganda.
    Keywords: Monetary policy, Intervention, Excess reserves, interbank interest rate
    JEL: E4 E42 E44 E5 G1
    Date: 2014–01
  7. By: Michael B. Devereux; James Yetman
    Abstract: In this paper we examine how monetary policy should respond to nominal exchange rates in a New Keynesian open economy model that allows for a non-trivial role for sterilised intervention. The paper develops the argument against the backdrop of the evolving policy-making environment of Asian economies. Sterilised intervention can be a potent tool that offers policymakers an additional degree of freedom in maximising global welfare. We show that the gains to sterilised intervention are greater when goods market integration is low and exchange rate pass-through is high. However, increased financial internationalisation reduces the effectiveness of sterilised intervention, as the international policy trilemma becomes more relevant. Unsterilised intervention may also have a role to play, although the potential welfare gains from this are generally smaller. Most central banks in Asia have actively used sterilised foreign exchange intervention as a policy tool to smooth exchange rates. But, over time, declining exchange rate pass-through and the increasing international integration of financial and goods markets will tend to reduce the efficacy of sterilised intervention. Given the limited effectiveness of unsterilised intervention, our model implies that the role of exchange rate movements in the optimal setting of monetary policy in Asia is decreasing.
    JEL: F3 F41
    Date: 2014–06
  8. By: Nelson Loo; Valeria Orellana
    Abstract: Central banks’ communication policies have changed dramatically over the last decades. They have moved from being very secretive to much more transparency with a special emphasis on communications. This is not only related to a cultural change in the society at large that demands more transparency from their authorities or to technological changes that allow more scrutiny over policy actions of authorities in general, but also because central bankers have realized that monetary policy works much better when it is open and transparent. In addition, in a world of independent central banks a greater degree of openness and transparency protects them from political pressures. Forward guidance is a form of communication that has been used by central banks for years, but that became much more relevant and explicit with the global financial crisis. In this note the evolution, benefits, costs, challenges and perspectives of this form of communication are analyzed
    Date: 2014–05
  9. By: Williams, John C. (Federal Reserve Bank of San Francisco)
    Abstract: Presentation to the Utah and Montana Bankers Association, Sun Valley, Idaho, June 30, 2014
    Date: 2014–06–30
  10. By: Christian Dreger; Jürgen Wolters
    Abstract: This paper investigates the usefulness of the money demand relationship in times of unconventional monetary policies by cointegration methods. In contrast to the bulk of the literature, evidence in favour of a stable long run money demand function is presented both for the US and the euro area. Results are based on standard monetary aggregates, i.e. MZM for the US and M3 in case of the euro area. The recent monetary policy shifts towards unconventional measures did not introduce instability in the relationships. The results suggest that money balances are still useful instruments to conduct monetary policy especially in periods where the nominal interest rates are at the zero lower bounds.
    Keywords: Unconventional monetary policy, money demand, stability
    JEL: C22 C52 E41
    Date: 2014
  11. By: Campbell Leith; Ding Liu
    Abstract: New Keynesian models rely heavily on two workhorse models of nominal inertia - price contracts of random duration (Calvo, 1983) and price adjustment costs (Rotemberg, 1982) - to generate a meaningful role for monetary policy. These alternative descriptions of price stickiness are often used interchangeably since, to a first order of approximation they imply an isomorhpic Phillips curve and, if the steady-state is efficient, identical objectives for the policy maker and as a result in an LQ framework, the same policy conclusions. In this paper we compute time-consistent optimal monetary policy in bench- mark New Keynesian models containing each form of price stickiness. Using global solution techniques we find that the in ation bias problem under Calvo contracts is significantly greater than under Rotemberg pricing, despite the fact that the for- mer typically exhibits far greater welfare costs of inflation. The rates of in inflation observed under this policy are non-trivial and suggest that the model can comfort- ably generate the rates of in ation at which the problematic issues highlighted in the trend in inflation literature emerge, as well as the movements in trend inflation emphasized in empirical studies of the evolution of inflation. Finally, we consider the response to cost push shocks across both models and find these can also be significantly different. The choice of which form of nominal inertia to adopt is not innocuous.
    Keywords: New Keynesian Model; Monetary Policy; Rotemberg Pricing; Calvo Pricing; In ation Bias; Time-Consistent Policy.
    JEL: E52 E63
    Date: 2014–06
  12. By: Fuertes, Ana-Maria; Kalotychou, Elena; Saka, Orkun
    Abstract: The authors test Paul De Grauwe’s eurozone fragility hypothesis using a time window around the announcement of the Outright Monetary Transactions (OMT) programme. The findings reveal significant contagion from Spain to other eurozone countries, but solely during the pre-announcement period. The authors conclude that in this case the OMT programme has succeeded in mitigating the self-fulfilling dynamics within the eurozone.
    Date: 2014–06
  13. By: Oana Toader (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR7322 - Université d'Orléans)
    Abstract: This study provides estimations of public implicit guarantees over the period 1997 to 2012 using a rating-based model. The investigation focuses on a sample of 45 large, listed European banks. It appears that the main element for determining the value of the public subsidy is the intrinsic strength of the bank. In addition, we provide evidence on the importance of guarantor strength on the value of the implicit guarantee: a higher sovereign rating of a bank‟s home country leads to larger implicit subsidies for bank' debt. Our findings also suggest that the recently observed decrease in the value of implicit subsidies goes beyond the decline in European sovereigns' strength. Rather, it is consistent with the implementation of resolution regimes and practices moving from a "bail-out" resolution policy to "bail-in" recapitalizations. Bank insolvencies would be handled in a more explicit context. Therefore, expectations on implicit public support are reduced.
    Keywords: banks ; implicit subsidy ; ratings ; resolution
    Date: 2014–06–26
  14. By: El Baz, Osama
    Abstract: This paper investigated the determinants of inflation in the Egyptian economy. Using annual data, covering the period (1991-2012), a Vector Auto Regression Model (VAR) was estimated. The results of the empirical model confirmed that inflation rate responds positively in the first period following shocks to itself, domestic liquidity growth rate, output gap, exchange rate depreciation, and world food prices. Also, expectations seemed to play an important role as inflation rate responds positively to a shock in itself in the first year following the shock, which reinforces the idea that inflationary expectations will generate more inflation. In the short run inflation is explained mostly by its own fluctuations followed by output gap, domestic liquidity growth rate, and nominal depreciation of the Egyptian pound against the US dollar, while in a 5-year horizon about 56% of inflation dynamics can be attributed to factors other than inflation expectations "itself".
    Keywords: Inflation,Phillips Curve, VAR, IRFs
    JEL: E5 E52 E58
    Date: 2014–05–12
  15. By: Lien Laureys (Bank of England; Centre for Macroeconomics (CFM))
    Abstract: When workers are exposed to human capital depreciation during periods of unemployment, hiring affects the unemployment pool’s composition in terms of skills, and hence the economy’s production potential. Introducing human capital depreciation during unemployment into an otherwise standard New Keynesian model with search frictions in the labour market leads to the finding that the flexibleprice allocation is no longer constrained-efficient even when the standard Hosios (1990) condition holds. This is because it generates a composition externality in job creation: firms ignore how their hiring decisions affect the extent to which the unemployed workers’ skills erode, and hence the output that can be produced by new matches. Consequently, it might be desirable from a social point of view for monetary policy to deviate from strict inflation targeting. Although optimal price inflation is no longer zero, strict inflation targeting is shown to stay close to the optimal policy.
    Date: 2014–06
  16. By: Ormeno, Arturo (Credit Suisse AG); Molnar, Krisztina (Dept. of Economics, Norwegian School of Economics and Business Administration)
    Abstract: Does survey data contain useful information for estimating macroeconomic models? We address this question by using survey data of inflation expectations to estimate the New Keynesian model by Smets and Wouters (2007) and compare its performance under rational expectations and adaptive learning. The survey information serves as an additional moment restriction and helps us to determine the learning agents' forecasting model for in ation. Adaptive learning fares similarly to rational expectations in fitting macro data, but clearly outperforms rational expectations in fitting macro and survey data simultaneously. In other words survey data contains additional information that is not present in the macro data alone.
    Keywords: Survey data; learning; rational expectations; inflation expectations; Bayesian econometrics.
    JEL: C61 D84 E30 E52
    Date: 2014–06–30
  17. By: Camille Cornand (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon - Université Jean Monnet - Saint-Etienne - Université Claude Bernard - Lyon I (UCBL)); Pauline Gandré (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon - Université Jean Monnet - Saint-Etienne - Université Claude Bernard - Lyon I (UCBL)); Céline Gimet (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon - Université Jean Monnet - Saint-Etienne - Université Claude Bernard - Lyon I (UCBL), CHERPA - Croyance, Histoire, Espace, Régulation Politique et Administrative - Institut d'Études Politiques [IEP] - Aix-en-Provence - Aix Marseille Université)
    Abstract: One of the most striking consequences of the recent episode of sovereign debt market stress in the Eurozone has been the increase in the share of public debt held by the domestic sector in fragile economies. First, we identify the shocks that explain most of the variation in this share in an S-VAR model on a sample of 7 Eurozone countries between 2007 and 2012. Home bias in sovereign debt responds positively to fundamentals and expectations shocks but we find no evidence that the increase in home bias is destabilizing per se. Second, we theoretically model the impact of the previous shocks in a second-generation model of crisis with endogenous home bias in sovereign debt. We derive conditions under which a higher home bias is associated with a change in the government's decision. Finally, we discuss which case of the model best applies to the distinct countries in our sample during the recent sovereign debt crisis in the Eurozone.
    Keywords: Eurozone; Sovereign debt crises; Home bias; Bayesian panel S-VAR; Second-generation model
    Date: 2014
  18. By: Thi-Hong-Hanh Pham (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272)
    Abstract: This paper studies the determinants of sovereign bond yields in nine emerging Asian countries over the period 1994-2012. In the long-run, we first reveal that sovereign bond yields weakly and negatively depends on the changes in public debt. This result is not consistent with the theoretical hypothesis that rising government debt may foster sovereign bond yields through the default risk. Second, we fail to find out a long-run relationship between potential economic growth and sovereign borrowing costs in emerging Asia. Lastly, this paper evidences the preliminary interventions of emerging Asian authorities in separating government debt management from monetary management.
    Keywords: Debt market; Sovereign bond yields; Emerging Asia; Panel analysis.
    Date: 2014–06–25
  19. By: Alexander, Gigi; Foley, Maggie
    Abstract: This study provides current empirical evidence on the impact of net U.S. government borrowing (budget deficits) on the nominal interest rate yield on ten-year Treasury notes. The model includes an ex ante real short-term real interest rate yield, an ex ante real long-term interest rate yield, the monetary base as a percent of GDP, expected future inflation, the percentage growth rate of real GDP, net financial capital inflows, and other variables. This study uses annual data and then uses quarterly data for the periods 1971-2008 and 1971-2012. Autoregressive two-stage least squares estimates imply that the federal budget deficit, expressed as a percent of GDP, exercises a positive and statistically significant impact on the nominal interest rate yield on ten-year Treasury notes. Robustness tests are provided in an Appendix.
    Keywords: nominal interest; net government borrowing
    JEL: E43 E52 H62 O41
    Date: 2014–06–11
  20. By: Michael D. Bordo; Ehsan U. Choudhri; Giorgio Fazio; Ronald MacDonald
    Abstract: Historical data for over hundred years and 14 countries is used to estimate the long-run effect of productivity on the real exchange rate. We find large variations in the productivity effect across four distinct monetary regimes in the sample period. Although the traditional Balassa-Samuelson model is not consistent with these results, we suggest an explanation of the results in terms of contemporary variants of the model that incorporate the terms of trade mechanism. Specifically we argue that changes in trade costs over time may affect the impact of productivity on the real exchange rate over time. We undertake simulations of the modern versions of the Balassa-Samuelson model to show that plausible parameter shifts consistent with the behavior of trade costs can explain the cross-regime variation of the productivity effect.
    JEL: F31 F41
    Date: 2014–06
  21. By: Stefan Nagel
    Abstract: Treasury bills and other near-money assets provide owners with liquidity service benefits that are reflected in prices in the form of a liquidity premium. I relate time variation in this liquidity premium to changes in the opportunity cost of money: The liquidity service benefits of near-money assets are more valuable when short-term interest rates are high and hence the opportunity cost of holding money is high. Consistent with this prediction, the liquidity premium of T-bills and other near-money assets is strongly positively correlated with the level of short-term interest rates. Once short-term interest rates are controlled for, Treasury security supply variables lose their explanatory power for the liquidity premium. I argue that an analysis of scarcity and price of near-money assets is incomplete without taking into account the substitution relationship with money and its supply by the central bank. Payment of interest on reserves (IOR) could potentially reduce liquidity premia because IOR reduces the opportunity cost of at least one type of money (reserves). In the UK and Canada, however, the introduction of IOR did not shrink liquidity premia. Apparently, the reduction in banks' opportunity cost of money did not result in a broader fall in the opportunity costs of money for non-bank market participants.
    JEL: E41 E43 G12
    Date: 2014–06
  22. By: Olivier de Bandt; Tovonony Razafindrabe
    Abstract: Relying on a novel dataset of detailed micro-data on import prices, this paper explores the close link that exists between nominal import price rigidity and the extent of exchange rate pass-through (ERPT). We show that previous evidence in favor of incomplete and low value of ERPT in the empirical literature may be explained by two factors: the relative importance of small variations in the exchange rate and, mainly, nominal rigidity. Once nominal rigidity is taken into account, we …nd for French manufacturers that ERPT may be incomplete in the short run, but with relatively high value, and complete in the long run. In addition, assessing non-linearity and asymmetry issues, we provide evidence that the shape of the import price reaction function is distorted by the presence of nominal rigidity. Indeed, the linearity assumption is veri…ed once nominal rigidity is taken into account. However, in the case where it is rejected, the import price reaction function is concave rather than convex, indicating that …rms aim at protecting market shares. As a consequence, the common belief that "prices rise faster than they fall" is the results of nominal import price rigidity as far as ERPT is concerned.
    Keywords: Exchange rate pass-through, nominal rigidity, import price
    JEL: F31 E31 C23
    Date: 2014

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