nep-cba New Economics Papers
on Central Banking
Issue of 2017‒03‒05
24 papers chosen by
Maria Semenova
Higher School of Economics

  1. Low inflation and monetary policy in the euro area By Conti, Antonio M.; Neri, Stefano; Nobili, Andrea
  2. Exit strategies for monetary policy By Aleksander Berentsen; Sébastien Kraenzlin; Benjamin Müller
  3. Central bank sentiment and policy expectations By Hubert, Paul; Labondance, Fabien
  4. Monetary policy surprises over time By Marcello Pericoli; Giovanni Veronese
  5. Unconventional Monetary Policy, Fiscal Side Effects and Euro Area (Im)balances By Hachula, Michael; Rieth, Malte; Piffer, Michele
  6. The impact of constrained monetary policy on fiscal multipliers on output and inflation By Bletzinger, Tilman; Lalik, Magdalena
  7. Trust, but verify. De-anchoring of inflation expectations under learning and heterogeneity By Busetti, Fabio; Delle Monache, Davide; Gerali, Andrea; Locarno, Alberto
  8. Inflation anchoring in the euro area By Speck, Christian
  9. An indicator of inflation expectations anchoring By Filippo Natoli; Laura Sigalotti
  10. Tail co-movement in inflation expectations as an indicator of anchoring By Natoli, Filippo; Sigalotti, Laura
  11. Unconventional monetary policy and the anchoring of inflation expectations By Ciccarelli, Matteo; García, Juan Angel; Montes-Galdón, Carlos
  12. Forecasting euro area inflation using targeted predictors: is money coming back? By Falagiarda, Matteo; Sousa, João
  13. Unconventional Monetary and Exchange Rate Policies By Joseph E. Gagnon; Tamim Bayoumi; Juan M. Londono; Christian Saborowski; Horacio Sapriza
  14. Forecasting Inflation in Vietnam with Univariate and Vector Autoregressive Models By Tran Thanh Hoa
  15. Did the Basel Process of Capital Regulation Enhance the Resiliency of European Banks? By Gehrig, Thomas Paul; Iannino, Maria Chiara
  16. A SIFI Badge for Banks in Europe: Reduction in Bail-Out Expectations or Monumental Heritage Protection? By Schäfer, Alexander
  17. Are Basel's Capital Surcharges for Global Systemically Important Banks Too Small? By Wayne Passmore; Alexander H. von Hafften
  18. Asymmetric Macro-Financial Spillovers By Bluwstein, Kristina
  19. Did Monetary Policy Matter? Narrative Evidence from the Classical Gold Standard By Lennard, Jason
  20. Comparer les mesures non conventionnelles de la FED et de la BCE : ce que disent les bilans des banques centrales. By Anne-Marie Rieu-Foucault
  21. The effects of tax on bank liability structure By Leonardo Gambacorta; Giacomo Ricotti; Suresh Sundaresan; Zhenyu Wang
  22. The Mist of Central Bank Balance Sheets By Otaviano Canuto; Matheus Cavallari
  23. Mind the output gap: the disconnect of growth and inflation during recessions and convex Phillips curves in the euro area By Gross, Marco; Semmler, Willi
  24. The Operation and Demise of the Bretton Woods System; 1958 to 1971 By Michael D. Bordo

  1. By: Conti, Antonio M.; Neri, Stefano; Nobili, Andrea
    Abstract: Inflation in the euro area has been falling since mid-2013, turned negative at the end of 2014 and remained below target thereafter. This paper employs a Bayesian VAR to quantify the contribution of a set of structural shocks, identified by means of sign restrictions, to inflation and economic activity. Shocks to oil supply do not tell the full story about the disinflation that started in 2013, as both aggregate demand and monetary policy shocks also played an important role. The lower bound to policy rates turned the European Central Bank (ECB) conventional monetary policy de facto contractionary. A country analysis confirms that the negative effects of oil supply and monetary policy shocks on inflation was widespread, albeit with different intensity across countries. The ECB unconventional measures since 2014 contributed to raising inflation and economic activity in all the countries. All in all, our analysis confirms the appropriateness of the ECB asset purchase programme. JEL Classification: C32, E31, E32, E52
    Keywords: Bayesian methods, inflation, monetary policy, oil supply, VAR models
    Date: 2017–01
  2. By: Aleksander Berentsen; Sébastien Kraenzlin; Benjamin Müller
    Abstract: In response to the financial crisis of 2007/08, all major central banks decreased interest rates to historically low levels and created large excess reserves. Central bankers currently discuss how to raise interest rates in such an environment. The term "exit strategy" refers to the various policies that allow central banks to achieve this objective. Exit instruments such as paying interest on reserves, term deposits, central bank bills and reverse repos are evaluated with respect to the central bank's ability to control the money market interest rate and their impact on money market trading activity, welfare, inflation and taxes. Each instrument is investigated under two polar coordination regimes: monetary dominance and fiscal dominance.
    Keywords: Exit strategies, money market, repo, monetary policy, interest rates
    JEL: E40 E50 D83
    Date: 2016–12
  3. By: Hubert, Paul (OFCE - SCiences Po.); Labondance, Fabien (Université de Bourgogne Franche-Comté — CRESE, OFCE — Sciences Po)
    Abstract: We explore empirically the theoretical prediction that optimism or pessimism have aggregate effects, in the context of monetary policy. First, we quantify the tone conveyed by FOMC policymakers in their statements using computational linguistics. Second, we identify sentiment as the unpredictable component of tone, orthogonal to fundamentals, expectations, monetary shocks and investors’ sentiment. Third, we estimate the impact of FOMC sentiment on the term structure of private interest rate expectations using a high-frequency methodology and an ARCH model. Optimistic FOMC sentiment increases policy expectations primarily at the one-year maturity. We also find that sentiment affects inflation and industrial production beyond monetary shocks.
    Keywords: Animal spirits; optimism; confidence; FOMC; interest rate expectations; central bank communication; ECB; aggregate effects
    JEL: E43 E52 E58
    Date: 2017–02–17
  4. By: Marcello Pericoli (Bank of Italy); Giovanni Veronese (Bank of Italy)
    Abstract: We document how the impact of monetary surprises in the euro area and the US on financial markets has changed since 1999. We use a definition of monetary policy surprises that singles out movements in the long end of the yield curve, rather than those that change nearby futures on the central bank reference rates. By focusing only on this component of monetary policy our results are more comparable over time. We find a hump-shaped response of the yield curve to monetary policy surprises, both in the pre-crisis period and since 2013. During the crisis years, Fed path-surprises, largely through their effect on term premia, account for the impact on interest rates, which is found to be increasing in tenor. In the euro area, the path-surprises reflect shifts in sovereign spreads and have a large impact on the entire constellation of interest rates, exchange rates and equity markets.
    Keywords: monetary policy surprises, unconventional monetary policy
    JEL: E44 E52 F31 G14
    Date: 2017–02
  5. By: Hachula, Michael; Rieth, Malte; Piffer, Michele
    Abstract: We study the effects and transmission channels of non-standard monetary policy in the euro area using structural vector autoregressions, identified with an external instrument. The instrument is the common component of unexpected variations in euro area sovereign yields vis-à-vis Germany for different maturities on policy announcement days. We find that expansionary monetary surprises are effective in stimulating economic activity, prices and inflation expectations. Shock transmission functions through public and private interest rates, asset prices and credit conditions. The policy innovations, however, also lead to a rise in primary public expenditures, a divergence of relative prices within the union and a widening of internal trade balances.
    JEL: E52 E58 E63
    Date: 2016
  6. By: Bletzinger, Tilman; Lalik, Magdalena
    Abstract: This paper uses two established DSGE models (QUEST III and Smets-Wouters) to assess the impact of fiscal spending cuts on output and, in particular, also on inflation in the euro area under alternative settings for monetary policy. We compare four different settings of constrained monetary policy, taking into account alternative agents’ expectations about future monetary policy. We illustrate that those expectations are even more important for the size of the fiscal multipliers than the difference between exogenously versus endogenously modelled constraints. We confirm the well-known finding that fiscal multipliers exhibit an over-proportional reaction when monetary policy is constrained. The novelty of our results is that this over-proportionality is stronger for the fiscal multiplier on inflation than on output. We relate this finding to the structural parameters of the models by means of a Global Sensitivity Analysis. JEL Classification: E31, E43, E52, E62, E63
    Keywords: constrained monetary policy, fiscal multipliers, zero lower bound
    Date: 2017–02
  7. By: Busetti, Fabio; Delle Monache, Davide; Gerali, Andrea; Locarno, Alberto
    Abstract: The paper studies how a prolonged period of subdued price developments may induce a de-anchoring of inflation expectations from the central bank's objective. This is shown within a framework where agents form expectations using adaptive learning, choosing among a set of alternative forecasting models. The analysis is accompanied by empirical evidence on the properties of inflation expectations in the euro area. Our results also suggest that monetary policy may lose effectiveness if delayed too much, as expectations are allowed to drift away from target for too long. JEL Classification: E31, E37, E58, D83
    Keywords: DSGE, expectations de-anchoring, inflation, learning
    Date: 2017–01
  8. By: Speck, Christian
    Abstract: Did the decline in inflation rates from 2012 to 2015 and the low levels of market-based inflation expectations lead to de-anchored inflation dynamics in the euro area? This paper is the first time-varying event study to investigate the reaction of inflation-linked swap (ILS) rates – a market-based measure of inflation expectations – to macroeconomic surprises in the euro area. Compared to the pre-crisis period, surprises have a much stronger effect on spot ILS rates during the crisis. Medium-term forward ILS rates remain insensitive to news most of the time, which implies inflation anchoring. Only short periods of sensitivity on the part of medium-term forward ILS rates are identified at times of low inflation or recession. The sensitivity is lower over more distant forecast horizons such that medium-term sensitivity represents an inflation adjustment process and provides no evidence for a de-anchoring of inflation expectations or a loss of credibility for the Eurosystem’s policy target. JEL Classification: E31, E44, G12, G14
    Keywords: central banking, event study, inflation anchoring, inflation expectations, inflation-linked swaps
    Date: 2017–01
  9. By: Filippo Natoli (Bank of Italy); Laura Sigalotti (Bank of Italy)
    Abstract: We compare the degree of anchoring of inflation expectations in the euro area, the United States and the United Kingdom, focusing on the post-crisis period. First of all, we estimate a set of measures of average and tail correlation using inflation swaps and options, as proposed by Natoli and Sigalotti (2016). To quantify the degree of anchoring, we also propose a new indicator based on the results of a logistic regression, obtained by measuring the odds that strong negative shocks to short-term expectations are connected to large declines in long-term expectations. The results reveal an increase in the risk of de-anchoring during the last quarter of 2014 for the euro area. While showing a significant reduction after the peak, our de-anchoring indicator remains high and volatile for 2015 and 2016. Inflation expectations in the US and the UK are instead found to be firmly anchored.
    Keywords: inflation expectations, anchoring, inflation swaps, inflation options, tail comovement, odds ratio
    JEL: C14 C58 E31 E44 G13
    Date: 2017–02
  10. By: Natoli, Filippo; Sigalotti, Laura
    Abstract: We analyze the degree of anchoring of inflation expectations in the euro area during the post-crisis period, with a focus on the time span from 2014 onwards when long-term beliefs have substantially drifted away from the policy target. Using a new estimation technique, we look at tail co-movements between short- and long-term distributions of inflation expectations, estimated from daily quotes of inflation derivatives. We find that, during 2014, average correlations between short- and long-term inflation expectations rose sharply; moreover, negative tail events impacting short-term beliefs have been increasingly channeled to long-term views, triggering both downward revisions in expectations and upward changes in uncertainty. Overall, our results signal a risk of downside de-anchoring of long-term inflation expectations. JEL Classification: C14, C58, E31, E44, G13
    Keywords: anchoring, inflation expectations, inflation swaps, inflations options, option-implied density, tail co-movement
    Date: 2017–01
  11. By: Ciccarelli, Matteo; García, Juan Angel; Montes-Galdón, Carlos
    Abstract: The effects of the unconventional monetary policy (UMP) measures undertaken by the U.S. Federal Reserve (and other major central banks) remain a crucial topic for research. This paper investigates their effects on the anchoring of long-term inflation expectations, a key dimension of UMP that has been largely overlooked. Our analysis provides two key insights. First, the anchoring of inflation expectations deteriorated significantly since late 2008. Second, the expansion of the Fed’s balance sheet contributed decisively to prevent and gradually reverse that de-anchoring during the Great Recession. Using a SVAR framework extended to incorporate policy news, we show that accounting for the predictable path of the balance sheet following the Fed’s asset purchase announcements is fundamental to properly assess the effects of UMP. JEL Classification: E43, E44, C52, C55
    Keywords: inflation expectations, news shocks, unconventional monetary policy
    Date: 2017–01
  12. By: Falagiarda, Matteo; Sousa, João
    Abstract: This paper sheds new light on the information content of monetary and credit aggregates for future price developments in the euro area. Overall, we find strong variation in the information content of these variables over time. We show that monetary and credit aggregates are very often selected among the top predictors of inflation, with their predictive power relative to other predictors generally improving in the post-2012 period. An out-of-sample forecasting exercise indicates that, when monetary and credit aggregates are loaded directly in the forecasting equation, the additional gains over the benchmark model are generally high and significant across horizons and HICP components only in the most recent period. When the forecasts are computed using factor-augmented regressions based on the best predictors, we confirm the importance of monetary and credit variables in forecasting inflation, even if their information content is diluted in a much broader pool of variables. JEL Classification: C53, E37, E41, E51, E58
    Keywords: diffusion index, forecasting, inflation, money, targeted predictors
    Date: 2017–02
  13. By: Joseph E. Gagnon; Tamim Bayoumi; Juan M. Londono; Christian Saborowski; Horacio Sapriza
    Abstract: This paper explores the direct effects and spillovers of unconventional monetary and exchange rate policies. We find that official purchases of foreign assets have a large positive effect on a country's current account that diminishes considerably as capital mobility rises. There is an important additional effect through the lagged stock of official assets. Official purchases of domestic assets, or quantitative easing (QE), appear to have no significant effect on a country's current account when capital mobility is high, but there is a modest positive impact when capital mobility is low. The effects of purchases of foreign assets spill over to other countries in proportion to their degree of international financial integration. We also find that increases in US bond yields are associated with increases in foreign bond yields and in stock prices, as well as with depreciations of foreign currencies, but that all of these effects are smaller on days of US unconventional monetary policy announcements. We develop a theoretical model that is broadly consistent with our empirical results and that highlights the potential usefulness of domestic unconventional policies as responses to the effects of foreign policies of a similar type.
    Keywords: Current account balance ; Unconventional monetary policy ; Foreign exchange intervention ; Quantitative easing
    JEL: F36 F42
    Date: 2017–02
  14. By: Tran Thanh Hoa (The State Bank of Vietnam)
    Abstract: In this paper, I apply univariate and vector autoregressive (VAR) models to forecast inflation in Vietnam. To investigate the forecasting performance of the models, two naïve benchmark models (one is a variant of a random walk and the other is an autoregressive model) are first built based on Atkeson-Ohanian (2001), Gosselin-Tkacz (2001) and the specific properties of inflation in Vietnam. Then, I compute the pseudo out-of-sample root mean square error (RMSE) as a measure of forecast accuracy for the candidate models and benchmarks, using rolling window and expanding window forecasting evaluation strategies. The process is applied to both monthly and quarterly data from Vietnam for the period from 2000 through the first half of 2015. I also apply the forecast-encompassing Diebold-Mariano test to support choosing statistically better forecasting models from among the different candidates. I find that VAR_m2 is the best monthly model to forecast inflation in Vietnam, whereas AR(6) is the best of the quarterly forecasting models, although it provides a statistically insignificantly better forecast than the benchmark BM2_q.
    Keywords: Inflation, Forecast, Univariate Models, Vector Autoregressive Models, Forecast Accuracy
    JEL: C22 C32 C51 C53 E31 E37
    Date: 2017–02
  15. By: Gehrig, Thomas Paul; Iannino, Maria Chiara
    Abstract: This paper analyses the evolution of the resiliency of the European banking sector after the implementation of the Basel Capital Accord. In particular, by analysing SRISK and CoVaR we trace systemic risk and measures of systematic risk as the Basel process unfolds. We observe that, though systematic risk for European banks have been decreasing over the last three decades, systemic risk has heightened especially for the largest systemic banks. While the Basel process has succeeded in containing systemic risk of small banks, it has been less successful for the larger institutions. The latter ones opportunistically exploited the option of self-regulation by employing internal models and effectively increasing SRISK. Hence, the sub-prime crisis found the largest and more systemic banks ill-prepared and lacking resiliency. This condition was even aggravated during the European sovereign crisis.
    JEL: G21 G01 B26
    Date: 2016
  16. By: Schäfer, Alexander
    Abstract: We analyze the reaction of European bank CDS spreads in response to the SIFI-regulation. Our results suggest that new regulation prepared by the FSB did not succeed in lowering bail-out expectations for the targeted banks. The findings show an overall decrease in CDS spreads and hence indicating both: an unintended rise in bail-out expectations and distortionary funding cost advantages for banks equipped with a SIFI-badge. The strongest drop in CDS spreads occurred when the SIFI list was published for the first time, revealing that the effect is particularly pronounced upon the initial designation. We furthermore show that the inadvertent rise in bail-out expectations is driven by the countries bail-out capacity, measured as total country bank assets over GDP. As a result, the SIFI badge creates a particular large value for SIFIs hosted in countries with small banking sectors that are credibly expected to be bailed-out by the government.
    JEL: G01 G14 G21
    Date: 2016
  17. By: Wayne Passmore; Alexander H. von Hafften
    Abstract: The Basel Committee promulgates bank regulatory standards that many major economies enact to a significant extent. One element of the Basel III capital standards is a system of capital surcharges for global systemically important banks (G-SIBs). If the purpose of the surcharges is to ensure the survival of G-SIBs through serious crises (like the 2007-09 financial crisis) without extraordinary public assistance, our analysis suggests that current surcharges are too low because of three shortcomings: (1) the Basel system underestimates the probability that a G-SIB can fail, (2) the Basel system fails to account for short-term funding, and (3) the Basel system excludes too many banks from current surcharges. Our best estimate suggests that the current surcharges should be between 225 and 525 basis points higher for G-SIBs that are not reliant on short-term funding; G-SIBs that are reliant on short-term funding should have even higher surcharges. Furthermore, we find that, even with significant confidence in the effectiveness of other Basel III reforms, modest increases in surcharges appear needed.
    Keywords: Basel III ; G-SIBs ; G-SIFIs ; Bank capital ; Bank equity ; Bank regulation ; Banks
    JEL: G01 G18 G21
    Date: 2017–02–21
  18. By: Bluwstein, Kristina (European University Institute)
    Abstract: The 2008 financial crisis has shown that financial busts can influence the real economy. However, there is less evidence to suggest that the same holds for financial booms. Using a Markov-Switching vector autoregressive model and euro area data, I show that financial booms tend to be less procyclical than financial busts. To identify the sources of asymmetry, I estimate a non-linear DSGE model with a heterogeneous banking sector and an occasionally binding borrowing constraint. The model matches the key features of the data and shows that the borrowers’ balance sheet channel accounts for the asymmetry in the macro-financial linkages. The muted macro-financial transmission during financial booms can be exploited for macroprudential policies. By comparing capital buffer rules with monetary policy ‘leaningagainst- the-wind’ rules, I find that countercyclical capital buffers improve welfare.
    Keywords: Macro-financial linkages; non-linearities; Markov-Switching VAR; credit channel; occasionally binding constraints; DSGE; macroprudential policy; leaning-against-the-wind policy
    JEL: E44 E52 E58
    Date: 2017–02–01
  19. By: Lennard, Jason (Department of Economic History, Lund University)
    Abstract: This paper investigates the causal effect of monetary policy on economic activity in the United Kingdom between 1890 and 1913. Based on the Romer and Romer (2004) narrative identification approach, I find that following a one percentage point monetary tightening, unemployment rose by 0.8 percentage points, while inflation fell by 2.7 percentage points. In addition, monetary policy shocks accounted for more than a quarter of macroeconomic volatility.
    Keywords: business cycles; gold standard; monetary policy; narrative identification
    JEL: E31 E32 E52 E58 N13
    Date: 2017–02–28
  20. By: Anne-Marie Rieu-Foucault
    Abstract: In the context of the 2007–2009 financial crisis, central banks have innovated in the form of multiple unconventional measures implemented within the existing operational framework for monetary policy. These innovations raise two issues in 2016: the categorisation of these new measures and the consistency between measures taken by the Fed and those taken by the ECB. This paper shows the existence of two important stylised facts: a structural break in the allocation of liquidity conditions and an apparent convergence of measures that actually conceals the fundamental differences between the operational mode of the Fed and that of the ECB, within the history and institutions. These two observations then lead to question the type and shape of the ECB mandate in line with the orientations of the political economy of European countries.
    Keywords: Banques centrales – Mesures non conventionnelles.
    JEL: E52 E58
    Date: 2017
  21. By: Leonardo Gambacorta (Bank for International Settlements); Giacomo Ricotti (Bank of Italy); Suresh Sundaresan (Columbia University, Graduate School of Business); Zhenyu Wang (Indiana University, Kelley School of Business)
    Abstract: This paper examines the effects of taxation on the liability structure of banks. We derive testable predictions from a dynamic model of optimal bank liability structure that incorporates bank runs, regulatory closure and endogenous default. Using the supervisory data provided by the Bank of Italy, we empirically test these predictions by exploiting exogenous variations of the Italian tax rates on productive activities (IRAP) across regions and over time (especially since the global financial crisis). We show that banks endogenously respond to a reduction in tax rates by reducing non-deposit liabilities more than deposits in addition to lowering leverage. The response on the asset side depends on the financial strength of the bank: well-capitalized banks respond to a reduction in tax rates by increasing their assets, but poorly-capitalized banks respond by cleaning up their balance sheet.
    Keywords: bank liability structure, corporate tax, leverage
    JEL: G21 G32 G38 H25
    Date: 2017–02
  22. By: Otaviano Canuto; Matheus Cavallari
    Abstract: Central banks of large advanced and many emerging market economies have recently gone through a period of extraordinary expansion of balance sheets and are all now possibly facing a transition to less abnormal times. However, the fact that one group is comprised by global reserve issuers and the other by bystanders receiving impacts of the former’s policies carries substantively different implications. Furthermore, using Brazil and the U.S. as examples, we also illustrate how the relationships between central bank and public sector balance sheets have acquired higher levels of complexity, risks and opacity.
    Keywords: Central Banks, Brazil, United States, Balance Sheets, Finance, Debt, Inflation, Public Sector
    Date: 2017–02
  23. By: Gross, Marco; Semmler, Willi
    Abstract: We develop a theoretical model that features a business cycle-dependent relation between out- put, price inflation and inflation expectations, augmenting the model by Svensson (1997) with a nonlinear Phillips curve that reflects the rationale underlying the capacity constraint theory (Macklem (1997)). The theoretical model motivates our empirical assessment for the euro area, based on a regime-switching Phillips curve and a regime-switching monetary structural VAR, employing different filter-based, semi-structural model-based and Bayesian factor model-implied output gaps. The analysis confirms the presence of a pronounced convex relationship between inflation and the output gap, meaning that the coefficient in the Phillips curve on the output gap recurringly increases during times of expansion and abates during recessions. The regime switching VAR reveals the business cycle dependence of macroeconomic responses to monetary policy shocks: Expansionary monetary policy induces less pressure on inflation at times of weak as opposed to strong growth; thereby rationalizing relatively stronger expansionary policy, including unconventional volume-based policy such as the Expanded Asset Purchase Programme (EAPP) of the ECB, during times of deep recession. JEL Classification: E31, E42, E52, E58
    Keywords: euro area, inflation targeting, monetary policy, monetary VAR, nonlinearity, Phillips curve
    Date: 2017–01
  24. By: Michael D. Bordo
    Abstract: This chapter revisits the history of the origins, operation and demise of the Bretton Woods International Monetary System. The Bretton Woods system was created by the !944 Articles of Agreement to design a new international monetary order for the post war at a global conference organized by the US Treasury at the Mount Washington Hotel in Bretton Woods ,New Hampshire at the height of World War II. The Articles represented a compromise between the American plan of Harry Dexter White and the British plan of John Maynard Keynes. The compromise created an adjustable peg system based on the US dollar convertible into gold at $35 per ounce along with capital controls. It was designed to combine the advantages of fixed exchange rates of the pre World War I gold standard with some flexibility to handle large real shocks. The compromise gave members both exchange rate stability and the independence for their monetary authorities to maintain full employment. It took over a decade for the fully current account convertible system to get started. The system only lasted for 12 years from 1959 to 1971 but it did deliver remarkable economic performance. The BWS evolved into a gold dollar standard which depended on the US monetary authorities following sound low inflation policies. As the System evolved it faced the same severe fundamental problems as in the interwar gold exchange standard of: adjustment, confidence and liquidity. The adjustment problem meant that member countries with balance of payments deficits, in the face of nominal rigidities, ran the gauntlet between currency crises and recessions. Surplus countries had to sterilize dollar inflows to prevent inflation. The U.S. as center country faced the Triffin dilemma. With the growth of trade and income member countries held more and more dollars instead of scarce gold as reserves generated by a growing US balance of payments deficit. As outstanding dollar liabilities grew relative to the US monetary gold stock confidence in the dollar would wane raising the likelihood of a run on Fort Knox.This led to the possibility that the US would follow tight financial policies to reduce the deficit thereby starving the rest of the world of needed liquidity leading to global deflation and depression as occurred in the 1930s. Enormous efforts by the US, the G10 and international institutions were devoted to solving this problem. As it turned out, after 1965 the key problem facing the global economy was inflation, not deflation, reflecting expansionary Federal Reserve policies to finance the Vietnam war and the Great Inflation. US inflation was exported through the balance of payments to the surplus countries of Europe and Japan leading them in 1971 to begin converting their outstanding dollar holdings into gold. In reaction President Richard Nixon closed the US gold window ending the BWS.
    JEL: N10
    Date: 2017–02

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