nep-cba New Economics Papers
on Central Banking
Issue of 2020‒04‒06
twenty-two papers chosen by
Sergey E. Pekarski
Higher School of Economics

  1. The impact of unconventional monetary policies on retail lending and deposit rates in the euro area By Boris Hofmann; Anamaria Illes; Marco Jacopo Lombardi; Paul Mizen
  2. Central bank information shocks and exchange rates By Franz, Thorsten
  3. Inflation-Targeting and Inflation Volatility: International Evidence from the Cosine-Squared Cepstrum By Nikolaos Antonakakis; Christina Christou; Luis A. Gil-Alana; Rangan Gupta
  4. Central bank swaps then and now: swaps and dollar liquidity in the 1960s By Robert N McCauley; Catherine R Schenk
  5. Repo market and leverage ratio in the euro area By Luca Baldo; Filippo Pasqualone; Antonio Scalia
  6. The impact of SNB monetary policy on the Swiss franc and longer-term interest rates By Fabian Fink; Lukas Frei; Thomas Maag; Tanja Zehnder
  7. Optimal Monetary Policy in the Presence of Food Price Subsidies By William Ginn; Marc Pourroy
  8. How do countries choose their monetary policy frameworks? By Cobham, David; Song, Mengdi
  9. The effect of monetary policy on the Swiss franc: an SVAR approach By Christian Grisse
  10. Expansionary yet different: credit supply and real effects of negative interest rate policy By Margherita Bottero; Enrico Sette
  11. Inflation targeting in low-income countries: Does IT work? By Michael Bleaney; Atsuyoshi Morozumi; Zakari Mumuni
  12. Monetary Policy in Troubled Times: New Governor...New Agenda By Jagjit S Chadha; Richard Barwell; Michael Grady
  13. The Fed's Response to Economic News Explains the "Fed Information Effect" By Michael D. Bauer; Eric T. Swanson
  14. A Portfolio-Balance Model of Inflation and Yield Curve Determination By Antonio Diez de los Rios
  15. Implications of negative interest rates for the net interest margin and lending of euro area banks By Klein, Melanie
  16. Optimally Solving Banks' Legacy Problems By Anatoli Segura; Javier Suarez
  17. An analysis of sovereign credit risk premia in the euro area: are they explained by local or global factors? By Sara Cecchetti
  18. Shadow Digital Money By McAndrews, James; Menand, lev
  19. Central Bank Mandates, Sustainability Objectives and the Promotion of Green Finance By Simon Dikau; Ulrich Volz
  20. Policy Announcement Design By Anna Cieslak; Semyon Malamud; Andreas Schrimpf
  21. Reserve management and sustainability: the case for green bonds? By Ingo Fender; Mike McMorrow; Vahe Sahakyan; Omar Zulaica
  22. A Model for the Optimal Management of Inflation By Salvatore Federico; Giorgio Ferrari; Patrick Schuhmann

  1. By: Boris Hofmann; Anamaria Illes; Marco Jacopo Lombardi; Paul Mizen
    Abstract: This paper investigates the overall effect of the European Central Bank's (ECB's) unconventional monetary policies (UMPs) implemented since 2008 on euro area bank retail lending and deposit rates offered to households and non-financial corporations. To do so, we use an analytical approach that combines the estimation of the cumulative effects of UMP on key money and capital market rates via daily event study analysis with monthly retail rate pass-through estimation. In counterfactual simulations, we quantify the full effect of the ECB's UMPs implemented since 2008 on retail lending and deposit rates and systematically explore differences in their effects over time and across euro area countries. Our results show that the ECB's UMPs - particularly the measures launched since 2012 - significantly lowered retail lending and deposit rates in Germany, France, Spain and in particular in Italy. The impact on banks' intermediation margins through retail lending-deposit rate spreads turns out to be not clean-cut, with significant compressions prevailing only in Germany and Italy.
    Keywords: retail rates, pass-through, unconventional monetary policy, European Central Bank
    JEL: E43 E52 G21
    Date: 2020–03
  2. By: Franz, Thorsten
    Abstract: The dynamic effects of ECB announcements, disentangled into pure monetary policy and central bank information shocks, on the euro (EUR) exchange rate are examined using a Bayesian Proxy Vector Autoregressive (VAR) model fed with high-frequency data. Contractionary monetary policy shocks result in a sizable appreciation of the nominal effective and bilateral EUR exchange rates, peaking on impact. By contrast, despite similar effects on interest rate differentials, responses to central bank information shocks exhibit strong heterogeneities across currency pairs. This disparity can be rationalized by an increase in investors' risk appetite, as measured by the VIX, triggering capital flows into speculative currencies when the ECB reveals a surprisingly sanguine economic outlook. In line with this, the EUR depreciates against a high-yielding carry trade investment portfolio, while it appreciates against a low-yielding carry trade funding portfolio.
    Keywords: central bank information,monetary policy,exchange rate,Proxy VAR,high-frequency data,carry trades
    JEL: E52 E58 F31
    Date: 2020
  3. By: Nikolaos Antonakakis (Webster Vienna Private University, Department of Business and Management, Praterstraße 23, 1020, Vienna, Austria; University of Portsmouth, Economics and Finance Subject Group, Portsmouth Business School, Portland Street, Portsmouth, PO1 3DE, United Kingdom); Christina Christou (School of Economics and Management, Open University of Cyprus, 2252, Latsia, Cyprus); Luis A. Gil-Alana (University of Navarra, Faculty of Economics and ICS (NCID), Edificio Amigos, E-31080, Pamplona, Spain); Rangan Gupta (Department of Economics, University of Pretoria, Pretoria, 0002, South Africa)
    Abstract: Existing empirical evidence on the effect of inflation-targeting on inflation volatility is, at best, mixed. However, comparing inflation volatility across alternative monetary policy regimes, i.e., pre- and post-inflation-targeting, begs the question. The question is not whether the volatility of inflation has changed, but instead whether the volatility is different than it otherwise would have been. Given this, our paper uses the cosine-squared cepstrum to provide overwhelming international evidence that inflation targeting has indeed reduced inflation volatility in 22 out of the 24 countries considered in our sample of established inflation-targeters, than it would have been the case if the central banks in these countries did not decide to set a target for inflation.
    Keywords: Cosine-Squared Cepstrum, Inflation-Targeting, Inflation Volatility
    JEL: C22 C65 E42 E52 E64
    Date: 2020–03
  4. By: Robert N McCauley; Catherine R Schenk
    Abstract: This paper explores the record of central bank swaps to draw out four themes. First, this recent device of central bank cooperation had a sustained pre-history from 1962-1998, surviving the transition from fixed to floating exchange rates. Second, Federal Reserve swap facilities have generally formed a part of a wider network of central bank swap lines. Third, we take issue with the view of swaps as previously used only to manage exchange rates and only more recently to manage offshore funding liquidity and yields. In particular, we spotlight how in the 1960s the Federal Reserve, working in conjunction with the BIS and European central banks, repeatedly used swaps to manage eurodollar funding liquidity and Libor yields. BIS, Bank of England and Swiss National Bank archives show an intention to offset seasonal disturbances to funding liquidity in order to prevent eurodollar yield spikes. Fourth, this earlier cooperation underscores the Federal Reserve's use of swaps to prevent eurodollar shortages from interfering with the transmission of its domestic monetary policy. The US interest in the eurodollar market, and thus its self interest in central bank cooperation, is unlikely to end even when Libor is replaced as the benchmark for US floating-rate loans and mortgages.
    Keywords: central bank swaps, international lender of last resort, central bank cooperation, eurodollar market, financial crises, Federal Reserve, Bank for International Settlements
    JEL: E52 E58 F33 G15
    Date: 2020–04
  5. By: Luca Baldo (Bank of Italy); Filippo Pasqualone (Bank of Italy); Antonio Scalia (Bank of Italy)
    Abstract: This paper provides new evidence on the effect of the leverage ratio (LR) on repo market activity in the euro area. The share of trades with central counterparties has increased in recent years as a result of greater regulatory efficiency. After controlling for factors that may affect participation in the repo market, banks are found to exert market power towards non-bank financial institutions by applying lower rates and larger bid-ask spreads. While there is a permanent rate differential between transactions conducted via CCPs – which can easily be netted for LR purposes - and those with non-banks, on average this differential and the bid-ask spread do not increase at quarter-end. The widening of the bid-ask spread at year-end is sizeable, but this is not necessarily due to the LR, since other important factors enter into play. This evidence lessens the concern that the additional LR reporting and disclosure requirements based on daily averages, which will take effect on June 2021, might cause a contraction in repo volume and greater rate dispersion.
    Keywords: repo market, leverage ratio, monetary policy transmission
    JEL: E4 E5 G2
    Date: 2020–03
  6. By: Fabian Fink; Lukas Frei; Thomas Maag; Tanja Zehnder
    Abstract: We estimate the impact of monetary policy rate changes made by the Swiss National Bank on the Swiss franc and on the expected path of future short-term interest rates. We employ an identification-through-heteroskedasticity approach to identify the causal effects. The approach accounts for the simultaneous relation of exchange rates and interest rates. We find that from 2000-2011, an unexpected policy rate hike appreciated the nominal Swiss franc on the same day. The null hypothesis that a policy rate change does not affect the Swiss exchange rates is clearly rejected. Importantly, the results indicate that simple methods that do not adequately account for simultaneity yield biased and typically nonsignificant estimates. Our findings further suggest that policy rate changes affect medium- to longer-term expectations about the stance of monetary policy, which in turn influence the Swiss franc.
    Keywords: Monetary policy shocks, interest rates, exchange rates, identification-through-heteroskedasticity
    JEL: E43 E52 E58 F31 C32
    Date: 2020
  7. By: William Ginn (FAU - Friedrich-Alexander Universität Erlangen-Nürnberg); Marc Pourroy (CRIEF - Centre de Recherche sur l'Intégration Economique et Financière - Université de Poitiers)
    Abstract: Food price subsidies are a prevalent means by which fiscal authorities may counteract food price volatility in middle-income countries (MIC). We develop a DSGE model for a MIC that captures this key channel of a policy induced price smoothing mechanism that is different to, yet in parallel with, the classic Calvo price stickiness approach, which can have consequential effects for monetary policy. We then use the model to address how the joint fiscal and monetary policy responds to an increase in inflation driven by a food price shock can affect welfare. We show that, in the presence of credit constrained households and households with a significant share of food expenditures , a coordinated reaction of fiscal and monetary policies via subsidized price targeting can improve aggregate welfare. Subsidies smooth prices and consumption, especially for credit constrained households, which can consequently result in an interest rate reaction less intensely with subsidized price targeting compared with headline price targeting.
    Keywords: DSGE Model,Food subsidies,Monetary Policy,Fiscal Policy,Subsidies,Commodities,Middle income countries
    Date: 2019–09
  8. By: Cobham, David; Song, Mengdi
    Abstract: This paper investigates the determinants of countries' choices of monetary policy framework (MPF). It uses a brief narrative focused on groupings of countries making similar choices to motivate an econometric analysis which also draws on previous work on the determinants of exchange rate regimes. That analysis brings in other more standard factors, as well as the trade networks of potential anchor currency blocs and the financial markets depth that are emphasised in the narrative. The model turns out to be able to predict three quarters of countries' choices of MPF, and there is no obvious systematic pattern in the errors.
    Keywords: monetary policy frameworks, inflation targets, exchange rate targets, discretion, trade networks, financial market depth
    JEL: E42 E52 E61 F40
    Date: 2019–07
  9. By: Christian Grisse
    Abstract: This paper revisits the effects of monetary policy on the exchange rate, focusing on the Swiss franc. I estimate a structural VAR using Bayesian methods introduced by Baumeister and Hamilton (2015) and identify monetary policy shocks by exploiting the interest rate and stock price comovement they induce. Priors are based on the previous empirical literature, leaving the exchange rate response to monetary policy agnostically open. The results show that increases in Swiss short-term interest rates are associated with a nominal Swiss franc appreciation against the euro and the US dollar within the same week, with the Swiss franc remaining permanently stronger than prior to the interest rate shock.
    Keywords: Monetary policy shocks, exchange rates, stock-bond comovement, delayed overshooting, structural vector autoregression, informative priors, sign restrictions
    JEL: C32 E43 E58 F31
    Date: 2020
  10. By: Margherita Bottero (Bank of Italy); Enrico Sette (Bank of Italy)
    Abstract: We show that negative interest rate policy (NIRP) has expansionary effects on bank credit supply— and the real economy —through a portfolio rebalancing channel, and that, by shifting down and flattening the yield curve, NIRP differs from rate cuts just above the zero lower bound. For identification, we exploit ECB’s NIRP and matched administrative datasets— including the credit register— from Italy, severely hit by the Eurozone crisis. NIRP affects banks with higher ex-ante net short-term interbank positions or, more broadly, more liquid balance-sheets. NIRP-affected banks rebalance their portfolios from liquid assets to lending, especially to ex-ante riskier and smaller firms—without higher ex-post delinquencies—and cut loan rates (even to the same firm), inducing sizable firm-level real effects. By contrast, there is no evidence of a retail deposits channel associated with NIRP.
    Keywords: negative interest rates, portfolio rebalancing, bank lending channel of monetary policy, liquidity management, Eurozone crisis
    JEL: E52 E58 G01 G21 G28
    Date: 2020–03
  11. By: Michael Bleaney; Atsuyoshi Morozumi; Zakari Mumuni
    Abstract: Previous research on inflation targeting (IT) has focused on high-income countries (HICs) and emerging market economies (EMEs). Only recently has enough data accumulated for the performance of IT in low-income countries (LICs) to be assessed. We show that IT has not so far been as effective in reducing inflation in LICs as in EMEs. Relatively weak institutions, a typical feature of LICs, help explain this result. Our interpretation is that poor institutions, leaving fiscal policy unconstrained, impair central banks’ ability to conduct monetary policy in a way consistent with IT.
    Keywords: Inflation targeting, Low-income countries, Institutions
    Date: 2020
  12. By: Jagjit S Chadha; Richard Barwell; Michael Grady
    Abstract: The new Governor of the Bank of England, Andrew Bailey, faces a formidable challenge. From his very first day in office on 16 March 2020 he has been confronted with an imbalance between the demands on his institution to support the economy and the capacity of the Bank to meet that challenge. The economy is engulfed in a crisis almost without parallel in peace-time. We are on the cusp of what may prove to be the first of several severe contractions in output as the authorities are forced to shut-down society to limit the death toll from the Covid-19 strain of the coronavirus. The case for extensive monetary support is clear. Unfortunately, at face value the Bank looks ill-equipped to provide that support through conventional means. Unlike his predecessors, Mr. Bailey does not have the luxury of being able to cut interest rates by several hundred basis points. Indeed, it has been clear for many years now that the Bank's capacity to support the economy through conventional monetary stimulus is much diminished. And whatever remained of the conventional monetary ammunition has been largely exhausted over the past month, now that rates are seemingly at the floor and asset purchases have resumed. The cupboard may seem bare but there will be pressure to do more. The Bank cannot stand by while the virus and the measures required to control its spread take their toll. Governor Bailey's Bank will have to explore every nook and cranny of the monetary armoury to find new ways to nurse the economy through the crisis. And with the Chancellor pressing ahead with a courageous "whatever it costs" strategy there will be mounting pressure on the Bank to do "whatever it takes" to support that effort, which in practice means much closer monetary-fiscal coordination and indeed a period of potential fiscal domination of the monetary economy.
    Date: 2020–03
  13. By: Michael D. Bauer; Eric T. Swanson
    Abstract: High-frequency changes in interest rates around FOMC announcements are a standard method of measuring monetary policy shocks. However, some recent studies have documented puzzling effects of these shocks on private-sector forecasts of GDP, unemployment, or inflation that are opposite in sign to what standard macroeconomic models would predict. This evidence has been viewed as supportive of a “Fed information effect” channel of monetary policy, whereby an FOMC tightening (easing) communicates that the economy is stronger (weaker) than the public had expected. We show that these empirical results are also consistent with a “Fed response to news” channel, in which incoming, publicly available economic news causes both the Fed to change monetary policy and the private sector to revise its forecasts. We provide substantial new evidence that distinguishes between these two channels and strongly favors the latter; for example, (i) high-frequency stock market responses to Fed announcements, (ii) a new survey that we conduct of individual Blue Chip forecasters, and (iii) regressions that include the previously omitted public macroeconomic data releases all indicate that the Fed and Blue Chip forecasters are simply responding to the same public news, and that there is little if any role for a “Fed information effect".
    Keywords: Federal Reserve, forecasts, survey, Blue Chip, Delphic forward guidance
    JEL: E52 E58 E43
    Date: 2020
  14. By: Antonio Diez de los Rios
    Abstract: We propose a portfolio-balance model of the yield curve in which inflation is determined through an interest rate rule that satisfies the Taylor principle. Because arbitrageurs care about their real wealth, they only absorb an increase in the supply of nominal bonds if they are compensated with an increase in their real rates of return. At the same time, because the Taylor principle implies that short-term nominal rates are adjusted more than one for one in response to changes in inflation, the real return on nominal bonds depends positively on inflation. In equilibrium, inflation increases when there is an increase in the supply of nominal bonds to compensate arbitrageurs for the additional supply they have to hold.
    Keywords: Asset Pricing; Debt Management; Inflation and prices; Interest rates; Monetary Policy
    JEL: E52 G12 H63
    Date: 2020–03
  15. By: Klein, Melanie
    Abstract: This paper explores the impact of low (but) positive and negative market interest rates on euro area banks' net interest margin (NIM) and its components, retail lending and retail deposit rates. Using two proprietary bank-level data sets, I find a positive impact of the level of the short-term rate on the NIM, which increases substantially at negative market rates. As low profitability could hamper the ability of banks to expand lending, I also investigate the impact of the NIM on new lending to the non-financial private sector. In general, the NIM is positively related to lending: When lending is less profitable, banks cut lending. However, at negative rates this effect vanishes. This finding suggests that banks adjusted their business practices when servicing new loans, thereby contributing to higher new lending in the euro area since 2014.
    Keywords: net interest margin,monetary policy,negative interest rates,bank profitability,lending
    JEL: G21 E43 E52
    Date: 2020
  16. By: Anatoli Segura (Bank of Italy); Javier Suarez (CEMFI, Centro de Estudios Monetarios y Financieros)
    Abstract: We characterize policy interventions directed to minimize the cost to the deposit guarantee scheme and the taxpayers of banks with legacy problems. Non-performing loans (NPLs) with low and risky returns create a debt overhang that induces bank owners to forego profitable lending opportunities. NPL disposal requirements can restore the incentives to undertake new lending but, as they force bank owners to absorb losses, can also make them prefer the bank being resolved. For severe legacy problems, combining NPL disposal requirements with positive transfers is optimal and involves no conflict between minimizing the cost to the authority and maximizing overall surplus.
    Keywords: Non performing loans, deposit insurance, debt overhang, optimal intervention, state aid.
    JEL: G01 G20 G28
    Date: 2019–04
  17. By: Sara Cecchetti (Bank of Italy)
    Abstract: We study the determinants of sovereign credit risk in the euro area in a time period that includes the financial and sovereign debt crisis, as well as the unconventional monetary policy adopted by the European Central Bank. First, we detect the presence of commonality in sovereign credit spreads of different countries, justifying the search for the common factors that drive CDS prices. Building on the work of Longstaff et al. (2011), we employ the econometric model used in Cecchetti (2017) to decompose sovereign credit default swap spreads into expected default losses and risk premia, finding evidence of a significant contribution of the latter component. We use the model to understand to what extent the variations in CDS spreads and in the two embedded components of selected euro-area countries are more linked to local or euro area economic variables. The results point to the importance of both global and local factors, which have a greater impact on the risk premium component. Finally, we estimate the contribution of the objective probability and risk premium components of redenomination risk (as measured by the ISDA basis) to the related CDS spread components, detecting some differences between countries.
    Keywords: bond excess return, credit default swap, distress risk premium, credit losses
    JEL: B26 C02 F30 G12 G15
    Date: 2020–03
  18. By: McAndrews, James; Menand, lev
    Abstract: Promises by media platforms to provide digital transaction services will likely lead to a flood of new money. While these developments are potentially valuable, under current law the money created is unsound. It is not insured by the government, nor is it backed by safe assets. We should not yoke good technology to unsound money. Federal regulation is needed to guarantee safety and soundness, to restore monetary control to the Federal Reserve, and to prevent a race to the bottom between competing state regulatory regimes. With modest changes to the U.S. Code, innovation in payments will be just that—innovation in payments—and not also unsupervised and unsound money issuance.
    Keywords: payments, digital money, regulation, fintech
    JEL: G1 L0
    Date: 2020–03
  19. By: Simon Dikau (Gratham Research Institute, London School of Economics and Political Science & Department of Economics, SOAS University of London); Ulrich Volz (Department of Economics & SOAS Centre for Sustainable Finance, SOAS University of London)
    Abstract: This paper examines the extent to which addressing climate-related risks and supporting sustainable finance fit into the current set of central bank mandates and objectives. To this end, we conduct a detailed analysis of central bank mandates and objectives, using the IMF’s Central Bank Legislation Database, and compare these to current arrangements and sustainability-related policies central banks have adopted in practice. To scrutinise the alignment of mandates with climate-related policies, we differentiate between the impact of environmental factors on the conventional core objectives of central banking and a potential supportive role of central banks with regard to green finance and sustainability. Of the 135 central banks in our sample, only 12% have explicit sustainability mandates, while another 40% are mandated to support the government’s policy priorities, which in most cases include sustainability goals. However, given that climate risks can directly affectcentral banks’traditional core responsibilities, most notably monetary and financial stability, even central banks without explicit or implicit sustainability objectives ought to incorporate climate-related physical and transition risks into their core policy implementation frameworks in order to efficiently and successfully safeguard macro-financial stability.
    Keywords: Central banks, central bank mandates, green finance
    JEL: Q5 E5
    Date: 2020–03
  20. By: Anna Cieslak (Duke University - Fuqua School of Business); Semyon Malamud (Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute); Andreas Schrimpf (Bank for International Settlements (BIS) - Monetary and Economic Department)
    Abstract: We study the general problem of information design for a policymaker - a central bank - that communicates its private information (the "state") to the public. We show that it is optimal for the policymaker to partition the state space into a finite number of "clusters” and to communicate to the public to which cluster the state belongs. Optimal communication is more precise when the policymaker's beliefs conform with prior public expectations, but is more vague in case of divergence. We characterize the policymaker's trade-offs via a novel object - the information relevance matrix - and label its eigenvectors as principal information components (PICs). PICs with the highest eigenvalues determine the dimensions of information with the highest welfare sensitivity and, hence, are the ones that the policymaker should be most precise about.
    Keywords: Central Bank Announcements, Learning, Bayesian Persuasion, Information Design
    JEL: D82 D83 E52 E58
    Date: 2020–01
  21. By: Ingo Fender; Mike McMorrow; Vahe Sahakyan; Omar Zulaica
    Abstract: Central banks' frameworks for managing foreign reserves have traditionally balanced a triad of objectives: liquidity, safety and return. Pursuing these objectives involves explicit trade-offs. More of an emphasis on returns, for instance, may require central banks to sacrifice some of the safety and liquidity of their overall holdings. Most recently, central banks have shown significant interest in incorporating environmental sustainability considerations into their policy frameworks, including their reserve management. This paper first explores whether sustainability considerations would support a tetrad of reserve management objectives, by drawing on the results of a recent BIS Survey on Reserve Management and Sustainability. It then illustrates how central banks might analyse (and weigh) all four objectives in allocating part of their foreign exchange reserves to green bonds using currently available market data.
    Keywords: central banks, green bonds, reserve management, sustainability
    JEL: E58 F31 G11 G17
    Date: 2020–03
  22. By: Salvatore Federico; Giorgio Ferrari; Patrick Schuhmann
    Abstract: Consider a central bank that can adjust the inflation rate by increasing and decreasing the level of the key interest rate. Each intervention gives rise to proportional costs, and the central bank faces also a running penalty, e.g., due to misaligned levels of inflation and interest rate. We model the resulting minimization problem as a Markovian degenerate two-dimensional bounded-variation stochastic control problem. Its characteristic is that the mean-reversion level of the diffusive inflation rate is an affine function of the purely controlled interest rate's current value. By relying on a combination of techniques from viscosity theory and free-boundary analysis, we provide the structure of the value function and we show that it satisfies a second-order smooth-fit principle. Such a regularity is then exploited in order to determine a system of functional equations solved by the two monotone curves that split the control problem's state space in three connected regions.
    Keywords: singular stochastic control; Dynkin game; viscosity solution; free boundary; smooth-fit; inflation rate; interest rate; central bank policies
    JEL: C61 C73 E58
    Date: 2019–10

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