nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒02‒10
28 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Demand for Endogenous Money: A Lesson in Institutional Change By Peter Howells
  2. The daily and policy-relevant liquidity effects By Daniel L. Thornton
  3. Does Inflation Targeting Make a Difference? By Frederic S. Mishkin; Klaus Schmidt-Hebbel
  4. The Taylor rule: can it be supported by the data? By Leon, Costas
  5. A Reassessment of the Problems with Interest Targeting: What Have We Learned from Japanese Monetary Policy? By Tom Cargill; Federico Guerrero
  6. Optimal fiscal and monetary policy when money is essential By S. Boragan Aruoba; Sanjay K. Chugh
  7. Central bank independence and inflation: a note By Charles T. Carlstrom; Timothy S. Fuerst
  8. Interest Rates: The Behavior, the Term Structure, and the Risk Structure By Govori, Fadil
  9. Long-Term Inflation Outcomes after Hyperinflation: Theory and Evidence By Federico Guerrero
  10. Endogenous Money, Non-neutrality and Interest-sensitivity in the Theory of Long Period Unemployment By Peter Docherty
  11. Central Bank Interventions, Communication and Interest Rate Policy in Emerging European Economies By Balázs Égert
  12. Industries and the bank lending effects of bank credit demand and monetary policy in Germany By Arnold, Ivo J.M.; Kool, Clemens J.M.; Raabe, Katharina
  13. Progress toward a Common Currency Basket System in East Asia By OGAWA Eiji; SHIMIZU Junko
  14. Rules, Discretion or Reputation? Monetary Policies and the Efficiency of Financial Markets in Germany, 14th to 16th Centuries By Oliver Volckart
  15. A new core inflation indicator for New Zealand. By Domenico Giannone; Troy Matheson
  16. Milton Friedman and U.S. monetary history: 1961-2006 By Edward Nelson
  17. Dollarization and financial integration By Cristina Arellano; Jonathan Heathcote
  18. Inflation and interest rates with endogenous market segmentation By Aubhik Khan; Julia Thomas
  19. Money matters for inflation in the euro area By Ansgar Belke; Thorsten Polleit; Wim Kösters; Martin Leschke
  20. Dynamics and monetary policy in a fair wage model of the business cylce By David, DE LA CROIX; Gregory, DE WALQUE; Rafael, WOUTERS
  21. The Store-of-Value-Function of Money as a Component of Household Risk Management By Ingrid Größl; Ulrich Fritsche
  22. Is Forward-Looking Inflation Targeting Destabilizing? The Role of Policy's Response to Current Output under Endogenous Investment By Kevin X.D. Huang; Qinglai Meng
  23. Inflation Persistence and the Phillips Curve Revisited By Marika Karanassou; Dennis J. Snower
  24. National bank notes and silver certificates By Bruce Champ; James B. Thomson
  25. A Yield Curve Perspective on Uncovered Interest Parity By Leo Krippner
  26. A ‘Second-Best’ Rationale to Deflationary Monetary Policy in Japan By Tom Cargill; Federico Guerrero
  27. The Balance Sheet Channel of Monetary Policy Transmission: Evidence from the UK By Eleni Angelopoulou; Heather D. Gibson
  28. Currency crises and foreign credit in emerging markets: credit crunch or demand effect? By Galina Hale; Carlos Arteta

  1. By: Peter Howells (School of Economics, University of the West of England)
    Keywords: Monetary Policy;
    JEL: E58
    Date: 2007–01
  2. By: Daniel L. Thornton
    Abstract: In an environment of low inflation, the Federal Reserve faces the risk that it has not provided enough monetary stimulus even when it has pushed the short-term nominal interest rate to its lower bound of zero. Assuming the nominal Treasury-bill rate has been lowered to zero, this paper considers whether further open market purchases of Treasury bills could spur aggregate demand through increases in the monetary base that may stimulate aggregate demand by increasing liquidity for financial intermediaries and households; by affecting expectations of the future paths of short-term interest rates, inflation, and asset prices; or by stimulating bank lending through the credit channel. This paper also examines the alternative policy tools that are available to the Federal Reserve in theory, and notes the practical limitations imposed by the Federal Reserve Act, The tools the Federal Reserve has at its disposal include open market purchases of Treasury bonds and private-sector credit instruments (at least those that may be purchased by the Federal Reserve); unsterilized and sterilized intervention in foreign exchange; lending through the discount window; and, perhaps in some circumstances, the use of options.
    Keywords: Liquidity (Economics) ; Monetary policy
    Date: 2007
  3. By: Frederic S. Mishkin; Klaus Schmidt-Hebbel
    Abstract: Yes, as inferred from panel evidence for inflation-targeting countries and a control group of high-achieving industrial countries that do not target inflation. Our evidence suggests that inflation targeting helps countries achieve lower inflation in the long run, have smaller inflation response to oil-price and exchange-rate shocks, strengthen monetary policy independence, improve monetary policy efficiency, and obtain inflation outcomes closer to target levels. Some benefits of inflation targeting are larger when inflation targeters have achieved disinflation and are able to make their inflation targets stationary. Despite these favorable results for inflation targeting, our evidence generally does not suggest that countries that adopt inflation targeting have attained better monetary policy performance relative to our control group of highly successful non-inflation targeters. However, inflation targeting does seem to help all country groups to move toward performance of the control group. The performance attained by industrial-country inflation targeters generally dominates performance of emerging-economy inflation targeters and is similar to that of industrial non-inflation targeting countries.
    JEL: E31 E52 E58
    Date: 2007–01
  4. By: Leon, Costas
    Abstract: The Taylor equation is a simple monetary policy rule that determines the Central Bank’s policy rate as a function of inflation and output. A significant body of literature verifies the consistency of the Taylor rule with the data. However, recently there has been a growing literature regarding the validity of the estimated parameters due to the non-stationarity of the interest rate. In this paper I test the consistency of the Taylor rule with the Greek data for the period 1996-2004. It appears that the data do not support the Taylor rule in the sense that they do not form a cointegration set of variables. Therefore, the estimated parameters should be considered fragile and the forecasting for the interest rate as a function of inflation and output should not be expected to be adequately consistent with the actual data.
    Keywords: Taylor rule; Monetary policy; Central bank; EMU; Greece.
    JEL: F41 E58
    Date: 2006–08–31
  5. By: Tom Cargill (Department of Economics, University of Nevada, Reno); Federico Guerrero (Department of Economics, University of Nevada, Reno)
    Abstract: Interest rate targeting is widely used by central banks to pursue price stability; however, the variation in inflation policy outcomes between central banks such as the Federal Reserve and the Bank of Japan despite a common policy instrument framework suggests interest- targeting has limitations. Despite the variation in policy outcomes, the role of targeting was enhanced with the advent of Taylor rules in the 1990s and interest rate targeting dominates central bank attitudes to the exclusion of any other policy instrument framework. The recent Japanese experience confronts us with the need to reassess the relative merits of interest targeting. This paper frames the discussion of the various problems of the interest-targeting framework within a model that encompasses a number of important previous results and stresses that interest rate targeting may leave the price level indeterminate in various plausible circumstances. In a low, or even zero interest rate environment, such as the one that characterized Japan, Taylor-type rules may offer no solution to the indeterminacy problem. The paper then discusses various aspects of the BoJ’s decision to adhere to interest rate targeting despite its limitations.
    Keywords: Interest-targeting, Monetary Policy, Deflation, Japan
    JEL: E52 E58 E31
    Date: 2006–12
  6. By: S. Boragan Aruoba; Sanjay K. Chugh
    Abstract: We study optimal fiscal and monetary policy in an environment where explicit frictions give rise to valued money, making money essential in the sense that it expands the set of feasible trades. Our main results are in stark contrast to the prescriptions of earlier flexible-price Ramsey models. Two especially important findings emerge from our work: the Friedman Rule is typically not optimal and inflation is stable over time. Inflation is not a substitute instrument for a missing tax, as is sometimes the case in standard Ramsey models. Rather, the inflation tax is exactly the right tax to use because the use of money has a rent associated with it. Regarding the optimal dynamic policy, realized (ex-post) inflation is quite stable over time, in contrast to the very volatile ex-post inflation rates that arise in standard flexible-price Ramsey models. We also find that because capital is underaccumulated, optimal policy includes a subsidy on capital income. Taken together, these findings turn conventional wisdom from traditional Ramsey monetary models on its head.
    Date: 2006
  7. By: Charles T. Carlstrom; Timothy S. Fuerst
    Abstract: We document increased central bank independence within the set of industrialized nations. This increased independence can account for nearly two thirds of the improved inflation performance of these nations over the last two decades.
    Keywords: Banks and banking, Central ; Inflation (Finance)
    Date: 2006
  8. By: Govori, Fadil
    Abstract: From the financial markets point of view the interest rate can be considered as the price of money. This makes the interest rate a very important instrument for efficient financial markets performance and a vital tool of the government's economic management. The control of interest rates is passed over to the Central Bank. There are many different interest rates. Interest rates will vary according to the amount of time money is tied up for and the riskiness of the investment. The actual interest rate will depend on a number of factors. These include: The length of time for which the money is borrowed (or saved); the security of the loan (or investment); the nature of the financial institution the money is borrowed from (or lent to); the amount of competition between financial institutions Monetary policy and the alteration of interest rates are important tool in the government's economic management. When the Central Bank feels that inflationary pressures are rising in the economy then it increases the rate of interest to dampen down the growth of aggregate demand. Demand falls when interest rates are raised through their effect on the components of aggregate demand. Consumption will fall when interest rates are raised. The rise in interest rates will therefore reduce the level of investment. The amount investment falls by depends on the interest elasticity of demand for investment. Changes in interest rates affects on different aspects of the economy (growth, prices, employment, spending, etc.). That is the interest rate transmission mechanism: One of the peculiarities of the money market is its way of quoting interest rates. Some money market instruments (Treasury bills, commercial paper, and bankers’ acceptances) are quoted on a discount basis. Other rates (fed funds, Federal Reserve discount rate, and repo rates) are quoted on an add-on basis. Each of these rates is different from the yield to maturity, the rate generally used for comparing coupon-bearing bonds. There are at least five different money market rates: The discount rate, the add-on rate, the bond equivalent yield, and the semiannual and annual yields to maturity. Both nominal and real interest rates differ by maturity, or term. A schedule of spot interest rates by maturity is called the term structure of interest rates. The term structure can be rising, flat, declining, or humped. Bonds and other debt instruments have varying degrees of default risk, and the yields on these instruments reflect the market’s assessment of this default risk. The relationship among these interest rates is called the risk structure of interest rates.
    Keywords: Interest Rates; Behavior of Interest Rate; Term Structure; Risk Structure
    JEL: E51 G13 E52 E44 E58 E43 E41 G12
    Date: 2007–01
  9. By: Federico Guerrero (Department of Economics, University of Nevada, Reno)
    Abstract: This paper does two things. First, it shows both anecdotal and cross-country evidence that indicates that countries that have experienced hyperinflation display significantly lower long-term rates of inflation than countries that lack the same experience. Secondly, it presents a model to rationalize the main empirical finding. There is more than one mechanism through which the long-term effects of hyperinflation may have an impact on long-term inflation outcomes. The suggested explanation this paper offers is that hyperinflations act by reducing the social costs of increasing the collection of conventional, distorsionary taxes relative to the collection of the inflation tax.
    Keywords: Hyperinflations, monetary institutions, inflation, central banks
    JEL: E31 E42 E58 E65
    Date: 2006–12
  10. By: Peter Docherty (School of Finance and Economics, University of Technology, Sydney)
    Abstract: This paper investigates the role played by endogenous money in models with interest-sensitive expenditures. In particular, it examines the impact of endogenous money on a baseline neoclassical model arguing against the frequently asserted claim that traditional neoclassical macroeconomics is compatible with endogenous money. It demonstrates firstly that endogenous money is a sufficient condition to render unstable a neoclassical model characterised by interest-sensitive expenditures, full employment and money neutrality. Secondly, it shows that the introduction of either money illusion on the part of workers or a Taylor rule governing monetary policy are alternative methods of stabilising models with interest-sensitive expenditures and endogenous money, though with different implications for the full employment and neutrality characteristics of the standard model. Thirdly, it raises questions about whether models which incorporate Taylor rules can be properly characterised as containing endogenous money and it provides an alternative interpretation of such models. The paper concludes by arguing that money supply endogeneity of the extreme or accommodationist type is of fundamental significance for the construction of a theory of long period unemployment but it identifies a set of remaining questions which need to be addressed in the advancement of this project.
    Keywords: endogenous money; money neutrality; unemployment; interest-sensitivity
    JEL: E40 E52 E58
    Date: 2006–05–01
  11. By: Balázs Égert (Oesterreichische Nationalbank; MODEM, University of Paris X-Nanterre and William Davidson Institute)
    Abstract: This paper analyses the effectiveness of foreign exchange interventions in Croatia, the Czech Republic, Hungary, Romania, Slovakia and Turkey using the event study approach. Interventions are found to be effective only in the short run when they ease appreciation pressures. Central bank communication and interest rate steps considerably enhance their effectiveness. The observed effect of interventions on the exchange rate corresponds to the declared objectives of the central banks of Croatia, the Czech Republic, Hungary and perhaps also Romania, whereas this is only partially true for Slovakia and Turkey. Finally, interventions are mostly sterilized in all countries except Croatia. Interventions are not much more effective in Croatia than in the other countries studied. This suggests that unsterilized interventions do not automatically inuence the exchange rate.
    Keywords: central bank intervention, communication, foreign exchange intervention, verbal intervention
    JEL: F31
    Date: 2006–12–22
  12. By: Arnold, Ivo J.M.; Kool, Clemens J.M.; Raabe, Katharina
    Abstract: This paper presents evidence on the industry effects of bank lending in Germany and identifies the industry effects of bank lending associated with changes in monetary policy and industryspecific bank credit demand. To this end, we estimate individual bank lending functions for 13 manufacturing and non-manufacturing industries and five banking groups using quarterly bank balance sheet and bank lending data for the period 1992:1-2002:4. The evidence from dynamic panel data models shows that industry-specific bank lending growth predominantly responds to changes in industry-specific bank credit demand rather than to changes in monetary policy. In fact, conclusions regarding the bank lending effects of monetary policy are very sensitive to the choice of industry. The empirical results lend strong support to the existence of industry effects of bank lending. Because industries are a prominent source of variation in the bank lending effects of bank credit demand and monetary policy, the paper concludes that the industry composition of bank credit portfolios is an important determinant of bank lending growth and monetary policy effectiveness.
    Keywords: Monetary policy transmission, credit channel, industry structure, dynamic panel data
    JEL: C23 E52 G21 L16
    Date: 2006
  13. By: OGAWA Eiji; SHIMIZU Junko
    Abstract: Ogawa and Shimizu (2005, 2006a) have proposed a possible way to create an Asian Monetary Unit (AMU) as a weighted average of the thirteen East Asian currencies (ASEAN + China, Japan, and Korea) and developed AMU Deviation Indicators for a surveillance process under the Chiang Mai Initiative. Both the AMU and the AMU Deviation Indicators are important in helping the countries in the region to recognize the necessity of moving toward a common currency basket system. However, there remains an open question about how to implement this system in East Asian countries. The purpose of this paper is to compile the latest issues of currency basket itself and to develop concrete steps toward a common currency basket system in East Asia. Particularly, we simulate possible individual currency basket weights based on trade shares of each East Asian country and convert them to G3 currency (the US dollar, the euro, and the Japanese yen) basket weights. We also investigate the discrepancies between the converted G3 currency basket weight of the AMU and the weights of the common G3 currency basket, which is to illustrate the reality of implementing a common currency basket system. We propose a possible way to shift from an individual G3 currency basket system to the AMU currency basket system. In this process, we expect that the Japanese yen would play a varying role at each stage toward monetary coordination in East Asia.
    Date: 2007–01
  14. By: Oliver Volckart
    Abstract: This paper examines the questions of whether and how feudal rulers were able to credibly commit to preserving monetary stability, and of which consequences their decisions had for the efficiency of financial markets. The study reveals that princes were usually only able to commit to issuing a stable coinage in gold, but not in silver. As for silver currencies, the hypothesis is that transferring the right of coinage to an autonomous city was the functional equivalent to establishing an independent central bank. An analysis of market performance indicates that financial markets between cities that were autonomous with regard to their monetary policies were significantly better integrated and more efficient than markets between cities whose currencies were supplied by a feudal ruler.
    Keywords: Financial markets, integration, monetary policy, Middle Ages
    JEL: G15 N13 N23 N43
    Date: 2007–02
  15. By: Domenico Giannone; Troy Matheson (Reserve Bank of New Zealand)
    Abstract: This paper introduces a new indicator of core inflation for New Zealand, estimated using a dynamic factor model and disaggregate price data. Using disaggregate price data we can directly compare the predictive performance of our core indicator with a wide range of other ‘core inflation’ measures estimated from disaggregate prices, such as the weighted median and the trimmed mean. Predictive performance is assessed relative to a centred 2 year moving average of past and future annual inflation outcomes. The 2 year centred moving average is used as an analytical approximation of the inflation target from the PTA, which requires the Reserve Bank to keep annual inflation between 1 and 3 per cent on average over the medium term. We find that our indicator produces relatively good estimates of this characterisation of core inflation when compared with estimates derived from a range of other models.
    JEL: C32 E31 E32 E52
    Date: 2006–10
  16. By: Edward Nelson
    Abstract: This paper brings together, using extensive archival material from several countries, scattered information about Milton Friedman's views and predictions regarding U.S. monetary policy developments after 1960 (i.e., the period beyond that covered by his and Anna Schwartz's Monetary History of the United States). I evaluate these interpretations and predictions in light of subsequent events.
    Keywords: Friedman, Milton ; Economic history
    Date: 2007
  17. By: Cristina Arellano; Jonathan Heathcote
    Abstract: How does a country’s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. ; We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen incentives to maintain access to debt markets. Given stronger repayment incentives, more borrowing can be supported, and thus dollarization can increase international financial integration. This prediction of theory is consistent with the experiences of El Salvador and Ecuador, which recently dollarized, as well as with that of highly-indebted countries like Italy which adopted the Euro as part of Economic and Monetary Union: in each case, around the time of regime change, spreads on foreign currency government debt declined substantially.
    Date: 2007
  18. By: Aubhik Khan; Julia Thomas
    Abstract: The authors examine a monetary economy where households incur fixed transactions costs when exchanging bonds and money and, as a result, carry money balances in excess of current spending to limit the frequency of such trades. As only a fraction of households choose to actively trade bonds and money at any given time, the market is endogenously segmented. Moreover, because households in this model economy have the ability to alter the timing of their trading activities, the extent of market segmentation varies over time in response to real and nominal shocks. The authors find that this added flexibility can substantially reinforce both sluggishness in aggregate price adjustment and the persistence of liquidity effects in real and nominal interest rates relative to that seen in models with exogenously segmented markets.
    Date: 2007
  19. By: Ansgar Belke; Thorsten Polleit; Wim Kösters; Martin Leschke
    JEL: E31 E58 E51 E52 E37
    Date: 2006
  20. By: David, DE LA CROIX (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics); Gregory, DE WALQUE; Rafael, WOUTERS
    Abstract: We first build a fair wage model in which effort varies over the business cycle. This mechanism decreases the need for other sources of sluggishness to explain the observed high inflation persistence. Second, we confront empirically our fair wage model with a New Keynesian model based on the standard assumption of monopolistic competition in the labor market. We show that, in terms of overall fit, the fair wage model outperforms the New Keynesian one. The extension of the fair wage model with lagged wage is judged insignificant by the data, but the extension based on a rent sharing argument including firmÕs productivity gains in the fair wage is not. Looking at the implications for monetary policy, we conclude that the additional trade-off problem created by the inefficient real wage behavior significantly affect nominal interest rates and inflation outcomes
    Keywords: Efficiency wage, effort, inflation persistence, monetary policy
    JEL: E4 E5
    Date: 2006–11–13
  21. By: Ingrid Größl; Ulrich Fritsche
    Abstract: We analyse how money as a store of value affects the decisions of a representative household under diversifiable and non-diversifiable risks given that the central bank successfully stabilizes the rate of inflation at a low level. Assuming exponential utility allows us to derive an explicit relationship between optimal money holdings, the household's desire to tilt, smooth and stabilize consumption as well as minimize portfolio risk. In this context we also show how the correlation between stochastic labour income and stock returns impact the store-of-value function of money. Finally we prove that the store-of-value benefits of money holdings continue to hold even if we take riskless alternatives into account.
    Keywords: Money demand, consumption, CRRA, CARA, exponential utility, households, risk, risk management
    JEL: D11 E21 E41
    Date: 2007
  22. By: Kevin X.D. Huang (Department of Economics, Vanderbilt University); Qinglai Meng (Department of Economics, Chinese University of Hong Kong)
    Abstract: In sticky price models with endogenous investment, virtually all monetary policy rules that set a nominal interest rate in response solely to future inflation induce real indeterminacy of equilibrium. Applying the Samuelson-Farebrother conditions, we obtain a necessary and sufficient condition for local real determinacy, which reveals that increasing price stickiness or letting policy respond also to current output may help ensure a unique equilibrium. We find that the first channel by itself has a quantitatively negligible effect and almost all strict inflation-targeting rules lead to indeterminacy, whether with higher price stickiness or overall stickiness by incorporating firm-specific capital, sticky wages, or both. The effect of the second avenue depends on labor supply elasticity and stickiness. With high labor supply elasticity and price stickiness, indeterminacy is much less likely to occur as policy also responds to output. With estimated labor supply elasticity or empirically reasonable price stickiness, policy's response to output helps little in ensuring determinacy; even incorporating firm-specific capital makes only a marginal improvement. Incorporating sticky wages, on the other hand, greatly enhances the role of policy's response to output in ensuring determinacy. With both sticky wages and firm-specific capital incorporated, even a tiny response of policy to current output can render equilibrium determinate for a wide range of response of policy to future inflation.
    Keywords: Forward-looking inflation targeting, current output, sticky prices, sticky wages, firm-specific capital, endogenous investment, indeterminacy, Samuelson-Farebrother conditions
    JEL: E12 E31 E52
    Date: 2007–02
  23. By: Marika Karanassou (Queen Mary, University of London and IZA); Dennis J. Snower (Institute for World Economics, CEPR and IZA)
    Abstract: A major criticism against staggered nominal contracts is that they give rise to the so called "persistency puzzle" - although they generate price inertia, they cannot account for the stylised fact of inflation persistence. It is thus commonly asserted that, in the context of the new Phillips curve (NPC), inflation is a jump variable. We argue that this "persistency puzzle" is highly misleading, relying on the exogeneity of the forcing variable (e.g. output gap, marginal costs, unemployment rate) and the assumption of a zero discount rate. We show that when the discount rate is positive in a general equilibrium setting (in which real variables not only affect inflation, but are also influenced by it), standard wage-price staggering models can generate both substantial inflation persistence and a nonzero inflation-unemployment tradeoff in the long-run. This is due to frictional growth, a phenomenon that captures the interplay of nominal staggering and permanent monetary changes. We also show that the cumulative amount of inflation undershooting is associated with a downward-sloping NPC in the long-run.
    Keywords: Inflation dynamics, Persistence, Wage-price staggering, New Phillips curve, Monetary policy, Frictional growth
    JEL: E31 E32 E42 E63
    Date: 2007–02
  24. By: Bruce Champ; James B. Thomson
    Abstract: From 1883 to 1892, the circulation of national bank notes in the United States fell nearly 50 percent. Previous studies have attributed this to supply-side factors that led to a decline in the profitability of note issue during this period. This paper provides an alternative explanation. The decline in note issue was, in large part, demand-driven. The presence of a competing currency with superior features caused the public to substitute away from national bank notes.
    Keywords: Paper money ; National bank notes ; Silver
    Date: 2006
  25. By: Leo Krippner (AMP Capital Investors and University of Waikato)
    Abstract: This article uses a dynamic multi-factor model of the yield curve with a rational-expectations, general-equilibrium-economy foundation to investigate the uncovered interest parity hypothesis(UIPH). The yield curve model is used to decompose the interest rate data used in the UIPH regressions into components that reflect rationally-based expectations of the cyclical and fundamental components of the underlying economy. The UIPH is not rejected based on the fundamental components of interest rates, but is soundly rejected based on the cyclical components. These results provide empirical support for suggestions in the existing theoretical literature that rationally-based interest rate and exchange rate dynamics associated with cyclical inter-linkages between the economy and financial markets may contribute materially to the UIPH puzzle.
    Keywords: uncovered interest parity; forward rate unbiasedness hypothesis; yield curve; term structure of interest rates; ANS model; Nelson and Siegel model
    JEL: E43 F31
    Date: 2006–12–21
  26. By: Tom Cargill (Department of Economics, University of Nevada, Reno); Federico Guerrero (Department of Economics, University of Nevada, Reno)
    Abstract: The Bank of Japan permitted a ten-year period of deflation (1995-2005) which appears to have ended in 2006. The deflation, as well as the preceding disinflation, adversely affected the financial and real sectors of the economy that in turn, made it difficult to recover from the collapse of asset prices in 1990 and 1991. Various ad hoc explanations have been offered to account for the deflation period. This paper offers a second-best explanation based on a two-player policy game between the Bank of Japan and the banking system in which the banking system relies on an accommodative policy of forgiveness and forbearance by the Ministry of Finance to deal with weak balance sheets. The paper does not explicitly model the Ministry of Finance preference function but incorporates the Bank of Japan’s perceived willingness of the Ministry to accommodate the banking system in the Bank’s reaction function. The model suggests that in the context of established deflationary expectations and large amounts of debt, the Bank of Japan explicitly regarded the level of debt as exceeding the socially optimal level, that Ministry of Finance forgiveness and forbearance contributed to this excess, and lacking an instrument to reverse deflationary expectations, the Bank of Japan employed deflation as a disciplining instrument to limit real debt.
    Keywords: Monetary Policy, Deflation, Japan
    JEL: E31 E58 E42 E50
    Date: 2006–12
  27. By: Eleni Angelopoulou (Bank of Greece and Athens University of Economics and Business); Heather D. Gibson (Bank of Greece)
    Abstract: This paper examines the sensitivity of investment to cash flow using a panel of UK firms in manufacturing with a view to shedding some light on the existence of a balance sheet channel or financial accelerator. In addition to examining the impact of cash flow in different subsamples based on company size or financial policy (dividend payouts, share issues and debt accumulation), we also investigate the extent to which investment becomes more sensitive to cash flow in periods of monetary tightness. To this end, we employ a monetary tightness indicator constructed for the UK using the narrative approach pioneered by Romer and Romer. The results provide some support for the view that UK firms show greater investment sensitivity to cash flow during periods of tight monetary policy.
    Keywords: Financial Constraints; Balance Sheet Channel, Investment.
    JEL: E22 E52 E44
    Date: 2007–01
  28. By: Galina Hale; Carlos Arteta
    Abstract: Currency crises of the past decade highlighted the importance of balance-sheet effects of currency crises. In credit-constrained markets such effects may lead to further declines in credit. Controlling for a host of fundamentals, we find a systematic decline in foreign credit to emerging market private firms of about 25% in the first year following currency crises, which we define as large changes in real value of the currency. This decline is especially large in the first five months, lessens in the second year and disappears entirely by the third year. We identify the effects of currency crises on the demand and supply of credit and find that the decline in the supply of credit is persistent and contributes to about 8% decline in credit for the first two years, while the 35% decline in demand lasts only five months.
    Keywords: Financial crises
    Date: 2007

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