nep-mon New Economics Papers
on Monetary Economics
Issue of 2007‒10‒06
33 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Successes and Failures of Monetary Policy Since the 1950s By David Laidler
  2. Monetary Policy, Default Risk and the Exchange Rate By Guimarães, Bernardo; Soares Gonçalves, Carlos Eduardo
  3. Monetary Policy in Dual Currency Environment By Felices Guillermo; Tuesta Vicente
  4. Does the Federal Reserve Follow a Non-Linear Taylor Rule? By Kenneth Petersen
  5. No-Arbitrage Taylor Rules By Andrew Ang; Sen Dong; Monika Piazzesi
  6. Efficiency of the Monetary Policy and Stability of Central Bank Preferences. Empirical Evidence for Peru By Rodriguez Gabriel
  7. The international transmission of monetary shocks in a dollarized economy: The case of USA and Lebanon By Jean-François Goux; Charbel Cordahi
  8. Monetary information arrivals and intraday exchange rate volatility : A comparison of the GARCH and the EGARCH models. By Darmoul Mokhtar; Nizar Harrathi
  9. Escaping Nash and Volatile Inflation By Ellison, Martin; Yates, Tony
  10. Regional real exchange rates and Phillips curves in monetary unions - Evidence from the US and EMU By Jan Marc Berk; Job Swank
  11. Will monetary policy become more of a science? By Frederic S. Mishkin
  12. Monetary Policy in East Asia: Common Concerns By Marvin Goodfriend
  13. Learning about Monetary Policy Rules when the Cost Channel Matters By Llosa Gonzalo; Tuesta Vicente
  14. The Economic Impact of Central Bank Transparency: A Survey By Cruijsen, C. van der; Eijffinger, S.C.W.
  15. Instability and nonlinearity in the Euro area Phillips curve. By Alberto Musso; Livio Stracca; Dick van Dijk
  16. Inflation persistence - euro area and new EU Member States. By Michal Franta; Branislav Saxa; Katerina Smidkova
  17. Foreign exchange intervention and central bank independence: The Latin American experience By Nunes, Mauricio; Da Silva, Sergio
  18. The role of credit aggregates and asset prices in the transmission mechanism: a comparison between the euro area and the US By Sylvia Kaufmann; Maria Teresa Valderrama
  19. Oil Shocks and Optimal Monetary Policy By Montoro Carlos
  20. Inflation Targeting, Credibility and Confidence Crises By Aloisio Pessoa de Araújo; Rafael Santos
  21. Monetary Arrangements for Emerging Economies By Aloisio Pessoa de Araújo; Marcia Leon; Rafael Santos
  22. Exact prediction of inflation and unemployment in Germany By Kitov, Ivan
  23. Real Wage Rigidities and the Cost of Disinflations By Guido Ascari; Christian Merkl
  24. Heterogeneous Consumers, Demand Regimes, Monetary Policy and Equilibrium Determinacy By Di Bartolomeo, Giovanni; Rossi, Lorenza
  25. Hazardous Times for Monetary Policy: What do Twenty-three Million Bank Loans Say about the Effects of Monetary Policy on Credit Risk? By Jiminez, G.; Ongena, S.; Pedro, J.L.; Saurina, J.
  26. The unusual behavior of the federal funds and 10-year Treasury rates: a conundrum or Goodhart’s Law? By Daniel L. Thornton
  27. A Small Open Economy as a Limit Case of a Two-Country New Keynesian DSGE Model: A Bayesian Estimation With Brazilian Data. By Marcos Antonio C. da Silveira
  28. A Multivariate Perspective for Modeling and Forecasting Inflation's Conditional Mean and Variance By Matteo Barigozzi; Marco Capasso
  29. CONSTRUCTING HISTORICAL EURO AREA DATA By Heather Anderson; Mardi Dungey; Denise R. Osborn; Farshid Vahid
  30. Reserve accumulation: objective or by-product? By Johannes Onno de Beaufort Wijnholds; Lars Søndergaard
  31. The Long-run Risk Model: Dynamics and Cyclicality of Interest Rates By Hasseltoft, Henrik
  32. Professor Becker on Free Banking: A Comment By van den Hauwe, Ludwig
  33. The role of the exchange rate for adjustment in Boom and Bust episodes. By Reiner Martin; Ludger Schuknecht; Isabel Vansteenkiste

  1. By: David Laidler (University of Western Ontario)
    Abstract: Successes and failures in monetary policy stem mainly from coherence or lack thereof in the monetary order, rather than the tactical skills of policy makers. Crucial here are questions of consistency among the economic ideas that the policy regime embodies, the way in which the economy actually functions, and the beliefs of private agents and policy makers about these matters. These postulates are used to frame accounts of the Bretton Woods System and its collapse, the Great Inflation that followed, the subsequent disappointing performance of money-growth targeting, the breakdown of the Japanese "bubble economy" the onset of theEMS crisis at the beginning of the 1990s, and since then, the launch of the Euro and the apparent success of inflation targeting. Though monetary policy seems rather successful at present, certain weaknesses in currently prevailing monetary orders are noted.
    Keywords: monetary policy; policy regimes; crises; pegged exchange rates; flexible exchange rates; inflation; inflation targets; money supply; central banks, central bank independence.
    JEL: E42 E58 E65 F33
    Date: 2007
  2. By: Guimarães, Bernardo; Soares Gonçalves, Carlos Eduardo
    Abstract: In a country with high probability of default, higher interest rates may render the currency less attractive if sovereign default is costly. This paper develops that intuition in a simple model and estimates the effect of changes in interest rates on the exchange rate in Brazil using data from the dates surrounding the monetary policy committee meetings and the methodology of identification through heteroskedasticity. Indeed, we find that unexpected increases in interest rates tend to lead the Brazilian currency to depreciate. It follows that granting more independence to a central bank that focus solely on inflation is not always a free-lunch.
    Keywords: default; exchange rate; identification through heteroskedasticity; monetary policy
    JEL: E5 F3
    Date: 2007–09
  3. By: Felices Guillermo (Bank of England); Tuesta Vicente (Central Reserve Bank of Peru)
    Abstract: We develop a small open economy general equilibrium model with sticky prices and partial dollarization -a situation where both domestic and foreign currencies coexist. We derive a tractable representation of the model in terms of domestic inflation and the output gap in which a trade-off, which depends on the degree of dollarization, arises endogenously due to the presence of foreign interest rate shocks. We use this framework to show analytically how higher degrees of dollarization induce larger volatilities of the output gap and inflation, thus hampering a central bank’s effectiveness in stabilizing the economy. Our impulse-response functions show that the transmission of such shocks has a positive (negative) effect on inflation and negative (positive) effect on the output gap when money aggregates and consumption are complements (substitutes). We also show that a standard Taylor rule guarantees real determinacy of the rational expectations equilibrium. Finally, we demonstrate that a higher degree of dollarization reduces the determinacy region when the overall money aggregate and consumption are substitutes.
    Keywords: Dollarization, Currency Substitution, Policy trade-off, Staggered Price Setting, Open Economy.
    JEL: E50 E52 F00 F30 F41
    Date: 2007–04
  4. By: Kenneth Petersen (University of Connecticut)
    Abstract: The Taylor rule has become one of the most studied strategies for monetary policy. Yet, little is known whether the Federal Reserve follows a non-linear Taylor rule. This paper employs the smooth transition regression model and asks the question: does the Federal Reserve change its policy-rule according to the level of inflation and/or the output gap? I find that the Federal Reserve does follow a non-linear Taylor rule and, more importantly, that the Federal Reserve followed a non-linear Taylor rule during the golden era of monetary policy, 1985-2005, and a linear Taylor rule throughout the dark age of monetary policy, 1960-1979. Thus, good monetary policy is associated with a non-linear Taylor rule: once inflation approaches a certain threshold, the Federal Reserve adjusts its policy-rule and begins to respond more forcefully to inflation.
    Keywords: Taylor rule, Federal Reserve, non-linearity, monetary policy
    JEL: E4 E5
    Date: 2007–09
  5. By: Andrew Ang; Sen Dong; Monika Piazzesi
    Abstract: We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and output gap account for over half of the variation of time-varying excess bond returns and most of the movements in the term spread. Taylor rules estimated with no-arbitrage restrictions differ from Taylor rules estimated by OLS, and the resulting monetary policy shocks are somewhat less volatile than their OLS counterparts.
    JEL: E43 E44 E52 G12
    Date: 2007–09
  6. By: Rodriguez Gabriel (Universidad of Ottawa and Central Bank of Peru)
    Abstract: Following the approach suggested by Favero and Rovelli (2003), I estimate a three-equations system for different sub-samples for Peru. The results indicate that the preferences of the monetary authority have changed between the diffeerent regimes. In particular, the parameter associated to the implicit target of in‡ation has been reduced significantly. The macroeconomic conditions from the side of the aggregate demand have been more favorable than those related to the aggregate supply. The standard deviation of the monetary rule suggests that it has been conducted successfully in the last regime.
    Keywords: Interest Rate Rule, Structural Breaks, Inflation Target-ing, Output Gap, Preferences, Macroeconomic Shocks
    JEL: C2 E5
    Date: 2007–05
  7. By: Jean-François Goux (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines]); Charbel Cordahi (Université Saint Esprit de Kaslik (USEK) - [Université Saint Esprit de Kaslik (USEK)])
    Abstract: We show that an American monetary shock wields an influence, though limited, over the Lebanese output in accordance with the literature advances. However, as we are waiting for a stronger transmission of U.S. short-term rates to Lebanese short-term rates, we notice that this transmission is weak in the first year. The result can be explained by the presence of pricing-to-market. After the end of the first year, we find the traditional result where the increase in the American interest rate is transmitted integrally to the Lebanese interest rate. We recognize this phenomenon as the dollarization effect.
    Keywords: interest rate; International transmission; law of one price; monetary shock; purchasing power parity
    Date: 2007–07
  8. By: Darmoul Mokhtar (Centre d'Economie de la Sorbonne); Nizar Harrathi (LEGI - Ecole Polytechnique de Tunis)
    Abstract: In this article, we examine the intradaily Euro-dollar exchange rate volatility persistence result from the dissymmetric impact of monetary policy signals stemming from the ECB Council and the FOMC. A model is constructed by extending the AR(1)-GARCH (1,1) to an exponential process EGARCH (1,1), using high-frequency data (five minutes frequency) which integrates a polynomials structure depending on signal variables, starting from the deseasonalized exchange rate returns series. It is found that, unlike the equity market, the best volatility predictions are derived from the EGARCH(1,1) process.
    Keywords: Exchange rate, official intervention, monetary policy, GARCH models.
    JEL: C22 E52 F31 G15
    Date: 2007–06
  9. By: Ellison, Martin; Yates, Tony
    Abstract: Why is inflation so much lower and at the same time more stable in developed economies in the 1990s, compared with the 1970s? This paper suggests that the United Kingdom, United States and other countries may have escaped from a volatile inflation equilibrium. Our argument builds on the story proposed by Tom Sargent in The conquest of American inflation, where the fall in inflation in the 1980s was attributed to the changing beliefs informing monetary policy. To explain the escape in inflation volatility, we unwind one of Sargent's simplifications and allow the monetary authority to react to some of the shocks in the economy. In this new model, a revised account of recent history is that when the evidence turned against the existence of a long-run inflation-output trade-off in the 1980s there was an escape from high inflation, but the authorities were also persuaded to stop using changes in inflation to offset shocks. Inflation and inflation volatility therefore escaped in tandem. Our analysis also sheds some light on why the escape in inflation occurred at the time it did. Our model, like the Sargent model it derives from, omits the revolution in institutional design and understanding that underpins monetary policy. So the gloomy predictions for the future derived from a literal reading of it are likely to be unfounded.
    Keywords: beliefs; escapes; Phillips curve; volatility
    JEL: E2 E3
    Date: 2007–09
  10. By: Jan Marc Berk; Job Swank
    Abstract: We study price level convergence within the US and EMU, using panel estimates of regional Phillips curves of the hybrid New-Keynesian type. The estimated half lives of deviations from trend PPP are around three years for US regions and two years for euro area countries. The start of EMU had no noticeable influence on PPP convergence in the euro area. Where nominal exchange rates accounted for the bulk of the adjustment process before 1999, this role was taken over by relative prices thereafter. Notwithstanding clear evidence of forward-lookingness, inflation persistence is substantial in both monetary unions, especially in the US.
    Keywords: Inflation; monetary union; purchasing power parity
    JEL: E31 E52 F41
    Date: 2007–09
  11. By: Frederic S. Mishkin
    Abstract: This paper reviews the progress that the science of monetary policy has made over recent decades. This progress has significantly expanded the degree to which the practice of monetary policy reflects the application of a core set of "scientific" principles. However, there remains, and will likely always remain, elements of art in the conduct of monetary policy.
    Date: 2007
  12. By: Marvin Goodfriend (Professor, Carnegie Mellon University (E-mail:
    Abstract: The paper identifies and evaluates consequences for monetary policy of five features of East Asian development: export orientation, integrated regional trade, bank-dependent finance, the potential for persistent trade surpluses, and the aggressive accumulation of international reserves. The case for a flexible exchange rate is made in terms of the New Neoclassical Synthesis (NNS). NNS logic indicates why fluctuations in "export optimism" create problems for the sustainability of a fixed exchange rate. Cooperative credit policy in East Asia is discussed by analogy to a credit union. The paper outlines problems for monetary policy created by bank-dependent finance in East Asia. A two- country NNS model indicates that a revaluation of the RMB against the dollar is likely to exert little effect on the US trade deficit, although it should help control inflation in China. The paper argues that China can adopt a flexible exchange rate in a few years with modest reforms of its banking system. Finally, the paper considers various reasons for the accumulation of international reserves in East Asia.
    Keywords: East Asia, Monetary Policy, Banking Policy, Exchange Rates, Trade Balance, International Reserves
    JEL: F3 F4
    Date: 2007–09
  13. By: Llosa Gonzalo (UCLA); Tuesta Vicente (Banco Central de Reserva del Perú)
    Abstract: We study how the stability of rational expectations equilibrium may be affected by monetary policy when agents learn using adaptive learning (E-stability concept) and the cost channel of monetary policy matters. We focus on both instrumental taylor-type rules and optimal rules. We show, analytically, that standard instrument rules -contemporaneous and forecast based rules - can easily induce indeterminacy and expectational instability when the cost channel is present. Overall, a naive application of the Taylor principle in this setting could be misleading. Regarding optimal rules, we find that "expectational-based" rules, under discretion and commitment, do not always induce determinate and E-stable equilibrium. This result stands in contrast to the findings of Evans and Honkapohja (2003) for for the baseline “New Keynessian" model.
    Keywords: Monetary Policy Rules, Cost Channel, Indeterminacy
    JEL: C23 O40 O47
    Date: 2007–08
  14. By: Cruijsen, C. van der; Eijffinger, S.C.W. (Tilburg University, Center for Economic Research)
    Abstract: We provide an up-to-date overview of the literature on the desirabil- ity of central bank transparency from an economic viewpoint. Since the move towards more transparency, a lot of research on its e?ects has been carried out. First, we show how the theoretical literature has evolved, by looking into branches inspired by Cukierman and Meltzer (1986) and by investigating several, more recent, research strands (e.g. coordination and learning). Then, we summarize the empirical literature which has been growing more recently. Last, we discuss whether: -the empirical research resolves all theoretical question marks, -how the ?ndings of the literature match the actual practice of central banks, and -where there is scope for more research.
    Keywords: Central Bank Transparency;Monetary Policy;Survey
    JEL: E31 E52 E58
    Date: 2007
  15. By: Alberto Musso (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Livio Stracca (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Dick van Dijk (Econometric Institute, Erasmus University Rotterdam, P.O. Box 1738, NL-3000 DR Rotterdam, The Netherlands.)
    Abstract: This paper provides a comprehensive analysis of the functional form of the euro area Phillips curve over the past three decades. In particular, compared to previous literature we analyse the stability of the relationship in detail, especially as regards the possibility of a time-varying mean of inflation. Moreover, we conduct a sensitivity analysis across different measures of economic slack. Our main findings are two. First, there is strong evidence of time variation in the mean and slope of the Phillips curve occurring in the early to mid 1980s, but not in inflation persistence once the mean shift is allowed for. As a result of the structural change, the Phillips curve became flatter around a lower mean of inflation. Second, we find no significant evidence of non-linearity, in particular in relation to the output gap. JEL Classification: E52, E58.
    Keywords: Inflation, output gap, structural change, asymmetry, smooth transition model.
    Date: 2007–09
  16. By: Michal Franta (Czech National Bank and CERGE-EI, P.O. Box 882, Politickych veznu 7, 111 21 Praha 1, Czech Republic.); Branislav Saxa (Czech National Bank and CERGE-EI, P.O. Box 882, Politickych veznu 7, 111 21 Praha 1, Czech Republic.); Katerina Smidkova (Czech National Bank, Na Prikope 28, 115 03 Prague 1.)
    Abstract: Is inflation persistence in the new EU Member States (NMS) comparable to that in the euro area countries? We argue that persistence may not be as different between the two country groups as one might expect. We confirm that one should work carefully with the usual estimation methods when analyzing the NMS, given the scope of the convergence process they went through. We show that due to frequent breaks in inflation time series in the NMS, parametric statistical measures assuming a constant mean deliver substantially higher persistence estimates for the NMS than for the euro area countries. Employing time-varying mean leads to the reversal of this result and suggests similar or lower inflation persistence for the NMS compared to euro area countries. Structural measures show that backward-looking behavior may be more important component in explaining inflation dynamics in the NMS than in the euro area countries. JEL Classification: E31, C22, C11, C32.
    Keywords: Inflation persistence, new Member States, time-varying mean, New Hybrid Phillips curve.
    Date: 2007–09
  17. By: Nunes, Mauricio; Da Silva, Sergio
    Abstract: Employing data from 13 Latin American countries, we find that greater central bank independence is associated with lesser intervention in the foreign exchange market, and also with leaning-against-the-wind intervention. We also find that the structural reforms that occurred in Latin America mostly in the 1990s helped to reduce the need for foreign exchange intervention.
    Keywords: central bank independence; foreign exchange intervention; Latin America
    JEL: F31 F41
    Date: 2007–09–29
  18. By: Sylvia Kaufmann (Oesterreichische Nationalbank, Economic Studies Division, Otto-Wagner-Platz 3, 1090 Vienna, Austria.); Maria Teresa Valderrama (Oesterreichische Nationalbank, Economic Studies Division, Otto-Wagner-Platz 3, 1090 Vienna, Austria.)
    Abstract: We analyze the interaction between credit and asset prices in the transmission of shocks to the real economy. We estimate a Markov switching VAR for the euro area and the US, including additionally GDP, CPI and a short-term interest rate. We find evidence for two distinct states in both regions. For the euro area, we find a regime which is correlated to the business cycle and which captures periods of very low real credit growth at the end of recessions. However, during this regime credit markets and asset price markets do not impede economic recovery. In the other regime, we do find a procyclical effect of credit and asset price shocks on GDP. Shocks in both variables explain each about 20% of GDP’s forecast error variance after four years. Credit shocks have a positive effect on inflation and explain about 35% of the forecast error variance, which confirms that credit aggregates contain information about the monetary stance. The effect of asset price shocks on inflation is insignificant and their share in explaining the forecast error variance negligible. For the US, regime 1 captures periods of stable GDP growth, and low and stable inflation, combined with accelerating asset prices. We find procyclical effects of credit and asset price shocks on GDP only in regime 2. Shocks in both variables explain about the same share (20%) of GDP forecast error variance, whereby the share explained by asset price shocks is about two and a half times larger than in regime 1. Shocks to credit and asset prices have no significant effect on CPI and explain each about 10% of its forecast error variance in both regimes. This is consistent with the view that monetary policy may achieve price stability without necessarily achieving financial stability. JEL Classification: C11, C32, E32, E44.
    Keywords: Asymmetry, asset prices, financial system, lending, transmission mechanism.
    Date: 2007–09
  19. By: Montoro Carlos (Banco Central de Reserva del Perú and LSE)
    Abstract: This paper investigates how monetary policy should react to oil shocks in a microfounded model with staggered price-setting and oil as a non-produced input in the production function. We extend Benigno and Woodford (2005) to obtain a second order approximation to the expected utility of the representative household when the steady state is distorted and the economy is hit by oil price shocks. The main result is that oil price shocks generate a trade-off between inflation and output stabilisation when oil has low substitutability in production. Therefore, it becomes optimal to the monetary authority to stabilise partially the effects of oil shocks on inflation and some inflation is desirable. We also find, in contrast to Benigno and Woodford (2005), that this trade-off remains even when we eliminate the effects of monopolistic distortions from the steady state. Our results also shed light on how technological improvements which reduces the dependence on oil, also reduce the impact of oil shocks on the economy. This can explain why oil shocks have lower impact on inflation in the 2000s in contrast to the 1970s. Since oil has become easier to substitute with other renewable resources, the impact of oil shocks has been dampened.
    Keywords: Optimal Monetary Policy, Welfare, Second Order Solution, Oil Price Shocks, Endogenous Trade-off.
    JEL: D61 E61
    Date: 2007–08
  20. By: Aloisio Pessoa de Araújo (EPGE/FGV); Rafael Santos
    Date: 2007–09
  21. By: Aloisio Pessoa de Araújo (EPGE/FGV); Marcia Leon; Rafael Santos
    Date: 2007–09
  22. By: Kitov, Ivan
    Abstract: Potential links between inflation, (t), and unemployment, UE(t), in Germany have been examined. There exists a consistent (conventional) Phillips curve despite some changes in monetary policy. This Phillips curve is characterized by a negative relation between inflation and unemployment with the latter leading the former by one year: UE(t-1) = -1.50(t) + 0.116. Effectively, growing unemployment has resulted in decreasing inflation since 1971, i.e. for the period where GDP deflator observations are available. The relation between inflation and unemployment is statistically reliable with R2=0.86, where unemployment spans the range from 0.01 to 0.12 and inflation, as represented by GDP deflator, varies from -0.01 to 0.07. A linear and lagged relationship between inflation, unemployment and labor force has been also obtained for Germany. Changes in labor force level are leading unemployment and inflation by five and six year, respectively. Therefore this generalized relationship provides a natural prediction of inflation at a six-year horizon, as based upon current estimates of labor force level. The goodness-of-fit for the relationship is 0.87 for the period between 1971 and 2006, i.e. including the periods of high inflation and disinflation.
    Keywords: inflation; unemployment; labor force; prediction; Germany
    JEL: J64 E52 C53 E31
    Date: 2007–09–30
  23. By: Guido Ascari (University of Pavia); Christian Merkl (IfW, University of Kiel and IZA)
    Abstract: This paper analyzes the cost of disinflations under real wage rigidities in a micro-founded New Keynesian model. The consensus is that real wage rigidities can be a useful mechanism to induce the inflation persistence that is absent in the standard Calvo model. Real wage rigidities thus generate a slump in output after a credible disinflationary policy. This consensus is flawed, since it depends on analyzing the model in a linearized framework. Once nonlinearities are taken into account, the results change dramatically, both qualitatively and quantitatively. Real wage rigidities imply neither inflation persistence, nor output costs of disinflations. Real wage rigidities actually create a boom after a permanent reduction in the inflation target of the monetary policy.
    Keywords: disinflation, sticky prices, real wage rigidities, nonlinearities
    JEL: E31 E50
    Date: 2007–09
  24. By: Di Bartolomeo, Giovanni; Rossi, Lorenza
    Abstract: This paper investigates the effects of monetary policy in presence of heterogeneous consumers. We study the effectiveness (quantitative effects) of monetary policy and equilibrium determinacy properties of a New Keynesian DSGE model where a fraction of households cannot smooth consumption. We show that two-demand regimes can emerge (according to the “slope” of IS curve) and that the main unconventional results, stressed by recent literature, only hold in the unconventional case of an IS curve positively sloped.
    Keywords: Heterogeneous consumers; liquidity constraints; determinacy; demand regimes
    JEL: E61 E63
    Date: 2005–09–05
  25. By: Jiminez, G.; Ongena, S.; Pedro, J.L.; Saurina, J. (Tilburg University, Center for Economic Research)
    Abstract: We investigate the impact of the stance and path of monetary policy on the level of credit risk of individual bank loans and on lending standards. We employ the Credit Register of the Bank of Spain that contains detailed monthly information on virtually all loans granted by all credit institutions operating in Spain during the last twenty-two years ? generating almost twenty-three million bank loan records in total. Spanish monetary conditions were exogenously determined during the entire sample period. Using a variety of duration models we find that lower short-term interest rates prior to loan origination result in banks granting more risky new loans. Banks also soften their lending standards ? they lend more to borrowers with a bad credit history and with high uncertainty. Lower interest rates, by contrast, reduce the credit risk of outstanding loans. Loan credit risk is maximized when both interest rates are very low prior to loan origination and interest rates are very high over the life of the loan. Our results suggest that low interest rates increase bank risk-taking, reduce credit risk in banks in the very short run but worsen it in the medium run. Risk-taking is not equal for all type of banks: Small banks, banks with fewer lending opportunities, banks with less sophisticated depositors, and savings or cooperative banks take on more extra risk than other banks when interest rates are lower. Higher GDP growth reduces credit risk on both new and outstanding loans, in stark contrast to the differential effects of monetary policy.
    Keywords: monetary policy;low interest rates;financial stability;lending standards;credit risk;risk-taking;business cycle;bank organization;duration analysis.
    JEL: E44 G21 L14
    Date: 2007
  26. By: Daniel L. Thornton
    Abstract: In February 2005, former Chairman Alan Greenspan referred to the decline in long-term rates in the wake of the Fed increasing the target for the federal funds rate by 150 basis points as a “conundrum.” Greenspan’s remarks generated considerable interest and research. I show that the relationship between the 10 year Treasury yield and the federal funds rate changed dramatically in the late 1980s, well in advance of Greenspan’s observation. I argue that the marked change in the relationship between the federal funds rate and long-term yields is a natural consequence of Goodhart’s Law.
    Date: 2007
  27. By: Marcos Antonio C. da Silveira
    Abstract: We build a two-country version of the DSGE model in Gali & Monacelli (2005), which extends for a small open economy the new Keynesain model used as tool for monetary policy analysis in closed economies. A distinctive feature of the model is that the terms of trade enters directly into the new Keynesian Phillips curve as a new pushing-cost variable feeding the inflation, so that there is no more the direct relationship between marginal cost and output gap that characterizes the closed economies. Unlike most part of the literature, we derive the small domestic open economy as a limit case of the two-coutry model, rather than assuming exogenous processes for the foreign variables. This procedure preserves the role played by foreign nominal frictions in the way as international monetary policy shocks are conveyed into the small domestic economy. Using the Bayesian approach, the small-economy case is estimated with Brazilian data and impulse-response functions are build to analyse the dynamic effects of structural shocks.
    Date: 2006–12
  28. By: Matteo Barigozzi; Marco Capasso
    Abstract: We test the importance of multivariate information for modelling and forecasting in- flation's conditional mean and variance. In the literature, the existence of inflation's conditional heteroskedasticity has been debated for years, as it seemed to appear only in some datasets and for some lag lengths. This phenomenon might be due to the fact that inflation depends on a linear combination of economy-wide dynamic common fac- tors, some of which are conditionally heteroskedastic and some are not. Modelling the conditional heteroskedasticity of the common factors can thus improve the forecasts of inflation's conditional mean and variance. Moreover, it allows to detect and predict con- ditional correlations between inflation and other macroeconomic variables, correlations that might be exploited when planning monetary policies. The Dynamic Factor GARCH (DF-GARCH) by Alessi et al. [2006] is used here to exploit the relations between inflation and the other macroeconomic variables for inflation fore- casting purposes. The DF-GARCH is a dynamic factor model as the one by Forni et al. [2005], with the addition of an equation for the evolution of static factors as in Giannone et al. [2004] and the assumption of heteroskedastic dynamic factors. When comparing the Dynamic Factor GARCH with univariate models and with the classical dynamic factor models, the DF-GARCH is able to provide better forecasts both of inflation and of its conditional variance.
    Keywords: Inflation, Factor Models, GARCH
    Date: 2007–10–01
  29. By: Heather Anderson; Mardi Dungey; Denise R. Osborn; Farshid Vahid
    Abstract: Time series analysis for the Euro Area requires the availability of sufficiently long historical data series, but the appropriate construction methodology has received little attention. The benchmark dataset, developed by the European Central Bank for use in its Area Wide Model (AWM), is based on fixed-weight aggregation across countries with historically distinct monetary policies and financial markets of varying international importance. This paper proposes a new methodology, based on the historical distance from monetary integration between core and periphery countries, for producing back-dated monetary and financial series for the Euro Area. The impact of using the new methodology versus the AWM data is illustrated through a structural VAR analysis and estimates of an international DSGE model. An important advantage of the new methodology is that it can be applied to develop appropriate series as new member countries join the Euro Area.
    JEL: C82 C43 E58
    Date: 2007–10
  30. By: Johannes Onno de Beaufort Wijnholds (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Lars Søndergaard (World Bank 1818 H St N.W., Washington D.C. USA.)
    Abstract: This paper examines whether the level of reserves in emerging market countries has become excessive. It presents a discussion of “adequacy” versus “excessive” levels of reserves, and presents calculations of reserve adequacy for a large number of emerging market countries. Two categories of countries can be distinguished: i) those whose reserves have grown on account of a need for self-insurance against financial crises, and which tend to be reasonably in line with adequacy measures (mainly Latin American countries and countries in central and eastern Europe), and ii) those whose reserve accumulation is nowadays primarily the result of rapid export-led growth supported by a lack of exchange rate flexibility. This is especially the case for several emerging Asian countries, whose reserve levels have grown far beyond what can reasonably considered adequate. Various opinions on Asian exchange rate and reserves policies are examined, and the costs and benefits of currency undervaluation are assessed. Attention is also paid to the composition of the reserves. The paper concludes by bringing together the various strands of the analysis and enumerating the main implications of largescale reserve accumulation for the international monetary system. JEL Classification: F31, F41.
    Keywords: International reserve accumulation, emerging markets.
    Date: 2007–09
  31. By: Hasseltoft, Henrik (Swedish Institute for Financial Research)
    Abstract: This paper shows that the long-run risk model of Bansal and Yaron (2004) is able to simultaneously explain the dynamics and cyclical properties of interest rates and the level and volatility of equity returns. Specifically, the model accounts for deviations from the expectations hypothesis of interest rates, the upward sloping nominal yield curve, the downward sloping term structure of volatility and the predictive power of the yield spread. Real (nominal) rates are positively (negatively) correlated with consumption growth and the nominal yield spread predicts future real consumption growth, excess stock returns and inflation. The cyclical properties of nominal interest rates are shown to critically depend on the value of the elasticity of intertemporal substitution and on the correlation between consumption and inflation. The driving forces of the model are uncertainty about expected consumption growth, time-varying volatility of consumption growth and deviations from the Fisher hypothesis.
    Keywords: long run risk; cyclicality; interest rates
    JEL: E43 G12
    Date: 2007–07–15
  32. By: van den Hauwe, Ludwig
    Abstract: Professor Becker´s paper about free banking written in 1956 was originally intended as a reaction to the 100-percent reserve proposals that were then popular at the University of Chicago. Today the original paper clearly illustrates how considerably our views and theories about free banking have evolved in the past 50 years. This development is to a considerable extent the result of the work and the writings of economists of the Austrian School. Professor Pascal Salin is one of the most prominent members of the Austrian free banking school. In a new introduction to this 1956 paper written especially for the Festschrift in honor of Professor Pascal Salin, Professor Gary Becker partially repudiates and mitigates some of his previous conclusions. This event offers a fitting opportunity to review some developments in the theory of free banking and related issues and to add a few clarifications concerning the present “state of the art” as regards an acceptable and adequate notion of free banking.
    Keywords: Free Banking; Monetary Regimes; Monetary Standards; Business Cycles
    JEL: E32 E42 E58
    Date: 2007–10–04
  33. By: Reiner Martin (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Ludger Schuknecht (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.); Isabel Vansteenkiste (European Central Bank, Kaiserstraße 29, 60311 Frankfurt, Germany.)
    Abstract: Numerous countries have experienced boom-bust episodes in asset prices in the past 20 years. This study looks at stylised facts and conducts statistical and econometric analysis for such episodes, distinguishing between industrialised countries that experienced external adjustment (via real effective exchange rate depreciation during busts) and those that relied on an internal adjustment process (and experienced no depreciation). The study finds that different adjustment experiences are correlated with the degree of macroeconomic imbalances and balance sheet problems. Internal adjustment seems more prevalent when financial vulnerabilities, excess demand and competitiveness loss remain relatively contained in the boom. In the bust, internal adjusters experience more protracted but less deep downturns than external adjusters as imbalances unwind more slowly. Some Central and East European EU Member States are currently experiencing strong credit and asset price growth in conjunction with rapid economic expansion. Against this background the experience of other countries may raise awareness of related policy challenges. JEL Classification: E32, E63, E65.
    Keywords: Booms and busts, external and internal adjustment, exchange rates, financial imbalances, competitiveness.
    Date: 2007–09

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