nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒07‒20
37 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Communicating with many Tongues: The Impact of FOMC Members’ Speeches on U.S. Financial Markets’ Returns and Volatility By Bernd Hayo; Ali M. Kutan; Matthias Neuenkirch
  2. Monetary Policy Implementation and the Federal Funds Rate By Nautz, Dieter; Schmidt, Sandra
  3. Informal central bank independence: an analysis for three European countries By David Cobham; Stefania Cosci; Fabrizio Mattesini
  4. The Optimal Monetary Instrument for Prudential Purposes By C.A.E. Goodhart; P. Sunirand; D.P. Tsomocos
  5. Optimal Exchange Rate Stabilization in a Dollarized Economy with Inflation Targets By Nicoletta Batini; Paul Levine; Joseph Pearlman
  6. Liquidity and Asset Prices By Raphael A. Espinoza; Dimitrios P. Tsomocos
  7. A persistence-weighted measure of core inflation in the euro area By Laurent Bilke; Livio Stracca
  8. The Causal Relationship between Inflation and Inflation Expectations in the United Kingdom By Kelly, Roger
  10. Time Aggregation, Long-Run Money Demand and the Welfare Cost of Inflation By Rangan Gupta; Josine Uwilingiye
  11. Commitment policy and optimal positive long-run inflation By Pontiggia, Dario
  13. A Reassessment of Japan's Monetary Policy during the Great Depression: The Constraints and Remedies By Masato Shizume
  14. The Optimal Choice of a Monetary Policy Instrument By Andrew Atkeson; Vyjayanthi Chari; Patrick Kehoe
  15. The Relative Size of New Zealand Exchange Rate and Interest Rate Responses to News By Andrew Coleman; Özer Karagedikli
  16. The Effectiveness of Monetary Policy Reconsidered By John Weeks
  17. The US dollar and the Euro: The Deus Ex-Machina By Lorca-Susino, Maria
  18. The Role of Media for Consumers' Inflation Expectation Formation By Michael J. Lamla; Sarah M. Lein
  20. Input Substitution, Export Pricing, and Exchange Rate Policy By Kang Shi; Juanyi Xu
  21. Exchange Rate and Interest Rate Volatility in a Target Zone: The Portuguese Case By António Portugal Duarte; João Sousa Andrade; Adelaide Duarte
  22. Does FOMC News Increase Global FX Trading? By Fischer, Andreas M.; Ranaldo, Angelo
  23. Friedman's Nobel Lecture reconsidered By James Forder
  25. A Macroeconomic Foundation for the Nelson and Siegel Class of Yield Curve Models By Leo Krippner
  26. Too Much for Self-Insurance? Asian Foreign Reserves By Yuko Hashimoto
  27. The stock market and the Fed By Fabrizio Mattesini; Leonardo Becchetti
  28. Inflation and the Measurement of Saving and Housing Affordability By Andrew Coleman
  29. Does money matter in the IS curve? The case of the UK By Barry E. Jones; Livio Stracca
  30. Facing up a sudden stop of capital flows: Policy lessons from the 90's peruvian experience By Paul Castillo; Daniel Barco
  31. Repo markets, counterparty risk and the 2007/2008 liquidity crisis By Christian Ewerhart; Jens Tapking
  32. Bond risk premia, macroeconomic fundamentals and the exchange rate By Taboga, Marco; Pericoli, Marcello
  33. Hoarding of International Reserves: A Comparison of the Asian and Latin American Experiences By Yin-wong Cheung; Hiro Ito
  34. The Country Risk and the nominal exchange rate between Peru and the United States. An approach through a model of asset markets for determining the exchange rate. (1998:12 - 2007:12) By Salazar, Eduardo
  35. Evaluating Foreign Exchange Market Intervention: Self-selection, Counterfactuals and Average Treatment Effects By Rasmus Fatum; Michael M. Hutchison
  36. Global liquidity glut or global savings glut? A structural VAR approach By Thierry Bracke; Michael Fidora
  37. Liquidity matters: Evidence from the Russian interbank market By A. KARAS; K. SCHOORS; G. LANINE

  1. By: Bernd Hayo (Faculty of Business Administration and Economics, Philipps Universitaet Marburg); Ali M. Kutan (Southern Illinois University Edwardsville and the William Davidson Institute, Michigan); Matthias Neuenkirch (Faculty of Business Administration and Economics, Philipps Universitaet Marburg)
    Abstract: We study the effects of FOMC communication, in particular speeches, on U.S financial markets returns and volatility over the period from 1998 to 2006. Using a GARCH model we empirically analyze the respective and combined influence of speeches, post-meeting statements, monetary policy reports, and testimonies. Firstly, we show that the impact on both returns and volatility is larger if the communication channel is more formal. Secondly, the communications of the Board of Governors (BOG) generally have a larger influence than those of the regional presidents. Thirdly, this tendency also holds when comparing the chairman’s and vice chairman’s impact with that of an “ordinary” BOG member, as well as when splitting the group of regional presidents into “voters” and “non-voters”. However, in the light of a number of unexpected signs of variables and their lack of statistical significance we conclude that Fed speeches by themselves may not be necessarily important events for financial markets. News agencies appear to perform the role of a filter for financial markets, with headlines sometimes substantially deviating from the underlying central bank speeches.
    Keywords: Central bank communication, central bank speeches, financial markets, monetary policy
    JEL: E52 G14
    Date: 2008
  2. By: Nautz, Dieter; Schmidt, Sandra
    Abstract: This paper investigates how the implementation of monetary policy affects the dynamics and the volatility of the federal funds rate. Since the early 1980s, the most important changes in the Fed’s conduct of monetary policy refer to the role of the federal funds rate target and the reserve requirement system. We show that the improved communication and transparency regarding the federal funds rate target has significantly increased the Fed’s influence on the federal funds rate since 1994. By contrast, the declining role of required reserves in the U.S. has contributed to higher federal funds rate volatility. Our results suggest that the planned introduction of remunerated reserves will further enhance the controllability of the federal funds rate.
    Keywords: Dynamics and Volatility of the Federal Funds Rate, Monetary Policy Implementation, Central Bank Communication, Reserve Requirements
    JEL: C22 E43 E52
    Date: 2008
  3. By: David Cobham (Heriot-Watt University, Edimburgh); Stefania Cosci (LUMSA, Rome); Fabrizio Mattesini (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: Changes in formal and informal central bank independence (CBI) in France, Italy and the UK in the period from the mid-1970s to the 1990s are examined; the major changes occurred in the 1990s, after the disinflations of the 1980s. Broad trends in the informal independence of central banks, defined as the ability to pursue price stability regardless of the government’s preferences, are identified on the basis of a monetary policy narrative and an analysis of a set of qualitative determinants of informal independence. The most important determinants are the social/political acceptance that monetary policy is the sphere of the central bank, the existence of antiinflationary commitments in the form of intermediate targets for monetary policy, the degree of social consensus on the means and ends of macroeconomic policy, and the relative technical expertise of the central bank. These broad trends help to explain some of the inflation experience of the 1980s and 1990s which cannot be understood in terms of changes to formal CBI.
    Keywords: Monetary policy, central bank independence, inflation
    JEL: E42 E58
    Date: 2008–07–14
  4. By: C.A.E. Goodhart; P. Sunirand; D.P. Tsomocos
    Abstract: The purpose of this paper is to assess the choice between adopting a monetary base or an interest rate setting instrument to maintain financial stability. Our results suggest that the interest rate instrument is preferable, since during times of a panic or financial crisis the Central Bank automatically satisfies the increased demand for money. Thus, it prevents sharp losses in asset values and enhanced asset volatility.
    Keywords: interest rates, monetary base, bank capital, financial stability, monetary policy
    JEL: D58 E44 G28
    Date: 2008
  5. By: Nicoletta Batini (International Monetary Fund); Paul Levine (University of Surrey); Joseph Pearlman (London Metropolitan University)
    Abstract: We build a small open-economy model with partial dollarization–households hold wealth in domestic currency and a foreign currency as in Felices and Tuesta (2006). The degree of dollarization is endogenous to the extent of exchange rate stabilization by the central bank. We identify the optimal monetary policy response under com-mitment and discretion and assess the optimal degree of exchange rate stabilization inthis set up, drawing policy implications for countries that target inflation in economies of this kind.
    Keywords: dollarized economies, optimal monetary policy, managed exchange rates, inflation-forecast-based rules
    JEL: E52 E37 E58
    Date: 2008–02
  6. By: Raphael A. Espinoza; Dimitrios P. Tsomocos
    Abstract: We show in an exchange economy with liquidity constraints that the volume of trade and asset prices depend on both the supply of liquidity by the Central Bank and on the liquidity of assets and commodities. As a result, monetary aggregates are informative for the assessment of economic developments and the conduct of monetary policy. We also show that the positive correlation between state prices and the future spot rate generates a risk-premium in the term structure of interest rates, even in absence of aggregate uncertainty. These results do not obtain in representative agent models but hold in any monetary economy with heterogeneous agents and short-term liquidity effects, where monetary costs act as transaction costs and the quantity theory of money is verified.
    Keywords: liquidity; cash-in-advance constraints; term structure of interest rates
    JEL: E43 G12
    Date: 2008
  7. By: Laurent Bilke (Lehman Brothers, 25 Bank Street, London E14 5LE, United Kingdom.); Livio Stracca (Counsel to the Executive Board, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: We propose a new core inflation measure for the Euro area which places the emphasis on the more lasting, i.e. persistent, price developments at a disaggregated level. The importance of each component of the HICP is reweighted according to its relative persistence, as measured by the sum of the autoregressive coefficients or by an indicator of mean reversion. Unlike headline inflation, our baseline core inflation measure is highly correlated with ECB monetary policy decisions, which could mean that it contains ex ante (pre monetary policy) information on inflationary pressure. JEL Classification: E31.
    Keywords: Core inflation, inflation persistence.
    Date: 2008–06
  8. By: Kelly, Roger (Monetary Policy Committee Unit, Bank of England)
    Abstract: Two major events have affected the monetary regime in the United Kingdom in recent years, namely the introduction of inflation targeting, and the granting of operational independence to the Bank of England. In this paper we examine what impact, if any, these events have had on inflation expectations. A series of Granger causality tests are used in order to examine the causal relationship between a measure of prices and inflation expectations. We find evidence that the introduction of inflation targeting caused both the general public and professionals to anchor their expectations, rather than basing them on current RPI inflation.
    Keywords: inflation; expectations
    JEL: D84 E31 E58
    Date: 2008–07
  9. By: Michael Geiger
    Abstract: China’s monetary policy applies to two sets of monetary policy instruments: (i) instruments of the Central Bank (CB), the People’s Bank of China (PBC); and (ii) non-Central Bank (NCB) policy instruments. Additionally, the PBC’s instruments include: (i) price-based indirect; and (ii) quantity-based direct instruments. The simultaneous usage of these instruments leads to various distortions that ultimately prevent the interest rate channel of monetary transmission from functioning. Moreover, the strong influence of quantity-based direct instruments and non-central bank policy instruments bring into question the approach of indirect monetary policy in general.
    Date: 2008
  10. By: Rangan Gupta (Department of Economics, University of Pretoria); Josine Uwilingiye (Department of Economics, University of Pretoria)
    Abstract: Two recent studies have found markedly different measures of the welfare cost of inflation in South Africa, obtained through the estimation of long-run money demand relationships using cointegration and long-horizon approaches. Realizing that the monetary aggregate and the interest rate variables are available at higher frequencies than the measure of income and that long-run properties of data are unaffected under alternative methods of time aggregation, we test for the robustness of the two estimation procedures under temporal aggregation and systematic sampling. Our results indicate that the long-horizon method is more robust to alternative methods of time aggregation, and, given this the welfare cost of inflation in South Africa for an inflation target band of 3 percent to 6 percent lies between 0.15 percent and 0.41 percent.
    Keywords: Cointegration, Long-Horizon Regression, Money Demand, Time Aggregation, Welfare Cost of Inflation.
    JEL: C15 C32 C43 E31 E41 E52
    Date: 2008–07
  11. By: Pontiggia, Dario
    Abstract: This paper studies different types of commitment policy in an economy where the deterministic steady state is inefficient. We show how a policy suggested by the approach of policy design entails positive long-run inflation, even in the purely forward-looking canonical New Keynesian model. The long-run inflation target is robust to inflation persistence due to backward-looking rule-of-thumb behaviour by price setters. The optimal long-run inflation target is positive in all but one of the six theoretical cases studied. We evaluate policies on the basis of both the deterministic equilibrium and the stochastic equilibrium and present robustness analysis in terms of two structural parameters.
    Keywords: Optimal monetary policy; inflation persistence; policy rules; timeless perspective
    JEL: E5 E3
    Date: 2008–06–30
  12. By: Rochelle M. Edge; Thomas Laubach; John C. Williams
    Abstract: This paper examines welfare-maximizing monetary policy in an estimated micro-founded general equilibrium model of the U.S. economy where the policymaker faces uncertainty about model parameters. Uncertainty about parameters describing preferences and technology implies uncertainty about the model’s dynamics, utility-based welfare criterion, and the “natural” rates of output and interest that would prevail absent nominal rigidities. We estimate the degree of uncertainty regarding natural rates due to parameter uncertainty. We find that optimal Taylor rules under parameter uncertainty respond less to the output gap and more to price inflation than would be optimal absent parameter uncertainty. We also show that policy rules that focus solely on stabilizing wages and prices yield welfare outcomes very close to the first-best.
    JEL: E5
    Date: 3008–05
  13. By: Masato Shizume (Research Institute for Economics and Business Administration, Kobe University)
    Abstract: Temin [1989] and Eichengreen [1992] argue that monetary policy played a key role in each country's economic performance during the Great Depression, and that some European policymakers hesitated to pursue an expansionary monetary policy even after departing from gold. Why did these policymakers not pursue the opportunities they were able to pursue to the fullest extent? This study explores this issue by looking at the case of Japan, focusing on the constraints it faced and the remedies available to it as a small, open economy. This study explores the relationship between interest rates in Japan and in the major international financial centers, using a new series of representative long-term interest rates and narratives. This study reveals that Japan imposed a restrictive monetary policy on itself even after departing from the gold standard. Japan did so because it needed to maintain its ties both with its trading partners and with the international financial markets.
    JEL: E42 N15
    Date: 2007–10
  14. By: Andrew Atkeson; Vyjayanthi Chari; Patrick Kehoe
    Abstract: Monetary policy instruments di¤er in tightness. how closely they are linked to in.a- tion. and transparency. how easily they can be monitored. Tightness is always desirable, while transparency is desirable only if policymakers cannot commit to future policies. We show that because interest rates can be made endogenously tight they have a natural advantage over both money growth and exchange rates. We also show that interest rates and exchange rates, because they are prices, are more transparent than money growth and thus have a natural advantage over money growth. Our model provides some insights into why developed economies tend to use inter- est rates as their primary policy instrument and why less-developed economies, in which interest rates are not available as an instrument, tend to use exchange rates.
    Date: 2007–11
  15. By: Andrew Coleman (Motu Economic and Public Policy Research); Özer Karagedikli (Bank of England)
    Abstract: This paper examines the relative size of the effects of New Zealand monetary policy and macroeconomic data surprises on the spot exchange rate, 2 and 5 year swap rate differentials, and the synthetic forward exchange rate schedule. We find that the spot exchange rate and 5 year swap rates respond by a similar magnitude to monetary surprises, implying there is little response of the forward exchange rate to this type of news. In contrast, the spot exchange rate responds by nearly three times as much as 5 year interest rates to CPI and GDP surprises, implying that forward rates appreciate to higher than expected CPI or GDP news. This is in contrast to standard theoretical models and US evidence. Lastly, we show that exchange rates but not interest rates respond to current account news. The implications of these results for monetary policy are considered.
    Keywords: New Zealand, interest rates, exchange rates, news
    Date: 2008–06
  16. By: John Weeks (Professor Emeritus, School of Oriental and African Studies, University of London)
    Abstract: This paper inspects the standard policy rule that under a flexible exchange rate regime with perfectly elastic capital flows monetary policy is effective and fiscal policy is not. The logical validity of the statement requires that the domestic price level effect of devaluation be ignored. The price level effect is noted in some textbooks, but not analysed. When it is subjected to a rigorous analysis, the interaction between exchange rate changes and domestic price level changes render the standard statement false. The logically correct statement would be, under a flexible exchange rate regime with perfectly elastic capital flows the effectiveness of monetary policy depends on the values of the import share and the sum of the trade elasticities. Monetary policy will be more effective than fiscal policy if and only if the sum of the trade elasticities exceeds the import share. Inspection of data from developing countries indicates a low effectiveness of monetary policy under flexible exchange rates. In the more general case of less than perfectly elastic capital flows, the conditions for monetary policy to be more effective than fiscal policy are even more restrictive. Use of empirical evidence on trade shares and interest rate differentials suggest that for most countries fiscal policy would prove more effective than monetary policy under a flexible exchange rate regime. In any case, the general theoretical assertion that monetary policy is more effective is incorrect. The results sustain the standard Keynesian conclusion that fiscal policy is more effective, whether the exchange rate is fixed or flexible. (...)
    Keywords: The Effectiveness of Monetary Policy Reconsidered
    Date: 2008–06
  17. By: Lorca-Susino, Maria
    Abstract: Until the 19th and mid-20th centuries, economic theory explained that the economic status of a country was represented by the strength of its currency.2 This strength is measured by the exchange rate of one currency vis-á-vis another currency, a “zero-sum” game in which one currency gains what the other loses. In fact, during the 19th century, the strength of the Pound Sterling facilitated Britain’s global hegemonic political and economic power known as the Pax Britanica. During the 20th century, the strength of the US dollar represented both the economic and political hegemony of the US around the world known as the Pax Americana. Nowadays, the weakness of the US dollar is making specialists wonder if we are witnessing the end of Pax Americana and the beginning of something else, possibly a Pax Europea, led by the strength of the euro. This is the argument surrounding the current behaviour of the US$-€ exchange rate and its effect on the economic performance of these two economic blocs. While the current exchange rate between the US dollar and the euro has been considered a blessing for the US, it has become a matter of concern for most Eurozone countries. In fact, we are witnessing an unprecedented scenario where the country with a weak currency is actually pleased and the group of countries with a strong currency is worried. The strength of the euro is becoming irritating for the Eurozone and, nevertheless, the weakness of the US dollar is also pushing it to the brink of losing its status as a global currency. This exchange rate debate is accompanied by another debate concerning how the latest monetary policy actions taken by the US and Eurozone monetary authorities3, aimed at solving current economic imbalances, are affecting the US$-€ exchange rate. Scholars, economists, and politicians argue that these monetary policies seem unable to solve today’s economic problems in the EU as well as in the Eurozone, but are having a tremendous impact on the US$-€ exchange rate. This paper will explain in layman’s terms the relationship (or lack thereof) between two of today’s most important economic issues: the US dollar and euro exchange rate, and the monetary policy behind it.
    Keywords: US dolla; euro; Monetary Policy; INTOR
    JEL: E5 A10
    Date: 2008–04
  18. By: Michael J. Lamla (KOF Swiss Economic Institute, ETH Zurich, Switzerland); Sarah M. Lein (KOF Swiss Economic Institute, ETH Zurich, Switzerland)
    Abstract: This paper analyzes the impact of the media on consumers' inflation expectations. We distinguish two channels through which media can influence expectations. First, the intensity of news coverage on inflation plays a role (volume channel). Second, the content of these reports matters (tone channel). Employing a unique data set capturing media reports on inflation in Germany comprising 01/1998-12/2006 we are able to discriminate between these two effects. We find that the volume effect generally improves the accuracy of consumer forecasts while the tone channel induces a media bias.
    Keywords: Monetary policy, expectation formation, media coverage, media bias
    JEL: E52 D83
    Date: 2008–06
  19. By: Athanasios Orphanides; John C. Williams
    Abstract: This paper examines the robustness characteristics of optimal control policies derived un- der the assumption of rational expectations to alternative models of expectations. We assume that agents have imperfect knowledge about the precise structure of the economy and form expectations using a forecasting model that they continuously update based on incoming data. We find that the optimal control policy derived under the assumption of rational expectations can perform poorly when expectations deviate modestly from rational expectations. We then show that the optimal control policy can be made more robust by deemphasizing the stabilization of real economic activity and interest rates relative to infla- tion in the central bank loss function. That is, robustness to learning provides an incentive to employ a "conservative" central banker. We then examine two types of simple monetary policy rules from the literature that have been found to be robust to model misspecification in other contexts. We find that these policies are robust to empirically plausible parame- terizations of the learning models and perform about as well or better than optimal control policies.
    JEL: E52
    Date: 2008–04
  20. By: Kang Shi (The Chinese University of Hong Kong, Hong Kong Institute for Monetary Research); Juanyi Xu (Hong Kong University of Science and Technology, Simon Fraser University, Hong Kong Institute for Monetary Research)
    Abstract: This paper develops a small open economy model with sticky prices to show why a flexible exchange rate policy is not desirable in East Asian emerging market economies. We argue that weak input substitution between local labor and import intermediates in traded goods production and extensive use of foreign currency in export pricing in these economies can help to explain this puzzle. In the presence of these two trade features, the adjustment role of the exchange rate is inhibited, so even a flexible exchange rate cannot stabilize the real economy in face of external shocks. Instead, due to the high exchange rate pass-through, exchange rate changes will lead to instability in both inflation and production cost. As a result, a fixed exchange rate may dominate a monetary policy rule with high exchange rate flexibility in terms of welfare. In a sense, our finding provides a rationale for the "fear of floating" phenomenon in these economies. That is, "fear of floating" may be central banks' rational reaction when these economies are constrained by the trade features mentioned above.
    Keywords: Input Substitution, Export Pricing, Exchange Rate Flexibility, Welfare
    JEL: F3 F4
    Date: 2008–10
  21. By: António Portugal Duarte (GEMF and Faculdade de Economia, Universidade de Coimbra); João Sousa Andrade (GEMF and Faculty of Economics of the University of Coimbra); Adelaide Duarte (GEMF and Faculty of Economics of the University of Coimbra)
    Abstract: This work examines the participation of the Portuguese economy in the ERM of the EMS based on some of the main predictions of the target zone literature. The exchange rate distribution reveals that the majority of the observations lie close to the central parity, thus rejecting one of the key predictions of the Krugman (1991) model. Using a M-GARCH model however we confirm that there is a trade-off between exchange rate volatility and interest rates differential volatility. These results express the increased credibility of the Portuguese monetary policy, due manly to the modernisation of the banking and financial system and to the progress made in terms of the disinflation process under an exchange rate target zone policy. In accordance to these results we can say that the participation of the Portuguese escudo in an exchange rate target zone was crucial to create the conditions of stability, credibility and confidence necessary for the adoption of a single currency.
    Keywords: Credibility, Exchange rate stability, M-GARCH, ERM, EMS, Volatility and target zones
    JEL: C32 C51 F31 F41 G15
    Date: 2008
  22. By: Fischer, Andreas M. (Swiss National Bank); Ranaldo, Angelo (Swiss National Bank)
    Abstract: Does global currency volume increase on days when the Federal Open Market Committee (FOMC) meets? To test the hypothesis of excess currency volume on FOMC days, we use a novel data set from the Continuous Linked Settlement (CLS) Bank. The CLS measure captures roughly half of the global trading volume in foreign exchange (FX) markets. We find strong evidence that trading volume increases in the order of 5% across currency areas on FOMC days during 2003 to 2007. This result holds irrespective of the size of price changes in currency markets and FOMC policy shocks. The new evidence of excess FX trading on FOMC days is inconsistent with standard models of the asset market approach with homogenous agents.
    Keywords: Trading volume; FOMC; Global linkages
    JEL: F31 G12
    Date: 2008–03–01
  23. By: James Forder
    Abstract: In his Nobel lecture, Friedman built on his earlier argument for a 'natural rate of unemployment' by painting a picture of an economics profession which, as a result of foolish mistakes, had accepted the Phillips curve as offering a lasting trade-off between inflation and unemployment and were thereby led to advocate a policy of inflation. It is argued here that in fact the orthodox economists of the time did not accept Phillips' analysis; almost no one made the mistakes in question; and very few advocated inflation on bases vulnerable to Friedman's theoretical critique. The Phillips curve was put to various uses, but advocating inflation was hardly amongst them. It is suggested that one lasting result of the uncritical acceptance of Friedman's history is to limit what appears to be within the reasonable range of views about macroeconomic policy.
    Keywords: Phillips Curve, Inflation, Friedman
    JEL: B22 B31 E12
    Date: 2008
  24. By: Genberg, Hans; He, Dong; Leung, Frank
    Abstract: This paper reviews the performance of the Hong Kong dollar Linked Exchange Rate system since the introduction of the three refinements to it in May 2005. It presents an analytical framework which argues that, in a fully credible exchange rate target zone regime, the spot exchange rate normally stays inside the band but does not have a natural tendency to converge towards the centre of the zone. While a certain level of interest rate differential between the Hong Kong dollar and the US dollar may persist, it should not grow significantly larger than what is implied by the width of the Convertibility Zone. Judged against this framework, the developments since May 2005 point to increased credibility of the refined Linked Exchange Rate system.
    Keywords: Hong Kong dollar linked exchange rate system
    JEL: E58 F31
    Date: 2007–06
  25. By: Leo Krippner (AMP)
    Abstract: Yield curve models of the Nelson and Siegel (1987) class have proven themselves popular empirical tools in finance and economics, but they lack a formal theoretical justification. Hence, this article uses a multifactor version of the Cox, Ingersoll and Ross (1985a) continuous-time general-equilibrium economy to derive a macroeconomic foundation for a theoretically-consistent version of the Nelson and Siegel class of yield curve models. It is established that the level and shape of the yield curve as represented by NS models may be explained succinctly in terms of expectations of inflation and real output growth within an underlying economic model. This theoretically-rigorous yet parsimonious and intuitive framework is applicable as a macro-finance tool, and the application in this article provides a ready interpretation of a series of empirical results from the macro-finance literature that relate the level and slope of the yield curve to output growth and inflation.
    Keywords: yield curve; term structure of interest rates; macro-finance; Nelson and Siegel model; Heath-Jarrow-Morton framework
    JEL: E43 E31 E32
    Date: 2008–06–01
  26. By: Yuko Hashimoto (Toyo University, International Monetary Fund, Hong Kong Institute for Monetary Research)
    Abstract: This paper attempts to identify whether the recent foreign reserve accumulation in Asian economies has been too extraordinary to recover the moderate level of reserves which depleted at the time of the currency crisis in 1997-1998. First of all, the level of reserves numerated by various economic fundamentals such as broad money, imports and short-term external debt in Asian economies was examined in order to judge whether the level was high enough to weather speculative pressures at the onset of the crisis in 1997. The analysis is based on a Brownian motion model with an absorbing barrier. Although most Asian economies appeared to have larger reserves (reserve indicators) than the estimated threshold at the time of the crisis of 1997, reserves in terms of short-term external debt were apparently not sufficient to avoid speculative attacks. Then, based on the estimated threshold of reserve indicators, the likelihood of a 25% devaluation within three months ahead is calculated. Probabilities of currency devaluation vary from time to time, among countries, and among reserve indicators. The devaluation likelihood was modest in the mid 1990s, but then it showed a big jump in 1997 in Indonesia, Thailand, Korea, and Philippines.
    Keywords: foreign reserves, accumulation, Asia, threshold, currency crisis
    Date: 2008–06
  27. By: Fabrizio Mattesini (Faculty of Economics, University of Rome "Tor Vergata"); Leonardo Becchetti (Faculty of Economics, University of Rome "Tor Vergata")
    Abstract: The paper investigates the reaction of the Federal Reserve to developments in the stock market. The issue is analyzed by first constructing an Index of Stock Price Misalignement in which the fundamental value of the stocks is computed on the basis of the discounted cash flow approach and by then including this index, among the regressors, into a forward looking Taylor rule. In accordance with the descriptive evidence, based mainly on the analysis of the FOMC meetings and public statements, our findings show that the Fed tends to lower the Fed funds rate when stock prices fall below their fundamental value, while there is no evidence of monetary stringency during episodes of exuberance in the stock market.
    Date: 2008–07–14
  28. By: Andrew Coleman (Motu Economic and Public Policy Research)
    Abstract: This paper analyses the effect of inflation on the measurement of saving and housing affordability in New Zealand. When the inflation rate is positive, the income and saving of lenders is overstated and the saving of borrowers is understated because a portion of the interest earnings on capital are not true earnings but merely compensation for inflation. Because New Zealand has a large international debt position, this distortion means aggregate saving is understated, possibly by 2 percent of gross domestic product per year. In addition, a standard measure of the cost of financing the purchase of a house is overstated by approximately fifty percent, as a large part of mortgage payments are actually saving. Nevertheless, at the end of 2007 the cost of financing house purchase in New Zealand was at a cyclical high, approximately 40 percent higher than its average level since 1990.
    Keywords: inflation, real interest rates, housing affordability
    JEL: E01 E40
    Date: 2008–06
  29. By: Barry E. Jones (Department of Economics, Binghamton University, PO Box 6000 Binghamton, NY 13902, USA.); Livio Stracca (Counsel to the Executive Board, European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Narrow and broad money measures (including Divisia aggregates) have been found to have explanatory power for UK output in backward-looking specifications of the IS curve. In this paper, we explore whether or not real balances enter into a forward-looking IS curve for the UK, building on the theoretical framework of Ireland (2004). To do this, we test for additive separability between consumption and money over a sizeable part of the post-ERM period using non-parametric methods. If consumption and money are not additively separable, then real money balances enter into the forward-looking IS curve (the converse does not hold, however). A main finding is that the UK data seem to be broadly consistent with additive separability for the the more recent period from 1999 to 2007. JEL Classification: C14, C43, C63, E21, E41.
    Keywords: Additive Separability, IS Curve, Non-Parametric Tests, Measurement Error, Divisia Monetary Aggregates.
    Date: 2008–06
  30. By: Paul Castillo (Banco Central de Reserva del Perú); Daniel Barco (Banco Central de Reserva del Perú)
    Abstract: This paper assesses the policies implemented in the Peruvian economy in response to the sudden stop of capital flows of the end of the nineties. The Peruvian experience during this episode is an interesting case-study because it offers an example of a highly dollarized economy where a sudden stop of capital flows neither had dramatic negative effects on the banking system nor generated an abrupt fall on output. We argue that the large pool of international reserves, the investments on the tradable sector before 1997 and the performance of the fiscal policy during and before the period of financial distress were fundamental to this outcome. We further extract policy lessons and discuss the strengths and the weakness of the Peruvian economy to this type of shocks nowadays.
    Keywords: Sudden Stops, Peru, International Reserves, and Policy Responses
    JEL: E44 E58 F32 F34
    Date: 2008–01
  31. By: Christian Ewerhart (Corresponding author: Institute for Empirical Research in Economics (IEW), Winterthurerstrasse 30, 8006 Zurich, Switzerland.); Jens Tapking (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: A standard repurchase agreement between two counterparties is considered to examine the endogenous choice of collateral assets, the feasibility of secured lending, and welfare implications of the central bank’s collateral framework. As an important innovation, we allow for two-sided counterparty risk. Our findings relate to empirical characteristics of repo transactions and have an immediate bearing on market developments since August 2007. JEL Classification: G21, G32, E51.
    Keywords: Counterparty risk, repurchase agreements, collateral, liquidity, haircuts.
    Date: 2008–06
  32. By: Taboga, Marco; Pericoli, Marcello
    Abstract: We introduce a two-country no-arbitrage term-structure model to analyse the joint dynamics of bond yields, macroeconomic variables and the exchange rate. The model allows to understand how exogenous shocks to the exchange rate affect the yield curves, how bond yields co-move in different countries and how the exchange rate is influenced by the interactions between macroeconomic variables and time-varying bond risk premia. Estimating the model with US and German data, we obtain an excellent fit of the yield curves and we are able to account for up to 75 per cent of the variability of the exchange rate. We find that time-varying risk premia play a non-negligible role in exchange rate fluctuations, due to the fact that a currency tends to appreciate when risk premia on long-term bonds denominated in that currency rise. A number of other novel empirical findings emerge.
    Keywords: Bond risk premia;exchange rate;no-arbitrage
    JEL: E43 C01
    Date: 2008–06
  33. By: Yin-wong Cheung (University of California, Santa Cruz, USA, Hong Kong Institute for Monetary Research); Hiro Ito (Portland State University, Portland, USA)
    Abstract: We examine the empirical determinants of the demand for international reserves and compare the experiences of some Asian and Latin American economies. Our empirical results indicate that different vintages of the model of international reserves give different inferences about the appropriate level of international reserves. The developed and developing economies have equations of the demand for international reserves that are quite different from each other. Further, the Asian economies and the Latin American economies have different empirical determinants of the demand for international reserves. Our results highlight the complexity of evaluating whether an economy is holding an excessive or deficient level of international reserves ¨C the inference can be heavily dependent on the choice of a benchmark model. A direct comparison affirms the perception that the Asian economies tend to hold more international reserves than the Latin American economies.
    Keywords: Foreign Exchange Reserves, Macro Determinants, Financial Factors, Institutional Variables, Excessive Hoarding of International Reserves
    JEL: F31 F33 F34 F36
    Date: 2008–07
  34. By: Salazar, Eduardo
    Abstract: This paper tries to explain, using a model that includes asset market risk country, the behavior of nominal exchange rate, as well as determine the impact of this risk in determining the exchange rate, also seeks to establish whether the exchange rate is below the level predicted by their bases to determine whether they have to take steps to bring its level of long-term. The econometric methodology used is that of the ordinary least squares, the results are consistent with the logic and economic theory, it shows that among the country risk and exchange rate there is a direct relationship, namely that reductions of country risk generate currency appreciations, also shows evidence that the nominal exchange rate is below its equilibrium level.
    Keywords: Riesgo país; Tipo de Cambio Nomina; Modelos de mercado de activos; Tipo de cambio de equilibrio
    JEL: F42 F41 C22 F31
    Date: 2008–04–14
  35. By: Rasmus Fatum (University of Alberta); Michael M. Hutchison (University of California, Santa Cruz, Hong Kong Institute for Monetary Research)
    Abstract: Estimating the effect of official foreign exchange market intervention is complicated by the fact that intervention at any point entails a self-selection choice made by the authorities and that no counterfactual is observed. To address these issues, we estimate the counterfactual exchange rate movement in the absence of intervention by introducing the method of propensity score matching to estimate the average treatment effect (ATE) of intervention. To derive the propensity scores we introduce a new intervention reaction function that includes the difference between market expectations and official announcements of macroeconomic developments that can influence the decision to intervene. We estimate the ATE for daily official intervention in Japan over the January 1999 to March 2004 period. This sample encompasses a remarkable variation in intervention frequencies as well as unprecedented frequent intervention towards the latter part of the period. We find that the effects of intervention vary dramatically and inversely with the frequency of intervention: Intervention is effective over the 1999 to 2002 period and ineffective (or possibly counterproductive) during 2003 and 2004. These results hold up to a variety of robustness tests. Only sporadic and relatively infrequent intervention appears to be effective.
    Keywords: Foreign Exchange Intervention, Bank of Japan, Self-Selection, Matching Methods
    JEL: E58 F31 G15
    Date: 2008–02
  36. By: Thierry Bracke (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Michael Fidora (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Since the late-1990s, the global economy is characterised by historically low risk premia and an unprecedented widening of external imbalances. This paper explores to what extent these two global trends can be understood as a reaction to three structural shocks in different regions of the global economy - (i) monetary shocks (“excess liquidity” hypothesis), (ii) preference shocks (“savings glut” hypothesis), and (iii) investment shocks (“investment drought” hypothesis). In order to uniquely identify these shocks in an integrated framework, we estimate structural VARs for the two main regions with widening imbalances, the United States and emerging Asia, using sign restrictions that are compatible with standard New Keynesian and Real Business Cycle models. Our results show that monetary shocks potentially explain the largest part of the variation in imbalances and financial market prices. We find that havings shocks and investment shocks explain less of the variation. Hence, a “liquidity glut” may have been a more important driver of real and financial imbalances in the US and emerging Asia than a “savings glut”. JEL Classification: E2, F32, F41, G15.
    Keywords: Global imbalances, global liquidity, savings glut, investment drought, current account, structural VARs.
    Date: 2008–06
    Abstract: We suggest a new transmission channel of contagion on the interbank market, namely the liquidity channel. We apply this idea to the Russian banking sector and .nd that the liquidity channel contributes signi.cantly to a better understanding and prediction of actual interbank market crises. Interbank market stability Granger causes the interbank market struc- ture, while the opposite causality is rejected. This emboldens the case for viewing the interbank market structure as endogenous. The results corroborate the thesis that prudential regulation at individual bank level is insu¢ cient to prevent systemic crises. We demonstrate that liquidity injections of a classical LOLR can e¤ectively mitigate coordination fail- ures on the interbank market not only in theory, but also in practice. In short: liquidity matters.
    Keywords: interbank market stability, contagion, liquidity channel, lender of last resort, Russia
    JEL: C8 G21
    Date: 2008–06

This nep-mon issue is ©2008 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.