nep-mon New Economics Papers
on Monetary Economics
Issue of 2008‒09‒05
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. International Financial Aggregation and Index Number Theory: A Chronological Half-Century Empirical Overview By Barnett, William A.; Chauvet, Marcelle
  2. Monetary Policy Surprises and Interest Rates: Choosing between the Inflation-Revelation and Excess Sensitivity Hypotheses By THORBECKE, Willem; Hanjiang ZHANG
  3. Optimal monetary policy with distinct core and headline inflation rates By Martin Bodenstein; Christopher J. Erceg; Luca Guerrieri
  4. The advantage of flexible targeting rules By Andrea Ferrero
  5. A pioneer of a new monetary policy? Sweden’s price level targeting of the 1930s revisited By Tobias Straumann; Ulrich Woitek
  6. Simple monetary rules under fiscal dominance By Michael Kumhof; Ricardo Nunes; Irina Yakadina
  7. The high-frequency impact of news on long-term yields and forward rates: Is it real? By Meredith J. Beechey; Jonathan H. Wright
  8. Optimal Fiscal and Monetary Policy under Sectorial Heterogeneity By Berriel, Tiago; Sinigaglia, Daniel
  9. Sterilization, monetary policy, and global financial integration By Joshua Aizenman; Reuven Glick
  10. Should there be intraday money markets? By Antoine Martin; James McAndrews
  11. Credit Market Distortions, Asset Prices and Monetary Policy By Pfajfar, D.; Santoro, E.
  12. Understanding changes in exchange rate pass-through By Yelena Takhtamanova
  13. DSGE models and central banks By Camilo E Tovar
  14. The Process of Circulation in Quesnay's Tableau Économique By Hernando Matallana
  15. Mean Reversion in US and International Short Rates By Charlotte Christiansen
  16. Explaining Macroeconomic and Term Structure Dynamics Jointly in a Non-linear DSGE Model By Martin Møller Andreasen
  17. Aggregate Trading Behaviour of Technical Models and the Yen-Dollar Exchange Rate 1976-2007 By Stephan Schulmeister
  18. Threshold adjustment in deviations from the law of one price By Luciana Juvenal; Mark P. Taylor
  19. Assessing the Impact of the ECB's Monetary Policy on the Stock Markets : A Sectoral View By Konstantin Kholodilin; Alberto Montagnoli; Oreste Napolitano; Boriss Siliverstovs
  20. Profitability of Technical Currency Speculation. The Case of Yen-Dollar Trading 1976-2007 By Stephan Schulmeister
  21. Understanding Bank Runs: The Importance of Depositor-Bank Relationships and Networks By Rajkamal Iyer; Manju Puri

  1. By: Barnett, William A.; Chauvet, Marcelle
    Abstract: This paper comprises a survey of a half century of research on international monetary aggregate data. We argue that since monetary assets began yielding interest, the simple sum monetary aggregates have had no foundations in economic theory and have sequentially produced one source of misunderstanding after another. The bad data produced by simple sum aggregation have contaminated research in monetary economics, have resulted in needless “paradoxes,” and have produced decades of misunderstandings in international monetary economics research and policy. While better data, based correctly on index number theory and aggregation theory, now exist, the official central bank data most commonly used have not improved in most parts of the world. While aggregation theoretic monetary aggregates exist for internal use at the European Central Bank, the Bank of Japan, and many other central banks throughout the world, the only central banks that currently make aggregation theoretic monetary aggregates available to the public are the Bank of England and the St. Louis Federal Reserve Bank. No other area of economics has been so seriously damaged by data unrelated to valid index number and aggregation theory. In this paper we chronologically review the past research in this area and connect the data errors with the resulting policy and inference errors. Future research on monetary aggregation and policy can most advantageously focus on extensions to exchange rate risk and its implications for multilateral aggregation over monetary asset portfolios containing assets denominated in more than one currency. The relevant theory for multilateral aggregation with exchange rate risk has been derived by Barnett (2007) and Barnett and Wu (2005).
    Keywords: Measurement error; monetary aggregation; Divisia index; aggregation; monetary policy; index number theory; exchange rate risk; multilateral aggregation; open economy monetary economics
    JEL: C43 E58 E52 E40 E41
    Date: 2008–08–08
  2. By: THORBECKE, Willem; Hanjiang ZHANG
    Abstract: Romer and Romer (R&R) reported that federal funds rate increases may raise expected inflation by revealing the Fed's private information about inflation. Gurkaynak, Sack, and Swanson (GSS) presented evidence that funds rate increases lowered long-term expected inflation. To choose between these hypotheses we examine how monetary policy surprises affect daily traded commodity prices, term interest rates, and forward interest rates. We find that funds rate increases in the 1970s raised gold and silver prices and that increases after 1989 lowered gold and silver prices. We also find that funds rate hikes over both sample periods primarily affected short-term interest rates and near-term forward rates. For the 1970s, these results suggest that R&R's explanation is correct. For recent years, they indicate that funds rate increases affect real rates and may also be consistent with GSS's findings.
    Date: 2008–08
  3. By: Martin Bodenstein; Christopher J. Erceg; Luca Guerrieri
    Abstract: In a stylized DSGE model with an energy sector, the optimal policy response to an adverse energy supply shock implies a rise in core inflation, a larger rise in headline inflation, and a decline in wage inflation. The optimal policy is well-approximated by policies that stabilize the output gap, but also by a wide array of "dual mandate" policies that are not overly aggressive in stabilizing core inflation. Finally, policies that react to a forecast of headline inflation following a temporary energy shock imply markedly different effects than policies that react to a forecast of core, with the former inducing greater volatility in core inflation and the output gap.
    Date: 2008
  4. By: Andrea Ferrero
    Abstract: This paper investigates the consequences of debt stabilization for inflation targeting. If the monetary authority perfectly stabilizes inflation while the fiscal authority holds constant the real value of debt at maturity, the equilibrium dynamics might be indeterminate. However, determinacy can be restored by committing to targeting rules for either monetary or fiscal policy that include a concern for stabilization of the output gap. In solving the indeterminacy problem, flexible inflation targeting appears to be more robust than flexible debt targeting to alternative parameter configurations and steady-state fiscal stances. Conversely, flexible fiscal targeting rules lead to more desirable welfare outcomes. The paper further shows that if considerations beyond stabilization call for a combination of strict inflation and debt targeting rules, the indeterminacy result can be overturned if the fiscal authority commits to holding constant debt net of interest rate spending.
    Keywords: Inflation targeting ; Banks and banking, Central ; Monetary policy ; Fiscal policy ; Debts, External
    Date: 2008
  5. By: Tobias Straumann; Ulrich Woitek
    Abstract: The paper re-examines Sweden’s price level targeting during the 1930s which is regarded as a precursor of today’s inflation targeting. According to conventional wisdom the Riksbank was the first central bank to adopt price level targeting as the guideline for its activities, although in practice giving priority to exchange rate stabilisation over price level stabilisation. On the basis of econometric analysis (Bayesian VAR) and the evaluation of new archival sources we come to a more skeptical conclusion. Our results suggest that it is hard to reconcile the Riksbank’s striving for a fixed exchange rate with the claim that it adopted price level targeting. This finding has implications for the prevailing view of the 1930s as a decade of great policy innovations.
    Keywords: Sweden, monetary policy, price level targeting, Great Depression
    JEL: N14 E42
    Date: 2008–08
  6. By: Michael Kumhof; Ricardo Nunes; Irina Yakadina
    Abstract: This paper asks whether an aggressive monetary policy response to inflation is feasible in countries that suffer from fiscal dominance, as long as monetary policy also responds to fiscal variables. We find that if nominal interest rates are allowed to respond to government debt, even aggressive rules that satisfy the Taylor principle can produce unique equilibria. But following such rules results in extremely volatile inflation. This leads to very frequent violations of the zero lower bound on nominal interest rates that make such rules infeasible. Even within the set of feasible rules the optimal response to inflation is highly negative, and more aggressive inflation fighting is inferior from a welfare point of view. The welfare gain from responding to fiscal variables is minimal compared to the gain from eliminating fiscal dominance.
    Date: 2008
  7. By: Meredith J. Beechey; Jonathan H. Wright
    Abstract: This paper uses high-frequency intradaily data to estimate the effects of macroeconomic news announcements on yields and forward rates on nominal and index-linked bonds, and on inflation compensation. To our knowledge, it is the first study in the macro announcements literature to use intradaily real yield data, which allow us to parse the effects of news announcements on real rates and inflation compensation far more precisely than we can using daily data. Long-term nominal yields and forward rates are very sensitive to macroeconomic news announcements. We find that inflation compensation is sensitive to announcements about price indices and monetary policy. However, for news announcements about real economic activity, such as nonfarm payrolls, the vast majority of the sensitivity is concentrated in real rates. Accordingly, we conclude that most of the sizeable impact of news about real economic activity on the nominal term structure of interest rates represents changes in expected future real short-term interest rates and/or real risk premia rather than changes in expected future inflation and/or inflation risk premia. This suggests that explanations for the puzzling sensitivity of long-term nominal rates need to look beyond just inflation expectations and toward models that encompass uncertainty about the long-run real rate of interest.
    Date: 2008
  8. By: Berriel, Tiago; Sinigaglia, Daniel
    Abstract: This paper characterizes optimal fiscal and monetary policy in a new keynesian model with sectorial heterogeneity in price stickiness. In particular, we (i) derive a purely quadratic welfare-based loss function from an approximation of the representative agent's utility function and (ii) provide the optimal target rule for fiscal and monetary policy. Differently from the homogeneous case, the loss function includes sectorial inflation variances instead of aggregate inflation, with weights proportional to the degree of price stickiness; and sectorial output gaps instead of aggregate output gap with equal weight in each sector. Optimal policy implies a very strong positive correlation among sectorial output gaps and some dispersion of sectorial inflation in response to shocks. Larger heterogeneity in price stickiness implies larger impact of shocks on aggregate inflation. Optimal taxes are more responsive in sectors with stickier prices.
    JEL: E52 E63
    Date: 2008–04–08
  9. By: Joshua Aizenman; Reuven Glick
    Abstract: This paper investigates the changing pattern and efficacy of sterilization within emerging market countries as they liberalize markets and integrate with the world economy. We estimate the marginal propensity to sterilize foreign asset accumulation associated with net balance of payments inflows, across countries and over time. We find that the extent of sterilization of foreign reserve inflows has risen in recent years to varying degrees in Asia as well as in Latin America, consistent with greater concerns about the potential inflationary impact of reserve inflows. We also find that sterilization depends on the composition of balance of payments inflows.
    Keywords: Emerging markets ; Bank reserves ; International finance
    Date: 2008
  10. By: Antoine Martin; James McAndrews
    Abstract: In this paper, we consider the case for an intraday market for reserves. We discuss the separate roles of intraday and overnight reserves and argue that an intraday market could be organized in the same way as the overnight market. We present arguments for and against a market for intraday reserves when the marginal cost of overnight reserves is positive. We also consider how reserves should be supplied when the cost of overnight reserves is zero. In that case, the distinction between overnight and intraday reserves becomes blurred, raising an important question: What is the role of the overnight market?
    Keywords: Bank reserves ; Money market ; Banks and banking, Central
    Date: 2008
  11. By: Pfajfar, D.; Santoro, E.
    Abstract: In this paper we develop a sticky price DSGE model to study the role of capital market imperfections for monetary policy implementation. Recent empirical and theoretical studies have stressed the e¤ect of .rms.external .nance on their pricing decisions. The so-called cost channel of the transmission mechanism has been explored within New Keynesian frameworks that pose particular emphasis on in.ation dynamics. These models generally disregard the role of external .nance for the dynamics of asset prices. We ask whether monetary policy should respond to deviations of asset prices from their frictionless level and, more importantly, if the answer to this question changes when financial frictions are properly taken into account. We analyze these issues from the vantage of equilibrium determinacy and stability under adaptive learning. We show that usual conditions for equilibrium uniqueness and E-stability are significantly altered when the cost channel matters. Nevertheless, we find that responding to actual or expected asset price misalignments helps at restoring determinacy and stability under learning. These conclusions are further enforced in the presence of a high degree of pass-through from policy to bank lending rates.
    Keywords: Monetary Policy, Capital Market Imperfections, Cost Channel, Asset Price.
    JEL: E31 E32 E52
    Date: 2008–04
  12. By: Yelena Takhtamanova
    Abstract: Recent research suggests that there has been a decline in the extent to which firms “pass through” changes in exchange rates to prices. Beyond providing further evidence in support of this claim, this paper proposes an explanation for the phenomenon. It then presents empirical evidence of a structural break during the 1990s in the relationship between the real exchange rate and CPI inflation for a set of fourteen OECD countries. It is suggested that the recent reduction in the real exchange rate pass-through can be attributed in part to the low-inflation environment of the 1990s.
    Keywords: Foreign exchange rates
    Date: 2008
  13. By: Camilo E Tovar
    Abstract: Over the past 15 years there has been remarkable progress in the specification and estimation of dynamic stochastic general equilibrium (DSGE) models. Central banks in developed and emerging market economies have become increasingly interested in their usefulness for policy analysis and forecasting. This paper reviews some issues and challenges surrounding the use of these models at central banks. It recognises that they offer coherent frameworks for structuring policy discussions. Nonetheless, they are not ready to accomplish all that is being asked of them. First, they still need to incorporate relevant transmission mechanisms or sectors of the economy; second, issues remain on how to empirically validate them; and finally, challenges remain on how to effectively communicate their features and implications to policy makers and to the public. Overall, at their current stage DSGE models have important limitations. How much of a problem this is will depend on their specific use at central banks.
    Keywords: DSGE models, central banks, monetary policy, communication and forecasting
    Date: 2008–09
  14. By: Hernando Matallana
    Abstract: At the end of the 17th century capitalism had become the new social and economic order in northern Western Europe. Ever since the trading channels through which money and commodities change hands between the different agents, the actual sequence of these all-comprising monetary exchange processes, and the intertwining of the processes of production and circulation have always been a central issue in heterodox economic thought. The paper discusses Quesnay’s contribution to the theoretical foundation of the social process of circulation of capital in a monetary production economy in the Tableau économique. Additionally, the accounting dynamics of the circulation process of the agricultural kingdom is described by means of system of credit-debit tables currently used by German authors.
    Date: 2008–08–06
  15. By: Charlotte Christiansen (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: In this paper we extend the CKLS one factor short rate model to include extreme value nonlinear mean reversion. Similarly to a recent stock market study, we include the smallest short rate during the previous year in the mean equation. We investigate the US and five other major markets (Canada, Germany, Japan, Switzerland, and the UK). There is extreme value mean reversion in the US short rate. For Japan there is both linear and nonlinear mean reversion. For the remaining short rates there is no evidence of mean reversion.
    Keywords: Short term interest rate, Mean reversion, Extreme value, Nonlinearity
    JEL: G12 G15 E43 C13
    Date: 2008–09–02
  16. By: Martin Møller Andreasen (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: This paper shows how a standard DSGE model can be extended to reproduce the dynamics in the 10 year yield curve for the post-war US economy with a similar degree of precision as in reduced form term structure models. At the same time, we are able to reproduce the dynamics of four key macro variables almost perfectly. Our extension of a standard DSGE model is to introduce three non-stationary shocks which allow us to explain interest rates with medium and long maturities without distorting the dynamics of the macroeconomy.
    Keywords: Price stickiness, Stochastic and deterministic trends, Term structure model, The Central Difference Kalman Filter, Yield curve
    JEL: E10 E32 E43 E44
    Date: 2008–09–02
  17. By: Stephan Schulmeister (WIFO)
    Abstract: The study analyses the interaction between the trading behaviour of 1,024 moving average and momentum models and the fluctuations of the yen-dollar exchange rate. I show first that these models would have exploited exchange rate trends quite profitably between 1976 and 2007. I then show that the aggregate transactions and positions of technical models exert an excess demand pressure on currency markets since they are mostly on the same side of the market. When technical models produce trading signals almost all of them are either buying or selling, when they maintain open positions they are either long or short. A strong interaction prevails between exchange rate movements and the transactions triggered by technical models. An initial rise of the exchange rate due to news, e.g., is systematically lengthened through a sequence of technical buy signals.
    Keywords: Exchange rate, Technical Trading, Speculation, Heterogeneous Agents
    Date: 2008–07–10
  18. By: Luciana Juvenal; Mark P. Taylor
    Abstract: Using self-exciting threshold autoregressive models, we explore the validity of the law of one price (LOOP) for sixteen sectors in nine European countries. We and strong evidence of nonlinear mean reversion in deviations from the LOOP and highlight the importance of modelling the real exchange rate in a nonlinear fashion in an attempt to measure speeds of real exchange rate adjustment. Using the US dollar as a reference currency, the half-lives of sectoral real exchange rates shocks, calculated by Monte Carlo integration, imply much faster adjustment than the consensus half-life estimates of three to five years. The results also imply that transaction costs vary significantly across sectors and countries.
    Keywords: Prices ; Foreign exchange rates
    Date: 2008
  19. By: Konstantin Kholodilin; Alberto Montagnoli; Oreste Napolitano; Boriss Siliverstovs
    Keywords: Higher Education, Financial Incentives, Competing Risk Model
    JEL: H52 H24 I28
    Date: 2008
  20. By: Stephan Schulmeister (WIFO)
    Abstract: The paper investigates the profitability of 1,024 moving average and momentum models and their components in the yen-dollar market. It turns out that all models would have been profitable between 1976 and 2007. The models produce more single losses than single profits. At the same time, the size of the single profits is on average much higher than the size of single losses because profitable positions last two to six times longer than unprofitable positions. Hence, the profitability of technical currency trading is exclusively due to the exploitation of persistent exchange rate trends. These results hold also when technical trading is examined over subperiods. The models which perform best over the most recent subperiod are in most cases significantly profitable also ex ante. However, the profitability of technical currency trading based on daily data has declined since the mid 1990s, and it has disappeared since 2000.
    Keywords: Exchange rate, Technical trading, Speculation
    Date: 2008–07–10
  21. By: Rajkamal Iyer; Manju Puri
    Abstract: We use a unique, new, database to examine micro depositor level data for a bank that faced a run. We use minute-by-minute depositor withdrawal data to understand the effectiveness of deposit insurance, the role of social networks, and the importance of bank-depositor relationships in influencing depositor propensity to run. We employ methods from the epidemiology literature which examine how diseases spread to estimate transmission probabilities of depositors running, and the significant underlying factors. We find that deposit insurance is only partially effective in preventing bank runs. Further, our results suggest that social network effects are important but are mitigated by other factors, in particular the length and depth of the bank-depositor relationship. Depositors with longer relationships and those who have availed of loans from a bank are less likely to run during a crisis, suggesting that cross-selling acts not just as a revenue generator but also as a complementary insurance mechanism for the bank. Finally, we find there are long term effects of a solvent bank run in that depositors who run do not return back to the bank. Our results help understand the underlying dynamics of bank runs and hold important policy implications.
    JEL: E58 G21
    Date: 2008–08

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