nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒01‒03
48 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Central Banks Two-Way Communication with the Public and Inflation Dynamics By Kosuke Aoki; Takeshi Kimura
  2. Opting Out of the Great Inflation: German Monetary Policy After the Break Down of Bretton Woods By Andreas Beyer; Vitor Gaspar; Christina Gerberding; Otmar Issing
  3. Optimal Monetary Policy under Imperfect Financial Integration By Nao Sudo; Yuki Teranishi
  4. Communicating monetary policy intentions: The case of Norges Bank By Amund Holmsen; Jan F. Qvigstad; Øistein Røisland; Kristin Solberg-Johansen
  5. Revealing the preferences of the US Federal Reserve By Pelin Ilbas
  6. Switching to the Inflation Targeting Regime: Does it necessary for the case of Egypt? By Ibrahim L. Awad
  7. The price puzzle: Mixing the temporary and permanent monetary policy shocks By Ida Wolden Bache; Kai Leitemo
  8. Stock Market Uncertainty and Monetary Policy Reaction Functions of the Federal Reserve Bank By Mario Jovanovic; Tobias Zimmermann
  9. The role of house prices in the monetary policy transmission mechanism in the U.S. By Hilde C. Bjørnland; Dag Henning Jacobsen
  10. Core Inflation - Why the Federal Reserve Got it Wrong By Andersson, Fredrik N. G.
  11. The “Credit–Cost Channel” of Monetary Policy. A Theoretical Assessment By Tamborini, Roberto
  12. Predictions of short-term rates and the expectations hypothesis of the term structure of interest rates By Michael Joyce; Jonathan Relleen; Steffen Sorensen
  13. Imperfect Knowledge and the Pitfalls of Optimal Control Monetary Policy By Athanasios Orphanides; John C. Williams
  14. Equilibrium income and monetary policy strategy: teaching macroeconomics with the MP curve By Canale, Rosaria Rita
  15. The Effects of Monetary Policy in the Czech Republic: An Empirical Study By Magdalena Morgese Borys; Roman Horvath
  16. Inflation Determinants in Paraguay: Cost Push versus Demand Pull Factors By Brieuc Monfort; Santiago Peña
  17. Measuring monetary policy expectations from financial market instruments By Joyce, Michael; Relleen, Jonathan; Sorensen, Steffen
  18. The daily and policy-relevant liquidity effects By Daniel L. Thornton
  19. Financial Intermediation, Liquidity and Inflation By Jonathan Chiu; Cesaire Meh
  20. Managing capital flows: The case of India. By Shah, Ajay; Patnaik, Ila
  21. Inflation Forecasting with Inflation Sentiment Indicators By Roland Döhrn; Christoph M. Schmidt; Tobias Zimmermann
  22. Financial globalization and monetary policy By Devereux, Michael B.; Sutherland, Alan
  23. Banking globalization, monetary transmission and the lending channel By Cetorelli, Nicola; Goldberg, Linda S.
  24. Modelling short-term interest rate spreads in the euro money market By Nuno Cassola; Claudio Morana
  25. The Term Structure and the Expectations Hypothesis: a Threshold Model By Matteo Modena
  26. What explains the spread between the euro overnight rate and the ECB's policy rate? By Tobias Linzert; Sandra Schmidt
  27. Long Run Inflation Indicators – Why the ECB got it Right By Andersson, Fredrik N. G.
  28. Impact of bank competition on the interest rate pass-through in the euro area By Michiel van Leuvensteijn; Christoffer Kok Sørensen; Jacob A. Bikker; Adrian van Rixtel
  29. The interday and intraday patterns of the overnight market - evidence from an electronic platform By Renaud Beaupain; Alain Durré
  30. Predictions of short-term rates and the expectations hypothesis of the term structure of interest rates By Massimo Guidolin; Daniel L. Thornton
  31. Sticky Prices, Limited Participation, or Both? By Niki X. Papadopoulou
  32. Futures contract rates as monetary policy forecasts By Giuseppe Ferrero; Andrea Nobili
  33. Policy Rate Decisions and Unbiased Parameter Estimation in Conventionally Estimated Monetary Policy Rules By Jiri Podpiera
  34. A Term Structure Decomposition of the Australian Yield Curve By Richard Finlay; Mark Chambers
  35. New Shocks, Exchange Rates and EquityPrices By Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
  36. Capital regulation, risk-taking and monetary policy: a missing link in the transmission mechanism? By Claudio Borio; Sahminan Haibin Zhu
  37. Global Governance of Global Monetary Relations: Rationale and Feasibility By Frieden Jeffry A.
  38. Imperfect Central Bank Communication: Information versus Distraction By Spencer Dale; Athanasios Orphanides; Par Osterholm
  39. Analyzing Determinants of Inflation When There Are Data Limitation:The Case of Sierra Leone By Jan Gottschalk; Ken Miyajima; Kadima D. Kalonji
  40. Extracting market expectations from yield curves augmented by money market interest rates - the case of Japan By Teppei Nagano; Naohiko Baba
  41. Interpreting deviations from covered interest parity during the financial market turmoil of 2007-08 By Naohiko Baba; Sahminan Frank Packer
  42. The organizational properties of money: Gustavo Del Vecchio's theory By Gianfranco Tusset
  43. DSGE Models and Central Banks By Tovar, Camilo Ernesto
  44. Probability of informed trading on the euro overnight market rate - an update By Julien Idier; Stefano Nardelli
  45. The term structure of interest rates across frequencies By Katrin Assenmacher-Wesche; Stefan Gerlach
  46. Why the effective price for money exceeds the policy rate in the ECB tenders? By Tuomas Välimäki
  47. Early warnings of inflation in India. By Bhattacharya, Rudrani; Patnaik, Ila; Shah, Ajay
  48. Sales and Monetary Policy By Bernardo Guimaraes; Kevin D. Sheedy

  1. By: Kosuke Aoki; Takeshi Kimura
    Abstract: Using a model of island economy where financial markets aggregate dispersed information ofthe public, we analyze how two-way communication between the central bank and the publicaffects inflation dynamics. When inflation target is observable and credible to the public,markets provide the bank with information about the aggregate state of the economy, andhence the bank can stabilize inflation. However, when inflation target is unobservable or lesscredible, the public updates their perceived inflation target and the information revealed frommarkets to the bank becomes less perfect. The degree of uncertainty facing the bank cruciallydepends on how two-way communication works.
    Keywords: Monetary policy, central bank communication, inflation target
    JEL: E31 E52 E58
    Date: 2008–11
  2. By: Andreas Beyer; Vitor Gaspar; Christina Gerberding; Otmar Issing
    Abstract: During the turbulent 1970s and 1980s the Bundesbank established an outstanding reputation in the world of central banking. Germany achieved a high degree of domestic stability and provided safe haven for investors in times of turmoil in the international financial system. Eventually the Bundesbank provided the role model for the European Central Bank. Hence, we examine an episode of lasting importance in European monetary history. The purpose of this paper is to highlight how the Bundesbank monetary policy strategy contributed to this success. We analyze the strategy as it was conceived, communicated and refined by the Bundesbank itself. We propose a theoretical framework (following Söderström, 2005) where monetary targeting is interpreted, first and foremost, as a commitment device. In our setting, a monetary target helps anchoring inflation and inflation expectations. We derive an interest rate rule and show empirically that it approximates the way the Bundesbank conducted monetary policy over the period 1975-1998. We compare the Bundesbank's monetary policy rule with those of the FED and of the Bank of England. We find that the Bundesbank's policy reaction function was characterized by strong persistence of policy rates as well as a strong response to deviations of inflation from target and to the activity growth gap. In contrast, the response to the level of the output gap was not significant. In our empirical analysis we use real-time data, as available to policy-makers at the time.
    JEL: E31 E32 E41 E52 E58
    Date: 2008–12
  3. By: Nao Sudo (Institute for Monetary and Economic Studies, Bank of Japan (E-mail: nao.sudo; Yuki Teranishi (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: yuuki.teranishi
    Abstract: After empirically showing imperfect financial integration among the euro countries, i.e., bank loan market heterogeneities in stickinesses of loan interest rates and markups from policy interest rate to loan rates, we build a New Keynesian model where such elements of imperfect financial integration coexist within a single currency area. Our welfare analysis reveals characteristics of optimal monetary policy. A central bank should take these heterogeneities into consideration. The optimal monetary policy is tied to difference in the degree of loan rate stickiness, the size of the steady-state loan rate markup, and the share of the loan market. By calibrating our model to the euro, we present the raking of the euro countries in terms of monetary policy priority. Because of the heterogeneity in the loan markets among the euro area countries, this ordering is not equivalent to the size of the financial market.
    Keywords: optimal monetary policy, financial integration, heterogeneous financial market, staggered loan contracts
    JEL: E44 E52
    Date: 2008–12
  4. By: Amund Holmsen (Norges Bank (Central Bank of Norway)); Jan F. Qvigstad (Norges Bank (Central Bank of Norway)); Øistein Røisland (Norges Bank (Central Bank of Norway)); Kristin Solberg-Johansen (Norges Bank (Central Bank of Norway))
    Abstract: Monetary policy works mainly through private agents' expectations. How precisely future policy intentions are communicated has, according to theory, implications for the outcome of monetary policy. Norges Bank has gone further than most other central banks in communicating its policy intentions. The Bank publishes its own interest rate forecast, along with forecasts of inflation, the output gap, and other key variables. Moreover, Norges Bank aims to be precise about how the policy intentions are formed. The Bank currently uses optimal policy in a timeless perspective as the normative benchmark when assessing the policy intentions. Given the reaction pattern based on the timeless perspective, the Bank identifies and explains the factors that bring about a change in the interest rate forecast from one Monetary Policy Report to the next. The main arguments for publishing the interest rate forecast are discussed and validated against three years of experience with such forecasts. In this paper, we find evidence of reduced volatility in market interest rates on the days with interest rate decisions, which suggests that communicating policy intentions more precisely improves the market participants' understanding of the central bank's reaction pattern.
    Keywords: Transparency, optimal monetary policy, interest rate forecasts
    JEL: E52 E58
    Date: 2008–12–12
  5. By: Pelin Ilbas (Norges Bank (Central Bank of Norway))
    Abstract: We use Bayesian methods to estimate the preferences of the US Federal Reserve by assuming that monetary policy is performed optimally under commitment since the mid-sixties. For this purpose, we distinguish between three subperiods, i.e. the pre-Volcker, the Volcker-Greenspan and the Greenspan period. The US economy is described by the Smets and Wouters (2007) model. We find that there has been a switch in the monetary policy regime since Volcker, with a focus on output growth instead of the output gap level as a target variable. We further show that both interest rate variability and interest rate smoothing are significant target variables, though less important than the in‡ation and output growth targets. We find that the "Great Moderation" of output growth is largely explained by the decrease in the volatility of the structural shocks. The Inflation Stabilization, however, is mainly due to the change in monetary policy that took place at the start of Volcker's mandate. During the Greenspan period, the optimal Taylor rule appears to be equally robust to parameter uncertainty as the unrestricted optimal commitment rule.
    Keywords: optimal monetary policy, central bank preferences, parameter uncertainty
    JEL: E42 E52 E58 E61 E65
    Date: 2007–09–01
  6. By: Ibrahim L. Awad (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: The purpose of this paper is to answer the question of whether the switching to the Inflation Targeting (IT) regime is necessary for the Egyptian case or not? Our judgment of applying IT regime in the Egyptian economy is established on doubled criterion. That is, the practical experience of the inflation targeters, and the efficiency of Monetary Targeting Regime (MTR) in the case of Egypt. Defining the efficiency of a monetary policy regime by the efficiency of the embedded nominal anchor to send the right message to all practitioners about the potential behavior of the price level, I assessed the efficiency of MTR in Egypt by measuring; whether there is a relationship between money and prices, the stability of the velocity of circulation, and the stability of the demand for money function. The study concluded that MTR is not efficient to tie down individuals expectations about the future path of inflation in Egypt. Taking into account that IT regime is a way to reform monetary policy and it does not worsen economic performance it becomes necessary for Egypt to switch to the IT regime once the prerequisites for IT regime have been met.
    Keywords: inflation targeting; demand for money function; monetary policy in Egypt.
    JEL: E31 E41 E51 E52 E58 E59
    Date: 2008–12
  7. By: Ida Wolden Bache (Norges Bank (Central Bank of Norway)); Kai Leitemo (Norwegian School of Management BI)
    Abstract: We argue that the correct identification of monetary policy shocks in a vector autoregression requires that the identification scheme distinguishes between permanent and transitorymonetary policy shocks. The permanent shocks reflect changes in the inflation target while the transitory shocks represent temporary deviations from the interest rate reaction function. Whereas both shocks may raise the nominal interest rate on impact, the inflation and output responses of the two shocks are different. We show, using a simple simulation experiment, that a failure to distinguish between the two types of shocks can result in a ”price puzzle”.
    Keywords: Monetary policy shocks, VAR modeling, identification, price puzzle
    JEL: E47 E52 E61
    Date: 2008–11–03
  8. By: Mario Jovanovic; Tobias Zimmermann
    Abstract: In this paper we examine the link between stock market uncertainty and monetary policy in the US. There are strong arguments why central banks should account for stock market uncertainty in their strategy. Amongst others, they can maintain the functioning of financial markets and moderate possible economic downswings. To describe the behavior of the Federal Reserve Bank, augmented forward-looking Taylor rules are estimated by GMM. The standard specification is expanded by a measure for stock market uncertainty, which is estimated by an exponential GARCH-model.We show that, given a certain level of inflation and output, US central bank rates are significantly lower when stock market uncertainty is high and vice versa. These results are achieved by using the federal funds rate from 1980:10 to 2007:7.
    Keywords: Monetary policy rules, financial markets, stock market uncertainty, EGARCH
    JEL: E58
    Date: 2008–11
  9. By: Hilde C. Bjørnland (Norwegian School og Management and Norges Bank (Central Bank of Norway)); Dag Henning Jacobsen (Norges Bank (Central Bank of Norway)and The World Bank)
    Abstract: We analyze the role of house prices in the monetary policy transmission mechanism in the U.S. using structural VARs. The VAR is identified using a combination of short-run and long-run (neutrality) restrictions, allowing for a contemporaneous interaction between monetary policy and various asset prices. By allowing the interest rate and asset prices to react simultaneously to news, we find the role of house prices in the monetary transmission mechanism to increase considerably. In particular, following a monetary policy shock that raises the interest rate by one percentage point, house prices fall immediately by 1 percent, for then to decline by a total of 4-5 percent after three years. Furthermore, the fall in house prices enhances the negative response in output and consumer price inflation that has traditionally been found in the conventional literature.
    Keywords: VAR, monetary policy, house prices, identification.
    JEL: C32 E52 F31 F41
    Date: 2008–12–12
  10. By: Andersson, Fredrik N. G. (Department of Economics, Lund University)
    Abstract: This paper introduces a new estimate of core inflation. Core inflation is a real time estimate of monetary inflation. Most existing core inflation estimate do not account for persistent relative price changes and are therefore likely to be poor estimates of the underlying monetary inflation rate. The proposed core inflation estimate estimates core inflation by first estimating the inflation signal in all price series from the price index with a wavelet based signal estimation algorithm. In the second step the weighted inflation average is calculated by using the expenditure weights from the price index as weights. Relative price changes are thus accounted for under the assumption that the household must apply to its long run budget restriction. The proposed estimate of core inflation is estimated using data from the United States and the United Kingdom. It is evaluated by comparing it to existing estimates of core inflation. The empirical analysis show that the proposed estimate has a smaller forecasting error of future inflation than the other estimates and that it rapidly responds to increases in monetary inflation.
    Keywords: Core Inflation; Signal Estimation; Wavelets
    JEL: E31 E52
    Date: 2008–12–02
  11. By: Tamborini, Roberto
    Abstract: Current macro-models based on the demand-side effects of monetary policy and sticky prices account for the observed correlations between policy interest rates, output and inflation, but they fail with regard to other empirical regularities, such as the negative effects of policy shocks on real wages and profits. Moreover, the lack in these models of an explicit role of the credit market in the transmission mechanism is now regarded as a major limitation. Drawing on the modern literature on the monetary transmission mechanisms with capital market imperfections, this paper presents a model of the “credit-cost channel” of monetary policy. The thrust of the model is that firms’ reliance on bank loans (“credit channel”) may make aggregate supply sensitive to bank interest rates (“cost channel”), which are in turn driven by the official rate controlled by the central bank. The model is assessed theoretically by examining whether, and under what conditions, changes in the policy interest rate produce the whole pattern of the observed relationships, with no recourse to non-competitive hypotheses and frictions. This result is obtained for parameter values in the range of available consensus estimates, with a caveat concerning labour-supply elasticity to the real wage rate.
    Keywords: Macroeconomics and monetary economics, monetary transmission mechanisms, credit channel, cost channel
    JEL: C32 E51
    Date: 2008
  12. By: Michael Joyce (Monetary Analysis, Bank of England, Threadneedle Street, London, EC2R, U.K.); Jonathan Relleen (Monetary Analysis, Bank of England, Threadneedle Street, London, EC2R, U.K.); Steffen Sorensen (Barrie+Hibbert Ltd, Financial Economic Research, 41 Lothbury, London, EC2R 7HG., U.K.)
    Abstract: This paper reviews the main instruments and associated yield curves that can be used to measure financial market participants’ expectations of future UK monetary policy rates. We attempt to evaluate these instruments and curves in terms of their ability to forecast policy rates over the period from October 1992, when the United Kingdom first adopted an explicit inflation target, to March 2007. We also investigate several model-based methods of estimating forward term premia, in order to calculate riskadjusted forward interest rates. On the basis of both in and out-of-sample test results, we conclude that, given the uncertainties involved, it is unwise to rely on any one technique to measure policy rate expectations and that the best approach is to take an inclusive approach, using a variety of methods and information. JEL Classification: E43, E44, E52.
    Keywords: Interest rates, forecasting, term premia.
    Date: 2008–12
  13. By: Athanasios Orphanides (Central Bank of Cyprus); John C. Williams (Federal Reserve Bank of San Francisco)
    Abstract: This paper examines the robustness characteristics of optimal control policies derived under the assumption of rational expectations to alternative models of expectations formation and uncertainty about the natural rates of interest and unemployment. 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 also allow for central bank uncertainty regarding the natural rates of interest and unemployment. We find that the optimal control policy derived under the assumption of perfect knowledge about the structure of the economy can perform poorly when knowledge is imperfect. These problems are exacerbated by natural rate uncertainty, even when the central bank's estimates of natural rates are efficient. We show that the optimal control approach can be made more robust to the presence of imperfect knowledge by deemphasizing the stabilization of real economic activity and interest rates relative to inflation in the central bank loss function. That is, robustness to the presence of imperfect knowledge about the economy 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 the alternative models of learning that we study and natural rate uncertainty and outperform the optimal control policy and generally perform as well as the robust optimal control policy that places less weight on stabilizing economic activity and interest rates.
    Keywords: Rational Expectations, Robust Control, Model Uncertainty, Natural Rate of Unemployment, Natural Rate of Interest.
    JEL: E52
    Date: 2008–07
  14. By: Canale, Rosaria Rita
    Abstract: The aim of the paper is to present a derivation of a simple tool describing monetary policy behaviour, useful to teach macroeconomic policies in open economies, the MP curve. The objective is to overcome the limits of the standard IS-LM model and underline the importance of the central bank strategy in influencing output and employment. We demonstrate that if the main policy instrument is the interest rate, the monetary policy authorities have very great influence in determining macroeconomic equilibrium. In fact the monetary policy strategy - of which the MP curve is the representation - is able to create, once given the dynamic supply curve and the IS curve, different levels of income in accordance to the inflation target, or different levels of inflation in accordance to the income target. Furthermore - because the nature and form of the MP curve depends both on constraints and targets the monetary policy considers and they might not be correctly interpreted - the central bank could assume a misleading behaviour, guiding the economic system toward a level of activity, not consistent with full employment and price stability
    Keywords: teaching intermidiate macroeconomics; monetary policy strategy; equilibrium income;
    JEL: E58 A20 E61
    Date: 2008–12–18
  15. By: Magdalena Morgese Borys; Roman Horvath
    Abstract: In this paper, we examine the effects of Czech monetary policy on the economy within the VAR, structural VAR, and factor-augmented VAR frameworks. We document a wellfunctioning transmission mechanism similar to the euro area countries, especially in terms of persistence of monetary policy shocks. Subject to various sensitivity tests, we find that a contractionary monetary policy shock has a negative effect on the degree of economic activity and the price level, both with a peak response after one year or so.Regarding prices at the sectoral level, tradables adjust faster than non-tradables, which is in line with microeconomic evidence on price stickiness. There is no price puzzle, as our data come from a single monetary policy regime. There is a rationale in using the realtime output gap instead of current GDP growth, as using the former results in much more precise estimates. The results indicate a rather persistent appreciation of the domestic currency after a monetary tightening, with a gradual depreciation afterwards.
    Keywords: Monetary policy transmission, real-time data, sectoral prices, VAR.
    JEL: E31 E52 E58
    Date: 2008–10
  16. By: Brieuc Monfort; Santiago Peña
    Abstract: This article uses two analytical methodologies to understand the dynamics of inflation in Paraguay, the mark-up theory of inflation and the monetary theory of inflation. We also study the impact of different monetary aggregates. The results suggest that monetary factors, in particular currency in circulation, play a major role in determining long-run inflation, while foreign prices, in particular from Brazil, or some food products have a large impact on the short-term dynamics of inflation. Wage indexation may also contribute to locking up price increases.
    Keywords: Paraguay , Inflation , Wage indexation , Price increases , Demand for money , Spillovers ,
    Date: 2008–12–05
  17. By: Joyce, Michael (Bank of England); Relleen, Jonathan (Bank of England); Sorensen, Steffen (Barrie+Hibbert Ltd)
    Abstract: This paper reviews the main instruments and associated yield curves that can be used to measure financial market participants' expectations of future UK monetary policy rates. We attempt to evaluate these instruments and curves in terms of their ability to forecast policy rates over the period from October 1992, when the United Kingdom first adopted an explicit inflation target, to March 2007. We also investigate several model-based methods of estimating forward term premia, in order to calculate risk-adjusted forward interest rates. On the basis of both in and out-of-sample test results, we conclude that, given the uncertainties involved, it is unwise to rely on any one technique to measure policy rate expectations and that the best approach is to take an inclusive approach, using a variety of methods and information.
    Keywords: Interest rates; forecasting; term premia
    JEL: E43 E44 E52
    Date: 2008–11–24
  18. By: Daniel L. Thornton (Federal Reserve Bank of St. Louis, 411 Locust St, St Louis, MO, 63166-0442, USA.)
    Abstract: The phrase “liquidity effect” was introduced by Milton Friedman (1969) to describe the first of three effects on interest rates caused by an exogenous change in the money supply. The lack of empirical support for the liquidity effect using monthly and quarterly data using various monetary and reserve aggregates led Hamilton (1997) to suggest that more convincing evidence of the liquidity effect could be obtained using daily data – the daily liquidity effect. This paper investigates the implications of the daily liquidity effect for Friedman’s liquidity effect using a comprehensive model of the Fed’s daily operating procedure. The evidence indicates that it is no easier to find convincing evidence of a Friedman’s liquidity effect using daily data than it has been using lower frequency data. JEL Classification: E40, E52.
    Keywords: liquidity effect, federal funds rate, monetary policy, operating procedure, FOMC.
    Date: 2008–12
  19. By: Jonathan Chiu; Cesaire Meh
    Abstract: This paper develops a search-theoretic model to study the interaction between banking and monetary policy and how this interaction affects the allocation and welfare. Regarding how banking affects the welfare costs of inflation: First, we find that, with banking, inflation generates smaller welfare costs. Second, we show that, lowering inflation improves welfare not just by reducing consumption/production distortions, but also by avoiding intermediation costs. Therefore, understanding the nature of intermediation cost is critical for accurately assessing the welfare gain of lowering the inflation target. Regarding how monetary policy affects the welfare effects of banking: First, banking always improves efficiency of production, but the banking technology has to be efficient to improve welfare (especially in low inflation economy). Second, welfare effects of banking depend on monetary policy. For low inflation, banking is not active. For high inflation, banking is active and improves welfare. For moderate inflation, banking is active but reduces welfare. Owing to general equilibrium feedback, banking is supported in equilibrium even though welfare is higher without banking.
    Keywords: Monetary policy framework
    JEL: E40 E50
    Date: 2008
  20. By: Shah, Ajay (National Institute of Public Finance and Policy); Patnaik, Ila (National Institute of Public Finance and Policy)
    Abstract: From the early 1990s, India embarked on easing capital controls. Liberalization emphasised openness towards equity flows, both FDI and portfolio flows. In particular, there are few barriers in the face of portfolio equity flows. In recent years, a massive increase in the value of foreign ownership of Indian equities has come about, largely reflecting improvements in the size, liquidity and corporate governance of Indian firms. While the system of capital controls appears formidable, the de facto openness on the ground is greater than is apparent, particularly because of the substantial enlargement of the current account. These changes to capital account openness were not accompanied by commensurate monetary policy reform. The monetary policy regime has consisted essentially of a pegged exchange rate to the US dollar throughout. Increasing openness on the capital account, coupled with exchange rate pegging, has led to a substantial loss of monetary policy autonomy. The logical way forward now consists of bringing the de jure capital controls uptodate with the de facto convertibility, and embarking on reforms of the monetary policy framework so as to shift the focus of monetary policy away from the exchange rate to domestic inflation.
    Keywords: International investment ; Long term capital movements ; International lending and debt problems ; Monetary systems
    JEL: F21 F34 E42
    Date: 2008–05
  21. By: Roland Döhrn; Christoph M. Schmidt; Tobias Zimmermann
    Abstract: In this paper we argue that future inflation in an economy depends on the way people perceive current inflation, their inflation sentiment.We construct some simple measures of inflation sentiment which capture whether price acceleration is shared by many components of the CPI basket. In a comparative analysis of the forecasting power of the different inflation indicators for the US and Germany, we demonstrate that our inflation sentiment indicators improve forecast accuracy in comparison to a standard Phillips curve approach. Because the forecast performance is particularly good for longer horizons, we also compare our indicators to traditional measures of core inflation.Here, the sentiment indicators outperform the weighted median and show a similar forecasting power as a trimmed mean. Thus, they offer a convincing alternative to traditional core inflation measures.
    Keywords: Inflation forecasting, monetary policy
    JEL: E30 E31 E37 C53
    Date: 2008–12
  22. By: Devereux, Michael B.; Sutherland, Alan
    Abstract: Recent data show substantial increases in the size of gross external asset and liability positions. The implications of these developments for optimal conduct of monetary policy are analyzed in a standard open economy model which is augmented to allow for endogenous portfolio choice. The model shows that monetary policy takes on new importance due to its impact on nominal asset returns. Nevertheless, the case for price stability as an optimal monetary rule remains. In fact, it is reinforced. Even without nominal price rigidities, price stability is optimal because it enhances the risk sharing properties of nominal bonds.
    Keywords: Portfolio Choice, International Risk Sharing, Exchange Rate
    JEL: E52 E58 F41
    Date: 2008
  23. By: Cetorelli, Nicola; Goldberg, Linda S.
    Abstract: The globalization of banking in the United States is influencing the monetary transmission mechanism both domestically and in foreign markets. Using quarterly information from all U.S. banks filing call reports between 1980 and 2005, we find evidence for the lending channel for monetary policy in large banks, but only those banks that are domestically-oriented and without international operations. We show that the large globally-oriented banks rely on internal capital markets with their foreign affiliates to help smooth domestic liquidity shocks. We also show that the existence of such internal capital markets contributes to an international propagation of domestic liquidity shocks to lending by affiliated banks abroad. While these results imply a substantially more active lending channel than documented in the seminal work of Kashyap and Stein (2000), the lending channel within the United States is declining in strength as banking becomes more globalized.
    Keywords: Lending channel, Bank, global, liquidity, transmission, internal capital markets
    JEL: E44 F36 G32
    Date: 2008
  24. By: Nuno Cassola (Financial Research Divison, DG Research, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Claudio Morana (Università del Piemonte Orientale, Facoltà di Economia, Dipartimento di Scienze Economiche e Metodi Quantitativi, Via Perrone 18, 28100, Novara, Italy; International Center for Economic Research (ICER, Torino) and Center for Research on Pensions and Welfare Policies (CeRP, Torino).)
    Abstract: In the framework of a new money market econometric model, we assess the degree of precision achieved by the European Central Bank ECB) in meeting its operational target for the short-term interest rate and the impact of the U.S. sub-prime credit crisis on the euro money market during the second half of 2007. This is done in two steps. Firstly, the long-term behaviour of interest rates with one-week maturity is investigated by testing for co-breaking and for homogeneity of spreads against the minimum bid rate (MBR, the key policy rate). These tests capture the idea that successful steering of very short-term interest rates is inconsistent with the existence of more than one common trend driving the one-week interest rates and/or with nonstationarity of the spreads among interest rates of the same maturity (or measured against the MBR). Secondly, the impact of several shocks to the spreads (e.g. interest rate expectations, volumes of open market operations, interest rate volatility, policy interventions, and credit risk) is assessed by jointly modelling their behaviour. We show that, after August 2007, euro area commercial banks started paying a premium to participate in the ECB liquidity auctions. This puzzling phenomenon can be understood by the interplay between, on the one hand, adverse selection in the interbank market and, on the other hand, the broad range of collateral accepted by the ECB. We also show that after August 2007, the ECB steered the “risk-free” rate close to the policy rate, but has not fully off-set the impact of the credit events on other money market rates. JEL Classification: C32, E43, E50, E58, G15.
    Keywords: Money market interest rates, euro area, sub-prime credit crisis, credit risk, liquidity risk, long memory, structural change, fractional co-integration, co-breaking, fractionally integrated factor vector autoregressive model.
    Date: 2008–12
  25. By: Matteo Modena
    Abstract: The expectations hypothesis implies that rational investors can predict future changes in interest rates by simply observing the yield spread. According to Mishkin (1990) the expectations theory can also be reformulated in terms of the ability of the spread to predict future inflation. Unfortunately, although appealing, the theory has found little empirical support. Time-varying term premia and changing risk perception have been advocated to rationalize the aforementioned weak empirical evidence. In this work we suggest that the time-varying nature of term premia makes single-equation models inappropriate to analyse the informative content of the term structure. In particular, when the deviations between the expected and the actual spread are large, which occurs in times of soaring term premia volatility, linear models fail to support the expectations theory. Within a threshold model for term premia, we provide evidence that the yield spread contains valuable information to predict future interest rates changes once the risk-averse attitude of economic agents is appropriately considered. Empirical results show that the predictive ability of the yield spread is contingent on the level of uncertainty as captured by the size of monetary policy surprise.
    Keywords: Expectations Hypothesis, Term Premia, Threshold Models.
    JEL: C01 C30 E43 G12
    Date: 2008–07
  26. By: Tobias Linzert (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Sandra Schmidt (Centre for European Economic Research, L7, 1, D-68161 Mannheim, Germany.)
    Abstract: We employ a time series econometric framework to explore the structural determinants of the spread between the European Overnight Rate and the ECB’s Policy Rate (EONIA spread) aiming to explain the widening of the EONIA spread from mid-2004 to mid-2006. In particular, we estimate a model on the EONIA spread since the introduction of the new operational framework in March 2004 until August 2006. We show that the increase in the EONIA spread can for the largest part be explained by the current liquidity deficit. Moreover, tight liquidity conditions as well as an increase in banks’ liquidity uncertainty lead to a significant upward pressure on the spread. The ECB’s liquidity policy only reduces the spread if a loose policy is conducted during the last week of a maintenance period. Interestingly, interest rate expectations have not been found to have an important influence. JEL Classification: E43, E52, C22.
    Keywords: Overnight Market Rate (EONIA), Interest Rate Determination, Monetary Policy Implementation, Operational Framework.
    Date: 2008–12
  27. By: Andersson, Fredrik N. G. (Department of Economics, Lund University)
    Abstract: This paper studies the issue of whether money contains useful information about future inflation in a panel of nine developed countries. A low frequency estimate of excess money growth is compared to an estimate of the inflation trend following the discussion in Woodford (2007). The empirical analysis shows that money contains more information about future CPI-inflation than an estimate of the inflation trend, and that the output gap has some influence over the medium run movements of inflation, but the effect varies over time. The result is the same for small countries as it is for large countries. Money thus contains information about future headline inflation that the inflation trend does not.
    Keywords: Inflation; Money; Inflation Indicators; Wavelet Analysis
    JEL: C19 E31 E32 E41
    Date: 2008–12–02
  28. By: Michiel van Leuvensteijn (CPB Netherlands Bureau for Economic Policy Analysis); Christoffer Kok Sørensen (European Central Bank); Jacob A. Bikker (Nederlandsche Bank); Adrian van Rixtel (Banco de España)
    Abstract: This paper analyses the impact of loan market competition on the interest rates applied by euro area banks to loans and deposits during the 1994-2004 period, using a novel measure of competition called the Boone indicator. We find evidence that stronger competition implies significantly lower spreads between bank and market interest rates for most loan market products. Using an error correction model (ECM) approach to measure the effect of competition on the pass-through of market rates to bank interest rates, we likewise find that banks tend to price their loans more in accordance with the market in countries where competitive pressures are stronger. Further, where loan market competition is stronger, we observe larger bank spreads (implying lower bank interest rates) on current account and time deposits. This would suggest that the competitive pressure is heavier in the loan market than in the deposit markets, so that banks compensate for their reduction in loan market income by lowering their deposit rates. We observe also that bank interest ratesin more competitive markets respond more strongly to changes in market interest rates. These findings have important monetary policy implications, as they suggest that measures to enhance competition in the European banking sector will tend to render the monetary policy transmission mechanism more effective.
    Keywords: Monetary transmission, banks, retail rates, competition, panel data
    JEL: D4 E50 G21 L10
    Date: 2008
  29. By: Renaud Beaupain (IESEG School of Management, 3 rue de la Digue, 59000 Lille, France.); Alain Durré (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper examines the interday and intraday dynamics of the euro area overnight money market on the basis of an original set of market activity and liquidity proxies constructed from both pre- and post-trade data. The empirical literature provides extensive evidence supporting the rejection of the martingale hypothesis both between days and within days, primarily for interest rates and volatility. We extend this analysis and investigate the seasonality of market activity and liquidity in a market dominated by utilitarian traders. We provide evidence that the Eurosystem's operational framework and calendar effects cause the observed regular patterns. We additionally show that utilitarian trading intensifies at the turn of the reserve maintenance period. The increased un-certainty associated with greater information asymmetry between market participants when reserve requirements become binding lead to a deterioration of market liquidity. Our analysis additionally turns out to be sensitive to the implementation in March 2004 of structural changes to the operational framework and to the more frequent occurrence of fine-tuning operations since October 2004. JEL Classification: E43, E58, C22, C32.
    Keywords: Overnight money market, Eurosystem's operational framework, seasonality, market microstructure, tick data.
    Date: 2008–12
  30. By: Massimo Guidolin (Federal Reserve Bank of St. Louis, 411 Locust St, St Louis, MO, 63166-0442, USA.); Daniel L. Thornton (Federal Reserve Bank of St. Louis, 411 Locust St, St Louis, MO, 63166-0442, USA.)
    Abstract: Despite its important role in monetary policy and finance, the expectations hypothesis (EH) of the term structure of interest rates has received virtually no empirical support. The empirical failure of the EH was attributed to a variety of econometric biases associated with the single-equation models used to test it; however, none account for it. This paper analyzes the EH by focusing on its fundamental tenet - the predictability of the short-term rate. This is done by comparing h-month ahead forecasts for the 1- and 3-month Treasury yields implied by the EH with the forecasts from random-walk, Diebold and Lei (2006), and Duffee (2002) models. The evidence suggests that the failure of the EH is likely a consequence of market participants’ inability to predict the short-term rate. JEL Classification: E40, E52.
    Keywords: Expectations theory, random walk, time-varying risk premium
    Date: 2008–12
  31. By: Niki X. Papadopoulou (Central Bank of Cyprus)
    Abstract: This paper investigates the micro mechanisms by which monetary policy affects and is transmitted through the U.S economy, by developing a unified, dynamic, stochastic, general equilibrium model that nests two classes of models. The first sticky prices and the second limited participation. Limited participation is incorporated by assuming that households’ are faced with quadratic portfolio adjustment costs. Monetary policy is characterized by a generalized Taylor rule with interest rate smoothing. The model is calibrated and investigates whether the unified model performs better in replicating empirical stylized facts, than the models that have only sticky price or limited participation. The unified model replicates the second moments of the data better than the other two types of models. It also improves on the ability of the sticky price model to deliver the hump-shaped response of output and inflation. Moreover, it also delivers on the ability of the limited participation model to replicate the fall in profits and wages, after a contractionary monetary policy.
    JEL: E31 E32 E44 E52
    Date: 2008–06
  32. By: Giuseppe Ferrero (Banca d’Italia, Via Nazionale 91, I-00184 Rome, Italy.); Andrea Nobili (Banca d’Italia, Via Nazionale 91, I-00184 Rome, Italy.)
    Abstract: The prices of futures contracts on short-term interest rates are commonly used by central banks to gauge market expectations concerning monetary policy decisions. Excess returns - the difference between futures rates and the realized rates - are positive, on average, and statistically significant, both in the euro area and in the United States. We find that these biases are significantly related to the business cycle only in the United States. Moreover, the sign and the significance of the estimated relationships with business cycle indicators are unstable over time. Breaking the excess returns down into risk premium and forecast error components, we find that risk premia are counter-cyclical in both areas. On the contrary, ex-post prediction errors, which represent the greater part of excess returns at longer horizons in both areas, are negatively correlated with the business cycle only in the United States. JEL Classification: E43, E44, E52.
    Keywords: Monetary policy expectations, excess returns, futures contracts, business cycle.
    Date: 2008–12
  33. By: Jiri Podpiera
    Abstract: The use of estimated policy rules has been on the rise over the past few decades as central banks have increasingly relied on them as policy benchmarks. While simple, conventionally estimated rules have proven insightful, their value is generally seen to depend, among other things, on the ability of the benchmark to accurately reflect the policy environment and on the relevance of the econometric assumptions behind the estimation method. This paper addresses a potential source of econometric bias that might naturally arise and adversely affect the accuracy of conventionally estimated policy rules as benchmarks. In particular, the discrete nature of the policy rate setting process at central banks leaves open the possibility that observed policy rate changes may include significant rounding errors. If so, parameter estimates using conventional econometric methods could be seriously biased; technically, this is an example of a censoring bias. To address this concern, the paper offers a new method for estimating monetary policy rules and demonstrates the ability of the resulting bias-adjusted policy rules to outperform conventionally estimated ones in characterizing the policy environments in the cases of the Czech Republic and the United States.
    Keywords: Bias in parameters, Monetary policy, Policy rule.
    JEL: E4 E5
    Date: 2008–10
  34. By: Richard Finlay (Reserve Bank of Australia); Mark Chambers (Reserve Bank of Australia)
    Abstract: We use data on coupon-bearing Australian Government bonds and overnight indexed swap (OIS) rates to estimate risk-free zero-coupon yield and forward curves for Australia from 1992 to 2007. These curves, and analysts’ forecasts of future interest rates, are then used to fit an affine term structure model to Australian interest rates, with the aim of decomposing forward rates into expected future overnight cash rates plus term premia. The expected future short rates derived from the model are on average unbiased, fluctuating around the average of actual observed short rates. Since the adoption of inflation targeting and the entrenchment of low and stable inflation expectations, term premia appear to have declined in levels and displayed smaller fluctuations in response to economic shocks. This suggests that the market has become less uncertain about the path of future interest rates. Towards the end of the sample period, term premia have been negative, suggesting that investors may have been willing to pay a premium for Commonwealth Government securities. Due to the complexity of the model and the difficulty of calibrating it to data, the results should not be interpreted too precisely. Nevertheless, the model does provide a potentially useful decomposition of recent changes in the expected path of interest rates and term premia.
    Keywords: expected future short rate; term premia; term structure decomposition; affine term structure model; zero-coupon yield
    JEL: C51 E43 G12
    Date: 2008–12
  35. By: Akito Matsumoto; Pietro Cova; Massimiliano Pisani; Alessandro Rebucci
    Abstract: We study exchange rate and equity price dynamics, in general equilibrium, in the presence of news shocks about future productivity and monetary policy. We identify a condition under which these asset prices become more volatile without affecting the volatility of the underlying processes-a positive correlation between news and current shocks. This condition also explains why persistent underlying processes generate volatile asset prices. In addition, we show that the correlation between exchange rate and equity returns depends critically on the currency denomination of the equity return and the monetary policy reaction to productivity shocks. The model we set up does well at matching second moments of exchange rate and equity returns for major floating currencies.
    Keywords: External shocks , Exchange rates , Stock prices , Productivity , Monetary policy , Asset prices , Floating exchange rates , Economic models ,
    Date: 2008–12–10
  36. By: Claudio Borio; Sahminan Haibin Zhu
    Abstract: Few areas of monetary economics have been studied as extensively as the transmission mechanism. The literature on this topic has evolved substantially over the years, following the waxing and waning of conceptual frameworks and the changing characteristics of the financial system. In this paper, taking as a starting point a brief overview of the extant work on the interaction between capital regulation, the business cycle and the transmission mechanism, we offer some broader reflections on the characteristics of the transmission mechanism in light of the evolution of the financial system. We argue that insufficient attention has so far been paid to the link between monetary policy and the perception and pricing of risk by economic agents - what might be termed the "risk-taking channel" of monetary policy. We develop the concept, compare it with current views of the transmission mechanism, explore its mutually reinforcing link with "liquidity" and analyse its interaction with monetary policy reaction functions. We argue that changes in the financial system and prudential regulation may have increased the importance of the risk-taking channel and that prevailing macroeconomic paradigms and associated models are not well suited to capturing it, thereby also reducing their effectiveness as guides to monetary policy.
    Keywords: risk-taking channel, transmission mechanism, capital regulation, procyclicality
    Date: 2008–12
  37. By: Frieden Jeffry A.
    Abstract: Is there a valid argument for international cooperation, and some form of international governance structure, in the international monetary realm? On the purely economic front, the argument is not strong. Yet a broader political economy approach concludes that national currency policy can in fact impose non-pecuniary externalities on partner nations. This is especially the case with major policy-driven misalignments, which cannot easily be countered by other governments. For example, one country’s substantially depreciated currency can provoke powerful protectionist pressures in its trading partners, so that exchange rate policy spills over into trade policy in potentially damaging ways. Inasmuch as one government’s policies create these sorts of costs for other countries, and for the world economy as a whole, there is a case for global governance. This might include some institutionalized mechanism to monitor and publicize substantial currency misalignments. While there appears to be little global political attention to such a mechanism now, there have been initiatives along these lines at the regional level, and there are some early stirrings of interest more generally.
    Keywords: Exchange rates, macroeconomic policy coordination
    JEL: F42 H87
    Date: 2008
  38. By: Spencer Dale (Board of Governors of the Federal Reserve System); Athanasios Orphanides (Central Bank of Cyprus); Par Osterholm (Department of Economics, Uppsala University)
    Abstract: Much of the information communicated by central banks is noisy or imperfect. This paper considers the potential benefits and limitations of central bank communications in a model of imperfect knowledge and learning. It is shown that the value of communicating imperfect information is ambiguous. If the public is able to assess accurately the quality of the imperfect information communicated by a central bank, such communication can inform and improve the public's decisions and expectations. But if not, communicating imperfect communication has the potential to mislead and distract. The risk that imperfect communication may detract from the public's understanding should be considered in the context of a central bank's communications strategy. The risk of distraction means the central bank may prefer to focus its communication policies on the information it knows most about. Indeed, conveying more certain information may improve the public's understanding to the extent that it "crowds out" a role for communicating imperfect information.
    Keywords: Transparency, Forecasts, Learning
    JEL: E52 E58
    Date: 2008–02
  39. By: Jan Gottschalk; Ken Miyajima; Kadima D. Kalonji
    Abstract: This paper examines the determinants of inflation in Sierra Leone using a structural vector autoregression (VAR) approach to help forecast inflation for operational purposes. Despite data limitations, the paper accurately models inflation in Sierra Leone. As economic theory predicts, domestic inflation is found to increase with higher oil prices, higher money supply, and nominal exchange rate depreciation. The paper then employs a historical decomposition approach to pinpoint the sources of a marked decline in inflation in 2006 and assesses its forecasting properties. Overall, the model serves as a useful addition to the toolkit for analyzing and forecasting inflation in countries with limited data availability.
    Keywords: Inflation , Sierra Leone , Data analysis , Economic forecasting , Oil prices , Money supply , Exchange rate depreciation , Forecasting models ,
    Date: 2008–12–08
  40. By: Teppei Nagano (Bank of Japan, 2-1-1 Nihonbashi-Hongokucho Chuo-ku, Tokyo 103-8660, Japan.); Naohiko Baba (Corresponding author: Bank for International Settlements, Centralbahnplatz 2, Basel CH-4002, Switzerland.)
    Abstract: This paper attempts to extract market expectations about the Japanese economy and the BOJ’s policy stance from the yen yield curves augmented by money market interest rates, during the period from the end of the quantitative easing policy in March 2006. We use (i) the swap yield curves augmented by OIS interest rates (OIS/Swap), and (ii) the JGB yield curve augmented by FB/TB interest rates. First, using the Nelson-Siegel [1987] model, we estimate three latent dynamic factors, which can be interpreted as reflecting market expectations. Second, we investigate the relative importance of price discovery for each factor between OIS/Swap and FBTB/JGB, and find that the former has a more dominant role of price discovery for all factors. Third, we estimate the efficient price for each factor common to both yield curves using a time-series structural model, which enables us to decompose each factor into the efficient price and idiosyncratic factor. JEL Classification: E43, E52, G12.
    Keywords: Yield curve, overnight index swap, price discovery, structural time-series model, swap spread.
    Date: 2008–12
  41. By: Naohiko Baba; Sahminan Frank Packer
    Abstract: This paper investigates the spillover effects of money market turbulence in 2007-08 on the short-term covered interest parity (CIP) condition between the US dollar and the euro through the foreign exchange (FX) swap market. Sharp and persistent deviations from the CIP condition observed during the turmoil are found to be significantly associated with differences in the counterparty risk between European and US financial institutions. Furthermore, evidence is found that dollar term funding auctions by the ECB, supported by dollar swap lines with the Federal Reserve, have stabilized the FX swap market by lowering the volatility of deviations from CIP.
    Keywords: FX swap, covered interest parity, financial market turmoil, counterparty risk, dollar swap lines, dollar term auction facility
    Date: 2008–12
  42. By: Gianfranco Tusset (University of Padua)
    Abstract: Between 1909 and 1917, Gustavo Del Vecchio built a theory of money as a medium of exchange where organizational and social aspects were investigated in depth, first by means of a conventional static investigation and then by adopting a dynamic perspective. Del Vecchio believed that money, credit, accumulation, and crisis could no longer be theorised with time omitted, and this induced him to formulate dynamic statements which put forward claims about money as a store of value. The organizational and social dimensions of money, time and uncertainty were all important and interconnected aspects in his scientific research, for they all sprang from his conceptualization of money as a medium of exchange.
    Keywords: economic organization, monetary services
    JEL: B13 B31
    Date: 2008–12
  43. By: Tovar, Camilo Ernesto
    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, Communication, Estimation, Modelling
    JEL: B4 C5 E0 E32 E37 E50 E52 E58 F37 F41 F47
    Date: 2008
  44. By: Julien Idier (Corresponding author: Banque de France, 39, rue Crois-des-Petits-Champs, F-75049 Paris Cedex 01, France.); Stefano Nardelli (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: In this paper the probability of informed trading (PIN) model developed by Easley and O’Hara (1992) is applied to analyze the role and impact of heterogeneities in euro overnight unsecured market. The empirical assessment of the functioning of this market is based on the PIN which measures the ability of traders to interpret signals on the expected evolution of the overnight rate. Results show that between 2000 and 2004 a heterogeneous learning process of market mechanisms within participants could be observed, whereas such asymmetries have been sharply decreasing since 2005. This is reviewed against some significant events that occurred in the euro money market, such as the reform of the Eurosystem’s operational framework in March 2004 and the recent financial market turmoil, which has represented a break in the steady decline of asymmetries as evidence suggest. JEL Classification: G14, E52.
    Keywords: Microstructure, PIN model, Money Markets.
    Date: 2008–12
  45. By: Katrin Assenmacher-Wesche (Schweizerische Nationalbank, Börsenstrasse 15, Postfach 2800, 8022 Zürich, Switzerland.); Stefan Gerlach (Johann Wolfgang Goethe Universität, Mertonstrasse 17, D-60325 Frankfurt am Main.)
    Abstract: This paper tests the expectations hypothesis (EH) of the term structure of interest rates in US data, using spectral regression techniques that allow us to consider different frequency bands. We find a positive relation between the term spread and the change in the long-term interest rate in a frequency band of 6 months to 4 years, whereas the relation is negative at higher and lower frequencies. We confirm that the variance of term premia relative to expected changes in long-term interest rates dominates at high and low frequencies, leading the EH to be rejected in those bands but not in the intermediate frequency band. JEL Classification: C22, E43.
    Keywords: Expectations theory of the term structure, interest rates, spectral egression, frequency domain.
    Date: 2008–12
  46. By: Tuomas Välimäki (Suomen Pankki, P.O. Box 160, FIN-00101 Helsinki, Finland.)
    Abstract: The tender spread, i.e. the difference between the effective price for money in the ECB’s main refinancing operations and the prevailing policy rate, is one of the main determinants behind the evolution of the EONIA with respect to the ECB’s operational target. This study assesses the reasons for which the average tender spread did not reduce after the banks’ demand for liquidity was isolated from their interest rate expectations in March 2004. The paper offers two potential explanations for the unexpected behavior. First, following the increased precision in the ECB’s liquidity provision after the end-of- period fine tuning operations were added to the regularly applied tools, even a small bias in the liquidity supply could have resulted in a strictly positive tender spread. Second, banks’ uncertainty over their individual allotments in the tender operations may have led to a strictly positive tender spread. Furthermore, the significant growth in the refinancing volumes may have intensified the allotment uncertainty. JEL Classification: D44, E58.
    Keywords: Main refinancing operations, liquidity, EONIA, tenders.
    Date: 2008–12
  47. By: Bhattacharya, Rudrani (National Institute of Public Finance and Policy); Patnaik, Ila (National Institute of Public Finance and Policy); Shah, Ajay (National Institute of Public Finance and Policy)
    Abstract: In India, year-on-year percentage changes of price indexes are widely used as the measure of inflation. In terms of monthly data, each observation of a one-year change in inflation is the sum of twelve one month changes. This suggests that better information about inflationary pressures can be obtained using point-on-point monthly changes. This requires seasonal adjustment. We apply standard seasonal adjustment procedures in order to obtain a point-on-point seasonally adjusted monthly time-series of inflation in India. In three interesting high inflation episodes { 1994-95, 2007 and 2008 - we find that this data yields a faster and better understanding of inflationary pressures.
    Date: 2008–08
  48. By: Bernardo Guimaraes; Kevin D. Sheedy
    Abstract: A striking fact about prices is the prevalence of ``sales': large temporary price cuts followedby a return exactly to the former price. This paper builds a macroeconomic model with arationale for sales based on firms facing consumers with different price sensitivities. Even iffirms can vary sales without cost, monetary policy has large real effects owing to sales beingstrategic substitutes: a firm's incentive to have a sale is decreasing in the number of otherfirms having sales. Thus the flexibility of prices at the micro level due to sales does nottranslate into flexibility at the macro level.
    Keywords: sales, monetary policy, nominal rigidities
    JEL: E3 E5
    Date: 2008–08

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