nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒01‒10
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Navigating the trilemma: capital flows and monetary policy in China By Reuven Glick; Michael Hutchison
  2. The topology of the federal funds market By Morten L. Bech; Enghin Atalay
  3. The balance sheet channel By Ethan Cohen-Cole; Enrique Martinez-Garcia
  4. Fiscal Storms: Inflation Targeting and Real Exchange Rates in Emerging Markets By Joshua Aizenman; Michael Hutchison; Ilan Noy
  5. Price-level targeting and risk management in a low-inflation economy By Roberto Billi
  6. Macroeconomic Stability: Transition Towards the Nominal Exchange Rate Stability By Frantisek Brazdik Author-Name: Juraj Antal
  7. Monetary Policy, Trend Inflation and the Great Moderation: An Alternative Interpretation By Olivier Coibion; Yuriy Gorodnichenko
  8. On the implementation of Markov-perfect interest rate and money supply rules: global and local uniqueness By Michael Dotsey; Andreas Hornstein
  9. The optimal liquidity principle with restricted borrowing By Mierzejewski, Fernando
  10. The Federal Reserve in crisis By Tatom, John
  11. Sophisticated monetary policies By Patrick J. Kehoe; V. V. Chari; Andrew Atkeson
  12. Insurance policies for monetary policy in the euro area By Keith Kuester; Volker Wieland
  13. Sources of the Great Moderation: Shocks, Frictions, or Monetary Policy? By Zheng Liu; Daniel F. Waggoner; Tao Zha
  14. Inflation expectations and risk premiums in an arbitrage-free model of nominal and real bond yields By Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
  15. Rethinking the measurement of household inflation expectations: preliminary findings By Wilbert van der Klaauw; Wändi Bruine de Bruin; Giorgio Topa; Simon Potter; Michael Bryan
  16. Modelling loans to non-financial corporations in the euro area By Christoffer Kok Sørensen; David Marqués Ibáñez; Carlotta Rossi
  17. An Examination of the Relationship between Food Prices and Government Monetary Policies in Iran By Shahnoushi, Naser; Henneberry, Shida; Manssori, Hooman
  18. Limited participation or sticky prices? New evidence from firm entry and failures By Lenno Uusküla
  19. Long run risks in the term structure of interest rates: estimation By Taeyoung Doh

  1. By: Reuven Glick; Michael Hutchison
    Abstract: In recent years China has faced an increasing trilemma—how to pursue an independent domestic monetary policy and limit exchange rate flexibility, while at the same time facing large and growing international capital flows. This paper analyzes the impact of the trilemma on China’s monetary policy as the country liberalizes its goods and financial markets and integrates with the world economy. It shows how China has sought to insulate its reserve money from the effects of balance of payments inflows by sterilizing through the issuance of central bank liabilities. However, we report empirical results indicating that sterilization dropped precipitously in 2006 in the face of the ongoing massive buildup of international reserves, leading to a surge in reserve money growth. We estimate a vector error correction model linking the surge in China’s reserve money to broad money, real GDP, and the price level. We use this model to explore the inflationary implications of different policy scenarios. Under a scenario of continued rapid reserve money growth (consistent with limited sterilization of foreign exchange reserve accumulation) and strong economic growth, the model predicts a rapid increase in inflation. A model simulation using an extension of the framework that incorporates recent increases in bank reserve requirements also implies a rapid rise in inflation. By contrast, model simulations incorporating a sharp slowdown in economic growth lead to less inflation pressure even with a substantial buildup in international reserves.
    Keywords: Monetary policy - China
    Date: 2008
  2. By: Morten L. Bech (Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045, USA.); Enghin Atalay (University of Chicago, Department of Economics, 1126 East 59th Street, Chicago, IL 60637, USA.)
    Abstract: We explore the network topology of the federal funds market. This market is important for distributing liquidity throughout the financial system and for the implementation of monetary policy. The recent turmoil in global financial markets underscores its importance. We find that the network is sparse, exhibits the small world phenomenon and is disassortative. Reciprocity tracks the federal funds rate and centrality measures are useful predictors of the interest rate of a loan. JEL Classification: E4, E58, E59, G1.
    Keywords: Network, topology, interbank, money market.
    Date: 2008–12
  3. By: Ethan Cohen-Cole; Enrique Martinez-Garcia
    Abstract: In this paper, we study the role of the credit channel of monetary policy in a synthesis model of the economy. Through the use of a well-specified banking sector and a regulatory capital constraint on lending, we provide an alternate mechanism that can potentially explain the periods of asymmetry in monetary policy without appealing to ad-hoc central bank preferences. This is accomplished through the characterization of the external finance premium that includes bank leverage and systemic risk.
    Keywords: Monetary policy
    Date: 2008
  4. By: Joshua Aizenman (Department of Economics, University of California, Santa Cruz); Michael Hutchison (Department of Economics, University of California, Santa Cruz); Ilan Noy (Department of Economics, University of Hawaii at Manoa)
    Abstract: We examine the inflation targeting (IT) experiences of emerging market economies, focusing especially on the roles of the real exchange rate and the distinction between commodity and non-commodity exporting nations. In the context of a simple empirical model, estimated with panel data for 17 emerging markets using both IT and non-IT observations, we find a significant and stable response running from inflation to policy interest rates in emerging markets that are following publically announced IT policies. By contrast, central banks respond much less to inflation in non-IT regimes. IT emerging markets follow a “mixed IT strategy” whereby both inflation and real exchange rates are important determinants of policy interest rates. The response to real exchange rates is much stronger in non-IT countries, however, suggesting that policymakers are more constrained in the IT regime—they are attempting to simultaneously target both inflation and real exchange rates and these objectives are not always consistent. We also find that the response to real exchange rates is strongest in those countries following IT policies that are relatively intensive in exporting basic commodities. We present a simple model that explains this empirical result.
    Keywords: Inflation targeting, real exchange rate, commodity exporters, emerging markets
    JEL: E52 E58 F3
    Date: 2008–12–01
  5. By: Roberto Billi
    Abstract: With inflation and policy interest rates at historically low levels, policymakers show great concern about "downside tail risks" due to a zero lower bound on nominal interest rates. Low probability or tail events, such as sustained deflation or recession, are disruptive for the economy and can be difficult to resolve. This paper shows that price-level targeting mitigates downside tail risks respect to inflation targeting when policy is conducted through a simple interest-rate rule subject to a zero lower bound. Thus, price-level targeting is a more effective policy framework than inflation targeting for the management of downside tail risks in a low-inflation economy. At the same time, the average performance of the economy is not very different if policy implements price-level targeting instead of inflation targeting through a simple interest-rate rule. Price-level targeting may imply less variability of inflation than inflation targeting because policymakers can shape private-sector expectations about future inflation more effectively by targeting directly the price level path rather than inflation.
    Date: 2008
  6. By: Frantisek Brazdik Author-Name: Juraj Antal
    Abstract: The novelty of this work is in the presentation of a theoretical frame work that allows the modeling of an announced switch of the monetary regime. In our experiment, the monetary authority announces stabilization of the nominal exchange rate after the announced number of periods. We analyze the effects of the monetary policy regime for the macroeconomic stability over the transition period. For our analysis, we consider representative forms of standard monetary regimes. Moreover, we rank the examined regimes in terms of loss functions.
    Keywords: New Keynesian models, small open economy, monetary regime switch.
    JEL: E17 E31 E52 E58 E61 F02 F41
    Date: 2008–10
  7. By: Olivier Coibion; Yuriy Gorodnichenko
    Abstract: With positive trend inflation, the Taylor principle is not enough to guarantee a determinate equilibrium. We provide new theoretical results on restoring determinacy in New Keynesian models with positive trend inflation and combine these with new empirical findings on the Federal Reserve's reaction function before and after the Volcker disinflation to find that 1) while the Fed satisfied the Taylor principle in the pre-Volcker era, the US economy was still subject to self-fulfilling fluctuations in the 1970s, 2) while the Fed's response to inflation is not statistically different before and after the Volcker disinflation, the US economy nonetheless moved from indeterminacy to determinacy in this time period, and 3) the change from indeterminacy to determinacy is due to the simultaneous decrease in the response to the output gap, increases in the response to inflation and output growth and the decline in steady-state inflation from the Volcker disinflation.
    JEL: C22 E3 E43 E5
    Date: 2008–12
  8. By: Michael Dotsey; Andreas Hornstein
    Abstract: Currently there is a growing literature exploring the features of optimal monetary policy in New Keynesian models under both commitment and discretion. This literature usually solves for the optimal allocations that are consistent with a rational expectations market equilibrium, but it does not study how the policy can be implemented given the available policy instruments. Recently, however, King and Wolman (2004) have shown that a time-consistent policy cannot be implemented through the control of nominal money balances. In particular, they find that equilibria are not unique under a money stock regime. The authors of this paper find that King and Wolman's conclusion of non-uniqueness of Markov-perfect equilibria is sensitive to the instrument of choice. Surprisingly, if, instead, the monetary authority chooses the nominal interest rate there exists a unique Markov-perfect equilibrium. The authors then investigate under what conditions a time-consistent planner can implement the optimal allocation by just announcing his policy rule in a decentralized setting.
    Date: 2008
  9. By: Mierzejewski, Fernando
    Abstract: A model is presented to characterise the (optimal) demand for cash balances in deregulated markets. After the model of James Tobin, 1958, net balances are determined in order to maximise the expected return of a certain portfolio combining risk and capital. Unlike the model of Tobin, however, the price of the underlying exposures are established in actuarial terms. Within this setting, the monetary equilibrium determines the rate at which a unit of capital is exchange by a unit of exposure to risk, or equivalently, it determines the market price of risk. In a Gaussian setting, such a price is expressed as a mean-to-volatility ratio and can then be regarded as an alternative measure to the Sharpe ratio. The effects of credit and monetary flows on money and security markets can be precisely described on these grounds. An alternative framework for the analysis of monetary policy is thus provided.
    Keywords: Liquidity-preference; Money demand; Monetary equilibrium; Market price of risk; Sharpe ratio
    JEL: G11 G22 E52 E44 E41
    Date: 2008–12–30
  10. By: Tatom, John
    Abstract: Since August 2007 the Board of Governors of the Federal Reserve System (Fed) has approached near panic in their adoption of multiple and inconsistent traditional policy measures and, since December 2007, they have multiplied these efforts by adopting major new policy tools, some of which may go well beyond their congressional mandate. These actions have been motivated, in the first instance, by an emerging mortgage foreclosure crisis that began in late-2006 and that the Fed first recognized in May 2007, in the second instance by a credit crisis that emerged in August in Europe and quickly moved on shore. This article summarizes and explains the Fed actions from August 2007 through March 2008, distinguishing its normal policy actions from a multitude of new facilities that it has created for policy response to illiquidity (or perhaps insolvency) in various corners of private credit markets. What stands out is that the Fed has aimed to target credit to various specific areas of the private financial market and as stridently aimed to insulate overall Fed credit, bank reserves, the federal funds rate or monetary aggregates from these novel responses. This campaign has involved creating numerous new facilities for the private sector and financing them largely by liquidating government securities held by the Fed. In the process, the Fed has transformed itself largely into a lender to the private sector rather than the government. It has violated the fundamental premise of central banking in a crisis to lend liberally at a premium and largely by lending against safe government securities and letting the marketplace direct new credit to solvent but illiquid institutions. It remains to be seen whether such an approach can stimulate a rebound on private credit markets and economic activity.
    Keywords: Foreclosure Crisis; Federal Reserve Policy; Sterilization; Central Banking
    JEL: E58 E52
    Date: 2008–03–31
  11. By: Patrick J. Kehoe; V. V. Chari; Andrew Atkeson
    Abstract: The Ramsey approach to policy analysis finds the best competitive equilibrium given a set of available instruments but is silent about unique implementation, namely, designing policies so that the associated competitive equilibrium is unique. This silence is particularly problematic in monetary policy environments, where many ways of specifying policy lead to indeterminacy. We show that sophisticated policies, which depend on the history of private actions and can differ on and off the equilibrium path, can uniquely implement any desired competitive equilibrium. A large literature has argued that monetary policy should adhere to the Taylor principle to eliminate indeterminacy. We show that adherence to the Taylor principle on these grounds is unnecessary for either determinacy or efficiency. We also show that sophisticated policies are robust to imperfect information.
    Date: 2008
  12. By: Keith Kuester; Volker Wieland
    Abstract: In this paper, the authors aim to design a monetary policy for the euro area that is robust to the high degree of model uncertainty at the start of monetary union and allows for learning about model probabilities. To this end, they compare and ultimately combine Bayesian and worst-case analysis using four reference models estimated with pre-EMU synthetic data. The authors start by computing the cost of insurance against model uncertainty, that is, the relative performance of worst-case or minimax policy versus Bayesian policy. While maximum insurance comes at moderate costs, they highlight three shortcomings of this worst-case insurance policy: (i) prior beliefs that would rationalize it from a Bayesian perspective indicate that such insurance is strongly oriented toward the model with highest baseline losses; (ii) the minimax policy is not as tolerant of small perturbations of policy parameters as the Bayesian policy; and (iii) the minimax policy offers no avenue for incorporating posterior model probabilities derived from data available since monetary union. Thus, the authors propose preferences for robust policy design that reflect a mixture of the Bayesian and minimax approaches. They show how the incoming EMU data may then be used to update model probabilities, and investigate the implications for policy. ; Forthcoming in the Journal of the European Economic Association.
    Date: 2008
  13. By: Zheng Liu; Daniel F. Waggoner; Tao Zha
    Abstract: We study the sources of the Great Moderation by estimating a variety of medium-scale DSGE models that incorporate regime switches in shock variances and in the inflation target. The best-fit model, the one with two regimes in shock variances, gives quantitatively different dynamics in comparison with the benchmark constant-parameter model. Our estimates show that three kinds of shocks accounted for most of the Great Moderation and business-cycle fluctuations: capital depreciation shocks, neutral technology shocks, and wage markup shocks. In contrast to the existing literature, we find that changes in the inflation target or shocks in the investment-specific technology played little role in macroeconomic volatility. Moreover, our estimates indicate much less nominal rigidities than those suggested in the literature.
    Date: 2008–11
  14. By: Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
    Abstract: Differences between yields on comparable-maturity U.S. Treasury nominal and real debt, the so-called breakeven inflation (BEI) rates, are widely used indicators of inflation expectations. However, better measures of inflation expectations could be obtained by subtracting inflation risk premiums from the BEI rates. We provide such decompositions using an estimated affine arbitrage-free model of the term structure that captures the pricing of both nominal and real Treasury securities. Our empirical results suggest that long-term inflation expectations have been well anchored over the past few years, and inflation risk premiums, although volatile, have been close to zero on average.
    Keywords: Inflation (Finance) ; Treasury bonds
    Date: 2008
  15. By: Wilbert van der Klaauw; Wändi Bruine de Bruin; Giorgio Topa; Simon Potter; Michael Bryan
    Abstract: This paper reports preliminary findings from a Federal Reserve Bank of New York research program aimed at improving survey measures of inflation expectations. We find that seemingly small differences in how inflation is referred to in a survey can lead respondents to consider significantly different price concepts. For near-term inflation, the "prices in general" question in the monthly Reuters/University of Michigan Surveys of Consumers can elicit responses that focus on the most visible prices, such as gasoline or food. Questions on the "rate of inflation" can lead to responses on the prices that U.S. citizens pay in general - an interpretation, or concept, closer to the definition of inflation that economists have in mind; they also lead to both lower levels of reported inflation and to lower disagreement among respondents. In addition, we present results associated with new survey questions that assess the degree of individual uncertainty about future inflation outcomes as well as future expected wage changes. Finally, using the panel dimension of the surveys, we find that individual responses exhibit considerable persistence, both in the expected level of inflation and in forecast uncertainty. Respondents who are more uncertain make larger revisions to their expectations in the next survey.
    Keywords: Inflation (Finance) ; Economic indicators ; Economic surveys ; Uncertainty
    Date: 2008
  16. By: Christoffer Kok Sørensen (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); David Marqués Ibáñez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Carlotta Rossi (Corresponding author: Banca d’Italia, via Nazionale 91, I-00184 Roma, Italy.)
    Abstract: We model the determinants of loans to non-financial corporations in the euro area. Using the Johansen (1992) methodology, we identify three cointegrating relationships. These relationships are interpreted as the long-run loan demand, investment and loan supply equations. The short-run dynamics of loan demand for the euro area are subsequently modelled by means of a Vector Error Correction Model (VECM). We perform a number of specification tests, which suggest that developments in loans to non-financial corporations in the euro area can be reasonably explained by the model. We then use the estimated model to analyse the impact of permanent and temporary shocks to the policy rate on bank lending to nonfinancial corporations. JEL Classification: C32, C51.
    Keywords: Bank credit, euro area, non-financial corporations, cointegration, error-correction model.
    Date: 2009–01
  17. By: Shahnoushi, Naser; Henneberry, Shida; Manssori, Hooman
    Abstract: This study examines the relationship between food prices and monetary policy variables, using a Vector Error Correction Model (VECM) approach applied to annual data from 1976 to 2006. Results indicate that food prices in Iran have a long-run and short-run equilibrium granger causality relationship with money supply. More specifically, monetary policy reforms are shown to have a significant impact on food prices and domestic agricultural production. These policies influence consumption patterns and have serious implications for poverty reduction, food security issues, and agricultural growth in Iran.
    Keywords: VEC model, food Prices, monetary policy, Iran, Agricultural and Food Policy,
    Date: 2009–02
  18. By: Lenno Uusküla
    Abstract: Traditional models of monetary transmission such as sticky price and limited participation abstract from firm creation and destruction. Only a few papers look at the empirical effects of the monetary shock on the firm turnover measures. But what can we learn about monetary transmission by including measures for firm turnover into the theoretical and empirical models? Based on a large scale vector autoregressive (VAR) model for the U.S. economy I show that a contractionary monetary policy shock increases the number of business bankruptcy filings and failures, and decreases the creation of firms and net entry. According to the limited participation model, a contractionary monetary shock leads to a drop in the number of firms. On the contrary the same shock in the sticky price model increases the number of firms. Therefore the empirical findings support more the limited participation type of the monetary transmission
    Keywords: monetary transmission, limited participation, sticky prices, firm entry, firm bankruptcy, structural VAR
    JEL: E32 C32
    Date: 2009–01–02
  19. By: Taeyoung Doh
    Abstract: This paper specifies and estimates a long run risks model with inflation by using the nominal term structure data in the United States from 1953 to 2006. The negative correlation between expected inflation and expected consumption growth in conjunction with the Epstein-Zin (1989) recursive preferences generates an upward sloping yield curve and fits the yield curve data better than the alternative specifications. However, the variations of the forward looking components of consumption growth and inflation in the estimated model are much smaller than implied by calibrated parameter values in the previous literature. An extended model with time varying volatilities alleviates this problem. In the extended model, estimated long run risks and volatilities, especially for inflation, are in line with survey data and the estimated inflation volatility explains a significant portion of the time variation of term premium.
    Date: 2008

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