nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒05‒30
fifteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Bidding behaviour in the ECB's main refinancing operations during the financial crisis. By Jens Eisenschmidt; Astrid Hirsch; Tobias Linzert
  2. Public Debt, Distortionary Taxation, and Monetary Policy By Piergallini, Alessandro; Rodano, Giorgio
  3. Determination of Inflation in an Open Economy Phillips Curve Framework: The Case of Developed and Developing Asian Countries By Pami Dua
  4. Regional Monetary Units for East Asia: Lessons from Europe By Girardin Eric
  5. How does fiscal policy affect monetary policy in the Southern African Community (SADC)? By Obinyeluaku, Moses; Viegi, Nicola
  6. Understanding Inflation-Indexed Bond Markets By John Y. Campbell; Robert J. Shiller; Luis M. Viceira
  7. Structural break, stability and demand for money in India By Singh, Prakash; Pandey, Manoj K.
  8. Optimal devaluations By Hevia, Constantino; Nicolini, Juan Pablo
  9. The Macroeconomics of Money Market Freezes By Bruche, Max; Suarez, Javier
  10. The Euro at 10: Successes and Challenges By Thierry Warin
  11. Effects of Japanese Macroeconomic Announcements on the Dollar/Yen Exchange Rate: High-Resolution Picture By Yuko Hashimoto; Takatoshi Ito
  12. The International Financial Crisis: an Expert Survey By Antonio Forte; Giovanni Pesce
  13. Risk Aversion, Intertemporal Substitution, and the Term Structure of Interest Rates By René Garcia; Richard Luger
  14. On the Unstable Relationship between Exchange Rates and Macroeconomic Fundamentals By Bacchetta, Philippe; van Wincoop, Eric
  15. Testing for Financial Contagion with Applications to the Canadian Banking System By Fuchun Li

  1. By: Jens Eisenschmidt (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Astrid Hirsch (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Tobias Linzert (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Liquidity provision through its repo auctions has been one of the main instruments of the European Central Bank (ECB) to address the recent tensions in financial markets since summer 2007. In this paper, we analyse banks’ bidding behaviour in the ECB’s main refinancing operations (MROs) during the ongoing turmoil in money and financial markets. We employ a unique data set comprising repo auctions from March 2004 to October 2008 with bidding data from 877 counterparties. We find that increased bid rates during the turmoil can be explained by, inter alia, the increased individual refinancing motive, the increased attractiveness of the ECB’s tender operations due to its collateral framework and banks’ bidding more aggressively, i.e. at higher rates to avoid being rationed at the marginal rate in times of increased liquidity uncertainty. JEL Classification: E52, D44, C33, C34.
    Keywords: Central Bank Auctions, Financial Market Turmoil, Panel Sample Selection Model, Bidding Behavior, Monetary Policy Instruments.
    Date: 2009–05
  2. By: Piergallini, Alessandro; Rodano, Giorgio
    Abstract: Since Leeper's (1991, Journal of Monetary Economics 27, 129-147) seminal paper, an extensive literature has argued that if fiscal policy is passive, that is, guarantees public debt stabilization irrespectively of the inflation path, monetary policy can independently be committed to inflation targeting. This can be pursued by following the Taylor principle, i.e., responding to upward perturbations in inflation with a more than one-for-one increase in the nominal interest rate. This paper considers an optimizing framework in which the government can only finance public expenditures by levying distortionary taxes. It is shown that households' participation constraints and Laffer-type effects may render passive fiscal policies unfeasible. For any given target inflation rate, there exists a threshold level of public debt beyond which monetary policy independence is no longer possible. In such circumstances, the dynamics of public debt can be controlled only by means of higher inflation tax revenues: inflation dynamics in line with the fiscal theory of the price level must take place in order for macroeconomic stability to be guaranteed. Otherwise, to preserve inflation control around the steady state by following the Taylor principle, monetary policy must target a higher inflation rate.
    Keywords: Public Debt; Distortionary Taxation; Monetary and Fiscal Policy Rules.
    JEL: H31 E63 H63
    Date: 2009–05–21
  3. By: Pami Dua
    Abstract: This paper investigates the determination of inflation in the framework of an open economy forward-looking as well as conventional backward-looking Phillips curve for eight Asian countries- Japan, Hong Kong, Korea, Singapore, Philippines, Thailand, China Mainland and India. Using Quarterly data and applying the instrumental variables estimation technique, it is found that the output gap is significant in explaining the inflation rate in almost all the countries. Furthermore, at least one measure of international competitiveness has a statistically significant influence on inflation in all the countries. The differences in the developed and developing world are highlighted by the significance of agriculture related supply shocks in determining inflation in the case of developing countries. For all countries, the forward-looking Phillips curve provides a better fit compared to the backward looking variant.[WP 178]
    Keywords: Inflation; Open Economy; Phillips Curve; Asian economies; inflation rate; supply shocks; monetary variables; demand factors; domestic factors; external factors; supply factors; devloping countries; developed countriesi
    Date: 2009
  4. By: Girardin Eric
    Abstract: This paper reports the European experience with a basket currency, the ECU. The ECU was initially introduced as a reference unit and later became the anchor of the European Monetary System. Public policy was complemented by private sector initiatives and use of the ECU for denomination of financial instruments. In practice, it turned out that a basket currency entails considerable unexpected technical complexities. There are no iron-clad economic principles and therefore there is some room for political considerations. In Europe three criteria were used for determining the weights: GDP shares, international trade shares, and financial market indicators. In addition, weights will change with exchange rate movements. Appreciating currencies will experience increasing weights and depreciating currencies decreasing weights. This may require a correction mechanism for political acceptability. In Europe, weights were rescaled by political authorities every five years. From an economic view point, weights depend critically on the purpose of the basket currency: is it a reference indicator, is it a currency for international transactions, or is it a parallel currency? Thus, before weights are to be discussed a clear vision of the role of the basket currency would be desirable. The vastly different growth performance among Asian economies also suggests a preference to forward rather than backward-looking measure. Turning then to the different functions of a basket currency, the use of basket currencies as a divergence indicator, or as a financial instrument in regional financial markets before elaborating a road map for the development of a basket currency in Asia is examined.[ DP 116]
    Keywords: Currency; Fixed Currency Unit; Monetary Unit; Basket Currency; Fixed Exchange Rate; Asian Currency Unit; European Currency Unit; Parallel Currency; Hard Currency Unit; Divergence Indicator; Short Maturities; Long Maturities; Cost-Benefit Analysis; Zero-Sum Game
    Date: 2009
  5. By: Obinyeluaku, Moses; Viegi, Nicola
    Abstract: Fiscal policy can affect monetary policy either through debt monetisation or through a direct effect on price dynamics. The former is the conventional classical view rooted in the quantity theory of money while the latter is the modern view of the Fiscal Theory of Price Determination. Based on the dynamic response of inflation to different shocks, we test the relationship between fiscal balances and monetary stability in 10 SADC countries. Results show that five out of 10 countries considered here were characterised throughout the period 1980-2006 by fiscally dominant regimes, with weak or no response of primary surpluses to public liabilities. The remaining five countries exhibit a monetary dominant regime. The study also finds that changes in primary surpluses affect price variability via aggregate demand, suggesting that fiscal outcomes could be a direct source of inflation variability, hence, the need for policy coordination in the region.
    Keywords: African Economic Integration; Fiscal Monetary Policy Coordination; VAR Analysis.
    JEL: C22 E63 C01
    Date: 2009–05–25
  6. By: John Y. Campbell (Dept. of Economics, Harvard University); Robert J. Shiller (Cowles Foundation, Yale University); Luis M. Viceira (Harvard Business School)
    Abstract: This paper explores the history of inflation-indexed bond markets in the US and the UK. It documents a massive decline in long-term real interest rates from the 1990's until 2008, followed by a sudden spike in these rates during the financial crisis of 2008. Breakeven inflation rates, calculated from inflation-indexed and nominal government bond yields, stabilized until the fall of 2008, when they showed dramatic declines. The paper asks to what extent short-term real interest rates, bond risks, and liquidity explain the trends before 2008 and the unusual developments in the fall of 2008. Low inflation-indexed yields and high short-term volatility of inflation-indexed bond returns do not invalidate the basic case for these bonds, that they provide a safe asset for long-term investors. Governments should expect inflation-indexed bonds to be a relatively cheap form of debt financing going forward, even though they have offered high returns over the past decade.
    Keywords: Expectations hypothesis, Liquidity, Term premia, TIPS
    JEL: E43 E44 G12
    Date: 2009–05
  7. By: Singh, Prakash; Pandey, Manoj K.
    Abstract: This paper attempts to take a meticulous look on stability of money demand in India Using annual data for period 1953-2007 and the Hansen (1992) and Gregory Hansen (1996) co-integration approaches with structural break. Results of the Gregory Hansen (1996) cointegration analysis show the presence of cointegration in demand for money, real GDP and nominal interest rate with structural break at 1965. Further, study also suggests for downward shift of about 0.33 % around 1965 in the demand for money function and put forward that demand for money is stable except for the period of 1975-1998.
    Keywords: Money Demand; Cointegration with Structural Break; Stability; Choice of Monetary Instrument
    JEL: E52 E41
    Date: 2009–03–05
  8. By: Hevia, Constantino; Nicolini, Juan Pablo
    Abstract: According to the conventional wisdom, when an economy enters a recession and nominal prices adjust slowly, the monetary authority should devalue the domestic currency to make the recession less severe. The reason is that a devaluation of the currency lowers the relative price of non-tradable goods, and this reduces the necessary adjustment in output relative to the case in which the exchange rate remains constant. This paper uses a simple small open economy model with sticky prices to characterize optimal fiscal and monetary policy in response to productivity and terms of trade shocks. Contrary to the conventional wisdom, in this framework optimal exchange rate policy cannot be characterized just by the cyclical properties of output. The source of the shock matters: while recessions induced by a drop in the price of exportable goods call for a devaluation of the currency, those induced by a drop in productivity in the non-tradable sector require a revaluation.
    Keywords: Economic Theory&Research,Debt Markets,Emerging Markets,Currencies and Exchange Rates,Economic Stabilization
    Date: 2009–05–01
  9. By: Bruche, Max; Suarez, Javier
    Abstract: This paper develops a tractable general equilibrium model in which money markets provide structural funding to some banks. When bank default risk becomes significant, retail deposit insurance creates an asymmetry between banks that operate in savings-rich regions, which can remain financed at cheap risk-free rates, and in savings-poor regions, which have to pay either large spreads in money markets or high rates for the scarce regional savings. We show that this asymmetry can cause a severe distortion of the aggregate allocation of credit. When interdependencies across borrowers are large (e.g., via demand externalities), output and welfare losses are also large and can be dramatically reduced by an aggressive subsidization of money market borrowing. The analysis offers some insights on the rationale for responding to a money markets freeze with full-allotment fixed-rate lending policies by central banks or the extension of government guarantees on non-deposit liabilities.
    Keywords: deposit insurance; financial crisis; money markets; spreads
    JEL: E44 G15 G21
    Date: 2009–05
  10. By: Thierry Warin
    Date: 2009–05–01
  11. By: Yuko Hashimoto; Takatoshi Ito
    Abstract: Market impacts of Japanese macroeconomic announcements within minutes on the dollar/yen foreign exchange are analyzed. High-frequency data collected from the actual trading platform, EBS, are used. First, impacts on returns are analyzed. Macroeconomic statistics releases that consistently had significant effects on exchange rate returns include Tankan survey (a short-term business survey conducted by Bank of Japan), GDP, industrial production (preliminary), PPI, CPI (Tokyo area), the unemployment rate and Balance of Payment statistics. Macroeconomic statistics releases that did not have impacts on returns include Trade Balance, Retail Sales and Housing start indicators. Second, for most of macroeconomic news items whose surprise components have return impacts also have impacts on deals and volatility. The announcement itself, in addition to the magnitude of surprise, is found to increase the deals and price volatility in the immediately after the announcement. In addition, some other items have no return impacts but deals and volatility impacts. These facts are consistent with a view that market participants have heterogeneous information, so that even without any price change, trades take place. Price discovery process may require some transactions with price fluctuations around new price level consistent with statistical announcement
    JEL: E44 F31 F41 G15
    Date: 2009–05
  12. By: Antonio Forte (Dipartimento di Economia e Metodi Matematici, Università di Bari); Giovanni Pesce (Dipartimento di Economia e Metodi Matematici, Università di Bari)
    Abstract: The advent of the international financial crisis, and of its effects on the economy, all the world now face the question how to manage the crisis and what measures to implement to restore a normal condition. In this paper we present and discuss the results and implications of an international expert survey. Our target is to understand the perception with regards to several aspects of the international financial crisis and some possible future implications for policy makers’ authorities.
    Keywords: international financial crisis, subprime, expert survey
    Date: 2009–04
  13. By: René Garcia; Richard Luger
    Abstract: We build and estimate an equilibrium model of the term structure of interest rates based on a recursive utility specification. We contrast it with an arbitrage-free model, where prices of risk are estimated freely without preference constraints. In both models, nominal bond yields are affine functions of macroeconomic state variables. The equilibrium model accounts for the tent-shaped pattern and magnitude of coefficients from predictive regressions of excess bond returns on forward rates and the hump-shaped pattern in the term structure of volatilities, while the reduced-form no-arbitrage model does not account for these important features of the yield curve. <P>Nous construisons et évaluons un modèle d’équilibre de la structure par terme des taux d’intérêt, fondé sur une caractéristique de la fonction d’utilité récursive. Nous le comparons à un modèle caractérisé par l’absence d’arbitrage, dans lequel les prix du risque sont estimés librement sans contrainte de préférence. Dans les deux modèles, les rendements des obligations nominales sont des fonctions affines des variables d’état macroéconomique. Le modèle d’équilibre prend en compte le profil en forme de tente (tent-shaped) et l’ampleur des coefficients de régression prédictive relatifs aux rendements des obligations excédant les taux d’intérêt à terme, de même que le profil en forme de bosse (hump-shaped) dans la structure par terme des volatilités, tandis que le modèle à forme réduite et caractérisé par l’absence d’arbitrage ne tient pas compte de ces caractéristiques importantes de la courbe de rendement.
    Keywords: Recursive utility, Yield curve, Affine macro-finance model, Bond risk premium, Expectations puzzle, Utilité récursive, courbe de rendement, modèle macrofinancier affine, prime de risque liée aux obligations, perplexité des attentes
    JEL: E43 E44 G12
    Date: 2009–05–01
  14. By: Bacchetta, Philippe; van Wincoop, Eric
    Abstract: It is well known from anecdotal, survey and econometric evidence that the relationship between the exchange rate and macro fundamentals is highly unstable. This could be explained when structural parameters are known and very volatile, neither of which seems plausible. Instead we argue that large and frequent variations in the relationship between the exchange rate and macro fundamentals naturally develop when structural parameters in the economy are unknown and change very slowly. We show that the reduced form relationship between exchange rates and fundamentals is driven not by the structural parameters themselves, but rather by expectations of these parameters. These expectations can be highly unstable as a result of perfectly rational "scapegoat" effects. This happens when parameters can potentially change much more in the long run than the short run. This generates substantial uncertainty about the level of parameters, even though monthly or annual changes are small. This mechanism can also be relevant in other contexts of forward looking variables and could explain the widespread evidence of parameter instability found in macroeconomic and financial data. Finally, we show that parameter instability has remarkably little effect on the volatility of exchange rates, the in-sample explanatory power of macro fundamentals and the ability to forecast out of sample.
    Keywords: Exchange rate; Time-varying coefficients
    JEL: F31 F37
    Date: 2009–05
  15. By: Fuchun Li
    Abstract: The author proposes a new test for financial contagion based on a non-parametric measure of the cross-market correlation. The test does not depend on the assumption that the data are drawn from a given probability distribution; therefore, it allows for maximal flexibility in fitting into the data. Simulation studies show that the test has reasonable size and good power to detect financial contagion, and that Forbes and Rigobon's test (2002) is conservative, suggesting that their test tends not to find evidence of contagion when it does exist. The author's new test is applied to investigate contagion from a variety of recent financial crises to the Canadian banking system. Three empirical results are obtained. First, compared to recent financial crises, including the 1987 U.S. stock market crash, 1994 Mexican peso crisis, and 1997 East Asian crisis, the ongoing 2007 subprime crisis has been having more persistent and stronger contagion impacts on the Canadian banking system. Second, the October 1997 East Asian crisis induced contagion in Asian countries, and it quickly spread to Latin American and G-7 countries. The contagion from the East Asian crisis to the Canadian banking system was not as strong or as persistent as that of the ongoing subprime crisis. However, it had a stronger impact on emerging markets. Third, there is no evidence of contagion from the 1994 Mexican peso crisis to the Canadian banking system. Contagion from that crisis occurred in Argentina, Brazil, and Chile, but the contagion effects of that crisis were limited to the Latin American region.
    Keywords: Financial stability; Central bank research; Econometric and statistical methods
    JEL: C12 G15
    Date: 2009

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