nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒07‒11
forty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Lenders of Last Resort in a Globalized World By Obstfeld, Maurice
  2. The welfare consequences of monetary policy By Federico Ravenna; Carl E. Walsh
  3. Negative Nominal Interest Rates: Three ways to overcome the zero lower bound By Buiter, Willem H
  4. Inflation expectations, uncertainty, the Phillips Curve, and monetary policy By Michael T. Kiley
  5. Deflationary vs. Inflationary Expectations - A New-Keynesian Perspective with Heterogeneous Agents and Monetary Believes By Felix Geiger; Oliver Sauter
  6. Input-output connections between sectors and optimal monetary policy By Engin Kara
  7. Strict and Flexible Inflation Forecast Targets: An Empirical Investigation By Glenn Otto; Graham Voss
  8. Estimating pure inflation in the Polish economy By Micha³ Brzoza-Brzezina; Jacek Kot³owski
  9. Evaluating the stresses from ECB monetary policy in the euro area By Lee , Jim; Crowley, Patrick M
  10. Is there a Role for International Trade Costs in Explaining the Central Bank Behavior? By Yilmazkuday, Hakan
  11. The communication policy of the European Central Bank: An overview of the first decade By Jakob de Haan; David-Jan Jansen
  12. The Link between Output, Inflation, Monetary Policy and Housing Price Dynamics By Demary, Markus
  13. Impact of Monetary Policy Changes in a Semi-Global Economy: Evidence from Bangladesh By Sayera Younus
  14. Monetary Policy Inertia: More a Fiction than a fact? By Consolo, Agostino; Favero, Carlo A
  15. Data Revisions in India and its Implications for Monetary Policy By Kishor, N. Kundan
  16. International Monies, Special Drawing Rights, and Supernational Money By Pietro Alessandrini; Michele Fratianni
  17. Modeling Inflation in India: The Role of Money By Kishor, N. Kundan
  18. Measuring Inflationary Pressure in Bangladesh: The P-Star Approach By Mustafa. K. Mujeri
  20. A Study on the Transmission of Money Market Tensions in EMEAP Economies During the Credit Crisis of 2007 - 2008 By Laurence Fung; Ip-wing Yu
  21. Bank liquidity, interbank markets, and monetary policy By Xavier Freixas; Antoine Martin; David Skeie
  22. Reset price inflation and the impact of monetary policy shocks By Mark Bils; Peter J. Klenow; Benjamin A. Malin
  23. WHAT MOVES BOND YIELDS IN CHINA? By Fan, Longzhen; Johansson, Anders C.
  24. Monetary Policy and Housing Sector Dynamics in a Large-Scale Bayesian Vector Autoregressive Model By Rangan Gupta; Marius Jurgilas; Alain Kabundi; Stephen M. Miller
  25. The High Cross-Country Correlations of Prices and Interest Rates By Espen Henriksen; Finn E. Kydland; Roman Sustek
  26. Inflation in Bangladesh: Does the Changing Consumption Pattern Affect its Measurement ? By Md. Akhtaruzzaman
  27. Structural Break, Stability and Demand for Money in India By Prakash Singh; Manoj K. Pandey
  28. The US Inflation-Unemployment Tradeoff: Methodological Issues and Further Evidence By Karanassou, Marika; Sala, Hector
  29. Renminbi as an International Currency: Potential and Policy Considerations By Hongyi Chen; Wensheng Peng; Chang Shu
  30. Do central bank liquidity facilities affect interbank lending rates? By Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
  31. Bayesian Analysis of Time-Varying Parameter Vector Autoregressive Model for the Japanese Economy and Monetary Policy By Jouchi Nakajima; Munehisa Kasuya; Toshiaki Watanabe
  32. Precautionary reserves and the interbank market By Adam Ashcraft; James McAndrews; David Skeie
  33. Financial Sophistication and the Distribution of the Welfare Cost of Inflation By Paola Boel; Gabriele Camera
  34. Inflation dynamics and food prices in an agricultural economy : the case of Ethiopia By Loening, Josef L.; Durevall, Dick; Birru, Yohannes A.
  35. Revisiting the Shocking Aspects of Asian Monetary Unification By Hans Genberg; Pierre L. Siklos
  36. Monetary-Fiscal Policy Interactions and Fiscal Stimulus By Troy Davig; Eric M. Leeper
  37. Relative Effectiveness of Monetary and Fiscal Policies on Output Growth in Bangladesh: A VAR Approach By Md. Habibur Rahman
  38. Assessing the Transmission of Monetary Policy Shocks Using Dynamic Factor Models By Dimitris Korobilis
  39. The Trilemma: An Empirical Assessment over 35 years since the 1970s By Durringer Fabien
  40. Reply to "Generalizing the Taylor principle": a comment By Troy Davig; Eric Leeper
  41. Can the Fed Predict the State of the Economy? By Tara M. Sinclair; Fred Joutz; Herman O. Stekler

  1. By: Obstfeld, Maurice
    Abstract: The recent financial crisis teaches important lessons regarding the lender-of-last resort function. Large swap lines extended in 2007-08 from the Federal Reserve to other central banks show that the classic concept of a national last-resort lender fails to address key vulnerabilities in a globalized financial system with multiple currencies. What system of emergency international financial support will best help to minimize the likelihood of future economic instability? Acting alongside national central banks, the International Monetary Fund has a key role to play in the constellation of lenders of last resort. As the income-level and institutional divergence between emerging and mature economies shrinks over time, the IMF may even evolve into a global last-resort lender that channels central bank liquidity where it is needed. The IMF’s effectiveness would be greatly enhanced by several complementary reforms in international financial governance, though some of these appear politically problematic at the present time.
    Keywords: central banking; financial crisis; International Monetary Fund; international monetary system; Lender of last resort
    JEL: E58 F33 F36
    Date: 2009–07
  2. By: Federico Ravenna; Carl E. Walsh
    Abstract: We explore the distortions in business cycle models arising from inefficiencies in price setting and in the search process matching firms to unemployed workers, and the implications of these distortions for monetary policy. To this end, we characterize the tax instruments that would implement the first best equilibrium allocations and then examine the trade-offs faced by monetary policy when these tax instruments are unavailable. Our findings are that the welfare cost of search inefficiency can be large, but the incentive for policy to deviate from the inefficient flexible-price allocation is in general small. Sizable welfare gains are available if the steady state of the economy is inefficient, and these gains do not depend on the existence of an inefficient dispersion of wages. Finally, the gains from deviating from price stability are larger in economies with more volatile labor flows, as in the U.S.
    Keywords: Labor market
    Date: 2009
  3. By: Buiter, Willem H
    Abstract: The paper considers three methods for eliminating the zero lower bound on nominal interest rates and thus for restoring symmetry to domain over which the central bank can vary its policy rate. They are: (1) abolishing currency (which would also be a useful crime-fighting measure); (2) paying negative interest on currency by taxing currency; and (3) decoupling the numéraire from the currency/medium of exchange/means of payment and introducing an exchange rate between the numéraire and the currency which can be set to achieve a forward discount (expected depreciation) of the currency vis-a-vis the numéraire when the nominal interest rate in terms of the numéraire is set at a negative level for monetary policy purposes.
    Keywords: Eisler; Gesell; liquidity trap; Monetary policy; quantitative easing; zero interest rate policy
    JEL: B1 B2 B3 E1 E3 E4 E5 F3 F4 G1 H2
    Date: 2009–06
  4. By: Michael T. Kiley
    Abstract: Inflation expectations play a central role in models of the Phillips curve. At long time horizons inflation expectations may reflect the credibility of a monetary authority's commitment to price stability. These observations highlight the importance of inflation expectations for monetary policy. These comments touch on three issues regarding inflation expectations: The evolving treatment of inflation expectations in empirical Phillips curve models; three recent models of information imperfections and inflation expectations; and potential policy implications of different models.
    Date: 2009
  5. By: Felix Geiger; Oliver Sauter
    Abstract: We expand a standard New-Keynesian model by allowing for a special role of money in the inflation and expectations building process. Motivated by the two-pillar Phillips curve, we introduce heterogeneous expectations. Thereby a fraction of agents forms inflation expectations by observing trend money growth. We show that in the presence of these monetary believers, contractive shocks to the economy produce smoother dynamics for inflation and output. We also find that monetary policy should follow a conventional Taylor rule with contemporaneous inflation and output data, if it is uncertain about the fraction of monetary believers.
    Keywords: New-Keynesian model, monetary policy, two-pillar Phillips curve, heterogeneous expectations, monetary believes
    JEL: E31 E41 E47 E52
    Date: 2009–06
  6. By: Engin Kara (National Bank of Belgium, Research Department)
    Abstract: This paper considers the monetary policy implications of a model that features input-output connections between stages of production, so that a distinction between CPI inflation and PPI inflation arises. More specifically, this paper addresses the policy conclusion by K. Huang and Z. Liu [2005, "Inflation targeting: What inflation rate to target", Journal of Monetary Economics 52], which states that central banks should use an optimal inflation index that gives substantial weight to stabilising both CPI and PPI. This paper argues that these authors' findings rely on the assumption that producer prices are as sticky as consumer prices and it also shows that, once empirically relevant frequencies of price adjustment are used to calibrate the model, CPI inflation receives substantial weight in the optimal inflation index. Moreover, this rule is remarkably robust to uncertainty regarding the model parameters, whereas the policy rule proposed by Huang and Liu can result in heavy welfare losses
    Keywords: Inflation targeting, Optimal Monetary Policy
    JEL: E32 E52 E58
    Date: 2009–06
  7. By: Glenn Otto (University of New South Wales, Australia); Graham Voss (University of Victoria, Canada, Hong Kong Institute for Monetary Research)
    Abstract: We examine whether standard theoretical models of inflation forecast targeting are consistent with the observed behaviour of the central banks of Australia, Canada, and the United States. The target criteria from these models restrict the conditionally expected paths of variables targeted by the central bank, in particular inflation and the output gap. We estimate various moment conditions, providing a description of monetary policy for each central bank under different maintained hypotheses. We then test whether these estimated conditions satisfy the predictions of models of optimal monetary policy. The overall objective is to examine the extent to which and the manner in which these central banks successfully balance inflation and output objectives over the near term. For all three countries, we obtain reasonable estimates for both the strict and flexible inflation forecast targeting models, though with some qualifications. Most notably, for Australia and the United States there are predictable deviations from forecasted targets, which is not consistent with models of inflation targeting. In contrast, the results for Canada lend considerable support to simple models of flexible inflation forecast targeting.
    JEL: E31 E58
    Date: 2009–05
  8. By: Micha³ Brzoza-Brzezina; Jacek Kot³owski (National Bank of Poland, Warsaw School of Economics)
    Abstract: This paper uses a restricted factor model to estimate the HICP index excluding relative prices changes. The index thus obtained, hereinafter referred to as pure inflation, demonstrates stronger relationship to the central bank instrument (short-term interest rate) than the HICP index and selected measures of core inflation. Pure inflation has also a forecasting performance for future HICP comparable or better than that of competing models. The estimated variable indicates a much weaker role of changes in relative prices in the recent period of rising inflation (2006-2008) than during previous inflation increases (1999-2000 and 2004-05). This may show that inflation was mainly driven by demand pressures in the years 2006-2008.
    Keywords: monetary policy, relative prices, factor model, core inflation
    JEL: C43 E31 E58
    Date: 2009–06–28
  9. By: Lee , Jim (Texas A&M University- Corpus Christi); Crowley, Patrick M (Texas A&M University - Corpus Christi)
    Abstract: This paper investigates the extent to which euro area monetary policy has responded to evolving economic conditions in individual member states as opposed to the euro area as a whole. Based on a forward-looking Taylor rule-type policy reaction function, we conduct counterfactual exercises that compare the monetary policy behaviour of the ECB under alternative hypothetical scenarios: (1) the euro member states make individual policy decisions, and (2) the ECB responds to the economic conditions of individual members. Stress measures are then constructed to evaluate the degree of divergence of member state economies under these two hypothetical scenarios. The results we obtain reflect the extent of heterogeneity among the national economies in the monetary union, indicating that euro area policy rates have been particularly close to the ‘counterfactual’ interest rates of the largest euro members and countries with similar economic conditions, namely Germany, Austria, Belgium and France.
    Keywords: European Central Bank; monetary policy reaction; Taylor rule; counterfactual analysis
    JEL: C53 E52
    Date: 2009–04–07
  10. By: Yilmazkuday, Hakan
    Abstract: This paper develops an open-economy DSGE model to analyze the effects of international trade costs on monetary policy of open economies. The implications of this micro-founded New-Keynesian model are tested on a prototype small economy that is open to international trade costs shocks, Canada. When a utility-based expected loss function is considered, the central bank is found to be far from being optimal in its actions, independent of international trade costs. When an ad hoc expected loss function considering the volatilities in inflation, output and interest rate is considered, it is found that the actions of the central bank are explained best when international trade costs in fact exist but the central bank ignores them. Given the ad hoc loss function, the actions of the central bank are best explained when 70% of weight is assigned to inflation, 15% of weight to interest rate and 15% of weight to output.
    Keywords: DSGE Model, Monetary Policy Rule, International Trade Costs, Inflation Targeting
    JEL: E58 E52 F41
    Date: 2009–06
  11. By: Jakob de Haan; David-Jan Jansen
    Abstract: Since its inception, the European Central Bank (ECB) has regarded communication as anintegral part of its monetary policy. This paper describes and evaluates ECB communications during the first decade of its operation.We conclude that, overall, ECB communication has contributed to the effectiveness of its monetary policy. Our review of the literature shows that ECB communications affect the level and volatility of financial prices - suggesting that private sector expectations reacted to ECB communication. In addition, there is evidence that communication has improved the predictability of interest rate decisions. 
    Keywords: communication; European Central Bank; transparency; monetary policy
    JEL: E44 E52 E58
    Date: 2009–06
  12. By: Demary, Markus
    Abstract: This study analyses empirically the link between real house prices and key macro variables like prices, output and interest rates for ten OECD countries. We find out that a monetary policy shock lowers real house prices in all ten countries, where the interest rate shock explains between 12 and 24 percent of the fluctuations in house prices. Impulse responses indicate that house prices rise after an output shock in nine of ten countries. But we also find evidence that real estate prices have a large impact on these key macroeconomic variables. We find out that the house price shock is a germane aggregate demand shock because it raises output and prices and leads to increasing money market rates in all countries. The story behind this finding is that increasing house prices lead to an increase in households' net worth which leads to increasing consumption expentitures and thereby stimulates aggregate demand. This stimulus on aggregate demand leads to increasing output and inflationary pressures on which the central bank reacts by tightening monetary policy. We find out that 12 to 20 percent of output fluctuations and around 10 to 20 percent of price fluctuations can be traced back to the housing demand shock. Moreover, we find that these housing demand shocks are a key driver of money market rates. We conclude that this channel is empirically relevant.
    Keywords: Inflation; Monetary Policy; Housing Prices; Vectorautoregressions
    JEL: C32 E32 E31 E44
    Date: 2009–05–08
  13. By: Sayera Younus
    Abstract: The study examines the impact of changes in monetary policy in Bangladesh. Specifically, the study examines the impact of domestic and foreign monetary shocks on Bangladesh’s major economic aggregates.In the context of a semi-global economy such as Bangladesh, the conduct of monetary policy becomes increasingly more difficult as globalization proceeds. It becomes important to examine the impact of changes in relevant 'foreign' variables (e.g., interest rate, money supply, exchange rate)while formulating domestic monetary policy. The empirical results of the present analysis show that innovations to foreign money supply have significant impacts on Bangladesh's real exchange rate,interest rate,land output.[Bangladesh Bank WP NO 0902]
    Keywords: Monetary Policy; Macroeconomic Variables
    Date: 2009
  14. By: Consolo, Agostino; Favero, Carlo A
    Abstract: Empirical estimates of monetary policy reaction functions feature a very high estimated degree of monetary policy inertia. This evidence is very hard to reconcile with the alternative evidence of low predictability of monetary policy rates. In this paper we examine the potential relevance of the problem of weak instruments to correctly identify the degree of monetary policy inertia in forward looking monetary policy reaction function of the type originally proposed by Taylor (1993). After appropriately diagnosing and taking care of the weak instruments problem, we find an estimated degree of policy inertia which is significantly lower than the common value in the empirical literature on monetary policy rules.
    Keywords: Monetary Policy Rulkes; Weak Identification
    JEL: E52 E58 G12
    Date: 2009–06
  15. By: Kishor, N. Kundan
    Abstract: This paper studies data revision properties of GDP growth and inflation as measured by the Wholesale Price Index (WPI) for the Indian economy. We find that data revisions to GDP growth and WPI inflation in India are significant. The results show that revisions to GDP growth and WPI inflation can not be characterized as either containing pure news or pure noise. We also find that there is a significant predictable component in revisions to GDP growth and inflation. Our findings suggest that if the Reserve Bank of India were to follow a Taylor rule for its monetary policy formulation, then the interest rate based on the preliminary data would be much lower than the one based on the fully revised data.
    Keywords: Data Revisions; Real-Time Data; Monetary Policy
    JEL: C53 C82 E52
    Date: 2009–07
  16. By: Pietro Alessandrini (Universita Politecnica delle Marche); Michele Fratianni (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)
    Abstract: The current international monetary system (IMS) is fragile because the dollar standard is rapidly deteriorating. The dual role the dollar as the dominant international money and national money cannot be easily reconciled because the US monetary authorities face a conflict between pursuing domestic objectives of employment and inflation and maintaining the international public good of a stable money. To strengthen the IMS, China has advocated the revitalization of the Special Drawing Rights (SDRs). But SDRs are neither money nor a claim on any international institution; are issued exogenously without any consideration to countries’ financing needs; and can activate international monies only though bilateral transactions. The historical record of SDRs as international reserves is altogether unimpressive. We propose instead the creation of a supernational bank money (SBM) within the institutional setting of a clearing union. This union would be a full-fledged agreement by participating central banks on specific rules of the game, such as size and duration of overdrafts, designation of countries that would have to bear the burden of external adjustment, and coordination of monetary policies objectives and at expense of the maintenance of the international public good. We also discuss structural changes that would make SDRs converge to SBMs.
    Keywords: international money, international monetary system, Special Drawing Right, supernational bank money
    JEL: E42 E52 F33 F36
    Date: 2009–07
  17. By: Kishor, N. Kundan
    Abstract: This paper studies the role of the real money gap- the deviation of real money balance from its long-run equilibrium level- for predicting inflation in India. Using quarterly data on manufacturing inflation from 1982 to 2007, we find that the real money gap is a significant predictor of inflation in India. Our results show that this variable is a better predictor of future inflation at quarterly horizon than the deviation of broad money growth from its target for the whole sample period. We also document a break in the overall predictability of inflation in the last quarter of 1995. We find that except for the real money gap, the forecasting power of other predictors under study has declined considerably after 1995.
    Keywords: Inflation. Monetary Policy; Indian Economy
    JEL: E31 E58 E52
    Date: 2009–07
  18. By: Mustafa. K. Mujeri
    Abstract: The paper estimates the P* model for Bangladesh economy and test its forecasting ability through generating recursive forecasts. The empirical result shows that the model performs relatively well and contains additional information regarding future rates of inflation. The price and output gap models fare consistently better then the velocity gap model which brings out the importance of non-monetary factors in explaining inflation dynamics in Bangladesh. The P* model can have wide applications in policy analysis. With financial sector liberalization and reforms, it is likely that the scope for the P* model to play a more proactive role would be ramified in Bangladesh. [BB WP no.0901]
    Keywords: inflation; Bangladesh; P* approach; forecasts; velocity gap model; price gap model; output gap model; financial sector; monetary targeting policy.
    Date: 2009
  19. By: Ljungwall, Christer (China Economic Research Center); Xiong, Yi (Peking University National School of Development, China Center for Economic Research); Zou, Yutong (Peking University National School of Development, China Center for Economic Research)
    Abstract: This paper investigates the current monetary policy regime of China’s Central Bank, the People’s Bank of China (PBoC). This is done from the specific viewpoint of PBoC financial strength and the cost of its monetary policy instruments. The result shows that PBoC is constrained by the costs of its monetary policy instruments. PBoC tend to use less costly but market-distorting instruments such as deposit interest rate cap and reserve-ratio requirements, rather than more market-oriented but more costly instruments such as central bank note issuance. These costs remain under control today, but may rise in the future as PBoC accumulates more foreign assets. This, in turn, will jeopardize the Chinese monetary authority’s capability to maintain price stability.
    Keywords: Central banking; Monetary policy; China
    JEL: E51 E52 E58 E63 O53
    Date: 2009–05–01
  20. By: Laurence Fung (Research Department, Hong Kong Monetary Authority); Ip-wing Yu (Research Department, Hong Kong Monetary Authority)
    Abstract: The recent tension in the interbank markets following the global financial crisis has raised concerns about the turbulence in interbank markets. This paper utilises two widely used indicators for measuring interbank stress (the interbank rate less the Overnight Index Swap rate and the interbank rate less the yield of government securities) to examine the transmission of interbank tension from the US dollar to nine interbank markets in the EMEAP economies. Using a vector autoregression model, we show that during the credit crisis of 2007 - 2008, the distress in the US dollar money market had a material impact with durations of seven to 13 days on the interbank markets for the Hong Kong dollar, Japanese yen, Australian dollar and New Zealand dollar. Moreover, based on a bivariate regime switching ARCH model, we also find evidence of volatility co-movement between the interbank stress indicator of the US dollar and that of the Hong Kong dollar, Japanese yen, Australian dollar, New Zealand dollar, Korean won and Singapore dollar during the crisis. The expected duration when two money markets are both in a high-volatility state is estimated to be as long as seven days. The short-lived impact on the EMEAP economies from a shock in the US dollar money market can be attributed to the policy actions taken by central banks and monetary authorities in the region and the coordinated efforts by policy makers worldwide to contain the credit crisis.
    Keywords: Interbank stress; Vector autoregression; Regime-switching ARCH
    JEL: E50 E58 G15
    Date: 2009–05
  21. By: Xavier Freixas; Antoine Martin; David Skeie
    Abstract: A major lesson of the recent financial crisis is that the ability of banks to withstand liquidity shocks and to provide lending to one another is crucial for financial stability. This paper studies the functioning of the interbank lending market and the optimal policy of a central bank in response to both idiosyncratic and aggregate shocks. In particular, we consider how the interbank market affects a bank's choice between holding liquid assets ex ante and acquiring such assets in the market ex post. We show that a central bank should use different tools to manage different types of shocks. Specifically, it should respond to idiosyncratic shocks by lowering the interest rate in the interbank market and address aggregate shocks by injecting liquid assets into the banking system. We also show that failure to adopt the optimal policy can lead to financial fragility.
    Keywords: Interbank market ; Banks and banking, Central ; Bank liquidity ; Interest rates
    Date: 2009
  22. By: Mark Bils; Peter J. Klenow; Benjamin A. Malin
    Abstract: A standard state-dependent pricing model implies very limited scope for using active monetary policy to stabilize real activity. Two modeling strategies which expand the role of monetary policy are time-dependent pricing and strategic complementarities between price-setting firms. These mechanisms have telltale implications for the persistence and volatility of "reset price inflation." Reset price inflation is the rate of change of all desired prices (including for goods that have not changed price in the current period). Using the micro data underpinning the CPI, we construct an empirical measure of reset price inflation and use this measure to assess the validity of the modeling approaches. We find that time-dependent models imply unrealistically high persistence and stability of reset price inflation. This discrepancy is exacerbated by adding strategic complementarities, even under state-dependent pricing. A state-dependent model with no strategic complementarities aligns most closely with the CPI data.
    Date: 2009
  23. By: Fan, Longzhen (School of Management, Fudan University); Johansson, Anders C. (China Economic Research Center)
    Abstract: This paper analyzes the joint dynamic processes of macroeconomic and monetary variables and bond yields in China. We show that macroeconomic variables as well as monetary policy variables have a significant impact on two factors that capture the variation in yields. An increase in the inflation rate and economic growth result in a rise in the yield curve. Similarly, an increase in the money supply causes a rise in the yield curve, albeit with a delayed effect. Finally, when official rates are raised, the long yield shows signs of a delayed decline. Overall, the long yield is more sensitive to most changes in macroeconomic and monetary variables. These results differ from an earlier study on bond yields by Ang and Piazzesi (2003), who show that the U.S. short-term rate is more sensitive to changes in macroeconomic variables. Possible explanations for the difference include certain unique structural features in the domestic financial system and the way monetary policy is conducted in China.
    Keywords: China; yield curve; macroeconomic factors; monetary policy
    JEL: E43 E44 E52 E58 G12
    Date: 2009–06–01
  24. By: Rangan Gupta (Department of Economics, University of Pretoria); Marius Jurgilas (Financial Stability Directorate, Bank of England); Alain Kabundi (Department of Economics and Econometrics, University of Johannesburg); Stephen M. Miller (College of Business, University of Las Vegas, Nevada)
    Abstract: Our paper considers the channel whereby monetary policy, a Federal funds rate shock, affects the dynamics of the US housing sector. The analysis uses impulse response functions obtained from a large-scale Bayesian Vector Autoregression (LBVAR) model that incorporates 143 monthly macroeconomic variables over the period of 1986:01 to 2003:12, including 21 variables relating to the housing sector at the national and four census regions. We find at the national level that housing starts, housing permits, and housing sales fall in response to the tightening of monetary policy. Housing sales reacts more quickly and sharply than starts and permits and exhibits more duration. Housing prices show the weakest response to the monetary policy shock. At the regional level, we conclude that the housing sector in the South drives the national data. The responses in the West differ the most from the other regions, especially for the impulse responses of housing starts and permits.
    Keywords: Monetary policy, Housing sector dynamics, Large-Scale BVAR models
    JEL: C32 R31
    Date: 2009–06
  25. By: Espen Henriksen; Finn E. Kydland; Roman Sustek
    Abstract: We document that, at business cycle frequencies, fluctuations in nominal variables, such as aggregate price levels and nominal interest rates, are substantially more synchronized across countries than fluctuations in real output. To the extent that domestic nominal variables are determined by domestic monetary policy, and central banks generally attempt to keep the domestic nominal environment stable, this might seem surprising. We ask if a parsimonious international business cycle model can account for this aspect of cross-country aggregate fluctuations. It can. Due to spillovers of technology shocks across countries, expected future responses of national central banks to fluctuations in domestic output and inflation generate movements in current prices and interest rates that are synchronized across countries even when output is not. Even modest spillovers produce cross-country correlations such as those in the data.
    JEL: E31 E32 E43 F42
    Date: 2009–07
  26. By: Md. Akhtaruzzaman
    Abstract: Ensuring price stability is one of the prime objectives of the monetary policy in Bangladesh, whereby the latest monetary policy statement aims at rapid growth with price stability. This note examines how changes in the consumption patterns as derived from the household income and expenditure surveys (HIES) of 1995/96 and 2005 affect the average weights of goods in the CPI and consequently the level of inflation in the economy. The note also makes a brief assessment of the implications of using average weights in the consumption basket rather than using specific weights representing different expenditure groups. The study shows that it is important to capture the changing structure of household consumption and ensure the use of representative weights in constructing CPI inflation. This generates a more realistic picture of price changes in the economy. Such changes have significant implications and should be effectively used to adjust the distribution of CPI weights in measuring inflation, so as to provide more accurate estimates of inflation in Bangladesh. [BB PP no.0802]
    Keywords: inflation; Bangladesh; consumption pattern; expenditure; price stability; monetary policy; consumer price index (CPI); CPI inflation; household income and expenditure surveys (HIES); CPI weights; commodity- specific weights
    Date: 2009
  27. By: Prakash Singh; Manoj K. Pandey
    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: E41 E52
    Date: 2009
  28. By: Karanassou, Marika (University of London); Sala, Hector (Universitat Autònoma de Barcelona)
    Abstract: This paper addresses the various methodological issues surrounding vector autoregressions, simultaneous equations, and chain reactions, and provides new evidence on the long-run inflation-unemployment tradeoff in the US. It is argued that money growth is a superior indicator of the monetary environment than the federal funds rate and, thus, the focus is on the inflation/unemployment responses to money growth shocks. SVAR (structural vector autoregression) and GMM (generalised method of moments) estimations confirm earlier findings in Karanassou, Sala and Snower (2005, 2008b) obtained from chain reaction structural models: the slope of the US Phillips curve is far from vertical, even in the long-run, which implies that the nominal and real sides of the economy are symbiotic. In the light of the significant and robust long-run inflation-unemployment tradeoffs, policy makers should reconsider the classical dichotomy thesis.
    Keywords: inflation, unemployment, money growth, SVAR, GMM, structural modelling, chain reactions
    JEL: E24 E31 E51
    Date: 2009–06
  29. By: Hongyi Chen (Hong Kong Institute for Monetary Research); Wensheng Peng (Barclays Capital); Chang Shu (Hong Kong Monetary Authority)
    Abstract: The potential of the renminbi as an international currency is underpinned by the large and fast growing Chinese economy. We present empirical evidence indicating that the renminbi has already become a significant force impacting the exchange rates of the Asian currencies. We also estimate a reserve currency model and counterfactual simulations, and suggest that the renminbi's potential as a reserve currency would be comparable to that of the Japanese yen and the British pound if the Chinese currency were to become a fully convertible currency today. The evolution of the international role of the remninbi will depend importantly on the pace of the liberalisation of the restrictions on currency convertibility, which is likely to be governed by the authorities' consideration of the associated benefits and costs. In particular, we see a two-way reinforcement of currency internationalisation and financial market developments and opening in China.
    Date: 2009–06
  30. By: Jens H. E. Christensen; Jose A. Lopez; Glenn D. Rudebusch
    Abstract: In response to the global financial crisis that started in August 2007, central banks provided extraordinary amounts of liquidity to the financial system. To investigate the effect of central bank liquidity facilities on term interbank lending rates, we estimate a six-factor arbitrage-free model of U.S. Treasury yields, financial corporate bond yields, and term interbank rates. This model can account for fluctuations in the term structure of credit risk and liquidity risk. A significant shift in model estimates after the announcement of the liquidity facilities suggests that these central bank actions did help lower the liquidity premium in term interbank rates.
    Keywords: Banks and banking, Central ; Bank liquidity
    Date: 2009
  31. By: Jouchi Nakajima; Munehisa Kasuya; Toshiaki Watanabe
    Abstract: This paper analyzes the time-varying parameter vector autoregressive (TVP-VAR) model for the Japanese economy and monetary policy. The time-varying parameters are estimated via the Markov chain Monte Carlo method and the posterior estimates of parameters reveal the time-varying structure of the Japanese economy and monetary policy during the period from 1981 to 2008. The marginal likelihoods of the TVP-VAR model and other VAR models are also estimated. The estimated marginal likelihoods indicate that the TVP-VAR model best fits the Japanese economic data.
    Keywords: Bayesian inference, Markov chain Monte Carlo, Monetary policy, State space model, Structural vector autoregressive model, Stochastic volatility, Time-varying parameter
    Date: 2009–05
  32. By: Adam Ashcraft; James McAndrews; David Skeie
    Abstract: Liquidity hoarding by banks and extreme volatility of the fed funds rate have been widely seen as severely disrupting the interbank market and the broader financial system during the 2007-08 financial crisis. Using data on intraday account balances held by banks at the Federal Reserve and Fedwire interbank transactions to estimate all overnight fed funds trades, we present empirical evidence on banks' precautionary hoarding of reserves, their reluctance to lend, and extreme fed funds rate volatility. We develop a model with credit and liquidity frictions in the interbank market consistent with the empirical results. Our theoretical results show that banks rationally hold excess reserves intraday and overnight as a precautionary measure against liquidity shocks. Moreover, the intraday fed funds rate can spike above the discount rate and crash to near zero. Apparent anomalies during the financial crisis may be seen as stark but natural outcomes of our model of the interbank market. The model also provides a unified explanation for several stylized facts and makes new predictions for the interbank market.
    Keywords: Bank reserves ; Federal funds rate ; Interbank market ; Liquidity (Economics)
    Date: 2009
  33. By: Paola Boel; Gabriele Camera
    Abstract: The welfare cost of anticipated inflation is quantified in a calibrated model of the U.S. economy that exhibits tractable equilibrium dispersion in wealth and earnings. Inflation does not generate large losses in societal welfare, yet its impact varies noticeably across segments of society depending also on the financial sophistication of the economy. If money is the only asset, then inflation hurts mostly the wealthier and more productive agents, while those poorer and less productive may even benefit from inflation. The converse holds in a more sophisticated financial environment where agents can insure against consumption risk with assets other than money.
    Keywords: money, heterogeneity, friedman rule, trade frictions, calibration
    JEL: E4 E5
    Date: 2009–06
  34. By: Loening, Josef L.; Durevall, Dick; Birru, Yohannes A.
    Abstract: Ethiopia has experienced a historically unprecedented increase in inflation, mainly driven by cereal price inflation, which is among the highest in Sub-Saharan Africa. Using monthly data from the past decade, the authors estimate error correction models to identify the relative importance of several factors contributing to overall inflation and its three major components, cereal prices, food prices, and non-food prices. The main finding is that, in a longer perspective, over three to four years, the main factors that determine domestic food and non-food prices are the exchange rate and international food and goods prices. In the short run, agricultural supply shocks and inflation inertia strongly affect domestic inflation, causing large deviations from long-run price trends. Money supply growth does affect food price inflation in the short run, although the money stock itself does not seem to drive inflation. The results suggest the need for a multi-pronged approach to fight inflation. Forecast scenarios suggest monetary and exchange rate policies need to take into account cereal production, which is among the key determinants of inflation, assuming a decline in global commodity prices. Implementation of successful policies will be contingent on the availability of foreign exchange and the performance of agriculture.
    Keywords: Markets and Market Access,Currencies and Exchange Rates,Economic Theory&Research,Food&Beverage Industry,Emerging Markets
    Date: 2009–06–01
  35. By: Hans Genberg (Hong Kong Institute for Monetary Research, Hong Kong Monetary Authority); Pierre L. Siklos (Wilfrid Laurier University, Viessmann European Research Centre, Hong Kong Institute for Monetary Research)
    Abstract: This paper revisits the question whether economies in Asia are likely to be good candidates for pursuing similar exchange rate policies and ultimately joining together in a monetary union. A number of authors have investigated this question before typically using some variant of the methodology originally used by Bayoumi and Eichengreen (BE) to study the same question for countries that were potential candidates to form common currency area in Europe. It is the contention of this paper that this methodology is flawed because it fails to identify properly the aggregate demand and aggregate supply shocks in each economy and hence cannot adequately address one of the central issues in determining the suitability of two or more countries joining a monetary union. To remedy this deficiency in the existing literature we propose an alternative methodology to identify structural shocks. We will therefore be able to revisit the debate about monetary integration in Asia based on more solid empirical foundations. The results show that these modifications do matter for the cross-country correlation of these shocks. In particular, aggregate demand shocks among the relatively smaller economies of Asia appear to be more highly correlated with the larger or more advanced economies in the regions such as Korea, Hong Kong, Singapore, and Japan, than they are amongst themselves when we rely on the standard BE methodology. When an alternative approach is used we conclude, for example, that aggregate supply shocks remain most highly correlated between China, Hong Kong and the remainder of the economies in our sample while Japan and Singapore, most notably, seem more ¡¥disconnected¡¦ with the rest of the region. Taking explicit account of foreign shocks not only prevents them from erroneously being confounded with domestic shocks as in the conventional methodology, it also makes it possible to evaluate the desirability of a common monetary policy response to common external shocks. Our results show that this can have an important bearing on assessing the desirability of forming a monetary union among the economies in the region. With respect to the implications for monetary unification in Asia our results do not clearly identify a group of countries for which shocks are unambiguously highly correlated and which therefore would be able to perform well with a common monetary policy.
    Date: 2009–05
  36. By: Troy Davig; Eric M. Leeper
    Abstract: Increases in government spending trigger substitution effects—both inter- and intra-temporal—and a wealth effect. The ultimate impacts on the economy hinge on current and expected monetary and fiscal policy behavior. Studies that impose active monetary policy and passive fiscal policy typically find that government consumption crowds out private consumption: higher future taxes create a strong negative wealth effect, while the active monetary response increases the real interest rate. This paper estimates Markov-switching policy rules for the United States and finds that monetary and fiscal policies fluctuate between active and passive behavior. When the estimated joint policy process is imposed on a conventional new Keynesian model, government spending generates positive consumption multipliers in some policy regimes and in simulated data in which all policy regimes are realized. The paper reports the model's predictions of the macroeconomic impacts of the American Recovery and Reinvestment Act's implied path for government spending under alternative monetary-fiscal policy combinations.
    JEL: E31 E52 E6 E62
    Date: 2009–07
  37. By: Md. Habibur Rahman
    Abstract: This paper investigates the relative importance of monetary and fiscal policies in altering real output of Bangladesh. An unrestricted vector auto regression (VAR) framework based on the St. Louis equations, is used to compute variance decompositions (VDCs)and impulse response function (IRF) through 1000 Monte Carlo Simulations. A 'Monetary— Fiscal Game' under oligopolistic framework is also used to justify the co-ordination and co-operation between the monetary and fiscal authorities. The outcomes of this study imply that monetary policy is relatively more effective than fiscal policy in stimulating real economic activity. The results also confirm the presence of interactions between monetary and fiscal policies. [BB WP no.0601]
    Keywords: monetary policy; fiscal policy; Bangladesh; vector auto regression (VAR); variance decompositions (VDCs); impulse response function (IRF); Monetary— Fiscal Game; St. Louis equations.
    Date: 2009
  38. By: Dimitris Korobilis (Department of Economics, University of Strathclyde)
    Abstract: The evolution of monetary policy in the U.S. is examined based on structural dynamic factor models. I extend the current literature which questions the stability of the monetary transmission mechanism, by proposing and studying time-varying parameters factor-augmented vector autoregressions (TVP-FAVAR), which allow for fast and efficient inference based on hundreds of explanatory variables. Different specifcations are compared where the factor loadings, VAR coefficients and error covariances, or combinations of those, may change gradually in every period or be subject to small breaks. The model is applied to 157 post-World War II U.S. quarterly macroeconomic variables. The results clearly suggest that the propagation of the monetary and non-monetary (exogenous) shocks has altered its behavior, and speciffically in a fashion which supports smooth evolution rather than abrupt change. The most notable changes were in the responses of real activity measures, prices and monetary aggregates, while other key indicators of the economy remained relatively unaffected.
    Keywords: Structural FAVAR, time varying parameter model, monetary policy
    JEL: C11 C32 E52
    Date: 2009–05
  39. By: Durringer Fabien
    Abstract: This research provides further insight of trilemma phenomenon which is defined as the impossibility for a country to achieve at the same time the triple desirable goals of stability of its exchange rate, independence of its monetary policy and freedom of its capital flows. Using three indices measuring these three variables, we prove that the trilemma relationship exists provided some extra explanatory variables are added in the econometric fixed-effect modelfs equation. Conditionality is therefore attached to the existence of the trilemma. Once these results are established we provide some additional analyses of the trilemma phenomenon. First, by introducing the concept of gperformanceh we show that certain countries are coping better than others facing the trilemma constraint. Second, by using a triangle graph representing the trilemma goals at the vertices, we analyze the tradeoff that countries have adopted over years when dealing with this problem. We manage to show graphically that, rather than positioning themselves to the vertices of this triangle, countries usually adopt positions close to one side of it. These results can therefore be understood as the choice between three gdilemmash represented by the trianglefs sides.
    Date: 2009–05
  40. By: Troy Davig; Eric Leeper
    Abstract: Farmer, Waggoner, and Zha (2009) show that a new Keynesian model with a regime-switching monetary policy rule can support multiple solutions that depend only on the fundamental shocks in the model. Their note appears to find solutions in regions of the parameter space where there should be no bounded solutions, according to conditions in Davig and Leeper (2007). This puzzling finding is straightforward to explain: Farmer, Waggoner, and Zha (FWZ) derive solutions using a model that differs from the one to which the Davig and Leeper (DL) conditions apply. In addition, FWZ impose cross-equation restrictions between behavioral relations and the exogenous driving process. This rather special assumption undermines the traditional sharp distinction in micro-founded general equilibrium models between 'deep' parameters and the parameters governing the exogenous processes.
    Date: 2009
  41. By: Tara M. Sinclair (Department of Economics The George Washington University); Fred Joutz (Department of Economics The George Washington University); Herman O. Stekler (Department of Economics The George Washington University)
    Abstract: Recent research has documented that the Federal Reserve produces systematic errors in forecasting inflation, real GDP growth, and the unemployment rate, even though these forecasts are unbiased. We show that these systematic errors reveal that the Fed is “surprised” by real and inflationary cycles. Using a modified Mincer-Zarnowitz regression, we show that the Fed knows the state of the economy for the current quarter, but cannot predict it one quarter ahead.
    Keywords: Forecast Evaluation; Federal Reserve; Systematic Errors; Recessions
    JEL: C53 E37 E52 E58
    Date: 2009–06

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