nep-mon New Economics Papers
on Monetary Economics
Issue of 2009‒11‒27
fifty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Taylor Rule and Interest Rate Uncertainty in the U.S. 1970-2006 By Martin Mandler
  2. Monetary Policy Implementation and Overnight Rate Persistence By Dieter Nautz; Jan Scheithauer
  3. Evaluating Monetary Policy By Svensson, Lars E O
  4. The Fed’s perceived Phillips curve: Evidence from individual FOMC forecasts By Peter Tillmann
  5. Estimated Interest Rate Rules: Do they Determine Determinacy Properties? By Jensen, Henrik
  6. Monetary Policy and the Lost Decade: Lessons from Japan By Daniel Leigh
  7. Money in monetary policy design: Monetary cross-checking in the New-Keynesian model By Beck, Günter; Wieland, Volker
  8. Political Constraints on Monetary Policy During the U.S. Great Inflation By Weise, Charles L.
  9. Decomposing Federal Funds Rate forecast uncertainty using real-time data By Martin Mandler
  10. Inflation Targeting at 20: Achievements and Challenges By Scott Roger
  11. The Liquidity and Liquidity Distribution Effects in Emerging Markets: The Case of Jordan By Jérôme Vandenbussche; Jérôme Vandenbussche; Stanley Watt; Stanley Watt; Szabolcs Blazsek; Szabolcs Blazsek
  12. Demand for Currency, New Technology and the Adoption of Electronic Money: Evidence Using Individual Household Data By Hiroshi Fujiki; Migiwa Tanaka
  13. Hybrid Inflation Targeting Regimes By Jorge Restrepo; Carlos Garcia; Scott Roger
  14. Foreign Demand for Domestic Currency and the Optimal Rate of Inflation By Schmitt-Grohé, Stephanie; Uribe, Martín
  15. Has the SARB Become More Effective Post Inflation Targeting? By Rangan Gupta; Alain Kabundi; Mampho P. Modise
  16. Monetary Policy, Velocity, and the Equity Premium By Gust, Christopher; López-Salido, J David
  17. Conventional and Unconventional Monetary Policy By Cúrdia, Vasco; Woodford, Michael
  18. Delegating Optimal Monetary Policy Inertia By Bilbiie, Florin Ovidiu
  19. Macroeconomic Patterns and Monetary Policy in the Run-up to Asset Price Busts By Pau Rabanal; Prakash Kannan; Alasdair Scott
  20. Global Liquidity Trap: A Simple Analytical Investigation By Ippei Fujiwara; Nao Sudo; Yuki Teranishi
  21. Monetary Policy and the Financing of Firms By De Fiore, Fiorella; Teles, Pedro; Tristani, Oreste
  22. Expectations, Deflation Traps and Macroeconomic Policy By Evans, George W.; Honkapohja, Seppo
  23. Monetary-Fiscal Policy Interactions and Fiscal Stimulus By Davig, Troy; Leeper, Eric M.
  24. The Macroeconomic Costs and Benefits of the EMU and other Monetary Unions: An Overview of Recent Research By Beetsma, Roel; Giuliodori, Massimo
  25. Low-frequency determinants of inflation in the euro area By Sven Schreiber
  26. Depression Econometrics: A FAVAR Model of Monetary Policy During the Great Depression By Ahmadi, Pooyan Amir; Ritschl, Albrecht
  27. Depression Econometrics: A FAVAR Model of Monetary Policy During the Great Depression By Pooyan Amir Ahmadi; Albrecht Ritschl
  28. A Preferred-Habitat Model of the Term Structure of Interest Rates By Vayanos, Dimitri; Vila, Jean-Luc
  29. "Optimal monetary policy when asset markets are incomplete" By Richard Anton Braun; Tomoyuki Nakajima
  30. On Quality Bias and Inflation Targets By Schmitt-Grohé, Stephanie; Uribe, Martín
  31. Inflation and Welfare in Long-Run Equilibrium with Firm Dynamics By Janiak, Alexandre; Monteiro, Paulo Santos
  32. A defence of the FOMC By Ellison, Martin; Sargent, Thomas J
  33. Monetary Policy Analysis and Forecasting in the World Economy: A Panel Unobserved Components Approach By Francis Vitek
  34. Pursuing Inflation Targeting Policy Framework in the Midst of Inflationary Pressures and Fiscal Constraint in Indonesia By Siregar, Reza
  35. Money is an Experience Good: Competition and Trust in the Private Provision of Money By Marimon, Ramon; Nicolini, Juan Pablo; Teles, Pedro
  36. Equilibrium Asset Prices and Investor Behavior in the Presence of Money Illusion By Basak, Suleyman; Yan, Hongjun
  37. Optimal Time-Invariant Monetary Policy By Charles Brendon
  38. Monetary and Macroprudential Policy Rules in a Model with House Price Booms By Pau Rabanal; Prakash Kannan; Alasdair Scott
  39. Optimal Monetary Policy and Firm Entry By V. LEWIS
  40. Representations for optimal stopping under dynamic monetary utility functionals By Volker Krätschmer; John Schoenmakers
  41. The role of Regime Shifts in the Term Structure of Interest Rates: Further evidence from an Emerging Market By Saltoglu, Burak; Yazgan, Ege
  42. A Banking Explanation of the US Velocity of Money: 1919-2004 By Benk, Szilárd; Gillman, Max; Kejak, Michal
  43. Foreign Currency Borrowing by Small Firms By Brown, Martin; Ongena, Steven; Yesin, Pinar
  44. International Competition and Inflation: A New Keynesian Perspective By Guerrieri, Luca; Gust, Christopher; López-Salido, J David
  45. Inflation Targeting and Business Cycle Synchronization By Flood, Robert P; Rose, Andrew K
  46. When Safe Proved Risky: Commercial Paper During the Financial Crisis of 2007-2009 By Marcin Kacperczyk; Philipp Schnabl
  47. Currency Carry Trade Regimes: Beyond the Fama Regression By Richard Clarida; Josh Davis; Niels Pedersen
  48. The Crisis in the Foreign Exchange Market By Melvin, Michael; Taylor, Mark P
  49. DSGE-CH: A dynamic stochastic general equilibrium model for Switzerland By Cuche-Curti, Nicolas A.; Dellas, Harris; Natal, Jean-Marc
  50. Asymmetries in the exchange rate pass-through into Romanian price indices By Cozmanca,Bogdan-Octavian; Manea, Florentina

  1. By: Martin Mandler (University of Giessen, Department of Economics and Business, Licher Straße 62, D-35394 Gießen)
    Abstract: This paper shows how to estimate forecast uncertainty about future short-term interest rates by combining a time-varying Taylor rule with an unobserved components model of economic fundamentals. Using this model I separate interest rate uncertainty into economically meaningful components that represent uncertainty about future economic conditions and uncertainty about future monetary policy. Results from estimating the model on U.S. data suggest important changes in uncertainty about future short-term interest rates over time and highlight the relative importance of the different elements which underlie interest rate uncertainty for the U.S.
    Keywords: Monetary policy, reaction functions, state-space models, output-gap forecasts, inflation forecasts
    JEL: E52 C32 C53
    Date: 2009
  2. By: Dieter Nautz; Jan Scheithauer
    Abstract: Overnight money market rates are the predominant operational target of monetary policy. As a consequence, central banks have re- designed the implementation of monetary policy to keep the deviations of the overnight rate from the key policy rate small and short-lived. This paper uses fractional integration techniques to explore how the operational framework of four major central banks affects the persis- tence of overnight rates. Our results suggest that a well-communicated and transparent interest rate target of the central bank is a particu- larly important condition for a low degree of overnight rate persistence.
    Keywords: Controllability and Persistence of Interest Rates; Oper- ational Framework of Central Banks; Long Memory and Fractional Integration
    JEL: E52 C22
    Date: 2009–11
  3. By: Svensson, Lars E O
    Abstract: Evaluating inflation-targeting monetary policy is more complicated than checking whether inflation has been on target, because inflation control is imperfect and flexible inflation targeting means that deviations from target may be deliberate in order to stabilize the real economy. A modified Taylor curve, the forecast Taylor curve, showing the tradeoff between the variability of the inflation-gap and output-gap forecasts can be used to evaluate policy ex ante, that is, taking into account the information available at the time of the policy decisions, and even evaluate policy in real time. In particular, by plotting mean squared gaps of inflation and output-gap forecasts for alternative policy-rate paths, it may be examined whether policy has achieved an efficient stabilization of both inflation and the real economy and what relative weight on the stability of inflation and the real economy has effectively been applied. Ex ante evaluation may be more relevant than evaluation ex post, after the fact. Publication of the interest-rate path also allows the evaluation of its credibility and the effectiveness of the implementation of monetary policy.
    Keywords: forecast Taylor curve; mean squared gaps; Monetary policy evaluation
    JEL: E52 E58
    Date: 2009–09
  4. By: Peter Tillmann (Justus Liebig University Gießen, Department of Economics, Licher Straße 62, D-35394 Gießen)
    Abstract: This note uncovers the Phillips curve trade-off perceived by U.S. monetary policymakers. For that purpose we use data on individual forecasts for unemployment and inflation submitted by each individual FOMC member, which was recently made available for the period 1992-1998. The results point to significant changes in the perceived trade-off over time with the Phillips curve flattening and the implied NAIRU falling towards the second half of the sample. Hence, the results suggest that policymakers were aware of these changes in real-time.
    Keywords: inflation forecast, NAIRU, Phillips curve, monetary policy, Federal Reserve
    JEL: E43 E52
    Date: 2009
  5. By: Jensen, Henrik
    Abstract: No. I demonstrate that econometric estimations of nominal interest rate rules may tell little, if anything, about an economy's determinacy properties. In particular, correct inference about the interest-rate response to inflation provides no information about determinacy. Instead, it could reveal whether optimal monetary policymaking is performed under discretion or commitment.
    Keywords: Equilibrium determinacy; Estimated Taylor rules; Interest rate rules; Monetary policy; Rules vs. discretion.
    JEL: E52 E58
    Date: 2009–11
  6. By: Daniel Leigh
    Abstract: This paper investigates how monetary policy can help ward off a protracted deflationary slump when policy rates are near the zero bound by studying the experience of Japan during the "Lost Decade" which followed the asset-price bubble collapse in the early 1990s. Estimation results based on a structural model suggest that the Bank of Japan's interest-rate policy fits a conventional forward-looking reaction function with an inflation target of about 1 percent. The disappointing economic performance thus seems primarily due to a series of adverse economic shocks rather than an extraordinary policy error. In addition, counterfactual policy simulations based on the estimated structural model suggest that simply raising the inflation target would not have yielded a lasting improvement in performance. However, a price-targeting rule or a policy rule that combined a higher inflation target with a more aggressive response to output would have achieved superior stabilization results.
    Keywords: Deflation , Economic stabilization , Economic models , External shocks , Inflation targeting , Interest rate policy , Monetary policy ,
    Date: 2009–10–23
  7. By: Beck, Günter; Wieland, Volker
    Abstract: In the New-Keynesian model, optimal interest rate policy under uncertainty is formulated without reference to monetary aggregates as long as certain standard assumptions on the distributions of unobservables are satisfied. The model has been criticized for failing to explain common trends in money growth and inflation, and that therefore money should be used as a cross-check in policy formulation (see Lucas (2007)). We show that the New-Keynesian model can explain such trends if one allows for the possibility of persistent central bank misperceptions. Such misperceptions motivate the search for policies that include additional robustness checks. In earlier work, we proposed an interest rate rule that is near-optimal in normal times but includes a cross-check with monetary information. In case of unusual monetary trends, interest rates are adjusted. In this paper, we show in detail how to derive the appropriate magnitude of the interest rate adjustment following a significant cross-check with monetary information, when the New-Keynesian model is the central bank's preferred model. The cross-check is shown to be effective in offsetting persistent deviations of inflation due to central bank misperceptions.
    Keywords: European Central Bank; monetary policy; money; New-Keynesian model; policy under uncertainty; quantity theory
    JEL: E32 E41 E43 E52 E58
    Date: 2009–10
  8. By: Weise, Charles L.
    Abstract: This paper argues that the Federal Reserve’s failure to control inflation during the 1970s was due to constraints imposed by the political environment. Members of the Fed understood that a serious attempt to tackle inflation would be unpopular with the public and would generate opposition from Congress and the Executive branch. The result was a commitment to the policy of gradualism, under which the Fed would attempt to reduce inflation with mild policies that would not trigger an outright recession, and premature abandonment of anti-inflation policies at the first sign of recession. Alternative explanations, in particular misperceptions of the natural rate of unemployment and misunderstandings of the nature of inflation, do not provide a complete explanation for Fed policy at key turning points during the Great Inflation. Evidence for this explanation of Fed behavior is found in Minutes and Transcripts of FOMC meetings and speeches of Fed chairmen. Empirical analysis verifies that references to the political environment at FOMC meetings are correlated with the stance of monetary policy during this period.
    Keywords: Great Inflation; Federal Reserve; monetary policy
    JEL: N1 E5 E6
    Date: 2009–10–10
  9. By: Martin Mandler (University of Giessen, Department of Economics and Business, Licher Straße 66, D-35394 Gießen)
    Abstract: Using real-time data I estimate out-of-sample forecast uncertainty about the Federal Funds Rate. Combining a Taylor rule with a model of economic fundamentals I disentangle economically interpretable components of forecast uncertainty: uncertainty about future economic conditions and uncertainty about future monetary policy. Uncertainty about U.S. monetary policy fell to unprecedented low levels in the 1980s and remained low while uncertainty about future output and inflation declined only temporarily. This points to an important role of increased predictability of monetary policy in explaining the decline in macroeconomic volatility in the U.S. since the mid-1980s.
    Keywords: monetary policy reaction function, interest rate uncertainty, state-space model
    JEL: E52 C32 C53
    Date: 2009
  10. By: Scott Roger
    Abstract: This paper provides an overview of inflation targeting frameworks and macroeconomic performance under inflation targeting. Inflation targeting frameworks are generally quite similar across countries, and a broad consensus has developed in favor of "flexible" inflation targeting. The evidence shows that, although inflation target ranges are missed frequently in most countries, the inflation and growth performance under inflation targeting compares very favorably with performance under alternative frameworks. Inflation targeters also tentatively appear to be coping better with the commodity price and financial shocks in 2007-2009 than non-inflation targeters. Key issues going forward include adapting inflation targeting to emerging market and developing countries, and incorporating financial stability issues into the framework.
    Keywords: Central bank policy , Cross country analysis , Developing countries , Disinflation , Emerging markets , Financial sector , Financial stability , Inflation targeting , Monetary policy , Price stabilization , Transparency ,
    Date: 2009–10–27
  11. By: Jérôme Vandenbussche; Jérôme Vandenbussche; Stanley Watt; Stanley Watt; Szabolcs Blazsek; Szabolcs Blazsek
    Abstract: This paper analyzes the determinants of daily changes in Jordan's interbank market overnight rate. It not only quantifies the classic liquidity effect, but also uncovers a liquidity distribution effect on both sides of the market, and shows that their magnitude is a decreasing and convex function of the level of excess reserves. It finds that the volatility of rate changes depends much more on the reserve surplus accumulated within a maintenance period than on the level of excess reserves. As Carpenter and Demiralp (2006), it uses the series of the central bank's daily forecast errors to identify the liquidity effect.
    Keywords: Banking systems , Central banks , Demand for money , Excess liquidity , Jordan , Liquidity management , Monetary operations , Monetary policy , Money markets , Money supply , Reserve requirements ,
    Date: 2009–10–20
  12. By: Hiroshi Fujiki (Associate Director-General and Senior Monetary Affairs Department, Bank of Japan (E-mail: hiroshi.fujiki; Migiwa Tanaka (Assistant Professor, Department of Economics, School of Business and Management, The Hong Kong University of Science and Technology (E-mail:
    Abstract: Accurate information on money demand is essential for evaluation of monetary policy. In this regard, it is important to study the effect of financial innovation to money demand. We investigate the effect of a new form of such technology, electronic money, to money demand. Specifically, we estimate currency demand functions conditional on electronic money adoption using unique household-level survey data from Japan. We obtain the following results. First, currency demand indicates that average cash balances do not decrease with the adoption of electronic money. Rather, it seems to increase under some specifications. Second, households at the lowest quantile of the cash balance distribution tend to have higher cash balances after adopting of electronic money. These findings indicate that consumers do not significantly substitute cash holding with e-money holding despite the rapid diffusion of electronic money among households.
    Keywords: Currency Demand, Transaction Demands for Money, Electronic Money
    JEL: E41
    Date: 2009–11
  13. By: Jorge Restrepo; Carlos Garcia; Scott Roger
    Abstract: This paper uses a DSGE model to examine whether including the exchange rate explicitly in the central bank's policy reaction function can improve macroeconomic performance. It is found that including an element of exchange rate smoothing in the policy reaction function is helpful both for financially robust advanced economies and for financially vulnerable emerging economies in handling risk premium shocks. As long as the weight placed on exchange rate smoothing is relatively small, the effects on inflation and output volatility in the event of demand and cost-push shocks are minimal. Financially vulnerable emerging economies are especially likely to benefit from some exhange rate smoothing because of the perverse impact of exchange rate movements on activity.
    Keywords: Central bank policy , Demand , Developing countries , Economic models , Exchange rates , External shocks , Inflation targeting , Monetary policy , Risk premium ,
    Date: 2009–10–26
  14. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: More than half of U.S. currency circulates abroad. As a result, much of the seignorage income of the United States is generated outside of its borders. In this paper we characterize the Ramsey-optimal rate of inflation in an economy with a foreign demand for its currency. In the absence of such demand, the model implies that the Friedman rule---deflation at the real rate of interest---maximizes the utility of the representative domestic consumer. We show analytically that once a foreign demand for domestic currency is taken into account, the Friedman rule ceases to be Ramsey optimal. Calibrated versions of the model that match the range of empirical estimates of the size of foreign demand for U.S. currency deliver Ramsey optimal rates of inflation between 2 and 10 percent per year. The domestically benevolent government finds it optimal to impose an inflation tax as a way to extract resources from the rest of the world in the form of seignorage revenue.
    Keywords: Foreign demand for Currency; Friedman Rule; Optimal Inflation Rate
    JEL: E41
    Date: 2009–11
  15. By: Rangan Gupta (Department of Economics, University of Pretoria); Alain Kabundi (Department of Economics and Econometrics, University of Johannesburg); Mampho P. Modise (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa)
    Abstract: This paper assesses the impact of a monetary policy shock on 15 key macroeconomic variables of South Africa, in the pre- and post-inflation targeting periods. For this purpose, we use a Factor-Augmented Vector Autoregressive (FAVAR) model comprising of 107 monthly time series over two equal sub-samples of 1989:01-1997:12 and 2000:01-2008:12. The results, based on impulse response functions, are in line with economic theory and indicate no puzzling effects often observed with small-scale monetary Vector Autoregressive (VAR) models. More importantly, we find that the ability of monetary policy in affecting key macroeconomic variables, including inflation, has increased in the post-targeting period. But, majority of the effects are insignificant, which could, however, also be due to the shorter-lengths of the sub-samples relative to the number of variables used in this study, rather than depicting the inability of monetary policy to significantly affect the South African economy.
    Keywords: Monetary Policy Shock, Inflation Targeting, Impulse Response Functions, FAVAR
    JEL: C32 E52 E58
    Date: 2009–11
  16. By: Gust, Christopher; López-Salido, J David
    Abstract: We develop a DSGE model in which monetary policy generates endogenous movements in risk. The key feature of our model is that households rebalance their financial portfolio allocations infrequently, as they face a fixed cost of transferring cash across accounts. We show that the model can account for the mean returns on equity and the risk-free rate,and generates countercyclical movements in the equity premium that help explain the response of stock prices to monetary shocks. While stimulative monetary policy can lower risk in equity markets, it is also associated with higher inflation expectations and inflation risk premia. The model gives rise to periods in which the zero lower bound constraint on the nominal interest rate binds and demand for liquidity jumps, leading to procyclical movements in velocity.
    Keywords: equity premium; monetary policy; velocity
    JEL: E44 E52
    Date: 2009–08
  17. By: Cúrdia, Vasco; Woodford, Michael
    Abstract: We extend a standard New Keynesian model to incorporate heterogeneity in spending opportunities and two sources of (potentially time-varying) credit spreads, and to allow a role for the central bank's balance sheet in equilibrium determination. We use the model to investigate the implications of imperfect financial intermediation for familiar monetary policy prescriptions, and to consider additional dimensions of central-bank policy --- variations in the size and composition of the central bank's balance sheet, and payment of interest on reserves --- alongside the traditional question of the proper choice of an operating target for an overnight policy rate. We also give particular attention to the special problems that arise when the zero lower bound for the policy rate is reached. We show that it is possible to provide criteria for the choice of policy along each of these possible dimensions, within a single unified framework, and to provide policy prescriptions that apply equally when financial markets work efficiently and when they are subject to substantial disruptions, and equally when the zero bound is reached and when it is not a concern.
    Keywords: credit frictions; credit spread; interest on reserves; quantitative easing
    JEL: E52
    Date: 2009–10
  18. By: Bilbiie, Florin Ovidiu
    Abstract: This paper shows that absent a commitment technology, central banks can nevertheless achieve the (timeless-)optimal commitment equilibrium if they are delegated with an objective function that is different from the societal one. In a prototypical forward-looking New Keynesian model, I develop a general linear-quadratic method to solve for the optimal delegation parameters that generate the optimal amount of inertia in a Markov-perfect equilibrium. I study the optimal design of some policy regimes that are nested within this framework: inflation, output-gap growth and nominal income growth targeting; and inflation and output-gap contracts. Notably, since the timeless-optimal equilibrium is time-consistent, so is any delegation scheme that implements it.
    Keywords: inflation, output gap growth and nominal income growth targeting.; discretion and commitment; inertia; optimal delegation; stabilization bias; time inconsistency; timeless-optimal policy
    JEL: C61 C73 E31 E52 E61
    Date: 2009–10
  19. By: Pau Rabanal; Prakash Kannan; Alasdair Scott
    Abstract: We find that inflation, output and the stance of monetary policy do not typically display unusual behavior ahead of asset price busts. By contrast, credit, shares of investment in GDP, current account deficits, and asset prices typically rise, providing useful, if not perfect, leading indicators of asset price busts. These patterns could also be observed in the build-up to the current crisis. Monetary policy was not the main, systematic cause of the current crisis. But, with inflation typically under control, central banks effectively accommodated these growing imbalances, raising the risk of damaging busts.
    Keywords: Asset prices , Credit expansion , Housing prices , Monetary policy , Price increases , Stock prices ,
    Date: 2009–11–16
  20. By: Ippei Fujiwara (Director, Institute for Monetary and Economic Studies (currently, Financial Markets Department), Bank of Japan. (E-mail:; Nao Sudo (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:; Yuki Teranishi (Deputy Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:
    Abstract: How should monetary policy cooperation be designed when more than one country simultaneously faces zero lower bounds on nominal interest rates? To answer this question, we examine monetary policy cooperation with both optimal discretion and commitment policies in a two- country model. We reach the following conclusions. Under discretion, monetary policy cooperation is characterized by the intertemporal elasticity of substitution (IES), a key parameter measuring international spillovers, and no history dependency. On the other hand, under commitment, monetary policy features history dependence with international spillover effects.
    Keywords: Optimal Monetary Policy Cooperation, Zero Lower Bound
    JEL: E52 F33 F41
    Date: 2009–11
  21. By: De Fiore, Fiorella; Teles, Pedro; Tristani, Oreste
    Abstract: How should monetary policy respond to changes in financial conditions? In this paper we consider a simple model where firms are subject to idyosincratic shocks which may force them to default on their debt. Firms' assets and liabilities are denominated in nominal terms and predetermined when shocks occur. Monetary policy can therefore affect the real value of funds used to finance production. Furthermore, policy affects the loan and deposit rates. We find that maintaining price stability at all times is not optimal; that the optimal response to adverse financial shocks is to lower interest rates, if not at the zero bound, and engineer a short period of inflation; that the Taylor rule may implement allocations that have opposite cyclical properties to the optimal ones.
    Keywords: bankruptcy costs; debt deflation; Financial stability; optimal monetary policy; price level volatility; stabilization policy.
    JEL: E20 E44 E52
    Date: 2009–08
  22. By: Evans, George W.; Honkapohja, Seppo
    Abstract: We examine global economic dynamics under infinite-horizon learning in a New Keynesian model in which the interest-rate rule is subject to the zero lower bound. As in Evans, Guse and Honkapohja (2008), we find that under normal monetary and fiscal policy the intended steady state is locally but not globally stable. Unstable deflationary paths can arise after large pessimistic shocks to expectations. For large expectation shocks pushing interest rates to the zero lower bound, temporary increases in government spending can be used to insulate the economy from deflation traps.
    Keywords: Adaptive Learning; Fiscal Policy; Monetary Policy; Zero Interest Rate Lower Bound
    JEL: E52 E58 E63
    Date: 2009–08
  23. By: Davig, Troy; Leeper, Eric M.
    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.
    Keywords: fiscal stimulus; multipliers; zero interest rate bound
    JEL: E52 E62 E63
    Date: 2009–10
  24. By: Beetsma, Roel; Giuliodori, Massimo
    Abstract: This article provides an overview of recent research into the macroeconomic costs and benefits of monetary unification. We are primarily interested in Europe’s monetary union. Given that unification entails the loss of a policy instrument its potential benefits have to be found elsewhere. Unification may serve as a vehicle for beneficial institutional changes. In particular, it may be a route towards an independent monetary policy, which alleviates the scope for political pressure to relax monetary policy. Unification also eliminates harmful monetary policy spill-overs and competitive devaluations. We explore how disagreement between the monetary and fiscal authorities about their policy objectives can lead to extreme macroeconomic outcomes. Further, we pay considerable attention to the desirability (or not) of fiscal constraints and fiscal coordination in a monetary union. Monetary commitment and fiscal free-riding play a key role in this regard. Similar free-riding issues also feature prominently in the analysis of how unification influences structural reforms. We end with a brief discussion of monetary unification outside Europe. The cost-benefit trade-off of unification may differ substantially between industrialized and less-developed countries, where differences in fiscal needs and, hence, the reliance on seigniorage revenues may dominate the scope for unification.
    Keywords: credibility; EMU; euro; exchange rates; fiscal constraints; fiscal policy; structural reforms
    JEL: E5 E6 F4
    Date: 2009–10
  25. By: Sven Schreiber (Macroeconomic Policy Institute (IMK) at Hans Boeckler Foundation, Duesseldorf)
    Abstract: We use frequency-wise Granger-causality tests and error-correction models to investigate the driving forces behind longer-run inflation developments in the euro area. Employing an eclectic approach we consider various relevant theories. With a general-to-specific testing strategy we distill the unemployment rate and long-term interest rates as causal for low-frequency variations of inflation. Money growth is found to be causal for inflation only if other variables are omitted, which we therefore interpret as a spurious result.
    Keywords: money growth, Granger causality, quantity theory
    JEL: E31 E40
    Date: 2009
  26. By: Ahmadi, Pooyan Amir; Ritschl, Albrecht
    Abstract: The prominent role of monetary policy in the U.S. interwar depression has been conventional wisdom since Friedman and Schwartz [1963]. This paper presents evidence on both the surprise and the systematic components of monetary policy between 1929 and 1933. Doubts surrounding GDP estimates for the 1920s would call into question conventional VAR techniques. We therefore adopt the FAVAR methodology of Bernanke, Boivin, and Eliasz [2005], aggregating a large number of time series into a few factors and inserting these into a monetary policy VAR. We work in a Bayesian framework and apply MCMC methods to obtain the posteriors. Employing the generalized sign restriction approach toward identification of Amir Ahmadi and Uhlig [2008], we find the effects of monetary policy shocks to have been moderate. To analyze the systematic policy component, we back out the monetary policy reaction function and its response to aggregate supply and demand shocks. Results broadly confirm the Friedman/Schwartz view about restrictive monetary policy, but indicate only moderate effects. We further analyze systematic policy through conditional forecasts of key time series at critical junctures, taken with and without the policy instrument. Effects are again quite moderate. Our results caution against a predominantly monetary interpretation of the Great Depression.
    Keywords: Bayesian FAVAR; Dynamic Factor Model; Friedman Schwartz Hypothesis; Great Depression; Monetary policy
    JEL: C11 C53 E37 E47 E52 N12
    Date: 2009–11
  27. By: Pooyan Amir Ahmadi; Albrecht Ritschl
    Abstract: The prominent role of monetary policy in the U.S. interwar depression has been conventional wisdom since Friedman and Schwartz [1963]. This paper presents evidence on both the surprise and the systematic components of monetary policy between 1929 and 1933. Doubts surrounding GDP estimates for the 1920s would call into question conventional VAR techniques. We therefore adopt the FAVAR methodology of Bernanke, Boivin, and Eliasz [2005], aggregating a large number of time series into a few factors and inserting these into a monetary policy VAR. We work in a Bayesian framework and apply MCMC methods to obtain the posteriors. Employing the generalized sign restriction approach toward identification of Amir Ahmadi and Uhlig [2008], we find the effects of monetary policy shocks to have been moderate. To analyze the systematic policy component, we back out the monetary policy reaction function and its response to aggregate supply and demand shocks. Results broadly confirm the Friedman/Schwartz view about restrictive monetary policy, but indicate only moderate effects. We further analyze systematic policy through conditional forecasts of key time series at critical junctures, taken with and without the policy instrument. Effects are again quite moderate. Our results caution against a predominantly monetary interpretation of the Great Depression.
    Keywords: Great Depression, monetary policy, Bayesian FAVAR, Dynamic Factor Model, Gibb Sampling
    JEL: N12 E37 E47 E52 C11 C53
    Date: 2009–11
  28. By: Vayanos, Dimitri; Vila, Jean-Luc
    Abstract: We model the term structure of interest rates as resulting from the interaction between investor clienteles with preferences for specific maturities and risk-averse arbitrageurs. Because arbitrageurs are risk averse, shocks to clienteles' demand for bonds affect the term structure---and constitute an additional determinant of bond prices to current and expected future short rates. At the same time, because arbitrageurs render the term structure arbitrage-free, demand effects satisfy no-arbitrage restrictions and can be quite different from the underlying shocks. We show that the preferred-habitat view of the term structure generates a rich set of implications for bond risk premia, the effects of demand shocks and of shocks to short-rate expectations, the economic role of carry trades, and the transmission of monetary policy.
    Keywords: Bond risk premia; Carry trades; Limited arbitrage; Preferred habitat; Term structure of interest rates
    JEL: E4 E5 G1
    Date: 2009–11
  29. By: Richard Anton Braun (Faculty of Economics, University of Tokyo); Tomoyuki Nakajima (Institute of Economic Research, Kyoto University)
    Abstract: This paper considers the properties of an optimal monetary policy when households are subject to countercyclical uninsured income shocks. We develop a tractable incompletemarkets model with Calvo price setting. Incomplete markets creates a new distortion and that distortion is large in the sense that the welfare cost of business cycles is large in our model. Nevertheless, the optimal monetary policy is very similar to the optimal policy that emerges in the representative agent framework and calls for nearly complete stabilization of the price-level.
    Date: 2009–10
  30. By: Schmitt-Grohé, Stephanie; Uribe, Martín
    Abstract: This paper studies whether the central bank should adjust its inflation target to account for the systematic upward bias in measured inflation due to quality improvements in consumption goods. We show that the answer to this question depends on what prices are assumed to be sticky. If nonquality-adjusted prices are assumed to be sticky, then the inflation target should not be corrected. If, on the other hand, quality-adjusted (or hedonic) prices are assumed to be sticky, then the inflation target should be raised by the magnitude of the bias.
    Keywords: Inflation Targets; Quality Bias; Ramsey Policy
    JEL: E52 E6
    Date: 2009–11
  31. By: Janiak, Alexandre (University of Chile); Monteiro, Paulo Santos (University of Warwick)
    Abstract: We analyze the welfare cost of inflation in a model with cash-in-advance constraints and an endogenous distribution of establishments' productivities. Inflation distorts aggregate productivity through firm entry dynamics. The model is calibrated to the United States economy and the long-run equilibrium properties are compared at low and high inflation. We find that, when the period over which the cash-in-advance constraint is binding is one quarter, an annual inflation rate of 10 percent leads to a decrease in the steady-state average productivity of roughly 0.5 percent compared to the optimum's steady-state. This decrease in productivity is not innocuous: it leads to a doubling of the welfare cost of inflation.
    Keywords: firm dynamics, productivity, inflation, welfare
    JEL: E40 E50 L16 O40
    Date: 2009–11
  32. By: Ellison, Martin; Sargent, Thomas J
    Abstract: We defend the forecasting performance of the FOMC from the recent criticism of Christina and David Romer. Our argument is that the FOMC forecasts a worst-case scenario that it uses to design decisions that will work well enough (are robust) despite possible misspecification of its model. Because these FOMC forecasts are not predictions of what the FOMC expects to occur under its model, it is inappropriate to compare their performance in a horse race against other forecasts. Our interpretation of the FOMC as a robust policymaker can explain all the findings of the Romers and rationalises differences between FOMC forecasts and forecasts published in the Greenbook by the staff of the Federal Reserve System.
    Keywords: forecasting; monetary policy; robustness
    JEL: C53 E52 E58
    Date: 2009–10
  33. By: Francis Vitek
    Abstract: This paper develops a panel unobserved components model of the monetary transmission mechanism in the world economy, disaggregated into its fifteen largest national economies. This structural macroeconometric model features extensive linkages between the real and financial sectors, both within and across economies. A variety of monetary policy analysis and forecasting applications of the estimated model are demonstrated, based on a novel Bayesian framework for conditioning on judgment.
    Keywords: Business cycles , Cross country analysis , Developed countries , Economic forecasting , Economic models , Emerging markets , Financial sector , Inflation , International financial system , Monetary policy , Monetary transmission mechanism , Real sector ,
    Date: 2009–10–28
  34. By: Siregar, Reza
    Abstract: Pushing for a higher and a more robust growth while maintaining price stability within a target range of inflation continue to be core tasks for the macroeconomic policy management in Indonesia in recent years. Whilst inflation was successfully kept below the target of 7 percent at the end of 2007, the monthly year on year inflation has already gone above 10 percent by May 2008 and is expected to reach 11 percent by end of 2008. Fiscal policy continues to be relatively marginalized and lacks of stimulus, with a significant share of the current expenditure of the 2008 budget has to be allocated to finance subsidy and debt service. Our study investigates the commitment of the country to its inflation targeting (IT) policy in the midst of fiscal constraint and the urgent need to push for higher growth rate. It examines preliminary outcomes of the IT policy and highlights dilemmas and potential policy trade-offs.
    Keywords: Inflation Targeting Policy; Expenditure Policy; Inflation; and Fiscal Constraint
    JEL: E62 E31 E52
    Date: 2009–01–30
  35. By: Marimon, Ramon; Nicolini, Juan Pablo; Teles, Pedro
    Abstract: We study the interplay between competition and trust as efficiency-enhancing mechanims in the private provision of money. With commitment, trust is automatically achieved and competition ensures efficiency. Without commitment, competition plays no role. Trust does play a role but requires a lower bound on efficiency. Stationary inflation must be positive and, therefore, the Friedman rule cannot be achieved. The quality of money can only be observed after its purchasing capacity is realized. In that sense money is an experience good. We show that the two problems, the time-inconsistency in the private provision of money and moral-hazard in the provision of experience goods, are isomorphic, and therefore the same results are attained in both settings.
    Keywords: Currency competition; Experience goods; Inflation; Trust
    JEL: E40 E50 E58 E60
    Date: 2009–08
  36. By: Basak, Suleyman; Yan, Hongjun
    Abstract: This article analyzes the implications of money illusion for investor behavior and asset prices in a securities market economy with inflationary fluctuations. We provide a belief-based formulation of money illusion which accounts for the systematic mistakes in evaluating real and nominal quantities. The impact of money illusion on security prices and their dynamics is demonstrated to be considerable even though its welfare cost on investors is small in typical environments. A money-illusioned investor's real consumption is shown to generally depend on the price level, and specifically to decrease in the price level. A general-equilibrium analysis in the presence of money illusion generates implications that are consistent with several empirical regularities. In particular, the real bond yields and dividend price ratios are positively related to expected inflation, the real short rate is negatively correlated with realized inflation, and money illusion may induce predictability and excess volatility in stock returns. The basic analysis is generalized to incorporate heterogeneous investors with differing degrees of illusion.
    Keywords: Asset Pricing; Bounded Rationality; Equilibrium; Expected Inflation; Money Illusion; New Keynesian
    JEL: C60 D50 D90 G12
    Date: 2009–08
  37. By: Charles Brendon
    Abstract: This paper investigates how best to determine time-invariant policy rules in macroeconomic models with forward-looking constraints, where fully optimal policy is known to be time-inconsistent. It proposes a new ‘coefficient optimisation’ approach that improves upon the timeless perspective method of Woodford (2003) in deterministic problems, and on average in stochastic problems, without resorting to asymptotic (‘unconditional’) loss comparisons.
    Keywords: Timeless perspective, Time consistency, Optimal monetary policy, Time-invariant policy
    JEL: E31 E52 E58 E61
    Date: 2009
  38. By: Pau Rabanal; Prakash Kannan; Alasdair Scott
    Abstract: We argue that a stronger emphasis on macrofinancial risk could provide stabilization benefits. Simulations results suggest that strong monetary reactions to accelerator mechanisms that push up credit growth and asset prices could help macroeconomic stability. In addition, using a macroprudential instrument designed specifically to dampen credit market cycles would also be useful. But invariant and rigid policy responses raise the risk of policy errors that could lower, not raise, macroeconomic stability. Hence, discretion would be required.
    Keywords: Asset prices , Capital markets , Central banks , Credit controls , Credit demand , Credit risk , Economic models , External shocks , Household credit , Housing prices , Monetary policy , Price increases ,
    Date: 2009–09–23
  39. By: V. LEWIS
    Abstract: This paper characterises optimal short-run monetary policy in an economy with monopolistic competition, endogenous firm entry, a cash-in-advance constraint and preset wages. Firms must make profits to cover entry costs; thus the markup on goods prices is efficient. However, a distortion results from the absence of a markup on leisure. This distortion affects the investment margin due to the labour requirement in entry. In the absence of fiscal instruments such as labour income subsidies, the optimal monetary policy under sticky wages achieves higher welfare than under flexible wages. The policy maker uses the money supply instrument to raise the real wage - the cost of leisure - above its flexible-wage level, in response to expansionary shocks. This induces a rise in labour hours and more production of goods and new firms.
    Keywords: entry, optimal policy
    JEL: E52 E63
    Date: 2009–08
  40. By: Volker Krätschmer; John Schoenmakers
    Abstract: In this paper we consider the optimal stopping problem for general dynamic monetary utility functionals. Sufficient conditions for the Bellman principle and the existence of optimal stopping times are provided. Particular attention is payed to representations which allow for a numerical treatment in real situations. To this aim, generalizations of standard evaluation methods like policy iteration, dual and consumption based approaches are developed in the context of general dynamic monetary utility functionals. As a result, it turns out that the possibility of a particular generalization depends on specific properties of the utility functional under consideration.
    Keywords: monetary utility functionals, optimal stopping, duality, policy iteration
    JEL: C61 C63 G12 G13
    Date: 2009–11
  41. By: Saltoglu, Burak; Yazgan, Ege
    Abstract: In this paper, we investigate the interrelations among Turkish interest rates with different maturities by using a regime switching Vector Error Correction (VECM) model. We find a long run equilibrium relationship among interest rates with various maturities. Furthermore we conclude that term structure dynamics exhibit significant nonlinearity. Forecasting experiment also reveals that the nonlinear term structure models do fare better than other linear specifications. However, we cannot conclude that interest rate adjustments are made in an asymmetric way in the long run equilibrium.
    Keywords: Term Structure of Interest Rates; Regime Switching; Forecasting; Foreacast Evaluation; Cointegration
    JEL: C13 C22
    Date: 2009
  42. By: Benk, Szilárd; Gillman, Max; Kejak, Michal
    Abstract: The paper shows that US GDP velocity of M1 money has exhibited long cycles around a 1.25% per year upward trend, during the 1919-2004 period. It explains the velocity cycles through shocks constructed from a DSGE model and annual time series data (Ingram et al., 1994). Model velocity is stable along the balanced growth path, which features endogenous growth and decentralized banking that produces exchange credit. Positive shocks to credit productivity and money supply increase velocity, as money demand falls, while a positive goods productivity shock raises temporary output and velocity. The paper explains such velocity volatility at both business cycle and long run frequencies. With filtered velocity turning negative, starting during the 1930s and the 1987 crashes, and again around 2003, results suggest that the money and credit shocks appear to be more important for velocity during less stable times and the goods productivity shock more important during stable times.
    Keywords: business cycle; credit shocks; velocity; Volatility
    JEL: E13 E32 E44
    Date: 2009–11
  43. By: Brown, Martin; Ongena, Steven; Yesin, Pinar
    Abstract: We examine the firm- and country-level determinants of the currency denomination of small business loans. We first model the choice of loan currency in a framework which features a trade-off between lower cost of debt and the risk of firm-level distress costs, and also incorporates the impact of information asymmetry between banks and firms. When foreign currency funds come at a lower interest rate, all foreign currency earners as well as those local currency earners with high revenues and low distress costs choose foreign currency loans. When the banks have imperfect information on the currency and level of firm revenues, even more local earners switch to foreign currency loans, as they do not bear the full cost of the corresponding credit risk. We then test the implications of our model by using a 2005 survey with responses from 9,098 firms in 26 transition countries. The survey contains details on 3,105 recent bank loans. At the firm level, our findings suggest that firms with foreign currency income and assets are more likely to borrow in a foreign currency. In contrast, firm-level distress costs and financial transparency affect the currency denomination only weakly. At the country level, the interest rate advantages of foreign currency funds and the exchange rate volatility do not explain the foreign currency borrowing in our sample. However, foreign bank presence, weak corporate governance and the absence of capital controls encourage foreign currency borrowing. All in all, we cannot confirm that "carry-trade behavior" is the key driver of foreign currency borrowing by small firms in transition economies. Our results do, however, support the conjecture that banking-sector structures and institutions that aggravate information asymmetries may facilitate foreign currency borrowing.
    Keywords: banking structure; competition; foreign currency borrowing; market structure
    JEL: F34 F37 G21 G30
    Date: 2009–11
  44. By: Guerrieri, Luca; Gust, Christopher; López-Salido, J David
    Abstract: We develop and estimate an open economy New Keynesian Phillips curve (NKPC) in which variable demand elasticities give rise to movements in desired markups in response to changes in competitive pressure from abroad. A parametric restriction on our specification yields the standard NKPC, in which the elasticity is constant, and there is no role for foreign competition to influence domestic inflation. By comparing the unrestricted and restricted specifications, we provide evidence that foreign competition plays an important role in accounting for the behavior of inflation in the traded goods sector. Our estimates suggest that foreign competition accounted for more than half of a 4 percentage point decline in domestic goods inflation in the 1990s. Our results also provide evidence against demand curves with a constant elasticity in the context of models of monopolistic competition.
    Keywords: inflation; New Keynesian Phillips curve; variable markups
    JEL: E31 E32 F41
    Date: 2009–11
  45. By: Flood, Robert P; Rose, Andrew K
    Abstract: Inflation targeting seems to have a small but positive effect on the synchronization of business cycles; countries that target inflation seem to have cycles that move slightly more closely with foreign cycles. Thus the advent of inflation targeting does not explain the decoupling of global business cycles, for two reasons. Indeed business cycles have not in fact become less synchronized across countries.
    Keywords: bilateral; data; empirical; GDP; insulation; regime
    JEL: F42
    Date: 2009–07
  46. By: Marcin Kacperczyk; Philipp Schnabl
    Abstract: Commercial paper is one of the largest money market instruments and has long been viewed as a safe haven for investors seeking low risk. However, during the financial crisis of 2007-2009, the commercial paper market experienced twice the modern-day equivalent of a bank run with investors unwilling to refinance maturing commercial paper. We analyze the supply of and demand for commercial paper and show that, in contrast to previous turbulent episodes, the crisis centered on commercial paper issued by, or guaranteed by, financial institutions. We describe the importance of Federal Reserve’s interventions in restoring stability of the market. Finally, we propose three possible explanations for the sharp decline of the commercial paper market: substitution to alternative sources of financing by commercial paper issuers, adverse selection, and institutional constraints among money market funds.
    JEL: G11 G2
    Date: 2009–11
  47. By: Richard Clarida; Josh Davis; Niels Pedersen
    Abstract: We examine the factors that account for the returns on currency carry trade strategies. Using a dataset of daily returns spanning 18 years for 5 different long - short currency carry portfolios, we first document a robust empirical relationship between carry trade excess returns and exchange rate volatility, both realized and implied. Specifically, we extend and refine the results in Bhansali (2007) by documenting that currency carry trade strategies implemented with forward contracts have payoff and risk characteristics that are similar to those of currency option strategies that sell out of the money puts on high interest rates currencies. Both strategies have the feature of collecting premiums or carry to generate persistent excess returns that unwind sharply resulting in losses when actual and implied volatility rise. We next also document significant volatility regime sensitivity for Fama regressions estimated over low and high volatility periods. Specifically we find that the well known result that a regression of the realized exchange rate depreciation on the lagged interest rate differential produces a negative slope coefficient (instead of unity as predicted by uncovered interest parity) is an artifact of the volatility regime: when volatility is in the top quartile, the Fama regression produces a positive coefficient that is greater than unity. The third section of the paper documents the existence of an intuitive and significant co-movement between currency risk premium and risk premia in yield curve factors that drive bond yields in the countries that comprise carry trade pairs. We show that yield curve level factors are positively correlated with carry trade excess returns while yield curve slope factors are negatively correlated with carry trade excess returns. Importantly, we show that this correlation is robust to the current crisis and to the inclusion of equity volatility in the model. What distinguishes carry trade returns in the current crisis from non crisis periods is not changed loading on yield curve factors but a much larger loading on the equity factor.
    JEL: F3 F31
    Date: 2009–11
  48. By: Melvin, Michael; Taylor, Mark P
    Abstract: We provide an overview of the important events of the recent global financial crisis and their implications for exchange rates and market dynamics. Our goal is to catalogue all that was truly of major importance in this episode. We also construct a quantitative measure of crises that allows for a comparison of the current crisis to earlier events. In addition, we address whether one could have predicted costly events before they happened in a manner that would have allowed market participants to moderate their risk exposures and yield better returns from currency speculation.
    Keywords: Financial crisis; foreign exchange market
    JEL: F31
    Date: 2009–09
  49. By: Cuche-Curti, Nicolas A. (Swiss National Bank); Dellas, Harris (University of Bern); Natal, Jean-Marc (Swiss National Bank)
    Abstract: This paper presents a DSGE (dynamic stochastic general equilibrium) model of the Swiss economy used since 2007 in the monetary policy decision process at the Swiss National Bank. In addition to forecasting the likely course of main macro variables under various scenarios for the Swiss economy, the model DSGE-CH serves as a laboratory for studying business cycles and examining the effects of actual and hypothetical monetary policies. The microfounded model DSGE-CH represents Switzerland as a small open economy with optimizing economic agents facing several real and nominal rigidities and exogenous foreign and domestic shocks. The comparison of the model’s implications with the real world indicates that DSGE-CH performs well along standard dimensions. It captures the overall stochastic structure of the Swiss economy as represented by the moments of its key macroeconomic variables; furthermore, it has appropriate dynamic properties, as judged by its impulse response functions. Finally, it quite accurately replicates the historical path of major Swiss variables.
    Keywords: DSGE; forecasting; small open economy; Switzerland
    JEL: E27 E52 E58
    Date: 2009–10–01
  50. By: Cozmanca,Bogdan-Octavian (Academy of Economic Studies Bucharest and National Bank of Romania); Manea, Florentina (RBS Romania)
    Date: 2009–11

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