nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒01‒23
fifteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Negative Nominal Interest Rates: Three ways to overcome the zero lower bound By Willem Buiter
  2. A Macro-Finance Approach to Exchange Rate Determination By Yu-chin Chen; Kwok Ping Tsang
  3. The Lag in Effect of Inflation Targeting and Policy Evaluation By WenShwo Fang; Stephen M. Miller
  4. Monetary Policy & Monetary Regime in an Interest Free Economy: An Alternate Approach In Monetary Economics amidst Great Recession By Shaikh, Salman
  5. Towards a Flexible Exchange Rate Policy in Russia By Roland Beck; Geoff Barnard
  6. Monetary Shocks and Central Bank Liquidity with Credit Market Imperfections By Pierre-Richard Agenor; Koray Alper
  7. Inflation Targeting and the Crisis: An Empirical Assessment By de Carvalho Filho, Irineu
  8. Central bank independence and conservatism under uncertainty: Substitutes or complements? By Carsten Hefeker; Blandine Zimmer
  9. Policy irreversibility and interest rate smoothing By Kobayashi, Teruyoshi
  10. Measuring consumer inflation expectations in Europe and examining their forward-lookingness By Lyziak, Tomasz
  11. Stock Market Conditions and Monetary Policy in a DSGE Model for the U.S. By Efrem Castelnuovo; Salvatore Nisticò
  12. Discrete-Time Interest Rate Modelling By Lane P. Hughston; Andrea Macrina
  13. Falling into the Liquidity Trap: Notes on the Global Economic Crisis By Thomas R. Michl
  14. Government borrowing is pointless where a government issues its own currency. By Musgrave, R.S.
  15. Monetary Policies and the Economic Growth By Scarlat, Valentin

  1. By: Willem Buiter
    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. 
    Date: 2009–07
  2. By: Yu-chin Chen (University of Washington); Kwok Ping Tsang (Virginia Tech)
    Abstract: The nominal exchange rate is both a macroeconomic variable equilibrating international markets, and a financial asset that embodies expectations and prices risks about cross border currency-holdings. Recognizing this, we adopt a joint macro-finance strategy to model the exchange rate. We incorporate into a monetary exchange rate model macroeconomic stabilization through Taylor-rule monetary policy on one hand, and on the other, market expectations and perceived risks embodied in the cross-country yield curves. Using monthly data between 1985 and 2005 for Canada, Japan, the UK and the US, we summarize information in the relative yield curves between country-pairs using the Nelson and Siegel (1987) latent factors, and combine them with monetary policy targets (output gap and inflation) into a Vector Autoregression (VAR) for bilateral exchange rate changes. We find strong evidence that both the financial and macro variables are important for explaining exchange rate dynamics and excess currency returns, especially for the yen and the pound relative to the dollar. By decomposing the yield curves into expected future yields and bond market term premia, we show that both expectations and perceived risks are priced into the currency market. These findings provide support for the view that the nominal exchange rate is determined by both macroeconomic as well as financial forces.
    Date: 2009–12
  3. By: WenShwo Fang (Feng Chia University); Stephen M. Miller (University of Connecticut)
    Abstract: The lag in effect of monetary policy contains vital information for the policy evaluation. Allowing for a time-varying treatment effect, we show that inflation targeting effectively lowers inflation for both developed and developing countries. Developed countries reach their targets rapidly with a two-year lag in effect. Developing countries, however, reduce inflation gradually toward their targets and do not reach their ultimate goal by the end year of 2007.
    Keywords: time lag, inflation targeting, time-varying treatment effect, policy evaluation
    JEL: C52 E31 E52
    Date: 2010–01
  4. By: Shaikh, Salman
    Abstract: This paper reviews limited, but precious academic literature on central banking and monetary management in Islamic finance. It discusses the building blocks of an Islamic monetary system. It discusses how savings would feature despite discontinuation of interest, how inflation will be checked with central banks not having at its disposal conventional OMO, how liquidity will be managed in banking sector when central bank wants to inject liquidity or mop up funds. How and to what extent the institution of Zakat would enable the government to meet its fiscal targets and does not crowd out private sector. How balance of payments and exchange rate stability can be managed in an interest free economy. If in the short term, the government or central bank needs alternative source of revenue other than Zakat, they can issue GDP linked bonds. This could replace T-bill and provide a base instrument for OMO and liquidity management in the banking and financial sector.
    Keywords: Islamic corporate finance; pricing of capital; interest free finance; Interest; Interest free economy; Usury; Time value of money; Riba; Musharakah; Mudarabah; Ijara; Salam; Istisna; Qard-e-Hasan; Diminishing Musharakah
    JEL: E42 E52 E60
    Date: 2010–01
  5. By: Roland Beck; Geoff Barnard
    Abstract: In the years preceding the onset of the global financial crisis, the Central Bank of Russia (CBR) had two goals: to reduce inflation and limit the real appreciation of the rouble. Given the strength of Russia’s balance of payments during the ten years through the first half of 2008, the de facto tight management of the nominal exchange rate resulted in large interventions which were only partially sterilised. As a result, inflation remained persistently high. During the global financial crisis in 2008-09 Russia’s monetary policy was initially constrained by a large degree of private debt dollarisation. After a gradual adjustment of the exchange rate to the new oil price environment which was costly due to reserve losses, the CBR started to lower interest rates and to allow for a somewhat higher degree of exchange rate flexibility. Looking ahead, even greater exchange rate flexibility should be permitted since (i) commodity exporting countries can successfully run inflation targeting and (ii) we find that exchange rate pass-through has been limited and asymmetric and can be taken into account under inflation targeting. Preparations for inflation targeting should focus on a commitment to price stability as the primary goal of monetary policy. At the same time the authorities should enhance their understanding of how monetary developments affect inflation and financial stability and accelerate financial sector reforms aimed at financial deepening.<P>Vers une politique de taux de change plus flexible en Russie<BR>Pendant les années précédant le déclenchement de la crise financière mondiale, la banque centrale de Russie avait deux objectifs : réduire l’inflation et limiter l’appréciation réelle du rouble. Étant donné le solde très positif de la balance des paiements pendant la décennie se terminant à la première moitié de 2008, la gestion du taux de change nominal a eu pour résultat des interventions importantes qui n’ont été que partiellement stérilisées. L’inflation est donc restée élevée. Pendant la crise financière mondiale en 2008-09 la politique monétaire de la Russie a été contrainte par le niveau élevé de dollarisation de la dette privée. Après un ajustement graduel du taux de change à la situation nouvelle des prix du pétrole qui a été coûteux à cause des pertes de réserves, la banque centrale a commencé à baisser les taux d’intérêt et à permettre plus de flexibilité du taux de change. Dans le futur, la Russie devrait permettre davantage de flexibilité du taux de change puisque (i) les pays exportateurs de matières premières peuvent gérer un régime de ciblage de l’inflation ; et (ii) nous trouvons que la transmission des mouvements du taux de change à l’inflation n’a été que modérée et asymétrique et qu’on peut en tenir compte sous un tel régime. Les préparations pour le ciblage de l’inflation devraient être focalisées sur un engagement à la stabilité des prix comme objectif principal de la politique monétaire. En même temps, les autorités devraient améliorer leur compréhension de la façon dont les développements monétaires affectent l’inflation et la stabilité financière ainsi qu’accélérer les réformes financières visant un approfondissement du secteur financier.
    Keywords: economy, exchange rate policy, inflation targeting, inflation, interest rate, monetary policy, Russia, ciblage de l’inflation, économie, inflation, politique de taux de change, politique monétaire, Russie, taux de change, taux d'intérêt
    JEL: E31 E5 E52 E58 F31
    Date: 2009–12–18
  6. By: Pierre-Richard Agenor; Koray Alper
    Date: 2009
  7. By: de Carvalho Filho, Irineu
    Abstract: This paper appraises how countries with inflation targeting fared during the current crisis, with the goal of establishing the stylized facts that will guide and motivate future research. We find that relative to other countries, IT countries lowered nominal policy rates by more and this loosening translated into an even larger differential in real interest rates; were less likely to face deflation scares; and saw sharp real depreciations not associated with a greater perception of risk by markets. We also find some weak evidence that IT countries did better on unemployment rates and advanced IT countries have had relatively stronger industrial production performance. Finally, we find that advanced IT countries had higher GDP growth rates than their non-IT peers, but no such difference for emerging countries or the full sample.
    Keywords: Inflation targeting; economic crisis; monetary policy
    JEL: E00
    Date: 2010–01–11
  8. By: Carsten Hefeker (University of Siegen, Hoelderlinstrasse 3, D-57068 Siegen); Blandine Zimmer (LARGE, University of Strasbourg, 47 avenue de la Forêt Noire, F-67082 Strasbourg Cedex)
    Abstract: This paper revisits the trade-off between central bank independence and conservatism using a New Keynesian model with uncertainty about the central banker's output gap target. It is shown that when this uncertainty is high, the trade-off no longer holds. In this case, the optimal combination between independence and conservatism is characterised by complementarity.
    Keywords: Central bank independence, Conservatism, Transparency of monetary policy
    JEL: E52 E58
    Date: 2010
  9. By: Kobayashi, Teruyoshi
    Abstract: Many empirical studies argue that the inertial behavior of the policy rates in industrialized countries can be well explained by a linear partial adjustment version of the Taylor rule. However, the explanatory power of the lagged interest rate has been questioned from various points of view. This paper formally examines a situation in which a central bank has an aversion for frequent policy reversals. Imposing an irreversibility constraint on the control space makes the lagged interest rate a state variable, but the policy function cannot then be expressed as a partial adjustment form even if the original Taylor rule is the correct policy function in the absence of the constraint. The simulation results reveal that the conventional regression tends to falsely support the functionally misspecified partial adjustment model. This implies that the significant role of the lagged interest may simply reflect the central banks’ reversal aversion.
    Keywords: gradualism; interest rate smoothing; irreversibility; Taylor rule.
    JEL: E58 E52
    Date: 2010–01
  10. By: Lyziak, Tomasz
    Abstract: This paper presents numerical measures of European consumers’ inflation expectations derived on the basis of European Commission qualitative survey data with different quantification methods, i.e. with the probability method, the regression method and the logistic (and linear) function method. The study aims at assessing differences between those measures and the resulting uncertainty in measuring inflation expectations of this group of economic agents. Moreover, in the empirical part of the paper the formation of expectations by consumers in European economies is examined, with a particular focus on estimating the degree of forward-lookingness of expectations.
    Keywords: Inflation Expectations; Consumers; Survey; EU
    JEL: D84 D12 C42
    Date: 2009
  11. By: Efrem Castelnuovo (University of Padua); Salvatore Nisticò (Università di Roma "Tor Vergata" and LUISS "Guido Carli")
    Abstract: This paper investigates the interactions between stock market fluctuations and monetary policy within a DSGE model for the U.S. economy. First, we design a framework in which fluctuations in households financial wealth are allowed - but not necessarily required - to exert an impact on current consumption. This is due to the interaction, in the financial markets, of long-time traders holding wealth accumulated over time with newcomers holding no wealth at all. Importantly, we introduce nominal wage stickiness to induce pro-cyclicality in real dividends. Additional nominal and real frictions are modeled to capture the pervasive macroeconomic persistence of the observables employed to estimate our model. We fit our model to post-WWII U.S. data, and report three main results. First, the data strongly support a significant role of stock prices in affecting real activity and the business cycle. Second, our estimates also identify a significant and counteractive response of the Fed to stock-price fluctuations. Third, we derive from our model a microfounded measure of financial slack, the "stock-price gap", which we then contrast to alternative ones, currently used in empirical studies, to assess the properties of the latter to capture the dynamic and cyclical implications of our DSGE model. The behavior of our "stock-price gap" is consistent with the episodes of stock-market booms and busts occurred in the post-WWII, as reported by independent analyses, and closely correlates with the current financial meltdown. Typically employed proxies of financial slack such as detrended log-indexes or growth rates show limited capabilities of capturing the implications of our model-consistent index of financial stress. Cyclical properties of the model as well as counterfactuals regarding shocks to our measure of financial slackness and monetary policy shocks are also proposed.
    Keywords: Stock Prices, Monetary Policy, Bayesian Estimation, Wealth Effects.
    JEL: E30 E52
    Date: 2010–01
  12. By: Lane P. Hughston (Department of Mathematics, Imperial College); Andrea Macrina (Department of Mathematics, King's College London, Institute of Economic Research, Kyoto University)
    Abstract: This paper presents an axiomatic scheme for interest rate models in discrete time. We take a pricing kernel approach, which builds in the arbitrage-free property and pro- vides a link to equilibrium economics. We require that the pricing kernel be consistent with a pair of axioms, one giving the inter-temporal relations for dividend-paying as- sets, and the other ensuring the existence of a money-market asset. We show that the existence of a positive-return asset implies the existence of a previsible money-market account. A general expression for the price process of a limited-liability asset is derived. This expression includes two terms, one being the discounted risk-adjusted value of the dividend stream, the other characterising retained earnings. The vanishing of the latter is given by a transversality condition. We show (under the assumed axioms) that, in the case of a limited-liability asset with no permanently-retained earnings, the price process is given by the ratio of a pair of potentials. Explicit examples of discrete-time models are provided.
    Keywords: Interest rates models, pricing kernels, financial time series, Flesaker-Hughston models, transversality condition, financial bubbles
    Date: 2010–01
  13. By: Thomas R. Michl
    Abstract: <p>This paper examines the underlying structural imbalances leading up to the Great Recession of 2007-2009 from the vantage point of Hyman Minsky’s theory of the liquidity trap. The traditional approach to the liquidity trap focuses on the zero interest rate boundary, while Minsky’s theory focuses on three conditions that make investment spending unresponsive to monetary policy: low underlying ex post profitability of capital, weak expectations about future profitability, and uncertainty about prospective yields. The paper structures an empirical investigation of profitability and accumulation around these three factors. </p><p>The Great Recession was preceded by an unbalanced recovery in which residential investment led demand while business fixed investment was structurally weak, given the strong ex post profitability of capital and the low interest rate environment. It is hypothesized that increased import penetration and concerns about the sustainability of profitability eroded both expectations and confidence about prospective yields. The Great Recession appears in this and several other dimensions to be a crisis of disproportionality.</p>
    Date: 2010
  14. By: Musgrave, R.S.
    Abstract: The alleged justifications for government borrowing in a country which issues its own currency are examined here. The conclusion is that no justification exists for borrowing money in the normal sense of the phrase “borrow money”: that is, the use by one entity of money loaned by another entity, and so as to fund expenditure by the first entity. In contrast, and where a deflationary stance is required, it is justifiable for government (or as is more usual, the central bank) to borrow in the sense of withdrawing funds from the private sector and purely so as to stop those funds being spent. Moreover, inflation destroys a proportion of the money “borrowed”. Plus government effectively confiscates (via tax) the money needed to pay interest on this “borrowed” money. This is essentially a money shredding operation. This is not the normal meaning of the word borrow. Many of the points made here apply to the central bank of a common currency area. Individual countries within a common currency area are not considered.
    Keywords: Abba Lerner; Modern Monetary Theory; government borrowing
    JEL: E42 E58 H6
    Date: 2010–01–15
  15. By: Scarlat, Valentin
    Abstract: Talking about the economic growth, is to be stressed the essential contribution of the investment to a country economic development, role which is unanimously recognized and accepted. It is well-known that even the most developed market economies were built up with notable investment efforts, in order to enable a high efficiency of the fixed assets and to ensure a rational use of the natural resources and of the labour force. The investment process is mainly conditioned by the imprevisible action of certain elements, both immanent to the economic system and exogenous to it, as well, such as: technology, politics, optimistic and pessimistic forecasting, population confidence, taxes and government expenditures, monetary base fluctuation etc.
    Keywords: economic growth; investment; high efficiency; taxes and government expenditures; monetary policy
    JEL: E42 E52 F43
    Date: 2009–09–15

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