nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒04‒17
forty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Implementation of Monetary Policy in India By Deepak Mohanty
  2. Monetary Transmission Right from the Start: The (Dis)Connection Between the Money Market and the ECB’s Main Refinancing Rates By Puriya Abbassi; Dieter Nautz
  3. Modeling Monetary Policy By Reynard, Samuel; Schabert, Andreas
  4. Degree of Openness and Inflation Targeting Policy: Model of a Small Open Economy By Bousrih Jihene; Bousrih Jihene
  5. Zone targeting monetary policy preferences and financial market conditions: a flexible nonlinear policy reaction function of the SARB monetary policy By Ruthira Naraidoo; Leroi Raputsoane
  6. Optimal versus realized policy rules in a regime-switching framework By Sophie Pardo; Nicolas Rautureau; Thomas Vallée
  7. The Euro Through the Looking-Glass: Perceived Inflation Following the 2002 Currency Changeover By Lunn, Pete; Duffy, David
  8. Financial Market Conditions, Real Time, Nonlinearity and European Central Bank Monetary Policy: In-Sample and Out-of-Sample Assessment By Costas Milas; Ruthira Naraidoo
  9. Expectations and economic fluctuations: an analysis using survey data By Sylvain Leduc; Keith Sill
  10. Identification in Structural Vector Autoregressions Through Graphical Modelling and Monetary Policy: A Cross-Country Analysis By Fragetta, Matteo
  11. Macroeconomic dynamics and inflation regimes in the U.S. Results from threshold vector autoregressions By Mandler, Martin
  12. Liquidity demand and welfare in a heterogeneous-agent economy By Yi Wen
  13. Inflation Targeting and Inflation Uncertainty By Bedri Kamil Onur Tas
  14. Simple and robust rules for monetary policy By John B. Taylor; John C. Williams
  15. Conundrum or Complication: A Study of Yield Curve Dynamics under Unusual Economic Conditions and Monetary Policies. By Peter Cripwell; David Edelman
  16. Large-scale asset purchases by the Federal Reserve: did they work? By Joseph Gagnon; Matthew Raskin; Julie Remache; Brian Sack
  17. Time Varying Inflation Targets, Inflation Expectations and Credibility By Bedri Kamil Onur Tas
  18. Bank-Lending Standards, the Cost Channel and Inflation Dynamics By Sylvia Kaufmann; Johann Scharler
  19. The Relationship between Exchange Rates and Interest Rate Differentials: a Wavelet Approach By Hacker, Scott; Kim, Hyunjoo; Månsson, Kristofer
  20. Is low inflation really causing the decline in exchange rate pass-through? By Miguel A. León-Ledesma; Reginaldo P. Nogueira Júnior
  21. Using Long-Run Restrictions to Investigate the Sources of Exchange Rate Fluctuations By Pao-Lin Tien
  22. The Macroeconomic Consequences of EMU : International Evidence from a DSGE Model By Jürgen Jerger; Oke Röhe
  23. How Has the Monetary Transmission Mechanism Evolved Over Time? By Jean Boivin; Michael T. Kiley; Frederic S. Mishkin
  24. Bretton-Woods Systems, Old and New, and the Rotation of Exchange-Rates Regimes By Stephen Hall
  25. Effect of Official Dollarization on Macroeconomic Performance and Money-Price Relationship in Ecuador By Selahattin Togay; Bedri Kamil Onur Taþ
  26. Crisis? What Crisis? Currency vs. Banking in the Financial Crisis of 1931 By Albrecht Ritschl; Samad Sarferaz
  27. Does monetary policy affect bank risk-taking? By Yener Altunbas; Leonardo Gambacorta; David Marques-Ibanez
  28. New Monetarist Economics: models By Stephen D. Williamson; Randall Wright
  29. Does Export Pricing Explain ‘Fear of Floating’ in Small Open Emerging Market Economies? By M Farid;
  30. Asia Confronts the Impossible Trinity By Patnaik, Ila; Shah, Ajay
  31. Monetary Policy, the Housing Market, and the 2008 Recession: A Structural Factor Analysis By Matteo Luciani
  32. Inflation and Globalisation: A Dynamic Factor Model with Stochastic Volatility By Joseph P. Byrne; Fatima Kaneez; Alexandros Kontonikas
  33. Picking the Brains of MPC Members By Apel, Mikael; Claussen, Carl Andreas; Lennartsdotter, Petra
  34. News Shocks and the Slope of the Term Structure of Interest Rates By André Kurmann; Christopher Otrok
  35. The bank lending channel revisited By Piti Disyatat
  36. Modeling U.S. Inflation Dynamics: A Bayesian Nonparametric Approach By Markus Jochmann
  37. Simultaneous monetary policy announcements and international stock markets response: an intraday analysis By Hussain, Syed Mujahid
  38. Money and the Welfare Cost of Inflation in an R&D-Growth Model By Angus C. Chu; Ching-Chong Lai
  39. The changing nature of financial intermediation and the financial crisis of 2007-09 By Tobias Adrian; Hyun Song Shin
  40. Global Relative Price Shocks: The Role of Macroeconomic Policies By Adam Cagliarini; Warwick McKibbin
  41. Inventories, inflation dynamics, and the New Keynesian Phillips Curve By Thomas A. Lubik; Wing Leong Teo
  42. Liquidity in the Foreign Exchange Market: Measurement, Commonality, and Risk Premiums By Mancini, Loriano; Ranaldo, Angelo; Wrampelmeyer, Jan
  43. Assessing the Casual Relationship between Euro-Area Money and Price in Time-Varying Environment By Stephen Hall
  44. An Investigation of the Causal Relations between Exchange Rates and Interest Rate Differentials Using Wavelets By Hacker, Scott; Kim, Hyunjoo; Månsson, Kristofer
  45. Is a Calvo price setting model consistent with micro price data? By Luis J. Álvarez; Pablo Burriel
  46. Democracy, Populism and Hyperinflation(s): Some Evidence from Latin America By Manoel Bittencourt

  1. By: Deepak Mohanty
    Abstract: How does the Reserve Bank of India implement monetary policy? The objectives and framework of monetary policy, as they have evolved, the operational aspects of monetary policy have been discussed. The processes of monetary policy formulation and communication have also been depicted. [Speech delivered at the Bankers Club, Bhubaneswar].
    Keywords: financial, GDP growth, reserve bank, India, monetary policy, communication, formulation, stability, economy, India, inflation rate, exchange, demand function,
    Date: 2010
  2. By: Puriya Abbassi; Dieter Nautz
    Abstract: The relation between the ECB’s main refinancing (MRO) rates and the money market is key for the monetary transmission process in the euro area. This paper investigates how money market rates respond to the new information revealed by MRO auctions. Our results confirm a stabilizing level relationship between the overnight rate Eonia and MRO rates before the financial crisis. Since the start of the financial crisis, however, we find that MRO auction outcomes even exacerbated the disconnection of money market rates from the policy-intended interest rate level. These findings support the fixed rate full allotment policy introduced by the ECB as an unconventionalmeasure to re-stabilize banks’ refinancing conditions.
    Keywords: Financial Crisis, Monetary transmission process, Central bank auctions, European Central Bank, Money markets
    JEL: E43 E52 E58 D44
    Date: 2010–03
  3. By: Reynard, Samuel (Swiss National Bank); Schabert, Andreas (University of Dortmund)
    Abstract: We develop a macroeconomic framework where money is supplied against only few eligible securities in open market operations. The relationship between the policy rate, expected inflation and consumption growth is affected by money market conditions, i.e. the varying liquidity value of eligible assets and the associated risk. This induces a liquidity premium, which explains the observed systematic wedge between the policy rate and consumption Euler interest rate that standard models equate. It further implies a dampened response of consumption to policy rate shocks that is humpshaped when we account for realistic central bank transfers and the dynamics of bond holdings.
    Keywords: Monetary Policy; Open market operations; Liquidity premium; Money market rate; Consumption Euler rate; Monetary policy transmission
    JEL: E32 E43 E52 E58
    Date: 2009–11–09
  4. By: Bousrih Jihene (UNIVERSITY OF RENNES 1); Bousrih Jihene
    Abstract: In this paper, we present the dynamics of a Neo-Keynesian model applied to a small open economy in order to study the impact of openness on the choice of the appropriate inflation targeting policy. In the event of exogenous shocks, we can use either a CPI inflation targeting policy or a domestic inflation targeting policy. We conclude that there is a relation between the degree of openness of the economy and the type of infation targeting policy. By considering a domestic shock, when the economy is more open towards outside, we may find that the adoption of CPI inflation targeting is benefical. Whereas in the event of foreign shock, the optimal rule would be the domestic inflation targeting. By considering the criteria of social welfare, we find that for an important degree of openness, the policy of CPI inflation targeting remains the optimal monetary rule.
    Keywords: Monetary policy, Domestic Inflation, CPI Inflation, Pass-Through, Degree of Openness
    JEL: E31 E37 E52 F41
    Date: 2010
  5. By: Ruthira Naraidoo (Department of Economics, University of Pretoria); Leroi Raputsoane (Department of Economics, University of Pretoria)
    Abstract: Based on a representation of policymaker’s preferences that capture inflation zone targeting behaviors, we estimate a flexible model of the monetary policy reaction function of the South African Reserve Bank (SARB). To address the current debate on the importance of financial asset prices in monetary policy decision making, we augment the analysis to allow for responses to financial market conditions over and above prices and output stabilisation. The main findings are that the monetary authorities’ response towards inflation is zone symmetric. Secondly, the monetary authorities’ response towards output is asymmetric with increased reaction during business cycle downturns versus upturns. Thirdly, the monetary authorities’ pay close attention to financial conditions index. They place the same weight on financial market booms and recessions so that their response is symmetric.
    Keywords: Zones, asymmetries, financial conditions index
    JEL: C51 E12 E58
    Date: 2010–03
  6. By: Sophie Pardo (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Nicolas Rautureau (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272); Thomas Vallée (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272)
    Abstract: In this paper we compare a deterministic model and a Markov switching model to analyze the behavior of the US economy and the Federal Reserve. We examine both optimal and empirical monetary policies for the US Federal Reserve between 1960 and 2008. We compare the optimal monetary policy to the actual interest rates and to the empirical reaction function. We also evaluate the sensitivity of the results to the preferences assigned to each objective. We find that there is no unique optimal solution that fits the Federal Reserve behavior over the entire period. The best fit to the actual interest rates is obtained by an optimal policy with preference switches following the rule: a high-volatility regime coincides with a priority on inflation alone while in a low-volatility regime there is equal policy priority on output stabilization and inflation.
    Date: 2010
  7. By: Lunn, Pete; Duffy, David
    Abstract: Following the Euro changeover in January 2002, consumers across the Euro Area perceived a sharp rise in inflation, in contrast to official figures. Several theories have been advanced to explain this apparent economic illusion, but they struggle to account for its striking scale and persistence. We offer an alternative account, based on the premise that the currency changeover increased consumers' perceptual error when assessing the value of monetary amounts. Under plausible assumptions, this would lead them to experience a loss of purchasing power. We confirm two empirical hypotheses in support of the theory: (1) the extent of overestimation of inflation was strongly associated with subjective difficulty using the Euro; (2) there was a simultaneous downward shift in expected inflation. Our results imply that currency changeovers are not simple matters of numerical conversion.
    Keywords: consumer behaviour/Euro changeover/inflation expectations/inflation perceptions/uncertainty
    Date: 2010–03
  8. By: Costas Milas (Economics Group, Keele Management School, Keele University, UK and Rimini Centre for Economic Analysis, Rimini, Italy); Ruthira Naraidoo (Department of Economics, University of Pretoria)
    Abstract: We explore how the ECB sets interest rates in the context of policy reaction functions. Using both real-time and revised information, we consider linear and nonlinear policy functions in inflation, output and a measure of financial conditions. We find that amongst Taylor rule models, linear and nonlinear models are empirically indistinguishable within sample and that model specifications with real-time data provide the best description of in-sample ECB interest rate setting behavior. The 2007-2009 financial crisis witnesses a shift from inflation targeting to output stabilisation and a shift, from an asymmetric policy response to financial conditions at high inflation rates, to a more symmetric response irrespectively of the state of inflation. Finally, without imposing an a priori choice of parametric functional form, semiparametric models forecast out-of-sample better than linear and nonlinear Taylor rule models.
    Keywords: monetary policy, nonlinearity, real time data, financial conditions
    JEL: C51 C52 C53 E52 E58
    Date: 2009–10
  9. By: Sylvain Leduc; Keith Sill
    Abstract: Using survey-based measures of future U.S. economic activity from the Livingston Survey and the Survey of Professional Forecasters, we study how changes in expectations, and their interaction with monetary policy, contribute to fluctuations in macroeconomic aggregates. We find that changes in expected future economic activity are a quantitatively important driver of economic fluctuations: a perception that good times are ahead typically leads to a significant rise in current measures of economic activity and inflation. We also find that the short-term interest rate rises in response to expectations of good times as monetary policy tightens. Our results provide quantitative evidence on the importance of expectations-driven business cycles and on the role that monetary policy plays in shaping them.
    Keywords: Economic forecasting ; Monetary policy ; Business cycles
    Date: 2010
  10. By: Fragetta, Matteo (CELPE (Centre of Labour Economics and Economic Policy), University of Salerno, Italy)
    Abstract: There is an ongoing debate on how to identify monetary policy shocks in SVAR models. Graphical modelling exploits statistical properties of data for identification and offers a data based tool to shed light on the issue. We conduct a cross-country analysis, considering European Monetary Union (EMU), Japan and US. We obtain some important results. The information set of the monetary authorities, which is essential for the identification of the monetary shock seems to depend on availability of data in terms of higher frequency with respect to the policy instrument (US and Japan). Moreover, there is not yet a widespread consensus on whether or not the European Monetary Union should be considered as a closed economy. Our results indicate that EMU official interest rate depends on the US federal funds rate.
    Keywords: monetary policy; SVAR; graphical modelling
    JEL: C32 E50
    Date: 2010–04–12
  11. By: Mandler, Martin
    Abstract: This paper studies regime dependence in macroeconomic dynamics in the U.S. using a threshold vector autoregressive model in which endogenous regime switches are triggered by the inflation rate. The model separates a high from a low inflation regime with both regimes being strongly persistent. Generalized impulse response functions highlight important across-regime differences in the responses of the economy to monetary policy and inflation shocks. Simulating both regimes with individual structural equations interchanged shows a change in inflation dynamics to be the most important source of the transition of the U.S. economy from the high into the low inflation state while the change in the monetary policy reaction functions has only very little effect. Our results indicate that favorable changes in the economic structure and less frequent and smaller shocks are important explanations for the observed decline in U.S. macroeconomic volatility since the mid 1980s.
    Keywords: threshold vector autoregression; Great Moderation
    JEL: C32 E32 E58
    Date: 2010–03
  12. By: Yi Wen
    Abstract: This paper provides an analytically tractable general-equilibrium model of money demand with micro-foundations. The model is based on the incomplete-market model of Bewley (1980) where money serves as a store of value and provides liquidity to smooth consumption. The model is applied to study the effects of monetary policies. It is shown that heterogeneous liquidity demand can lead to sluggish movements in aggregate prices and positive responses from aggregate output to transitory money injections. However, permanent money growth can be extremely costly: With log utility function and an endogenously determined distribution of money balances that matches the household data, agents are willing to reduce consumption by 8% (or more) to avoid 10% annual inflation. The large welfare cost of inflation arises because inflation destroys the liquidity value and the buffer-stock function of money, thus raising the volatility of consumption for low-income households. The astonishingly large welfare cost of moderate inflation provides a justification for adopting a low inflation target by central banks and offers an explanation for the empirical relationship between inflation and social unrest in developing countries.
    Keywords: Liquidity (Economics)
    Date: 2010
  13. By: Bedri Kamil Onur Tas
    Date: 2009–12
  14. By: John B. Taylor; John C. Williams
    Abstract: This paper focuses on simple normative rules for monetary policy which central banks can use to guide their interest rate decisions. Such rules were first derived from research on empirical monetary models with rational expectations and sticky prices built in the 1970s and 1980s. During the past two decades substantial progress has been made in establishing that such rules are robust. They perform well with a variety of newer and more rigorous models and policy evaluation methods. Simple rules are also frequently more robust than fully optimal rules. Important progress has also been made in understanding how to adjust simple rules to deal with measurement error and expectations. Moreover, historical experience has shown that simple rules can work well in the real world in that macroeconomic performance has been better when central bank decisions were described by such rules. The recent financial crisis has not changed these conclusions, but it has stimulated important research on how policy rules should deal with asset bubbles and the zero bound on interest rates. Going forward the crisis has drawn attention to the importance of research on international monetary issues and on the implications of discretionary deviations from policy rules.
    Keywords: Monetary policy
    Date: 2010
  15. By: Peter Cripwell (School of Business, University College Dublin); David Edelman (School of Business, University College Dublin)
    Abstract: The definition of the decline of long term yields in the light of increasing short term yields as a conundrum by Chairman Greenspan in February 2005 has generated a significant amount of research. This paper presents a study of yield curve dynamics over this period using economic surprise data as the diagnostic tool. Results are presented for both US and Japanese data which indicate a non-linear response of the yield curve to economic data and monetary policy over the period in question. Further, a limited model is presented that is consistent with the observations. This can lead to an explanation of the conundrum in terms of a non-linear yield response to expected long term inflation and a variable expected long term real rate.
    Keywords: federal reserve, term structure of interest rates, inflation
    JEL: E43 E44 E52 E58
    Date: 2010–04–12
  16. By: Joseph Gagnon; Matthew Raskin; Julie Remache; Brian Sack
    Abstract: Since December 2008, the Federal Reserve's traditional policy instrument, the target federal funds rate, has been effectively at its lower bound of zero. In order to further ease the stance of monetary policy as the economic outlook deteriorated, the Federal Reserve purchased substantial quantities of assets with medium and long maturities. In this paper, we explain how these purchases were implemented and discuss the mechanisms through which they can affect the economy. We present evidence that the purchases led to economically meaningful and long-lasting reductions in longer-term interest rates on a range of securities, including securities that were not included in the purchase programs. These reductions in interest rates primarily reflect lower risk premiums, including term premiums, rather than lower expectations of future short-term interest rates.
    Keywords: Monetary policy ; Interest rates ; Federal funds rate ; Securities ; Federal Reserve System ; Rate of return
    Date: 2010
  17. By: Bedri Kamil Onur Tas
    Date: 2009–12
  18. By: Sylvia Kaufmann; Johann Scharler
    Abstract: If firms borrow working capital to finance production, then nominal interest rates have a direct influence on inflation dynamics, which appears to be the case empirically. However, interest rates may only partly mirror the cost of working capital. In this paper we explore the role of bank lending standards as a potential additional cost source and evaluate their empirical importance in explaining inflation dynamics in the US and in the euro area.
    Keywords: New Keynesian Phillips Curve, Cost Channel, Bank Lending Standards, Bayesian Analysis
    JEL: E40 E50
    Date: 2009–10
  19. By: Hacker, Scott (Jonkoping International Business School); Kim, Hyunjoo (Jonkoping International Business School); Månsson, Kristofer (Jonkoping International Business School)
    Abstract: This paper uses wavelet analysis to investigate the relationship between the spot exchange rate and the interest rate differential for seven pairs of countries, with a small country, Sweden, included in each of the cases. The key empirical results show that there tends to be a negative relationship between the spot exchange rate (domestic-currency price of foreign currency) and the nominal interest rate differential (approximately the domestic interest rate minus the foreign interest rate) at the shortest time scales, while a positive relationship is shown at the longest time scales. This indicates that among models of exchange rate determination using the asset approach, the sticky-price models are supported in the short-run while in the long-run the flexible-price models appear to better explain the sign of the relationship.
    Keywords: exchange rates; interest rate differential; uncovered interest parity; monetary approach; small-economy; wavelet analysis
    JEL: E44 F31 F42
    Date: 2010–02–11
  20. By: Miguel A. León-Ledesma; Reginaldo P. Nogueira Júnior
    Abstract: Recent literature has argued that exchange rate pass-through (ERPT) into domestic inflation has been declining in many countries following a dramatic change in inflation environment during the 1990s. Available empirical results face two central challenges: (i) the evidence on declining ERPT is mostlybased on sample-splitting approaches and hence subject to a degree of arbitrariness; and (ii) the link between a lower ERPT and inflation environment is usually based on simple correlation analysis and hence silent about temporal causality. We address these issues by making use of a state-space model that allows ERPT to be time-varying and dependent on the inflation environment. We estimate the model for 12 developed and emerging economies and test whether inflation contains significant information about the future evolution of the ERPT. The results reinforce the view of a smooth decline in the impact of exchange rates on domestic inflation, but do not support the hypothesis that lower inflation precedes this declining ERPT.
    Keywords: Exchange Rate Pass-Through, Inflation, State-space Models, Causality Tests.
    JEL: E42 E52 E58 F31 F41
    Date: 2010–04
  21. By: Pao-Lin Tien (Department of Economics, Wesleyan University)
    Abstract: This paper makes use of long-run restrictions to identify macroeconomic shocks and evaluate their relative importance for exchange rate fluctuations. Unlike previous studies that employ a similar approach, I consider a large eight variable vector autoregressive system that includes short term interest rates rather than money stocks in order to help identify monetary policy shocks. Results for the U.S. and the U.K. show that monetary policy shocks and other macroeconomic shocks behave according to theory. However, monetary shocks account for only a small fraction of the variance of the real exchange rate. Instead, “taste shocks” that can be associated with the degree of trade openness, terms of trade, and current account appear to be the key factor driving the U.S.-U.K. real exchange rate. Results for other countries under consideration (Canada, Germany, and Japan) are similar.
    Keywords: vector autoregression, taste shocks, monetary shocks, exchange rate movements, long-run identifying restrictions
    JEL: F31
    Date: 2009–12
  22. By: Jürgen Jerger (Osteuropa-Institut, Regensburg (Institut for East European Studies)); Oke Röhe (University of Regensburg)
    Abstract: In this paper, we estimate a New Keynesian DSGE model developed by Ireland (2003) on French, German and Spanish data with the aim to explore the macroeconomic consequences of EMU. In order to validate the results from the DSGE model, we amend this analysis by stability tests of monetary policy reaction functions for these countries. We find that (a) the DSGE structure is well suited for the characterization of key macroeconomic features of the three economies; (b) significant effciency gains were realized in terms of lower adjustment cost of prices and the capital stock; (c) the behavior of monetary policy did not change in Germany, unlike in France and Spain. Specifically, the impact of inflation on interest rates increased considerably in the two latter countries.
    Keywords: DSGE, monetary policy, EMU
    JEL: E31 E32 E52
    Date: 2009–10
  23. By: Jean Boivin; Michael T. Kiley; Frederic S. Mishkin
    Abstract: We discuss the evolution in macroeconomic thought on the monetary policy transmission mechanism and present related empirical evidence. The core channels of policy transmission – the neoclassical links between short-term policy interest rates, other asset prices such as long-term interest rates, equity prices, and the exchange rate, and the consequent effects on household and business demand – have remained steady from early policy-oriented models (like the Penn-MIT-SSRC MPS model) to modern dynamic-stochastic-general-equilibrium (DSGE) models. In contrast, non-neoclassical channels, such as credit-based channels, have remained outside the core models. In conjunction with this evolution in theory and modeling, there have been notable changes in policy behavior (with policy more focused on price stability) and in the reduced form correlations of policy interest rates with activity in the United States. Regulatory effects on credit provision have also changed significantly. As a result, we review the empirical evidence on the changes in the effect of monetary policy actions on real activity and inflation and present new evidence, using both a relatively unrestricted factor-augmented vector autoregression (FAVAR) and a DSGE model. Both approaches yield similar results: Monetary policy innovations have a more muted effect on real activity and inflation in recent decades as compared to the effects before 1980. Our analysis suggests that these shifts are accounted for by changes in policy behavior and the effect of these changes on expectations, leaving little role for changes in underlying private-sector behavior (outside shifts related to monetary policy changes).
    JEL: E2 E3 E4 E5
    Date: 2010–04
  24. By: Stephen Hall
    Abstract: A recent contribution to the literature argues that the present international monetary system in many ways operates like the Bretton-Woods system. Asia is the new periphery of the system and pursues an export-led development strategy. The members of the new periphery peg their currencies to the U.S. dollar at undervalued exchange rates and accumulate foreign reserves. In contrast, the old periphery - - consisting of Western Europe, Canada and parts of Latin America - - interacts with the centre with flexible exchange rates; its aggregate current account has been roughly in balance. As under the older system, the United States remains the centre country, pursuing a monetary-policy strategy that overlooks the exchange rate. An implication of this argument is the following asymmetry hypothesis: under both regimes the United States does not take external factors into account in conducting monetary policy while the periphery does take external factors into account. We provide results of a test of the asymmetry hypothesis. Then, we present a new method for decomposition of the business cycle using a time-varying-coefficient technique that allows us to test the relationship between the cycle and macroeconomic policies. We apply this technique to five countries for three sub-periods over the 1959 to 2007 period.
    Keywords: Revived Bretton-Woods System; Asymmetry Hypothesis; Time-Series Decomposition; Time-Varying-Coefficient Estimation
    JEL: C22 E32 F33
    Date: 2009–09
  25. By: Selahattin Togay (Gazi University); Bedri Kamil Onur Taþ (TOBB ETU)
    Abstract: This paper investigates effects of official dollarization on the macroeconomic performance of Ecuador using a time series perspective. More specifically, we investigate how dollarization effects inflation, GDP, inflation uncertainty and money-price relationship in Ecuador. There are four main findings of this study. First, inflation is lower after official dollarization. Second, GDP growth is higher after official dollarization when controlling for several other factors like rising oil prices and increase in the equity markets of emerging economies. Third, inflation uncertainty measured by inflation variance through GARCH is lower during official dollarization. Finally, money supply is endogenous after official dollarization and exogenous before official dollarization. As a result, we conclude that dollarization improved the macroeconomic performance of Ecuador and changed the money-price relationship in Ecuador.
    Keywords: Official Dollarization, Ecuador, Inflation uncertainty, GARCH model, Moneyprice relation, Endogeneity of money
    JEL: F31 E51 E42 E31
    Date: 2009
  26. By: Albrecht Ritschl; Samad Sarferaz
    Abstract: This paper examines the role of currency and banking in the German financial crisis of 1931 for both Germany and the U.S. We specify a structural dynamic factor model to identify financial and monetary factors separately for each of the two economies. We find that monetary transmission through the Gold Standard played only a minor role in causing and propagating the crisis, while financial distress was important. We also find evidence of crisis propagation from Germany to the U.S. via the banking channel. Banking distress in both economies was apparently not endogenous to monetary policy. Results confirm Bernanke's (1983) conjecture that an independent, non-monetary financial channel of crisis propagation was operative in the Great Depression.
    Keywords: Great Depression, 1931 financial crisis, international business cycle transmission, Bayesian factor analysis, currency, banking
    JEL: N12 N13 E37 E47 C53
    Date: 2010–02
  27. By: Yener Altunbas; Leonardo Gambacorta; David Marques-Ibanez
    Abstract: This paper investigates the relationship between short-term interest rates and bank risk. Using a unique database that includes quarterly balance sheet information for listed banks operating in the European Union and the United States in the last decade, we find evidence that unusually low interest rates over an extended period of time contributed to an increase in banks' risk. This result holds for a wide range of measures of risk, as well as macroeconomic and institutional controls.
    Keywords: bank risk, monetary policy, credit crisis
    Date: 2010–03
  28. By: Stephen D. Williamson; Randall Wright
    Abstract: The purpose of this paper is to discuss some of the models used in New Monetarist Economics, which is our label for a body of recent work on money, banking, payments systems, asset markets, and related topics. A key principle in New Monetarism is that solid microfoundations are critical for understanding monetary issues. We survey recent papers on monetary theory, showing how they build on common foundations. We then lay out a tractable benchmark version of the model that allows us to address a variety of issues. We use it to analyze some classic economic topics, like the welfare effects of inflation, the relationship between money and capital accumulation, and the Phillips curve. We also extend the benchmark model in new ways, and show how it can be used to generate new insights in the study of payments, banking, and asset markets.
    Date: 2010
  29. By: M Farid;
    Abstract: Trade data on East Asian EMEs shows the predominant use of Dollar Currency Pricing (DCP). Using a DSGE model with six-stage vertical production chain, staggered prices, and cross-border trade in intermediate inputs, we aim to provide an alternative explanation for ‘fear of floating’ by EMEs. We examine interactions between firms’ pricing rules and the transmission of external shocks under different exchange rate regimes. We find that weak input substitution and DCP of exports eliminate expenditure-switching and the allocative role of exchange rate adjustment, resulting in ‘exchange rate disconnect’, and hence ‘fear of floating’ by EMEs.
    Keywords: Vertical production chain; Staggered price contracts; Input Substitution; External Currency Pricing; Monetary Policy
    JEL: E31 E52 F41
    Date: 2010–03
  30. By: Patnaik, Ila (Asian Development Bank Institute); Shah, Ajay (Asian Development Bank Institute)
    Abstract: In this paper, we examine capital account openness and exchange rate flexibility in 11 Asian economies. Asia has made slow progress in de jure capital account openness, but has made much more progress in de facto capital account openness. While there has been a gradual increase in exchange rate flexibility, most Asian economies continue to have largely inflexible exchange rates. This combination of advancing de facto capital account integration without greater exchange rate flexibility has led to procyclical monetary policy, when capital flows are procyclical. This paper emphasises the need for a consistent monetary policy framework.
    Keywords: capital account openness; exchange rate flexibility; asian economies
    JEL: E40 E60 F41
    Date: 2010–03–12
  31. By: Matteo Luciani (Dipartimento di Economia, Sapienza University of Rome Italy)
    Abstract: DThis paper estimates a Structural Dynamic Factor Model on a panel of 102 US quarterly series. We model economic comovements by means of 5 underlying structural shocks (oil price, productivity, aggregate demand, monetary policy, and housing demand). The results of the benchmark model (impulse responses and variance decompositions) are in line with those predicted by economic theory and usually estimated by the empirical literature. We show that while over the whole sample the contribution of the housing demand shock is negligible, after the early eighties' liberalizations in housing finance, the housing demand shock has become a substantial source of business cycle fluctuations. The model is then used to analyze the causes of the 2008 recession: results indicate that we cannot exclude that monetary policy played a non negligible role in leading the way for the downturn in residential investment and the ensuing recession.\\ JEL Classification: C32, E32, E52, R2
    Keywords: Structural Factor Model, Business Cycle, Monetary Policy, Housing.; Structural Factor Model, Business Cycle, Monetary Policy, Housing
    JEL: C32 E32 E52 R2
    Date: 2010
  32. By: Joseph P. Byrne; Fatima Kaneez; Alexandros Kontonikas
    Abstract: National inflation rates reflect domestic and international (regional and global) influences. The relative importance of these components remains a controversial empirical issue. We extend the literature on inflation co-movement by utilising a dynamic factor model with stochastic volatility to account for shifts in the variance of inflation and endogenously determined regional groupings. We find that most of inflation variability is explained by the country specific disturbance term. Nevertheless, the contribution of the global component in explaining industrialised countries’ inflation rates has increased over time.
    Keywords: Inflation, Dynamic Factor Model, Stochastic Volatility, Globalisation
    JEL: C32 E31 E52
    Date: 2010–01
  33. By: Apel, Mikael (Monetary Policy Department, Central Bank of Sweden); Claussen, Carl Andreas (Monetary Policy Department, Central Bank of Sweden); Lennartsdotter, Petra (Monetary Policy Department, Central Bank of Sweden)
    Abstract: This paper reports and analyzes the results from a questionnaire sent to all present and former members of the Riksbank’s Executive Board, the monetary policy committee (MPC) of the Swedish central bank. The questions cover a number of issues discussed in the growing literature on monetary policy making by committees. The paper thus relates research to the views of practitioners in a way that has not been done before. We find, among other things, that many members consider the six-person strong Riksbank MPC to be slightly too large, that it is very common that members have decided before the policy meeting how they will vote, and that members, when forming their opinions, consider input from the staff more important than input from their colleagues.
    Keywords: Monetary Policy Committee; Sveriges Riksbank; Questionnaire Study
    JEL: D71 E52 E58
    Date: 2010–01–01
  34. By: André Kurmann; Christopher Otrok
    Abstract: We provide a new structural interpretation of the relationship between the slope of the term structure of interest rates and macroeconomic fundamentals. We first adopt an agnostic identification approach that allows us to identify the shocks that explain most of the movements in the slope. We find that two shocks are sufficient to explain virtually all movements in the slope. Impulse response functions for the first shock, which explains the majority of the movements in the slope, lead us to interpret this main shock as a news shock about future productivity. We confirm this interpretation by formally identifying such a news shock as in Barsky and Sims (2009) and Sims (2009). We then assess to what extent a New Keynesian DSGE model is capable of generating the observed slope responses to a news shock. We find that augmenting DSGE models with a term structure provides valuable information to discipline the description of monetary policy and the model’s response to news shocks in general.
    Keywords: Term structure of interest rates, news, productivity shocks, business cycles, monetary policy
    JEL: E30 E43 E52
    Date: 2010
  35. By: Piti Disyatat
    Abstract: A central proposition in research on the role that banks play in the transmission mechanism is that monetary policy imparts a direct impact on deposits and that deposits, insofar as they constitute the supply of loanable funds, act as the driving force of bank lending. This paper argues that the emphasis on policy-induced changes in deposits is misplaced. A reformulation of the bank lending channel is proposed that works primarily through the impact of monetary policy on banks' balance sheet strength and risk perception. Such a recasting implies, contrary to conventional wisdom, that greater reliance on market-based funding enhances the importance of the channel. The framework also shows how banks, depending on the strength of their balance sheets, could act either as absorbers or amplifiers of shocks originiating in the financial system.
    Keywords: systemic risk, Macroprudential regulation, Portfolio distress loss, Credit default swap, Dynamic conditional correlation
    Date: 2010–02
  36. By: Markus Jochmann (Department of Economics, University of Strathclyde)
    Abstract: This paper uses an infinite hidden Markov model (IHMM) to analyze U.S. inflation dynamics with a particular focus on the persistence of inflation. The IHMM is a Bayesian nonparametric approach to modeling structural breaks. It allows for an unknown number of breakpoints and is a flexible and attractive alternative to existing methods. We found a clear structural break during the recent financial crisis. Prior to that, inflation persistence was high and fairly constant.
    Keywords: inflation dynamics, hierarchical Dirichlet process, IHMM, structural breaks, Bayesian nonparametrics
    JEL: C11 C22 E31
    Date: 2010–01
  37. By: Hussain, Syed Mujahid (Department of Finance and Statistics, Hanken School of Economics, Helsinki)
    Abstract: This paper investigates the return and volatility responses of major European and the US equity indices to monetary policy surprises using extensive intraday data on 5-minute price quotes along with a comprehensive dataset on monetary policy decisions and macroeconomic news. Our results show that monetary policy decisions generally exert an immediate and significant influence on stock index returns and volatilities in both European US markets. Our findings also indicate that European Central Bank’s (ECB) press conferences following monetary policy decisions on the same day have define impacts on European index return volatilities, implying that they convey important information to market participants. However, in contrast to some earlier evidence, we do not find any support for the hypothesis that return volatilities in European and US markets are significantly affected by the path surprises. Overall, our analysis suggests that the use of high frequency data is critical for separating the effects of monetary policy actions from those of macroeconomic news announcements on stock index returns and volatilities.
    Keywords: conditional mean; conditional volatility; macroeconomic news; monetary policy; high frequency data
    JEL: G14 G15
    Date: 2010–03–10
  38. By: Angus C. Chu (Institute of Economics, Academia Sinica, Taipei, Taiwan); Ching-Chong Lai (Institute of Economics, Academia Sinica, Taipei, Taiwan)
    Abstract: This study analyzes the effects of inflation on R&D and innovation-driven growth. In the theoretical section, we incorporate money demand into a quality-ladder model with elastic labor supply and derive the following results. If the elasticity of substitution between consumption and the real money balance is less (greater) than unity, then R&D and output growth are decreasing (increasing) in inflation. If either labor supply is inelastic or the elasticity of substitution between consumption and the real money balance is unity, then social welfare monotonically increases as the nominal interest rate approaches zero (i.e. the Friedman rule). Quantitatively, decreasing inflation in the US to achieve price stability improves welfare (equivalent to a permanent increase in consumption of at least 0.5%). In the empirical section, we use cross-country data to establish a negative and statistically significant relationship between inflation and R&D.
    Keywords: economic growth, inflation, money, R&D; economic growth, inflation, money, R&D
    JEL: E41 O41
    Date: 2010–03
  39. By: Tobias Adrian; Hyun Song Shin
    Abstract: The financial crisis of 2007-09 highlighted the changing role of financial institutions and the growing importance of the "shadow banking system," which grew out of the securitization of assets and the integration of banking with capital market developments. This trend was most pronounced in the United States, but it also had a profound influence on the global financial system as a whole. In a market-based financial system, banking and capital market developments are inseparable, and funding conditions are tied closely to fluctuations in the leverage of market-based financial intermediaries. Balance-sheet growth of market-based financial intermediaries provides a window on liquidity by indicating the availability of credit, while contractions of balance sheets have tended to precede the onset of financial crises. We describe the changing nature of financial intermediation in the market-based financial system, chart the course of the recent financial crisis, and outline the policy responses that have been implemented by the Federal Reserve and other central banks.
    Keywords: Financial crises ; Intermediation (Finance) ; Liquidity (Economics) ; Monetary policy ; Capital market
    Date: 2010
  40. By: Adam Cagliarini (Reserve Bank of Australia); Warwick McKibbin (Centre for Applied Macroeconomic Analysis, Australian National University)
    Abstract: We use the multi-sector and multi-country G-Cubed model to explore the potential role of three major shocks – to productivity, risk premia and US monetary policy – to explain the large movements in relative prices between 2002 and 2008. We find that productivity shocks were major drivers of relative price movements, while shocks to risk premia and US monetary policy contributed temporarily to some of the relative price dispersions we observe in the data. The effect of US monetary policy shocks on relative prices was most pronounced in countries that fix their currency to the US dollar. Those countries that float were largely shielded from these effects. We conclude that the shocks we consider cannot fully capture the magnitude of the relative price movements over this period, suggesting that other driving forces could also be responsible, including those outside of the model.
    Keywords: productivity; relative prices; G-Cubed; risk premia; economic policy
    JEL: E37 E52 E65
    Date: 2009–12
  41. By: Thomas A. Lubik; Wing Leong Teo
    Abstract: We introduce inventories into an otherwise standard New Keynesian model and study the implications for inflation dynamics. Inventory holdings are motivated as a means to generate sales for demand-constrained firms. We derive various representations of the New Keynesian Phillips curve with inventories and show that one of these specifications is observationally equivalent to the standard model with respect to the behavior of inflation when the model's cross-equation restrictions are imposed. However, the driving variable in the New Keynesian Phillips curve - real marginal cost - is unobservable and has to be proxied by, for instance, unit labor costs. An alternative approach is to impute marginal cost by using the model's optimality conditions. We show that the stock-sales ratio is linked to marginal cost. We also estimate these various specifications of the New Keynesian Phillips curve using GMM. We find that predictive power of the inventory-specification at best approaches that of the standard model, but does not improve upon it. We conclude that inventories do not play a role in explaining inflation dynamics within our New Keynesian Phillips curve framework.
    Keywords: Inflation (Finance)
    Date: 2010
  42. By: Mancini, Loriano (Swiss Finance Institute at EPFL); Ranaldo, Angelo (Swiss National Bank); Wrampelmeyer, Jan (University of Zurich)
    Abstract: This paper develops a liquidity measure tailored to the foreign exchange (FX) market, quantifies the amount of commonality in liquidity across exchange rates, and determines the extent of liquidity risk premiums embedded in FX returns. The new liquidity measure utilizes ultra high frequency data and captures cross-sectional and temporal variation in FX liquidity during the financial crisis of 2007–2008. Empirical results show that liquidity co-moves across currency pairs and that systematic FX liquidity decreases dramatically during the crisis. Extending an asset pricing model for FX returns by the novel liquidity risk factor suggests that liquidity risk is heavily priced.
    Keywords: Foreign Exchange Market; Measuring Liquidity; Commonality in Liquidity; Liquidity Risk Premium; Subprime Crisis
    JEL: F31 G12 G15
    Date: 2009–11–20
  43. By: Stephen Hall
    Abstract: The paper provides new evidence on the causal relationship between money and price for the euro area using quarterly data for the period 1980 to 2006, employing two alternative methods of estimation: the vector error correction (VEC) and time-varying coefficient (TVC) estimation techniques. The latter technique has the advantage over the former technique in that it can deal with possible specification biases and spurious relationships that may have arisen from structural changes. The empirical results from the VEC method reveal a bidirectional causal relationship between money and price. Contrary, the results from the TVC technique suggest that money is acting as an exogenous process determining the price level.
    Keywords: Causality; VEC, Time Varying Coefficient Estimation; Euro Area
    JEL: C20 E41
    Date: 2009–09
  44. By: Hacker, Scott (Jonkoping International Business School); Kim, Hyunjoo (Jonkoping International Business School); Månsson, Kristofer (Jonkoping International Business School)
    Abstract: Monthly and quarterly data for the spot exchange rate of the Swedish Krona against major currencies have been used in this paper to investigate the causality in a Granger sense at different time scales between the spot exchange rate and the nominal interest rate differential by using wavelet analysis. Impulse response functions are also utilized to examine the signs of how one of these variables affects the other over time. One key empirical finding from the causality tests is that there is only substantial evidence of a causal relationship in the long run between the two variables. When using monthly data, this is true in both directions. When considering impulse responses on how the interest rate differential affects the exchange rate, there appears to be some evidence of more negative relationships at the shorter time scales and more positive relationships at the longer time scales.
    Keywords: exchange rate; interest rate differential; Granger causality; wavelet analysis; uncovered interest rate parity
    JEL: C32 E44 F31 F42
    Date: 2010–02–11
  45. By: Luis J. Álvarez (Banco de España); Pablo Burriel (Banco de España)
    Abstract: This paper shows that the standard Calvo model clearly fails to account for the distribution of price durations found in micro data. We propose a novel price setting model that fully captures heterogeneity in individual pricing behavior. Specifically, we assume that there is a continuum of firms that set prices according to a Calvo mechanism, each of them with a possibly different price adjustment parameter. The model is estimated by maximum likelihood and closely matches individual consumer and producer price data. Incorporating estimated price setting rules into a standard DSGE model shows that fully accounting for pricing heterogeneity is crucial to understanding inflation and output dynamics. The standard calibration that assumes within sector homogeneity, as in Carvalho (2006), is at odds with micro data evidence and leads to a substantial distortion of estimates of the real impact of monetary policy.
    Keywords: price setting, Calvo model, heterogeneity, hazard rate
    JEL: C40 D40 E30
    Date: 2010–04
  46. By: Manoel Bittencourt
    Abstract: We test for the populist view of inflation in Latin America between 1970 and 2007. The empirical results - based on the relatively novel panel time-series data and analysis - confirm the theoretical prediction that recently elected governments coming into power after periods of political dictatorship, and which are faced with high economic inequality, end up generating high inflation and macroeconomic instability. All in all, we suggest that the implementation of democracy as such requires not only the right political context' - or an appropriately constrained executive - to work well, but it also must come with certain economic institutions (e.g. central bank independence and a credible and responsible fiscal authority), institutions which would raise the costs of pursuing populist policies in the first place.
    Keywords: Democracy, populism, hyperination, Latin America
    JEL: E31 E65 N16 O23 O54
    Date: 2010

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