nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒05‒15
twenty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Modeling Monetary Policy By Samuel Reynard; Andreas Schabert
  2. Trading off monetary and financial stability: a balance of risk framework By Jan Willem van den End
  3. Modelling anti-inflationary monetary targeting: with an application to Romania By Marcelo Sánchez
  4. Substitution between domestic and foreign currency loans in Central Europe. Do central banks matter? By Michał Brzoza-Brzezina; Tomasz Chmielewski; Joanna Niedźwiedzińska
  5. Off-the-record target zones: Theory with an application to Hong Kong's currency board By Chen, Yu-Fu; Funke, Michael; Glanemann, Nicole
  6. Should Central Banks of Small Open Economies Respond to Exchange Rate Fluctuations? The Case of South Africa By Sami Alpanda; Kevin Kotze; Geoffrey Woglom
  7. Monetary policy through the “credit-cost channel”. Italy and Germany pre and post-EMU By Giuliana Passamani; Roberto Tamborini
  8. A direct test of the endogeneity of money: implications for Gulf Cooperation Council (GCC) countries By Bedri Kamil Onur Tas; Selahattin Togay
  9. Monetary Policy under a Fiscal Theory of Sovereign Default By Andreas Schabert
  10. Offshore Markets for the Domestic Currency: Monetary and Financial Stability Issues By Dong He; Robert N. McCauley
  11. How Well Does Sticky Information Explain Inflation and Output Inertia? By Carrillo Julio A.
  12. How has the monetary transmission mechanism evolved over time? By Jean Boivin; Michael T. Kiley; Frederic S. Mishkin
  13. Housing collateral and the monetary transmission mechanism By Walentin, Karl; Sellin, Peter
  14. Business Cycle Synchronization in Europe: Evidence from the Scandinavian Currency Union By U. Michael Bergman; Lars Jonung
  15. Reading the recent monetary history of the U.S., 1959-2007 By Jesus Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez.
  16. Investigating the Zero Lower Bound on the Nominal Interest Rate under Financial Instability By Carrillo Julio A.; Poilly Céline
  17. A Comparison of Inflation Expectations and Inflation Credibility in South Africa: Results from Survey Data By Jannie Rossouw; Vishnu Padayachee; Adél Bosch
  18. Zimbabwe’s Currency Crisis: Which Currency To Adopt In The Aftermath Of The Multi-Currency Regime? By Makochekanwa, Albert
  19. Structural shocks and the comovements between output and interest rates By Elmar Mertens
  20. The Discursive Dilemma in Monetary Policy By Claussen , Carl Andreas; Røisland, Øistein
  21. The Impact of Central Bank's intervention in the foreign exchange market on the Exchange Rate: The case of Zambia (1995-2008) By Mwansa, Katwamba
  22. The discursive dilemma in monetary policy By Carl Andreas Claussen; Øistein Røisland
  23. Exchange Rate Flexibility Across Financial Crises By Virginie Coudert; Cecile Couharde; Valerie Mignon
  24. Stock market conditions and monetary policy in an DSGE model for the US By Castelnuovo , Efrem; Nisticò, Salvatore
  25. Costly Information, Planning Complementarity and the New Keynesian Phillips Curve By Acharya, Sushant
  26. Towards a Program for Financial Stability. By Robert E. Krainer

  1. By: Samuel Reynard (Swiss National Bank); Andreas Schabert (University of Amsterdam)
    Abstract: We develop a macroeconomic framework where money is
    Keywords: Monetary policy; Open market operations; Liquidity
    JEL: E52 E58 E43 E32
    Date: 2009–11–10
  2. By: Jan Willem van den End
    Abstract: This paper presents a framework that quantifies the trade-offs for a central bank that includes financial stability in its strategy and uses macroprudential instruments next to the interest rate. It is an innovative application of the Kaminsky and Reinhart early warning method, by assuming that the central bank takes into account financial variables as signals of inflation risks. The empirical application shows that trading off monetary and macroprudential policy reduces the overall costs related to inflation and financial instability. This can be achieved by changing the preferences of the central bank, lengthening the monetary policy horizon and by a more flexible inflation target. Estimation results of a probit model indicate that the monetary stance in the US and the Euro area has not adequately traded off price stability against financial stability.
    Keywords: financial stability; macroprudential policy; monetary policy; policy co-ordination; inflation
    JEL: E31 E52 E61 G28
    Date: 2010–05
  3. By: Marcelo Sánchez (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper attempts to characterise an anti-inflationary monetary targeting (MT) regime. In order to derive a formal representation of this regime, we formulate the central bank’s optimisation problem under the assumption that it is possible for the monetary targeted variable to have an impact on inflation. We apply a rather general framework to the Romanian experience with MT in the period 1999-2005. We find that during this period Romania's MT regime can be characterised by a concern for price stability and an additional role for smoothing of the central bank's instrument (base money growth). Our results suggest that exchange rate variability and output gap stability appear not to have entered the objective function significantly. JEL Classification: E52, E58, C32, C61.
    Keywords: monetary targeting, optimal monetary policy, Romania.
    Date: 2010–05
  4. By: Michał Brzoza-Brzezina (National Bank of Poland, ul. Świętokrzyska 11/21, 00-919 Warszawa, Poland.); Tomasz Chmielewski (Warsaw School of Economics, al. Niepodległości 162, 02-554 Warszawa, Poland.); Joanna Niedźwiedzińska (National Bank of Poland, ul. Świętokrzyska 11/21, 00-919 Warszawa, Poland.)
    Abstract: In this paper we analyse the impact of monetary policy on total bank lending in the presence of a developed market for foreign currency denominated loans and potential substitutability between domestic and foreign currency loans. Our results, based on a panel of four biggest Central European countries (the Czech Republic, Hungary, Poland and Slovakia) confirm significant and probably strong substitution between these loans. Restrictive monetary policy leads to a decrease in domestic currency lending but simultaneously accelerates foreign currency denominated loans. This makes the central bank’s job harder. JEL Classification: E44, E52, E58.
    Keywords: Domestic and foreign currency loans, substitution, monetary policy, Central Europe.
    Date: 2010–05
  5. By: Chen, Yu-Fu (BOFIT); Funke, Michael (BOFIT); Glanemann, Nicole (BOFIT)
    Abstract: This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmetric one-sided regimes. Market participants' beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong's one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities finally revamped the regime as a symmetric two-sided system with a narrow exchange rate band.
    Keywords: Currency Board Arrangement; Target Zone Model; Hong Kong
    JEL: C61 E42 F31 F32
    Date: 2010–04–26
  6. By: Sami Alpanda; Kevin Kotze; Geoffrey Woglom
    Abstract: We estimate a New Keynesian small open economy DSGE model for South Africa, using Bayesian techniques. The model features imperfect competition, incomplete asset markets, partial exchange rate pass-through, and other commonly used nominal and real rigidities, such as sticky prices, price indexation and habit formation. We study the effects of various shocks on macroeconomic variables, and calculate the optimal Taylor rule coefficients using a loss function for the central bank. We find that the optimal Taylor rule places a heavier weight on inflation and output than the estimated Taylor rule, but almost no weight on the depreciation of currency.
    Keywords: optimal monetary policy, small open economy, Bayesian estimation
    JEL: F41 E52
    Date: 2010
  7. By: Giuliana Passamani; Roberto Tamborini
    Abstract: In this paper we present an empirical analysis of the "credit-cost channel" (CCC) of monetary policy transmission. This model combines bank credit supply, as a means whereby monetary policy affects economic activity ("credit channel"), and interest rates on loans as a cost to firms ("cost channel"). The thrust of the model is that the CCC makes both aggregate demand and aggregate supply dependent on monetary policy. As a consequence a) credit market conditions (e.g. risk spreads) are important sources and indicators of macroeconomic shocks, b) the real effects of monetary policy are larger and persistent. We have applied the Johansen-Juselius CVAR methodology to Italy and Germany in the "hard" EMS period and in the EMU period. The short-run and long-run effects of the CCC are detectable for both countries in both periods. We have also replicated the Johansen-Juselius technique for the simulation of rule-based stabilization policy for both Italy and Germany in the EMU period. As a result, we have found confirmation that inflationtargeting by way of inter-bank rate control, grafted onto the estimated CCC model, would stabilize inflation through structural shifts of the stochastic equilibrium paths of both inflation and output.
    Keywords: Macroeconomics and monetary economics, Monetary transmission mechanisms, Structural cointegration models, Italian economy, German economy
    JEL: E51 C32
    Date: 2010
  8. By: Bedri Kamil Onur Tas (TOBB ETU); Selahattin Togay (Gazi University)
    Abstract: This paper contributes to the ongoing discussion about the endogeneity of money supply by empirically investigating the GCC countries. We propose and implement a direct test of money supply endogeneity that depends on econometric specification of exogeneity. To be able to make comparisons with previous studies in the literature, we also conducted Granger Causality tests to analyze the causality relationship between bank credit and money supply. Both of the empirical studies provide empirical evidence for the endogeneity of money supply in GCC countries. The results of the paper have many significant monetary policy implications for the upcoming monetary unification of the GCC countries.
    Date: 2010
  9. By: Andreas Schabert (University of Amsterdam, and TU Dortmund University)
    Abstract: This paper examines equilibrium determination under different monetary policy regimes when the government might default on its debt. We apply a cash-in-advance model where the government does not have access to non-distortionary taxation and does not account for initial outstanding debt when it sets the income tax rate. Solvency is then not guaranteed and sovereign default can affect the return on public debt. If the central bank sets the interest rate in a conventional way, the equilibrium allocation cannot be determined. If, instead, money supply is controlled, the equilibrium allocation can uniquely be determined.
    Keywords: Equilibrium determination; interest rate policy; money supply; public debt; sovereign default
    JEL: E31 E52 E63
    Date: 2009–11–06
  10. By: Dong He (Research Department, Hong Kong Monetary Authority); Robert N. McCauley (Bank for International Settlements)
    Abstract: We show in this paper that offshore markets intermediate a large chunk of financial transactions in major reserve currencies such as the US dollar. We argue that, for emerging market economies that are interested to see some international use of their currencies, offshore markets can help to increase the recognition and acceptance of the currency, while still allowing the authorities to retain a measure of control on the pace of capital account liberalisation. The development of offshore markets could pose risks to monetary and financial stability in the home economy, which need to be prudently managed. Experience in dealing with the Euromarkets by the Federal Reserve and other authorities of the major reserve currency economies show that policy options are available for managing such risks.
    Keywords: offshore markets; currency internationalisation; monetary stability; financial stability
    JEL: E51 E58 F33
    Date: 2010–03
  11. By: Carrillo Julio A. (METEOR)
    Abstract: This paper compares two approaches that aim to explain the lagged and persistent behaviorof inflation and output after a variation in the interest rate. Two variants that produce inertiaare added to a baseline DSGE model of sticky prices: 1) a lagged inflation indexation rulealong with habit formation; and 2) sticky information applied to firms, workers, and households. The rival models are then confronted to a monetary SVAR using U.S. data in order to estimate the rates of inflation indexation, habit formation, price rigidities, information stickiness, and the monetary policy rule parameters. It is shown that the sticky information model has a modest advantage at fitting inflation than the lagged inflation index. model with habits. For output, the opposite is true. These differences are consistent throughout the robustness analysis, but they are not big enough to imply a significant statistical difference in terms of the goodness of fit of each model. In addition, the results suggest that sticky information may replace entirely sticky prices as a explanation of price setting behavior, but the latter might not apply to wages. Finally, the analysis find that information stickiness should be pervasive (i.e., applied to households, firms, and workers) in order to replicate the responses of aggregate variables to a shock in monetary policy.
    Keywords: monetary economics ;
    Date: 2010
  12. 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).
    Date: 2010
  13. By: Walentin, Karl (Research Department, Central Bank of Sweden); Sellin, Peter (Monetary Policy Department, Central Bank of Sweden)
    Abstract: In this paper our main aim is to quantify the role that housing collateral plays for the monetary transmission mechanism. Furthermore, we want to explore the implications of the increase in household indebtedness, and specifically the loan-to-value ratio, in the last two decades. We set up a two sector DSGE model with production of goods and housing. Households can only borrow by using their houses as collateral. The structure of the model closely follows Iacoviello and Neri (2010). To be able to do quantitatively relevant exercises we estimate the model using Bayesian methods on Swedish data for 1986q1-2008q3. We quantify the reinforcement of the monetary transmission mechanism that housing used as collateral implies in the presence of nominal loan contracts. This mechanism functions through the effects of the interest rate on house prices as well as on inflation and thereby the real value of nominal debt. This component of the monetary transmission mechanism becomes stronger the higher the loan-to-value ratio is. A change in the maximum loan-to-value ratio from 85% to 95%, all else being equal, implies that the effect of a monetary policy shock is increased by 4% for inflation, 8% for GDP and 24% for consumption. We conclude that to properly understand the monetary transmission mechanism and its changing nature over time, we need to take into account the effects of housing related collateral constraints.
    Keywords: House prices; residential investment; monetary policy; monetary transmis- sion mechanism; collateral constraints; Bayesian estimation
    JEL: E21 E32 E44 E52 R21 R31
    Date: 2010–04–01
  14. By: U. Michael Bergman; Lars Jonung
    Abstract: This paper studies business cycle synchronization in the three Scandinavian countries Denmark, Norway and Sweden prior to, during and after the Scandinavian Currency Union 1873-1913. We find that the degree of synchronization tended to increase during the currency union, thus supporting earlier empirical evidence. Estimates of factor models suggest that common Scandinavian shocks are important for these three countries. At the same time we find evidence suggesting that the importance of these shocks does not depend on the monetary regime.
    Keywords: european union eu denmark sweden norway jonung bergman scandinavian currency union synchronisation of cycles co-movement of cycles monetary unions symnetry symmetry european business cycles
    JEL: E32 F41
    Date: 2010–02
  15. By: Jesus Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez.
    Abstract: The authors report the results of the estimation of a rich dynamic stochastic general equilibrium model of the U.S. economy with both stochastic volatility and parameter drifting in the Taylor rule. They use the results of this estimation to examine the recent monetary history of the U.S. and to interpret, through this lens, the sources of the rise and fall of the great American inflation from the late 1960s to the early 1980s and of the great moderation of business cycle fluctuations between 1984 and 2007.
    Keywords: Economic conditions - United States ; Business cycles - Econometric models ; Econometric models ; Monetary policy - United States
    Date: 2010
  16. By: Carrillo Julio A.; Poilly Céline (METEOR)
    Abstract: This paper introduces a zero lower bound constraint on the nominal interest rate in a financial accelerator model with nominal and real rigidities. We .rst analyze the implicationsfor aggregate dynamics of binding the zero lower bound for shocks that depress the nominalinterest rate. We include a sudden decrease in the value of the business sector net worth and an increase in its returns volatility, as two financial shocks that originate in the endogenous credit market of the model. We then explore the effects of the central bank management of expectations and a fiscal stimulus in a deep recession scenario, where the interest rate initially binds its zero bound. We find that a commitment by the central bank to keep the interest rate low for more time than prescribed by a typical interest rate rule may indeed reduce the volatility of output and inflation. For government purchases, we find a fiscal multiplier greater than one for at least 5 quarters. This is due to the presence of the zero lower bound and the Fisher (1933)’s debt-deflation channel, which implies that government spending may reduce the business sector risk premium and thus the cost of investment.
    Keywords: monetary economics ;
    Date: 2010
  17. By: Jannie Rossouw; Vishnu Padayachee; Adél Bosch
    Abstract: This paper reports a comparison of South African household inflation expectations and inflation credibility surveys undertaken in 2006 and 2008. The objective is to test for possible feed-through between inflating credibility and inflation expectations. It supplements similar earlier research that focused only on the 2006 survey results. The single most important difference between the survey results of 2006 and 2008 is that female and male respondents reported inflation expectations at the same level in 2006, while female respondents expected higher inflation than male respondents in the 2008 inflation expectations survey. More periodic survey data will be required for developing final conclusions on the possibility of feed-through effects. A very large percentage of respondents in the inflation credibility surveys indicate that they 'don't know' whether the historic rate of inflation is an accurate indication of price increases. It will be necessary to reconsider the structure of credibility surveys to increase the number of respondents providing views on the accuracy of historic inflation data.
    Keywords: Inflation; inflation credibility; inflation expecttaions; inflation surveys; multinomial analysis
    JEL: E31 E52 E58
    Date: 2010
  18. By: Makochekanwa, Albert
    Abstract: The study presented main features of possible currency options which can be potentially adopted by Zimbabwe in the aftermath of multi-currency regime. The currency options analyzed are dollarization, joining the CMA and re-introduction of the Zimbabwe dollar (Z$). The proposed management systems to underpin the reintroduction of the Zimbabwean dollar are currency board, free banking and Reserve Bank of Zimbabwe (RBZ). For each of the options analyzed, the practicality of Zimbabwe in adopting and/or implementing such currency was also explained. Although any of the three options could be adopted and implemented, the study considered the options in the following descending order of priority: (i) dollarization, (ii) retaining the Z$ but under the management system of a currency board, (iii) Joining the CMA, (iv) retaining the Z$ under the management of RBZ, with the institution having new management, and lastly (v) free banking.
    Keywords: Multi-currency; hyperinflation; dollarization; currency board; free banking
    JEL: F32 F31
    Date: 2009–12–28
  19. By: Elmar Mertens
    Abstract: Stylized facts on U.S. output and interest rates have so far proved hard to match with DSGE models. But model predictions hinge on the joint specification of economic structure and a set of driving processes. In a model, different shocks often induce different comovements, such that the overall pattern depends as much on the specified transmission mechanisms from shocks to outcomes, as well as on the composition of these driving processes. I estimate covariances between output, nominal and real interest rate conditional on several shocks, since such evidence has largely been lacking in previous discussions of the output-interest rate puzzle. ; Conditional on shocks to neutral technology and monetary policy, the results square with simple models, like the standard RBC model or a textbook version of the New Keynesian model. In addition, news about future productivity help to explain the overall counter-cyclical behavior of the real rate. ; A sub-sample analysis documents also interesting changes in these pattern. During the Great Inflation (1959-1979), permanent shocks to inflation accounted for the counter-cyclical behavior of the real rate and its inverted leading indicator property. Over the Great Moderation (1982-2006), neutral technology shocks were more dominant in explaining comovements between output and interest rates, and the real rate has been pro-cyclical.
    Date: 2010
  20. By: Claussen , Carl Andreas (Monetary Policy Department, Central Bank of Sweden); Røisland, Øistein (Monetary Policy Department)
    Abstract: The discursive dilemma implies that the policy decision of a board of policymakers depends on whether the board reaches the decision by voting directly on policy (conclusion-based procedure), or by voting on the premises for the decision (premise-based procedure). We derive results showing when the discursive dilemma may occur, both in a general model and in a standard monetary policy model. When the board aggregates by majority voting, a discursive dilemma can occur if either (i) the relationship between the premise and the decision is non- monotonic, or (ii) if the board members have di¤erent judgments on at least two of the premises. Normatively, a premise-based procedure tends to give better decisions when there is disagreement on parameters of the model.
    Keywords: Discursive dilemma; Monetary policy; MPC; Policy boards
    JEL: D71 E52 E58
    Date: 2010–04–01
  21. By: Mwansa, Katwamba
    Abstract: The central bank of Zambia called Bank of Zambia (BOZ) has, like many other central banks in both developing and developed economies, been from time to time intervening in the foreign exchange market by either purchasing or selling foreign exchange (mainly United States of America Dollars) to the market. Central banks have given a myriad of reasons for this particular behaviour. Chief among these and which is the focus of this paper is to smooth volatility or reverse a trend of the domestic currency in this case the kwacha. Despite central banks’ intervention activities in the foreign exchange markets, literature on the efficacy of these interventions in terms of impacting domestic currencies has remained controversial. While some strands of literature seem to suggest that such intervention has an impact on the currencies some literature disagrees. Early studies done in the 1980s suggest that intervention operations do not affect the exchange rate and if they do this effect is very small and only in the short run. More recent studies however, have found evidence of the effect on both the level and volatility of exchange rates. Further, recent studies focused on emerging market and developing countries have found strong evidence of the effect of central banks’ intervention operations in the foreign exchange market on exchange rates. This paper therefore examines the effect of the BOZ’s foreign currency market interventions on the level and volatility of the kwacha/ USD exchange rate between 1995 and 2008. In order to study the impact of interventions on the kwacha, the paper uses monthly data (both sales and purchases) on foreign exchange intervention and employs the GARCH (1, 1) and Exponential GARCH frameworks to model volatility. The results from GARCH model suggest that sales of foreign exchange in this case the $ causes the exchange rate to appreciate while purchases of the $ cause the exchange rate to depreciate. As for the impact on volatility, the GARCH (1, 1) model reveals that BOZ interventions increase volatility. Empirical results from the EGARCH model on the other hand suggest that both sales and purchases of $ cause the exchange rate to appreciate. The results on the impact of intervention on volatility are mixed though generally intervention appears to be increasing volatility.
    Keywords: foreign exchange intervention; Bank of Zambia; EGARCH
    JEL: F31 A10
    Date: 2009–05
  22. By: Carl Andreas Claussen (Sveriges Riksbank); Øistein Røisland (Norges Bank (Central Bank of Norway))
    Abstract: The discursive dilemma implies that the policy decision of a board of policymakers depends on whether the board reaches the decision by voting directly on policy (conclusion-based procedure), or by voting on the premises for the decision (premise-based procedure). We derive results showing when the discursive dilemma may occur, both in a general model and in a standard monetary policy model. When the board aggregates by majority voting, a discursive dilemma can occur if either (i) the relationship between the premise and the decision is non-monotonic, or (ii) if the board members have different judgments on at least two of the premises. Normatively, a premise-based procedure tends to give better decisions when there is disagreement on parameters of the model.
    Date: 2010–04–20
  23. By: Virginie Coudert; Cecile Couharde; Valerie Mignon
    Abstract: This paper studies the impact of global financial turmoil on the exchange rate policies in emerging countries. Many emerging countries have loosened the link of their currencies to the US dollar since the bursting of the subprime crisis in July 2007. Spillovers from advanced financial markets to currencies in emerging countries stem from the same causes documented in the literature on contagion, such as the drying–up of investors’ liquidity, the rise in risk aversion, and the updating of their risk assessments. Consequently, interdependencies across currencies are likely to be exacerbated during crisis periods. To test this hypothesis, we assess the exchange rate policies by their degree of flexibility, itself proxied by the exchange rate volatility, and investigate their relationship to a global financial stress indicator, measured by the volatility on global markets. We introduce the possibility of non-linearities by running smooth transition regressions (STR) over a sample of 21 emerging countries from January 1994 to September 2009. The results confirm that exchange rate flexibility does increase more than proportionally with the global financial stress, for most countries in the sample. We also evidence regional contagion effects spreading from one emerging currency to other currencies in the neighboring area.
    Keywords: Financial crises; dollar pegs; contagion effects; nonlinearity
    JEL: F31 G15 C22
    Date: 2010–04
  24. By: Castelnuovo , Efrem (Università di Padova and Bank of Finland Research); Nisticò, Salvatore (Università di Roma ‘Tor Vergata’ and LUISS ‘Guido Carli’)
    Abstract: This paper investigates the relationship between stock market fluctuations and monetary policy in a DSGE model for the US economy. We initially adopt a framework in which fluctuations in households’ financial wealth are allowed – but not required – to influence current consumption. This is due to interaction in the financial markets between long-time traders holding wealth accumulated over time and zero-wealth newcomers. 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 used to estimate our model. We fit our model to US post-WWII data and report three main results. First, the data strongly support a significant impact of stock prices on real activity and business cycles. Second, our estimates also identify a significant and counteractive Fed response to stock-price fluctuations. Third, we derive from our model a microfounded measure of financial slack – the stock-price gap – which we then compare with alternative measures, currently used in empirical studies, to assess the properties of the latter for capturing 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 in the post-WWII period, as reported by independent analyses, and closely correlates with the current financial meltdown. Typically, the proxies used for 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: E12 E44 E52
    Date: 2010–04–28
  25. By: Acharya, Sushant
    Abstract: I show that in a setting with costly information processing, strategic complementarity in pricing, by generating planning complementatrities, results in the aggregate price responding slowly to nominal shocks even though individual firm prices change by large amounts in response to idiosyncratic shocks. Klenow and Kryvtsov (2008) conclude that none of the commonly used pricing models is capable of matching all the facts from micro data and at the same time generate a large and persistent response to monetary policy. Unlike the standard state dependent pricing models which rely on physical costs of changing prices to generate unresponsiveness of prices, I instead focus on costs of planning and processing information, a channel which researchers have found empirically more important than physical costs of changing prices in determining pricing decisions of firms. The model is able to match all the features of micro pricing data and at the same time generates a sluggish response of aggregate price to monetary policy, thus predicting a short run Phillips curve. Also, the model generates firms behavior in which they set price plans rather than prices and also shows that firms may choose to index prices to long run inflation optimally as is often assumed in New-Keynesian models. The paper highlights the fact that to explain non-neutrality in the short run, prices need not be sticky, it is just that they do not contain all the information in the short run but become informationally efficient in the long run resulting in a long run neutrality result.
    Keywords: Planning Complementarity; Price Rigidity; Costly Information Acquisition; Real effects of Nominal Shocks; Forecasting; Strategic Complementarity
    JEL: E5 D8 E3
    Date: 2010–04–14
  26. By: Robert E. Krainer (University of Wisconsin Madison)
    Abstract: Fifty years ago Milton Friedman published a book entitled A Program for Monetary Stability. In it he outlined a number of suggestions for the conduct of monetary and fiscal policies that he thought would contribute to monetary stability and pari passu to price stability and a greater degree of output/employment stability. In this paper I review some of his policy prescriptions in light of the financial and economic crisis of 2007-2009.From the perspective of financial development the world today is much different from the world that Friedman knew in the late 1950’s. In what way would his policy recommendations have to be modified to account for these changes in financial development? To stabilize the banking system we argue that his proposal for 100 percent reserves or narrow banking merits serious consideration in current policy discussions. To stabilize asset markets we propose two policies that Friedman would not likely endorse. The first is to reinstate selective credit controls in the areas of the securities markets and the real estate market. The second policy designed to dampen excessive variability in the stock market is for the Central Bank to carry out some open market operations in an index fund of equities.
    Keywords: Financial Stability, Narrow Banking, Open Market Operations in Equities, Selective Credit Controls.
    JEL: E32 E44 E52 G18 G21
    Date: 2010

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