nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒07‒24
33 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Financial market imperfections and monetary policy strategy. By Meixing DAI
  2. The sensitivity of long-term interest rates to economic news: comment By Michelle L. Barnes; N. Aaron Pancost
  3. Has Inflation Targeting Changed Monetary Policy Preferences? By Jerome Creel; Paul Hubert
  4. Estimating Monetary Policy Reaction Functions Using Quantile Regressions By Wolters, Maik Hendrik
  5. Is the Phillips curve useful for monetary policy in Nigeria? By Carlos Garcia
  6. The Design and Effects of Monetary Policy in Sub-Saharan African Countries By Mohsin S. Khan
  7. U.S. foreign-exchange-market intervention during the Volcker-Greenspan era By Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
  8. Bayesian Estimation of a Simple Macroeconomic Model for a Small Open and Partially Dollarized Economy By Salas, Jorge
  9. Hybrid Inflation Targeting Regimes1 By Carlos Garcia; Jorge Restrepo; Scott Roger
  10. Is more exchange rate intervention necessary in small open economies? The role of risk premium and commodity shocks By Carlos Garcia; Wildo Gonzalez
  11. The Phillips curve and US monetary policy: what the FOMC transcripts tell us By Ellen E. Meade; Daniel L. Thornton
  12. Does foreign exchange reserve decumulation lead to currency appreciation? By Kathryn M.E. Dominguez; Rasmus Fatum; Pavel Vacek
  13. Adoption of inflation targeting and tax revenue performance in emerging market economies: An empirical investigation By Lucotte, Yannick
  14. How much does the public know about the ECB's monetary policy? Evidence from a survey of Duch households By Carin van der Cruijsen; David-Jan Jansen; Jakob de Haan
  15. Innocent frauds meet Goodhart’s Law in monetary policy By Bezemer, Dirk J; Gardiner, Geoffrey
  16. Rationale behind the responses of monetary policy to the real exchange rate in small open economies By Carlos Garcia; Wildo Gonzalez
  17. The US Term Structure and Central Bank Policy By Weber, Enzo; Wolters, Jürgen
  18. Financial globalization, financial frictions and optimal monetary policy By Ester Faia; Eleni Iliopulos
  19. Implications for models in monetary policy By Stan du Plessis
  20. Incorporation financial sector risk into monetary policy models: application to Chile By Dale F. Gray; Carlos Garcia; Leonardo Luna; Jorge Restrepo
  21. Liquidity, Interbank Market, and Capital Formation By Tarishi Matsuoka
  22. Credit Traps By Efraim Benmelech; Nittai K. Bergman
  23. Monetary policy and firms’ investment: Dynamic panel data evidence from Malaysia By Abdul Karim, Zulkefly
  24. The Macroeconomic Consequences of EMU: International Evidence from a DSGE Model By Jerger, Jürgen; Röhe, Oke
  25. The Euro-Project at Risk By Wilhem Hankel; Andreas Hauskrecht; Bryan Stuart
  26. The bank lending channel of monetary policy and its effect on mortgage lending By Lamont K. Black; Diana Hancock; Wayne Passmore
  27. The large scale asset purchases had large international effects By Christopher J. Neely
  28. Risk and Policy Shocks on the US Term Structure By Weber, Enzo; Wolters, Jürgen
  29. Wage setting patterns and monetary policy: international evidence By Giovanni Olivei; Silvana Tenreyro
  30. Linkages between Excess Currency and Stock Market Returns:Granger Causality in Mean and Variance By Eirini Syngelaki;
  31. Monetary policy and firm-level stock returns in an emerging market: Dynamic panel evidence from Malaysia By Abdul Karim, Zulkefly
  32. The fiscal multiplier and spillover in a global liquidity trap By Ippei Fujiwara; Kozo Ueda
  33. Persistence in US Interest Rate Spreads and the Expectations Hypothesis By Strohsal, Till; Weber, Enzo

  1. By: Meixing DAI
    Abstract: In a model with imperfect money, credit and reserve markets, we examine if an inflation-targeting central bank using the funds rate operating procedure to indirectly control market interest rates also needs a monetary aggregate as policy instrument. We show that if private agents use information extracted from money and financial markets to form inflation expectations and if the access to liquidity is subject to non-price rationing, the central bank can use a narrow monetary aggregate and the discount interest rate as independent policy instruments to reinforce the credibility of its announcements and the role of inflation target as nominal anchor for inflation expectations. This study shows how a monetary policy strategy combining inflation targeting and monetary targeting can be conceived to guarantee macroeconomic stability and the credibility of monetary policy. Friedman’s k-percent money growth rule, generating dynamic instability, and two alternative stabilizing feedback monetary targeting rules are examined.
    Keywords: Imperfect financial markets, non-price rationing, inflation targeting, monetary targeting, macroeconomic stability, Friedman’s k-percent rule, feedback money growth rules, two-pillar strategy.
    JEL: E44 E52 E58
    Date: 2010
  2. By: Michelle L. Barnes; N. Aaron Pancost
    Abstract: Refet Gürkaynak, Brian Sack, and Eric Swanson (2005) provide empirical evidence that long forward nominal rates are overly sensitive to monetary policy shocks, and that this is consistent with a model where long-term inflation expectations are not anchored because agents must infer the central bank's inflation target from noisy interest rate movements. Using the same data, methodology, and model, we show that their empirical results are neither persistent nor robust to small changes in sample period or methodology. In addition, their theoretical results rely mainly on an ad hoc law of motion for the inflation target-imperfect information about the target plays only a small role in un-anchoring expectations in their model.
    Keywords: Interest rates ; Monetary policy
    Date: 2010
  3. By: Jerome Creel (Observatoire Français des Conjonctures Économiques); Paul Hubert (Observatoire Français des Conjonctures Économiques)
    Abstract: The literature on inflation targeting has up to now focused on its impact on macroeconomic performance or private expectations. In contrast, this paper proposes to investigate empirically whether the institutional adoption of this framework has changed the policy preferences of the central banker. We test the hypothesis that inflation targeting has constituted a switch towards a greater focus on inflation. We use three complementary methods: a structural break analysis, time-varying parameters and Markov-Switching VAR which make possible to estimate linear or nonlinear, and forward or backward looking specifications, to account for heteroskedasticity without having to assume a date break ex ante. Our main result is that inflation targeting has not led to a stronger response to inflation. We infer that the inflation targeting paradigm should not be confounded with the inflation targeting framework.
    Keywords: Monetary Policy; Inflation Targeting; Taylor Rule; Structural Break; Time-Varying coefficients, Markov-Switching VAR
    JEL: E52 E58
    Date: 2010–07
  4. By: Wolters, Maik Hendrik
    Abstract: Monetary policy rule parameters are usually estimated at the mean of the interest rate distribution conditional on inflation and an output gap. This is an incomplete description of monetary policy reactions when the parameters are not uniform over the conditional distribution of the interest rate. I use quantile regressions to estimate parameters over the whole conditional distribution of the Federal Funds Rate. Inverse quantile regressions are applied to deal with endogeneity. Realtime data of inflation forecasts and the output gap are used. I find significant and systematic variations of parameters over the conditional distribution of the interest rate.
    Keywords: monetary policy rules; IV quantile regression; real-time data
    JEL: C14 E58 E52
    Date: 2010–07–13
  5. By: Carlos Garcia (ILADES-Georgetown University, Universidad Alberto Hurtado)
    Abstract: The objective of this article is to determine if the Phillips curve is a relevant tool to conduct monetary policy in African countries wishing to adopt an inflation-targeting regime. I choose Nigeria as a case of study because it is in the early stage of the implementation of this regime. I estimate a medium-sized model for monetary policy analysis. The model reflects a synthesis between the New Keynesian and the Real Business Cycle (RBC) approaches. Then I estimate the model by using Bayesian econometric technique in order to overcome the shortage of data availability. The study concludes that there is evidence that central banks can control the inflation rate through a Phillips curve, a Taylor rule that includes the exchange rate, and the sterilization of the resources from oil exports. Nevertheless, there are limits to the stabilization program. The same evidence suggests that it is important to implement a credible inflation-targeting regime to reduce inflation gradually, instead of abrupt stabilization attempts with high costs in lost output.
    Keywords: Monetary policy, Phillips curve, inflation-target regime.
    JEL: E31 E52 E58 O23
    Date: 2010–06
  6. By: Mohsin S. Khan (Peterson Institute for International Economics)
    Abstract: Since the 1990s there have been a number of major changes in the design and conduct of monetary policy. In a globalized environment, there is less time to adjust to shocks and greater need to achieve closer convergence of economic performance among trading partners. As a result, a number of developing countries have adopted exchange rate regimes with more flexibility, and thereby greater scope for monetary policy. Notable examples include a number of sub-Saharan African countries moving from fixed exchange-rate regimes to more flexible regimes and the adoption of formal or informal inflation targeting regimes by some of these countries. These changes have triggered considerable debate on how monetary policy should be conducted and the effects it has on the real economy. Mohsin Khan discusses the conventional objectives, targets, and instruments of monetary policy, including an analysis of the monetary transmission process. This paper examines the problems of dynamic inconsistency and inflationary bias, where governments deviate from their stated or target inflation level in order to obtain short-run output gains. Most economists now agree that any rules-based regime permits a margin for discretion, and they reject the idea that rules and discretion are mutually exclusive. As policymakers in many countries throughout the world have gravitated toward an approach based more on rules than on full discretion, a key issue is choosing an appropriate policy target, or nominal anchor. Khan discusses nominal anchors and current monetary frameworks before moving on to analyze the output effects of monetary policy. He looks at the relationship between the growth of GDP and different monetary aggregates in 20 sub-Saharan African economies and finds empirical support for the hypothesis that credit growth is more closely linked than is money growth to the growth of real GDP in these countries.
    Keywords: Monetary policy, Africa
    JEL: E52 N17
    Date: 2010–07
  7. By: Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
    Abstract: The Federal Reserve abandoned foreign-exchange-market intervention because it conflicted with the System’s commitment to price stability. By the early 1980s, economists generally concluded that, absent a portfolio-balance channel, sterilized foreign-exchange-market intervention did not provide central banks with a mechanism for systematically influencing exchange rates independent of their monetary policies. If intervention were to have anything other than a fleeting, hit-or-miss effect on exchange rates, monetary policy had to support it. Exchange rates, however, often responded to U.S. monetary-policy initiatives, so intervention to offset or reverse those exchange-rate responses can seem a contrary policy move and can create uncertainty about the strength of the System's commitment to price stability. That the U.S. Treasury maintained primary responsibility for foreign-exchange intervention only compounded this uncertainty. In addition, many FOMC participants feared that swap drawings and warehousing could contravene the Congressional appropriations process and, therefore, potentially pose a threat to System independence, a necessary condition for monetary-policy credibility.
    Keywords: Banks and banking, Central ; Foreign exchange administration ; Monetary policy ; Federal Open Market Committee
    Date: 2010
  8. By: Salas, Jorge (Central Bank of Peru)
    Abstract: I describe a simple new-keynesian macroeconomic model for a small open and partially dollarized economy, which closely resembles the Quarterly Projection Model (QPM) developed at the Central Bank of Peru (Vega et al. (2009)). Then I use Bayesian techniques and quarterly data from Peru to estimate a large group of parameters. The empirical findings provide support for some of the parameters values imposed in the original QPM. In contrast, I find that another group of coefficients – e.g., the weights on the forward-looking components in the aggregate demand and the Phillips curve equations, among several others – should be modified to be more consistent with the data. Furthermore, the results validate the operation of different channels of monetary policy transmission, such as the traditional interest rate channel and the exchange rate channel. I also find evidence that in the most recent part of the sample (2004 onwards), the expectations channel has become more prominent, as implied by the estimated values of the forward-looking parameters in the aggregate demand and the Phillips curve equations.
    Keywords: Monetary Policy; Partial Dollarization; Bayesian Estimation
    JEL: E52 E58 F41 C11
    Date: 2010–07
  9. By: Carlos Garcia (ILADES-Georgetown University, Universidad Alberto Hurtado); Jorge Restrepo (Banco Central de Chile); Scott Roger (IMF Institute, International Monetary Fund, Washington D.C.-USA)
    Abstract: This paper uses a DSGE model to examine whether including the exchange rate explicitly in the central bank’s policy reaction function can improve macroeconomic performance. It is found that including an element of exchange rate smoothing in the policy reaction function is helpful both for financially robust advanced economies and for financially vulnerable emerging economies in handling risk premium shocks. As long as the weight placed on exchange rate smoothing is relatively small, the effects on inflation and output volatility in the event of demand and cost-push shocks are minimal. Financially vulnerable emerging economies are especially likely to benefit from some exchange rate smoothing because of the perverse impact of exchange rate movements on activity.
    Keywords: Inflation targeting, monetary policy, exchange rate
    JEL: E42 E52 F41
    Date: 2009–12
  10. By: Carlos Garcia (ILADES-Georgetown University, Universidad Alberto Hurtado); Wildo Gonzalez (Banco Central de Chile)
    Abstract: We estimate how the monetary policy works in small open economies with inflation target. To do so, we build a dynamic stochastic general equilibrium model that incorporates the basic features of these economies. We conclude that the monetary policy in a group of representative small open economies (including Australia, Chile, Colombia, Peru and New Zealand) presents strong differences due to shocks from the international financial markets (risk premium shocks, mainly) that explain mostly the variability of the real exchange rate, which has important reallocation effects in the short run. By using the allocations of the Ramsey problem as benchmark, this article shows that if the central banks in small open economies want to reduce the observed volatility of the inflation rate and the output gap, more exchange rate intervention is necessary in order to reduce the volatility produced by risk premium shocks.
    Keywords: Small open economies economy models; monetary policy rules; exchange rates; Bayesian econometrics, Risk premium shocks, Ramsey problem.
    JEL: C32 E52 F41
    Date: 2010–04
  11. By: Ellen E. Meade; Daniel L. Thornton
    Abstract: The Phillips curve framework, which includes the output gap and natural rate hypothesis, plays a central role in the canonical macroeconomic model used in analyses of monetary policy. It is now well understood that real-time data must be used to evaluate historical monetary policy. We believe that it is equally important that macroeconomic models used to evaluate historical monetary policy reflect the framework that policymakers used to formulate that policy. To that end, we use the Federal Open Market Committee (FOMC) transcripts to examine the role that the Phillips curve framework played in Fed policymaking from 1982 through 2003. The FOMC?s transcripts allow us to trace the evolution in policymakers? discussion of the Phillips curve framework over time. Our analysis suggests that the Phillips curve was much less central to the formulation and implementation of US monetary policy than it is in models commonly used to evaluate that policy.
    Keywords: Phillips curve ; Monetary policy ; Federal Open Market Committee
    Date: 2010
  12. By: Kathryn M.E. Dominguez; Rasmus Fatum; Pavel Vacek
    Abstract: Many developing countries have increased their foreign reserve stocks dramatically in recent years, often motivated by the desire for precautionary self-insurance. One of the negative consequences of large accumulations for these countries is the risk of valuation losses. In this paper we examine the implications of systematic reserve decumulation by the Czech authorities aimed at mitigating valuation losses on euro-denominated assets. The policy was explicitly not intended to influence the value of the koruna relative to the euro. Initially the timing and size of reserve sales was not predictable, eventually sales occurred on a daily basis (in three equal installments within the day). This project examines whether these reserve sales, both during the regime of discretionary timing as well as when sales occurred every day, had unintended consequences for the domestic currency. Our findings using intraday exchange rate data and time-stamped reserve sales indicate that when decumulation occurred every daythese sales led to significant appreciation of the koruna. Overall, our results suggest that the manner in which reserve sales are carried out matters for whether reserve decumulation influences the relative value of the domestic currency.
    Keywords: Foreign exchange ; Monetary policy ; International economic relations
    Date: 2010
  13. By: Lucotte, Yannick
    Abstract: Inflation targeting is a monetary policy framework which was adopted by several emerging countries over the last decade. Previous empirical studies suggest that inflation targeting has significant effects on either inflation or inflation variability in emerging targeting countries. But, by reinforcing the disinflation process and so, by reducing drastically seigniorage revenue, the adoption of this monetary policy framework could also affect the design of fiscal policy. In a recent paper, Minea and Villieu (2009a) show theoretically that inflation targeting provides an incentive for governments to improve institutional quality in order to enhance tax revenue performance. In this paper, we test this theoretical prediction by investigating whether the adoption of inflation targeting affects the fiscal effort in emerging markets economies. Using propensity score matching methodology, we evaluate the “treatment effect” of inflation targeting on fiscal mobilization in thirteen emerging countries that have adopted this monetary policy framework by the end of 2004. Our results show that, on average, inflation targeting has a significant positive effect on public revenue collection.
    Keywords: Inflation targeting; Public revenue; Treatment effect; Propensity score matching; Emerging countries.
    JEL: E62 E58 H2
    Date: 2010–07–13
  14. By: Carin van der Cruijsen; David-Jan Jansen; Jakob de Haan
    Abstract: Carin van der Cruijsen, David-Jan Jansen and Jakob de Haan Does the general public know what central banks do? Is this kind of knowledge relevant? Using a survey of Dutch households, we investigate these questions for the case of the European Central Bank (ECB). Our findings suggest that knowledge on the ECB’s objectives is far from perfect. Both a weak desire to be informed and unawareness of insufficient knowledge are barriers for improving the public's understanding of monetary policy. However, our results also show that more intensive use of information improves understanding, suggesting that the media channel may play an important and constructive role in building knowledge. Finally, we find that knowledge on monetary policy objectives contributes to an individual’s ability to form realistic inflation expectations.
    Keywords: monetary policy; knowledge; transparency; financial literacy; inflation expectations; ECB.
    JEL: D12 D84 E52 E58
    Date: 2010–07
  15. By: Bezemer, Dirk J; Gardiner, Geoffrey
    Abstract: This paper discusses recent UK monetary policies as instances of Galbraith’s ‘innocent frauds’, including the idea that money is a thing rather than a relationship, the fallacy of composition that what is possible for one bank is possible for all banks, and the belief that the money supply can be controlled by reserves management. The origins of the idea of QE, and its defense when it was applied in Britain, are analysed through this lens. An empirical analysis of the effect of reserves on lending is conducted; we do not find evidence that QE ‘worked’ either by a direct effect on money spending, or through an equity market effect. These findings are placed in a historical context in a comparison with earlier money control experiments in the UK.
    Keywords: quantitative easing; UK; innocent frauds; accounting
    JEL: E58 E52
    Date: 2010–07
  16. By: Carlos Garcia (ILADES-Georgetown University, Universidad Alberto Hurtado); Wildo Gonzalez (Banco Central de Chile)
    Abstract: We estimate how monetary policy works in small open economies. To do so, we build a dynamic stochastic general equilibrium model that incorporates the basic features of these economies. We conclude that the monetary policy in a group of small open economies (including Australia, Chile, Colombia, Peru and New Zealand) is rather similar to that observed in developed countries. Nevertheless, our results also indicate that there are strong differences due to shocks from the international financial markets (risk premium shocks, mainly) that explain mostly the variability of the real exchange rate, which has important reallocation effects in the short run. In addition, we find that in practice central banks do not face any trade-off responding to these shocks through changes in the interest rate. This result is consistent with the fact that in each country under study, the exchange rate must be included in the policy reaction function.
    Keywords: small open economy models; monetary policy rules; exchange rates; Bayesian econometrics
    JEL: C32 E52 F41
    Date: 2009–12
  17. By: Weber, Enzo; Wolters, Jürgen
    Abstract: The expectations hypothesis of the term structure (EHT) implies cointegration between interest rates of different maturities and predicts certain values for adjustment speed. We estimate reduced-form vector error correction models of the US term structure. These are derived from a structural model combining the EHT, autocorrelated risk premia, interest rate smoothing and monetary policy feedback, which is able to capture a wide range of empirical outcomes. We explicitly test the necessary preconditions for the validity of the theoretical model. Premia persistence rises with longer-rate maturity, while the influence of the according spreads in the central bank reaction function diminishes.
    Keywords: Expectations Hypothesis; Risk Premium; Policy Reaction Function
    JEL: E43
    Date: 2009–10–01
  18. By: Ester Faia; Eleni Iliopulos
    Abstract: How should monetary policy be optimally designed in an environment with high degrees of financial globalization? To answer this question we lay down an open economy model where net lending toward the rest of the world is constrained by a collateral constraint motivated by limited enforcement. Borrowing is secured by collateral in the form of durable goods whose accumulation is subject to adjustment costs. We demonstrate that, although this economy can generate persistent current account deficits, it can also deliver a stationary equilibrium. The comparison between different monetary policy regimes (floating versus pegged) shows that the impossible trinity is reversed: a higher degree of financial globalization, by inducing more persistent and volatile current account deficits, calls for exchange rate stabilization. Finally, we study the design of optimal (Ramsey) monetary policy. In this environment the policy maker faces the additional goal of stabilizing exchange rate movements, which exacerbate fluctuations in the wedges induced by the collateral constraint. In this context optimality requires deviations from price stability and calls for exchange rate stabilization.
    Keywords: Monetary policy ; Globalization ; International finance ; Foreign exchange rates ; Financial stability ; International trade
    Date: 2010
  19. By: Stan du Plessis (Department of Economics, University of Stellenbosch)
    Abstract: Monetary authorities have been implicated in the financial crisis of 2007-2008. John Muellbauer, for example, has blamed what he thought was initially inadequate policy responses by central banks to the crisis on their models, which are, in his words, “overdue for the scrap heap”. This paper investigates the role of monetary policy models in the crisis and finds that (i) it is likely that monetary policy contributed to the financial crisis and (ii) that an inappropriately narrow suite of models made this mistake easier. The core models currently used at prominent central banks were not designed to discover emergent financial fragility. In that respect John Muellbauer is right. But the implications drawn here are less dramatic than his: while the representative agent approach to microfoundations now seems indefensible, other aspects of modern macroeconomics are not similarly suspect. The case made here is rather for expanding the suite of models used in the regular deliberations of monetary authorities, with new models that give explicit roles to the financial sector, to money and to the process of exchange. Recommending a suite of models for policy making entails no methodological innovation. That is what central banks do; though, of course, how they do it is open to improvement. The methodological innovation is the inclusion of a model that would be sensitive to financial fragility, a sensitivity that was absent in the run-up to the current financial crisis.
    Keywords: Monetary policy, financial crisis, methodology of policy models
    JEL: B40 E13 E44 E52
    Date: 2010
  20. By: Dale F. Gray (International Monetary Fund, Washington D.C.-USA); Carlos Garcia (ILADES-Georgetown University, Universidad Alberto Hurtado); Leonardo Luna (Transelec, Chile); Jorge Restrepo (Banco Central de Chile)
    Abstract: This article analyzes whether market-based financial stability indicators (FSIs) should be included in monetary policy models and, if so, how.1 Since the economy and interest rates affect financial sector credit risk, and the financial sector affects the economy, this article builds a model of financial sector vulnerability and integrates it into a macroeconomic framework, typically used for monetary policy analysis. More specifically, should the central bank explicitly include the financial stability indicator in its monetary policy (interest rate) reaction function? This is the most important question to be answered in this article. The alternative would be to react only indirectly to financial risk by reacting to inflation and gross domestic product (GDP) gaps, since they already include the effect that financial factors have on the economy.
    Keywords: financial sector risk, monetary policy models
    JEL: E32 E61 E62 E63 F41
    Date: 2009–12
  21. By: Tarishi Matsuoka (Graduate School of Economics, Kyoto University)
    Abstract: This paper presents a monetary model that links interbank markets to capital accumulation and growth. The purpose of this paper is to study how interbank markets affect real economic activities, and to find the monetary policy implications. The model shows that, in a stationary equilibrium, the economy with interbank markets attains higher capital stock than the economy without the markets, because of precautionary money savings. In addition, I find that inflationary policy is more desirable in the economy without well-functioning interbank markets.
    Keywords: overlapping generations, random relocation, inflation, interbank markets
    JEL: E42 E51 G21
    Date: 2010–07
  22. By: Efraim Benmelech; Nittai K. Bergman
    Abstract: This paper studies the limitations of monetary policy transmission within a credit channel frame- work. We show that, under certain circumstances, the credit channel transmission mechanism fails in that liquidity injections by the central bank into the banking sector are hoarded and not lent out. We use the term ‘credit traps’ to describe such situations and show how they can arise due to the interplay between financing frictions, liquidity, and collateral values. Our analysis offers a characterization of the problems created by credit traps as well as potential solutions and policy implications. Among these, the analysis shows how quantitative easing and fiscal policy acting in conjunction with monetary policy may be useful in increasing bank lending. Further, the model shows how small contractions in monetary policy or in loan supply can lead to collapses in lending, aggregate investment, and collateral prices.
    JEL: E44 E51 E58 G32 G33
    Date: 2010–07
  23. By: Abdul Karim, Zulkefly
    Abstract: This study examines the effects of monetary policy on firms’ balance sheet, with a particular focus on the effects upon the firms’ fixed-investment spending. It uses a dynamic panel system GMM estimation proposed by Blundell and Bond (1998). The focal point has given to the two main channels of monetary policy transmission mechanism such as interest rates and broad credit channel in transmitting to firm investment spending. By estimating the firms’ investment model using a dynamic neo-classical framework, the empirical results tend to support the relevance of interest rates and broad credit channel in transmitting to the firm balance sheet condition that is firm’s investment spending. The results also reveal that the effect of monetary policy channels to the firms’ investment are heterogeneous fashioned, which is the small firms who faced financial constraint are responded more due to monetary tightening as compared to the large firm (less constraint firms). Thus, the monetary authority has to concern the microeconomic aspects of the firm in formulation their monetary policy.
    Keywords: Monetary policy; Financial Constraint; Firm Investment; Dynamic Panel Data
    JEL: C23 E52 D92
    Date: 2010–02–10
  24. By: Jerger, Jürgen; Röhe, Oke
    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 efficiency 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: 2009–10–01
  25. By: Wilhem Hankel; Andreas Hauskrecht (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); Bryan Stuart
    Abstract: In contrast to Robert Mundell's Optimum Currency Area theory and his recommendation of forming a monetary union, the economic fundamentals of Euro area member countries have not harmonized. The opposite holds: the Euro core countries - most of all Germany, but also the Netherlands and Finland - increased productivity growth while limiting nominal wage growth. However, Mediterranean countries - particularly Greece, but also Spain, Portugal, and Italy - have dramatically lost international competitiveness. Although the overall balance of payments for the Euro area at large is almost balanced, internal disequilibria are skyrocketing and default risk premiums and tensions within the Euro area are rising, thus jeopardizing the stability of the monetary union. The findings confirm that a common currency without fiscal union is inherently unstable. The international financial and economic crisis has merely triggered events which highlight this instability. The paper discusses three possible scenarios for the future of the Euro: a laissez faire approach, a bailout, and finally an exit strategy for the Mediterranean countries, or an organized exit by a group of core countries led by Germany, forming their own smaller monetary union.
    Keywords: Optimum currency areas, monetary union, risk spreads, central banking, exchange rates, fiscal policy
    JEL: E42 E63 F15 F33 F34
    Date: 2010–05
  26. By: Lamont K. Black; Diana Hancock; Wayne Passmore
    Abstract: The bank lending channel of monetary policy suggests that banks play a special role in the transmission of monetary policy. We look for this special role by examining the business strategies of banks as it relates to mortgage funding and mortgage lending. "Traditional banks" have a large supply of excess core deposits and specialize in information-intensive lending to borrowers (which is proxied here using mortgage lending in subprime communities), whereas "market-based banks" are funded with managed liabilities and mainly lend to relatively easy-to-evaluate borrowers. We predict that only "transition banks" operating between these business strategies are likely to increase their loan rate spreads substantially in response to monetary tightening. To fund ongoing mortgage originations, these banks must substitute from core deposits to managed liabilities, which have a large external finance premium due to these banks' information-intensive lending. Consistent with this prediction, we find evidence of a bank lending channel only among transition banks - they significantly reduce mortgage lending in response to monetary contractions.
    Date: 2010
  27. By: Christopher J. Neely
    Abstract: The Federal Reserve's large scale asset purchases (LSAP) of agency debt, MBSs and long-term U.S. Treasuries not only reduced long-term U.S. bond yields also significantly reduced long-term foreign bond yields and the spot value of the dollar. These changes were much too large to have been generated by chance and they closely followed LSAP announcement times. These changes in U.S. and foreign bond yields are roughly consistent with a simple portfolio choice model. Likewise, the exchange rate responses to LSAP announcements are roughly consistent with a UIP-PPP based model. The success of the LSAP in reducing long-term interest rates and the value of the dollar shows that central banks are not toothless when short rates hit the zero bound.
    Keywords: Monetary policy ; Interest rates
    Date: 2010
  28. By: Weber, Enzo; Wolters, Jürgen
    Abstract: We document two stylised facts of US short- and long-term interest rate data incompatible with the pure expectations hypothesis: Relatively slow adjustment to long-run relations and low contemporaneous correlation. We construct a small structural model which features three types of randomness: While a persistent monetary policy shock implies immediate identical reactions through the term structure, both a transitory policy shock and an autocorrelated risk premium allow for the sustained decoupling observed in the data. Indeed, we find important impacts and persistence of risk premia and a decomposition of policy shocks judging a larger part as transitory the longer the investment horizon.
    Keywords: Expectations Hypothesis; Risk Premium; Policy Reaction Function; Persistence; Transitory Shocks
    JEL: E43 C32
    Date: 2010–03–16
  29. By: Giovanni Olivei; Silvana Tenreyro
    Abstract: Systematic differences in the timing of wage setting decisions among industrialized countries provide an ideal framework to study the importance of wage rigidity in the transmission of monetary policy. The Japanese Shunto presents the best-known case of bunching in wage setting decisions: From February to May, most firms set wages that remain in place until the following year; wage rigidity, thus, is relatively higher immediately after the Shunto. Similarly, in the United States, a large fraction of firms adjust wages in the last quarter of the calendar year. In contrast, wage agreements in Germany are well spread within the year, implying a relatively uniform degree of rigidity. We exploit variation in the timing of wage setting decisions within the year in Japan, the United States, Germany, the United Kingdom, and France to investigate the effects of monetary policy under different degrees of effective wage rigidity. Our findings lend support to the long-held, though scarcely tested, view that wage rigidity plays a key role in the transmission of monetary policy.
    Keywords: Monetary policy ; Wages
    Date: 2010
  30. By: Eirini Syngelaki (Economics,Finance and Accounting, National University of Ireland, Maynooth);
    Abstract: This paper investigates the causal linkages between monetary and equity market integration of the new member states (NMS) as well as of the non economic monetary union (Non- EMU) member states with the euro zone, after the official launch of the euro. Granger causality in mean and in variance tests are utilized. Our results reveal a number of interesting facts that can be summarized as follows. Firstly, there is little evidence of causality in mean effects for all countries. Secondly, there are significant spill over effects for the NMS. Thirdly, the excess currency return is the chief variable which leads the excess stock market return volatility of the NMS. Our findings have obvious implications for both investors and policy makers.
    Keywords: monetary market integration, equity market integration, Granger causality in-mean and in-variance, AR, Univariate GARCH
    JEL: F36 C22 G15
    Date: 2010
  31. By: Abdul Karim, Zulkefly
    Abstract: This paper investigates the effect of monetary policy shocks (domestic and international monetary policy) on Malaysian firm-level equity returns in a dynamic panel data framework. After controlling for a variety of other stock return determinants, I find that firm stock returns have responded negatively to monetary policy shocks. Moreover, the effect of domestic monetary policy shocks on stock returns is also heterogeneous fashion, which is small firm equity is significantly affected by monetary policy, whereas large firm equity is not significantly affected. The effect of domestic monetary policy is also heterogeneous by firm’s nature of business, which is only industrial product is significantly affected by monetary policy, whereas others sub-sector economy are not affected. The effect of international monetary policy upon firm-level stock returns is also heterogeneous, which is significantly affected the large firm equity, whereas insignificantly affected the small firm equity. The industrial product and property firm stock returns are also significantly affected by international monetary policy; whereas, others sub-sector are not significantly affected. The equity return of financially constraint firm is also significantly more affected upon domestic monetary policy than less-constraint firm. However, international monetary policy is insignificantly influenced the financially constraints firm; whereas, the stock returns of less-constraint firm is significantly affected. This finding stated that the relevance of international risk factor (in particular international monetary policy) in influencing the firm-level stock returns. Therefore, domestic monetary authority has to consider the development in international monetary policy in formulating their monetary policy. In the meantime, the monetary authority has to observe the development in domestic stock market, which is can be influenced by monetary policy in order to take advantage of the effect of stock market to economy activity.
    Keywords: Monetary policy shocks; firm’s stock return; dynamic panel data; augmented multifactor model
    JEL: G12 C23 E52
    Date: 2009–10–07
  32. By: Ippei Fujiwara; Kozo Ueda
    Abstract: We consider the fiscal multiplier and spillover in an environment in which two countries are caught simultaneously in a liquidity trap. Using an optimizing two-country sticky price model, we show that the fiscal multiplier and spillover are contrary to those predicted in textbook economics. For the country with government expenditure, the fiscal multiplier exceeds one, the currency depreciates, and the terms of trade worsen. The fiscal spillover is negative if the intertemporal elasticity of substitution in consumption is less than one and positive if the parameter is greater than one. Incomplete stabilization of marginal costs due to the existence of the zero lower bound is a crucial factor in understanding the effects of fiscal policy in open economies.
    Keywords: International liquidity ; Liquidity (Economics) ; Fiscal policy ; Monetary policy
    Date: 2010
  33. By: Strohsal, Till; Weber, Enzo
    Abstract: The present work provides an economic explanation of a well-known (seeming) violation of the expectations hypothesis of the term structure (EHT) - the frequent finding of unit roots in interest rate spreads. We derive from EHT that the nonstationarity stems from the holding premium, which is hence cointegrated with the spread. We model the premium as being proportional to the IGARCH variance of excess returns and further propose a cointegration test. Simulating the distribution of the test statistic we actually find cointegration relations between premia and spreads in US data. The EHT appears to perform much better than previously thought.
    Keywords: Expectations Hypothesis; Holding Premium; GARCH; Persistence; Cointegration
    JEL: E43 C32
    Date: 2010–05–31

This nep-mon issue is ©2010 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.