nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒07‒31
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. A Time-Invariant Duration Policy under the Zero Lower Bound By Kozo Ueda
  2. Monetary policy and capital regulation in the US and Europe By Ethan Cohen-Cole; Jonathan Morse
  3. Trusting the bankers: a new look at the credit channel of monetary policy By Matteo Ciccarelli; Angela Maddaloni; José-Luis Peydró
  4. Global Liquidity Trap By Ippei Fujiwara; Tomoyuki Nakajima; Nao Sudo; Yuki Teranishi
  5. Nominal Uniqueness and Money Non-neutrality in the Limit-Price Exchange Process. By Gaël Giraud; Dimitrios P. Tsomocos
  6. Inflation and inflation uncertainty in the euro area By Guglielmo Maria Caporale; Luca Onorante; Paolo Paesani
  7. Adoption of Inflation Targeting and Tax Revenue Performance in Emerging Market Economies: An Empirical Investigation By Yannick Lucotte
  8. The Indian exchange rate and central bank action: A GARCH analysis By Ashima Goyal; Sanchit Arora
  9. Should African Monetary Unions Be Expanded? An Empirical Investigation of the Scope for Monetary Integration in Sub-Saharan Africa By Xavier Debrun; Paul R. Masson; Catherine A. Pattillo
  10. Money Transmission Mechanisms and Identified Long-Run Relationships between the Banking Sector's Balance Sheet and the Macroeconomy in Pakistan By J L Ford; Zahid Mohammad
  11. Examining The Case For Reserve Pooling In East Asia: Empirical Analysis By Ramkishen S. Rajan; Graham Bird; Reza Y. Siregar
  12. Peru: Drivers of De-dollarization By Mercedes Garcia-Escribano
  13. Monetary Policy Analysis and Forecasting in the Group of Twenty: A Panel Unobserved Components Approach By Francis Vitek
  14. Globalization, Pass-Through and Inflation Dynamic By Pierpaolo Benigno; Ester Faia
  15. Is the Euro-Area Core Price Index Really More Persistent than the Food and Energy Price Indexes? By José Manuel Belbute
  16. Procyclicality in Central Bank Reserve Management: Evidence from the Crisis By Jukka Pihlman; Han van der Hoorn
  17. Monetary Policy Effects: Evidence from the Portuguese Flow of Funds By Isabel Marques Gameiro; João Sousa
  18. World Food Prices and Monetary Policy By Roberto Chang; Luis Catão
  19. The Future of Central Banking: A Lesson from United States History By Bennett T. McCallum
  20. Chronicle of currency collapses: re-examining the effects on output By Matthieu Bussière; Sweta C. Saxena; Camilo E. Tovar
  21. General Equilibrium with Monopolistic Firms and Occasionally Binding Cash-in-Advance Constraints By Dixon, Huw; Pourpourides, Panayiotis M.

  1. By: Kozo Ueda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: kouzou.ueda
    Abstract: Optimal commitment policy under the zero lower bound entails a high degree of complexity and time-inconsistency in a stochastic economy. This paper proposes a time-invariant duration policy that mitigates those problems and facilitates policy implementation and communication while retaining effectiveness in inflation stabilization. Under the time- invariant duration policy, a central bank commits itself to maintaining low interest rates for some duration even after adverse shocks disappear, but unlike the optimal commitment policy, the duration is independent of the ex post spell of the adverse shocks. Consequently, the time- inconsistency problem does not increase even if the ex post spell of the adverse shocks lengthens, and policy rates are expressed in an extremely simple, explicit form. Simulation results suggest that the time-invariant duration policy performs virtually as effectively as the optimal commitment policy in stabilizing inflation, and far better than a discretionary policy and simple interest rate rules with or without inertia.
    Keywords: Zero lower bound on nominal interest rates, optimal monetary policy, liquidity trap, time-inconsistency
    JEL: E31 E52
    Date: 2010–07
  2. By: Ethan Cohen-Cole (Robert H Smith School of Business, 4420 Van Munching Hall, University of Maryland, College Park, MD 20742, USA.); Jonathan Morse (Federal Reserve Bank of Boston, 600 Atlantic Avenue, Boston, MA, USA.)
    Abstract: From the onset of the 2007-2009 crisis, the Federal Reserve and the European Central Bank have aggressively lowered interest rates. Both sets of changes are at odds with an anti-inflationary stance of monetary policy; indeed, as the crisis began in August 2007 inflation expectations were high and rising, particularly in the United States. We have two additions to the literature. One, we present a model economy with a leveraged and regulated financial sector. Two, we find optimal Taylor rules for our economy that are consistent with a strong pro-inflationary reaction during financial crisis while maintaining a standard output-inflation mandate. We have three interpretations of our results. One, because the Federal Reserve has partial control over bank regulation it can exercise regulatory lenience. Two, the Fed’s stronger output orientation means that it will potentially respond more quickly when faced with constrained banks. Three, our results support procyclical capital regulation. JEL Classification: E52, E58, G18, G28.
    Keywords: monetary policy, capital regulation, crisis.
    Date: 2010–07
  3. By: Matteo Ciccarelli (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Angela Maddaloni (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); José-Luis Peydró (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: Any empirical analysis of the credit channel faces a key identification challenge: changes in credit supply and demand are difficult to disentangle. To address this issue, we use the detailed answers from the US and the confidential and unique Euro area bank lending surveys. Embedding this information within a standard VAR model, we find that: (1) the credit channel is active through the balance-sheets of households, firms and banks; (2) the credit channel amplifies the impact of a monetary policy shock on GDP and inflation; (3) for business loans, the impact through the (supply) bank lending channel is higher than through the demand and balance-sheet channels. For household loans the demand channel is the strongest; (4) during the crisis, credit supply restrictions to firms in the Euro area and tighter standards for mortgage loans in the US contributed significantly to the reduction in GDP. JEL Classification: E32, E44, E5, G01, G21.
    Keywords: Non-financial borrower balance-sheet channel, Bank lending channel, Credit channel, Credit crunch, Lending standards, Monetary policy.
    Date: 2010–07
  4. By: Ippei Fujiwara (Director, Financial Markets Department, Bank of Japan (E-mail:; Tomoyuki Nakajima (Associate Professor, Institute of Economic Research, Kyoto University (E-mail:; Nao Sudo (Deputy Director, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:; Yuki Teranishi (Deputy Director, Financial Systems and Bank Examination Department, Bank of Japan (E-mail:
    Abstract: In this paper we consider a two-country New Open Economy Macroeconomics model, and analyze the optimal monetary policy when countries cooperate in the face of a "global liquidity trap" -- i.e., a situation where the two countries are simultaneously caught in liquidity traps. The notable features of the optimal policy in the face of a global liquidity trap are history dependence and international dependence. The optimality of history dependent policy is confirmed as in local liquidity trap. A new feature of monetary policy in global liquidity trap is whether or not a country's nominal interest rate is hitting the zero bound affects the target inflation rate of the other country. The direction of the effect depends on whether goods produced in the two countries are Edgeworth complements or substitutes. We also compare several classes of simple interest-rate rules. Our finding is that targeting the price level yields higher welfare than targeting the inflation rate, and that it is desirable to let the policy rate of each country respond not only to its own price level and output gap, but also to those in the other country.
    Keywords: Zero Interest Rate Policy, Two-country Model, International Spillover, Monetary Policy Coordination
    JEL: E52 E58 F41
    Date: 2010–07
  5. By: Gaël Giraud (Centre d'Economie de la Sorbonne - Paris School of Economics); Dimitrios P. Tsomocos (Saïd Business School University)
    Abstract: We define continuous-time dynamics for exchange economies with fiat money. Traders have locally rational expectations, face a cash-in-advance constraint, and continuously adjust their short-run dominant strategy in a monetary strategic market game involving a double-auction with limit-price orders. Money has a positive value except on optimal rest-points where it becomes a "veil" and trade vanishes. Typically, there is a peicewise globally unique trade-ant-price curve both in real and in nominal variables. Money is not neutral, either in the short-run or long-run, and a localized version of the quantity theory of money holds in the short-run. An optimal money growth rate is derived, which enables monetary trade curves to converge towards Pareto optimal rest-points. Below this growth rate, the economy enters a (sub-optimal) liquidity trap where monetary policy is ineffective ; above this threshold inflation rises. Finally, market liquidity, measured through the speed of real trades, can be linked to gains-to-trade, households' expectations, and the quantity of circulating money.
    Keywords: Bank, money, price-quantity dynamics, inside money, outside money, rational expectations, liquidity, double auction, limit-price orders, inflation, bounded rationality.
    JEL: D50 D83 E12 E24 E30 E40 E41 E50 E58
    Date: 2010–06
  6. By: Guglielmo Maria Caporale (Centre for Empirical Finance, Brunel University, West London, UB8 3PH, United Kingdom.); Luca Onorante (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Paolo Paesani (University of Rome “Tor Vergata”.)
    Abstract: This paper estimates a time-varying AR-GARCH model of inflation producing measures of inflation uncertainty for the euro area, and investigates their linkages in a VAR framework, also allowing for the possible impact of the policy regime change associated with the start of EMU in 1999. The main findings are as follows. Steadystate inflation and inflation uncertainty have declined steadily since the inception of EMU, whilst short-run uncertainty has increased, mainly owing to exogenous shocks. A sequential dummy procedure provides further evidence of a structural break coinciding with the introduction of the euro and resulting in lower long-run uncertainty. It also appears that the direction of causality has been reversed, and that in the euro period the Friedman-Ball link is empirically supported, consistently with the idea that the ECB can achieve lower inflation uncertainty by lowering the inflation rate. JEL Classification: E31, E52, C22.
    Keywords: Inflation, Inflation Uncertainty, Time-Varying Parameters, GARCH Models, ECB, EMU.
    Date: 2010–07
  7. By: Yannick Lucotte (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)
    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
    Date: 2010–07–13
  8. By: Ashima Goyal (Indira Gandhi Institute of Development Research); Sanchit Arora (Indira Gandhi Institute of Development Research)
    Abstract: We study, with daily and monthly data sets, the impact of conventional monetary policy measures such as interest rates, intervention and other quantitative measures, and of Central Bank communication on exchange rate volatility. Since India has a managed float, we also test if the measures affect the level of the exchange rate. Using dummy variables in the best of an estimated family of GARCH models, we find forex market intervention to be the most effective of all the CB instruments evaluated for the period of analysis. We also find that CB communication has a large potential but was not effectively used.
    Keywords: exchange rate volatility, monetary policy, intervention, communication, GARCH
    JEL: E52 E58 F31
    Date: 2010–07
  9. By: Xavier Debrun; Paul R. Masson; Catherine A. Pattillo
    Abstract: This paper develops a full-fledged cost-benefit analysis of monetary integration, and applies it to the currency unions actively pursued in Africa. The benefits of monetary union come from a more credible monetary policy, while the costs derive from real shock asymmetries and fiscal disparities. The model is calibrated using African data. Simulations indicate that the proposed EAC, ECOWAS, and SADC monetary unions bring about net benefits to some potential members, but modest net gains and sometimes net losses for others. Strengthening domestic macroeconomic frameworks is shown to provide some of the same improvements as monetary integration, reducing the latter’s relative attractiveness.
    Date: 2010–07–09
  10. By: J L Ford; Zahid Mohammad
    Abstract: This paper employs semi-annual observations from 1964s1 to 2005s1 to evaluate the monetary transmission mechanism that has operated in Pakistan. It does so by using the familiar VAR approach and by analysing impulse responses and variance decompositions to banking sector and macroeconomic variables consequent upon innovations to the chosen indicator of monetary conditions. Those analyses demonstrate that the bank lending channel operates in Pakistan. The resultant VEC models embody cointegration; and this is used to identify long-run relationships between the variables. Observations are extended to 2008s2 to provide some indication of the out-of-sample quality of information provided by those relationships. Investigations using the Kalman filter provide evidence that, crucially, the innovations to the monetary indicators are influenced by sudden adjustments of monetary policy instruments.
    Keywords: monetary transmission mechanisms, disaggregation of bank loans, VARs, VECs, identified cointegration vectors, innovations to SBP's monetary instruments and monetary indicator innovations
    JEL: E52 E58
    Date: 2010–07
  11. By: Ramkishen S. Rajan; Graham Bird; Reza Y. Siregar
    Abstract: Two features of East Asia’s recovery from the financial turmoil of 1997- 98 appear to be rather paradoxical. First, the regional economies (except Hong Kong, China and Malaysia) have allowed a relatively greater albeit modest degree of variability of their currencies according to market conditions. Second, the regional monetary authorities have simultaneously appeared keen on bolstering reserves to historically high levels. This paper examines the subject of reserve management in the broader context of monetary cooperation in East Asia. The paper briefly reviews the factors that go into the determination of “optimal reserves†in general, and specifically in the case of East Asia. It then goes on to investigate the gains, if any, to be reaped if the East Asian economies were to pool their reserves. [Working Paper No. 15]
    Keywords: East Asia, Financial turmoil, Hong Kong, China, Malaysia, Optimal Reserves, monetary authorities
    Date: 2010
  12. By: Mercedes Garcia-Escribano
    Abstract: Peru has successfully pursued a market-driven financial de-dollarization during the last decade. Dollarization of credit and deposit of commercial banks - across all sectors and maturities - has declined, with larger declines for commercial credit and time and saving deposits. The analysis presented in this paper confirms that de-dollarization has been driven by macroeconomic stability, introduction of prudential policies to better reflect currency risk (such as the management of reserve requirements), and the development of the capital market in soles. Further de-dollarization efforts could focus on these three fronts. Given the now consolidated macroeconomic stability, greater exchange rate flexibility could foster de-dollarization; additional prudential measures could further discourage banks’ lending and funding in foreign currency; while further capital market development in domestic currency would help overall financial de-dollarization.
    Date: 2010–07–19
  13. By: Francis Vitek
    Abstract: This paper develops a panel unobserved components model of the monetary transmission mechanism in the world economy, disaggregated into twenty national economies along the lines of the Group of Twenty. This structural macroeconometric model features extensive linkages between the real and financial sectors, both within and across economies. A variety of monetary policy analysis and forecasting applications of the estimated model are demonstrated, based on a Bayesian framework for conditioning on judgment.
    Date: 2010–06–29
  14. By: Pierpaolo Benigno (Professor, LUISS Guido Carli and EIEF (E-mail:; Ester Faia (Professor, Goethe University Frankfurt, Kiel IfW and CEPREMAP (E-mail:
    Abstract: An important aspect of the globalization process is the increase in interdependence among countries through the deepening of trade linkages. This process should increase competition in each destination market and change the pricing behavior of firms. We present an extension of Dornbusch (1987)fs model to analyze the extent to which globalization, interpreted as an increase in the number of foreign products in each destination market, modifies the slope and the position of the New-Keynesian aggregate-supply equation and, at the same time, affects the degree of exchange rate pass-through. We provide empirical evidence that supports the results of our model.
    Keywords: AS equations, Oligopolistic Competition, Inflation Dynamic
    JEL: E31 F41
    Date: 2010–07
  15. By: José Manuel Belbute (Universidade de Évora, Departamento de Economia e CEFAGE-UE)
    Abstract: The purpose of this paper is to measure the degree of persistence of the overall, core, food and energy Harmonized Indexes of Consumer Prices for the European Monetary Zone (HICP-EAs) and to identify its implications for decision-making in the private sector and in public policy. Using a non-parametric approach, our results demonstrate the presence of a statistically significant level of persistence in four HICP-EAs: headline, core, food and energy. Moreover, contrary to popular belief, the core index does not reflect permanent price changes. We also find evidence that the food and energy price indexes are more volatile and more persistent than the other two price indexes. Our results also show a reduction in persistence for both the headline and the core price indexes after the implementation of the single monetary policy, but not for food and energy. These results have important implications for both the private sector and for policymakers who use the core as a reference price index for their decision-making because the use of this index can lead to an erroneous perception of price movements
    Keywords: Harmonized Index of Consumption Prices, Core Inflation, Euro Area, Persistence
    JEL: C14 C22 E31 E52
    Date: 2010
  16. By: Jukka Pihlman; Han van der Hoorn
    Abstract: A decade-long diversification of official reserves into riskier investments came to an abrupt end at the beginning of the global financial crisis, when many central bank reserve managers started to withdraw their deposits from the banking sector in an apparent flight to quality and safety. We estimate that reserve managers pulled around US$500 billion of deposits and other investments from the banking sector. Although clearly not the main cause, this procyclical investment behavior is likely to have contributed to the funding problems of the banking sector, which required offsetting measures by other central banks such as the Federal Reserve and Eurosystem central banks. The behavior highlights a potential conflict between the reserve management and financial stability mandates of central banks. This paper analyzes reserve managers’ actions during the crisis and draws some lessons for strategic asset allocation of reserves going forward.
    Date: 2010–06–25
  17. By: Isabel Marques Gameiro; João Sousa
    Abstract: This paper uses a VAR approach to study the transmission of monetary policy shocks in Portugal, focusing in particular on the financial decisions of households, corporations (financial/non-financial), the government and the rest of the world. We confirm that, in many ways, households and firms react in a similar way as found in other countries, with evidence that the monetary policy shock has a contractionary effect on economic activity and increases the financing needs of households and non-financial corporations. We also find evidence that the financial sector plays an important role, supplying the necessary funds to these sectors. We do not find much evidence of a significant systematic behaviour of the government or the rest of the world.
    JEL: E52 G11
    Date: 2010
  18. By: Roberto Chang; Luis Catão
    Abstract: The large swings in world food prices in recent years renew interest in the question of how monetary policy in small open economies should react to such imported price shocks. We examine this issue in a canonical open economy setting with sticky prices and where food plays a distinctive role in utility. We show how world food price shocks affect natural output and other aggregates, and derive a second order approximation to welfare. Numerical calibrations show broad CPI targeting to be welfare-superior to alternative policy rules once the variance of food price shocks is sufficiently large as in real world data.
    Date: 2010–07–13
  19. By: Bennett T. McCallum (Professor, Carnegie Mellon University and National Bureau of Economic Research (E-mail:
    Abstract: This paper is being prepared for the 2010 international conference of the Institute for Monetary and Economic Studies of the Bank of Japan, gThe Future of Central Banking under Globalization,h to be held May 26-27, 2010, in Tokyo. I am grateful to Marvin Goodfriend for helpful discussions.
    Date: 2010–07
  20. By: Matthieu Bussière (Banque de France, 31 rue Croix des petits champs, 75001 Paris, France.); Sweta C. Saxena (International Monetary Fund (IMF), 700 19th Street, N.W., Washington DC 20431, USA.); Camilo E. Tovar (Bank for International Settlements (BIS), Centralbahnplatz 2, CH - 4002 Basel, Switzerland.)
    Abstract: The impact of currency collapses (i.e. large nominal depreciations or devaluations) on real output remains unsettled in the empirical macroeconomic literature. This paper provides new empirical evidence on this relationship using a dataset for 108 emerging and developing economies for the period 1960-2006. We provide estimates of how these episodes affect growth and output trend. Our main finding is that currency collapses are associated with a permanent output loss relative to trend, which is estimated to range between 2% and 6% of GDP. However, we show that such losses tend to materialise before the drop in the value of the currency, which suggests that the costs of a currency crash largely stem from the factors leading to it. Taken on its own (i.e. ceteris paribus) we find that currency collapses tend to have a positive effect on output. More generally, we also find that the likelihood of a positive growth rate in the year of the collapse is over two times more likely than a contraction, and that positive growth rates in the years that follow such episodes are the norm. Finally, we show that the persistence of the crash matters, i.e. one-time events induce exchange rate and output dynamics that differ from consecutive episodes. JEL Classification: E32, F31, F41, F43.
    Keywords: currency crisis, nominal devaluations, nominal depreciations, exchange rates, real output growth, recovery from crises.
    Date: 2010–07
  21. By: Dixon, Huw (Cardiff Business School); Pourpourides, Panayiotis M. (Cardiff Business School)
    Abstract: We show a simple way to introduce monopolistic competition in a general equilibrium model where prices are fully flexible, the velocity of money is variable and cash-in-advance (CIA) constraints occasionally bind. We establish the conditions under which money has real effects and demonstrate that an equilibrium that occurs at a binding CIA constraint is welfare inferior to any equilibrium that occurs at a non-binding CIA constraint with the same level of technology. We argue that even though the probability of a binding CIA constraint can be increasing with money supply, under certain conditions, expansionary money supply is welfare improving.
    Keywords: general equilibrium; monopolistic competition
    JEL: D43 E31 E41 E51
    Date: 2010–07

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