nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒09‒25
nineteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Explaining Inflation Persistence by a Time-Varying Taylor Rule By Conrad, Christian; Eife, Thomas A.
  2. Money, reserves, and the transmission of monetary policy: does the money multiplier exist? By Seth B. Carpenter; Selva Demiralp
  3. Monetary policy, asset prices and consumption in China By Tuuli Koivu
  4. The impacts of economic structures on the performance of simple policy rules in a small open economy By Siok Kun, Sek
  5. Monetary Policy, Trend Inflation and the Great Moderation:An Alternative Interpretation By Olivier Coibion; Yuriy Gorodnichenko
  6. Supply, demand and monetary policy shocks in a multi-country New Keynesian Model By Stéphane Dées; M. Hashem Pesaran; L. Vanessa Smith; Ron P. Smith
  7. Are the intraday effects of central bank intervention on exchange rate spreads asymmetric and state dependent? By Rasmus Fatum; Jesper Pedersen; Peter Norman Sørensen
  8. Short and long interest rate targets By Bernardino Adão; Isabel Correia; Pedro Teles
  9. Correlation Structure between Inflation and Oil Futures Returns: An Equilibrium Approach By Jaime Casassus; Diego Ceballos
  10. Driven by the Markets? ECB Sovereign Bond Purchases and the Securities Markets Programme By Ansgar Belke
  11. Household money holdings in the euro area: An explorative investigation By Franz Seitz; Julian von Landesberger
  12. Foreign Currency Loans - Demand or Supply Driven? By Brown, Martin; Kirschenmann, Karolin; Ongena; Steven
  13. Short-run and Long-run Effects of Banking in a New Keynesian Model By Miguel Casares; Jean-Christophe Poutineauy
  14. Capital Inflows, Inflation and Exchange Rate Volatility: An Investigation for Linear and Nonlinear Causal Linkages By Abdul Rashid; Fazal Husain
  15. Exchange Rate Target Zones: A Survey of the Literature By António Portugal Duarte; João Sousa Andrade; Adelaide Duarte
  16. Working to Improve Price Indices Development in Pakistan By Mahmood Khalid; Zahid Asghar
  17. Deposit Dollarization and Its Impact on Financial Deepening in the Developing World By Eduardo Court; Emre Ozsoz; Erick W. Rengifo
  18. $1.25 Trillion is still real money : some facts about the effects of the Federal Reserve’s mortgage market investments By Andreas Fuster; Paul S. Willen
  19. The Current Version of the Bank of Greece Model By Koumparoulis, Dimitrios

  1. By: Conrad, Christian; Eife, Thomas A.
    Abstract: In a simple New Keynesian model, we derive a closed form solution for the inflation persistence parameter as a function of the policy weights in the central bank’s Taylor rule. By estimating the time-varying weights that the FED attaches to inflation and the output gap, we show that the empirically observed changes in U.S. inflation persistence during the period 1975 to 2010 can be well explained by changes in the conduct of monetary policy. Our findings are in line with Benati’s (2008) view that inflation persistence should not be considered a structural parameter in the sense of Lucas.
    Keywords: inflation persistence; Great Moderation; monetary policy; New Keynesian model; Taylor rule
    Date: 2010–09–16
  2. By: Seth B. Carpenter; Selva Demiralp
    Abstract: With the use of nontraditional policy tools, the level of reserve balances has risen significantly in the United States since 2007. Before the financial crisis, reserve balances were roughly $20 billion whereas the level has risen well past $1 trillion. The effect of reserve balances in simple macroeconomic models often comes through the money multiplier, affecting the money supply and the amount of bank lending in the economy. Most models currently used for macroeconomic policy analysis, however, either exclude money or model money demand as entirely endogenous, thus precluding any causal role for reserves and money. Nevertheless, some academic research and many textbooks continue to use the money multiplier concept in discussions of money. We explore the institutional structure of the transmission mechanism beginning with open market operations through to money and loans. We then undertake empirical analysis of the relationship among reserve balances, money, and bank lending. We use aggregate as well as bank-level data in a VAR framework and document that the mechanism does not work through the standard multiplier model or the bank lending channel. In particular, if the level of reserve balances is expected to have an impact on the economy, it seems unlikely that a standard multiplier story will explain the effect.
    Date: 2010
  3. By: Tuuli Koivu (Bank of Finland.)
    Abstract: This paper studies the wealth channel in China. Using the structural vector autoregression method, we find that a loosening of China’s monetary policy indeed leads to higher asset prices, which in turn are linked to household consumption. However, the importance of the wealth channel as a part of the monetary policy transmission mechanism in China is still limited. JEL Classification: E52, P24.
    Keywords: China, monetary policy, asset prices.
    Date: 2010–09
  4. By: Siok Kun, Sek
    Abstract: Applying a stochastic dynamic general equilibrium model, the performance of various simple rules is analyzed in a small open economy context. The aspects that are considered in the analysis include the degree of exchange rate pass-through, trade openness, the policy objective and the source and persistency of shocks. The main objective of this analysis is to investigate if the rule reacts to exchange rate performs better than the basic closed economy rule without exchange rate term. Comparison on the performances is also made between the consumer inflation targeting and domestic inflation targeting rules. The results show that adding the exchange rate term to the policy rule enhances improvement especially in the higher pass-through case. The superior rule is the hybrid rule that reacts to the exchange rate term. CPI inflation targeting rules outperform the domestic inflation targeting rules in term of welfare loss. However, more complicated domestic inflation targeting rules generate lower loss in term of relative loss. On the second part of this chapter, comparisons on the performances of different exchange rate regimes are made under different source and persistency of shocks. The floating (pegged) regime is favored under more prominent real (nominal) shocks. The results suggest that emerging countries that experience very large real shocks should float their exchange rate.
    Keywords: simple policy rule; exchange rate pass-through; open economy model
    JEL: E58 N15 E52 H30 N25 F41 E61
    Date: 2009–11
  5. By: Olivier Coibion (Department of Economics, College of William and Mary); Yuriy Gorodnichenko (Department of Economics, University of California, Berkeley)
    Abstract: With positive trend inflation, the Taylor principle is not enough to guarantee a determinate equilibrium. We provide new theoretical results on restoring determinacy in New Keynesian models with positive trend inflation and combine these with new empirical findings on the Federal Reserve’s reaction function before and after the Volcker disinflation to find that 1) while the Fed likely satisfied the Taylor principle in the pre-Volcker era, the US economy was still subject to self-fulfilling fluctuations in the 1970s, 2) the US economy moved from indeterminacy to determinacy during the Volcker disinflation, and 3) the switch from indeterminacy to determinacy was due to the changes in the Fed’s response to macroeconomic variables and the decline in trend inflation during the Volcker disinflation.
    Keywords: Trend inflation, Determinacy, Great Moderation, Monetary Policy.
    JEL: C22 E3 E43 E5
    Date: 2010–09–15
  6. By: Stéphane Dées (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); M. Hashem Pesaran (Cambridge University, Faculty of Economics, Austin Robinson Building, Sidgwick Avenue, Cambridge, CB3 9DD, United Kingdom.); L. Vanessa Smith (Cambridge University, Trumpington Street, Cambridge CB2 1AG, United Kingdom.); Ron P. Smith (Birkbeck College, London, United Kingdom.)
    Abstract: This paper estimates and solves a multi-country version of the standard DSGE New Keynesian (NK) model. The country-specific models include a Phillips curve determining inflation, an IS curve determining output, a Taylor Rule determining interest rates, and a real effective exchange rate equation. The IS equation includes a real exchange rate variable and a countryspecific foreign output variable to capture direct inter-country linkages. In accord with the theory all variables are measured as deviations from their steady states, which are estimated as long-horizon forecasts from a reduced-form cointegrating global vector autoregression. The resulting rational expectations model is then estimated for 33 countries on data for 1980Q1-2006Q4, by inequality constrained IV, using lagged and contemporaneous foreign variables as instruments, subject to the restrictions implied by the NK theory. The multi-country DSGE NK model is then solved to provide estimates of identified supply, demand and monetary policy shocks. Following the literature, we assume that the within country supply, demand and monetary policy shocks are orthogonal, though shocks of the same type (e.g. supply shocks in different countries) can be correlated. We discuss estimation of impulse response functions and variance decompositions in such large systems, and present estimates allowing for both direct channels of international transmission through regression coefficients and indirect channels through error spillover effects. Bootstrapped error bands are also provided for the cross country responses of a shock to the US monetary policy. JEL Classification: C32, E17, F37, F42.
    Keywords: Global VAR (GVAR), New Keynesian DSGE models, supply shocks, demand shocks, monetary policy shocks.
    Date: 2010–09
  7. By: Rasmus Fatum; Jesper Pedersen; Peter Norman Sørensen
    Abstract: This paper investigates the intraday effects of unannounced foreign exchange intervention on bid-ask exchange rate spreads using official intraday intervention data provided by the Danish central bank. Our starting point is a simple theoretical model of the bid-ask spread which we use to formulate testable hypotheses regarding how unannounced intervention purchases and intervention sales influence the market asymmetrically. To test these hypotheses we estimate weighted least squares (WLS) time-series models of the intraday bid-ask spread. Our main result is that intervention purchases and sales both exert a significant influence on the exchange rate spread, but in opposite directions: intervention purchases of the smaller currency, on average, reduce the spread while intervention sales, on average, increase the spread. We also show that intervention only affects the exchange rate spread when the state of the market is not abnormally volatile. Our results are consistent with the notion that illiquidity arises when traders fear speculative pressure against the smaller currency and confirms the asymmetry hypothesis of our theoretical model.
    Keywords: Financial markets ; Banks and banking, Central ; Monetary policy ; Foreign exchange rates ; International finance
    Date: 2010
  8. By: Bernardino Adão; Isabel Correia; Pedro Teles
    Abstract: We show that short and long nominal interest rates are independent monetary policy instruments. The pegging of both helps solving the problem of multiplicity that arises when only short rates are used as the instrument of policy. A peg of the nominal returns on assets of different maturities is equivalent to a peg of state-contingent interest rates. These are the rates that should be targeted in order to implement unique equilibria. At the zero bound, while it is still possible to target state-contingent interest rates, that is no longer equivalent to the target of the term structure.
    Date: 2010
  9. By: Jaime Casassus; Diego Ceballos
    Abstract: We use a general equilibrium model of a monetary economy to understand the economics behind the correlation between in nation and oil futures returns. Oil is used as both, an input to the production of capital and as a consumption good. We estimate our model using maximum likelihood with the following datasets: crude oil futures prices, nominal interest rates, in nation rates and money supply growth rates. We nd that some of the positive correlation found in empirical studies is due to the fact that oil is in the consumption basket; however, this accounts only for a minor part of it. There exist other important sources of correlation related to monetary shocks and output shocks. In particular, we nd that the correlation is extremely sensitive to the reaction of the central bank to output shocks, while the reaction to in nation changes is less signi cant. Our estimates suggest that the monetary authority overreacts to output shocks by increasing the money supply in a more than necessary amount, generating a signi cant source of positive correlation. From a practical perspective, We nd that it is a good strategy to use as a hedge, the futures whose maturity is closer to the hedging horizon. This is particularly true for short-term hedging.
    Keywords: Correlation structure, inflation, futures, hedging, oil, monetary policy
    JEL: E31 G13 Q31 E44 E52 E23 D51
    Date: 2010
  10. By: Ansgar Belke
    Abstract: After the dramatic rescue package for the euro area, the governing council of the European Central Bank decided to purchase European government bonds – to ensure an “orderly monetary policy transmission mechanism”. Many observers argued that, by bond purchases, national fi scal policies could from now on dominate the common monetary policy. This note argues that they are quite right. The ECB has indeed become more dependent in political and fi nancial terms. The ECB has decided to sterilise its bond purchases – compensating those purchases through sales of other bonds or money market instruments to keep the overall money supply unaff ected. This is to counter accusations that the ECB is monetizing government debt. This note addresses how eff ective these sterilisation policies are. One problem inherent in the sterilization approach is that it reshuffl es only the liability side of the ECB’s balance sheet. It is not well-suited to either diminish the bloated ECB balance sheet or to remove the potentially toxic covered or sovereign bonds from it. In addition, the intake of potentially toxic assets as collateral and by outright purchases in the central bank balance sheet artifi cially keeps the asset prices up and does not prevent the (quite intransparent) risk transfer from one group of countries to another to occur. Finally, sterilization takes place in a setting of still ultra-lax monetary policies, i.e. of new liquidity-enhancing operations with unlimited allotment, and, hence, does not appear to be overly irrelevant. A credible strategy to deal with the fi nancial crisis should deal primarily with the asset side of the ECB balance sheet. This note also addresses negative side eff ects of the SMP such as, for instance, the fact that the ECB is currently curbing real returns at the bond markets through its bond purchases. Currently, the real return of Spanish, Portuguese and Italian bonds only amounts to 3 to 3.5 percent. This is almost certainly not enough to attract private capital these countries are heavily dependent on. The most worrisome aspect is that the euro area has stumbled into a perpetuation of unconventional monetary policies by the execution of the SMP. Of course, the intentions are to bail out banks (but not just banks) and to support governments with issuance. What is diffi cult to see at the moment is how, once started, it will be able to stop. Finally, the ECB has been too silent about the following key questions which tends to frighten potential private investors in euro area sovereign bonds: What exactly is the composition of the sovereign bonds the ECB is buying? Which criteria are applied to select bonds to purchase? How is the ECB’s bond purchase strategy characterized in cases and periods of primary issuance? How long is the SMP going to last and what amounts may be spent?
    Keywords: accountability; bail-out; bond purchases; central bank independence; insolvency risk; Securities Markets Programme; transparency
    JEL: G32 E42 E51 E58 E63
    Date: 2010–06
  11. By: Franz Seitz (University of Applied Sciences Weiden, Hetzenrichter Weg 15, D-92637 Weiden, Germany.); Julian von Landesberger (European Central Bank, Directorate General Economics, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: In this paper we analyse household holdings of the broad monetary aggregate M3 in the euro area from 1991 until 2009. We develop four models, two in nominal, two in real terms, with satisfactory economic and statistical properties. The main determinants are a transactions variable, wealth considerations, opportunity costs and uncertainty. The models are robust to different estimation strategies, samples considered and a multitude of mis-specification tests. The exercise also provides insights that go beyond the portfolio allocation decision of households. According to our analysis, it is quite apparent that in equilibrium, households jointly determine consumption and broad money holdings both influenced by wealth as well as interest rates. JEL Classification: E41, C23, C32, D21.
    Keywords: money demand, cointegrated VARs, households.
    Date: 2010–09
  12. By: Brown, Martin; Kirschenmann, Karolin; Ongena; Steven
    Abstract: Motivated by current concerns over foreign currency exposures in emerging economies, we examine the currency denomination of business loans made in Bulgaria prior to the current crisis. We analyze information on the requested and granted currency for more than hundred thousand loans granted by one bank to sixty thousand different firms during the period 2003- 2007. This unique data set allows us to disentangle demand-side from supply-side determinants of foreign currency loans. We find that the bank in our sample often grants loans in foreign currency even when a firm requests a loan in local currency. The bank lends in foreign currency, not only to less risky firms, but also when the firm requested a large or long-term loan and after the bank itself received more funding in euro. These results suggest that foreign currency borrowing in Eastern Europe is not only be driven by borrowers who try to benefit from lower interest rates but may be partly supply-driven with banks hesitant to lend long-term in local currency and eager to match the currency structure of their assets and liabilities. --
    Keywords: foreign currency debt,banking
    JEL: G21 G30 F34 F37
    Date: 2010
  13. By: Miguel Casares (Departamento de Economía-UPNA); Jean-Christophe Poutineauy (Faculté des Sciences Economiques, Université de Rennes I, Rennes, France)
    Abstract: This paper introduces both endogenous capital accumulation and deposit-in-advance requirements in the banking model of Goodfriend and McCallum (2007). Impulse response functions from technology and monetary shocks show some attenuation effect due to the procyclical behavior of the marginal finance cost. In addition, an adverse financial shock produces sizeable realistic declines in output, inflation and interest rates. In the long-run analysis, one economy where banking intermediation requires 4% of total labor force suffers from a permanent welfare cost equivalent to 1.96% of output.
    Keywords: financial attenuator, financial shocks, welfare cost of banking.
    JEL: E32 E43 E44
    Date: 2010
  14. By: Abdul Rashid; Fazal Husain (Pakistan Institute of Development Economics)
    Abstract: Since the early 1990s, there is an upsurge in foreign capital flows to developing economies, particularly into emerging markets. One view argues that capital inflows do help to increase efficiency, a better allocation of capital and to fill up the investment-saving gap. Adherents to that view advise countries to launch capital account liberalisation. In this study, we investigate the effects of capital inflows on domestic price level, monetary expansion and exchange rate volatility. To proceed with this, linear and nonlinear cointegration and Granger causality tests are applied in a bi-variate as well as in multivariate framework. The key message of the analysis is that there is a significant inflationary impact of capital inflows, in particular during the last 7 years. The finding suggest that there is a need to manage the capital inflows in such a way that they should neither create an inflationary pressure in the economy nor fuel the exchange rate volatility.
    Keywords: Capital Inflows, Inflationary Pressures, Exchange Rate Volatility, Monetary Expansion, Nonlinear Dynamics
    JEL: C22 C32 F21 F31 F32
    Date: 2010
  15. By: António Portugal Duarte (GEMF/Faculdade de Economia, Universidade de Coimbra, Portugal); João Sousa Andrade (GEMF/Faculdade de Economia, Universidade de Coimbra, Portugal); Adelaide Duarte (GEMF/Faculdade de Economia, Universidade de Coimbra, Portugal)
    Abstract: This work selectively reviews the literature on exchange rate target zones and their theoretical and empirical methodologies and examines whether they can be used to clarify to what extent this type of exchange rate regime could contribute to greater exchange rate stability. We discuss the main contributions of the first and second generations of exchange rate target zone models. In an attempt to reconcile the poor empirical performance of the Krugman (1991) model with the reality of exchange rate target zone regimes, this line of research integrates target zones with alternative underlying economic models, such as imperfect credibility, intra-marginal interventions and sticky price models. It was thus possible to understand the correlations observed between the exchange rate, its fundamentals determinants and the interest rate differential, and to explain the fact that the statistical distribution of the exchange rate is hump-shaped rather than U-shaped. This implies that the initial emphasis of target zone models on nonlinearities, “honeymoon effect”, “smooth pasting” and marginal interventions has vanished. Exchange rate target zones are better described as similar to managed floating regimes with intra-marginal interventions, with some marginal interventions when the exchange rate reaches the edges of the floating band.
    Keywords: Exchange rate target zones, imperfect credibility, intra-marginal interventions realignments and sticky prices.
    JEL: F31 F41 G15
    Date: 2010–07
  16. By: Mahmood Khalid; Zahid Asghar (Pakistan Institute of Development Economics)
    Abstract: Given the importance of Consumer Price Index (CPI), there has been long debate on its measurement issues. It is the best and most well-known indicator of inflation, which is further used for evaluating the monetary and fiscal policy of a country. Other uses of CPI for indexation are social security benefits, rents, contractual payments, taxation, deflating national income accounts, purchasing power parity index, inflation incidence for different income groups of population, impact of inflation on demographic composition of the population. Any measurement error in CPI may overstate or understate inflation that will have serious repercussions for monetary, fiscal and other economic policies. The report of the Boskin Commission [Boskin, et al. (1996)] has identified possible sources of bias in the CPI like substitution bias, outlet bias, quality bias, new product bias. In this paper we have tried to evaluate these biases and to start a debate on improving Consumer Price Index (CPI) construction in Pakistan. We found that there are biases of Commodity Substitution Bias, Outlet Substitution Bias, Quality Adjustment Bias, Index Calculation Bias and New Product Bias. Other limitations for the CPI index including; Issue of selecting a representative product (or good), Defining issue of average quality, Data collection, weights determination and Base year change were also found.
    Keywords: Consumer Price Index, Biases in CPI, CPI Formulae
    JEL: C43 E31 E52
    Date: 2010
  17. By: Eduardo Court (Pontificia Universidad Catolica Del Peru, Centrum Catolica); Emre Ozsoz (Fashion Institute of Technology, State University of New York (SUNY), Social Sciences Department, and Fordham University, Center for International Policy Studies (CIPS)); Erick W. Rengifo (Fordham University, Department of Economics and Center for International Policy Studies (CIPS))
    Abstract: One of the main reasons for dollarization is the erosion of money's function as a store of value as the Currency Substitution view suggests. It has not been uncommon for countries with high inflationary processes to have high dollarization ratios and banking system that faces important challenges and risks that significantly affect their ability to provide capital to the overall economy (financial intermediation). In these economies, dollarization played a dual role: in one hand, the role of a hedging instrument protecting the value of money and, in the other hand, contributing to generate the so-called currency mismatch and default risks. This paper investigates the role of dollarization on the development of financial intermediation in developing economies. Our empirical findings suggest that dollarization has a negative impact on financial deepening, except on high-inflation economies.
    Keywords: Dollarization, Financial Development, Financial Deepening
    JEL: F31 G21
    Date: 2010
  18. By: Andreas Fuster; Paul S. Willen
    Abstract: This paper measures the effects on the primary U.S. mortgage market of the large-scale asset purchase (LSAP) program in which the Federal Reserve bought $1.25 trillion of mortgage-backed securities in 2009 and 2010. We use an event-study approach and measure the movements in both prices and quantities around the initial announcement of the LSAP and subsequent changes to the program. We use a new dataset to document the changes in the menu of rates and points offered to borrowers and show that there was wide dispersion in the rate changes generated by the announcement of the LSAP program, with some borrowers seeing immediate rate reductions of up to 40 basis points and other borrowers confronting rate increases. We show that the LSAP program led to a substantial boost in market activity, with discontinuous increases in searches, applications and originations for refinance mortgages, but not purchase mortgages. Finally, we show that more creditworthy borrowers were significantly more likely to benefit from the improved credit availability.
    Keywords: Mortgage-backed securities
    Date: 2010
  19. By: Koumparoulis, Dimitrios
    Abstract: At the Bank of Greece econometric modeling started in 1975 when the Bank’s first model of the Greek economy was developed under the leadership of the outgoing Governor of the Bank C. Garganas. The model was extensively used for many years in forecasting as well as in policy analysis and proved to be an indispensable tool for the policy decisions of the Bank over a broad spectrum of issues. Model of Greece is an ongoing activity fuelled by the changes in the economy as well as by modeling theoretical advances. This paper describes and documents the use of the current version of the Bank of Greece model.
    Keywords: econometric modeling; cointegration techniques
    JEL: C50 E17
    Date: 2010

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