nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒10‒30
twenty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The Effectiveness of Monetary Policy During the Recent Financial Turmoil By Puriya Abbassi; Tobias Linzert
  2. Money demand stability: A case study of Nigeria By Kumar, Saten; Webber, Don J.; Fargher, Scott
  3. Explaining ECB and FED interest rate correlation: Economic interdependence and optimal monetary policy By Martin Mandler;
  4. Financial Stability and Monetary Policy - The case of Brazil By Benjamin M. Tabak; Marcela T. Laiz; Daniel O. Cajueiro
  5. Imperfect Interbank Markets and the Lender of Last Resort By Tarishi Matsuoka
  6. Real time data, regime shifts, and a simple but effective estimated Fed policy rule, 1969-2009 By Smant, David / D.J.C.
  7. Bank Lending in Turkey: Effects of Monetary and Fiscal Policies By Deniz Igan; Burcu Aydin
  8. Modeling Inflation After the Crisis By James H. Stock; Mark W. Watson
  9. Testing for nonlinear causation between capital inflows and domestic prices By Rashid , Abdul
  10. Credit Crunch in a Small Open Economy By Michał Brzoza-Brzezina; Krzysztof Makarski
  11. Credit risk transfers and the macroeconomy By Ester Faia
  12. Monetary Policy Matters: New Evidence Based on a New Shock Measure By Christopher W. Crowe; S. Mahdi Barakchian
  13. U.S. Monetary and Fiscal Policy in the 1930s By Price V. Fishback
  14. Unconventional monetary policy and the great recession - Estimating the impact of a compression in the yield spread at the zero lower bound By Christiane Baumeister; Luca Benati
  15. Equilibrium Price Dispersion and Rigidity: A New Monetarist Approach By Allen Head; Lucy Qian Liu; Guido Menzio; Randall Wright
  16. Measuring Renminbi Misalignment: Where Do We Stand? By Yin-Wong Cheung; Menzie D. Chinn; Eiji Fujii
  17. Exchange-Rate Pass Through, Openness, and the Sacrifice Ratio By Daniels, Joseph P; VanHoose, David D
  18. The promise and performance of the federal reserve as lender of last resort 1914-1933 By Michael D. Bordo; David C. Wheelock
  19. Explaining the money demand of non-financial corporations in the Euro area: A macro and a micro view By Carmen Martinez-Carrascal; Julian von Landesberger
  20. MONETARY POLICY AND OIL PRICES By Hošek, Jan; Komárek, Luboš; Motl, Martin
  21. "Bretton Woods 2 Is Dead, Long Live Bretton Woods 3?" By Jorg Bibow
  22. The Paradox of Interest Rates of the Greenback Era: A Reexamination By Zhylyevskyy, Oleksandr (Alex)
  23. Deep Habits, Nominal Rigidities and Interest Rate Rules By Zubairy, Sarah
  24. The cross section of money market fund risks and financial crises By Patrick E. McCabe
  25. The Optimal Path of the Chinese Renminbi By Dupuy, Philippe; Carlotti, Jean-Etienne
  26. Currency Carry Trades By Travis J. Berge; Òscar Jordà; Alan M. Taylor

  1. By: Puriya Abbassi; Tobias Linzert
    Abstract: The recent financial crisis has deeply affected the marginal cost of funding bank loans and thus the proper functioning of the interest rate channel. We analyze the effectiveness of monetary policy in the euro area with respect to the predictability of money market rates on the basis of monetary policy expectations, and the impact of extraordinary central bank measures on money markets. We find that market’s expectations are less relevant for money market rates up to 12 months after August 2007 compared to the pre-crisis period. At the same time, our results indicate that the ECB’s net increase in outstanding open market operations as of October 2008 accounts for at least a 100 basis point decline in Euribor rates. These findings show that central banks have effective tools at hand to conduct monetary policy in times of crises.
    Keywords: Monetary transmission mechanism; Financial Crisis; Monetary policy implementation; European Central Bank; Money market
    JEL: E43 E52 E58
    Date: 2010–10
  2. By: Kumar, Saten; Webber, Don J.; Fargher, Scott
    Abstract: This paper presents an empirical investigation into the level and stability of money demand (M1) in Nigeria between 1960 and 2008. In addition to estimating the canonical specification, alternative specifications are presented that include additional variables to proxy for the cost of holding money. Results suggest that the canonical specification is well-determined, the money demand relationship went through a regime shift in 1986 which slightly improved the scale economies of money demand, and money demand is stable. These findings imply that Nigeria could effectively use the supply of money as an instrument of monetary policy.
    Keywords: Money demand; Structural breaks; Cointegration; Monetary policy
    JEL: C22 E41
    Date: 2010–09–29
  3. By: Martin Mandler (University of Giessen);
    Abstract: This paper studies whether the observed high correlation between monetary policy in the U.S. and the Euro area can be explained by economic fundamentals, i.e. by macroeconomic interdependence between the two regions. We show that an optimal monetary policy reaction function for the ECB that accounts explicitly for economic interrelationships between the two economies reproduces substantial parts of the observed patterns of interest rate correlation and represents a good approximation to the actually observed monetary policy of the ECB. It implies strong reactions to shocks to US variables, particularly to shocks to the Federal Funds Rate.
    Keywords: optimal monetary policy, monetary policy reaction function, vector autoregressions
    JEL: E47 E52 E58
    Date: 2010
  4. By: Benjamin M. Tabak; Marcela T. Laiz; Daniel O. Cajueiro
    Abstract: This paper investigates the effects of monetary policy over banks' loans growth and non-performing loans for the recent period in Brazil. We contribute to the literature on bank lending and risk taking channel by showing that during periods of loosening/tightening monetary policy, banks increase/decrease their loans. Moreover, our results illustrate that large, well-capitalized and liquid banks absorb better the effects of monetary policy shocks. We also find that low interest rates lead to an increase in credit risk exposure, supporting the existence of a risk-taking channel. Finally, we show that the impact of monetary policy differs across state-owned, foreign and private domestic banks. These results are important for developing and conducting monetary policy.
    Date: 2010–10
  5. By: Tarishi Matsuoka (Graduate School of Economics, Kyoto University)
    Abstract: This paper presents a monetary model in which interbank markets bear limited commitment to contracts. Limited commitment reduces the proportion of assets that can be used as collateral, and thus banks with high liquidity demands face borrowing constraints in interbank markets. These constraints can be relieved by the central bank (a lender of last resort) through the provision of liquidity loans. I show that the constrained-efficient allocation can be decentralized by controlling only the money growth rate if commitment to interbank contracts is not limited. Otherwise, a proper combination of central bank loans and monetary policy is needed to bring the market equilibrium into a state of constrained efficiency.
    Keywords: Overlapping generations, money, interbank markets, limited commitment, the lender of last resort
    JEL: E42 E51 G21
    Date: 2010–10
  6. By: Smant, David / D.J.C.
    Abstract: Estimates of Taylor rule equations for Federal Reserve policy over periods before the Greenspan period are misleading. Until 1979 Fed policy changed the real funds rate in response to the output gap, with no response to an inflation target. During the Volcker period the policy rule kept the real funds rate at a high but constant level, with no response to the output gap. Taking into account the regime shifts, a simple but effective funds rate equation can be estimated using only inflation and output gap.
    Keywords: Taylor rule; policy regime shifts; real time data
    JEL: E43 E58
    Date: 2010–10–22
  7. By: Deniz Igan; Burcu Aydin
    Abstract: The period following the 2000-01 crisis was marked by a successful disinflation program sustained through inflation targeting and fiscal discipline in Turkey. This paper studies the impact of monetary and fiscal policies on credit growth during this period. Using quarterly bank-level data covering 2002-08, we find evidence that liquidity-constrained banks have sharper decline in lending during contractionary monetary policies and that crowding-out effect disappears more for banks with a retail-banking focus when fiscal policies are prudent.The results are statistically weak, suggesting that bank lending channel is not strong in Turkey and government finances has limited direct impact on credit.
    Date: 2010–10–18
  8. By: James H. Stock; Mark W. Watson
    Abstract: In the United States, the rate of price inflation falls in recessions. Turning this observation into a useful inflation forecasting equation is difficult because of multiple sources of time variation in the inflation process, including changes in Fed policy and credibility. We propose a tightly parameterized model in which the deviation of inflation from a stochastic trend (which we interpret as long-term expected inflation) reacts stably to a new gap measure, which we call the unemployment recession gap. The short-term response of inflation to an increase in this gap is stable, but the long-term response depends on the resilience, or anchoring, of trend inflation. Dynamic simulations (given the path of unemployment) match the paths of inflation during post-1960 downturns, including the current one.
    JEL: C22 E31
    Date: 2010–10
  9. By: Rashid , Abdul
    Abstract: The nonlinear cointegration and Granger causality tests are applied in a bi-variate framework to investigate the effects of capital inflows, monetary expansion and interest rates on domestic price levels. The key message of the analysis is that there is a significant inflationary impact of capital inflows, money supply-to-GDP ratio and domestic debt, in particular during period of large capital inflows from 2001 to 2008. Whereas, interest rate and exchange rate do not have any significant nonlinear causal links with domestic price levels during the examined periods.
    Keywords: Capital Inflows; Inflationary Pressures; Monetary Expansion; Nonlinear Dynamics
    JEL: C32 F32 F21
    Date: 2010–06–14
  10. By: Michał Brzoza-Brzezina (National Bank of Poland, Economic Institute; Warsaw School of Economics); Krzysztof Makarski (National Bank of Poland, Economic Institute; Warsaw School of Economics)
    Abstract: We construct an open-economy DSGE model with a banking sector to analyse the impact of the recent credit crunch on a small open economy. In our model the banking sector operates under monopolistic competition, collects deposits and grants collateralized loans. Collateral effects amplify monetary policy actions, interest rate stickiness dampens the transmission of interest rates, and financial shocks generate non-negligible real and nominal effects. As an application we estimate the model for Poland - a typical small open economy. According to the results, financial shocks had a substantial, though not overwhelming, impact on the Polish economy during the 2008/09 crisis, lowering GDP by approximately 1.5 percent.
    Keywords: credit crunch, monetary policy, DSGE with banking sector
    JEL: E32 E44 E52
    Date: 2010
  11. By: Ester Faia (Goethe University Frankfurt, House of Finance, office 3.47, Grueneburgplatz 1, 60323, Frankfurt am Main, Germany.)
    Abstract: The recent financial crisis has highlighted the limits of the "originate to distribute" model of banking, but its nexus with the macroeconomy and monetary policy remains unexplored. I build a DSGE model with banks (along the lines of Holmström and Tirole [28] and Parlour and Plantin [39]) and examine its properties with and without active secondary markets for credit risk transfer. The possibility of transferring credit reduces the impact of liquidity shocks on bank balance sheets, but also reduces the bank incentive to monitor. As a result, secondary markets allow to release bank capital and exacerbate the effect of productivity and other macroeconomic shocks on output and inflation. By offering a possibility of capital recycling and by reducing bank monitoring, secondary credit markets in general equilibrium allow banks to take on more risk. JEL Classification: E3, E5, G3.
    Keywords: credit risk transfer, dual moral hazard, monetary policy, liquidity, welfare.
    Date: 2010–10
  12. By: Christopher W. Crowe; S. Mahdi Barakchian
    Abstract: Conventional VAR and non-VAR methods of identifying the effects of monetary policy shocks on the economy have found a negative output response to monetary tightening using U.S. data over the 1960s-1990s. However, we show that these methods fail to find this contractionary effect when the sample is restricted to the period since the 1980s, apparently due to changes in the policymaking environment that reduce their effectiveness. Identifying policy shocks using Fed Funds futures data, we recover the contractionary effect of monetary tightening on output and find that almost half of output variation over the period appears due to policy shocks.
    Date: 2010–10–14
  13. By: Price V. Fishback
    Abstract: The paper provides a survey of fiscal and monetary policies during the 1930s under the Hoover and Roosevelt Administrations and how they influenced the policies during the recent Great Recession. The discussion of the causal impacts of monetary policy focuses on papers written in the last decade and the findings of scholars using dynamic structural general equilibrium modeling. The discussion of fiscal policy shows why economists do not see the New Deal as a Keynesian stimulus, describes the significant shift toward excise taxation during the 1930s, and surveys estimates of the impact of federal spending on local economies. The paper concludes with discussion of the lessons for the present from 1930s monetary and fiscal policy.
    JEL: E5 E62 N12 N92
    Date: 2010–10
  14. By: Christiane Baumeister (Research Department, Bank of Canada, 234 Wellington Street, Ottawa, Ontario, Canada, K1A 0G9.); Luca Benati (Monetary Policy Research Division, Banque de France, 31, Rue Croix des Petits Champs, 75049 Paris CEDEX 01, France.)
    Abstract: We explore the macroeconomic impact of a compression in the long-term bond yield spread within the context of the Great Recession of 2007-2009 via a Bayesian time-varying parameter structural VAR. We identify a ‘pure’ spread shock which, leaving the short-term rate unchanged by construction, allows us to characterise the macroeconomic impact of a compression in the yield spread induced by central banks’ asset purchases within an environment in which the short rate cannot move because it is constrained by the zero lower bound. Two main findings stand out. First, in all the countries we analyse (U.S., Euro area, Japan, and U.K.) a compression in the long-term yield spread exerts a powerful effect on both output growth and inflation. Second, conditional on available estimates of the impact of the FED’s and the Bank of England’s asset purchase programmes on long-term government bond yield spreads, our counterfactual simulations indicate that U.S. and U.K. unconventional monetary policy actions have averted significant risks both of deflation and of output collapses comparable to those that took place during the Great Depression. JEL Classification: E30, E32.
    Keywords: Great Recession, structural VARs, time-varying parameters, Bayesian VARs, stochastic volatility, Monte Carlo integration, policy counterfactuals.
    Date: 2010–10
  15. By: Allen Head (Department of Economics, Queen's University); Lucy Qian Liu (International Monetary Fund (IMF)); Guido Menzio (Department of Economics, University of Pennsylvania); Randall Wright (Department of Economics, University of Wisconsin-Madison)
    Abstract: Why do some sellers set prices in nominal terms that do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption. Here it is a result. We use search theory, with two consequences: prices are set in dollars since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When money increases, some sellers keep prices constant, earning less per unit but making it up on volume, so profit is unaffected. The model is consistent with the micro data. But, in contrast with other sticky-price models, money is neutral.
    Keywords: Search, Sticky Prices, Monetary Policy
    JEL: D43 E51 E52
    Date: 2010–09–03
  16. By: Yin-Wong Cheung (University of California, Santa Cruz and Hong Kong Institute for Monetary Research); Menzie D. Chinn (University of Wisconsin, Madison); Eiji Fujii (Kwansei Gakuin University)
    Abstract: The value of China's currency, the renminbi (RMB), and the conduct of China's exchange rate policy have generated intense debate in academic and international policy circles. Despite the accumulation of empirical evidence regarding the degree of RMB misalignment over the past few years, the debate continues unabated. In this study, we highlight the challenges to properly assessing the nature and degree of currency misalignment, in terms of the choice of the model, the method of calculation, and data uncertainty. In particular, we demonstrate the susceptibility of misalignment estimates to model selection and data revisions. Further, we explicitly discuss the implications of sampling uncertainty for determining the extent of RMB misalignment.
    Keywords: Absolute Purchasing Power Parity, China, Currency Misalignment, Sampling Uncertainty, Data Revision
    JEL: F31 F41
    Date: 2010–09
  17. By: Daniels, Joseph P (Department of Economics Marquette University); VanHoose, David D (Hankamer School of Business Baylor University)
    Abstract: Considerable recent work has reached mixed conclusions about whether and how globalization affects the inflation-output trade-off and suggests that the ultimate effect of openness on the output-inflation relationship is influenced by a variety of factors. In this paper, we consider the impact of exchange-rate pass through and how pass through conditions the effect of openness on the sacrifice ratio. We develop a simple theoretical model showing how both the extent of pass through and openness can interact to influence the output-inflation relationship. Next we empirically explore the nature of these two variables and their interaction. Results indicate that greater pass through increases the sacrifice ratio, that there is significant interaction among pass through and openness, and—once the extent of pass through is taken into account alongside other factors that affect the sacrifice ratio, such as central bank independence—openness exerts an empirically ambiguous effect on the sacrifice ratio.
    Keywords: exchange-rate pass through, openness, sacrifice ratio, Economics
    JEL: F40 F41 F43
    Date: 2010–08
  18. By: Michael D. Bordo; David C. Wheelock
    Abstract: This paper examines the origins and early performance of the Federal Reserve as lender of last resort. The Fed was established to overcome the problems of the National Banking era, in particular an “inelastic” currency and the absence of an effective lender of last resort. As conceived by Paul Warburg and Nelson Aldrich at Jekyll Island in 1910, the Fed’s discount window and bankers acceptance-purchase facilities were expected to solve the problems that had caused banking panics in the National Banking era. Banking panics returned with a vengeance in the 1930s, however, and we examine why the Fed failed to live up to the promise of its founders. Although many factors contributed to the Fed’s failures, we argue that the failure of the Federal Reserve Act to faithfully recreate the conditions that had enabled European central banks to perform effectively as lenders of last resort, or to reform the inherently unstable U.S. banking system, were crucial. The Fed’s failures led to numerous reforms in the mid-1930s, including expansion of the Fed’s lending authority and changes in the System’s structure, as well as changes that made the U.S. banking system less prone to banking panics. Finally, we consider lessons about the design of lender of last resort policies that might be drawn from the Fed’s early history.>
    Keywords: Lenders of last resort ; Banks and banking, Central ; Federal Reserve Act
    Date: 2010
  19. By: Carmen Martinez-Carrascal (Banco de España, Servicio de Estudios, Alcalá 50, 28014 Madrid, Spain.); Julian von Landesberger (European Central Bank, Directorate General Economics, 60311 Frankfurt am Main, Germany.)
    Abstract: This paper analyses euro area non-financial corporations (NFC) money demand, both from a macro and a microeconomic point of view. At a macro level, money holdings are modelled as a function of real gross added value, the price level, the long-term interest rate on bank lending to non-financial corporations, the own rate of return on M3 and the real capital stock of the NFC sector. The results indicate that NFCs’ money holdings adjust quickly when deviations from their long-run level are registered, and that the large increase observed recently in NFCs’ money holdings has been driven by changes in their fundamentals and hence they stand in line with their long-run equilibrium level. The disaggregated analysis also shows that cash holdings are linked to balance-sheet ratios (such as non-liquid short term assets, tangible assets or indebtedness) and other variables such as the firm’ cash flow, its volatility or the size of the firm, which cannot be taken into account in the macro analysis. Likewise, results indicate that the main drivers of the increase in NFC cash holdings in the last years have been cyclical factors, captured by gross-added value and the cash-flow respectively. Variations in the opportunity cost of holding money, have also contributed to explain M3 developments but more modestly than at the end of the nineties, when its increase contributed negatively to cash accumulation. JEL Classification: E41, C23, C32, D21.
    Keywords: money demand, cointegrated VARs, panel estimation.
    Date: 2010–10
  20. By: Hošek, Jan (Czech National Bank); Komárek, Luboš (Czech National Bank,); Motl, Martin (Czech National Bank,)
    Abstract: This article discusses the relationship between monetary policy and oil prices and, in a broader sense, commodity prices. Firstly, it focuses on describing the relationship between key macroeconomic variables, gas prices and other commodity prices relative to oil prices. Subsequently, it discusses the existence of “transmission channels” through which monetary policy can be propagated to oil prices (or prices of commodities). It then provides an insight into the CNB’s forecasting process, both by looking retrospectively at the oil price outlook in the past and by analysing a transitory and a permanent shock (a rise in the oil price of USD 30/b). The simulated oil price shock is calculated from the average level of Brent oil prices in the first quarter of 2010, i.e. USD 77.50/b.
    Keywords: oil price ; monetary policy ; real interest rate ; oil price shock JEL Classification: G12 ; G14 ; D53
    Date: 2010
  21. By: Jorg Bibow
    Abstract: This paper sets out to investigate the forces and conditions that led to the emergence of global imbalances preceding the worldwide crisis of 2007–09, and both the likelihood and the potential sustainability of reemerging global imbalances as the world economy recovers from that crisis. The "Bretton Woods 2" hypothesis of sustainable global imbalances featuring a quasi-permanent U.S. current account deficit overlooked that the domestic counterpart to the United States' external deficit—soaring household indebtedness—was based not on safe debts but rather toxic ones. We critique the "global saving glut" hypothesis, and propose the "global dollar glut" hypothesis in its stead. With the U.S. private sector in retrenchment mode, the question arises whether fiscal expansion might not only succeed in filling the gap in U.S. domestic demand but also restart global arrangements along BW2 lines, albeit this time based on public debt—call it "Bretton Woods 3." This paper explores the chances of a BW3 regime, highlighting the role of "dollar leveraging" in sustaining U.S. trade deficits. Longer-term prospects for a postdollar standard are discussed in the light of John Maynard Keynes’s "bancor" plan.
    Keywords: Reserve Currency; Global Monetary Order; Global Saving Glut; Global Dollar Glut; Global Crisis
    JEL: E12 E58 E65 F33
    Date: 2010–05
  22. By: Zhylyevskyy, Oleksandr (Alex)
    Abstract: The two leading explanations for the counterintuitive behavior of interest rates during the Greenback Era (1862–1878) – the resumption expectations model of Calomiris (1988) and the capital flow argument of Friedman and Schwartz (1963) – are inconsistent with each other in terms of their treatment of financial arbitrage. A methodology to identify unexploited arbitrage opportunities in financial data is proposed. Observable returns strongly suggest that the money market of the Greenback Era did not systematically admit arbitrage, except possibly around the times of the Gold Corner of 1869 and the Panic of 1873, which implies that Calomiris provides a more plausible explanation.
    Keywords: Greenback Era; money market; arbitrage opportunity; interest rate paradox
    JEL: N21
    Date: 2010–10–13
  23. By: Zubairy, Sarah
    Abstract: This paper explores how the introduction of deep habits in a standard new-Keynesian model affects the properties of widely used interest rate rules. In particular, an interest rate rule satisfying the Taylor principle is no longer a su±cient condition to guarantee determinacy. Including interest rate smoothing and a response to output deviations from steady state significantly improve the regions of determinacy. However, under all the simple interest rate rules considered here with contemporaneous variables, determinacy is not guaranteed for very high degree of deep habits. The intuition behind these findings is tied to how deep habits give rise to counter-cyclical markups, a property that makes it an appealing feature in the study of demand shocks.
    Keywords: Taylor principle; interest rate rules; sticky prices; deep habits
    JEL: E31 E52
    Date: 2010–08–18
  24. By: Patrick E. McCabe
    Abstract: This paper examines the relationship between money market fund (MMF) risks and outcomes during crises, with a focus on the ABCP crisis in 2007 and the run on money funds in 2008. I analyze three broad types of MMF risks: portfolio risks arising from a fund's assets, investor risk reflecting the likelihood that a fund's shareholders will redeem shares disruptively, and sponsor risk due to uncertainty about MMF sponsors' support for distressed funds. I find that during the run on MMFs in September and October 2008, outflows were larger for MMFs that had previously exhibited greater degrees of all three types of risk. In contrast, as the asset-backed commercial paper (ABCP) crisis unfolded in 2007, many MMFs suffered capital losses, but investor flows were relatively unresponsive to risks, probably because investors correctly believed that sponsors would absorb the losses. However, the consequences of MMF risks were quite costly for some sponsors: Using a unique data set of sponsor interventions, I show that sponsor financial support was more likely for MMFs that previously earned higher gross yields (a measure of portfolio risk) and funds with bank-affiliated sponsors. Funds' gross yields and bank affiliation (but not funds' ratings) also would have helped forecast holdings of distressed ABCP. This paper provides some useful lessons for investors and policymakers. The significance of MMF risks in predicting poor outcomes in past crises highlights the importance of monitoring such risks, and I offer some useful proxies for doing so. The paper also argues for greater attention to the systemic risks posed by the industry's reliance on discretionary sponsor support.
    Date: 2010
  25. By: Dupuy, Philippe; Carlotti, Jean-Etienne
    Abstract: This paper provides evidence on the consistency of the determination of the Chinese real effective exchange rate (REER) over time. Especially, we validate coin- tegration between the REER and a set of fundamentals using recent developments in model selection. Error correction model (ECM) path dependence in model se- lection is addressed by using the General-To-Specific (GETS) approach enabling us to obtain empirically constant and encompassing ECM. As inference in finite sam- ples is commonly of concern, statistics' distributional properties for cointegration tests are estimated by Monte Carlo simulations. The final specification of the model is compatible with the natural real exchange rate of Stein (1994). We study the implications of our findings in terms of foreign exchange policy.
    Keywords: Exchange Rate; Equilibrium value; GETS; Global Imbalances
    JEL: F31 F36
    Date: 2010–02
  26. By: Travis J. Berge; Òscar Jordà; Alan M. Taylor
    Abstract: A wave of recent research has studied the predictability of foreign currency returns. A wide variety of forecasting structures have been proposed, including signals such as carry, value, momentum, and the forward curve. Some of these have been explored individually, and others have been used in combination. In this paper we use new econometric tools for binary classification problems to evaluate the merits of a general model encompassing all these signals. We find very strong evidence of forecastability using the full set of signals, both in sample and out-of-sample. This holds true for both an unweighted directional forecast and one weighted by returns. Our preferred model generates economically meaningful returns on a portfolio of nine major currencies versus the U.S. dollar, with favorable Sharpe and skewness characteristics. We also find no relationship between our returns and a conventional set of so-called risk factors.
    JEL: C44 F31 F37 G14 G15
    Date: 2010–10

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