nep-mon New Economics Papers
on Monetary Economics
Issue of 2010‒12‒11
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. How Does Monetary Policy Change? Evidence on Inflation Targeting Countries By Jaromír Baxa; Roman Horvath; Borek Vasicek
  2. Inflation risk premia in the US and the euro area By Peter Hördahl; Oreste Tristani
  3. The choice of adopting inflation targeting in emerging economies: Do domestic institutions matter? By Yannick Lucotte
  4. Exchange Rate Policy in Brazil By John Williamson
  5. Peru: Drivers of De-dollarization By Mercedes García-Escribano
  6. The Indian Exchange Rate and Central Bank Action: A GARCH Analysis By Ashima Goyal; Sanchit Arora
  7. Monetary Policy in the presence of Informal Labour Markets By Paul Castillo; Carlos Montoro
  8. Recent Developments in Monetary Policy By Peter Howells; Iris Biefang Frisancho-Mariscal
  9. Monetary policy, capital inflows and the housing boom By Sa, Filipa; Wieladek, Tomasz
  10. On monetary policy and stock market anomalies By Alexandros Kontonikas; Alexandros Kostakis
  11. World Food Prices and Monetary Policy By Luis Catão; Roberto Chang
  12. The Long-Run Impact of Inflation in South Africa By Kafayat Amusa; Rangan Gupta; Shaakira Karaolia; Beatrice D. Simo Kengne
  13. Asset Prices and Monetary Policy in a Sticky-Price Economy with Financial Frictions By NUTAHARA Kengo
  14. The Effects Of Monetary Policy Shocks In Peru: Semi-Structural Identification Using A Factor-Augmented Vector Autoregressive Model By Erick Lahura
  15. "The Central Bank 'Printing Press': Boon or Bane? Remedies for High Unemployment and Fears of Fiscal Crisis" By Greg Hannsgen; Dimitri B. Papadimitriou
  16. Canadian Monetary Policy: Lessons from the Crisis By Angelo Melino
  17. External imbalances in a monetary union. Does the Lawson doctrine apply to Europe? By Mariam Camarero; Josep Lluís Carrion-i-Silvestre; Cecilio Tamarit
  18. Level, Slope, Curvature of Sovereign Yield Curve and Fiscal Behaviour By António Afonso; Manuel M. F. Martins
  19. Imprecision of central bank announcements and credibility By Daniel Laskar
  20. The Option Of Last Resort: A Two-Currency Emu By Arghyrou, Michael G; Tsoukalas, John D.

  1. By: Jaromír Baxa (Institute of Economic Studies, Charles University, Prague and Institute of Information Theory and Automation, Academy of Sciences of the Czech Republic, Prague); Roman Horvath (Czech National Bank and Institute of Economic Studies, Charles University, Prague); Borek Vasicek (Departament d'Economia Aplicada, Universitat Autonoma de Barcelona)
    Abstract: We examine the evolution of monetary policy rules in a group of inflation targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom) applying moment- based estimator at time-varying parameter model with endogenous regressors. Using this novel flexible framework, our main findings are threefold. First, monetary policy rules change gradually pointing to the importance of applying time-varying estimation framework. Second, the interest rate smoothing parameter is much lower that what previous time-invariant estimates of policy rules typically report. External factors matter for all countries, albeit the importance of exchange rate diminishes after the adoption of inflation targeting. Third, the response of interest rates on inflation is particularly strong during the periods, when central bankers want to break the record of high inflation such as in the U.K. or in Australia at the beginning of 1980s. Contrary to common wisdom, the response becomes less aggressive after the adoption of inflation targeting suggesting the positive effect of this regime on anchoring inflation expectations. This result is supported by our finding that inflation persistence as well as policy neutral rate typically decreased after the adoption of inflation targeting.
    Keywords: Taylor rule, inflation targeting, monetary policy, time-varying parameter model,endogenous regressors.
    JEL: E43 E52 E58
    Date: 2010–09
  2. By: Peter Hördahl (Bank for International Settlements, Centralbahnplatz 2, CH-4002, Basel, Switzerland.); Oreste Tristani (European Central Bank, DG Research, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We use a joint model of macroeconomic and term structure dynamics to estimate inflation risk premia in the United States and the euro area. To sharpen our estimation, we include in the information set macro data and survey data on inflation and interest rate expectations at various future horizons, as well as term structure data from both nominal and index-linked bonds. Our results show that, in both currency areas, inflation risk premia are relatively small, positive, and increasing in maturity. The cyclical dynamics of long-term inflation risk premia are mostly associated with changes in output gaps, while their high-frequency fluctuations seem to be aligned with variations in inflation. However, the cyclicality of inflation premia differs between the US and the euro area. Long term inflation premia are countercyclical in the euro area, while they are procyclical in the US. JEL Classification: E43, E44.
    Keywords: Term structure of interest rates, inflation risk premia, central bank credibility.
    Date: 2010–12
  3. By: Yannick Lucotte (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)
    Abstract: Over the last decade, a growing number of emerging countries has adopted inflation targeting as monetary policy framework. In a recent paper, Freedman and Laxton (2009) ask the question “Why Inflation Targeting?”. This paper empirically investigates this question by analyzing a large set of institutional and political factors potentially associated with a country's choice of adopting IT. Using panel data on a sample of thirty inflation targeting and non-inflation emerging countries, for the period 1980-2006, our results suggest that central bank independence, policy-makers' incentives, and characteristics of political system play an important role in the choice of IT, while the level of financial development and political stability do not seem to matter. Empirical findings are confirmed by extensive robustness tests.
    Keywords: Inflation targeting; central bank independence; financial development; political institutions; emerging countries
    Date: 2010
  4. By: John Williamson (Peterson Institute for International Economics)
    Abstract: The macroeconomic regime implanted in Brazil during the second administration of Fernando Henrique Cardoso, and largely maintained by his successor, is typical of those of the advanced countries. The anchor is provided by an inflation-targeting regime (with a target inflation rate somewhat greater than in most advanced countries, of 4.5 percent a year, with a band around it of +/–2 percent). The exchange rate floats. The float is often described as free, but given the extent of recent reserve accumulation it would not qualify as a free float as understood by most economists. Fiscal policy has actually been more ambitious under the Lula regime, resulting for a time in a primary surplus of at least 4.25 percent of GDP (subsequently reduced to allow for a higher rate of public investment, and also temporarily reduced further to help combat the crisis). Monetary policy has then been directed at achieving the inflation target given fiscal policy, which--given history--has implied maintaining high interest rates. While the majority of the framework in Brazil is acceptable, it is a bit too laissez-faire in that the exchange rate should be targeted at a rate consistent with macroeconomic balance, which the authorities should treat as a reference rate.
    Keywords: exchange rates, inflation targeting, emerging-market economies, Brazil, reference rates
    JEL: F31 E50
    Date: 2010–12
  5. By: Mercedes García-Escribano (International Monetary Fund)
    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.
    Keywords: Dollarization; de-dollarization; monetary policy
    JEL: E50 G20 G21 G28
    Date: 2010–11
  6. By: Ashima Goyal; 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
  7. By: Paul Castillo (Banco Central de Reserva del Perú); Carlos Montoro (Banco Central de Reserva del Perú and Bank for International Settlements)
    Abstract: In this paper we analyse the effects of informal labour markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, we incorporate the informal sector in a modified New Keynesian model with labour market frictions as in the Diamond-Mortensen-Pissarides model. Our main results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on aggregate wages and inflation. Finding that is consistent with the empirical literature on the e¤ects of informal labour markets in business cycle fluctuations. This result implies that in economies with large informal labour markets the interest rate channel of monetary policy is relatively weaker. Furthermore, the model produces cyclical flows from informal to formal employment consistent with the data.
    Keywords: Monetary Policy, New Keynesian Model, Informal Economy, Labour Market Frictions.
    JEL: E32 E50 J64 O17
    Date: 2010–09
  8. By: Peter Howells (University of the West of England, Bristol); Iris Biefang Frisancho-Mariscal (University of the West of England, Bristol)
    Abstract: In the fifteen years leading up to the financial crisis in 2008, there emerged a great deal of agreement on the optimal design of monetary policy. This policy ‘consensus’ was accompanied also by a widely-shared view of how macroeconomies worked as the ‘Keynesian’ versus ‘monetarist’ debates slipped into the past. This paper charts the emergence of this consensus and then looks at the way in which the apparently settled ideas of monetary policy have been disrupted by recent events. In particular, it looks at the way in which the crisis has forced a revision of both the targets and instruments of monetary policy.
    Keywords: Monetary policy, quantity theory, Phillips curve
    JEL: E4 E5
    Date: 2010–12
  9. By: Sa, Filipa (Trinity College, University of Cambridge; IZA); Wieladek, Tomasz (Bank of England)
    Abstract: A range of hypotheses have been put forward to explain the boom in house prices that occurred in the United States from the mid-1990s to 2007. This paper considers the relative importance of two of these hypotheses. First, global imbalances increased liquidity in the US financial system, driving down long-term real interest rates. Second, the Federal Reserve kept interest rates low in the first half of the 2000s. Both factors reduced the cost of borrowing and may have encouraged the boom in house prices. This paper develops an empirical framework to separate the relative contributions of these two factors to the US housing market. The results suggest that capital inflows to the United States played a bigger role in generating the increase in house prices than monetary policy loosening. Using VAR methods, we find that compared to monetary policy, the effect of a capital inflows shock on US house prices and residential investment is about twice as large and substantially more persistent. Results from variance decompositions suggest that, at a forecast horizon of 20 quarters, capital flows shocks explain 15% of the variation in real house prices, while monetary policy shocks explain only 5%. In a simple counterfactual exercise, we find that if the ratio of the current account deficit to GDP had remained constant since the end of 1998, real house prices by the end of 2007 would have been 13% lower. Similar exercises with constant policy rates and the path of policy rates implied by the Taylor rule deliver smaller effects.
    Keywords: house prices; capital inflows; monetary policy
    JEL: E50 F30
    Date: 2010–11–29
  10. By: Alexandros Kontonikas; Alexandros Kostakis
    Abstract: This study utilizes a macro-based VAR framework to investigate whether stock portfolios formed on the basis of their value, size and past performance characteristics are affected in a differential manner by unexpected US monetary policy actions during the period 1967-2007. Full sample results show that value, small capitalization and past loser stocks are more exposed to monetary policy shocks in comparison to growth, big capitalization and past winner stocks. Subsample analysis, motivated by variation in the realized premia and parameter instability, reveals that monetary policy shocks’ impact on these portfolios is significant and pronounced only during the pre-1983 period.
    Keywords: Monetary policy, Federal funds rate, Market anomalies, Credit channel, Risk premia
    JEL: E44 E58 G12
    Date: 2010–11
  11. By: Luis Catão; Roberto Chang
    Abstract: In recent years, large fluctuations in world food prices have renewed interest in the question of how monetary policy in small open economies should react to imported price shocks. We address this issue in an open economy setting similar to previous ones except that food plays a distinctive role in utility. A key novelty of our model is that the real exchange rate and the terms of trade can move in opposite directions in response to food price shocks. This has several consequences for observables and for policy. Under a variety of model calibrations, broad CPI targeting emerges as welfare-superior to alternative policy rules once the variance of food price shocks is as large as in real world data.
    JEL: E5 E6 F41
    Date: 2010–12
  12. By: Kafayat Amusa (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa); Rangan Gupta (Department of Economics, University of Pretoria); Shaakira Karaolia (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa); Beatrice D. Simo Kengne (Department of Economics, University of Pretoria and South African Treasury, Pretoria, South Africa)
    Abstract: This paper evaluates the hypothesis of long-run super-neutrality of money (LRSN) within the context of the South African economy. The long-run impact of inflation on the interest rate and subsequently, output is estimated by employing a trivariate structural vector autoregression model. The estimation results suggest that the hypothesis of LRSN cannot be rejected, thereby potentially supporting the arguments asserted by Sidrauski (1967).
    Keywords: money neutrality, structural vector autoregression
    JEL: E5 E31
    Date: 2010–12
  13. By: NUTAHARA Kengo
    Abstract: A recent study shows that equilibrium indeterminacy arises if monetary policy responds to asset prices, especially share prices, in a sticky-price economy. We show that equilibrium indeterminacy never arise if the working capital of firms is subject to their asset values by financial frictions.
    Date: 2010–12
  14. By: Erick Lahura (Central Bank of Peru and LSE)
    Abstract: The main goal of this paper is to analyze the effects of monetary policy shocks in Peru, taking into account two important issues that have been addressed separately in the VAR literature. The first one is the difficulty to identify the most appropriate indicator of monetary policy stance, which is usually assumed rather than determined from an estimated model. The second one is the fact that monetary policy decisions are based on the analysis of a wide range of economic and financial data, which is at odds with the small number of variables specified in most VAR models. To overcome the first issue, Bernanke and Mihov (1998) proposed a semi-structural VAR model from which the indicator of monetary policy stance can be derived rather than assumed. Meanwhile, the data problem has been resolved recently by Bernanke, Boivin and Eliasz (2005) using a Factor-Augmented Vector Autoregressive (FAVAR) model. In order to capture these two issues simultaneously, we propose an extension of the FAVAR model that incorporates a semi-structural identification approach a la Bernanke and Mihov, resulting in a VAR model that we denominate SS-FAVAR. Using data for Peru, the results show that the SS-FAVAR's impulse-response functions (IRFs) provide a more coherent picture of the effects of monetary policy shocks compared to the IRFs of alternative VAR models. Furthermore, it is found that innovations to nonborrowed reserves can be identified as monetary policy shocks for the period 1995-2003.
    Keywords: VAR, FAVAR, Monetary Policy, Semi-Structural Identification.
    JEL: C32 C43 E50 E52 E58
    Date: 2010–08
  15. By: Greg Hannsgen; Dimitri B. Papadimitriou
    Abstract: In recent years, the US public debt has grown rapidly, with last fiscal year's deficit reaching nearly $1.3 trillion. Meanwhile, many of the euro nations with large amounts of public debt have come close to bankruptcy and loss of capital market access. The same may soon be true of many US states and localities, with the governor of California, for example, publicly regretting that he has been forced to cut bone, and not just fat, from the state's budget. Chartalist economists have long attributed the seemingly limitless borrowing ability of the US government to a particular kind of monetary system, one in which money is a "creature of the state" and the government can create as much currency and bank reserves as it needs to pay its bills (this is not to say that it lacks the power to impose taxes). In this paper, we examine this situation in light of recent discussions of possible limits to the federal government's use of debt and the Federal Reserve's "printing press." We examine and compare the fiscal situations in the United States and the eurozone, and suggest that the US system works well, but that some changes must be made to macro policy if the United States and the world as a whole are to avoid another deep recession.
    Keywords: Budget Deficit; Federal Debt; Debt Tolerances
    JEL: E00 E32 E50 E62 E63
    Date: 2010–12
  16. By: Angelo Melino (University of Toronto; The Rimini Centre for Economic Analysis (RCEA))
    Abstract: The following is a report from a panel of the same title held at the Rimini Conference in Economics and Finance, Rimini, Italy, 10-13 June 2010, and organized by the Rimini Conference for Economic Analysis (RCEA). Panel Chair: Angelo Melino (University of Toronto and RCEA). Panelists: David Andolfatto (Vice President and Economist, Federal Reserve Bank of St. Louis; Professor of Economics, Simon Fraser University; RCEA), David E.W. Laidler (Professor Emeritus, University of Western Ontario; Fellow-in-Residence, C.D. Howe Institute; FRSC; Honorary Senior Fellow RCEA), John Murray (Deputy Governor, Bank of Canada).
    Date: 2010–01
  17. By: Mariam Camarero (Jaume I University); Josep Lluís Carrion-i-Silvestre (University of Barcelona); Cecilio Tamarit (University of Valencia)
    Abstract: A monetary union raises new economic questions about the interpretation and the implications of high current account de?cits for the economic performance of its members in the medium term. Recent literature has argued that conventional measures of external sustainability are misleading because they omit capital variations on net foreign asset positions. In this paper we analyze external sustainability making use of the database developed by Lane and Milesi-Ferretti (2007a) that incudes these valuation effects. The sample period studied covers from the launching of the monetary integration process in Europe (the creation of the ?European Snake? in 1972) up to 2007. The econometric methodology used accounts for the increasing cross-section dependence among EMU countries as well as possible structural breaks endogenously determined. The results point to the need of abrupt adjustments, either led by the markets or promoted by pro-active policy measures in order to o¤set external disequilibria. The lack of these timely interventions together with the rigidities and institutional imperfections of the present EMU are on the ground of the excessive cost in terms of growth and employment of the current crisis.
    Keywords: Current account imbalances, EMU, panel stationarity, structural breaks, cross-section dependence
    JEL: F32 F41 C23
    Date: 2010–12
  18. By: António Afonso; Manuel M. F. Martins
    Abstract: We study fiscal behaviour and the sovereign yield curve in the U.S. and Germany in the period 1981:I-2009:IV. The latent factors, level, slope and curvature, obtained with the Kalman filter, are used in a VAR with macro and fiscal variables, controlling for financial stress conditions. In the U.S., fiscal shocks have generated (i) an immediate response of the short-end of the yield curve, associated with the monetary policy reaction, lasting between 6 and 8 quarters, and (ii) an immediate response of the longend of the yield curve, lasting 3 years, with an implied elasticity of about 80% for the government debt ratio shock and about 48% for the budget balance shock. In Germany, fiscal shocks entail no significant reactions of the latent factors and no response of the monetary policy interest rate. In particular, while (i) budget balance shocks created no response from the yield curve shape, (ii) surprise increases in the debt ratio caused some increase in the short-end and the long-end of the yield curve in the following 2nd and 3rd quarters.
    Keywords: yield curve, fiscal policy, financial markets.
    JEL: E43 E44 E62 G15 H60
    Date: 2010–11
  19. By: Daniel Laskar
    Abstract: We consider a model where the central bank faces a credibility problem in its announcements, but also cares about its credibility and, therefore, wants to make truthful announcements. We show that, although the central bank would be able to perfectly transmit its information to the private sector through precise announcements, the central bank may nonetheless prefer to make imprecise announcements. This choice of the central bank would be suboptimal from the point of view of society. However, if the central bank gives enough weight to making truthful announcements, this suboptimality disappears, because the central bank would then prefer precise announcements to imprecise announcements.
    Date: 2010
  20. By: Arghyrou, Michael G (Cardiff Business School); Tsoukalas, John D.
    Abstract: This article, originally published at on 7 February 2010, spells out our two-currency EMU proposal as a plan of last resort for resolving the present EMU sovereign-debt crisis. The key ingredients of our proposal involve a temporary split of the euro into two currencies, both run by the European Central Bank. The hard euro will be maintained by the core-EMU members whereas periphery EMU countries will adopt for a suitable period of time the weak euro. All existing debts will continue to be denominated in strong-euro terms. The plan involves a one-off devaluation of the weak euro versus the strong one, simultaneously with the introduction of far-reaching reforms and rapid fiscal consolidation in the periphery EMU countries. We argue that due to enhanced market credibility, our two-tier euro plan has a realistic chance of success in resolving the EMU crisis, if all other approaches fail.
    Keywords: euro; two-currency EMU
    JEL: E44 F30
    Date: 2010–11

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