nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒01‒16
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary aggregates and monetary policy: an empirical assessment for Peru By Lahura, Erick
  2. The Threat of 'Currency Wars': a European Perspective By Zsolt Darvas; Jean Pisani-Ferry
  3. Inflation Targeting By Lars E.O. Svensson
  4. Monetary policy implementation and uncovered interest parity: empirical evidence from Oceania By Alfred Guender; Bevan Cook
  5. On the Response of Economic Aggregates to Monetary Policy Shocks By Zainab Jehan; Abdul Rashid
  6. The Bank Lending Channel in Peru: evidence and transmission mechanism By Carrera, Cesar
  7. Expansionary Monetary Policy Under Liquidity Trap: 2009 in Light of 1929. A Counterfactual Analysis. By Claude Diebolt; Antoine Parent; Jamel Trabelsi
  8. Monetary Policy, inflation and unemployment By Nicolas Groshenny
  9. Learning about monetary policy rules when labor market search and matching frictions matter By Takushi Kurozumi; Willem Van Zandweghe
  10. Determinacy under inflation targeting interest rate policy in a sticky price model with investment (and labor bargaining) By Takushi Kurozumi; Willem Van Zandweghe
  11. How Are Inflation Targets Set? By Roman Horváth; Jakub Matějů
  12. Macro-finance models of interest rates and the economy By Hess Chung; Jean-Philippe Laforte; David Reifschneider; John C. Williams
  13. U.S. Foreign-Exchange-Market Intervention and the Early Dollar Float: 1973 – 1981 By Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
  14. How Amsterdam got fiat money By Stephen Quinn; William Roberds
  15. Policymaking from a "macroprudential" perspective in emerging market economies By Ramon Moreno
  16. Does the Kiwi fly when the Kangaroo jumps? The effect of Australian macroeconomic news on the New Zealand dollar By Andrew Coleman; Özer Karagedikli
  17. The minimum liquidity deficit and the maturity structure of central banks' open market operations: lessons from the financial crisis By Jens Eisenschmidt; Cornelia Holthausen
  18. The role of the chinese dollar peg for macroeconomic stability in China and the world economy By Gunther Schnabl
  19. What drives core inflation? A dynamic factor model analysis of tradable and nontradable prices By Michael Kirker
  20. Revisiting the 1929 Crisis: Was the Fed Pre-Keynesian? New Lessons from the Past. By Claude Diebolt; Antoine Parent; Jamel Trabelsi

  1. By: Lahura, Erick (Banco Central de Reserva del Perú)
    Abstract: In recent years the theoretical and empirical literature has shown a tendency to discard the use of money in monetary policy. This paper provides an empirical evaluation of the relevance of monetary aggregates in the conduct of monetary policy in Peru, a small open and partially dollarized economy. Based on recursive analysis of vector error correction models and allowing for structural breaks, we find that M3 is the only monetary aggregate that helps forecast inflation in Peru and therefore can be useful in monetary policy. There is no clear evidence about the usefulness of any other narrower monetary aggregate either as a potential monetary policy instrument or as an information variable.
    Keywords: cointegration, dollarization, Granger causality, monetary aggregates, monetary policy, structural change, weak and strong exogeneity
    JEL: C32 E52 E58
    Date: 2010–12
  2. By: Zsolt Darvas; Jean Pisani-Ferry
    Abstract: The 'currency war', as it has become known, has three aspects: 1) the inflexible pegs of undervalued currencies; 2) recent attempts by floating exchange-rate countries to resist currency appreciation; 3) quantitative easing. Europe should primarily be concerned about the first issue, which relates to the renewed debate about the international monetary system. The attempts of floating exchange-rate countries to resist currency appreciation are generally justified while China retains a peg. Quantitative easing cannot be deemed a 'beggar-thy-neighbour' policy as long as the Fed’s policy is geared towards price stability. Current US inflationary expectations are at historically low levels. Central banks should come to an agreement about the definition of price stability at a time of deflationary pressures. The euro’s exchange rate has not been greatly impacted by the recent currency war; the euro continues to be overvalued, but less than before.
    Keywords: currency war, quantitative easing, currency intervention, international monetary system
    JEL: E52 E58 F31 F33
    Date: 2010–12–15
  3. By: Lars E.O. Svensson
    Abstract: Inflation targeting is a monetary-policy strategy that is characterized by an announced numerical inflation target, an implementation of monetary policy that gives a major role to an inflation forecast and has been called forecast targeting, and a high degree of transparency and accountability. It was introduced in New Zealand in 1990, has been very successful in terms of stabilizing both inflation and the real economy, and has, as of 2010, been adopted by about 25 industrialized and emerging-market economies. The chapter discusses the history, macroeconomic effects, theory, practice, and future of inflation targeting.
    JEL: E42 E43 E47 E52 E58
    Date: 2010–12
  4. By: Alfred Guender; Bevan Cook (Reserve Bank of New Zealand)
    Abstract: The close integration of Australian and New Zealand financial markets and the similarity of the monetary policy regimes provide the perfect backdrop for testing the empirical relevance of uncovered interest rate parity (UIP) in Oceania. We find that changes in the bilateral exchange rate have become more sensitive to the short-term interest differential over time. Most important, after the introduction of the Official Cash Rate regime in New Zealand, the responsiveness of the exchange rate has accelerated to such an extent that it is incompatible with UIP. Evidence on UIP over longer horizons is mixed with a 10-year horizon since 1990 providing the strongest support for the theory.
    JEL: F31 F36 E52
    Date: 2010–12
  5. By: Zainab Jehan; Abdul Rashid
    Abstract: This study empirically investigates how shocks to monetary policy measures (short-term nominal interest rate and broad money supply) affect economic aggregates: output growth, price levels and nominal exchange rate. The study is carried out for Pakistan using quarterly data covering the period from 1980 to 2009. In doing this, Johansen’s (1988) co integration technique and vector error correction model are applied to explore the long-run relationship among the variables. We find significant evidence on the existence of a long-run stable relationship between our monetary measures and economic aggregates. The impulse response functions (IRFs) are computed to examine the response of each macroeconomic variable to a standard deviation shock to monetary measures. The IRF graphs reveal a price puzzle in closed as well as in open economy model. However, an initial appreciation of exchange rate is observed, indicating the overshooting hypothesis phenomenon for Pakistan.
    Keywords: Monetary Policy, Economic Aggregates, VECM, Impulse Response Function.
    JEL: C3 E4 E5
    Date: 2011–01–01
  6. By: Carrera, Cesar (Banco Central de Reserva del Perú)
    Abstract: In the past ten years the Peruvian economy has experienced important structural changes regarding monetary policy. This document focuses on the bank lending channel as part of the transmission process to macroeconomic activity in the Peruvian economy based on Bernanke, Gertler, and Gilchrist (1996) flight-to-quality argument. The purpose of this work is to identify the bank lending channel (using bank level data), and test its relevance for understanding the transmission to economic activity by comparing monetary policy effects under two scenarios; with and without a bank lending channel (using structural autoregressive vectors). As in Gambacorta (2005), I consider a sample period in which a policy variable can capture the monetary policy stance of the central bank. For the case of Peru, I conclude that the bank lending channel has operated but this channel is not important for identifying the transmission process from monetary policy to macroeconomic activity.
    Keywords: Monetary policy transmission, Bank lending channel, flight-to-quality, panel of banks
    JEL: C22 C23 E44 E51 E52 E58
    Date: 2010–12
  7. By: Claude Diebolt (BETA/CNRS, Université de Strasbourg, France.); Antoine Parent; Jamel Trabelsi
    Date: 2010
  8. By: Nicolas Groshenny (Reserve Bank of New Zealand)
    Abstract: To what extent did deviations from the Taylor rule between 2002 and 2006 help to promote price stability and maximum sustainable employment? To address that question, this paper estimates a New Keynesian model with unemployment and performs a counterfactual experiment where monetary policy strictly follows a Taylor rule over the period 2002:Q1 - 2006:Q4 The paper finds that such a policy would have generated a sizeable increase in unemployment and resulted in an undesirably low rate of inflation. Around mid-2004, when the counterfactual deviates the most from the actual series, the model indicates that the probability of an unemployment rate greater than 8 percent would have been as high as 80 percent, while the probability of an inflation rate above 1 percent would have been close to zero.
    JEL: E32 C51 C52
    Date: 2010–12
  9. By: Takushi Kurozumi; Willem Van Zandweghe
    Abstract: This paper examines implications of incorporating labor market search and matching frictions into a sticky price model for determinacy and E-stability of rational expectations equilibrium (REE) under interest rate policy. When labor adjustment takes place solely at the extensive margin, forecast-based policy that meets the Taylor principle is likely to induce indeterminacy and E-instability, regardless of whether it is strictly or flexibly inflation targeting. When labor adjustment takes place at both the extensive and intensive margins, the strictly inflation-forecast targeting policy remains likely to induce indeterminacy, but it generates a unique E-stable fundamental REE as long as the Taylor principle is satisfied. These results suggest that introducing the search and matching frictions alter determinacy properties of the strictly inflation-forecast targeting policy, but not its E-stability properties in the presence of the intensive margin of labor.
    Date: 2010
  10. By: Takushi Kurozumi; Willem Van Zandweghe
    Abstract: In a sticky price model with investment spending, recent research shows that inflation-forecast targeting interest rate policy makes determinacy of equilibrium essentially impossible. We examine a necessary and sufficient condition for determinacy under interest rate policy that responds to a weighted average of an inflation forecast and current inflation. This condition demonstrates that the average-inflation targeting policy ensures determinacy as long as both the response to average inflation and the relative weight of current inflation are large enough. We also find that interest rate policy which responds solely to past inflation guarantees determinacy when its response satisfies the Taylor principle and is not large. These results still hold even when wages and hours worked are determined by Nash bargaining.
    Date: 2010
  11. By: Roman Horváth (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Czech National Bank); Jakub Matějů (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic; Czech National Bank)
    Abstract: This paper aims to contribute to a better understanding on how inflation targets are set. For this reason, we first gather evidence from official central bank and government publications and from a questionnaire sent to central banks on how inflation targets are set; we then estimate the determinants of the level of inflation target in 19 inflation targeting countries using unbalanced panel interval regressions (to deal with the issue that targets are typically set as a range rather than as a point). Inflation targets are found to reflect macroeconomic fundamentals. Higher level as well as higher variability of inflation are associated with higher target. The setting of the inflation target is also found to have an important international dimension, as higher world inflation is positively correlated with inflation targets. Rapidly growing countries exhibit higher inflation targets. Our results also suggest that the larger width of inflation target is set in a more volatile macroeconomic environment. We find that central bank credibility is negatively associated with the level of inflation target, suggesting that less credible central banks are likely to recognize the risks related to anchoring inflation expectations at low levels. On the other hand, government party orientation does not matter even in less independent central banks.
    Keywords: inflation targeting, central bank, inflation, credibility, independence
    JEL: E31 E42 E52 E58
    Date: 2011–01
  12. By: Hess Chung; Jean-Philippe Laforte; David Reifschneider; John C. Williams
    Abstract: Before the recent recession, the consensus among researchers was that the zero lower bound (ZLB) probably would not pose a significant problem for monetary policy as long as a central bank aimed for an inflation rate of about 2 percent; some have even argued that an appreciably lower target inflation rate would pose no problems. This paper reexamines this consensus in the wake of the financial crisis, which has seen policy rates at their effective lower bound for more than two years in the United States and Japan and near zero in many other countries. We conduct our analysis using a set of structural and time series statistical models. We find that the decline in economic activity and interest rates in the United States has generally been well outside forecast confidence bands of many empirical macroeconomic models. In contrast, the decline in inflation has been less surprising. We identify a number of factors that help to account for the degree to which models were surprised by recent events. First, uncertainty about model parameters and latent variables, which were typically ignored in past research, significantly increases the probability of hitting the ZLB. Second, models that are based primarily on the Great Moderation period severely understate the incidence and severity of ZLB events. Third, the propagation mechanisms and shocks embedded in standard DSGE models appear to be insufficient to generate sustained periods of policy being stuck at the ZLB, such as we now observe. We conclude that past estimates of the incidence and effects of the ZLB were too low and suggest a need for a general reexamination of the empirical adequacy of standard models. In addition to this statistical analysis, we show that the ZLB probably had a first-order impact on macroeconomic outcomes in the United States. Finally, we analyze the use of asset purchases as an alternative monetary policy tool when short-term interest rates are constrained by the ZLB, and find that the Federal Reserve's asset purchases have been effective at mitigating the economic costs of the ZLB. In particular, model simulations indicate that the past and projected expansion of the Federal Reserve's securities holdings since late 2008 will lower the unemployment rate, relative to what it would have been absent the purchases, by 1-1/2 percentage points by 2012. In addition, we find that the asset purchases have probably prevented the U.S. economy from falling into deflation.
    Keywords: Inflation (Finance) ; Macroeconomics - Econometric models
    Date: 2011
  13. By: Michael D. Bordo; Owen F. Humpage; Anna J. Schwartz
    Abstract: The dollar’s depreciation during the early floating rate period, 1973 – 1981, was a symptom of the Great Inflation. In that environment, sterilized foreign exchange interventions were ineffective in halting the dollar’s decline, but showed a limited ability to smooth dollar movements. Only after the Volcker FOMC changed its monetary-policy approach and demonstrated a willingness to maintain a disinflationary stance despite severe economic weakness and high unemployment did the dollar begin a sustained appreciation. Also contributing to the ineffectiveness of the interventions was the Desk’s method of operation. The small, covert interventions, particularly prior to 1977, seemed inconsistent with an expectations channel of influence, and financing intervention with short-term borrowed funds seemed inconsistent with a portfolio-balance channel of influence. The Desk never clearly articulated an intervention transmission mechanism. The episode indicated the shortcomings of sterilized intervention and led to their cessation in April 1981.
    JEL: F3 N1 N2
    Date: 2010–12
  14. By: Stephen Quinn; William Roberds
    Abstract: We investigate a fiat money system introduced by the Bank of Amsterdam in 1683. Using data from the Amsterdam Municipal Archives, we partially reconstruct changes in the bank's balance sheet from 1666 through 1702. Our calculations show that the Bank of Amsterdam, founded in 1609, was engaged in two archetypal central bank activities—lending and open market operations—both before and after its adoption of a fiat standard. After 1683, the bank was able to conduct more regular and aggressive policy interventions, from a virtually nonexistent capital base. The bank's successful experimentation with a fiat standard foreshadows later developments in the history of central banking.
    Date: 2010
  15. By: Ramon Moreno
    Abstract: Recurrent capital inflows pose important challenges for authorities in emerging market economies seeking to preserve financial stability. Raising interest rates to dampen imbalances that could arise from capital flows can also attract more capital inflows and accentuate appreciation pressures. For this reason authorities have used a number of instruments to mitigate the effects of capital flows, all with financial stability implications. Many of these instruments (eg reserve requirements) may have been used for other purposes but the global financial crisis has raised interest in examining them from a financial stability, or "macroprudential" perspective. This paper reviews some of these instruments, drawing in part on material provided by central banks to the BIS. The instruments include foreign exchange market intervention and foreign reserve accumulation; measures to strengthen bank balance sheets and capital and measures to maintain the quality of credit or to ifnluence credit growth or allocation, and capital controls. Certain implementation issues are also discussed, including signals to respond to, timing of prudential measures and procyclicality and effectiveness and calibration. An unresolved question is how the instruments described are to be used in conjunction with interest rate policy. Over the medium term, these instruments raise concerns because they may impair the development of the financial system.
    Keywords: capital flows, monetary policy, macroprudential
    Date: 2011–01
  16. By: Andrew Coleman; Özer Karagedikli (Reserve Bank of New Zealand)
    Abstract: We conduct an event study that examines how the New Zealand - US (NZ/US) and the Australia - US (AU/US) exchange rates responds to the release of Australian macroeconomic news including the CPI, GDP, trade balance, and monetary policy decisions. We use two different measures of the unanticipated component of the news announcements. First, we use the difference between the actual value of the data and a survey of market participants' expectations of that data announcement. Second, we use the immediate response of the AU/US exchange rate to the news announcement.Our study has three main conclusions: 1) We show that the effects of the macro news in one country can also transmit to another country via the non-bilateral exchange rate (probably in anticipation of future spill-over effects). 2) Combined with results that show that the AU/US exchange rate responds by very little to New Zealand news, the results suggest that the low variation in the New Zealand - Australia cross rate is because both currencies respond in a similar fashion to Australian (but not New Zealand) macroeconomic data. 3) We highlight the problems associated with the events studies in which the surprises are calculated from a market price and propose a new estimator that overcomes this problem.
    JEL: C11 C13 C53
    Date: 2010–12
  17. By: Jens Eisenschmidt (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Cornelia Holthausen (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This paper studies the relationship between the size of the banking sector’s refinancing needs vis-à-vis the central bank and auction rates in its open market operations in times of financial market stress. In a theoretical model, it is found that marginal rates at central bank auctions may increase if the share of troubled banks becomes too high relative to the total size of the banking sector’s refinancing needs. An empirical analysis then aims at determining the size of open market operations needed to absorb large stress levels in interbank money markets and hence contain central bank auction rates. Finally, the paper analyses effects of the composition of open market operations of different maturities on auction rates. It is found that a too high share of longer-term refinancing induces a rise in auction rates which is undesirable. Therefore, the analysis suggests that there is a lower bound for the amount of liquidity provided through short-term operations. JEL Classification: G01, G10, G21.
    Keywords: central bank, money market, open market operations, financial crisis.
    Date: 2010–12
  18. By: Gunther Schnabl (Institute for Economic Policy, University of Leipzig)
    Abstract: During the 1997/98 Asian crisis and the 2007-2010 world financial and economic crisis, China has proved to be a stabilizer for East Asia and the world. The paper stresses the crucial role of the dollar peg for macroeconomic stability in China. The paper explores the current role of China's nominal exchange rate stabilization as stabilizing factor for China, East Asia and the world economy. Distortions originating in real exchange rate stabilization are identified and are argued to be a risk for global growth perspectives. To prevent further economic and financial turmoil the paper recommends policy coordination between China and the US. The exit from unconventional low interest rate policies in the US combined with the end of real (but not nominal) exchange rate stabilization in China is seen as necessary to stabilize longterm growth in China, East Asia and the US.
    Keywords: China, dollar peg, structural distortions, international policy coordination, global imbalances
    JEL: F15 F31 F33
    Date: 2011–01–10
  19. By: Michael Kirker (Reserve Bank of New Zealand)
    Abstract: I develop a new estimate of core inflation for New Zealand and Australia based on a dynamic factor model. By using an over-identification restriction, the factors of the model are classified as tradable and nontradable factors. This innovation allows us to examine the relative contributions of tradable and nontradable prices towards core inflation. The results show that core inflation in both countries is primarily driven by the nontradable factor. The nontradable factor also explains significantly more of the variance in headline inflation relative to the tradable factor. Finally, both the tradable and nontradable factors show similar profiles across both countries suggesting common drivers.
    JEL: C11 E31 E52
    Date: 2010–12
  20. By: Claude Diebolt (BETA/CNRS, Université de Strasbourg, France.); Antoine Parent; Jamel Trabelsi
    Date: 2010

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