nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒01‒23
sixteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary policy implementation and overnight rate persistence By Nautz, Dieter; Scheithauer, Jan
  2. Communication for Multi-Taskers: Perspectives on Dealing with Both Monetary Policy and Financial Stability By Pierre L. Siklos
  3. Money Supply Rules and Exchange Rate Dynamics By Juha Tervala
  4. Non-standard monetary policy measures and monetary developments By Domenico Giannone; Michele Lenza; Huw Pill; Lucrezia Reichlin
  5. The (in)stability of money demand in the Euro area By Nautz, Dieter; Rondorf, Ulrike
  6. Should Canadian Monetary Policy Respond to Asset Prices? Evidence from a Structural Model By Fiodendji, Komlan
  7. Interest Rate Policy and Supply-side Adjustment Dynamics By Daniel Kienzler; Kai Daniel Schmid
  8. Money and Memory: Implicit Agents in Search Theories of Money By Heiner Ganßmann
  9. Sticky Information and Determinacy By Alexander Meyer-Gohde
  10. Non‐Standard Monetary Policy Measures By Domenico Giannone; Michèle Lenza; Huw Pill; Lucrezia Reichlin
  11. A De Facto Asian-Currency Unit Bloc in East Asia: It Has Been There but We Did Not Look for It By Girardin, Eric
  12. To devalue or not to devalue? How East European countries responded to the outflow of capital in 1997-99 and in 2008-09 By Popov, Vladimir
  13. Money Illusion and Rational Expectations: New Evidence from Well Known Survey Data By Novella Maugeri
  14. Public Debt Dynamics and Debt Feedback By Reda, Cherif; Fuad, Hasanov
  15. Exit Strategies By Ignazio Angeloni; Ester Faia; Roland Winkler
  16. Getting beyond carry trade: what makes a safe haven currency? By Maurizio Michael Habib; Livio Stracca

  1. By: Nautz, Dieter; Scheithauer, Jan
    Abstract: Overnight money market rates are the predominant operational target of monetary policy. As a consequence, central banks have redesigned the implementation of monetary policy to keep the deviations of the overnight rate from the key policy rate small and short-lived. This paper uses fractional integration techniques to explore how the operational framework of four major central banks affects the persistence of overnight rates. Our results suggest that a well-communicated and transparent interest rate target of the central bank is a particularly important condition for a low degree of overnight rate persistence. --
    Keywords: Controllability and Persistence of Interest Rates,Operational Framework of Central Banks,Long Memory and Fractional Integration
    JEL: E52 C22
    Date: 2010
  2. By: Pierre L. Siklos (Wilfrid Laurier University and Viessmann European Research Centre, Waterloo, ON, Canada; The Rimini Centre for Economic Analysis (RCEA), Rimini, Italy)
    Abstract: This paper examines the communications challenges facing central banks who will be sharing responsibilities with other agencies for macro-prudential objectives, in addition to conventional monetary policy goals. Following a description and analysis of surveys of central banks, and the attributes that make up an index of central bank transparency, some policy proposals are made. It is argued that a hybrid of inflation and price level targeting, combined with a requirement by the macro-prudential regulators to issue press releases much like central banks publish an announcement and rationale for the setting of monetary policy instruments, may improve the central bank communication in a post-crisis world.
    Keywords: central bank communication, transparency, price level targeting
    JEL: E52 E58 E65
    Date: 2011–01
  3. By: Juha Tervala
    Abstract: This paper examines the implications of monetary policy rules for exchange rate dynamics. I extend a standard New Open Economy Macroeconomics model with the introduction of a simple money supply rule, whereby central banks change their monetary policy if output diverges from potential output or if inflation diverges from the target inflation. A key result is that, in the case of permanent technology and monetary shocks, the nominal exchange rate does not follow a random walk; instead, the exchange rate undershoots its long-run value. An undershooting of the exchange rate derives from the active monetary policy that both countries conduct.
    Keywords: Monetary policy rules, open economy macroeconomics, exchange rate
    JEL: E5 F3 F4
    Date: 2010–12
  4. By: Domenico Giannone (Université Libre de Bruxelles – ECARES, Avenue Roosevelt CP 114 Brussels, Belgium.); Michele Lenza (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Huw Pill (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Lucrezia Reichlin (London Business School)
    Abstract: Standard accounts of the Great Depression attribute an important causal role to monetary policy errors in accounting for the catastrophic collapse in economic activity observed in the early 1930s. While views vary on the relative importance of money versus credit contraction in the propagation of this policy error to the wider economy and ultimately price developments, a broad consensus exists in the economics profession around the view that the collapse in financial intermediation was a crucial intermediary step. What lessons have monetary policy makers taken from this episode? And how have they informed the conduct of monetary policy by leading central banks in recent times? This paper sets out to address these questions, in the context of the financial crisis of 2008-09 and with application to the euro area. It concludes that the Eurosystem’s non-standard monetary policy measures have supported monetary policy transmission and avoided the calamity of the 1930s. JEL Classification: E5, E4, E32.
    Keywords: Non-standard monetary policy, monetary policy shocks, Great Recession, money and credit.
    Date: 2011–01
  5. By: Nautz, Dieter; Rondorf, Ulrike
    Abstract: The instability of standard money demand functions has undermined the role of monetary aggregates for monetary policy analysis in the euro area. This paper uses country-specific monetary aggregates to shed more light on the economics behind the instability of euro area money demand. Our results obtained from panel estimation indicate that the observed instability of standard money demand functions could be explained by omitted variables like e.g. technological progress that are important for money demand but constant across member countries. --
    Keywords: Money demand,cross-country analysis,panel error correction model,euro area
    JEL: E41 E51 E52
    Date: 2010
  6. By: Fiodendji, Komlan
    Abstract: Although the Bank of Canada admits asset prices are considered in its policy deliberations because of their effects on inflation or output gap, the Bank of Canada denies trying to stabilize asset prices around fundamental values. However, since the start of the Bank of Canada we have seen a boom as well as a bust in the stock market. Are we to believe that the Bank of Canada did not react to these stock market fluctuations, apart from their impact consequences on economy? We investigate this issue by using a structural model based on the New Keynesian framework that is augmented by a stock market variable. We use an econometric method that allows us to distinguish the direct effect of stock prices on Bank of Canada policy rates from indirect effects via inflation or GDP. Our results suggest that stock market stabilization plays a larger role in Bank of Canada interest rate decisions than it is willing to admit. Furthermore, these results should give new relevant insights into the influence of stock market index prices on monetary policy in Canada and should provide relevant insights regarding the opportunities and limitations of incorporating financial indicators in monetary policy decision making. They should give financial market participants, such as analysts, bankers and traders, a better understanding of the impact of stock market index prices on the Bank of Canada policy. The results imply that the preferences of the monetary authority have changed between the different subperiods. In particular, the parameter associated with the implicit target of inflation has been reduced significantly. The findings suggest that the introduction of inflation targeting in Canada was accompanied by a fundamental change in the objectives of monetary policy, not only with respect to the average target, but also in terms of precautions taken to keep inflation in check in the face of uncertainty about the economy.
    Keywords: Asset prices; Monetary policy; Central bank preferences; inflation targeting
    JEL: E0 E5 E52
    Date: 2011–01–06
  7. By: Daniel Kienzler; Kai Daniel Schmid
    Abstract: In contrast to the present consensus view of stabilization policy, theoretical and empirical research strongly support the consideration of supply-side adjustment to pronounced variations of factor-utilization in order to trace a more realistic pattern of macroeconomic adjustment dynamics within simulation studies. Against this background, our paper seeks to illuminate the relevance of endogenous supply-side adjustment for monetary policy research. We modify a basic New Keynesian model by explicitly considering demand-side stimulus on the evolution of productive capacity and analyze stability, impulse response, and welfare issues if the central bank follows a simple monetary policy rule. Thereby, we control for the robustness of our policy implications by various states of output gap mismeasurement the central bank might be confronted with. We find that, in contrast to a basic New Keynesian Model, output gap stabilization plays a more prominent role when potential output is endogenous.
    Keywords: monetary policy, factor-utilization, endogenous potential output, output gap mismeasurement
    JEL: E32 E50 E52
    Date: 2010–12
  8. By: Heiner Ganßmann (Institut für Soziologie, Freie Universität Berlin)
    Abstract: Recent search theoretical models of monetary economies promise micro-foundations and thus a decisive improvement in the theory of money compared to the traditional mainstream approach that starts from a Walrasian general equilibrium framework to introduce money exogenously at the macro level. The promise of micro-foundations is not fulfilled, however. It can be shown that search models implicitly refer to central, most likely collective, agents doing essential work to sustain the monetary economy.
    Keywords: micro-foundations, multi-agent modelling, model, macro, monetary economy, money, information, network
    Date: 2010–07
  9. By: Alexander Meyer-Gohde
    Abstract: The infinite-dimensional sticky-information Phillips curve is cast as a finite-dimensional timevarying system of difference equations in order to directly assess determinacy in the model with demand given by the forward-looking IS equation and monetary policy by an interest rate rule. An equivalence to the model without lagged expectations holds (albeit tenuously) for the particular specification and a common truncation method produces spurious determinacy.
    Keywords: Determinacy, Taylor rule, Sticky Information, Time-Varying Difference Equations
    JEL: C62 E31 E43 E52
    Date: 2011–01
  10. By: Domenico Giannone; Michèle Lenza; Huw Pill; Lucrezia Reichlin
    Date: 2011–01
  11. By: Girardin, Eric (Asian Development Bank Institute)
    Abstract: Pegging in a coordinated way to a regional basket currency is considered by many as optimal for east-Asian countries. By contrast, according to existing empirical studies, these countries have most often relied on non-cooperative United States dollar or G3 pegs. We show for the first time that by the late 1990s, with some reversals, a majority of east-Asian countries had already moved, de facto, away from the dollar peg and started targeting a basket, including east-Asian currencies (an “Asian Currency Unit”). Common-shock or market-based interpretations of such moves are ruled out since we document that, with few exceptions, countries in the region have in reality stuck to fixed exchange rates. We obtain such results using a Markov-switching estimation benchmarked against Bai-Perron structural break tests for the synthesis model of Frankel and Wei (2007), which augments the inference about currency weights in a basket with the weight on exchange-market pressure. In order to measure the latter, the forward positions of central banks in the foreign exchange market are taken into account.
    Keywords: asian currency unit; east asian currencies; exchange rate regimes
    JEL: F31 F41
    Date: 2011–01–14
  12. By: Popov, Vladimir
    Abstract: If there is a negative terms of trade or financial shock leading to the deterioration in the balance of payments, there are two basic options for a country that has limited foreign exchange reserves. First, a country can maintain a fixed exchange rate (or even a currency board) and wait until the reduction of foreign exchange reserves leads to the reduction of money supply: this will drive domestic prices down and stimulate exports, raise interest rates and stimulate the inflow of capital, and finally will correct the balance of payments. Second, the country can allow the devaluation of national currency – flexible exchange rate will automatically bring the balance of payments back into the equilibrium. Because national prices are less flexible than exchange rates, the first type of adjustment is associated with the greater reduction of output. The empirical evidence on East European countries and other transition economies for 1998-99 period (outflow of capital after the 1997 Asian and 1998 Russian currency crises and slowdown of output growth rates) suggests that the second type of policy response (devaluation) was associated with smaller loss of output than the first type (monetary contraction). 2008-09 developments provide additional evidence for this hypothesis.
    Keywords: Devaluation; capital account shocks; fixed and flexible exchange rates; macroeconomic response to shocks
    JEL: F42 F32 F41 F31 F43
    Date: 2010
  13. By: Novella Maugeri
    Abstract: This paper provides further evidence in favor of less than fully rational expectations by making use two instruments, one quite well known, and the other more novel, namely survey data on inflation expectations and Smooth Transition Error Correction Models (STECMs). We use the so called ‘probabilistic approach’ to derive a quantitative measure of expected inflation from qualitative survey data for France, Italy and the UK. The United States are also included by means of the Michigan Survey of Consumers’ expectations series. First, we perform the standard tests to assess the ‘degree of rationality’ of consumers’ inflation forecasts. Afterwards, we specify a STECM of the forecast error, and we quantify the strategic stickiness in the long-run adjustment process of expectations stemming from money illusion. Our evidence is that consumers’ expectations do not generally conform to the prescriptions of the rational expectations hypothesis. In particular, we find that the adjustment process towards the long-run equilibrium is highly nonlinear and it is asymmetric with respect to the size of the past forecast errors. We interpret these findings as supporting the money illusion hypothesis.
    Keywords: Nonlinear error correction, inflation expectations, sticky expectations
    JEL: C22 D84 E31
    Date: 2010–12
  14. By: Reda, Cherif; Fuad, Hasanov
    Abstract: We study the dynamics of U.S. public debt in a parsimonious VAR. We find that including debt feedback ensures the stationarity of debt while standard VARs excluding debt may imply an explosive debt path. We also find that the response of debt to inflation or interest shocks is not robust and depends on the policy regime. The recent past suggests that a positive shock to inflation increases debt while the same to interest rate decreases it. Positive shocks to growth and primary surplus unambiguously reduce debt.
    Keywords: debt; fiscal policy; growth; VAR; generalized impulse responses
    JEL: E62 C32 H60
    Date: 2010–12
  15. By: Ignazio Angeloni; Ester Faia; Roland Winkler
    Abstract: We study alternative scenarios for exiting the post-crisis fiscal and monetary accommodation using the model of Angeloni and Faia (2010), that combines a standard DSGE framework with a fragile banking sector, suitably modified and calibrated for the euro area. Credibly announced and fast fiscal consolidations dominate – based on simple criteria – alternative strategies incorporating various degrees of gradualism and surprise. The fiscal adjustment should be based on spending cuts or else be relatively skewed towards consumption taxes. The phasing out of monetary accommodation should be simultaneous or slightly delayed. We also find that, contrary to widespread belief, Basel III may well have an expansionary macroeconomic effect
    Keywords: exit strategies, debt consolidation, fiscal policy, monetary policy, capital requirements, bank runs
    JEL: E63
    Date: 2011–01
  16. By: Maurizio Michael Habib (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Livio Stracca (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: There is already a substantial literature documenting the fact that low yield currencies typically appreciate during times of global financial stress and behave as safe havens. The main objective of this paper is to find out what the fundamentals of safe haven currencies are. We analyse a large panel of 52 currencies in advanced and emerging countries over almost 25 years of data. We find that only a few factors are robustly associated to a safe haven status, most notably the net foreign asset position, an indicator of external vulnerability, and to a lesser extent the absolute size of the stock market, an indicator of market size and development. The interest rate spread against the US is significant only for advanced countries, whose currencies are subject to carry trade. More generally, we find that it is hard to predict what currencies would do when global risk aversion is high, as estimates are imprecise and often not stable or robust. This suggests caution in over-interpreting exchange rate movements during financial crises. JEL Classification: E44, F31, G15.
    Keywords: VIX, global risk aversion, safe haven currencies, carry trade, globalisation.
    Date: 2011–01

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