nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒02‒26
34 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Optimal Central Bank Lending By Andreas Schabert
  2. The Opportunistic approach to monetary policy and financial markets By Kasai Ndahiriwe; Ruthira Naraidoo
  3. Monetary policy transmission in an emergingmarket setting By Ila Patnaik; Ajay Shah; Rudrani Bhattacharya
  4. Identifying the Weights in Exchange Market Pressure By Franc Klaassen
  5. Monetary Policy, Trend Inflation and Inflation Persistence By Fang Yao
  6. The Effects of Housing Prices and Monetary Policy in a Currency Union By Pau Rabanal; Oriol Aspachs-Bracons
  7. Central Bank Balances and Reserve Requirements By Simon Gray
  8. Quantitative easing in the United States after the crisis: conflicting views. By Domenica Tropeano
  9. Interpreting Currency Movements During the Crisis: What's the Role of Interest Rate Differentials? By Nicoletta Batini; Thomas Dowling
  10. Firm Entry, Inflation and the Monetary Transmission Mechanism By Vivien LEWIS; Céline POILLY
  11. AMU and Monetary Cooperation in Asia By Eiji Ogawa; Junko Shimizu
  12. Estimating monetary policy reaction functions : A discrete choice approach By Jef Boeckx
  13. The 2007-? financial crisis: a money market perspective By Nuno Cassola; Claudio Morana
  14. Exchange Rate Policy under Sovereign Default Risk By Andreas Schabert
  15. Inflation Perceptions and Expectations in Sweden - Are Media Reports the ‘Missing Link’? By Lena Dräger
  16. Targets, Policy Lags and Sticky Prices in a Two-Equation Model of US Stabilization Policy By David Kiefer
  17. The Impact of Monetary Policy on Economic Activity - Evidence from a Meta-Analysis By Masagus M. Ridhwan; Henri L.F. de Groot; Peter Nijkamp
  18. Learning About Inflation Measures for Interest Rate Rules By Luis-Felipe Zanna; Marco Airaudo
  19. Money and Keynesian Uncertainty By Lucarelli, B.
  20. What are the Effects of Monetary Policy Shocks? Evidence from Dollarized Countries By Tim Willems
  21. Optimal Monetary and Fiscal Policies in a Search-Theoretic Model of Money and Unemployment By Pedro Gomis-Porqueras; Benoit Julien; Chengsi Wang
  22. Where It All Began: Lending of Last Resort and the Bank of England during the Overend, Gurney Panic of 1866 By Marc Flandreau, Stefano Ugolini
  23. An Empirical The Restoration of the Gold Standard after the US Civil War: A Volatility Analysis By Max Meulemann; Martin Uebele; Bernd Wilfling
  24. The promise and performance of the Federal Reserve as Lender of Last Resort 1914-1933 By Michael D. Bordo; David C. Wheelock
  25. Anticipated Alternative Policy-Rate Paths in Policy Simulations By Laséen, Stefan; Svensson, Lars E.O.
  26. Accession to the European Union, Interest Rates and Indebtedness: Greece and Portugal By Pedro Bação; António Portugal Duarte
  27. Capital Account Liberalization and the Role of the RMB By Nicholas Lardy; Patrick Douglass
  28. Temporarily Unstable Government Debt and Inflation By Troy Davig; Eric M. Leeper
  29. India's financial globalisation By Ila Patnaik; Ajay Shah
  30. Asian Competitive Devaluations By Li-Gang Liu; Sherman Robinson; Zhi Wang
  31. Pensions, Debt and Inflation Risk in a Monetary Union By Yvonne Adema
  32. Non-positive scaling factor in probability quantification methods: deriving consumer inflation perceptions and expectations in the whole euro area and Ireland By Lyziak, Tomasz
  33. The Comparison in Transaction Efficiency between Dispersive and Concentrated Money Creation By Kichiji, Nozomi; Nishibe, Makoto
  34. Capital Flows, Exchange Rate Flexibility, and the Real Exchange Rate By Jean-Louis Combes; Patrick Plane; Tidiane Kinda

  1. By: Andreas Schabert (Dortmund University, and University of Amsterdam)
    Abstract: We analyze optimal monetary policy in a sticky price
    Keywords: Optimal monetary policy; central bank instruments; collateralized lending; liquidity premium; inflation
    JEL: E4 E5 E32
    Date: 2010–06–21
  2. By: Kasai Ndahiriwe (Department of Economics, University of Pretoria); Ruthira Naraidoo (Department of Economics, University of Pretoria)
    Abstract: We test the concept of the Opportunistic Approach to monetary policy in South Africa post 2000 inflation targeting regime. Our findings support the two features of the opportunistic approach. First, we find that the models that include an intermediate target that reflects the recent history of inflation rather than simple inflation target improve the fit of the models. Second, the data supports the view that the South African Reserve Bank (SARB) behaves with some degree of nonresponsiveness when inflation is within the zone of discretion but react aggressively otherwise. Recursive estimates from our preferred model reveal that overall there has been a subdued reaction to inflation, output and financial conditions amidst the increased economic uncertainty of the 2007- 2009 financial crisis.
    Keywords: monetary policy, opportunistic approach, intermediate inflation, financial conditions
    JEL: C51 C52 C53 E52 E58
    Date: 2011–02
  3. By: Ila Patnaik; Ajay Shah; Rudrani Bhattacharya
    Abstract: Some emerging economies have a relatively ineffective monetary policy transmission owing to weaknesses in the domestic financial system and the presence of a large and segmented informal sector. At the same time, small open economies can have a substantial monetary policy transmission through the exchange rate channel. In order to understand this setting, we explore a unified treatment of monetary policy transmission and exchangerate pass-through. The results for an emerging market, India, suggest that the most effective mechanism through which monetary policy impacts inflation runs through the exchange rate.
    Keywords: Economic models , Emerging markets , Exchange rates , Monetary policy , Monetary transmission mechanism ,
    Date: 2011–01–06
  4. By: Franc Klaassen (University of Amsterdam)
    Abstract: Exchange market pressure (EMP) measures the pressure on a currency
    Keywords: currency crisis models; ERM crisis; exchange rate regime; instrumental variables; monetary policy; persistence
    JEL: E42 E58 F31 F33
    Date: 2011–02–11
  5. By: Fang Yao
    Abstract: This paper presents a new mechanism through which monetary policy rules affect inflation persistence. When assuming that price reset hazard functions are not constant, backward- looking dynamics emerge in the NKPC. This new mechanism makes the traditional demand channel of monetary transmission have a long-lasting effect on inflation dynamics. The Calvo model fails to convey this insight, because its constant hazard function leads those important backward-looking dynamics to be canceled out. I first analytically show how it works in a simple setup, and then solve a log-linearized model numerically around positive trend inflation. With realistic calibration of trend inflation and the monetary policy rule, the model can account for the pattern of changes in inflation persistence observed in the post-wwii U.S. data. In addition, with increasing hazard functions, the "Taylor principle" is sufficient to guarantee the determinate equilibrium even under extremely high trend inflation.
    Keywords: Intrinsic inflation persistence, Hazard function, Trend inflation, Monetary policy, New Keynesian Phillips curve
    JEL: E31 E52
    Date: 2011–02
  6. By: Pau Rabanal; Oriol Aspachs-Bracons
    Abstract: The recent boom-and-bust cycle in housing prices has refreshed the debate on the drivers of housing cycles as well as the appropriate policy response. We analyze the case of Spain, where housing prices have soared since it joined the EMU. We present evidence based on a VAR model, and we calibrate a New Keynesian model of a currency area with durable goods to explain it. We find that labor market rigidities provide stronger amplification effects to all type of shocks than financial frictions do. Finally, we show that when the central bank reacts to house prices, the non-durable sector suffers an important contraction. As a result, the boom-and-bust cycle would not have been avoided if Spain had remained outside the EMU during the 1996-2007 period.
    Keywords: Demand , Economic models , European Economic and Monetary Union , External shocks , Housing , Housing prices , Interest rates , Labor markets , Monetary policy , Spain ,
    Date: 2011–01–07
  7. By: Simon Gray
    Abstract: Most central banks oblige depository institutions to hold minimum reserves against their liabilities, predominantly in the form of balances at the central bank. The role of these reserve requirements has evolved significantly over time. The overlay of changing purposes and practices has the result that it is not always fully clear what the current purpose of reserve requirements is, and this necessarily complicates thinking about how a reserve regime should be structured. This paper describes three main purposes for reserve requirements - prudential, monetary control and liquidity management - and suggests best practice for the structure of a reserves regime. Finally, the paper illustrates current practices using a 2010 IMF survey of 121 central banks.
    Keywords: Central bank policy , Central banks , Commercial banks , Depositories , Liquidity management , Reserve requirements ,
    Date: 2011–02–16
  8. By: Domenica Tropeano (University of Macerata)
    Abstract: <p>The paper deals with the conflicting interpretations of the monetary policy carried out by the Federal Reserve during and after the financial crisis of 2007-08. That policy has been labelled as quantitative easing. The first interpretation of that policy is that the central bank will continue to flood the market with money to cause inflation or at least inflationary expectations. A depreciation would eventually do the same job too. Another interpretation, partially based on Minsky's theory of investment, is that easy monetary policy carried out beyond the lender-of-last-resort intervention might have the aim of sustaining the price of investment and validating firms' plans. In other words, it would be complementary to fiscal policy with the aim of sustaining profits and investment. The problem is that the Kaleckian model Minsky was using hardly corresponds to the present situation of the U.S. economy. The interpretation here proposed is that the aim of monetary policy is the recovery of financial asset prices to sustain banks profits and to restore the value of household wealth. This design might be considered as successful if we look at the recent data. But those signals are not encouraging if we look at long term sustainability of policies. The recovery of stock prices has encouraged speculation on anything possible by the big banks. Moreover the recovery of financial asset prices in<br />contrast to the slow motion of housing prices might increase the already high inequality in wealth distribution.</p>
    Date: 2011–02
  9. By: Nicoletta Batini; Thomas Dowling
    Abstract: Using an adaptation of the Uncovered Interest Parity (UIP) condition, this paper analyzes the drivers behind the large, symmetric exchange rate swings observed during the financial crisis of 2008-2010. Employing a Nelson-Siegel model, we estimate yield curves and decompose the exchange rate movements into changes we attribute to monetary policy and a residual. We find that the depreciation phase of the currencies in our sample was largely dominated by safe-haven effects rather than carry trade activity or other return considerations. For some countries, however, the appreciation that began at the end of 2008 seems largely to reflect downward movement in the cumulative revisions to nominal forward differentials, suggesting carry trade.
    Keywords: Currencies , Developed countries , Economic models , Emerging markets , Exchange rate adjustments , Exchange rates , Financial crisis , Global Financial Crisis 2008-2009 , Interest rates , Monetary policy ,
    Date: 2011–01–20
  10. By: Vivien LEWIS (Ghent University and Goethe University Frankfurt, IMFS); Céline POILLY (UNIVERSITE CATHOLIQUE DE LOUVAIN, IMMAQ, Institut de Recherches Economiques et Sociales (IRES))
    Abstract: This paper estimates a business cycle model with endogenous firm entry by matching impulse responses to a monetary policy shock in US data. Our VAR includes net business formation, profits and markups. We evaluate two channels through which entry may influence the monetary transmission process. Through the competition effect, the arrival of new entrants makes the demand for existing goods more elastic, and thus lowers desired markups and prices. Through the variety effect, increased firm and product entry raises consumption utility and thereby lowers the cost of living. This implies higher markups and, through the New Keynesian Phillips Curve, lower inflation. While the proposed model does a good job at matching the observed dynamics, it generates insufficient volatility of markups and profits. Estimates of standard parameters are largely unaffected by the introduction of firm entry. Our results lend support to the variety effect; however, we find no evidence for the competition effect.
    Keywords: entry, inflation, monetary transmission, monetary policy, extensive margin
    JEL: E32 E52
    Date: 2011–02–08
  11. By: Eiji Ogawa; Junko Shimizu
    Abstract: Regional monetary and financial cooperation among the monetary authorities of Asian countries have been further strengthening through the recent global financial crisis in 2007-2008. Finance Ministers and Central Bank Governors of the ASEAN Members States, People’s Republic of China (PRC), Japan and Korea (ASEAN plus three) and the monetary authority of Hong Kong, China announced that the Chiang Mai Initiative Multilateralization (CMIM) agreement came into effect on March 24, 2010. They also reached agreement on establishing a surveillance office, which is called an ASEAN plus three Macroeconomic Research Office (AMRO) and would ensure technical details of regional surveillance. The regional monetary cooperation in Asia has been discussed for years. For example, Ogawa and Shimizu (2005) proposed both an Asian Monetary Unit (AMU), which is a common currency basket computed as a weighted average of the thirteen ASEAN plus three currencies, and AMU Deviation Indicators (AMU DIs), which indicates deviation of each Asian currency in terms of the AMU compared with the benchmark rate. The AMU and the AMU DIs are considered as both surveillance measures under the Chiang Mai Initiative and coordinated exchange rate policies among Asian countries. In this paper, we show that monitoring the AMU and the AMU DIs plays an important role in the regional surveillance process under the CMIM. By using daily and monthly data of AMU and AMU DIs in the period between January 2000 to June 2010, which are available in a website of the Research Institute of Economy, Trade, and Industry (RIETI), we examine their usefulness as a surveillance indicator. Our studies of AMU and AMU DIs confirm as follows: First, an AMU peg system stabilizes Nominal Effective Exchange Rate (NEER) of each Asian country. Second, the AMU and the AMU DIs could warn overvaluation or undervaluation for each of Asia currencies. Third, trade imbalances within the region have been growing as the AMU DIs have been widening. Forth, the AMU DIs could predict huge capital inflows and outflows for the Asian country. The above fact-findings support usefulness of using the AMU and the AMU DIs as surveillance indicators for monetary cooperation in Asia.
    Keywords: regional monetary cooperation, common currency basket, Asian Monetary Unit
    Date: 2010–10
  12. By: Jef Boeckx (National Bank of Belgium, Research Department)
    Abstract: I propose a discrete choice method for estimating monetary policy reaction functions based on research by Hu and Phillips (2004). This method distinguishes between determining the underlying desired rate which drives policy rate changes and actually implementing interest rate changes. The method is applied to ECB rate setting between 1999 and 2010 by estimating a forward-looking Taylor rule on a monthly basis using real-time data drawn from the Survey of Professional Forecasters. All parameters are estimated significantly and with the expected sign. Including the period of financial turmoil in the sample delivers a less aggressive policy rule as the ECB was constrained by the lower bound on nominal interest rates. The ECB's non-standard measures helped to circumvent that constraint on monetary policy, however. For the pre-turmoil sample, the discrete choice model's estimated desired policy rate is more aggressive and less gradual than least squares estimates of the same rule specification. This is explained by the fact that the discrete choice model takes account of the fact that central banks change interest rates by discrete amounts. An advantage of using discrete choice models is that probabilities are attached to the different outcomes of every interest rate setting meeting. These probabilities correlate fairly well with the probabilities derived from surveys among commercial bank economists.
    Keywords: monetary policy reaction functions, discrete choice models, interest rate setting, ECB
    JEL: C25 E52 E58
    Date: 2011–02
  13. By: Nuno Cassola (ECB); Claudio Morana (Università del Piemonte Orientale and CeRP)
    Abstract: The evolution of the spreads between unsecured money market rates of various maturities and central banks’ key policy rates has been subject to considerable debate and controversy in relation to the worldwide financial market turbulence that started in August 2007. Our contribution to the ongoing debate on the dynamics of money market spreads is empirical and methodological, motivated by the “shocking” evidence of non-stationary behaviour of money market spreads. In fact, in our view, empirical work assessing the effectiveness of central bank policies has largely overlooked the complexity of the market environment and its implications for the statistical properties of the data. Thus, our main goal is to carefully document both the economic and statistical “fingerprint” of money market turbulence, in the framework of a new econometric framework, carefully accounting for the persistence properties of the data.
    Keywords: money market interest rates, euro area, sub-prime credit crisis, credit risk, liquidity risk, long memory, structural change, fractionally integrated heteroskedastic factor vector autoregressive model
    JEL: C32 E43 E50 E58 G15
    Date: 2010–11
  14. By: Andreas Schabert (TU Dortmund University, and University of Amsterdam)
    Abstract: We examine monetary policy options for a small open economy where sovereign default might occur due to intertemporal insolvency. Under interest rate policy and floating exchange rates the equilibrium is indetermined. Under a fixed exchange rate the equilibrium is uniquely determined and independent of sovereign default.
    Keywords: Exchange rate peg; interest rate policy; equilibrium determination; sovereign default; public debt
    JEL: E52 E63 F31 F41
    Date: 2011–02–11
  15. By: Lena Dräger (University of Hamburg, Deutchland, and KOF Swiss Economic Institute, ETH Zurich, Switzerland)
    Abstract: Using quantitative survey data from the Swedish Consumer Tendency Survey as well as a unique data set on media reports about inflation, we analyze the formation process of inflation perceptions and expectations as well as interrelations between the variables. Throughout the analysis, the role of media reports about inflation is emphasized and results for the low inflation period January 1998 to December 2007 are compared to those including the high inflation year 2008. Rejecting rationality, we find that perceptions, but not expectations, are affected asymmetrically by news, where media effects are generally stronger in times of high and volatile inflation. For the low inflation sample period, inflation expectations are more affected by shocks to perceptions than vice versa, but Granger causality runs from expectations to perceptions. Including more volatile inflation, we find more feed-back between the variables and a strong media effect especially on perceptions.
    Keywords: Inflation expectations, inflation perceptions, media reports
    JEL: C32 E31 E37
    Date: 2011–02
  16. By: David Kiefer
    Abstract: Carlin and Soskice (2005) advocate a 3-equation model of stabilization policy. One equation is a monetary reaction rule MR derived by assuming that governments have performance objectives, but are constrained by a Phillips curve PC. Central banks attempt to implement these objectives by setting interest rates along an IS curve. They label this the IS-PC-MR model. Observing that governments have more tools than just the interest rate, we drop the IS equation, simplifying their model to 2 equations. Adding a random walk model of the unobserved potential growth, we develop their PC-MR model into a state space specification of the short-run political economy. This is an appropriate econometric method because it incorporates recursive forecasts of unobservable state variables based on contemporaneous information measured with real-time data. Our results are generally consistent with US economic history. One qualification is that governments are more likely to target growth rates than output gaps. Another is that policy affects outcomes after a single lag. This assumption fits the data better than an alternative double-lag timing: one lag for output, plus a second for inflation has been proposed. We also infer that inflation expectations are more likely to be backward rather than forward looking.
    Keywords: new Keynesian stabilization, policy targets, microfoundations, real-time data
    JEL: E3 E6
    Date: 2011
  17. By: Masagus M. Ridhwan (VU University Amsterdam, Bank Indonesia); Henri L.F. de Groot (VU University Amsterdam); Peter Nijkamp (VU University Amsterdam)
    Abstract: This paper presents the findings a meta-analysis identifying the causes of variation in the impact of monetary policies on economic development. The sample of observations included in our meta-analysis is drawn from primary studies that uniformly employ Vector Autoregressive (VAR) models. Our findings reveal that capital intensity, financial deepening, the inflation rate, and economic size are important in explaining the variation in outcomes across regions and over time. Differences in the type of models used in the primary studies also significantly contribute to the explanation of the variation in study outcomes.
    Keywords: Monetary policy; Economic development; Meta-analysis
    JEL: E52 R11
    Date: 2010–04–21
  18. By: Luis-Felipe Zanna; Marco Airaudo
    Abstract: Empirical evidence suggests that goods are highly heterogeneous with respect to the degree of price rigidity. We develop a DSGE model featuring heterogeneous nominal rigidities across two sectors to study the equilibrium determinacy and stability under adaptive learning for interest rate rules that respond to inflation measures differing in their degree of price stickiness. We find that rules responding to headline inflation measures that assign a positive weight to the inflation of the sector with low price stickiness are more prone to generate macroeconomic instability than rules that respond exclusively to the inflation of the sector with high price stickiness. By this we mean that they are more prone to induce non-learnable fundamental-driven equilibria, learnable self-fulfilling expectations equilibria, and equilibria where fluctuations are unbounded. We discuss how our results depend on the elasticity of substitution across goods, the degree of heterogeneity in price rigidity, as well as on the timing of the rule.
    Keywords: Economic models , Inflation , Inflation rates , Price stabilization , Stabilization measures ,
    Date: 2010–12–22
  19. By: Lucarelli, B.
    Abstract: Keynes’s theory of a monetary economy and his liquidity preference theory of investment will be examined in order to highlight the essential properties of money under the conditions of uncertainty, which inevitably prefigures the existence of involuntary unemployment and could – within a laissez faire, deregulated financial system – induce phases of endemic financial instability and crises.
    Keywords: uncertainty; money; liquidity preference; crisis; investment
    JEL: B10 D53 B31 A20 B50 B22 A10
    Date: 2010–06–26
  20. By: Tim Willems (University of Amsterdam)
    Abstract: Traditional ways of analyzing the effects of monetary policy shocks via structural vector autoregressions require the use of unrealistic identifying assumptions: they either do not allow for a response of output and prices on impact of the shock, or they exclude contemporaneous values of these variables from the monetary authority's information set. This paper relaxes these incredible restrictions by exploiting a convenient natural setting, namely the fact that we can use data from dollarized countries. The fact that non-monetary US shocks do not seem to be transmitted to these countries, has the additional advantage that it makes the exercise less vulnerable to potential misidentification of the US monetary policy shock. The results obtained in this way suggest that prices fall quite rapidly after a monetary contraction. Consistent with this finding, the effects of monetary policy shocks on output seem to be small.
    Keywords: Monetary policy effects; Price puzzle; Structural VARs; Identification; Block exogeneity
    JEL: E52 E31 C32
    Date: 2010–10–01
  21. By: Pedro Gomis-Porqueras (School of Economics, Australian National University); Benoit Julien (School of Economics, University of New South Wales); Chengsi Wang (School of Economics, University of New South Wales)
    Abstract: In this paper we study the optimal monetary and fiscal policies of a general equilibrium model of unemployment and money with search frictions both in labor and goods markets as in Berentsen, Menzio and Wright (2010). We abstract from revenue-raising motives to focus on the welfare-enhancing properties of optimal policies. We show that some of the inefficiencies in the Berentsen, Menzio and Wright (2010) framework can be restored with appropriate fiscal policies. In particular, when lump sum monetary transfers are possible, a production subsidy financed by money printing can increase output in the decentralized market and a vacancy subsidy financed by a dividend tax even when the Hosios’ rule does not hold.
    Keywords: Search and matching; Fiscal polices; Money; Unemployment; Efficiency
    JEL: E52 E63
    Date: 2010–11
  22. By: Marc Flandreau, Stefano Ugolini (IHEID, The Graduate Institute of International and Development Studies, Geneva)
    Abstract: The National Monetary Commission was deeply concerned with importing best practice. One important focus was the connection between the money market and international trade. It was said that Britain’s lead in the market for “acceptances” originating in international trade was the basis of its sterling predominance. In this article, we use a so-far unexplored source to document the portfolio of bills that was brought up to the Bank of England for discount and study the behavior of the Bank of England during the crisis of 1866 (the so-called Overend- Gurney panic) when the Bank began adopting lending of last resort policies (Bignon, Flandreau and Ugolini 2011). We compare 1865 (a “normal” year) to 1866. Important findings include: (a) the statistical predominance of foreign bills in the material brought to the Bank of England; (b) the correlation between the geography of bills and British trade patterns; (c) a marked contrast between normal times lending and crisis lending in that main financial intermediaries and the “shadow banking system” only showed up at the Bank’s window during crises; (d) the importance of money market investors (bills brokers) as chief conduit of liquidity provision in crisis; (e) the importance of Bank of England’s supervisory policies in ensuring lending-of-lastresort operations without enhancing moral hazard. An implication of our findings is that Bank of England’s ability to control moral hazard for financial intermediaries involved in acceptances was another reason for the rise of sterling as an international currency.
    Date: 2011–02–16
  23. By: Max Meulemann; Martin Uebele; Bernd Wilfling
    Abstract: Using a Markov-switching GARCH model this paper analyzes the volatility evolution of the greenback's price in gold from after the Civil War until the return to gold convertibility in 1879. The econometric inference associated with our methodology indicates a switch to a regime of low volatility roughly seven months before the actual resumption. Since this empirical finding is most likely to be reconciled with a change in market expectations, we conclude that expectations affected the exchange rate more than fundamentals. Our analysis also demonstrates that regime switches in the volatility of exchange rates may refl ect historical events that remain undiscovered otherwise.
    Keywords: Monetary history, 19th century, USA, greenback, Markov-switching GARCH models
    JEL: A
    Date: 2011–02
  24. By: Michael D. Bordo (Rutgers University and NBER); David C. Wheelock (Federal Reserve Bank of St. Louis)
    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: Federal Reserve Act, lender of last resort, discount window, banking panics, Great Depression
    JEL: E58 G28 N21 N22
    Date: 2011–02–15
  25. By: Laséen, Stefan (Monetary Policy Department, Central Bank of Sweden); Svensson, Lars E.O. (Sveriges Riksbank)
    Abstract: This paper specifies a new convenient algorithm to construct policy projections conditional on alternative anticipated policy-rate paths in linearized dynamic stochastic general equilibrium (DSGE) models, such as Ramses, the Riksbank's main DSGE model. Such projections with anticipated policy-rate paths correspond to situations where the central bank transparently announces that it, conditional on current information, plans to implement a particular policy-rate path and where this announced plan for the policy rate is believed and then anticipated by the private sector. The main idea of the algorithm is to include among the predetermined variables (the "state" of the economy) the vector of nonzero means of future shocks to a given policy rule that is required to satisfy the given anticipated policy-rate path.
    Keywords: Optimal monetary policy; instrument rules; policy rules; optimal policy projections
    JEL: E52 E58
    Date: 2011–01–01
  26. By: Pedro Bação (Faculdade de Economia Universidade de Coimbra / GEMF); António Portugal Duarte (Faculdade de Economia Universidade de Coimbra / GEMF)
    Abstract: The increase in both public and private indebtedness has been one of the main macroeconomic developments in recent years. This trend has been accompanied by large current account deficits, especially in smaller countries, such as Greece and Portugal. One possible explanation for this behaviour is the reduction in interest rates that convergence to the European single currency produced. At the same time as interest rates declined, these countries experienced a strong increase in domestic demand and a real exchange rate appreciation. Adoption of the euro implied that the appreciation of the real exchange rate could not be compensated by means of nominal devaluations, resulting in reduced competitiveness. In this paper we study the macroeconomic performance of Greece and Portugal during the process of convergence to the single currency and their prospects, in the light of the current financial crisis. To this end we make use of a consumption model developed by Gabriel Fagan and Vítor Gaspar. The experience of these two countries may give important lessons for candidate countries.
    Keywords: consumption, euro, interest rates, indebtedness, exchange rates
    JEL: F36 E21 F32
    Date: 2010–12
  27. By: Nicholas Lardy (Peterson Institute for International Economics); Patrick Douglass (Peterson Institute for International Economics)
    Abstract: Despite an erosion of consensus on its benefits, capital account convertibility remains a long-term goal of China. This paper identifies three major preconditions for convertibility in China: a strong domestic banking system, relatively developed domestic financial markets, and an equilibrium exchange rate. The authors examine each of these in turn and find that, in significant respects, China does not yet meet any of the conditions necessary for convertibility. They then evaluate China’s progress to date on capital account liberalization, including recent efforts to promote RMB internationalization and greater use of the RMB in trade settlement. The paper concludes with an overview of remaining obstacles to convertibility and policy recommendations.
    JEL: G15 G21 O16 F31
    Date: 2011–02
  28. By: Troy Davig; Eric M. Leeper
    Abstract: Many advanced economies are heading into an era of fiscal stress: populations are aging and governments have made substantially more promises of old-age benefits than they have made provisions to finance. This paper models the era of fiscal stress as stemming from relentlessly growing promised government transfers that initially are fully honored, being financed by new sales of government debt that bring forth higher future income taxes. As debt levels and tax rates rise, the population's tolerance for taxation declines and the probability of reaching the fiscal limit increases. At the limit a fixed tax rate is adopted, adjustments in taxes no longer stabilize debt, and some new stabilizing combination of policies must arise. We examine how, in the period before the fiscal limit, rapidly rising debt interacts with expectations of how and when policies will adjust. Temporarily explosive debt has no effect on inflation if households expect all adjustments to occur through entitlements reform, but if households believe it is possible that in the future monetary policy will shift from targeting inflation to stabilizing debt, then debt feeds directly into the path of inflation and monetary policy can no longer control inflation. News that reduces expected primary surpluses can bring future inflation into the present, well before the news shows up in fiscal measures.
    JEL: E31 E52 E62 E63
    Date: 2011–02
  29. By: Ila Patnaik; Ajay Shah
    Abstract: India embarked on reintegration with the world economy in the early 1990s. At first, a certain limited opening took place emphasising equity flows by certain kinds of foreign investors. This opening has had myriad interesting implications in terms of both microeconomics and macroeconomics. A dynamic process of change in the economy and in economic policy then came about, with a co-evolution between the system of capital controls, macroeconomic policy, and the internationalisation of firms including the emergence of Indian multinationals.Through this process, de facto openness has risen sharply. De facto openness has implied a loss of monetary policy autonomy when exchange rate pegging was attempted. The exchange rate regime has evolved towards greater flexibility.
    Keywords: Capital controls , Capital flows , Economic integration , Exchange rate regimes , External borrowing , Financial sector , Foreign direct investment , Globalization , India , Monetary policy ,
    Date: 2011–01–07
  30. By: Li-Gang Liu (Peterson Institute for International Economics And Marcus Noland, Peterson Institute for International Economics); Sherman Robinson (Peterson Institute for International Economics); Zhi Wang (Peterson Institute for International Economics)
    Abstract: In this paper we examine three issues. The first is the path of China's nominal and real exchange rates since 1990. As it turns out, this is more complicated than is commonly assumed, with basic results exhibiting sensitivity to the exchange rate measure used. We conclude that while China did experience a large nominal depreciation, its much higher relative inflation eroded this devaluation, and in real terms the reminbi has actually appreciated during the 1990s. The Chinese devaluation was at best a contributing factor to the Asian financial crises, not their primary cause.
    Date: 2010–12
  31. By: Yvonne Adema (Erasmus University Rotterdam, and Netspar)
    Abstract: This paper investigates the international spillovers of government debt and the associated risk of inflation within a monetary union when countries have different pension systems. I use a stochastic two-country two-period overlapping-generations model, where one country has PAYG pensions and the other country has funded pensions. The paper shows that the PAYG country can shift part of its long-term debt burden to the funded country. Moreover, the PAYG country gains from unexpected inflation at the cost of the funded country. In response to these conflicting interests about inflation, inflation risk may rise with the level of debt in the PAYG country. Higher inflation risk harms both countries. Actually, in contrast to the debt burden, the PAYG country cannot share the negative effects of a rise in inflation risk with the funded country. The scenarios analysed might be especially relevant for the years to come.
    Keywords: spillovers; pensions; debt; inflation
    JEL: E31 F41 G11 G12 H55 H63
    Date: 2010–10–29
  32. By: Lyziak, Tomasz
    Abstract: There are problems with using probability quantification methods when the scaling factor applied in those methods becomes non-positive. The way of adjusting them proposed in this note and verified empirically allows using them in such circumstances. The results for the euro area and Ireland suggest that the recent financial crisis made consumer inflation perception and expectations go down, however it did not create deflationary expectations in this groups of economic agents.
    Keywords: Inflation Expectations; Survey Data; Euro Area
    JEL: D84 C46
    Date: 2011–02–14
  33. By: Kichiji, Nozomi; Nishibe, Makoto
    Date: 2011–02
  34. By: Jean-Louis Combes; Patrick Plane; Tidiane Kinda
    Abstract: This paper analyzes the impact of capital inflows and exchange rate flexibility on the real exchange rate in developing countries based on panel cointegration techniques. The results show that public and private flows are associated with a real exchange rate appreciation. Among private flows, portfolio investment has the highest appreciation effect-almost seven times that of foreign direct investment or bank loans-and private transfers have the lowest effect. Using a de facto measure of exchange rate flexibility, we find that a more flexible exchange rate helps to dampen appreciation of the real exchange rate stemming from capital inflows.
    Keywords: Capital flows , Capital inflows , Developing countries , Economic models , Exchange rate appreciation , Exchange rate regimes , External financing , Flexible exchange rates , Private capital flows , Real effective exchange rates ,
    Date: 2011–01–10

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