nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒03‒05
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Firms’ Money Demand and Monetary Policy By Bafile, Romina; Piergallini, Alessandro
  2. Central bank capital adequacy for central banks with or without a monetary policy By Luca Papi
  3. Measuring Monetary Conditions in A Small Open Economy: The Case of Malaysia By Abdul Majid, Muhamed Zulkhibri
  4. Monetary Policy under Myopia. By Gaël Giraud; Nguenamadji Orntangar
  5. Policy Rate Pass-through and the Adjustment of Retail Interest Rates in Malaysia? Empirical Evidence from Commercial Banks and Finance Companies By Abdul Majid, Muhamed Zulkhibri
  6. A Macro-Finance Approach to Exchange Rate Determination By Yu-chin Chen; Kwok Ping Tsang
  7. Non-Stationary Interest Rate Differentials and the Role of Monetary Policy By Philipp Matros; Enzo Weber
  8. Monetary Policy Analysis in Real-Time. Vintage combination from a real-time dataset By Carlo Altavilla; Matteo Ciccarelli
  9. Asset Price and Monetary Policy ¡V The Effect of Expectation Formation By Nan-Kuang Chen; Han-Liang Cheng
  10. On the Welfare Costs of Misspecified Monetary Policy Objectives By Avouyi-Dovi, S.; Sahuc, J-G.
  11. International liquidity provision during the financial crisis: a view from Switzerland By Raphael Auer; Sebastien Kraenzlin
  12. Connectionist-based rules describing the pass-through of individual goods prices into trend inflation in the United States By Richard G. Anderson; Jane M. Binner; Vincent A. Schmidt
  13. Predicting Output and Inflation in Less Developed Financial Markets Using the Yield Curve: Evidence from Malaysia By Abdul Majid, Muhamed Zulkhibri
  14. Firm Entry, Inflation and the Monetary Transmission Mechanism By V. LEWIS; C. POILLY
  15. The portfolio balance effect and reserve diversification: an empirical analysis By Costas Karfakis
  16. Inflation Convergence and the New Keynesian, Phillips Curve in the Czech Republic By Katarína Danišková; Jarko Fidrmuc
  17. The forecasting horizon of inflationary expectations and perceptions in the EU – Is it really 12 months? By Lars Jonung; Staffan Linden
  18. Low interest rates and housing booms: the role of capital inflows, monetary policy and financial innovation By Sa, Filipa; Towbin, Pascal; wieladek, tomasz
  19. The Concepts of Equilibrium Exchange Rate: A Survey of Literature By Siregar, Reza
  20. Inflation persistence and the rationality of inflation expectations By Brissimis, Sophocles; Migiakis, Petros

  1. By: Bafile, Romina; Piergallini, Alessandro
    Abstract: Standard New Keynesian models for monetary policy analysis are "cashless". When the nominal interest rate is the central bank's operating instrument, the LM equation is endogenous and, it is argued, can be ignored. The modern theoretical and quantitative debate on the importance of money for the conduct of monetary policy, however, overlooks firms' money demand. Working in an otherwise baseline New Keynesian setup, this paper shows that the monetary policy transmission mechanism is critically affected by the firms' money demand choice. Specifically, we prove that equilibrium determinacy may require either an active interest-rate policy (i.e., overreacting to inflation) or a passive interest-rate policy (i.e., underreacting to inflation), depending on the elasticity of production with respect to real money balances. We then calibrate the model to U.S. quarterly data and develop a sensitivity analysis in order to investigate the quantitative implications of our theoretical results. We find that macroeconomic stability is more likely to be guaranteed under an active, although not overly aggressive, monetary-policy stance.
    Keywords: Firms’ Money Demand; Interest-Rate Policy.
    JEL: E52 E41
    Date: 2011–02–21
  2. By: Luca Papi (Universit… Politecnica delle Marche, Department of Economics, MoFiR)
    Date: 2011–01
  3. By: Abdul Majid, Muhamed Zulkhibri
    Abstract: The paper explores the measurement of monetary condition in Malaysia to augment the existing monetary policy framework. As an open economy, Monetary Condition Index (MCI) and Financial Condition Index (FCI) are applicable to understand the monetary condition especially in the era of financial deregulation and liberalisation. The results obtained suggest that the index is most useful when the exchange market exhibits stable conditions, and would be a constructive tool in the simultaneous management of the foreign currency and domestic money markets. However, the frequent experience of instability caused by supply and demand shocks with persistent and large inertia in the economy complicates the practical use of MCI and FCI in Malaysia. While this approach obviously does not provide answers to every question and as a leading indicator for inflation, it nonetheless makes it possible to measure the monetary condition in the Malaysian economy.
    Keywords: Monetary condition index; Monetary Policy; Malaysia
    JEL: E52 E44
    Date: 2010–01–01
  4. By: Gaël Giraud (Centre d'Economie de la Sorbonne - Paris School of Economics et ESCP-Europe); Nguenamadji Orntangar (Centre d'Economie de la Sorbonne - Paris School of Economics)
    Abstract: This paper provides a new framework for monetary macro-policy, where the Central Bank potentially intervenes both on short-term and long-term loans markets, and can do this alternatively by manipulating interest rates or money supply. Following Bonnisseau and Orntangar (2010) and Giraud and Tsomokos (2010), we develop a discrete-time out-of-equilibrium dynamics with real trades, performed by myopic heterogeneous households in a cash-in-advance economy with several goods. Positive value and non-neutrality of fiat money are shown to be compatible with a local quantity theory of money. Every monetary policy induces a globally unique trade path, both for real and nominal variables.Thus, monetary policy and myopia suffice to pin down the absolute level of prices. However, a minimal money growth rate is exhibited, which depends upon the level of households' long-term debt and current gains-to-trade. Below this growth rate, the economy falls into a local liquidity trap ; above it, the economy eventually converges towards a Pareto-optimal rest-point while inflation raises in an unbounded fashion. As a consequence, a literal application of Taylor's rule leads the economy to a local liquidity trap. These findings provide insight into recent non-conventional monetary policies led by Central Banks.
    Keywords: Central Bank, gains to trade, Taylor rule, myopia, liquidity trap, finite speed of trade.
    JEL: D50 E40 E50 E58
    Date: 2011–02
  5. By: Abdul Majid, Muhamed Zulkhibri
    Abstract: This paper examines the interest rate pass-through from money market rates to various retail lending and deposit rates for financial institutions in Malaysia. The evidence shows that vast majority of retail lending rates pass-through is less than complete, while the speed of adjustment varies across administered interest rates. Adjustment in lending rates tended to be more sluggish than that of deposit rates. The finance companies, moreover, are quicker in adjusting their deposit rates than the commercial banks, but are slower in adjusting their loan rates. The empirical analysis also shows that interest rate adjustment is asymmetric and faster in the period of monetary easing rather than in the period of monetary tightening. The evidence suggests the importance of financial institutions in the transmission of monetary policy reflecting the adjustment processes are not uniform across different types of institutions and instruments.
    Keywords: Interest rate pass-through; Price rigidity; Monetary Policy; Malaysia
    JEL: E43 E52 E44
    Date: 2010–09–01
  6. By: Yu-chin Chen (University of Washington and Hong Kong Institute for Monetary Research); Kwok Ping Tsang (Virginia Tech and Hong Kong Institute for Monetary Research)
    Abstract: The nominal exchange rate is both a macroeconomic variable equilibrating international markets and a financial asset that embodies expectations and prices risks associated with cross border currency holdings. Recognizing this, we adopt a joint macro-finance strategy to model the exchange rate. We incorporate into a monetary exchange rate model macroeconomic stabilization through Taylor-rule monetary policy on one hand, and on the other, market expectations and perceived risks embodied in the cross-country yield curves. Using monthly data between 1985 and 2005 for Canada, Japan, the UK and the US, we employ a state-space system to model the relative yield curves between country-pairs using the Nelson and Siegel (1987) latent factors, and combine them with monetary policy targets (output gap and inflation) into a vector autoregression (VAR) for bilateral exchange rate changes. We find strong evidence that both the financial and macro variables are important for explaining exchange rate dynamics and excess currency returns, especially for the yen and the pound rates relative to the dollar. Moreover, by decomposing the yield curves into expected future yields and bond market term premiums, we show that both expectations about future macroeconomic conditions and perceived risks are priced into the currencies. These findings provide support for the view that the nominal exchange rate is determined by both macroeconomic and financial forces.
    Keywords: Exchange Rate, Term Structure, Latent Factors, Term Premiums
    JEL: E43 F31 G12 G15
    Date: 2011–01
  7. By: Philipp Matros (Universität Regensburg); Enzo Weber (Osteuropa-Institut, Regensburg (Institut for East European Studies))
    Abstract: The present work deals with a frequently detected failure of the uncovered interest rate parity (UIP) - the absence of bivariate cointegration between domestic and foreign interest rates. We explain non-stationarity of the interest differential via central bank reactions to exchange rate variations. Thereby, the exchange rate in levels introduces an additional stochastic trend into the system. Trivariate cointegration between the interest rates and the exchange rate accounts for the missing stationarity property of the interest differential. We apply the concept to the case of Turkey and Europe,where we can validate the theoretical considerations by multivariate time series techniques.
    Keywords: Uncovered Interest Rate Parity, Monetary Policy Rules, Cointegration, Vector-Error Correction Model
    JEL: E44 F31 C32
    Date: 2011–01
  8. By: Carlo Altavilla (University of Naples Parthenope and CSEF); Matteo Ciccarelli (European Central Bank)
    Abstract: This paper explores the role that the imperfect knowledge of the structure of the economy plays in the uncertainty surrounding the effects of rule-based monetary policy on unemployment dynamics in the euro area and the US. We employ a Bayesian model averaging procedure on a wide range of models which differ in several dimensions to account for the uncertainty that the policymaker faces when setting the monetary policy and evaluating its effect on real economy. We find evidence of a high degree of dispersion across models in both policy rule parameters and impulse response functions. Moreover, monetary policy shocks have very similar recessionary effects on the two economies with a different role played by the participation rate in the transmission mechanism. Finally, we show that a policy maker who does not take model uncertainty into account and selects the results on the basis of a single model may come to misleading conclusions not only about the transmission mechanism, but also about the differences between the euro area and the US, which are on average essentially small.
    Keywords: Monetary policy, Taylor rule, Real-time data, Great Moderation, Forecasting.
    JEL: E52 E58 C32 C53 C82
    Date: 2011–02–20
  9. By: Nan-Kuang Chen (National Taiwan University and Hong Kong Institute for Monetary Research); Han-Liang Cheng (Chung-Hua Institution for Economic Research)
    Abstract: This paper is a theoretical study of the effects of monetary policy reacting to fluctuations in asset price, accounting for the expectation formation effect of policy regime shift in a DSGE model calibrated to the U.S. economy. We find that the effect of expectation formation can substantially influence the movement of asset price. In contrast to the linear policy rule, under the regime switching policy rule reacting to asset price can generate substantial stabilization effect: the "expected" inflation-output volatility frontier shifts downward, thereby lowering both the volatilities of inflation and output for all possible policy choices. The trade-off between the expected volatility of inflation and that of output, as demonstrated by the "Taylor curve," greatly diminishes, implying that the Taylor rule which considers expectation formation effect and asset price movement expands the set of monetary policy choices available for monetary authority.
    Keywords: Asset Price, Monetary Policy, Regime Switching, DSGE
    JEL: E3 E52 G1
    Date: 2011–03
  10. By: Avouyi-Dovi, S.; Sahuc, J-G.
    Abstract: This paper quantifies the effects on welfare of misspecified monetary policy objectives in a stylized DSGE model. We show that using inappropriate objectives generates relatively large welfare costs. When expressed in terms of ‘consumption equivalent’ units, these costs correspond to permanent decreases in steady-state consumption of up to two percent. The latter are generated by both the inappropriate choice of weights and the omission of variables. In particular, it is costly to assume an interest-rate smoothing incentive for central bankers when it is not socially optimal to do so. Finally, a parameter uncertainty decomposition indicates that uncertainty about the properties of markup shocks gives rise to the largest welfare costs.
    Keywords: Welfare ; Monetary policy objectives ; DSGE model ; Bayesian econometrics.
    JEL: C11 C32 E58
    Date: 2011
  11. By: Raphael Auer; Sebastien Kraenzlin
    Abstract: We document the provision of CHF liquidity by the Swiss National Bank (SNB) to banks domiciled outside Switzerland during the recent financial crisis. What makes the Swiss case special is the size of this liquidity provision—making up 80 percent of all short term CHF liquidity provided by the SNB—and also the measures that were adopted to distribute this liquidity. In addition to making CHF available to other central banks via SWAP facilities, the SNB also allows banks domiciled outside Switzerland to directly participate in its REPO transactions. Although this policy was adopted for reasons that predate the financial crisis, during the crisis it proved tremendously helpful as it gave the European banking system direct access to the primary funding facility for CHF.
    Keywords: Demand for money ; Monetary policy - Switzerland ; International finance
    Date: 2011
  12. By: Richard G. Anderson; Jane M. Binner; Vincent A. Schmidt
    Abstract: This paper examines the inflation "pass-through" problem in American monetary policy, defined as the relationship between changes in the growth rates of individual goods and the subsequent economy-wide rate of growth of consumer prices. Granger causality tests robust to structural breaks are used to establish initial relationships. Then, feedforward artificial neural network (ANN) is used to approximate the functional relationship between selected component subindexes and the headline CPI. Moving beyond the ANN “black box,” we illustrate how decision rules can be extracted from the network. Our custom decompositional extraction algorithm generates rules in humanreadable and machine-executable form (Matlab code). Our procedure provides an additional route, beyond direct Bayesian estimation, for empirical econometric relationships to be embedded in DSGE models. A topic for further research is embedding decision rules within such models.
    Keywords: Inflation (Finance) ; Consumer price indexes
    Date: 2011
  13. By: Abdul Majid, Muhamed Zulkhibri
    Abstract: This paper investigates the role of the term spread to predict domestic output and inflation in less developed financial market with the focus on Malaysia bond market. By controlling for past values of the dependent variable, this paper finds that the term spread of various bond maturities contain relevant information about future output and inflation at short horizons. Besides that, we employ a probit model to assess the ability for the yield curve to predict future economic slowdown. The results suggest that the term spread has contributed significantly in the probability of predicting future economic slowdown. Despite the under-developed bond market, the findings point to the potential for bond yields to play a greater role in monetary analysis beyond conventional indicators. From the policy point of views, the results from our analysis suggest that there is a significant potential for incorporating more technical and model based approaches using the yield curve beyond the usual indicator analysis.
    Keywords: Term spread; Forecasting; Monetary Policy; Malaysia
    JEL: E43 E52
    Date: 2011–01–01
  14. By: V. LEWIS; C. POILLY
    Abstract: This paper estimates a business cycle model with endogenous …rm entry by matching impulse responses to a monetary policy shock in US data. Our VAR includes net business formation, pro…ts and markups. We evaluate two channels through which entry may inuence 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 …rm 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 ination. While the proposed model does a good job at matching the observed dynamics, it generates insufficient volatility of markups and pro…ts. Estimates of standard parameters are largely unaffected by the introduction of …rm entry. Our results lend support to the variety e¤ect; however, we …nd no evidence for the competition effect.
    Keywords: entry, ination, monetary transmission, monetary policy, extensive margin
    JEL: E32 E52
    Date: 2011–01
  15. By: Costas Karfakis
    Abstract: The purpose of this study is to examine whether the portfolio balance effect, operating through the outstanding debts of US and euro area, and the signaling effect of sterilized intervention, operating through the relative composition of official reserves of developing and emerging countries, explain the developments of the euro/dollar exchange rate. The empirical analysis reveals that both effects are statistically significant and have the correct signs. The Clark-West testing procedure indicates that the model which relates the exchange rate to official reserves and the interest rate differential outperforms the random walk model in the forecasting accuracy.
    Date: 2010–12
  16. By: Katarína Danišková (Comenius University Bratislava); Jarko Fidrmuc (Osteuropa-Institut, Regensburg (Institut for East European Studies))
    Abstract: The New Keynesian Phillips Curve has become an important part of modern monetary policy models. It describes the relationship between inflation and real marginal cost, which is derived from micro-founded models with rational expectations, sticky prices, and forward and backward looking behaviour. This answers the previous critique of the Phillips Curve. We estimate several specifications of the New Keynesian Phillips Curve for the Czech Republic between 1996 and 2009. We show that the GMM suffers under the problem of weak instruments leading to biased estimates. In turn, the FIML is robust and yields significant estimates of structural parameters implying a strong forward looking behaviour.
    Keywords: inflation, New Keynesian Phillips Curve, marginal costs, output gap, real unit labour costs
    JEL: E31 E52 C32
    Date: 2011–01
  17. By: Lars Jonung; Staffan Linden
    Abstract: We use survey based inflationary expectations to explore the forecasting horizons implicitly used by the respondents to questions about the expected rate of inflation during the coming 12 months. We examine the forecast errors, the mean error and the RMSEs, to study if the forecast horizon is truly 12 months as implied by the questionnaires. Our working hypothesis is that the forecast error has a U-shaped pattern, reaching its lowest value on the 12-month horizon. Our exploratory study reveals large differences across countries. For most countries, we get the expected U-shaped outcome for the forecast errors. The horizon implicitly used by respondents when answering the questions is not related to the explicit time horizon of the questionnaire. On average respondents use the same horizon when answering both questions.
    JEL: C33 E31 E32 E37 E58
    Date: 2010–12
  18. By: Sa, Filipa (; Towbin, Pascal (Banque de France); wieladek, tomasz (Bank of England)
    Abstract: A number of OECD countries experienced an environment of low interest rates and a rapid increase in housing market activity during the last decade. Previous work suggests three potential explanations for these events: expansionary monetary policy, capital inflows due to a global savings glut and excessive financial innovation combined with inappropriately lax financial regulation. In this study we examine the effects of these three factors on the housing market. We estimate a panel VAR for a sample of OECD countries and identify monetary policy and capital inflows shocks using sign restrictions. To explore how these effects change with the structure of the mortgage market and the degree of securitisation, we augment the VAR to let the coefficients vary with mortgage market characteristics. Our results suggest that both types of shocks have a significant and positive effect on real house prices, real credit to the private sector and real residential investment. The responses of housing variables to both types of shocks are stronger in countries with more developed mortgage markets, roughly doubling the responses to a monetary policy shock. The amplification effect of mortgage-backed securitisation is particularly strong for capital inflows shocks, increasing the response of real house prices, residential investment and real credit by a factor of two, three and five, respectively.
    Keywords: House prices; capital flows; financial innovation; monetary policy
    JEL: C33 E51 F32 G21
    Date: 2011–02–21
  19. By: Siregar, Reza
    Abstract: The aim of this paper is to review and examine a collection of ‘most commonly applied’ theoretical and empirical models of equilibrium exchange rate. The presentation on each model starts with an introduction of core theoretical frameworks. It will then be followed by discussions on relevant empirical steps to estimate the equilibrium rate. The rest of the paper will focus on assessing the strengths and weaknesses of the model and how each relates to the other.
    Keywords: Equilibrium; Exchange Rate Models; PPP; Monetary Model; BEER; DEER; FEER; PEER and NATREX
    JEL: F32 F31
    Date: 2011–02
  20. By: Brissimis, Sophocles; Migiakis, Petros
    Abstract: The rational expectations hypothesis for survey and model-based inflation forecasts − from the Survey of Professional Forecasters and the Greenbook respectively − is examined by properly taking into account the persistence characteristics of the data. The finding of near-unit-root effects in the inflation and inflation expectations series motivates the use of a local-to-unity specification of the inflation process that enables us to test whether the data are generated by locally non-stationary or stationary processes. Thus, we test, rather than assume, stationarity of near-unit-root processes. In addition, we set out an empirical framework for assessing relationships between locally non-stationary series. In this context, we test the rational expectations hypothesis by allowing the co-existence of a long-run relationship obtained under the rational expectations restrictions with short-run "learning" effects. Our empirical results indicate that the rational expectations hypothesis holds in the long run, while forecasters adjust their expectations slowly in the short run. This finding lends support to the hypothesis that the persistence of inflation comes from the dynamics of expectations.
    Keywords: Inflation; rational expectations; high persistence
    JEL: C32 D84 C50 E31 E52 E37
    Date: 2010–12

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