nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒03‒12
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Communication Matters: U.S. Monetary Policy and Commodity Price Volatility By Bernd Hayo; Ali M. Kutan; Matthias Neuenkirch
  2. The threat of 'currency wars': A European perspective By Zsolt Darvas; Jean Pisani-Ferry
  3. Measuring Monetary Conditions in A Small Open Economy: The Case of Malaysia By Abdul Majid, Muhamed Zulkhibri
  4. When is Quantitative Easing effective? By Markus Hoermann; Andreas Schabert
  5. The Role of Monetary Policy Uncertainty in the Term Structure of Interest Rates By Junko Koeda; Ryo Kato
  6. Medium-term projection model of the National Bank of Serbia By Mirko Djukic; Jelena Momcilovic; Ljubica Trajcev
  7. Measuring disagreement in UK consumer and central bank inflation forecasts By Richhild Moessner; Feng Zhu; Colin Ellis
  8. Capital Regulation, Monetary Policy and Financial Stability By Pierre-Richard Agénor; Koray Alper; Luiz Pereira da Silva
  9. A Macroprudential Perspective in Central Banking By Shigenori Shiratsuka
  10. Comparing the delegation of monetary and fiscal policy By Simon Wren-Lewis
  11. How does public information on central bank intervention strategies affect exchange rate volatility ? the case of Peru By Mundaca, B. Gabriela
  12. Optimal inflation and firms' productivity dynamics By Henning Weber
  13. Expectations Traps and Monetary Policy with Limited Commitment By Christoph Himmels; Tatiana Kirsanova
  14. Financial Innovation and Regional Money By Nagayasu, Jun
  15. Financial Crises and Assets as Media of Exchange By KOBAYASHI Keiichiro
  16. Inflation and unemployment in Switzerland: from 1970 to 2050 By Oleg Kitov; Ivan Kitov
  17. The Term Structure of Interest Rates in Small Open Economy DSGE Model By Aleš Maršál
  18. Belief Dispersion and Order Submission Strategies in the Foreign Exchange Market By Ingrid Lo; Stephen Sapp
  19. "Money in Finance" By L. Randall Wray
  20. A Financial Crisis in a Monetary Economy By KOBAYASHI Keiichiro

  1. By: Bernd Hayo (Philipps-University Marburg); Ali M. Kutan (Southern Illinois University Edwardsville; The Emerging Markets Group, London; William Davidson Institute, Michigan); Matthias Neuenkirch (Philipps-University Marburg)
    Abstract: Using a GARCH model, we analyze the influence of U.S. monetary policy action and communication on the price volatility of commodities for the period 1998–2009. We find, first, that U.S. monetary policy events have an economically significant impact on price volatility. Second, expected target rate changes and communications decrease volatility, whereas target rate surprises and unorthodox monetary policy measures increase it. Third, we find a change in reaction to central bank communication during the recent financial crisis: the “calming” effect of communication found for the whole sample is partly offset during that period.
    Keywords: Central Bank Communication, Commodities, Federal Reserve Bank, Monetary Policy, Price Volatility
    JEL: E52 E58 G14 Q10 Q40
    Date: 2011
  2. By: Zsolt Darvas (Institute of Economics Hungarian Academy of Sciences); Jean Pisani-Ferry (Bruegel, Brussels)
    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: 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: E58 E44
    Date: 2010–09–01
  4. By: Markus Hoermann (TU Dortmund University); Andreas Schabert (University of Amsterdam, and TU Dortmund University)
    Abstract: We present a simple macroeconomic model with open market operations that allows examining the effects of quantitative and credit easing. The central bank controls the policy rate, i.e. the price of money in open market operations, as well as the amount and the type of assets that are accepted as collateral for money. When the policy rate is sufficiently low, this set-up gives rise to an (il-)liquidity premium on non-eligible assets. Then, a quantitative easing policy, which increases the size of the central bank's balance sheet, can increase real activity and prices, while a credit easing policy, which changes the composition of the balance sheet, can lower interest rate spreads, stimulate real activity, and reduce prices. The effectiveness of quantitative and credit easing is however limited to the extent that eligible assets are scarce. Nevertheless, they can help escaping from the zero lower bound.
    Keywords: Monetary policy; collateralized lending; quantitative easing; credit easing; liquidity premium; zero lower bound
    JEL: E4 E5 E32
    Date: 2011–01–04
  5. By: Junko Koeda (Assistant Professor, Department of Economics, University of Tokyo, 7-3-1, Hongo, Bunkyo-ku, Tokyo, Japan. Tel: +81-3- 5841-5649, (E-mail:; Ryo Kato (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: We examine the effect of uncertainty arising from policy-shock volatility on yield-curve dynamics. In contrast to the assumption of many macro-finance models, policy-shock processes appear to be time varying and persistent. We allow for this heteroskedasticity by constructing a no-arbitrage GARCH affine term structure model, in which policy-shock volatility is defined as the conditional volatility of the error term in a Taylor rule. We find that an increase in monetary policy uncertainty raises the medium- and longer-term spreads in a model that incorporates macroeconomic dynamics.
    Keywords: GARCH, Estimation, Term Structure of Interest Rates, Financial Markets and the Macro-economy, Monetary Policy
    JEL: C13 C32 E43 E44 E52
    Date: 2010–10
  6. By: Mirko Djukic (National Bank of Serbia); Jelena Momcilovic (National Bank of Serbia); Ljubica Trajcev (National Bank of Serbia)
    Abstract: Medium-term projections are an important element of the decision-making process in an inflation targeting regime, that the National Bank of Serbia has been implementing for the past several years. The main goal of medium-term projections is to give an answer to what should be the policy rate path that would ensure that inflation in the coming period moves close to the targeted inflation rate. The most important tool for medium-term projections is a macroeconomic model, which is a set of equations aiming to describe the price-formation mechanism in Serbia and the transmission channel of monetary policy to prices. The model is comprised of four main behavioral equations for inflation, exchange rate, output gap and policy rate, and of a number of side behavioral equations and identities. For estimating trends and gaps on history, we use multivariate Kalman filter. The model in the current form has been used since end-2008 and is subject to regular adjustments and improvements.
    Keywords: medium-term projection model, inflation targeting, Kalman filter
    JEL: C53 E17 E58
    Date: 2010–12
  7. By: Richhild Moessner; Feng Zhu; Colin Ellis
    Abstract: We provide a new perspective on disagreement in inflation expectations by examining the full probability distributions of UK consumer inflation forecasts based on an adaptive bootstrap multimodality test. Furthermore, we compare the inflation forecasts of the Bank of England's Monetary Policy Committee (MPC) with those of UK consumers, for which we use data from the 2001-2007 February GfK NOP consumer surveys. Our analysis indicates substantial disagreement among UK consumers, and between the MPC and consumers, concerning one-year- ahead inflation forecasts. Such disagreement persisted throughout the sample, with no signs of convergence, consistent with consumers' inflation expectations not being "well-anchored" in the sense of matching the central bank's expectations. UK consumers had far more diverse views about future inflation than the MPC. It is possible that the MPC enjoyed certain information advantages which allowed it to have a narrower range of inflation forecasts.
    Keywords: Adaptive kernel method, adaptive multimodality test, consumer survey, inflation forecasts, nonparametric density estimation
    Date: 2011–02
  8. By: Pierre-Richard Agénor; Koray Alper; Luiz Pereira da Silva
    Abstract: This paper examines the roles of bank capital regulation and monetary policy in mitigating procyclicality and promoting macroeconomic and financial stability. The analysis is based on a dynamic stochastic model with imperfect credit markets. Macroeconomic (financial) stability is defined in terms of the volatility of nominal income (real house prices). Numerical experiments show that even if monetary policy can react strongly to inflation deviations from target, combining a credit-augmented interest rate rule and a Basel III-type countercyclical capital regulatory rule may be optimal for promoting overall economic stability. The greater the degree of interest rate smoothing, and the stronger the policymaker's concern with macroeconomic stability, the larger is the sensitivity of the regulatory rule to credit growth gaps.
    Date: 2011
  9. By: Shigenori Shiratsuka (Institute for Monetary and Economic Studies, Bank of Japan (E-mail:
    Abstract: This paper explores a policy framework for central banks from a macroprudential perspective, to pursue price and financial system stability in a consistent and sustainable manner. Triggered by the recent financial crisis, fundamental reform of the financial system is advocated to establish more stable foundations for supporting sustainable growth in the global economy. Achieving higher stability purely by more stringent microprudential regulations tends to result in lower efficiency in financial intermediation. Crises are fundamentally endogenous to the financial system and arise from exposure to common risks among financial institutions, underpinned by complicated incentives at both the micro and macro levels. In that context, macroprudential policy is often pointed out as a missing element in the current policy framework in order to strike a balance between the efficiency and stability of the financial system as a whole. Pursuing both price and financial system stability in a consistent and sustainable manner requires combination of monetary and prudential policies, especially macroprudential policy. To that end, this paper proposes to extend constrained discretion for monetary policy, proposed as the conceptual basis for flexible inflation targeting, to overall central banking, encompassing monetary and macroprudential policies.
    Keywords: Macroprudential policy, Procyclicality, Financial imbalances, Asset-price and credit bubble, Constrained discretion.
    JEL: E58 G28
    Date: 2011–02
  10. By: Simon Wren-Lewis
    Abstract: The apparent success of independent central banks in conducting monetary policy has led many to argue that some form of policy delegation should also be applied to the macroeconomic aspects of fiscal policy. A number of countries have recently established Fiscal Councils, although their role is typically to give advice on paths for government debt and deficits rather than decide upon and implement policy. This paper examines how useful a comparison between monetary and fiscal policy can be in motivating and guiding Fiscal Councils. Simple analogies between inflation bias and deficit bias can be misleading, and the motives for delegating aspects of fiscal policy may be rather different from those generally associated with monetary policy. In addition, lack of knowledge about the desirable goals of long run debt policy, compared to a greater understanding of the objectives of monetary policy, may help explain key differences in the nature of delegation between the two. The paper ends by making some comparisons between the delegation of monetary and fiscal policy in the United Kingdom.
    Keywords: Delegation, fiscal councils, deficit bias, government debt
    JEL: E62 E65
    Date: 2011
  11. By: Mundaca, B. Gabriela
    Abstract: Intervention operations in the foreign exchange market are used by the Banco Central de Reserva del Peru to manage both the level and volatility of their exchange rates. The Banco Central de Reserva del Peru provides information to the market about the specific hours of the day interventions would take place and the total amount of intervention. It consistently buys and sells on the foreign exchange market to avoid large appreciations and depreciations of the Peruvian nuevo sol against the U.S. dollar (Sol/USD), respectively. The estimates in this paper indicate that past information on interventions has moved the sol in the intended direction but only during the time the Banco Central de Reserva del Peru has announced it would be active in the foreign exchange market. The authors also find that the expectation of future interventions by the Banco Central de Reserva del Peru decreases the volatility of the sol when it intervenes to avoid an appreciation of the sol; however, the opposite occurs when the intervention takes place to defend the sol from depreciation. Indeed, the sol has been less volatile during periods when the Banco Central de Reserva del Peru has intervened than otherwise.
    Keywords: Debt Markets,Emerging Markets,Economic Stabilization,Currencies and Exchange Rates,Macroeconomic Management
    Date: 2011–02–01
  12. By: Henning Weber
    Abstract: Empirical data indicate that firms tend to have below-average productivity upon entry and that they tend to experience post-entry productivity growth. I present a New Keynesian model with growth in firm-specific productivity and firm turnover that captures these two phenomena. The model predicts that the optimal rate of long-run inflation is positive and equal to growth in firm-specific productivity. When linearized at positive optimal inflation, the model is observationally equivalent to the basic New Keynesian model with homogenous productivity linearized at zero inflation. Optimal stabilization policies are the same in both models, and the Taylor principle ensures determinacy in either model
    Keywords: Optimal long-run inflation, trend inflation, heterogenous firms
    JEL: E01 E31 E32
    Date: 2011–02
  13. By: Christoph Himmels (Department of Economics, University of Exeter); Tatiana Kirsanova (Department of Economics, University of Exeter)
    Abstract: We study the existence and uniqueness properties of monetary policy with limited commitment in LQ RE models. We use a New Keynesian model with debt accumulation in the spirit of Leeper (1991) as a `lab', because this model generates multiple equilibria under pure discretion, and under full commitment there are two distinct determinate regimes. We study how these properties change over the continuum of intermediate cases between commitment and discretion. We find that although multiple equilibria exist for high degrees of precommitment, even a small degree of precommitment selects a unique equilibrium for a wide range of parameters. We discuss the stability properties of policy equilibria which can be used to design an equilibrium selection criterion. We also demonstrate very different welfare implications for different policy equilibria.
    Keywords: Limited Commitment, Commitment, Discretion, Multiple Equilibria
    JEL: E31 E52 E58 E61 C61
    Date: 2011
  14. By: Nagayasu, Jun
    Abstract: This paper studies the effect that financial innovation, which seems very prominent in recent years, has on money. Using Japanese regional data and the money demand specification, we first provide evidence of instability in the simple money-output relationship. However, when this relationship is extended to include a proxy for a comprehensive measure of financial innovation, the model is found to be stable. Furthermore, consistent with economic theory, evidence is obtained of financial innovation leading to decreased demand for liquid financial assets. In this respect, demand deposits seem to possess very similar characteristics to cash in Japan in recent years.
    Keywords: Regional money; panel cointegration
    JEL: E41
    Date: 2011–01
  15. By: KOBAYASHI Keiichiro
    Abstract: We construct a monetary model of financial crises that can explain two characteristic features of the global financial crisis in 2008/2009, namely, the widespread freeze of asset transactions and a sharp contraction in aggregate output. We assume that the assets, such as real estate, work as media of exchange on a de facto basis in the goods market. In the financial crisis, excessively indebted investors hoard the assets hoping for a miraculous rise in their value (risk-shifting behavior), although the asset hoarding hinders the assets from working as media of exchange in the goods trading. Accordingly, the asset hoarding causes the disappearance of a significant portion of broad "money," which directly results in a contraction in aggregate production. Since the root of the problem is an external diseconomy caused by excessive indebtedness of investors, fiscal and monetary policies and debt reduction for investors have almost equivalent effects in terms of recovery efforts in a financial crisis.
    Date: 2011–02
  16. By: Oleg Kitov; Ivan Kitov
    Abstract: An empirical model is presented linking inflation and unemployment rate to the change in the level of labour force in Switzerland. The involved variables are found to be cointegrated and we estimate lagged linear deterministic relationships using the method of cumulative curves, a simplified version of the 1D Boundary Elements Method. The model yields very accurate predictions of the inflation rate on a three year horizon. The results are coherent with the models estimated previously for the US, Japan, France and other developed countries and provide additional validation of our quantitative framework based solely on labour force. Finally, given the importance of inflation forecasts for the Swiss monetary policy, we present a prediction extended into 2050 based on official projections of the labour force level.
    Date: 2011–02
  17. By: Aleš Maršál (Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)
    Abstract: I lay out small open economy model with nominal rigidities to study the implication of model dynamics on the term structure of interest rates. It has been shown that in order to obtain at least moderate match simultaneously of the macro and finance data, one has to introduce long-memory habits in consumption together with a large number of highly persistent exogenous shocks. These elements of the model however worsen the fit of macro data. I find that in the open economy framework the foreign demand channel allows us to match some of the data features even without including habits and a large number of exogenous shocks.
    Keywords: DSGE small open economy model, term structure of interest rates, perturbation method, second order approximation
    JEL: G12 E17
    Date: 2011–02
  18. By: Ingrid Lo; Stephen Sapp
    Abstract: This paper empirically examines how dispersions across investors beliefs influence traders order submission decisions in the foreign exchange market. Previous research has found that dispersion in traders beliefs regarding future macroeconomic announcements has a significant impact on both price dynamics and trading volume before the announcements in the foreign exchange and other financial markets. However, little is known about how this dispersion impacts traders choice in submitting different types of orders and thus to supply and demand liquidity either before or after such announcements. Since the types of orders submitted by traders at these times are the building blocks of the observed price and trading dynamics, it is important to understand how differences in investors' information sets before and after important macroeconomic announcements affect their order submission decisions. We find that (i) belief dispersion affects the size and aggressiveness of orders both before and after macroeconomic announcements, (ii) the magnitude of the impact of factors known to affect order choice depends on the level of belief dispersion, and (iii) the influence of information shocks (the revelation of unexpected information) on order choices depends on the level of belief dispersion.
    Keywords: Exchange rates; Market structure and pricing
    JEL: D4 G1
    Date: 2011
  19. By: L. Randall Wray
    Abstract: This paper begins by defining, and distinguishing between, money and finance, and addresses alternative ways of financing spending. We next examine the role played by financial institutions (e.g., banks) in the provision of finance. The role of government as both regulator of private institutions and provider of finance is also discussed, and related topics such as liquidity and saving are explored. We conclude with a look at some of the new innovations in finance, and at the global financial crisis, which could be blamed on excessive financialization of the economy.
    Keywords: Money; Money of Account; Finance; Financial Instruments; Financial Institutions; Financial Innovation; Financialization; Liquidity; Saving; State Money; Chartalism; Shadow Bank; Hyman Minsky; Securitization; Robert Clower
    JEL: B14 B15 B22 B52 E12 E40 E42 E50 E51 E52 G14 G21
    Date: 2011–03
  20. By: KOBAYASHI Keiichiro
    Abstract: We generalize Lagos and Wright's (2005) framework for a monetary economy in a way that there exist two technologies, "high" and "low," for producing the goods in a decentralized matching market. The high technology is more productive than the low technology, while the agents who use the high technology cannot commit in advance to deliver the goods. The lack of commitment makes it infeasible to produce the goods with the high technology if trade is conducted via a simple cash payment. To use the high technology, private valuable assets, e.g., residential property, should be put up as a "hostage" à la Williamson (1983) in the transaction. In this setting, a deterioration in the balance sheet due to a financial crisis leads to the disappearance of residential assets which are not yet put up as collateral, and hinder the usage of the high technology, leading to a decline in aggregate productivity. In this case, monetary injections cannot restore productivity after a financial crisis.
    Date: 2011–02

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