nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒03‒19
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The role of monetary policy in managing the euro - dollar exchange rate By Mylonidis, Nikolaos; Stamopoulou, Ioanna
  2. Real indeterminacy and the timing of money in open economies By Stephen McKnight
  3. Monetary disorder and financial regimes - The demand for money in Argentina, 1900-2006 By Matteo Mogliani; Giovanni Urga; Carlos Winograd
  4. Financial frictions and the zero lower bound on interest rates: a DSGE analysis By Merola, Rossana
  5. Modelling and Forecasting the Indian Re/US Dollar Exchange Rate By Pami Dua; Rajiv Ranjan
  6. Australasian money demand stability:Application of structural break tests By Don J. Webber; Saten Kumar
  7. The Capital Inflow “Problem” Revisited By Reinhart, Carmen; Reinhart, Vincent
  8. Optimal Simple Monetary and Fiscal Rules under Limited Asset Market Participation By Giorgio Motta; Patrizio Tirelli
  9. Monetary Shocks and the Cyclical Behavior of Loan Spreads By Pierre-Richard Agénor; George Bratsiotis; D. Pfajfar
  10. 28 Months Later: How Inflation Targeters Outperformed Their Peers in the Great Recession By de Carvalho Filho, Irineu
  11. Time- or State-Dependence? An Analysis of Inflation Dynamics using German Business Survey Data By Carstensen, Kai; Schenkelberg, Heike
  12. How do inflation expectations form? New insights from a high-frequency survey By Gabriele Galati; Peter Heemeijer; Richhild Moessner
  13. On the stability properties of optimal interest rules under learning By Michele Berardi
  14. Overdeterminacy and endogenous cycles: Trygve Haavelmo’s business cycle model and its implications for monetary policy By Kallåk Anundsen , André; Sigurd Holmsen Krogh, Tord; Nymoen, Ragnar; Vislie, Jon
  15. Endogenous Growth, Monetary Shocks and Nominal Rigidities By Barbara Annicchiarico; Alessandra Pelloni; Lorenza Rossi
  16. Money demand and economic uncertainty in Barbados By Jackman, Mahalia
  17. Expectations Traps and Monetary Policy with Limited Commitment By Himmels, Christoph; Kirsanova, Tatiana
  18. Monetary Union Stability: The Need for a Government Banker and the Case for a European Public Finance Authority By Thomas I. Palley
  19. Non-stationary inflation and panel estimates of the n ew Keynesian Phillips curve for Australia By Rao, B. Bhaskara; Paradiso, Antonio; Esposito, Piero
  20. Collapse. The story of the international financial crisis, its causes and policy consequences By Stan du Plessis
  21. Statistical evidence on the mean reversion of interest rates By Jan Willem van den End

  1. By: Mylonidis, Nikolaos; Stamopoulou, Ioanna
    Abstract: The US Federal Reserve’s new relaxed monetary policy (the so-called quantitative easing) has triggered controversy among economists and policy makers about its effectiveness. This paper investigates the role of monetary policy in managing the euro – dollar exchange rate via alternative cointegration tests and impulse response functions. It is found that monetary fundamentals have neither long- nor short-run impact on the exchange rate. This implies that the Fed’s quantitative easing schemes are unlikely to have any significant impact on the euro – dollar rate.
    Keywords: Exchange rates; Monetary model; Cointegration; Impulse response functions
    JEL: E52 F31
    Date: 2011–03–01
  2. By: Stephen McKnight (El Colegio de México)
    Abstract: Should central banks target producer price inflation or consumer price inflation in the setting of monetary policy? Previous studies suggest that in order to avoid real indeterminacy and self-fulfilling fluctuations, the interest rate rule for open economies should react to producer price inflation. However, as this paper shows, the preference towards a particular inflation index crucially depends upon the timing assumption on money employed in the determinacy analysis. This timing assumption importantly determines the transactions-facilitating services of money. It is shown that the conclusions of the existing literature, that advocate targeting producer price inflation, is a by-product of adopting end-of-period timing, i.e. what matters for transactions purposes is the money one leaves the goods market with. However, we find that the conditions for equilibrium determinacy change significantly once cash-in-advance timing is adopted, i.e. what matters for current transactions is the money one enters the goods market with. Thus in stark contrast to previous studies, we show that under cash-in-advance timing, targeting consumer price inflation is preferable to targeting producer price inflation in preventing self-fulfilling expectations.
    Keywords: real indeterminacy, open economy monetary models, trade openness, interest rate rules
    JEL: E32 E43 E53 E58 F41
    Date: 2011–03
  3. By: Matteo Mogliani (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris); Giovanni Urga (Cass Business School - City University London - City University London, University of Bergamo - University of Bergamo); Carlos Winograd (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - Ecole des Ponts ParisTech - Ecole Normale Supérieure de Paris - ENS Paris, Université d'Evry - Val d'Essonne - Université d'Evry - Val d'Essonne)
    Abstract: Argentina is a unique experience of protracted economic instability and monetary disorder. In the framework of a long-term view, we investigate the demand for narrow money in Argentina from 1900 to 2006, shedding some light on the existence of money demand equilibria in extremely turbulent economies. The paper examines the effect of monetary regime changes by dealing with the presence of structural breaks in long-run equations. We estimate and test for regime changes through a sequential approach and we embed breaks in long-run models. A robust cointegration analysis can be hence performed in a single-equation framework. We find that estimated parameters are in sharp contrast with those reported in the literature for Argentina, but in line with those reported for industrialized countries, while significant structural breaks appear consistent with major policy shocks that took place in Argentina during the 20th century.
    Keywords: money demand ; financial regimes ; structural breaks ; single-equation cointegration ; cointegration test ; Argentina monetary history
    Date: 2011–03–09
  4. By: Merola, Rossana
    Abstract: Recent developments in Canada, the United Kingdom, the euro area, Japan, Sweden, Switzerland and the United States have triggered a debate on whether monetary policy is effective when the nominal interest rate is close to zero. In this context, the monetary authority is no longer in a position to pursue a policy of monetary easing by lowering nominal interest rates further. However, some economists have down-played the risk of hitting the zero lower bound, at least for the US economy. In this paper, I assess the implications of the zero lower bound in a DSGE model with financial frictions. The financial accelerator mechanism is formalized as in Bernanke, Gertler and Gilchrist (1995). The paper attempts to address three main issues. First, I evaluate whether the zero lower bound -- by limiting the use of the nominal interest rate as a policy instrument -- might hamper the monetary authority from offsetting the negative effects of an adverse shock. Second, I analyze whether price-level targeting, through the stabilization of private sector expectations, might be a better monetary rule than inflation targeting in order to avoid the "liquidity trap". Third, I investigate the effectiveness of fiscal stimulus (namely, an increase in government expenditure) when financial markets are imperfect and the nominal interest rate is close to its zero lower bound. In this context, two questions will be addressed: first, do financial frictions weaken the effect of a fiscal expansion? Second, how are results affected when the zero lower bound is binding? To address these questions, I introduce a negative demand shock and an adverse financial shock. I find that by adopting a price-level targeting rule, the monetary authority might alleviate the recession generated by the interaction of financial frictions and lower-bounded nominal interest rates. Alternatively, an increase in government expenditure has a positive impact on output, but fiscal multipliers are below one, due to a strong crowding-out effect of private consumption. This effect is muted when the nominal interest rate is lower bounded. In analyzing discretionary fiscal policy, this paper does also focus on two crucial aspects: the duration of the fiscal stimulus and the presence of implementation lags.
    Keywords: Optimal monetary policy; financial accelerator; lower bound on nominal interest rates; price-level targeting; fiscal stimulus.
    JEL: E31 E58 E52 E44
    Date: 2010–07
  5. By: Pami Dua (Department of Economics, Delhi School of Economics, Delhi, India); Rajiv Ranjan (Reserve Bank of India, India)
    Abstract: This paper develops vector autoregressive and Bayesian vector autoregressive models to forecast the Indian Re/US dollar exchange rate which is governed by a managed floating exchange rate regime. It considers extensions of the monetary model that include the forward premium, capital inflows, volatility of capital flows, order flows and central bank intervention. The study finds that the monetary model generally outperforms the naïve model. It also finds that forecast accuracy can be improved by extending the monetary model to include forward premium, volatility of capital inflows and order flow. Information on intervention by the central bank also helps to improve forecasts at the longer end. The study also reports that the Bayesian vector autoregressive models generally outperform their corresponding VAR variants.
    Keywords: exchange rate; monetary model; VAR and Bayesian VAR models
    JEL: C11 C32 C53 F31 F47
    Date: 2011–02
  6. By: Don J. Webber (Department of Business Economics, Auckland University of Technology and UWE, Bristol); Saten Kumar (Department of Business Economics, Auckland University of Technology and Department of Economics)
    Abstract: Estimates of the demand for money provide important foundations for monetary policy setting but if the estimation technique does not explicitly account for structural changes then such estimates will be biased. This paper presents an investigation into the level and stability of money demand (M1) for Australia and New Zealand over the 1960-2009 period and demonstrates that both countries experienced regime shifts; Australia also experienced an intercept shift. Application of four time series methods provide consistent results with 1984 and 1998 break dates. CUSUM and CUSUMSQ stability tests reveal that M1 demand functions were unstable over the 1984 to 1998 period for both countries although tests for stability are not rejected thereafter.
    Keywords: Money demand; Cointegration; Structural breaks; Australia; New Zealand
    JEL: C22 E41
    Date: 2011–01
  7. By: Reinhart, Carmen; Reinhart, Vincent
    Abstract: Capital inflows can be a mixed blessing, especially in economies with thin domestic financial markets and when driven by investors with a short-term focus. Many levers of policy can be applied to resist the effects of the inflows. One that has been widely relied upon has been currency intervention. Key to that appears to be keeping their bilateral exchange rate stable vis-à-vis the U.S. dollar. But this requires them to resist currency appreciation and accumulate dollar reserves when the anchor country is mired in financial problems and keeps monetary policy accommodative in an unprecedented manner. The willingness of emerging market economies to limit exchange rate fluctuations will be tested as monetary policy in advanced economies remains geared toward domestic considerations. Meanwhile, some advanced economies will be looking to finance large deficits and to roll over large debts. In that environment, prior reticence toward capital controls and other restrictions on finance may well lift. For emerging markets, this insulates them from monetary policy in advanced economies that may be inappropriate for domestic circumstances. For advanced economies, this limits the competition for the debt they dearly have to sell. In such a world, the policy tools we discussed will be increasingly relied upon.
    Keywords: capital flows; reserves; exchange rates;capital controls
    JEL: F40 F30
    Date: 2011–02
  8. By: Giorgio Motta; Patrizio Tirelli
    Abstract: When the central bank is the sole policymaker, the combination of limited asset market participation and consumption habits can have dramatic implications for the optimal monetary policy rule and for stability properties of a business cycle model characterized by price and nominal wage rigidities. In this framework, a simple countercyclical fiscal rule plays a twofold role. On the one hand it ensures uniqueness of the rational expectations equilibrium when monetary policy follows a standard Taylor rule. On the other hand it brings aggregate dynamics substantially closer to their socially efficient levels.
    Keywords: Rule of Thumb Consumers, DSGE, Determinacy, Limited Asset Market Participation, Taylor Principle, Optimal Simple Rule
    JEL: E52
    Date: 2011–03
  9. By: Pierre-Richard Agénor; George Bratsiotis; D. Pfajfar
    Abstract: This paper examines the impact of monetary shocks on the loan spread in a DSGE model that combines the cost channel effect of monetary transmission with the role of collateral under asymmetric information. Its key feature is the endogenous derivation of the default probability that results in a lending rate being set as a countercyclical risk premium over the cost of borrowing from the central bank. The endogenous probability of default is shown to provide an accelerator effect through which monetary shocks can amplify the loan spread The behavior of the spread appears to be consistent with existing empirical evidence.
    Date: 2011
  10. By: de Carvalho Filho, Irineu
    Abstract: Twenty-eight months after the onset of the global financial crisis of August 2008, the evidence on post-crisis GDP growth emerging from a sample of 51 advanced and emerging countries is flattering for inflation targeting countries relative to their peers. The positive effect of IT is not explained away by plausible pre-crisis determinants of post-crisis performance, such as growth in private credit, ratios of short-term debt to GDP, reserves to short-term debt and reserves to GDP, capital account restrictions, total capital inflows, trade openness, current account balance and exchange rate flexibility, or post-crisis drivers such as the growth performance of trading partners and changes in terms of trade. We find that inflation targeting countries lowered nominal and real interest rates more sharply than other countries; were less likely to face deflation scares; and had sharp real depreciations without a relative deterioration in their risk assessment by markets. While the task of establishing causal relationships from cross-sectional macroeconomics series is daunting, our reading of this evidence is consistent with the resilience of IT countries being related to their ability to loosen their monetary policy when most needed, thereby avoiding deflation scares and the zero lower bound on interest rates.
    Keywords: Inflation targeting; economic crisis; monetary policy; Great Recession
    JEL: E00 E4 E3
    Date: 2011–03
  11. By: Carstensen, Kai; Schenkelberg, Heike
    Abstract: This paper evaluates the predictions of different price setting theories using a new dataset constructed from a large panel of business surveys of German retail firms over the period 1970-2010. The dataset contains firm-specific information on both price realizations and expectations. Aggregating the price data we find clear evidence in favor of state-dependence; for periods of relatively high and volatile inflation not only the size of price changes (intensive margin) but also the fraction of price adjustment (extensive margin) is important for aggregate inflation dynamics. Moreover, at the business cycle frequency, variations in the extensive margin explain a large fraction of inflation variability even for moderate inflation periods. This holds both for price realizations and expectations suggesting a role for state-dependent sticky plan models. Moreover, results from a structural sign-restriction VAR model show that the extensive margin reacts significantly to a monetary policy shock and is more important for the response of overall inflation than the intensive margin conditional on the shock. These findings confirm the validity of state-dependent pricing models that stress the importance of the extensive margin - even for low inflation periods.
    Keywords: Price setting behavior; time dependent pricing; state dependent pricing; monetary policy transmission
    JEL: E31 E32 E50
    Date: 2011–03–07
  12. By: Gabriele Galati; Peter Heemeijer; Richhild Moessner
    Abstract: We provide new insights on the formation of inflation expectations – in particular at a time of great financial and economic turmoil – by evaluating results from a survey conducted from July 2009 through July 2010. Participants in this survey answered a weekly questionnaire about their short-, medium- and long-term inflation expectations. Participants received common information sets with data relevant to euro area inflation. Our analysis of survey responses reveals several interesting results. First, our evidence is consistent with long-term expectations having remained well anchored to the ECB’s definition of price stability, which acted as a focal point for long-term expectations. Second, the turmoil in euro area bond markets triggered by the Greek fiscal crisis influenced short- and mediumterm inflation expectations but had only a very small impact on long-term expectations. By contrast, long-term expectations did not react to developments of the euro area wide fiscal burden. Third, participants changed their expectations fairly frequently. The longer the horizon, the less frequent but larger these changes were. Fourth, expectations exhibit a large degree of time-variant non-normality. Fifth, inflation expectations appear fairly homogenous across groups of agents at the shorter horizon but less so at the medium- and long-term horizons.
    Keywords: Inflation expectations; monetary policy; crisis
    JEL: E31 E32 E37 E52 C53
    Date: 2011–03
  13. By: Michele Berardi
    Abstract: In recent literature on monetary policy, it has been argued that a sensible policy rule should be able to induce learnability of the fundamental equilibrium: if private agents update their beliefs over time using adaptive learning technques, they should be able to converge towards rationality. Evans and Honkapohja (2003) showed that in a New Keynesian model an expectations based rule has such a desirable property, while a fundamentals based one does not. In order to implement an expectations based rule, though, the policymaker needs to observe private sector expectations. We show that there exists an alternative rule, based only on fundamentals, that can achieve the same positive results in terms of stability of private sector?s learning dynamics. Moreover, such a rule is learnable by the policymaker, and the combined learning dynamics of the private sector and the central bank make the economy converge to the fundamental equilibrium.
    Date: 2011
  14. By: Kallåk Anundsen , André (Dept. of Economics, University of Oslo); Sigurd Holmsen Krogh, Tord (Dept. of Economics, University of Oslo); Nymoen, Ragnar (Dept. of Economics, University of Oslo); Vislie, Jon (Dept. of Economics, University of Oslo)
    Abstract: This paper presents the business cycle model that Trygve Haavelmo developed as part of his research program in macroeconomic and monetary theory. Driven by a mismatch between the marginal return to capital and the rate of return required by capital owners, this model generates endogenous cycles. The theory leads to a distinct analysis of the scope and limitations of monetary policy. A main message of the model is that care should be taken when conducting 'autonomous' monetary policy and that special emphasis should be put on the soundness of nancial mar- kets. Adopting a strict nominal anchor as the main objective of monetary policy might generate imbalances in the capital market.
    Keywords: investments; business cycles; monetary policy
    JEL: E22 E32 E44 E52
    Date: 2011–03–10
  15. By: Barbara Annicchiarico (Faculty of Economics, University of Rome "Tor Vergata"); Alessandra Pelloni (Faculty of Economics, University of Rome "Tor Vergata"); Lorenza Rossi (University of Pavia)
    Abstract: We introduce endogenous growth in an otherwise standard NK model with staggered prices and wages. Some results follow: (i) monetary volatility negatively affects long-run growth; (ii) the relation between nominal volatility and growth depends on the persistence of the nominal shocks and on the Taylor rule considered; (iii) a Taylor rule with smoothing increases the negative effect of nominal volatility on mean growth.
    Keywords: Growth, volatility, business cycle, monetary policy
    JEL: E32 E52 O42
    Date: 2011–03–08
  16. By: Jackman, Mahalia
    Abstract: Using the unrestricted error correction model proposed by Pesaran et al (2001), this paper investigates the relationship between economic uncertainty and money demand in Barbados. Results suggest that in the short run, agents tend to increase money holdings in the face of heightened uncertainty. However, this impact does not carry on into the longer term. Rather, the results suggest that nominal assets may become less attractive during prolonged periods of economic uncertainty.
    Keywords: Money demand; economic uncertainty; Barbados; fixed exchange rate
    JEL: C32 E41
    Date: 2010–12–18
  17. By: Himmels, Christoph; Kirsanova, Tatiana
    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: E58 E52 C61 E63 E61
    Date: 2011–02–28
  18. By: Thomas I. Palley (New America Foundation, Washington DC)
    Abstract: This paper argues monetary union stability requires a government banker that manages the bond market and it offers a specific proposal for stabilizing the euro that does not violate the “no country bail-out” clause. There is accumulating evidence that the euro’s current architecture is unstable. The source of instability is high interest rates on highly indebted countries which creates unsustainable debt burdens. Remedying this problem requires a central bank that acts as government banker and pushes down government bond interest rates to sustainable levels. That can be accomplished by creation of a European Public Finance Authority (EPFA) that issues public debt which the European Central Bank (ECB) is allowed to trade. The debate over the euro’s financial architecture also has significant political implications. That is because the current neoliberal inspired architecture, which imposes a complete separation between the central bank and public finances, puts governments under continuous financial pressures. Over time, that pressure makes it difficult to maintain the European social democratic welfare state. This gives a political reason for reforming the euro and creating an EPFA that supplements the economic case for reform.
    Keywords: monetary union, stability, government banker, euro.
    Date: 2011
  19. By: Rao, B. Bhaskara; Paradiso, Antonio; Esposito, Piero
    Abstract: This paper uses a recent panel method of Russell and Banerjee (2008) to estimate the new Keynesian Phillips curve for Australia. Our estimates show that while the hybrid new Keynesian Phillips curve and backward looking conventional Phillips curve are well determined, estimates of the Phillips curve with the pure forward looking expectations are unsatisfactory.
    Keywords: Panel data estimates; new Keynesian Phillips curve; Australia and Unit roots in the rate of inflation.
    JEL: E31
    Date: 2011–03–02
  20. By: Stan du Plessis (Department of Economics, University of Stellenbosch)
    Abstract: This paper is the story of success and failure in the financial markets, the markets for goods and services and in politics. It is a difficult story to tell because the crisis had many causes, but the focus here is on three main factors. First, the incentives that contributed to a credit-fuelled bubble, especially in property markets. Monetary and regulatory policies feature prominently in this part of the story. Second, because the housing bubble alone cannot explain the magnitude of the subsequent events, gearing in the financial sector, which affected asset markets unrelated to sub-prime mortgages will be examined. These developments are explained by reference to private financial sector decisions, including the role of the shadow-banking sector, and their regulatory backdrop. Finally, an answer will be sought to the question of how highly geared banks first became fragile and then failed with such dire consequences for the economy that massive policy intervention had become essential. The consequences of these large policy interventions and the international tensions caused by them are also explored.
    Keywords: Financial crisis, Banks, Financial regulation, Monetary policy, Fiscal policy, Currency wars
    JEL: G20 G28 E58
    Date: 2011
  21. By: Jan Willem van den End
    Abstract: Based on two hundred years of annual data of the Netherlands , Germany , US and Japan we analyse the mean reversion of long-term interest rates, by unit root tests over rolling windows and taking into account structural breaks and regime changes. While short-term rates and the yield curve tend to revert to their long-term average value, long-term rates can persistently deviate from it. At the outside, we only find weak statistical evidence for mean reversion of long-term rates. Outcomes of smooth transition autoregressive ( STAR ) models for long-term interest rates, indicate that the speed of mean reversion is regime dependent, being stronger when rates are far from their equilibrium value.
    Keywords: interest rates; statistical methods; time-series models
    JEL: C22 C49 G12
    Date: 2011–03

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