nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒04‒30
twenty-six papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. The effectiveness of monetary policy in steering money market rates during the recent financial crisis By Puriya Abbassi; Tobias Linzert
  2. The Evolution of the Monetary Policy Regimes in the U.S. By Jinho Bae; Chang-Jin Kim; Dong Heon Kim
  3. Does the level of capital openness explain “fear of floating” amongst the inflation targeting countries? By Mukherjee, Sanchita
  4. Volatility, money market rates, and the transmission of monetary policy By Seth B. Carpenter; Selva Demiralp
  5. Inflation Targeting in Brazil, Chile and South Africa: An Empirical Investigation of Their Monetary Policy Framework By Mona Kamal
  6. Is Monetary Policy in New Members States Asymmetric? By Borek Vasicek
  7. The Cost Channel of Monetary Policy in a Post Keynesian Macrodynamic Model of Inflation and Output Targeting By Gilberto Tadeu Lima; Mark Setterfield
  8. "Hegemonic Currencies during the Crisis: The Dollar versus the Euro in a Cartalist Perspective" By David Fields; Matías Vernengo
  9. Money Market Integration and Sovereign CDS Spreads Dynamics in the New EU States By Peter Chobanov; Amine Lahiani; Nikolay Nenovsky
  10. A Monetary Theory with Non-Degenerate Distributions By Hongfei Sun; Shouyong Shi; Guido Menzio
  11. The Quantity Theory revisited: A new structural Approach By Makram El-Shagi; Sebastian Giesen; L. J. Kelly
  12. EU Enlargement and Monetary Regimes from the Insurance Model Perspectives By Nikolay Nenovsky
  13. Inflation and inflation uncertainty: Evidence from two Transition Economies By Ahmad Zubaidi Baharumshah; Akram Hasanov; Stilianos Fountas
  14. Business cycle dynamics under rational inattention By Bartosz Maćkowiak; Mirko Wiederholt
  15. Expectations of inflation: the biasing effect of thoughts about specific prices By Wändi Bruine de Bruin; Wilbert van der Klaauw; Giorgio Topa
  16. Distributional dynamics under smoothly state-dependent pricing By James Costain; Anton Nakov
  17. Exchange Rate Regimes, Trade, and the Wage Comovements By Yoshinori Kurokawa; Jiaren Pang; Yao Tang
  18. Macroeconomic Stress Testing and the Resilience of the Indian Banking System: A Focus on Credit Risk By Niyogi Sinha Roy, Tanima; Bhattacharya, Basabi
  19. Cross-section Dependence and the Monetary Exchange Rate Model: A Panel Analysis By Joscha Beckmann; Ansgar Belke; Frauke Dobnik
  20. Inflation variability and the relationship between inflation and growth By Raghbendra Jha; Tu Dang
  21. Social Status, Human Capital Formation and the Long-run Effects of Money By Chen, Hung-Ju
  22. How did the crisis in international funding markets affect bank lending? Balance sheet evidence from the United Kingdom By Aiyar, Shekhar
  23. Currency Speculation in a Game-Theoretic Model of International Reserves By Carlos J. Perez; Manuel S. Santos
  24. Central bank communication on financial stability By Benjamin Born; Michael Ehrmann; Marcel Fratzscher
  25. International Propagation of Financial Shocks in a Search and Matching Environment By Marlène Isoré
  26. Tailwinds and headwinds: how does growth in the BRICs affect inflation in the G7? By Lipinska, Anna; Millard, Stephen

  1. By: Puriya Abbassi (Gutenberg-Universität Mainz, Saarstrasse 21, D-55128 Mainz, Germany.); Tobias Linzert (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: The recent financial crisis deeply affected the money market yield curve and thus, potentially, the proper functioning of the interest rate channel of monetary policy transmission. Therefore, we analyze the effectiveness of monetary policy in steering euro area money market rates using two measures: first, the predictability of money market rates on the basis of monetary policy expectations, and second the impact of extraordinary central bank measures on money market rates. We find that market expectations about monetary policy are less relevant for money market rates up to 12 months after August 2007 compared to the pre-crisis period. At the same time, our results indicate that the ECB’s net increase in outstanding open market operations as of October 2008 accounts for at least a 100 basis point decline in Euribor rates. These findings show that central banks have effective tools at hand to conduct monetary policy in times of crises. JEL Classification: E43, E52, E58.
    Keywords: Monetary transmission mechanism, Financial Crisis, Monetary policy implementation, European Central Bank, Money market.
    Date: 2011–04
  2. By: Jinho Bae (Department of Economics, Konkuk University, Seoul, South Korea); Chang-Jin Kim (Department of Economics, Korea University, Seoul, South Korea); Dong Heon Kim (Department of Economics, Korea University, Seoul, South Korea)
    Abstract: The existing literature on U.S. monetary policy provides no sense of a cnsensus regarding the existence of a monetary policy regime. This paper explores the evolution of U.S. monetary policy regimes via the development of a Markov-switching model predicated on narrative and statistical evidence of a monetary policy regime. We identified five regimes for the period spanning 1956:I - 2005:IV and they roughly corresponded to the Chairman term of the Federal Reserve, except for the Greenspan era. More importantly, we demonstrate that the conflicting results regarding the response to inflation for the pre-Volcker period in the existing literature is not attributable to the different data but due to different samples, and also provided an insight regarding the Great Inflation?namely, that the near non-response to inflation in the early 1960s appears to have constituted the initial seed of the Great Inflation. We also find via analysis of the Markov-switching model for the U.S. real interest rate, that the regime changes in the real interest rate follow the regime changes in monetary policy within two years and that the evolution of real interest rate regimes provides a good explanation for the conflicting results regarding the dynamics of real interest rate.
    Keywords: Monetary policy rule; Markov switching; Great Inflation; Real interest rate; Evolution
    JEL: E5 C32
    Date: 2011
  3. By: Mukherjee, Sanchita
    Abstract: Abstract Under the assumption of perfect capital mobility, inflation targeting (IT) requires central banks to primarily focus on domestic inflation and to let their exchange rate float freely. This is consistent with the macroeconomic trilemma suggesting monetary independence, perfect capital mobility and a fixed exchange rate regime are mutually incompatible. However, some recent empirical evidence suggests that many developed and developing countries following an IT regime are reacting systematically both to deviations of inflation from its target and to exchange rates. I empirically examine whether the responsiveness of the interest rate to exchange rate fluctuations can be explained in terms of limited capital openness. Applying Arellano-Bond dynamic panel estimation method for 22 IT countries, I find that short-term interest rates do respond to real exchange rate fluctuations. However, the responsiveness of the interest rate to the exchange rate declines significantly as capital market openness increases. The results indicate that capital controls have a significant impact on the exchange rate policy of the IT central banks, as the central banks have relatively less control over the exchange rate movements with greater openness of the capital market.
    Keywords: Macroeconomic Trilemma; Inflation Targeting; Interest Rates; Exchange Rate Policy; Capital Market Openness
    JEL: E58 E52 E44 F41
    Date: 2011–04–12
  4. By: Seth B. Carpenter; Selva Demiralp
    Abstract: Central banks typically control an overnight interest rate as their policy tool, and the transmission of monetary policy happens through the relationship of this overnight rate to the rest of the yield curve. The expectations hypothesis, that longer-term rates should equal expected future short-term rates plus a term premium, provides the typical framework for understanding this relationship. We explore the effect of volatility in the federal funds market on the expectations hypothesis in money markets. We present two major results. First, the expectations hypothesis is likely to be rejected in money markets if the realized federal funds rate is studied instead of an appropriate measure of the expected federal funds rate. Second, we find that lower volatility in the bank funding markets market, all else equal, leads to a lower term premium and thus longer-term rates for a given setting of the overnight rate. The results appear to hold for the US as well as the Euro Area and the UK. The results have implications for the design of operational frameworks for the implementation of monetary policy and for the interpretation of the changes in the Libor-OIS spread during the financial crisis. We also demonstrate that the expectations hypothesis is more likely to hold the more closely linked the short- and long-term interest rates are.
    Date: 2011
  5. By: Mona Kamal
    Abstract: This paper tackles the monetary policy performance in Brazil, Chile and South Africa under inflation targeting framework. Furthermore, it provides an empirical assessment through using the unrestricted Vector Auto-regression (VAR) and Structural Vector Auto-regression (SVAR) approaches depending on data spans the period from the first quarter of 1970 to the fourth quarter of 2007. On the other hand, it utilizes the Likelihood Ratio (LR) Statistic to test for possible structural changes due to the adoption of inflation targeting regime in those countries. The main findings are as follows: inflation targeting does make a difference in the performance of monetary policy in those countries. Furthermore, the experience of Brazil, Chile and South Africa provides important lessons for other emerging market economies to adopt such a framework.
    Keywords: Monetary policy, Vector Auto-regression (VAR), Structural Vector Auto-regression (SVAR) approach, Inflation Targeting Framework.
    JEL: E52 E58
    Date: 2010–11–01
  6. By: Borek Vasicek
    Abstract: Estimated Taylor rules became popular as a description of monetary policy conduct. There are numerous reasons why real monetary policy can be asymmetric and estimated Taylor rule nonlinear. This paper tests whether monetary policy can be described as asymmetric in three new European Union (EU) members (the Czech Republic, Hungary and Poland), which apply an inflation targeting regime. Two different empirical frameworks are used: (i) a Generalized Method of Moments (GMM) estimation of models that allow discrimination between the sources of potential policy asymmetry but are conditioned by specific underlying relations (Dolado et al., 2004, 2005; Surico, 2007a,b); and (ii) a flexible framework of sample splitting where nonlinearity enters via a threshold variable and monetary policy is allowed to switch between regimes (Hansen, 2000; Caner and Hansen, 2004). We find generally little evidence for asymmetric policy driven by nonlinearities in economic systems, some evidence for asymmetric preferences and some interesting evidence on policy switches driven by the intensity of financial distress in the economy.
    Keywords: monetary policy, inflation targeting, nonlinear Taylor rules, threshold estimation
    JEL: C32 E52 E58
    Date: 2010–12–01
  7. By: Gilberto Tadeu Lima (Department of Economics, University of Sao Paulo); Mark Setterfield (Department of Economics, Trinity College)
    Abstract: This paper contributes to the debate about whether or not inflation targeting is compatible with Post Keynesian economics. It does so by developing a model that takes into account the potentially inflationary consequences of interest rate manipulations. Evaluations of the macroeconomic implications of this so-called cost channel of monetary policy are common in the mainstream literature. But this literature uses supply-determined macro models and provides standard optimizing microfoundations for the various ways in which the interest rate can affect mark-ups, prices and ultimately the form of the Phillips curve. Our purpose is to study the implications of different Phillips curves, each embodying the cost channel and derived from Post Keynesian, cost-based-pricing microfoundations, in a monetary-production economy. We focus on the impact of these Phillips curves on macroeconomic stability and the consequent efficacy of inflation and output targeting. Ultimately, our results suggest that the presence of the cost channel is of less significance than the general orientation of the policy regime, and corroborate earlier finding that, in a monetary-production economy, more orthodox policy regimes are inimical to macro stabilization.
    Keywords: Cost channel of monetary policy, incomes policy, inflation targeting, macroeconomic stability
    JEL: E12 E52 E60
    Date: 2011–04
  8. By: David Fields; Matías Vernengo
    Abstract: This paper suggests that the dollar is not threatened as the hegemonic international currency, and that most analysts are incapable of understanding the resilience of the dollar, not only because they ignore the theories of monetary hegemonic stability or what, more recently, has been termed the geography of money; but also as a result of an incomplete understanding of what a monetary hegemon does. The hegemon is not required to maintain credible macroeconomic policies (i.e., fiscally contractionary policies to maintain the value of the currency), but rather to provide an asset free of the risk of default. It is argued that the current crisis in Europe illustrates why the euro is not a real contender for hegemony in the near future.
    Keywords: Dollar; Euro; International Currency
    JEL: F31 F33
    Date: 2011–04
  9. By: Peter Chobanov; Amine Lahiani; Nikolay Nenovsky
    Abstract: When the first phase of the crisis focused primarily on the interbank market volatility, the second phase spread on the instability of public finance. Although the overall stance of public finances of the new members is better than the old member countries, the differences within the new group are significant (from the performer Estonia to the laggard Hungary). Sovereign CDS spreads have become major variables focused on risks and expectations about the fiscal situation of different countries. In the paper we investigate, first, whether there is a link in the new member states (NMS) between the expectations about the condition of their public finances and the dynamics of money markets,including integration of national money markets with the euro area.....Our study confirm that the strong link between monetary and public finance risk as apart of total systemic risk increase during the crisis especially for currency boards regimes, when the link becomes stronger and pronounced. For the inflation targeting countries the link became weaker and less pronounced.
    Keywords: money markets, sovereign CDS spreads, EU enlargement, monetary regimes, financial crisis
    JEL: E43 G10 P20 F31 F34
    Date: 2010–10–01
  10. By: Hongfei Sun (Queen's University); Shouyong Shi (University of Toronto); Guido Menzio (University of Pennsylvania)
    Abstract: Dispersion of money balances among individuals is the basis for a range of policies but it has been abstracted from in monetary theory for tractability reasons. In this paper, we fill in this gap by constructing a tractable search model of money with a non-degenerate distribution of money holdings. We assume search to be directed in the sense that buyers know the terms of trade before visiting particular sellers. Directed search makes the monetary steady state block recursive in the sense that individuals` policy functions, value functions and the market tightness function are all independent of the distribution of individuals over money balances, although the distribution affects the aggregate activity by itself. Block recursivity enables us to characterize the equilibrium analytically. By adapting lattice-theoretic techniques, we characterize individuals’ policy and value functions, and show that these functions satisfy the standard conditions of optimization. We prove that a unique monetary steady state exists. Moreover, we provide conditions under which the steady-state distribution of buyers over money balances is non-degenerate and analyze the properties of this distribution.
    Keywords: Money, Distribution, Search, Lattice-Theoretic
    JEL: E00 E4 C6
    Date: 2011–03
  11. By: Makram El-Shagi; Sebastian Giesen; L. J. Kelly
    Abstract: While the long run relation between money and inflation is well established, empirical evidence on the adjustment to the long run equilibrium is very heterogeneous. In this paper we show, that the development of US consumer price inflation between 1960Q1 and 2005Q4 is strongly driven by money overhang. To this end, we use a multivariate state space framework that substantially expands the traditional vector error correction approach. This approach allows us to estimate the persistent components of velocity and GDP. A sign restriction approach is subsequently used to identify the structural shocks to the signal equations of the state space model, that explain money growth, inflation and GDP growth. We also account for the possibility that measurement error exhibited by simple-sum monetary aggregates causes the consequences of monetary shocks to be improperly identified by using a Divisia monetary aggregate. Our findings suggest that when the money is measured using a reputable index number, the quantity theory holds for the United States.
    Keywords: Divisia money, state space decomposition, sign restrictions
    JEL: E31 E52 C32
    Date: 2011–04
  12. By: Nikolay Nenovsky
    Abstract: Some ten years ago, Michael Dooley (Dooley, 1997; Dooley, 2000) put forward an insurance model of currency crises, which after some modifications gives a good theoretical basis for explanation of the overall dynamics of the post communist transformation and diversity across countries and periods. The article analyses, within the framework of the insurance model, the role of monetary regimes (currency anchor) and EU enlargement (political and geostrategic anchor) and their relationships. The insurance game model not only contains an explanatory power, but it also has the potential to suggest a range of measures that could be useful in overcoming the "bad" dynamics, which we are witnessing today not only in the new member-states, but also EU-wide.
    Keywords: post communist transformation, monetary regimes, insurance model of currency crisis
    JEL: F33 F36 P20 P30
    Date: 2010–06–01
  13. By: Ahmad Zubaidi Baharumshah (Department of Economics, Universiti Putra Malaysia); Akram Hasanov (Department of Economics, Universiti Putra Malaysia); Stilianos Fountas (Department of Economics, University of Macedonia)
    Abstract: This paper examines the causal link between inflation and inflation uncertainty for the transition economies of Russia and Ukraine. The Iterated Cumulative Sums of Squares Exponential Generalized Autoregressive Conditional Heteroskedasticity (ICSS-EGARCH-M-t) models that allow for asymmetry and regime shifts in the variance of inflation are employed to establish the inflation-inflation uncertainty causal relationship. We find three breaks in the inflation volatility series that coincide with the major historical events in these two countries. The empirical results reveal strong support of the Friedman-Ball hypothesis in both countries. Additionally, we discover that the reverse causal relation between inflation and inflation uncertainty as predicted by the Holland hypothesis holds in Ukraine, but this stabilization policy behavior does not seem to prevail in Russia.
    Keywords: transition economies, inflation, inflation uncertainty, ICSS-EGARCH-t.
    JEL: I20 I23
    Date: 2011–04
  14. By: Bartosz Maćkowiak (CEPR and European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Mirko Wiederholt (Department of Economics, Northwestern University, 2001 Sheridan Road, Evanston, IL 60208, USA.)
    Abstract: We develop a dynamic stochastic general equilibrium model with rational inattention by households and firms. Consumption responds slowly to interest rate changes because households decide to pay little attention to the real interest rate. Prices respond quickly to some shocks and slowly to other shocks. The mix of fast and slow responses of prices to shocks matches the pattern found in the empirical literature. Changes in the conduct of monetary policy yield very different outcomes than in models currently used at central banks because systematic changes in policy cause reallocation of attention by decision-makers in households and firms. JEL Classification: D83, E31, E32, E52.
    Keywords: information choice, rational inattention, monetary policy, business cycles.
    Date: 2011–04
  15. By: Wändi Bruine de Bruin; Wilbert van der Klaauw; Giorgio Topa
    Abstract: National surveys follow consumers’ expectations of future inflation, because they may directly affect the economic choices they make, indirectly affect macroeconomic outcomes, and be considered in monetary policy. Yet relatively little is known about how individuals form the inflation expectations they report on consumer surveys. Medians of reported inflation expectations tend to track official estimates of realized inflation, but show large disagreement between respondents, due to some expecting seemingly extreme inflation. We present two studies to examine whether individuals who consider specific price changes when forming their inflation expectations report more extreme and disagreeing inflation expectations due to focusing on specific extreme price changes. In Study 1, participants who were instructed to recall any price changes or to recall the largest price changes both thought of various items for which price changes were perceived to have been extreme. Moreover, they reported more extreme year-ahead inflation expectations and showed more disagreement than did a third group that had been asked to recall the average change in price changes. Study 2 asked participants to report their year-ahead inflation expectations, without first prompting them to recall specific price changes. Half of participants nevertheless thought of specific prices when generating their inflation expectations. Those who thought of specific prices reported more extreme and more disagreeing inflation expectations, because they were biased toward various items associated with more extreme perceived price changes. Our findings provide new insights into expectation formation processes and have implications for the design of survey-based measures of inflation.
    Keywords: Consumer surveys ; Inflation (Finance) ; Prices
    Date: 2011
  16. By: James Costain (Banco de España, Calle Alcalá 48, 28014 Madrid, Spain.); Anton Nakov (Banco de España and European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Starting from the assumption that firms are more likely to adjust their prices when doing so is more valuable, this paper analyzes monetary policy shocks in a DSGE model with firm-level heterogeneity. The model is calibrated to retail price microdata, and inflation responses are decomposed into “intensive”, “extensive”, and “selection” margins. Money growth and Taylor rule shocks both have nontrivial real effects, because the low state dependence implied by the data rules out the strong selection effect associated with fixed menu costs. The response to firm-specific shocks is gradual, though inappropriate econometrics might make it appear immediate. JEL Classification: E31, E52, D81.
    Keywords: Nominal rigidity, state-dependent pricing, menu costs, heterogeneity, Taylor rule.
    Date: 2011–04
  17. By: Yoshinori Kurokawa; Jiaren Pang; Yao Tang
    Abstract: The introduction of exchange rate regimes into the standard Ricardian model of trade implies stronger positive wage comovements between trading countries which fix their bilateral exchange rates. Regression results based on data from OECD countries between 1973 to 2010 suggest that countries in the European Monetary Union experienced stronger positive wage comovements with their main trade partners. In comparison, the positive wage comovements between countries engaged in non-currency-union pegs were weaker.
    Date: 2011–04
  18. By: Niyogi Sinha Roy, Tanima; Bhattacharya, Basabi
    Abstract: The paper undertakes a macroprudential analysis of the credit risk of Public Sector Banks during the liberalization period. Using the Vector Autoregression methodology, the paper investigates the dynamic impact of changes in the macroeconomic variables on the default rate, the Financial Stability Indicator of banks by simulating interactions among all the variables included in the model. Feedback effects from the banking sector to the real economy are also estimated. The impact of variations in different Monetary Policy Instruments such as Bank Rate, Repo Rate and Reverse Repo Rate on the asset quality of banks is examined using three alternative baseline models. Impulse Response Functions of the estimated models are augmented by conducting sensitivity and scenario stress testing exercises to assess the banking sector’s vulnerability to credit risk in the face of hypothetically generated adverse macroeconomic shocks. Results indicate the absence of cyclicality and pro-cyclicality of the default rate. Adverse shocks to output gap, Real Effective Exchange Rate appreciation above its trend value, inflation rate and policy-induced monetary tightening significantly affect bank asset quality. Of the three policy rates, Bank Rate affects bank soundness with a lag and is more persistent while the two short-term rates impact default rate instantaneously but is much less persistent. Scenario stress tests reveal default rate of Public Sector Banks could increase on an average from 4% to 7% depending on the type of hypothetical macroeconomic scenario generated. An average buffer capital of 3% accumulated during the period under consideration could thus be inadequate for nearly twice the amount of Non-Performing Assets generated if macroeconomic conditions worsened. An important policy implication of the paper is that as the Indian economy moves gradually to Full Capital Account Convertibility, the banking sector is likely to come under increased stress in view of the exchange rate volatility with adverse repercussions on interest rates and bank default rates. In this emerging scenario, monetary policy stance thus emerges as an important precondition for banking stability. The study also highlights the inadequacy of existing capital reserves should macroeconomic conditions deteriorate and the urgency to strengthen the buffer capital position.
    Keywords: Banks; Macro Prudential analysis; Stress test
    JEL: E52 G21
    Date: 2011–03–16
  19. By: Joscha Beckmann; Ansgar Belke; Frauke Dobnik
    Abstract: This paper tackles the issue of cross-section dependence for the monetary exchange rate model in the presence of unobserved common factors using panel data from 1973 until 2007 for 19 OECD countries. Applying a principal component analysis we distinguish between common factors and idiosyncratic components and determine whether non-stationarity stems from international or national stochastic trends. We find evidence for a cross-section cointegration relationship between the exchange rates and fundamentals which is driven by those common international trends. In addition, the estimated coefficients of income and money are in line with the suggestions of the monetary model.
    Keywords: Monetary exchange rate model, common factors, panel data, cointegration, vector error-correction models
    JEL: C32 C23 F31 F41
    Date: 2011
  20. By: Raghbendra Jha; Tu Dang
    Abstract: We examine the effect of inflation variability and economic growth using annual historical data on both developing and developed countries. The data cover 182 developing countries and 31 developed countries for the period 1961-2009. Proxying inflation variability by the five-year coefficient of variation of inflation, we obtain the following results: (1) For developing countries, there is significant evidence to suggest that when the rate of inflation exceeds 10 % inflation variability has a negative effect on economic growth. (2) For developed countries, there is no significant evidence that inflation variability is detrimental to growth.
    JEL: C51 E31 E58 O40
    Date: 2011–04
  21. By: Chen, Hung-Ju
    Abstract: This study examines the effects of monetary policy in a two-sector cash-in-advance economy of human capital accumulation. Agents concern about their social status represented by the relative physical capital and relative human capital. We find that if the desire for social status depends only on relative physical capital, money is superneutral in the growth-rate sense. However, if the desire for social status depends on relative human capital, the money growth rate will have a positive effect on the long-run economic growth rate. Furthermore, an increase in the desire to pursue human capital will raise the long-run growth rate, but an increase in the desire to pursue physical capital will lower it.
    Keywords: Cash-in-advance economy; Endogenous growth; Social status.
    JEL: O42 E52 C62
    Date: 2011
  22. By: Aiyar, Shekhar (Bank of England)
    Abstract: Evidence abounds on the propagation of financial stresses originating in the US mortgage market to banking systems worldwide through international funding markets. But the transmission of this external funding shock to the real economy via bank lending is surprisingly underexamined, given the central importance ascribed to this channel of contagion by policymakers. This paper provides evidence of this transmission for the UK-resident banking system, the largest in the world by asset size. It uses a novel data set, created from detailed and confidential balance sheet data reported by individual banks quarterly to the Bank of England. I find that the shock to foreign funding caused a substantial pullback in domestic lending. The results are derived using a range of instruments to correct for endogeneity and omitted variable bias. Foreign subsidiaries and branches reduced lending by a larger amount than domestically owned banks, while the latter calibrated the reduction in domestic lending more closely to the size of the funding shock.
    Keywords: Liquidity shock; transmission mechanism; bank lending; instrumental variables.
    JEL: E30 E50 G20
    Date: 2011–04–18
  23. By: Carlos J. Perez (Universidad Carlos III de Madrid); Manuel S. Santos (Department of Economics, University of Miami)
    Abstract: This paper is concerned with the ability of speculation to gener- ate a currency crisis. We consider a game-theoretic setting between a unit mass of speculators and a government that holds foreign currency reserves. We analyze conditions under which the speculators may be able to force the government to devaluate the currency. Among these conditions, we analyze the role of heterogeneous beliefs, transaction costs, the level of international reserves, and the widening of cur- rency bands. The explicit consideration of international reserves in our model makes speculators’ actions to be strategic substitutes— rather than strategic complements. This is a main analytical depar- ture with respect to related global games of currency speculation not including reserve holdings (e.g., Morris and Shin, 1998). Our sim- ple framework with international reserves becomes suitable to review some long-standing policy issues.
    Keywords: Currency speculation, international reserves, currency crises, global games, asymmetric information.
    JEL: F31 D8
    Date: 2011
  24. By: Benjamin Born (University of Bonn.); Michael Ehrmann (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Marcel Fratzscher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Central banks regularly communicate about financial stability issues, by publishing Financial Stability Reports (FSRs) and through speeches and interviews. The paper asks how such communications affect financial markets. Building a unique dataset, it provides an empirical assessment of the reactions of stock markets to more than 1000 releases of FSRs and speeches by 37 central banks over the past 14 years. The findings suggest that FSRs have a significant and potentially long-lasting effect on stock market returns, and also tend to reduce market volatility. Speeches and interviews, in contrast, have little effect on market returns and do not generate a volatility reduction during tranquil times, but have had a substantial effect during the 2007-10 financial crisis. The findings suggest that financial stability communication by central banks are perceived by markets to contain relevant information, and they underline the importance of differentiating between communication tools, their content and the environment in which they are employed. JEL Classification: E44, E58, G12.
    Keywords: central bank, financial stability, communication, event study.
    Date: 2011–04
  25. By: Marlène Isoré
    Abstract: This paper develops a two-country multi-frictional model where the freeze on liquidity access to commercial banks in one country raises unemployment rates via credit rationing in both countries. The expenditure-switching channel, whereby asymmetric monetary shocks traditionally lead to negative comovements of home and foreign outputs, is considerably weakened via opposite forces driving the exchange rate. Meanwhile, it is proved that financial market integration forms a transmission channel per se, without resorting to international cross-holdings of risky assets. The search and matching modeling serves two purposes. First, it accounts for the time needed to restore a normal level of confidence following financial market disruptions. Second, it allows dissociating pure liquidity contractions from non-walrasian financial shocks, arriving despite global excess savings and due to heterogeneity in the quality of the banking system. The former induce negative comovements of home and foreign outputs, in accordance with the literature, whereas the new type of financial shocks does generate financial contagion.
    Keywords: matching theory, financial markets, credit rationing, financial multiplier, international transmission, financial crises, open economy macroeconomics
    JEL: C78 E44 E51 F41 F42 G15
    Date: 2011–04
  26. By: Lipinska, Anna (Bank of England); Millard, Stephen (Bank of England)
    Abstract: In this paper, we analyse the impact of a persistent productivity increase in a set of countries – which we think of as the BRIC economies – on inflation in their trading partners, the G7. In particular we want to understand conditions under which this shock can lead to tailwinds or headwinds in the economies of trading partners. We build a three-country DSGE model in which there are two oil-importing countries (home and foreign) and one oil-exporting country. We perform several experiments where we try to disentangle the importance of different factors that can shape inflation dynamics in the home country when the foreign country is hit by a persistent productivity shock. These factors are wage stickiness, the role of the oil sector and its share in both consumption and production, foreign monetary policy and the degree of completeness of financial markets. We find that the tailwinds effect, lowering inflation in the home economy, dominates the headwinds effect as long as there is scope for borrowing and lending across countries and the foreign country’s production is not too oil intensive.
    Date: 2011–04–15

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