nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒05‒07
sixteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. New Instruments of Monetary Policy By Jagjit S. Chadha; Sean Holly
  2. Dove or Hawk? characterizing monetary regime switches during financial liberalization in India By Hutchison, Michael; Sengupta, Rajeswari; Singh, Nirvikar
  3. Dynamics of Monetary Policy Uncertainty and the Impact on the Macroeconomy By Herro, Nicholas; Murray, James
  4. The threat of 'currency wars': a European perspective By Jean Pisani-Ferry; Zsolt Darvas
  5. The effects of capital market openness on exchange rate pass-through and welfare in an inflation targeting small open economy By Mukherjee, Sanchita
  6. The bank lending channel: lessons from the crisis By Leonardo Gambacorta; David Marques-Ibanez
  7. Fixed Exchange Rate Regimes and Price Stability: Evidence from MENA Countries By Darine Ghanem
  8. Capital Regulation, Monetary Policy and Financial Stability By Pierre-Richard Agénor; K. Alper; Luiz A. Pereira da Silva
  9. Non-Conventional Monetary Policies: QE and the DSGE literature By Evren Caglar; Jagjit S. Chadha; Jack Meaning; James Warren; Alex Waters
  10. Dislocations in the won-dollar swap markets during the crisis of 2007-09 By Naohiko Baba; Ilhyock Shim
  11. Macro-prudential Policy on Liquidity: What does a DSGE Model tell us? By Jagjit S. Chadha; Luisa Corrado
  12. Motivations and strategies for a real revaluation of the Yuan By Dai, Meixing
  13. Capital Controls: A Meta-analysis Approach By Magud, Nicolas; Reinhart, Carmen; Rogoff, Kenneth
  14. Release of the kraken: a novel money multiplier equation's debut in 21st century banking By Hanley, Brian P.
  15. Illiquid Banks, Financial Stability, and Interest Rate Policy By Douglas W. Diamond; Raghuram Rajan
  16. Portfolio holdings in the euro area - home bias and the role of international, domestic and sector-specific factors By Jochem, Axel; Volz, Ute

  1. By: Jagjit S. Chadha; Sean Holly
    Abstract: We assess recent developments in monetary policy practice following the financial crisis drawing on papers from a specially convened conference in March 2010. In particular, we consider why central banks throughout the world have injected substantial quantities of liquidity into the financial system and seen their balance sheets expand to multiples of GDP. We outline the rationale for balance sheet operations: (i) portfolio balance of the non-bank financial sector; (ii) an offset for the zero bound; (iii) signalling mechanism about medium term inflation expectations and (iv) the alleviation of the government's budget constraint. We briefly outline the recent experience with QE and draw a distinction between liquidity and macroeconomic stabilisation operations.
    Keywords: zero bound, open-market operations, quantitative easing, monetary policy
    JEL: E31 E40 E51
    Date: 2011–01
  2. By: Hutchison, Michael; Sengupta, Rajeswari; Singh, Nirvikar
    Abstract: The last decade has seen a worldwide move by emerging markets to adopt explicit or implicit inflation targeting regimes. A notable and often discussed exception to this trend, of course, is China which follows pegged exchange rate regime supported by capital controls. Another major exception is India. It is not clear how to characterize the monetary regime or identify the nominal monetary anchor in India. Is central bank policy in India following a predictable rule that is heavily influenced by a quasi inflation target? To address this point, we investigate monetary policy regime change in India using a Markov switching model to estimate a time-varying Taylor-type rule for the Reserve Bank of India. We find that the conduct of monetary policy over the last two decades can be characterized by two regimes, which we term ‘hawk’ and ‘dove.’ In the first of these regimes, the central bank reveals a greater relative (though not absolute) weight on controlling inflation vis-à-vis narrowing the output gap. The central bank was in the “dove” regime about half of the sample period, during these episodes focusing more on the output gap and exchange rate targets to stimulate exports, rather than on moderating inflation. India is following its own direction in the conduct of monetary policy, seemingly not overly influenced by the emphasis on quasi-inflation targeting seen in many emerging markets.
    Keywords: Monetary policy; Regime switches; Central banking; Inflation targeting
    JEL: E0 E58 F3 E52 E5 E4
    Date: 2011–04–20
  3. By: Herro, Nicholas; Murray, James
    Abstract: A large literature lauds the benefits of central bank transparency and credibility, but when a central bank like the U.S. Federal Reserve has a dual mandate, is not specific to the extent it targets employment versus price stability, and is not specific to the magnitude interest rates should change in response to these targets, market participants must depend largely on past data to form expectations about monetary policy. We suppose market participants estimate a Taylor-like regression equation to understand the conduct of monetary policy, which likely guides their short-run and long-run expectations. When the Federal Reserve's actions deviate from its historical targets for macroeconomic variables, an environment of greater uncertainty may be the result. We quantify this degree of uncertainty by measuring and aggregating recent deviations of the federal funds rate from econometric forecasts predicted by constant gain learning. We incorporate this measure of uncertainty into a VAR model with ARCH shocks to measure the effect monetary policy uncertainty has on inflation, output growth, unemployment, and the volatility of these variables. We find that a higher degree of uncertainty regarding monetary policy is associated with greater volatility of output growth and unemployment.
    Keywords: Uncertainty; learning; volatility; Taylor rule; vector autoregression; ARCH.
    JEL: E32 E31 E58
    Date: 2011–04–19
  4. By: Jean Pisani-Ferry; Zsolt Darvas
    Abstract: This Policy Contribution was prepared as a briefing paper for the European Parliament Economic and Monetary Affairs Committee's Monetary Dialogue, entitled The threat of currency wars?: global imbalances and their effect on currencies,? held on 30 November 2010. Bruegel Fellows Jean Pisani-Ferry and Zsolt Darvas argue the so-called currency war? is manifested in three ways: 1) the inflexible pegs of undervalued currencies; 2) 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. Central banks should come to an agreement about the definition of price stability at a time of deflationary pressures, as current US inflationary expectations are at historically low levels. Finally, the exchange rate of the Euro has not been greatly impacted by the recent currency war; the euro continues to be overvalued, but less than before.
    Date: 2010–12
  5. By: Mukherjee, Sanchita
    Abstract: This paper analyzes the impact of capital market openness on exchange rate pass-through and subsequently on the social loss in an inflation targeting small open economy under a pure commitment policy. Applying the intuition behind the macroeconomic trilemma, I examine whether a more open capital market in an inflation targeting country improves the credibility of the central bank and consequently reduces exchange rate pass-through. First, I empirically examine the effect of capital openness on exchange rate pass-through using a New Keynesian Phillips curve. The empirical investigation reveals that limited capital openness leads to greater pass-through from the exchange rate to domestic inflation, which raises the marginal cost of deviation from the inflation target. This subsequently worsens the inflation output-gap trade-off and increases the social loss of the inflation targeting central bank under pure commitment. However, the calibration results suggest that the inflation output-gap trade-off improves and the social loss decreases even in the presence of larger exchange rate pass-through if the capital controls are effective at insulating the exchange rate from interest rate and risk-premia shocks.
    Keywords: Monetary policy; Inflation Targeting; Exchange rate pass-through; Capital account openness; Small open economy
    JEL: E58 E52 F47 F41 E44
    Date: 2011–04–12
  6. By: Leonardo Gambacorta; David Marques-Ibanez
    Abstract: The 2007-2010 financial crisis highlighted the central role of financial intermediaries' stability in buttressing a smooth transmission of credit to borrowers. While results from the years prior to the crisis often cast doubts on the strength of the bank lending channel, recent evidence shows that bank-specific characteristics can have a large impact on the provision of credit. We show that new factors, such as changes in banks' business models and market funding patterns, had modified the monetary transmission mechanism in Europe and in the US prior to the crisis, and demonstrate the existence of structural changes during the period of financial crisis. Banks with weaker core capital positions, greater dependence on market funding and on non-interest sources of income restricted the loan supply more strongly during the crisis period. These findings support the Basel III focus on banks' core capital and on funding liquidity risks. They also call for a more forward-looking approach to the statistical data coverage of the banking sector by central banks. In particular, there should be a stronger focus on monitoring those financial factors that are likely to influence the functioning of the monetary transmission mechanism particularly in a period of crisis.
    Keywords: bank lending channel, monetary policy, financial innovation
    Date: 2011–05
  7. By: Darine Ghanem
    Abstract: In this study, we empirically test whether pegged regime was successful in achieving and maintaining consistently low inflation rates in 17 MENA countries over the period of 1980-2007. Taking into account unobserved country heterogeneity, as well as, the endogeneity of exchange rate regimes we estimate a dynamic panel data model of the effects of exchange rate regimes on inflation using officially announced exchange rate regimes in addition to de facto regimes in place. Our findings suggest a strong link between the choice of the exchange rate regime and inflation performance.[...]
    Date: 2010–11
  8. By: Pierre-Richard Agénor; K. Alper; Luiz A. 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: 2011–04
  9. By: Evren Caglar; Jagjit S. Chadha; Jack Meaning; James Warren; Alex Waters
    Abstract: At the zero lower bound, the scale and scope of non-conventional monetary policies have become the key decision variables for monetary policy makers. In the UK, quantitative easing has involved the creation of a fund to purchase medium term dated government bonds with borrowed central bank reserves and so has increased the liquidity of the non-bank financial sector and temporarily eased the budget constraint of HMT. Some of these reserves have been used to increase the extent of capital held by banks and there have also been direct injections of capital into the banking system. We assess some of the issues arising from the three policies by using three separate DSGE models, which take seriously the role of financial frictions. We find that it is possible to correct the effects of a lower zero bound in DSGE models, by (i) offsetting the liquidity premium embedded in long term bonds and/or (ii) adopting countercyclical subsidies to bank capital able and/or (iii) the creation of central bank reserves that reduce the costs of loan supply. But the correct quantitative response and ongoing interaction with standard monetary policy remains an open question.
    Keywords: zero bound, open-market operations, quantitative easing
    JEL: E31 E40 E51
    Date: 2011–01
  10. By: Naohiko Baba; Ilhyock Shim
    Abstract: Foreign exchange (FX) derivatives markets in the Korean won are comparatively thin and vulnerable to impaired functioning. During the crisis, Korea faced dislocations in its FX swap and cross-currency swap markets, so severe that covered interest parity (CIP) between the Korean won and the US dollar was seriously violated. Using a variation of the EGARCH model, we find that global market uncertainty - as proxied by VIX, the volatility index - was the main factor explaining the movement of deviations from CIP in the three-month FX swap market during the crisis period. The credit risk of Korean banks - as proxied by their credit default swap spread - was also a significant factor explaining deviations from CIP in the three-year cross-currency swap market before the crisis, while the credit risk of US banks was significant during the crisis period. The Bank of Korea's provision of funds using its own foreign reserves was not effective in reducing deviations from CIP, but the Bank of Korea's loans of the US dollar proceeds of swaps with the US Federal Reserve were effective. This is because the loans funded by swaps with the US Federal Reserve effectively added to Korea's foreign reserves and enhanced market confidence.
    Keywords: FX swap, cross-currency swap, regime switching, EGARCH model, foreign reserves
    Date: 2011–04
  11. By: Jagjit S. Chadha; Luisa Corrado
    Abstract: The financial crisis has led to the development of an active debate on the use of macro-prudential instruments for regulating the banking system, in particular for liquidity and capital holdings. Within the context of a micro-founded macroeconomic model, we allow commercial banks to choose their optimal mix of assets, apportioning these either to reserves or private sector loans. We examine the implications for quantities, relative non-financial and financial prices from standard macroeconomic shocks alongside shocks to the expected liquidity of banks and to the efficiency of the banking sector. We focus on the response by the monetary sector, in particular the optimal reserve-deposit ratio adopted by commercial banks over the business cycle. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold a greater stock of liquid assets, such as reserves, but also to provide incentives to increase the cyclical variation in reserves holdings as this acts to limit excessive procyclicality of lending to the private sector.
    Keywords: Liquidity, interest on reserves, policy instruments, Basel
    JEL: E31 E40 E51
    Date: 2011–04
  12. By: Dai, Meixing
    Abstract: Most Western economists and policy makers agree that the Yuan is significantly undervalued and push the Chinese government for a large nominal revaluation of the Yuan. This paper, while surveying recent research on Chinese exchange rate policy, gives some new insights into this issue. Notably, this paper defends that China is not solely responsible for the Yuan’s undervaluation, the Chinese central bank cannot optimally invest an increasing amount of foreign currency reserves, and the Yuan’s nominal revaluation is not the only way to resolve the problem. After having analyzed the advantages and disadvantages of a nominal versus a real revaluation of the Yuan for the Chinese economy, I advocate and analyze, besides a modest nominal revaluation, a multitude of alternative policies to achieve a complete revaluation of the Yuan in real terms, which allows absorbing external disequilibrium while laying down the foundation for the long-term growth of the Chinese economy.
    Keywords: Renminbi (RMB); revaluation of the Yuan; foreign exchange reserves; external disequilibrium; measures of macroeconomic adjustment.
    JEL: F4 E2 F3 E5 E6
    Date: 2011–04–21
  13. By: Magud, Nicolas; Reinhart, Carmen; Rogoff, Kenneth
    Abstract: In this note we summarize our recent paper, where we delved into the details of this apple-to-oranges problem with the aim of defining a minimum common ground. We begin our analysis by explicitly documenting the kinds of measures that are construed as capital controls. Along the way, we describe the more drastic differences across countries/episodes and between controls on inflows and outflows as well a more subtle differences in types of inflow or outflow controls. Given that success is measured differently across studies, we standardize (to some degree) the results across studies. Inasmuch as possible, we highlight episodes that are less well known than the heavily analyzed cases of Chile and Malaysia. Our results are based on a meta-analysis of 37 empirical studies.
    Keywords: capital controls; capital inflows; exchange rate; monetary policy
    JEL: F32 F30 E50 F33
    Date: 2011–03
  14. By: Hanley, Brian P.
    Abstract: Use of a promise to pay by a bank to insure an outstanding loan in order to return the value of the insured amount into capital for use in writing a new loan is an invention in banking with calculably greater potential economic impact than the original invention of reserve banking. The consequence of this lending invention is to render the existing money multiplier equations of reserve banking obsolete whenever it is used. The equations describing this multiplier do not converge. Each set of parameters for reserve percentage, nesting depth, etc. creates a unique logarithmic curve rather than approaching a limit. Thus it is necessary to show behavior of this new equation by numerical methods. It is shown that remarkable multipliers occur and early nesting iterations can raise the multiplier into the thousands. This money creation innovation has the demonstrated capacity to impact nations. Understanding this new multiplier is necessary for economic analyses of the GFC. --
    Keywords: GFC,CDS,AIG,money multiplier,banking multiplier
    JEL: E20 E51 E17 H56 H63
    Date: 2011
  15. By: Douglas W. Diamond; Raghuram Rajan
    Abstract: Do low interest rates alleviate banking fragility? Banks finance illiquid assets with demandable deposits, which discipline bankers but expose them to damaging runs. Authorities may choose to bail out banks being run. Unconstrained bailouts undermine the disciplinary role of deposits. Moreover, competition forces banks to promise depositors more, increasing intervention and making the system worse off. By contrast, constrained intervention to lower rates maintains private discipline, while offsetting contractual rigidity. It may still lead banks to make excessive liquidity promises. Anticipating this, central banks can reduce financial fragility by raising rates in normal times to offset their propensity to reduce rates in adverse times.
    JEL: E4 E5 G2
    Date: 2011–04
  16. By: Jochem, Axel; Volz, Ute
    Abstract: This paper aims to identify the determinants of portfolio restructuring in EMU member states since the introduction of the euro and especially during the financial turbulence of the past years. We find that, besides exchange rate volatility and traditional indicators of information and transaction costs, the perception of sovereign risk has become more important as a determinant of portfolio allocation. The shares of financial corporations have been affected disproportionately by this development. At the same time, banks substantially reduced their international investment, possibly the result of a deleveraging process. --
    Keywords: Financial Integration,Home Bias,Institutional Sectors,Financial Crisis
    JEL: F30 F32 F36 G11
    Date: 2011

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