nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒05‒14
35 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Lessons for Monetary Policy: What Should the Consensus Be? By Otmar Issing
  2. On the importance of sectoral and regional shocks for price-setting By Guenter W. Beck; Kirstin Hubrich; Massimiliano Marcellino
  3. Macro-prudential Policy on Liquidity: What Does a DSGE Model Tell Us? By Jagjit S. Chadha; Luisa Corrado
  4. Toward Inflation Targeting in Sri Lanka By Shanaka J. Peiris; Rahul Anand; Ding Ding
  5. The price puzzle and monetary policy transmission mechanism in Pakistan: Structural vector autoregressive approach By Javid, Muhammad; Munir, Kashif
  6. Estimating a Small Open-Economy Model for Egypt: Spillovers, Inflation Dynamics, and Implications for Monetary Policy By Kenji Moriyama; Elif C Arbatli
  7. CPI Inflation Targeting and the UIP Puzzle: An Appraisal of Instrument and Target Rules By Alfred Guender
  8. Inflation and Bank of Russia's policy: is there a link? By Yulia Vymyatnina; Anna Ignatenko
  9. Monetary Transmission in Dollarized and Non-Dollarized Economies: The Cases of Chile, New Zealand, Peru and Uruguay By David O Coble Fernandez; Santiago Acosta Ormaechea
  10. Trend inflation and Monetary policy rules: Determinacy analyses in New Keynesian model with capital accumulation By Elena, Gerko; Kirill, Sossounov
  11. Should Central Banks Raise their Inflation Targets? Some Relevant Issues By Bennett T. McCallum
  12. The threat of 'currency wars': a European perspective By Zsolt Darvas; Jean Pisani-Ferry
  13. Monetary Policy Transmission Mechanisms in Pacific Island Countries By Yongzheng Yang; Matt Davies; Shengzu Wang; Yiqun Wu; Jonathan C. Dunn
  14. International Welfare Effects of Monetary Policy By Juha Tervala
  15. The Timeless Perspective vs. Discretion: Theory and Monetary Policy Implications for an Open Economy By Alfred Guender
  16. A monetary policy strategy in good and bad times: lessons from the recent past By Stephan Fahr; Roberto Motto; Massimo Rostagno; Frank Smets; Oreste Tristani
  17. The bank lending channel: lessons from the crisis By Leonardo Gambacorta; David Marques-Ibanez
  18. Monetary and fiscal policy should be merged, which in turn changes the role of central banks By Musgrave, Ralph S.
  19. Communicational Bias in Monetary Policy: Can Words Forecast Deeds? By Pablo Pincheira; Mauricio Calani
  20. Keeping Up with the Joneses and the Welfare Effects of Monetary Policy By Juha Tervala
  21. Convergence of Euro Area Inflation Rates By Lopez, C.; Papell, David H.
  22. Determinants of the EONIA spread and the financial crisis By Carla Soares; Paulo M.M. Rodrigues
  23. Reconsidering the Role of Food Prices in Inflation By James P Walsh
  24. The effect of monetary policy on investors’ risk perception: Evidence from the UK and Germany By Dan Luo; Iris Biefang-Frisancho Mariscal; Peter Howells
  25. Are the Effects of Monetary Policy Shocks Big or Small? By Olivier Coibion
  26. In the quest of macroprudential policy tools By Samano, Daniel
  27. Deregulation of Savings Bank Deposit Interest Rate: A Discussion Paper By Reserve Bank of India RBI
  28. What international monetary system for a fast-changing world economy By Agnès Bénassy-Quéré; Jean Pisani-Ferry
  29. Inflation Dynamics and the Great Recession By Laurence Ball and Sandeep Mazumder
  30. Assessing monetary policy in the euro area: a factor-augmented VAR approach By Rita Soares
  31. Currency Wars: What do effective exchange rates tell us? By Jean Pisani-Ferry
  32. Reform of the international monetary system: Some concrete steps By Yongding Yu; Agnès Bénassy-Quéré; Jean Pisani-Ferry
  33. Instrument Versus Target Rules As Specifications of Optimal Monetary Policy: What are the Issues, If Any? By Richard T. Froyen; Alfred Guender
  34. Liquidity, Contagion and Financial Crisis By Gümbel, Alexander; Sussman, Oren
  35. The Dynamics of the Term Structure of Interest Rates in the United States in Light of the Financial Crisis of 2007-10 By Carlos I. Medeiros; Marco Rodriguez Waldo

  1. By: Otmar Issing
    Abstract: This paper outlines important lessons for monetary policy. In particular, the role of inflation targeting, which was much acclaimed prior to the financial crisis and since then has not lost much of its endorsement, is critically reviewed. Ignoring the relation between monetary policy and asset prices, as is the case in this monetary policy approach, can lead to financial instability. In contrast, giving, inter alia, monetary factors a role in central banks’ policy decisions, as is done in the ECB’s encompassing approach, helps prevent these potentially harmful side effects and thus allows for fostering financial stability. Finally, this paper makes a case against increasing the central banks’ inflation target.
    Keywords: Asset prices , Central banks , Credit , European Central Bank , Financial stability , Inflation targeting , Monetary aggregates , Monetary policy , Money ,
    Date: 2011–04–29
  2. By: Guenter W. Beck (University of Siegen, Hölderlinstr. 3, 57076 Siegen, Germany and CFS.); Kirstin Hubrich (Research Department, European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Massimiliano Marcellino (European University Institute, Via Roccettini, 9, I-50014 Fiesole, Florenz, Italy; Bocconi University and CEPR.)
    Abstract: We use a novel disaggregate sectoral euro area data set with a regional breakdown to investigate price changes and suggest a new method to extract factors from over-lapping data blocks. This allows us to separately estimate aggregate, sectoral, country-specific and regional components of price changes. We thereby provide an improved estimate of the sectoral factor in comparison with previous literature, which decomposes price changes into an aggregate and idiosyncratic component only, and interprets the latter as sectoral. We find that the sectoral component explains much less of the variation in sectoral regional inflation rates and exhibits much less volatility than previous findings for the US indicate. We further contribute to the literature on price setting by providing evidence that country- and region-specific factors play an important role in addition to the sector-specific factors. We conclude that sectoral price changes have a “geographical” dimension, that leads to new insights regarding the properties of sectoral price changes. JEL Classification: E31, C38, D4, F4.
    Keywords: Disaggregated prices, euro area regional and sectoral inflation, common factor models.
    Date: 2011–05
  3. By: Jagjit S. Chadha (Keynes College, University of Kent); Luisa Corrado (Faculty of Economics, University of Rome "Tor Vergata")
    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 asset creation, apportioning this to either 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. Overall we find some rationale for Basel III in providing commercial banks with an incentive to hold liquid assets, such as reserves, as this acts to limit the procyclicality of lending to the private sector.
    Keywords: Liquidity, interest on reserves, policy instruments, Basel.
    JEL: E31 E40 E51
    Date: 2011–05–02
  4. By: Shanaka J. Peiris; Rahul Anand; Ding Ding
    Abstract: This paper develops a practical model-based forecasting and policy analysis system (FPAS) to support a transition to an inflation forecast targeting regime in Sri Lanka. The FPAS model provides a relatively good forecast for inflation and a framework to evaluate policy trade-offs. The model simulations suggest that an open-economy inflation targeting rule can reduce macroeconomic volatility and anchor inflationary expectations given the size and type of shocks faced by the economy. Sri Lanka could aim to target a broad inflation range initially due to its susceptibility supply-side shocks while enhancing exchange rate flexibility and strengthening the effectiveness of monetary policy in the transition to an inflation forecast targeting regime.
    Keywords: Central banks , Forecasting models , Inflation targeting , Monetary policy , Sri Lanka ,
    Date: 2011–04–13
  5. By: Javid, Muhammad; Munir, Kashif
    Abstract: This paper address the issue of monetary policy effectiveness and the price puzzle, a positive response of prices to monetary tightening, in Pakistan. Study examines the effects of monetary policy shock on price level and other macroeconomic variables such as output, exchange rate and money supply within the structural VAR framework over the period 1992: M1 to 2010:M08. We find that a contractionary monetary policy shock has a positive effect on prices and the output increase over some horizon following the monetary tightening but continuously falls after initial rise. The results also indicate that monetary contractions in Pakistan over period reviewed associated with persistent depreciation of domestic currency value relative to the U.S. dollar.
    Keywords: Monetary policy; Price puzzle; Structural VAR; Pakistan
    JEL: E52 E4
    Date: 2011
  6. By: Kenji Moriyama; Elif C Arbatli
    Abstract: This paper estimates a small open economy model for Egypt to analyze inflation, output dynamics and monetary policy during 2005-2010. The interest rate channel is found to be relatively weak in Egypt, complicating the use of interest rates as the immediate target of monetary policy. However, the paper also finds a significant level of persistence in the policy rate, making monetary policy pro-cyclical. More active use of interest rate policy, measures to improve domestic debt markets and a gradual move towards inflation targeting can help support a successful disinflation strategy for Egypt.
    Date: 2011–05–06
  7. By: Alfred Guender (University of Canterbury)
    Abstract: Employing an optimizing framework, this paper shows that a target rule dominates a simple instrument rule when the focus of monetary policy is on CPI inflation. The target rule approach produces a systematic relationship between the current CPI inflation rate and the lagged policy instrument that renders the former immune to the stochastic risk premium. No matter how policy parameters are set, the optimal simple instrument rule cannot replicate the superior stabilization results achieved by the target rule approach. The optimal simple instrument rule also fails to account for the UIP puzzle. In contrast, the target rule approach can motivate the widely reported phenomenon whereby high interest rate currencies tend to appreciate. In fact the degree of openness and the central bank’s relative aversion to CPI inflation variability determine the sensitivity of observed changes in the nominal exchange rate to the lagged interest rate differential.
    Keywords: CPI Inflation Targeting; UIP Puzzle; Instrument Rule; Target Rule; Optimal Monetary Policy
    JEL: E4 E5 F3
    Date: 2011–05–01
  8. By: Yulia Vymyatnina; Anna Ignatenko (St. Petersburg Institute for Economics and Mathematics, Russian Academy of Sciences (RAS))
    Abstract: One of the most important aims of monetary policy of the Bank of Russia is to reduce CPI inflation under simultaneous stabilization of ruble exchange rate to the major world currencies. While such task setting is obviously contradictory and requires usage of additional instrument, it is unclear whether Central bank can influence inflation processes at all. The work inquires into how inflation is influenced by credit aggregates, oil prices and exchange rate as the major factors limiting possibilities of Bank of Russia's influence on the price level. Conclusions include recommendations on monetary policy of the Bank of Russia. (in Russian)
    Keywords: monetary policy, inflation, Bank of Russia, oil prices, exchange rate pass through
    JEL: E41
    Date: 2011–02–28
  9. By: David O Coble Fernandez; Santiago Acosta Ormaechea
    Abstract: The paper conducts a comparative study of the monetary policy transmission in two economies that run a well-established IT regime, Chile and New Zealand, vis-à-vis two economies operating under relatively newer IT regimes, and which are exposed to a significant degree of dollarization, Peru and Uruguay. It is shown that the traditional interest rate channel is effective in Chile and New Zealand. For Peru and Uruguay, the exchange rate channel is instead more relevant in the transmission of monetary policy. This latter result follows from the limited impact of the policy rate in curbing inflationary pressures in these two countries, in combination with the fact that they have a relatively large and persistent exchange rate pass through. Finally, it is shown that the on-going de-dollarization process of Peru and Uruguay has somewhat strengthened their monetary transmission through the interest rate channel.
    Keywords: Chile , Cross country analysis , Dollarization , Economic models , Exchange rates , Inflation targeting , Interest rates , Monetary policy , Monetary transmission mechanism , New Zealand , Peru , Uruguay ,
    Date: 2011–04–20
  10. By: Elena, Gerko; Kirill, Sossounov
    Abstract: The eects of positive trend inflation is analyzed in the framework of the standard New-Keynesian model with Calvo price setting and capital accumulation. It is build on the work of Duport (2001) and Ascari and Ropele (2007) who separately considered eects of capital accumulation and trend inflation in the similar context. It is shown that the simultaneous presence of positive inflation and capital accumulation greatly aects determinacy property of equilibrium in this setup. Namely, in order to maintain stability in addition to actively react to inflation monetary authorities should react to output uctuations but not to a great extend. Overreaction to output may lead to indeterminacy. We also show that for a large set of plausible parameters standard Taylor rule leads to indeterminacy. Alternative monetary policy rules are also analyzed.
    Keywords: Indeterminacy Interest rate policy rule
    JEL: E32 E58 E52
    Date: 2011–01–11
  11. By: Bennett T. McCallum
    Abstract: Should central banks, because of the zero-lower-bound problem, raise their inflation-rate targets? Several arguments are relevant. (1) In the absence of the ZLB, the optimal steady-state inflation rate, according to standard New Keynesian reasoning, lies between the Friedman-rule value of deflation at the steady-state real interest rate and the Calvo-model value of zero, with calibration indicating a larger weight on the latter. (2) An attractive modification of the Calvo pricing equation would, however, imply that the weight on the second of these values should be zero. (3) There may be some scope for activist monetary policy to be effective even when the one-period interest rate is at the ZLB; but there is professional disagreement on this matter. (4) Present institutional arrangements are not immutable. In particular, elimination of traditional currency is feasible (even arguably attractive) and would remove the ZLB constraint on policy. (5) Increasing target inflation for the purpose of avoiding occasional ZLB difficulties would tend to undermine the rationale for central bank independence and would constitute an additional movement away from policy recognition of the economic necessity for intertemporal discipline.
    JEL: E31 E52 E58
    Date: 2011–05
  12. By: Zsolt Darvas; Jean Pisani-Ferry
    Abstract: This Policy Contribution was prepared as a briefing paper for the European Parliament Economic and Monetary Affairs CommitteeÂ?s Monetary Dialogue, entitled Â?The threat of Â?currency warsÂ?: global imbalances and their effect on currencies,Â? held on 30 November 2010. Bruegel Fellows Jean Pisani-Ferry and Zsolt Darvas argue the so-called Â?currency warÂ? 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 Â?beggar-thy-neighbourÂ? policy as long as the FedÂ?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
  13. By: Yongzheng Yang; Matt Davies; Shengzu Wang; Yiqun Wu; Jonathan C. Dunn
    Abstract: During the global financial crisis, central banks in Pacific island countries eased monetary policy to stimulate economic activity. Judging by the ensuing movements in commercial bank interest rates and private sector credit, monetary policy transmission appears to be weak. This is confirmed by an empirical examination of interest rate pass-through and credit growth. Weak credit demand and underdeveloped financial markets seem to have limited the effectiveness of monetary policy, but the inflexibility of exchange rates and rising real interest rates have also served to frustrate the central banks’ efforts despite a supporting fiscal policy. While highlighting the importance of developing domestic financial markets in the long run, this experience also points to the need to coordinate macroeconomic policies and to use all macroeconomic tools available in conducting countercyclical policies, including exchange rate flexibility.
    Keywords: Central banks , Cross country analysis , Demand , Exchange rate regimes , Exchange rates , Fiscal policy , Interest rates , Monetary policy , Pacific Island Countries ,
    Date: 2011–04–28
  14. By: Juha Tervala (Aboa Centre for Economics and University of Turku)
    Abstract: In this paper, I examine the international welfare effects of monetary policy. I develop a New Keynesian two-country model, where central banks in both countries follow the Taylor rule. I show that a decrease in the domestic interest rate, under producer currency pricing, is a beggar-thyself policy that reduces domestic welfare and increases foreign welfare in the short term, regardless of whether the cross-country substitutability is high or low. In the medium term, it is a beggar-thy-neighbour (beggar-thyself) policy, if the Marshall-Lerner condition is satisfied (violated). Under local currency pricing, a decrease in the domestic interest rate is a beggar-thy-neighbour policy in the short term, but a beggarthyself policy in the medium term. Both under producer and local currency pricing, a monetary expansion increases world welfare in the short term, but reduces it in the medium term.
    Keywords: Open economy macroeconomics, monetary policy, beggar-thyself, beggar-thy-neighbour, Taylor rule, welfare analysis
    JEL: E32 E52 F30 F41
    Date: 2011–04
  15. By: Alfred Guender (University of Canterbury)
    Abstract: Compared to the standard Phillips curve, an open-economy version that features a real exchange rate channel leads to a markedly different target rule in a New Keynesian optimizing framework. Under optimal policy from a timeless perspective (TP) the target rule involves additional history dependence in the form of lagged inflation. The target rule also depends on more parameters, notably the discount factor as well as two IS and two Phillips curve parameters. Stabilization policy in this open economy model is no longer isomorphic to policy in a closed economy. Because of the additional history dependence in an open economy target rule price level targeting is no longer consistent with optimal policy. The gains from commitment are smaller in economies where the real exchange rate channel exerts a direct effect on inflation in the Phillips curve.
    Keywords: CPI Inflation Targeting; UIP Puzzle; Instrument Rule; Target Rule; Optimal Monetary Policy
    JEL: E52 F41
    Date: 2011–04–13
  16. By: Stephan Fahr (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Roberto Motto (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Massimo Rostagno (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Frank Smets (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Oreste Tristani (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: We evaluate the ECB’s monetary policy strategy against the underlying economic structure of the euro area economy, in normal times and in times of severe financial dislocations. We show that in the years preceding the financial crisis that started in 2007 the strategy was successful at ensuring macroeconomic stability and steady growth despite shocks to the supply side and to the transmission mechanism which complicated the policy process. Emphasis on monetary indicators in the ECB’s monetary policy strategy – the monetary pillar – was instrumental in avoiding more volatile and less predictable patterns of inflation and growth. After the collapse of financial intermediation in late 2008, the strategy of the ECB was to preserve the integrity of the monetary policy transmission mechanism by adopting a comprehensive package of non-standard policy measures. According to our quantitative evaluation of the impact of the non-standard policy package, which notably did not include entering commitments regarding the future path of the policy rate, the liquidity interventions decided in October 2008 and in May 2009 were critical to preserving price stability and forestalling a more disruptive collapse of the macro-economy. JEL Classification: E31, E44, E51, E58.
    Keywords: Monetary Policy, Monetary transmission, Credit, Supply factors, Financial crisis, Non-standard policy measures.
    Date: 2011–05
  17. By: Leonardo Gambacorta (Bank for International Settlements (BIS).); David Marques-Ibanez (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    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 forwardlooking 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. JEL Classification: E51, E52, E44.
    Keywords: bank lending channel, monetary policy, financial innovation.
    Date: 2011–05
  18. By: Musgrave, Ralph S.
    Abstract: Keeping monetary and fiscal policy separate causes economic distortions, thus the two should be merged. That is, in a recession for example, the government and central bank should simply spend more (and/or collect less tax), and fund the latter from new or “printed” money. Merging monetary and fiscal policy necessitates a different relationship or split of responsibilities as between governments and central banks, but this is not a big problem. Plus the new relationship dispenses with an illogical element in the current typical relationship, namely that both central bank and government influence aggregate demand.
    Keywords: fiscal policy: monetary policy: distortions: Abba Lerner: central banks: national debt: modern monetary theory: functional finance
    JEL: E62 E58 E52
    Date: 2011–04–25
  19. By: Pablo Pincheira; Mauricio Calani
    Abstract: Communication with the public is an ever-growing practice among central banks and complements their decisions of interest rate setting. In this paper we examine one feature of the communicational practice of the Central Bank of Chile which summarizes the assessment of the Board about the most likely future of monetary policy. We show that this assessment, which is called communicational bias or simply c-bias, contains valuable information regarding the future stance of monetary policy. We do this by comparing, against several benchmarks, the c-bias ability to correctly forecast the direction of monetary policy rates. Our results are consistent with the hypothesis that the Central Bank of Chile has (in our sample period) matched words and deeds. In fact, the c-bias is a more accurate predictor than two versions of random walks and than a uniformly-distributed random variable. It also outperforms, at some horizons, the predictive ability of a discrete Taylor-rule-type model that uses persistence, output gap and inflation-deviation-from-target as arguments. Furthermore, the c-bias is more accurate than survey-based forecasts at several forecasting horizons. We also show that the c-bias can provide information to improve monetary policy rate forecasts based on the forward rate curve.
    Date: 2011–02–28
  20. By: Juha Tervala (Aboa Centre for Economics and University of Turku)
    Abstract: This paper examines the implications of "keeping up with the Joneses" preferences (jealousy) for the welfare effects of monetary policy. I develop a New Keynesian model, where households are jealous and the central bank follows the Taylor rule. I show that the welfare effects of monetary policy over time depend significantly on the relative strength of the consumption externality caused by jealousy and the monopolistic distortion. If jealousy (the monopolistic distortion) dominates, then a decrease in the interest rate reduces (increases) welfare in the short run, but increases (reduces) welfare in the medium run.
    Keywords: Monetary policy, jealousy, consumption externality
    JEL: E40 E50 E52
    Date: 2011–04
  21. By: Lopez, C.; Papell, David H.
    Abstract: We study the behavior of inflation rates among the 12 initial Euro countries in order to test whether and when the group convergence initially dictated by the Maastricht treaty and now by the ECB, occurs. We also assess the impact of events such as the advent of the Euro and the 2008 financial crisis. Due to the small size of the estimation sample, we propose a new procedure that increases the power of panel unit root tests when used to study group-wise convergence. Applying this new procedure to Euro area inflation, we find strong and lasting evidence of convergence among the inflation rates soon after the implementation of the Maastricht treaty and a dramatic decrease in the persistence of the differential after the occurrence of the single currency. After the 2008 crisis, Euro area inflation rates follow the ECB’s price stability benchmark, although Greece reports relatively higher inflation.
    Keywords: groupwise convergence, inflation, Euro area, 2008 crisis.
    JEL: C32 E31
    Date: 2011
  22. By: Carla Soares; Paulo M.M. Rodrigues
    Abstract: The financial markets turmoil of 2007-09 impacted on the overnight segment, which is the first step of monetary policy implementation. We model the volatility of the EONIA spread as an EGARCH. However, the nature of the EGARCH considered will be different in the period before the fixed rate full allotment policy of the ECB (2004 - 2008) where we follow the approach of Hamilton (1996) and in the period afterwards (2008 - 2009) where a conventional EGARCH seems sufficient to capture the behaviour of volatility. The results suggest a greater difficulty during the turmoil for the ECB to steer the level of the EONIA spread relative to the main reference rate. The liquidity effect has been reduced since 2007 and in particular since the full allotment policy at the refinancing operations. On the other hand, the liquidity policy and especially the provision of long-term liquidity followed was effective in reducing market volatility. Liquidity provision conditions were also found to have influenced the EONIA spread only since the financial market turmoil. Fine-tuning operations contributed to stabilize money market conditions, especially during the turmoil. The EGARCH parameter estimates also suggest a structural change in the behaviour of the EONIA spread in reaction to shocks.
    JEL: E43 E52 G21
    Date: 2011
  23. By: James P Walsh
    Abstract: Food prices are generally excluded from measures of inflation most closely watched by policymakers due either to their transitory nature or their higher volatility. However, in lower income countries, food price inflation is not only more volatile but also on average higher than nonfood inflation. Food inflation is also in many cases more persistent than nonfood inflation, and shocks in many countries are propagated strongly into nonfood inflation. Under these conditions, and particularly given high global commodity price inflation in recent years, a policy focus on measures of core inflation that exclude food prices can misspecify inflation, leading to higher inflationary expectations, a downward bias to forecasts of future inflation and lags in policy responses. In constructing measures of core inflation, policymakers should therefore not assume that excluding food price inflation will provide a clearer picture of underlying inflation trends than headline inflation.
    Keywords: Agricultural commodities , Commodity price fluctuations , Consumer price indexes , External shocks , Inflation , Low-income developing countries , Prices ,
    Date: 2011–04–06
  24. By: Dan Luo (University of Nottingham); Iris Biefang-Frisancho Mariscal (University of the West of England); Peter Howells (University of the West of England)
    Abstract: We use vector autoregressive models to estimate the effect of monetary policy on investors’ risk aversion. The latter is proxied by a variety of option based implied volatility indices for Germany and the UK. There is clear evidence of a procyclical response between monetary policy and risk aversion. Monetary policy shocks affect UK investors risk attitude for longer periods, while they have a stronger impact on German investors for a shorter period of time. There is also evidence that the Bank of England reacts to increases in risk aversion with expansionary monetary policy. In contrast, the ECB appears to tighten monetary policy, although this result may be explained by the ECB making policy decisions for a group of countries. These results are robust w.r.t. to the various risk aversion and monetary policy stance proxies.
    Keywords: Monetary policy, Risk aversion, impulse responses
    JEL: G12 E43 E44
    Date: 2011–05
  25. By: Olivier Coibion
    Abstract: This paper studies the small estimated effects of monetary policy shocks from standard VAR’s versus the large effects from the Romer and Romer (2004) approach. The differences are driven by three factors: the different contractionary impetus, the period of reserves targeting and lag length selection. Accounting for these factors, the real effects of policy shocks are consistent across approaches and most likely medium. Alternative monetary policy shock measures from estimated Taylor rules also yield medium-sized real effects and indicate that the historical contribution of monetary policy shocks to real fluctuations has been significant, particularly during the 1970s and early 1980s.
    JEL: E3 E4 E5
    Date: 2011–05
  26. By: Samano, Daniel
    Abstract: The global financial crisis of late 2008 could not have provided more convincing evidence that price stability is not a sufficient condition for financial stability. In order to attain both, central banks must develop macroprudential instruments in order to prevent the occurrence of systemic risk episodes. For this reason testing the effectiveness of different macroprudential tools and their interaction with monetary policy is crucial. In this paper we explore whether two policy instruments, namely, a capital adequacy ratio (CAR) rule in combination with a Taylor rule may provide a better macroeconomic outcome than a Taylor rule alone. We conduct our analysis by appending a macroeconometric financial block to an otherwise standard semistructural small open economy neokeynesian model for policy analysis estimated for the Mexican economy. Our results show that with the inclusion of the second policy instrument the central bank can obtain substantial gains. Moreover, we find that when the CAR rule is adequately designed the central authority can mitigate output gap shocks of twice the variance than the Taylor rule alone scenario. Thus, under this two rule case the central authority can isolate financial shocks and dampen their effects over macroeconomic variables.
    Keywords: macroprudential tools; macroprudential policy; capital adequacy ratio; Taylor rule
    JEL: E58 E52 E44
    Date: 2011–03
  27. By: Reserve Bank of India RBI
    Abstract: The paper is an attempt to deal with pros and cons of deregulating savings deposit interest rate and take on board the suggestions of various stakeholders for either maintaining the status quo or deregulating the savings deposit interest rate. URL:[ tent/PDFs/DPS270411F.pdf].
    Keywords: savings bank, deregulating, India, financial sector reform, monetary policy, deposit, lending rates, Benchmark Prime Lending Rate (BPLR), households, rural areas, semi-urban, pricing, savings deposit, interest rate,
    Date: 2011
  28. By: Agnès Bénassy-Quéré; Jean Pisani-Ferry
    Abstract: Though the renminbi is not yet convertible, the international monetary regime has already started to move towards a 'multipolar' system, with the dollar, the euro and the renminbi as its key likely pillars. This shift corresponds to the long-term evolution of the balance of economic weight in the world economy. Such an evolution may mitigate some of the flaws of the present (non-) system, such as the rigidity of key exchange rates, the asymmetry of balance of-payments adjustments or what remains of the Triffin dilemma. However it may exacerbate other problems, such as short-run exchange rate volatility or the scope for â??currency warsâ??, while leaving key questions unresolved, such as the response to capital flows global liquidity provision. Hence, in itself, a multipolar regime can be both the best and the worst of all regimes.Which of these alternatives will materialise depends on the degree of cooperation within a multilateral framework.
    Date: 2011–04
  29. By: Laurence Ball and Sandeep Mazumder
    Abstract: This paper examines inflation dynamics in the Unites States since 1960, with a particular focus on the Great Recession. A puzzle emerges when Phillips curves estimated over 1960- 2007 are used to predict inflation over 2008-2010: inflation should have fallen by more than it did. We resolve this puzzle with two modifications of the Phillips curve, both suggested by theories of costly price adjustment: we measure core inflation with the median CPI inflation rate, and we allow the slope of the Phillips curve to change with the level and variance of inflation. We then examine the hypothesis of anchored inflation expectations. We find that expectations have been fully "shock-anchored" since the 1980s, while "level anchoring" has been gradual and partial, but significant. It is not clear whether expectations are sufficiently anchored to prevent deflation over the next few years. Finally, we show that the Great Recession provides fresh evidence against the New Keynesian Phillips curve with rational expectations.
    Date: 2011–05
  30. By: Rita Soares
    Abstract: In order to overcome the omitted information problem of small-scale vector autoregression (VAR) models, this study combines the VAR methodology with dynamic factor analysis and assesses the effects of monetary policy shocks in the euro area in the period during which there is a single monetary policy. Using the factor-augmented vector auto-regressive (FAVAR) approach of Bernanke et al. (2005), we summarise the information contained in a large set of macroeconomic time series with a small number of estimated factors and use them as regressors in recursive VARs to evaluate the impact of the non-systematic component of the ECB’s actions. Overall, our results suggest that the inclusion of factors in the VAR allows us to obtain a more coherent picture of the effects of monetary policy innovations, both by achieving responses easier to understand from the theoretical point of view and by increasing the precision of such responses. Moreover, this framework allows us to compute impulse-response functions for all the variables included in the panel, thereby providing a more complete and accurate depiction of the effects of policy disturbances. However, the extra information generated by the FAVAR also delivers some puzzling responses, in particular those relating to exchange rates.  
    JEL: C32 E52 E58
    Date: 2011
  31. By: Jean Pisani-Ferry
    Abstract: In November, South Korea joined the ranks of countries striving to limit the upwards pressure on their currency when two lawmakers submitted a parliamentary proposal to impose various taxes on foreign capital inflows and outflows. If any of these measures pushes through, South Korea would become the first (traditionally financially liberalised) OECD country to reinstate capital controls. This brings the list of countries intervening directly, indirectly or considering intervention to more than 23. This is an unwelcome and disturbing, but hardly surprising, development: as policy rates in the US are at near-zero levels and monetary policy is geared towards managing the yield curve in order to meet domestic objectives, emerging countries throughout the world are scrambling to protect themselves from the negative spillovers in the form of massive capital inflows...
    Date: 2010–11
  32. By: Yongding Yu; Agnès Bénassy-Quéré; Jean Pisani-Ferry
    Abstract: Reform of the international monetary system is under discussion after three decades of apathy. Tectonic shifts in the balance of international power have made reform more urgent. However, in the short term, there is little chance of a grand redesign of the international monetary system. Nevertheless, concrete steps should be taken. First, consensus is needed on exchange rates, capital flows and reserves. Second, financial safety nets must be improved so that countries do not have to self-insure by accumulating  reserves or rely on possible bilateral swap lines to access liquidity. Third, a change in the composition of the Special Drawing Right should be planned for, to strengthen the multilateral framework. The most workable short-term deliverables seem to be (i) guidelines on and surveillance of capital controls; (ii) a new regime for deciding on SDR allocations that would facilitate more frequent use of this instrument; and (iii) the inclusion of the renmimbi in the SDR basket. These reforms would be a partial move, preparing the ground for further developments.
    Date: 2011–03
  33. By: Richard T. Froyen; Alfred Guender (University of Canterbury)
    Abstract: One issue in the literature on monetary policy in New Keynesian models has been the relative merits of instrument versus target rules. This paper focuses on optimal instrument and target rules within three workhorse models in the literature: IS-LM, AS-AD and the New Keynesian model. The focus on optimal rules enables us to exploit the equivalence among alternative expressions of optimal policies for a given information set. We find that in the AD-AS model, characterized by the presence of observable information variables and unobservable target variables, an optimal explicit instrument rule, a combination policy, and a target rule produce identical outcomes for the target variables. In the New Keynesian model, the optimal explicit instrument rule achieves the same stabilization results as the globally optimal target rule. However, the latter approach provides a more direct rationale for introducing inertia into policymaking. This seems to be the key advantage of the target rule approach. Along other dimensions such as robustness and transparency, target rules offer no clear advantages over optimal instrument rules.
    JEL: E3 E5
    Date: 2011–02–01
  34. By: Gümbel, Alexander (Toulouse School of Economics); Sussman, Oren (University of Oxford)
    Abstract: We develop a theoretical model where a redistribution of bank capital (e.g., due to reckless trading and/or faulty risk management) leads to a “freeze” of the interbank market. The fire-sale market plays a central role in spreading the crisis to the real economy. In crisis, credit rationing and liquidity hoarding appear simultaneously; endogenous levels of collateral (or margin requirements) are affected by both low fire-sale prices and high lending rates. Relative to previous analysis, this dual channel generates a stronger price and output effect. The main focus is on the policy analysis. We show that i) non-discriminating equity injections are more effective than liquidity injections, but in both the welfare effect is an order-of-magnitude lower than the price effect; ii) a discriminating policy that bails out only distressed banks is feasible but will be limited by incentive-compatibility constraints; iii) a restriction on international capital flows has an ambiguous effect on welfare.
    Keywords: Debt deflation, Bailout, Liquidity Injection
    JEL: G21 G28 G33
    Date: 2010–06–25
  35. By: Carlos I. Medeiros; Marco Rodriguez Waldo
    Abstract: This paper assesses the dynamics of the term structure of interest rates in the United States in light of the financial crisis in 2007-10. In particular, this paper assesses the dynamics of the term structure of U.S. Treasury security yields in light of economic and financial events and the monetary policy response since the inception of the crisis in mid-2007. To this end, this paper relies on estimates of the term structure using Nelson-Siegel models that make use of unobservable or latent factors and macroeconomic variables. The paper concludes that both the latent factors and macroeconomic variables explain the dynamics of the term structure of interest rates, and the expectations of the impact on macroeconomic variables of changes in financial factors, and vice versa, have changed little with the financial crisis.
    Keywords: Bonds , Financial crisis , Global Financial Crisis 2008-2009 , Interest rate structures , Interest rates , United States ,
    Date: 2011–04–18

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