nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒05‒24
eighteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Hyperbolic Discounting and Positive Optimal Inflation By Graham, Liam; Snower, Dennis J.
  2. Capital Flows, Monetary Policy and FOREX Interventions in Peru By Rossini, Renzo; Quispe, Zenon; Rodriguez, Donita
  3. Inflation Targeting and Regional Inflation Persistence: Evidence from Korea By Peter Tillmann
  4. The monetary transmission mechanism in the euro area: has it changed and why? By Martina Cecioni; Stefano Neri
  5. Monetary Policy Games, Instability and Incomplete Information By Richard Barrett; Ioanna Kokores; Somnath Sen
  6. Financial frictions and optimal monetary policy in an open economy By Marcin Kolasa; Giovanni Lombardo
  7. Is Malaysia exempted from impossible trinity: empirical evidence from 1991-2009 By Lim, Ewe Ghee; Goh, SooKhoon
  8. Monetary Policy and Stock Market Booms By Christiano, Lawrence; Ilut, Cosmin; Motto, Roberto; Rostagno, Massimo
  9. Central banking in Latin America: changes, achievements, challenges By Klaus Schmidt-Hebbel
  10. Can Sterilized FX Purchases under Inflation Targeting be Expansionary? By MArcio Gomes Pinto Garcia
  11. News Shocks, Price Levels, and Monetary Policy By Ryo Jinnai
  12. Inflation Dynamics and the Great Recession By Laurence M. Ball; Sandeep Mazumder
  13. "Was Keynes's Monetary Policy, a outrance in the Treatise, a Forerunnner of ZIRP and QE? Did He Change His Mind in the General Theory?" By Jan Kregel
  14. Price Stickiness Asymmetry, Persistence and Volatility in a New Keynesian Model By Alessandro Flamini
  15. Up for count? Central bank words and financial stress By Blix Grimaldi, Marianna
  16. Micro approaches to foreign exchange determination By Martin D. D. Evans; Dagfinn Rime
  17. Competing bimetallic ratios: Amsterdam, London and bullion arbitrage in the 18th century By Pilar Nogues-Marco
  18. Housing, consumption and monetary policy: how different are the U.S. and the euro area? By Alberto Musso; Stefano Neri; Livio Stracca

  1. By: Graham, Liam (University College London); Snower, Dennis J. (Kiel Institute for the World Economy)
    Abstract: The Friedman rule states that steady-state welfare is maximized when there is deflation at the real rate of interest. Recent work by Khan et al (2003) uses a richer model but still finds deflation optimal. In an otherwise standard new Keynesian model we show that, if households have hyperbolic discounting, small positive rates of inflation can be optimal. In our baseline calibration, the optimal rate of inflation is 2.1% and remains positive across a wide range of calibrations.
    Keywords: optimal monetary policy, inflation targeting, unemployment, Phillips curve, nominal inertia, monetary policy
    JEL: E20 E40 E50
    Date: 2011–05
  2. By: Rossini, Renzo (Central Reserve Bank of Peru); Quispe, Zenon (Central Reserve Bank of Peru); Rodriguez, Donita (Central Reserve Bank of Peru)
    Abstract: This article explains the main features of the sterilized intervention in the foreign exchange market and the use of non-conventional policy instruments as applied by the Central Reserve Bank of Peru in order to avoid credit booms or busts in a context of a partially dollarized financial system. This monetary policy framework is based on a risk management approach that includes as the main policy tool the short-term interest rate within an inflation targeting regime. This framework helped to reduce the impact of the recent global financial crisis on the Peruvian economy and allowed to rejoin the path of growth with low inflation, avoiding major disruptions from the surge of capital inflows.
    Keywords: Central banks, policy framework
    JEL: E52 E58 F31 F32
    Date: 2011–05
  3. By: Peter Tillmann (University of Giessen)
    Abstract: The adoption of a credible monetary policy regime such as inflation targeting is known to reduce the persistence of inflation fluctuations. This conclusion, however, is derived from aggregate inflation or sectoral inflation rates, not from regional inflation data. This paper studies the regional dimension of inflation targeting, i.e. the consequences of inflation targeting for regional inflation persistence. Based on data for Korean cities and provinces it is shown that the adoption of inflation targeting leads (i) to a fall in inflation persistence at the regional level and (ii) to a reduction in the cross-regional heterogeneity in inflation persistence. A common factor model lends further support to the role of the common component, and hence monetary policy, for regional inflation persistence.
    Keywords: inflation targeting, inflation persistence, monetary policy regime, regional inflation, factor model
    JEL: E31 E52 R11
    Date: 2011
  4. By: Martina Cecioni (Bank of Italy); Stefano Neri (Bank of Italy)
    Abstract: Based on a structural VAR and a dynamic general equilibrium model, we provide evidence of the changes in the monetary transmission mechanism (MTM) in the European Monetary Union after the adoption of the common currency in 1999. The estimation of a Bayesian VAR over the periods before and after 1999 suggests that the effects of a monetary policy shock on output and prices have not significantly changed over time. We claim that this cannot be the final word on the evolution of the MTM as changes in the conduct of monetary policy and the structure of the economy may have offset each other giving rise to similar responses of output and inflation to monetary policy shocks between the two periods. The estimation of a DSGE model with several real and nominal frictions over the two sub-samples shows that monetary policy has become more effective in stabilizing the economy as the result of a decrease in the degree of nominal rigidities and a shift in monetary policy towards inflation stabilization.
    Keywords: monetary policy, transmission mechanism, Bayesian methods
    JEL: E32 E37 E52 E58
    Date: 2011–04
  5. By: Richard Barrett; Ioanna Kokores; Somnath Sen
    Abstract: Central banks, in executing monetary policy, while pursuing traditional objectives, such as the control of inflation, may try also to promote financial stability. In this paper, we explore a simple monetary policy game played between the central bank and the financial sector. The central bank can be of two types, one traditional and the other concerned with controlling the financial markets; however, the financial sector is unsure which, due to incomplete information. The conclusion of the paper is that for small shocks to inflation there is a pooling equilibrium, whereas for larger shocks there is separation. In the latter case, central bank concern for the stability of the financial sector is outed. We conclude by relating our results to the recent worldwide financial crisis.
    Keywords: Monetary policy, central bank, financial stability, strategic behaviour, incomplete information
    JEL: E44 E52 E58 E61
    Date: 2011–04
  6. By: Marcin Kolasa (National Bank of Poland and Warsaw School of Economics.); Giovanni Lombardo (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: A growing number of papers have studied positive and normative implications of financial frictions in DSGE models. We contribute to this literature by studying the welfare-based monetary policy in a two-country model characterized by financial frictions, alongside a number of key features, like capital accumulation, non-traded goods and foreign-currency debt denomination. We compare the cooperative Ramsey monetary policy with standard policy benchmarks (e.g. PPI stability) as well as with the optimal Ramsey policy in a currency area. We show that the two-country perspective offers new insights on the trade-offs faced by the monetary authority. Our main results are the following. First, strict PPI targeting (nearly optimal in our model if credit frictions are absent) becomes excessively procyclical in response to positive productivity shocks in the presence of financial frictions. The related welfare losses are non-negligible, especially if financial imperfections interact with nontradable production. Second, (asymmetric) foreign currency debt denomination affects the optimal monetary policy and has important implications for exchange rate regimes. In particular, the larger the variance of domestic productivity shocks relative to foreign, the closer the PPI-stability policy is to the optimal policy and the farther is the currency union case. Third, we find that central banks should allow for deviations from price stability to offset the effects of balance sheet shocks. Finally, while financial frictions substantially decrease attractiveness of all price targeting regimes, they do not have a significant effect on the performance of a monetary union agreement. JEL Classification: E52, E61, E44, F36, F41.
    Keywords: financial frictions, open economy, optimal monetary policy.
    Date: 2011–05
  7. By: Lim, Ewe Ghee; Goh, SooKhoon
    Abstract: This paper examines Bank Negara Malaysia’s (BNM) monetary policy autonomy in 1991-2009, a period of volatile capital flows, during which BNM operated under several exchange regimes: managed floating; fixed exchange rates; and fixed exchange rates with selective capital controls. Using a modified version of the Brissimis, Gibson and Tsakalotos (2002) model, the paper’s empirical estimates show that the same-period offset coefficients are significantly less than unity under all regimes, indicating that the Malaysian central bank possesses some short-run control over monetary policy (even under fixed exchange rates). Although the long-run offset coefficient continues to be less than unity under managed floating, it is not significantly less than unity under fixed exchange rates. These results show that Malaysia is not exempted from the impossible trinity except in the very short-run. Perhaps one of the reasons Malaysia abandoned its US dollar exchange rate peg on 20 July 2005 to move back to managed floating is to increase its monetary policy independence. One implication of the Malaysian monetary policy experience is that managed floating with active sterilization may be a viable strategy for emerging market economies to deal with volatile capital flows.
    Keywords: Offset Coefficient; Sterilization Coefficient; Monetary Autonomy; Impossible Trinity
    JEL: F41
    Date: 2011–03
  8. By: Christiano, Lawrence (Northwestern University; National Bureau of Economic Research); Ilut, Cosmin (Duke University); Motto, Roberto (European Central Bank); Rostagno, Massimo (European Central Bank)
    Abstract: Historical data and model simulations support the following conclusion. Inflation is low during stock market booms, so that an interest rate rule that is too narrowly focused on inflation destabilizes asset markets and the broader economy. Adjustments to the interest rate rule can remove this source of welfare-reducing instability. For example, allowing an independent role for credit growth (beyond its role in constructing the inflation forecast) would reduce the volatility of output and asset prices.
    Keywords: inflation targeting, sticky prices, sticky wages, stock price boom, DSGE model, New Keynesian model, news, interest rate rule
    JEL: E42 E58
    Date: 2011–03
  9. By: Klaus Schmidt-Hebbel (Catholic Universty of Chile)
    Abstract: Latin America's central banks were strengthened in the 1990s by independence laws, adoption of new policy regimes (foremost inflation targeting), and more transparent policy decisions bound by ex-ante rules and ex-post accountability. Central bank modernization - supported by significant fiscal adjustment and financial-sector strengthening - led most Latin American countries to converge to one-digit inflation rates and contributed to higher and more stable growth than in the past. Yet the region's new policy framework was put to severe testing by the global financial crisis and recession. Quick and innovative policy responses by the region's central banks helped domestic financial systems and the real economy to resist well the massive financial and real consequences of the banking crisis and recession in industrial countries. Empirical evidence reported here shows that the central banks' new policy framework and policy response during the crisis dampened significantly the amplitude of the recession. Having weathered well the global financial crisis and recession, now Latin America's central banks face a large array of policy challenges, which are reviewed in this lecture. Some are common to central banks in industrial and emerging economies, derived from the crisis itself and the issues it poses for improving the role of central banks in attaining more effectively both monetary and financial stability. Other challenges are idiosyncratic to emerging economies in the region (and elsewhere) that are facing renewed growth, high commodity prices, large capital inflows, and real exchange-rate appreciation.
    Keywords: Monetary Policy, Central Banks, Latin America
    JEL: E52 E58 O54
    Date: 2011–05
  10. By: MArcio Gomes Pinto Garcia (Department of Economics PUC-Rio)
    Abstract: Unlike common wisdom, sterilized FX purchases under inflation targeting, i.e., those that keep the interest rate at the level targeted by the central bank, generally increase aggregate demand. We resort to a simple model with a credit channel to argue that FX purchases, by funding bank credit, end up increasing aggregate and money demand, while expanding loans and reducing the loan interest rate. Therefore, restoring the interest rate to the level previous to the FX purchase may not be sufficient to avoid the expansionary effect; the new money market equilibrium, at the same interest rate, will entail a larger money supply, higher output and larger money demand. Recent Brazilian evidence is reviewed, showing that this effect may be empirically relevant. If this is the case, inflation targeters may have another reason to be concerned when conducting FX sterilized interventions, besides their high cost and controversial effectiveness in preventing nominal appreciation. FX sterilized purchases may not only fail to prevent nominal appreciation, but also boost activity and inflation, thereby appreciating the real exchange rate.
    Date: 2011–04
  11. By: Ryo Jinnai
    Abstract: This paper presents a model in which improvement in the future TFP is, on impact, associated with increases in consumption, stock prices, and real wages, and decreases in GDP, investment, hours worked, and inflation. These predictions are consistent with empirical findings of Barsky and Sims. The model features research and development, sticky nominal wages, and the monetary authority responding to inflation and consumption growth. The proposed policy rule fits the actual Federal Funds rate as closely as an alternative policy rule responding to inflation and GDP growth, and is better at reducing distortion due to the nominal wage stickiness.
    Keywords: news shock, R&D, inflation, sticky wages, monetary policy
    JEL: E00 E30 E52
    Date: 2011–03
  12. By: Laurence M. Ball; 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.
    JEL: E31
    Date: 2011–05
  13. By: Jan Kregel
    Abstract: At the end of 1930, as the 1929 US stock market crash was starting to have an impact on the real economy in the form of falling commodity prices, falling output, and rising unemployment, John Maynard Keynes, in the concluding chapters of his Treatise on Money, launched a challenge to monetary authorities to take "deliberate and vigorous action" to reduce interest rates and reverse the crisis. He argues that until "extraordinary," "unorthodox" monetary policy action "has been taken along such lines as these and has failed, need we, in the light of the argument of this treatise, admit that the banking system can not, on this occasion, control the rate of investment, and, therefore, the level of prices." The "unorthodox" policies that Keynes recommends are a near-perfect description of the Japanese central bank's experiment with a zero interest rate policy (ZIRP) in the 1990s and the Federal Reserve's experiment with ZIRP, accompanied by quantitative easing (QE1 and QE2), during the recent crisis. These experiments may be considered a response to Keynes's challenge, and to provide a clear test of his belief in the power of monetary policy to counter financial crisis. That response would appear to be an unequivocal No.
    Date: 2011–05
  14. By: Alessandro Flamini (Department of Economics, The University of Sheffield)
    Abstract: In a two-sector New-Keynesian model, this paper shows that the dispersion in the degree of sectoral price stickiness plays a key role in the determination of the dynamics of aggregate inflation and, consequently, of the whole economy. The dispersion in price stickiness reduces the persistence of inflation and, to a smaller extent, of the interest rate. It also reduces the volatility of inflation, the interest rate and the output-gap. Thus two economies with the same average degree of price stickiness but a different variance may behave very differently, highlighting the relevance of sectoral data for economic estimations and forecasts.
    Keywords: Sectoral asymmetries, price stickiness, New Keynesian model, persistence, volatility.
    JEL: E31 E32 E37 E52
    Date: 2011–05
  15. By: Blix Grimaldi, Marianna (Monetary Policy Department, Central Bank of Sweden)
    Abstract: While knowing there is a financial distress 'when you see it' might be true, it is not particularly helpful. Indeed, central banks have an interest in understanding more systematically how their communication affects the markets, not least in order to avoid unnecessary volatility; the markets for their part have an interest in better deciphering the message of central banks, especially of course with regard to the conduct of future monetary policy. In this paper we use a novel approach rooted in textual analysis to begin to address these issues. Building on previous work from textual analysis, we are able to use quantitative methods to help identify and measure financial stress. We apply the techniques to the European Central Banks Monthly Bulletin and show that the results give a much more complete and nuanced picture of market distress than those based only on market data and may help improve how the Central Banks communication is designed and understood.
    Keywords: Financial stress; central bank communication; textual analysis; logit distribution
    JEL: E50 E58 G10
    Date: 2011–04–01
  16. By: Martin D. D. Evans (Georgetown University and NBER); Dagfinn Rime (Norges Bank (Central Bank of Norway))
    Abstract: Micro-based exchange-rate research examines the determination and behavior of spot exchange rates in an environment that replicates the key features of trading in the foreign exchange (FX) market. Traditional macro exchange-rate models play little attention to how trading in the FX market actually takes place. The implicit assumption is that the details of trading are unimportant for the behavior of exchange rates over months, quarters or longer. Micro-based models, by contrast, examine how information relevant to the pricing of FX becomes reflected in the spot exchange rate via the trading process. According to this view, trading is not an ancillary market activity that can be ignored when considering exchange-rate behavior. Rather, trading is an integral part of the process through which spot rates are determined and evolve. The past decade of micro-based research has uncovered a robust and strong empirical relation between exchange rates and measures of FX trading activity. One measure in particular, order flow (i.e., the net of buyer- and seller-initiated FX trades) appears as the proximate driver of exchange-rate changes over horizons ranging from a few minutes to a few months. This finding supports the view that trading is an integral part of exchange-rate determination. It also stands in stark contrast to the well-known deficiencies of macro models in accounting for exchange-rate variations over horizons shorter than a couple of years. In this paper we provide an overview of micro-based research on exchange-rate determination. We survey both models focusing on partial equilibrium, the traditional domain of microstructure research, and recent research that focuses on the link between currency trading and macroeconomic conditions in the general equilibrium setting of modern macroeconomic models. We believe micro-based research is making some progress towards understanding the links between macroeconomic conditions and the behavior of exchange rates over macro- and policy-relevant horizons.
    Keywords: Keywords: Exchange rate dynamics, Microstructure, Order flow
    JEL: F3 F4 G1
    Date: 2011–05–10
  17. By: Pilar Nogues-Marco
    Abstract: This article analyses the stability of bimetallism in the mid-18th century for the case of two large centres that had different legal ratios and only one international market ratio. A new theoretical framework is articulated for the situation of international independence to set legal bimetallic ratios by monetary authorities in different countries. Then, using new data handcollected from archival sources and relevant to the two main bullion markets in the 18th century, Amsterdam and London, this theoretical framework is utilised to identify the regimes that actually prevailed during that period, in which Amsterdam was effectively on the bimetallic standard while London was on the gold standard de facto.
    Keywords: Bimetallism, Bimetallic stability, Bullion markets, Arbitrage, Specie-point mechanism, Melting-minting points
    JEL: E42 N13 F15 N23
    Date: 2011–04
  18. By: Alberto Musso (European Central Bank); Stefano Neri (Banca d’Italia); Livio Stracca (European Central Bank)
    Abstract: This paper provides a systematic empirical analysis of the role of the housing market in the macroeconomy in the U.S. and the euro area. First, it establishes some stylised facts concerning key variables in the housing market on the two sides of the Atlantic, such as real house prices, residential investment and mortgage debt. It then presents evidence from Structural Vector Autoregressions (SVAR) by focusing on the effects of monetary policy, credit supply and housing demand shocks on the housing market and the broader economy. The analysis shows that similarities outweigh differences as far as the housing market is concerned. The empirical evidence suggests a stronger role for housing in the transmission of monetary policy shocks in the U.S. The evidence is less clear-cut for housing demand shocks. Finally, credit supply shocks seem to matter more in the euro area.
    Keywords: residential investment, house prices, credit, monetary policy
    JEL: E22 E44 E52
    Date: 2011–04

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