nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒05‒30
23 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Adentification Through Heteroscedasticity in a Multicountry and Multimarket Framework By Bernd Hayo; Britta Niehof
  2. Dynamic Effects of Monetary Policy Shocks in Malawi By Harold Ngalawa; Nicola Viegi
  3. Monetary Policy and the Exchange Rate in Colombia By Hernando Vargas Herrera
  4. Monetary Policy Mistakes and the Evolution of Inflation Expectations By Athanasios Orphanides; John Williams
  5. Reviewing excess liquidity measures - a comparison for asset markets By Drescher, Christian
  6. FOMC communication policy and the accuracy of Fed Funds futures By Menno Middeldorp
  7. Quantitative Easing in Japan from 2001 to 2006 and the World Financial Crisis By Yuzo Honda; Minoru Tachibana
  8. Uncertainty and Disagreement in Forecasting Inflation: Evidence from the Laboratory By Pfajfar, D.; Zakelj, B.
  9. Exchange Rates in Emerging Countries: Eleven Empirical Regularities from Latin America and East Asia By Sebastian Edwards
  10. Friedman's monetary economics in practice By Edward Nelson
  11. Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia By Gasteiger, Emanuel
  12. The Journal Rankings of Central Banks By Emanuel Kohlscheen
  13. Flexible inflation targets, forex interventions and exchange rate volatility in emerging countries By Berganza, Juan Carlos; Broto, Carmen
  14. The review of financial repression policies and banking system in Iran By Dehghan Nejad, Omid
  15. Inflation in the G7: mind the gap(s)? By James Morley; Jeremy M. Piger; Robert H. Rasche
  16. An Exploration of Optimal Stabilization Policy By N. Gregory Mankiw; Matthew C. Weinzierl
  17. Monetary policy, asset prices and the real economy in China By James Laurenceson; Ceara Hui
  18. Adapting the international monetary system to face 21st century challenges By Aldo Caliari
  19. Policy Analysis Tool Applied to Colombian Needs: PATACON Model Description By Andrés González; Lavan Mahadeva; Juan D. Prada; Diego Rodríguez
  20. The first line of defense: the discount window during the early stages of the financial crisis By Elizabeth Klee
  21. The fatal flaw: the revived Bretton-woods system, liquidity creation, and commodity-price bubbles By Harris Dellas; George S. Tavlas
  22. Bank relationships, business cycles, and financial crisis By Galina Hale
  23. Exchange Rate Dynamics and Fundamental Equilibrium Exchange Rates By Jamel Saadaoui

  1. By: Bernd Hayo (University of Marburg); Britta Niehof (University of Marburg)
    Abstract: This paper formally proves that Rigobon and Sack (2004)'s approach of identifying monetary policy shocks through heteroscedasticity can be extended to a multimarket and multicountry framework. Applying our multivariate framework allows deriving consistent estimators of monetary policy effects. The advantage of our extended approach is illustrated by applying it to European nancial markets. We analyse monetary policy actions of the European Central Bank (ECB), the Bank of England, the Swiss National Bank, and the Swedish Riksbank on major stock indices. First, in line with the Rigobon and Sack (2004) approach, we nd an increase in the variance of European stock and money market returns on days when monetary policy committee meetings are held. Second, monetary policy actions have a significant impact on nancial markets. Third, we discover that ECB monetary policy moves have spillover eects on the British and Swiss financial markets, but find no evidence of reverse causality.
    Keywords: Financial markets, instrumental variable estimation, identification through heteroscedasticity, spillover effects
    JEL: E44 E52 G15
    Date: 2011
  2. By: Harold Ngalawa; Nicola Viegi
    Abstract: This paper sets out to investigate the process through which monetary policy affects economic activity in Malawi. Using innovation accounting in a structural vector autoregressive model, it is established that monetary authorities in Malawi employ hybrid operating procedures and pursue both price stability and high growth and employment objectives. Two operating targets of monetary policy are identified, viz., bank rate and reserve money, and it is demonstrated that the former is a more effective measure of monetary policy than the latter. The study also illustrates that bank lending, exchange rates and aggregate money supply contain important additional information in the transmission process of monetary policy shocks in Malawi. Furthermore, it is shown that the floatation of the Malawi Kwacha in February 1994 had considerable effects on the country’s monetary transmission process. In the post-1994 period, the role of exchange rates became more conspicuous than before although its impact was weakened; and the importance of aggregate money supply and bank lending in transmitting monetary policy impulses was enhanced. Overall, the monetary transmission process evolved from a weak, blurred process to a somewhat strong, less ambiguous mechanism.
    JEL: E52 E58
    Date: 2011
  3. By: Hernando Vargas Herrera
    Abstract: The role of the exchange rate and the exchange rate regime in the monetary policy decision-making process in Colombia is described. The rationale for the intervention of the Central Bank in the FX market is explained and the experience in this regard is reviewed. Special attention is given to the seemingly varying effectiveness of different types of intervention and to the challenges posed by the sterilization of purchases of foreign currency. The exchange rate regime, FX regulation and FX policy determine the resilience of the economy in the face of external shocks and allow for the possibility of countercyclical monetary policy responses. A virtuous circle is created in which the volatility present in a flexible exchange rate regime improves the conditions for the functioning of a flexible exchange rate regime.
    Date: 2011–05–12
  4. By: Athanasios Orphanides; John Williams
    Abstract: What monetary policy framework, if adopted by the Federal Reserve, would have avoided the Great Inflation of the 1960s and 1970s? We use counterfactual simulations of an estimated model of the U.S. economy to evaluate alternative monetary policy strategies. We show that policies constructed using modern optimal control techniques aimed at stabilizing inflation, economic activity, and interest rates would have succeeded in achieving a high degree of economic stability as well as price stability only if the Federal Reserve had possessed excellent information regarding the structure of the economy or if it had acted as if it placed relatively low weight on stabilizing the real economy. Neither condition held true. We document that policymakers at the time both had an overly optimistic view of the natural rate of unemployment and put a high priority on achieving full employment. We show that in the presence of realistic informational imperfections and with an emphasis on stabilizing economic activity, an optimal control approach would have failed to keep inflation expectations well anchored, resulting in high and highly volatile inflation during the 1970s. Finally, we show that a strategy of following a robust first-difference policy rule would have been highly effective at stabilizing inflation and unemployment in the presence of informational imperfections. This robust monetary policy rule yields simulated outcomes that are close to those seen during the period of the Great Moderation starting in the mid-1980s.
    JEL: E52
    Date: 2011–05
  5. By: Drescher, Christian
    Abstract: The conduct of US monetary policy is often accompanied by controversial debates on the adequacy of monetary conditions. These can result from different concepts of excess liquidity measures. The paper analyzes the theoretical and empirical information content of these concepts for asset markets. The analysis classifies, reviews and assesses measures of monetary conditions. For those that qualify as excess liquidity measures, the analysis continues with a comparison of the sources of imbalances and a discussion of the adequacy for asset markets. The theoretical results are cross-checked with empirical evidence. All excess liquidity measures are estimated and compared in the light of recent US asset bubbles. The analysis draws the following main conclusions. Firstly, not all measures of monetary conditions qualify as excess liquidity measure. Secondly, the increasing relevance of asset markets leads to growing distortions of excess liquidity measures. Thirdly, the choice of excess liquidity measure has influence on the assessment of monetary conditions in asset markets.
    Keywords: monetary overhang; real money gap; nominal money gap; credit ratios; leverage ratios; price gap; natural interest rate gap; Taylor gap
    JEL: G1 E5
    Date: 2011–05
  6. By: Menno Middeldorp
    Abstract: Over the last two decades, the Federal Open Market Committee (FOMC), the rate-setting body of the United States Federal Reserve System, has become increasingly communicative and transparent. According to policymakers, one of the goals of this shift has been to improve monetary policy predictability. Previous academic research has found that the FOMC has indeed become more predictable. Here, I contribute to the literature in two ways. First, instead of simply looking at predictability before and after the Fed’s communication reforms in the 1990s, I identify three distinct periods of reform and measure their separate contributions. Second, I correct the interest rate forecasts embedded in fed funds futures contracts for risk premiums, in order to obtain a less biased measure of predictability. My results suggest that the communication reforms of the early 1990s and the “guidance” provided from 2003 significantly improved predictability, while the release of the FOMC’s policy bias in 1999 had no measurable impact. Finally, I find that FOMC speeches and testimonies significantly lower short-term forecasting errors.
    Keywords: Federal Open Market Committee ; Disclosure of information ; Interest rates ; Forecasting ; Monetary policy ; Federal funds
    Date: 2011
  7. By: Yuzo Honda (Kansai University); Minoru Tachibana (Osaka Prefecture University)
    Abstract: The Bank of Japan adopted the Quantitative Easing (QE) Policy from March 2001 to March 2006. This paper investigates whether or not this QE had an effect in stimulating real economy in Japan. The identification of policy effect in the above Japanese case enables us to evaluate indirectly the effectiveness of the non-traditional monetary policy employed by US Federal Reserve Board (FRB) or the Bank of England (BOE) just after the collapse of Lehman Brothers. We extend vector autoregression analysis by Honda, Kuroki, and Tachibana (2007, 2010; HKT), including monthly samples before and after the period of QE, but at the same time fully exploiting prior information on the structural change of operating targets of monetary policy from call rate to bank reserve during the period of QE. There are two main results. First, this paper reconfirms our qualitative findings in HKT. That is, increases in bank reserve balances boost stock prices first, and then industrial production. Secondly, an increase in bank reserve balances by 1 trillion yen led to the rise of stock prices by the range of 0.2% to 0.9%, and to the increase of industrial production by the range of 0.03% to 0.18%. Finally, FRB called their policy after the Lehman shock gcredit easingh policy, but their policy includes both aspects of credit easing and QE. The results of the present paper suggest that even the QE aspect alone of the non-traditional monetary policy by FRB or BOE should have significant stimulating policy effects.
    Keywords: Quantitative easing; Money injection; Portfolio rebalancing; Stock price channel; Vector autoregression
    JEL: E44 E52
    Date: 2011–05
  8. By: Pfajfar, D.; Zakelj, B. (Tilburg University, Center for Economic Research)
    Abstract: We establish several stylized facts about the behavior of individual uncertainty and disagreement between individuals when forecasting inflation in the laboratory. Subjects correctly perceive the underlying inflation uncertainty in only 60% of cases, which can be interpreted as the overconfidence bias. Determinants of individual uncertainty, dis- agreement among forecasters and properties of aggregate distribution are analyzed. We find that the interquartile range of the aggregate distribution has the highest correlation with inflation variability; however the average confidence interval performs best in a forecasting exercise. Allowing subjects to insert asymmetric confidence intervals results in wider upper intervals than lower intervals on average, thus perceiving higher uncertainty with respect to inflation increases. In different treatments we study the influence of different monetary policy designs on the formation of confidence bounds. Inflation targeting produces lower uncertainty and higher accuracy of intervals than inflation forecast targeting.
    Keywords: Laboratory Experiments;Confidence Bounds;New Keynesian Model;Inflation Expectations
    JEL: C91 C92 E37 D80
    Date: 2011
  9. By: Sebastian Edwards
    Abstract: In this paper I discuss some of the most important lessons on exchange rate policies in emerging markets during the last 35 years. The analysis is undertaken from the perspective of both the Latin American and East Asian nations. Some of the topics addressed include: the relationship between exchange rate regimes and growth, the costs of currency crises, the merits of “dollarization,” the relation between exchange rates and macroeconomic stability, monetary independence under alternative exchange rate arrangements, and the effects of the recent global “currency wars” on exchange rates in commodity exporters.
    JEL: F0 F31 F32 F41
    Date: 2011–05
  10. By: Edward Nelson
    Abstract: This paper views the policy response to the recent financial crisis from the perspective of Milton Friedman's monetary economics. Five major aspects of the policy response are: 1) discount window lending has been provided broadly to the financial system, at rates low relative to the market rates prevailing pre-crisis; 2) the Federal Reserve's holdings of government securities have been adjusted with the aim of putting downward pressure on the path of several important interest rates relative to the path of short-term rates; 3) deposit insurance has been extended, helping to insulate the money stock from credit market disruption; 4) the commercial banking system has received assistance via a recapitalization program, while existing equity holders have borne losses; and 5) an interest-on-reserves system has been introduced. These five elements of the policy response are in keeping with those that would arise from Friedman's framework, while a number of the five depart appreciably from other prominent benchmarks (such as the Bagehot-Thornton prescription for discount rate policy, and New Keynesian approaches to stabilization policy). One notable part of the policy response, the TALF initiative, draws largely on frameworks other than Friedman's. But, in important respects, the overall monetary and financial policy response to the crisis can be viewed as Friedman's monetary economics in practice.
    Date: 2011
  11. By: Gasteiger, Emanuel
    Abstract: We present new results for the performance of Taylor rules in a New Keynesian model with heterogeneous expectations. Agents have either rational or adaptive expectations. We find that depending on the particular rule, expectational heterogeneity can create or increase the set of policies that leads to local explosiveness. This is a new level of destabilization compared to what is known. In addition, we demonstrate that policy inertia is an effective tool to safeguard the economy against local explosiveness. Thus, we provide a rationalization for central banks to adjust interest rates with notable inertia in response to shocks.
    Keywords: Monetary Policy; Taylor Rules; Heterogeneous Expectations;
    JEL: D84 E52
    Date: 2011–05–10
  12. By: Emanuel Kohlscheen (Central Bank of Brazil)
    Abstract: This paper analyzes the citation patterns of the central banks of the 15 largest monetary areas of the world that had an active working paper series in 2010. It proceeds to construct a novel journal ranking that is more suited for monetary authorities than the academic journal rankings currently in vogue. We report individual country rankings as well as the global rankings. While important regional differences emerge, the Journal of Monetary Economics, the American Economic Review, the Journal of Money, Credit and Banking and the Journal of Finance stand out as the top outlets in the global ranking. Sweden’s Riksbanken appears to be the monetary authority that is most finely tuned with academia, followed by the European Central Bank.
    Date: 2011–05
  13. By: Berganza, Juan Carlos (BOFIT); Broto, Carmen (BOFIT)
    Abstract: Emerging economies with inflation targets (IT) face a dilemma between fulflling the theoretical conditions of "strict IT", which implies a fully flexible exchange rate, or applying a "flexible IT", which entails a de facto managed floating exchange rate with forex interventions to moderate exchange rate volatility. Using a panel data model for 37 countries we find that, although IT lead to higher exchange rate instability than alternative regimes, forex interventions in some IT countries have been more effective in reducing volatility than in non-IT countries, which may justify the use of "flexible IT" by policymakers.
    Keywords: inflation targeting; exchange rate volatility; foreign exchange interventions; emerging economies
    JEL: E31 E42 E52 E58 F31
    Date: 2011–05–26
  14. By: Dehghan Nejad, Omid
    Abstract: The methods of determining the banking interest rate are the main issues in the Iranian economy, this note provides the analysis of banking interest rate and the ways of providing and allocating financial resources in Iran and also, discusses why the financial repression policies in the monetary and banking system do not allow the Iranian economy to growth in its full capacity.
    Keywords: Banking Interest Rate; Financial Repression; Monetary and Banking System; Financial Resources
    JEL: E5
    Date: 2011–04–26
  15. By: James Morley; Jeremy M. Piger; Robert H. Rasche
    Abstract: We investigate the importance of trend inflation and the real-activity gap for explaining observed inflation variation in G7 countries since 1960. Our results are based on a bivariate unobserved-components model of inflation and unemployment in which inflation is decomposed into a stochastic trend and transitory component. As in recent implementations of the New Keynesian Phillips Curve, it is the transitory component of inflation, or “inflation gap”, that is driven by the real-activity gap, which we measure as the deviation of unemployment from its natural rate. Even when allowing for changes in the contributions of trend inflation and the inflation gap, we find that both are important determinants of inflation variation at business cycle horizons for all G7 countries throughout much of the past 50 years. Also, the real-activity gap explains a large fraction of the variation in the inflation gap for each country, both historically and in recent years. Taken together, the results suggest the New Keynesian Phillips Curve, once augmented to include trend inflation, is an empirically relevant model for the G7 countries. We also provide new estimates of trend inflation for the G7 that incorporate information in the real-activity gap for identification and, through formal model comparisons, new statistical evidence regarding structural breaks in the variability of trend inflation and the inflation gap.
    Keywords: Inflation (Finance) ; Phillips curve
    Date: 2011
  16. By: N. Gregory Mankiw; Matthew C. Weinzierl
    Abstract: This paper examines the optimal response of monetary and fiscal policy to a decline in aggregate demand. The theoretical framework is a two-period general equilibrium model in which prices are sticky in the short run and flexible in the long run. Policy is evaluated by how well it raises the welfare of the representative household. While the model has Keynesian features, its policy prescriptions differ significantly from textbook Keynesian analysis. Moreover, the model suggests that the commonly used "bang for the buck" calculations are potentially misleading guides for the welfare effects of alternative fiscal policies.
    JEL: E52 E62 E63
    Date: 2011–05
  17. By: James Laurenceson (School of Economics, The University of Queensland); Ceara Hui
    Abstract: The Global Financial Crisis served to refocus attention on the potential for monetary policy to exert an impact on asset prices. In turn, asset price fluctuations were shown to exert a powerful impact on the real economy. In this paper we consider these linkages in the case of China. Using SVAR modelling techniques, our results indicate that a monetary policy shock has a significant impact on asset prices, particularly share prices, and notably more so than on general goods and services prices. However, a shock to asset prices has little impact on the real economy. Policy implications are discussed.
    Date: 2011
  18. By: Aldo Caliari
    Abstract: Recent calls for more intense debate on and reforms to the international monetary system imply that the current system is unable to respond appropriately and adequately to challenges that have appeared, or become more acute, in recent years. This paper focuses on four such challenges: ensuring an orderly exit from global imbalances, facilitating more complementary adjustments between surplus and deficit countries without recessionary impacts, better supporting international trade by reducing currency volatility and better providing development and climate finance. After describing them, it proposes reforms to enable the international monetary system to better respond to these challenges.
    Keywords: global imbalances, current account adjustment, development finance, aggregate demand, Special Drawing Rights, international monetary system, International Monetary Fund, macroeconomic policy coordination
    JEL: F31 F32 F33 F42 F59 K33 O19
    Date: 2011–05
  19. By: Andrés González; Lavan Mahadeva; Juan D. Prada; Diego Rodríguez
    Abstract: In this document we lay out the microeconomic foundations of a dynamic stochastic general equilibrium model designed to forecast and to advice monetary policy authorities in Colombia. The model is called Policy Analysis Tool Applied to Colombian Needs (PATACON). In companion documents we present other aspects of the model and its platform, including the estimation of the parameters that affect the dynamics and the impulse responses functions.
    Date: 2011–05–17
  20. By: Elizabeth Klee
    Abstract: This paper develops a theoretical model of trading in the federal funds market that captures characteristics of discount window borrowing and the federal funds market during the first year of the financial crisis, including the narrowing of the spread between the discount rate and the target rate; the increased incidence of high-rate trading; and the decline in participation in the federal funds market. The model shows that differences in stigma of borrowing from the discount window across banks can cause the federal funds rate to rise, even when the spread between the discount rate and the target rate narrows. The model is then evaluated using both aggregate and institution-level data. The data suggest that in aggregate, federal funds volume brokered at rates above the primary credit rate and discount window borrowing both increased during the first stages of the crisis. Bank-level data suggest that institutions that went to the discount window paid lower rates in the federal funds market than banks that did not. This effect became stronger as the spread between the primary credit rate and the target rate narrowed, coincident with the intensification of the financial crisis.
    Date: 2011
  21. By: Harris Dellas (University of Bern and CEPR); George S. Tavlas (Bank of Greece)
    Abstract: Dooley, Folkerts-Landau and Garber (DFG) argue that the present constellation of global exchange-rate arrangements constitutes a revived Bretton-Woods system. DFG ALSO argue that the revived system will be sustainable, despite its large global imbalances. We argue that, to the extent that the present system constitutes a revived Bretton-Woods system, it is vulnerable to the same set of destabilizing forces - - including asset price bubbles and global financial crises - - that led to the breakdown of the earlier regime.
    Keywords: Bretton-Woods system;international liquidity;price bubbles;Markov switching model
    JEL: C22 F33 N10
    Date: 2011–01
  22. By: Galina Hale
    Abstract: Recent literature argues that the structure of a banking network is important for its stability. We use network analysis to formally describe bank relationships in the global banking network between 1980 and 2009 and analyze the effects of recessions and banking crises on these relationships. We construct a novel data set that builds a bank-level global network from loan-level data on syndicated loans to financial institutions. Our network consists of 7938 banking institutions from 141 countries. We find that the network became more interconnected and more asymmetric, and therefore potentially more fragile, prior to 2008, and that its expansion slowed in recent years, dramatically so during the 2008-09 crisis. We use a stylized model to describe potential effects of banking crises and recessions on bank relationships. Empirically, we find that the structure of a global banking network is not invariant to banking crises nor to recessions, especially those in the United States. While recessions appear to encourage banks to make new connections, especially on the periphery of the network, the global financial crisis of 2008-09 made banks very cautious in their lending, meaning that almost no new connections were made during the crisis, particularly in 2009. We also find that during country-specific recessions or banking crises past relationships become more important as few new relationships are formed.
    Keywords: Banks and banking ; Financial crises
    Date: 2011
  23. By: Jamel Saadaoui (CEPN - Centre d'Economie de l'Université Paris Nord - Université Paris-Nord - Paris XIII - CNRS : UMR7234)
    Abstract: The paper investigates if the most popular alternative to the purchasing parity power approach (PPP) to estimate equilibrium exchange rates, the fundamental equilibrium exchange rate (FEER) influences exchange rate dynamics in the long run. For a large panel of industrialized and emerging countries and on the period 1982-2007, we detect the presence of unit roots in the series of real effective exchange rates and in the series of FEERs. We find and estimate a cointegration relationship between real effective exchange rates and FEERs. The results show that the FEER has a positive and significant influence on exchange rate dynamics in the long run.
    Keywords: Fundamental equilibrium exchange rates; Panel unit root tests; Global imbalances; Fully modified ordinary least square; Dynamic ordinary least square; Pooled Mean Group
    Date: 2011–05–17

This nep-mon issue is ©2011 by Bernd Hayo. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.