nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒06‒25
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Money and Inflation in the Euro Area during the Financial Crisis By Christian Dreger; Jürgen Wolters
  2. Monetary Policy, Liquidity Stress and Learning Dynamics By Stefano Marzioni
  3. What does Monetary Policy do to Long-Term Interest Rates at the Zero Lower Bound? By Jonathan H. Wright
  4. Degree of Policy Precommitment in the UK: An Empirical Investigation of Monetary and Fiscal Policy Interactions By Tatiana Kirsanova; Stephanus le Roux
  5. Belling the cat: Eli F. Heckscher on the gold standard as a discipline device By Fregert, Klas
  6. Risk, Monetary Policy and the Exchange Rate By Gianluca Benigno; Pierpaolo Benigno; Salvatore Nisticò
  7. The history of interbank settlement arrangements: exploring central banks’ role in the payment system By Norman, Ben; Shaw, Rachel; Speight, George
  8. Exchange rate anchoring - Is there still a de facto US dollar standard? By Thierry Bracke; Irina Bunda
  9. Structural Breaks in Inflation Dynamics within the European Monetary Union By Thomas Windberger; Achim Zeileis
  10. Stock Prices and Monetary Policy Shocks: A General Equilibrium Approach By Challe, E.; Giannitsarou, C.
  11. The economics of TARGET2 balances By Ulrich Bindseil; Philipp Johann König
  12. Sharing the Burden: Monetary and Fiscal Responses to a World Liquidity Trap By David Cook; Michael B. Devereux
  13. Irving Fisher and Price-Level Targeting in Austria: Was Silver the Answer? By Richard C.K. Burdekin; Kris James Mitchener; Marc D. Weidenmier
  14. Comparative analysis of monetary and fiscal Policy: a case study of Pakistan By Jawaid, Syed Tehseen; Arif, Imtiaz; Naeemullah, Syed Muhammad
  15. Monetary Exit Strategy and Fiscal Spillovers By Jan Libich; Dat Thanh Nguyen; Petr Stehlík
  16. Hypothesis of Currency Basket Pricing of Crude Oil: An Iranian Perspective By Melhem Sadek; Diallo Abdul Salam; Terraza Michel
  17. What is the Importance of Monetary and Fiscal Shocks in Explaining US Macroeconomic Fluctuations? By Barbara Rossi; Sarah Zubairy
  18. The loss from uncertainty on policy targets By Giorgio Di Giorgio; Guido Traficante
  19. Systemic risk and financial development in a monetary model By Philippe Moutot
  20. Global Imbalances and Imported Disinflation in the Euro Area By Barthélemy, J.; Cléaud, G.

  1. By: Christian Dreger; Jürgen Wolters
    Abstract: This paper explores the stability of the relation between money demand for M3 and inflation in the euro area by including the recent period of the financial crisis. Evidence is based on a cointegration analysis, where inflation and asset prices are allowed to enter the long run relationship. By restricting the cointegrating space, equations for money and inflation are identified. The results indicate that the equilibrium evolution of M3 is still in line with money demand. In the long run, inflation is affected by asset prices and detrended output. Excess liquidity plays an important role for inflation dynamics. While the hypothesis of weak exogeneity is rejected for real money balances and inflation, real income, real asset prices and the term structure do not respond to deviations from the long run equilibria. A single equation analysis derived from this system still provides reliable information for the conduct of monetary policy in real time, since the error correction terms are very similar to those obtained by the system approach. To monitor the monetary development, a single money demand equation is sufficient, at least as a rough indication.
    Keywords: Money demand, inflation, excess liquidity, cointegration analysis
    JEL: C22 C52 E41
    Date: 2011
  2. By: Stefano Marzioni (LUISS Guido Carli University)
    Abstract: This paper examines the interactions between monetary policy and stability of interbank money markets. After showing some empirical evidence of a central bank's concern for money market stability I derive a forward smoothing interest rate rule moving from an explicit target in terms of a liquidity stress indicator. The implications of this approach on equilibrium determinacy and learnability are analyzed. I show that equilibrium uniqueness is not necessarily compatible with equilibrium learnability, and learnability, in general, has tighter requirements than determinacy.
    Keywords: LIBOR-OIS spread, Taylor Rule, Adaptive Learning, DSGE models, Monetary Policy.
    JEL: E43 E44 E52 E58
    Date: 2011
  3. By: Jonathan H. Wright
    Abstract: The federal funds rate has been stuck at the zero bound for over two years and the Fed has turned to unconventional monetary policies, such as large scale asset purchases to provide stimulus to the economy. This paper uses a structural VAR with daily data to identify the effects of monetary policy shocks on various longer-term interest rates during this period. The VAR is identified using the assumption that monetary policy shocks are heteroskedastic: monetary policy shocks have especially high variance on days of FOMC meetings and certain speeches, while there is nothing unusual about these days from the perspective of any other shocks to the economy. A complementary high-frequency event-study approach is also used. I find that stimulative monetary policy shocks lower Treasury and corporate bond yields, but the effects die off fairly fast, with an estimated half-life of about two months.
    JEL: C22 E43 E58
    Date: 2011–06
  4. By: Tatiana Kirsanova (Department of Economics, University of Exeter); Stephanus le Roux (Department for Work and Pensions)
    Abstract: This paper investigates the conduct of monetary and fiscal policy in the UK in the period of the Bank of England independence and before the start of the quantitative easing. Using a simple DSGE New Keynesian model of non-cooperative monetary and fiscal policy interactions under the fiscal intra-period leadership we demonstrate that the past policy in the UK is better explained as following optimal policy under discretion than under commitment. We estimate policy objectives of both policy makers, and derive implied policy rules.
    Keywords: Monetary and Fiscal Policy, Commitment, Discretion, Macroeconomic Stabilisation, Bayesian Estimation
    JEL: E52 E61 E63
    Date: 2011
  5. By: Fregert, Klas (Department of Economics, Lund University)
    Abstract: Unlike Knut Wicksell, Eli Heckscher did not believe the time had arrived for “managed money” to replace the gold standard after World War I. The war had shown that only a gold standard could bind the central bank to a time-consistent policy with reasonable price stability. Heckscher likened the problem of reinstating the gold standard to “Belling the cat” in Aesop’s fable. When the international gold standard crumbled in the Great Depression, he supported the Swedish price stabilization regime as a temporary system. Heckscher was an early discoverer of the time-consistency problem in monetary policy and hence stressed the importance of the institutional framework of monetary policy.
    Keywords: Heckscher; time-consistent policy; devaluation; deflation; gold standard
    JEL: B22 E31 E42
    Date: 2011–06–14
  6. By: Gianluca Benigno; Pierpaolo Benigno; Salvatore Nisticò
    Abstract: In this research, we provide new empirical evidence on the importance of time-varying uncertainty for the exchange rate and the excess return in currency markets. Following an increase in monetary policy uncertainty, the dollar exchange rate appreciates in the medium run, while an increase in the volatility of productivity leads to a dollar depreciation. We propose a general-equilibrium theory of exchange rate determination based on the interaction between monetary policy and time-varying uncertainty aimed at understanding these regularities. In the model, the behaviour of the exchange rate following nominal and real volatility shocks is consistent with the empirical evidence. Furthermore we show that risk factors and interest-rate smoothing are important in accounting for the negative coefficient in the UIP regression.
    JEL: E0 E43 E52 F3 F31 F41
    Date: 2011–06
  7. By: Norman, Ben (Bank of England); Shaw, Rachel (Bank of England); Speight, George (Bank of England)
    Abstract: Modern central banks have come to view payment systems as a key area of strategic interest, both as part of their responsibilities for financial stability and for the implementation of monetary policy. By considering the evolution of interbank settlement arrangements and central banking functions in the context of a number of diverse historical country case studies, this paper seeks to improve understanding of the development of, and reasons for, central banks’ current roles. Starting from a situation where the earliest banks gradually began to accept claims on each other, banks introduced a variety of innovations to clear and settle between themselves more efficiently. Focusing particularly on the lender of last resort function – a key characteristic of a central bank – this paper explores whether institutions at the centre of clearing and settlement arrangements developed central bank-like characteristics.
    Keywords: Monetary history; central banking; payments clearing and settlement
    JEL: N21 N23
    Date: 2011–06–13
  8. By: Thierry Bracke (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Irina Bunda (IMF-Singapore Regional Training Institute, 10 Shenton Way, MAS Building, Singapore 079117.)
    Abstract: The paper provides a measure of exchange rate anchoring behaviour across 149 emerging market and developing economies for the 1980-2010 period. An extension of the Frankel and Wei (2008) methodology is used to determine whether exchange rates are pegged or floating, and in the case of pegs, to which anchor currencies they are pegged. To capture the role of major currencies over time, an aggregate trade-weighted indicator is constructed based on exchange rate regimes of individual countries. The evolution of this aggregate indicator suggests that the US dollar has continuously dominated exchange rate regimes, despite some temporary decoupling during major financial crises. JEL Classification: F30, F31, F33.
    Keywords: de facto exchange rate regimes, international monetary system, emerging and developing economies, global currencies.
    Date: 2011–06
  9. By: Thomas Windberger; Achim Zeileis
    Abstract: To assess the effects of the EMU on inflation rate dynamics of its member states, the inflation rate series for 21 European countries are investigated for structural changes. To capture changes in mean, variance, and skewness of inflation rates, a generalized logistic model is adopted and complemented with structural break tests and breakpoint estimation techniques. These reveal considerable differences in the patterns of inflation dynamics and the structural changes therein. Overall, there is a convergence towards a lower mean inflation rate with reduced skewness, but it is accompanied by an increase in variance.
    Keywords: inflation rate, structural break, EMU, generalized logistic distribution
    JEL: E31 C22 C52
    Date: 2011–06
  10. By: Challe, E.; Giannitsarou, C.
    Abstract: Recent empirical literature documents that unexpected changes in the nominal interest rates have a significant effect on stock prices: a 25-basis point increase in the Fed funds rate is associated with an immediate decrease in broad stock indices that may range from 0.5 to 2.3 percent, followed by a gradual decay as stock prices revert towards their long-run expected value. In this paper, we assess the ability of a general equilibrium New Keynesian asset-pricing model to account for these facts. The model we consider allows for staggered price and wage setting, as well as time-varying risk aversion through habit formation. We find that the model predicts a stock market response to policy shocks that matches empirical estimates, both qualitatively and quantitatively. Our findings are robust to a range of variations and parameterizations of the model.
    Keywords: Monetary policy; Asset prices; New Keynesian general equilibrium model.
    JEL: E31 E52 G12
    Date: 2011
  11. By: Ulrich Bindseil; Philipp Johann König
    Abstract: It has recently been argued that intra-eurosystem claims and liabilities in the form of TARGET2 balances would raise fundamental issues within the European monetary union. This article provides a framework for the economic analysis of TARGET2 balances and discusses the key arguments behind this recent debate. The analysis is conducted within a system of financial accounts in which TARGET2 balances can arise either due to current account transactions or cross-border capital flows. It is argued that the recent volatility of TARGET2 balances reflects capital flow movements, while the previously prevailing current account positions did not find a strong reflection in TARGET2 balances. Some recent statements regarding TARGET2 appear to be due to a failure to distinguish between the monetary base (a central bank liability concept) and the liquidity deficit of the banking system vis-à-vis the central bank (a central bank asset concept). Furthermore, the article highlights the importance of TARGET2 for the stability of the euro area and points out that the proposal to limit the size of TARGET2 liabilities essentially contradicts the idea of a monetary union.
    Keywords: TARGET2, central bank balance sheet, liquidity deficit, financial crisis
    JEL: E58 F33
    Date: 2011–06
  12. By: David Cook; Michael B. Devereux
    Abstract: With integrated trade and financial markets, a collapse in aggregate demand in a large country can cause ‘natural real interest rates’ to fall below zero in all countries, giving rise to a global ‘liquidity trap’. This paper explores the policy choices that maximize the joint welfare of all countries following such a shock, when governments cooperate on both fiscal and monetary policy. Adjusting to a large negative demand shock requires raising world aggregate demand, as well as redirecting demand towards the source (home) country. The key feature of demand shocks in a liquidity trap is that relative prices respond perversely. A negative shock causes an appreciation of the home terms of trade, exacerbating the slump in the home country. At the zero bound, the home country cannot counter this shock. Because of this, it may be optimal for the foreign policy-maker to raise interest rates. Strikingly, the foreign country may choose to have a positive policy interest rate, even though its ‘natural real interest rate’ is below zero. A combination of relatively tight monetary policy in the foreign country combined with substantial fiscal expansion in the home country achieves the level and composition of world expenditure that maximizes the joint welfare of the home and foreign country. Thus, in response to conditions generating a global liquidity trap, there is a critical mutual interaction between monetary and fiscal policy.
    JEL: E5 F41 F42
    Date: 2011–06
  13. By: Richard C.K. Burdekin; Kris James Mitchener; Marc D. Weidenmier
    Abstract: The question of price level versus inflation targeting remains controversial. Disagreement concerns, not so much the desirability of price stability, but rather the means of achieving it. Irving Fisher argued for a commodity dollar standard where the purchasing power of money was fixed by indexing it to a basket of commodities. We show that movements in the price of silver closely track the movements in overall prices during the classical gold standard era. The one-to-one relationship between paper and silver bonds suggests that a simple “silver rule" could have sufficed to fix the purchasing power of money.
    JEL: E31 E4 E58 N1 N33
    Date: 2011–06
  14. By: Jawaid, Syed Tehseen; Arif, Imtiaz; Naeemullah, Syed Muhammad
    Abstract: This study investigates the comparative effect of fiscal and monetary policy on economic growth in Pakistan using annual time series data from 1981 to 2009. The cointegration result suggests that both monetary and fiscal policy have significant and positive effect on economic growth. The coefficient of monetary policy is much greater than fiscal policy which implies that monetary policy has more concerned with economic growth than fiscal policy in Pakistan. The implication of the study is that the policy makers should focus more on monetary policy than fiscal to enhance economic growth. The role of fiscal policy can be more effective for enhancing economic growth by eliminating corruption, leakages of resources and inappropriate use of resources. However, the combination and harmonization of both monetary and fiscal policy are highly recommended.
    Keywords: Monetary Policy; Fiscal Policy; Economic Growth.
    JEL: H30 E00 O40
    Date: 2010–12
  15. By: Jan Libich; Dat Thanh Nguyen; Petr Stehlík
    Abstract: The paper models strategic monetary-fiscal interactions in the aftermath of the global financial crisis - in a single country as well as a monetary union. It depicts both the short- term (stabilization) perspective and the long-term (sustainability) perspective, and the link between them. This is done in a game theoretic framework that allows for revisions of actions, deterministic or stochastic. In addition, we consider incomplete information about economic conditions, and different types of government. We find that, under ambitious fiscal policies, a legislated long-term monetary commitment may: (i) reduce the risk of a double-dip recession and deflation in the short-term, and at the same time (ii) facilitate the 'exit strategy' of monetary policy, ie prevent sub-optimally high future inflation caused by fiscal spillovers. Our analysis thus implies that an explicit numerical target for average inflation may play the role of a monetary 'credibility insurance' over all phases of the business cycle, and is beneficial especially in countries facing fiscal stress.
    JEL: E52 C70
    Date: 2011–02
  16. By: Melhem Sadek; Diallo Abdul Salam; Terraza Michel
    Abstract: The decline in the value of US dollar and the emergence of other currencies has opened the debate within OPEC, of whether it is possible to resort to the pricing of crude oil in alternative currencies. The debate was limited because of the inadequate liquidity of most other currencies. In this paper, we focus on the implications of the shift in the pricing of Iran’s crude oil to other currencies than the US dollar. The results demonstrated that the pricing for Iranian oil in US dollar had high reaction potential and responded moderately to the change in the exchange rate, when compared to the pricing in Euro and in Yen. Consequently, it appeared that stability on the financial market led to partial stability in the oil market.
    Keywords: Crude Oil Pricing, Currency Basket, OPEC, Exchange Rate of Dollar, Euros, Yen.
    Date: 2011–06
  17. By: Barbara Rossi; Sarah Zubairy
    Abstract: This paper analyzes the importance of monetary and fiscal policy shocks in explaining US macroeconomic fluctuations, and establishes new stylized facts. The novelty of our empirical analysis is that we jointly consider both monetary and fiscal policy, whereas the existing literature only focuses on either one or the other. Our main findings are twofold: fiscal shocks are relatively more important in explaining medium cycle fluctuations whereas monetary policy shocks are relatively more important in explaining business cycle fluctuations; and failing to recognize that both monetary and fiscal policy simultaneously affect macroeconomic variables might incorrectly attribute the fluctuations to the wrong source.
    Keywords: Monetary policy, government spending, fiscal policy, business cycle fluctuations, medium cycle
    JEL: E1 E5 E6 C5
    Date: 2011
  18. By: Giorgio Di Giorgio (LUISS Guido Carli University); Guido Traficante (Universita' Europea di Roma and LUISS Guido Carli University)
    Abstract: What is the welfare loss arising from uncertainty about true policy targets? We quantify these effects in a DSGE model where private agents are unable to distinguish between temporary shocks to potential output and to the inßation target. Agents use optimal Þltering techniques to construct estimates of the unknown variables. We Þnd that the welfare costs of not observing the inßation target and potential output are relevant even in the case of a small measurement error. We also show that, in our framework, uncertainty about the inßation target is more costly than uncertainty about potential output.
    Keywords: Monetary Policy, Kalman Filter, Potential Output.
    JEL: E5 E37 E52 E58
    Date: 2011
  19. By: Philippe Moutot (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: In a stochastic pure endowment economy with money but no financial markets, two types of agents trade one non-durable good using two alternative types of cash constraints. Simulations of the corresponding variants are compared to Arrow-Debreu and Autarky equilibriums. First, this illustrates how financial innovation or financial regression, including systemic risk, may arise in a neo-classical model with rational expectations and may or may not be countered. Second, the price and money partition dynamics that the two variants generate absent any macroeconomic shock, exhibit jumps as well as fat-tails and vary depending on the discount rate. JEL Classification: E44.
    Keywords: Financial development, Systemic Risk, Heterogeneity, Rational expectations, Monetary model, Cash constraints.
    Date: 2011–06
  20. By: Barthélemy, J.; Cléaud, G.
    Abstract: We estimate a medium-scale DSGE model for the euro area in an open economy framework. The model includes structural trends on all variables, which allow us to estimate on gross data. We first provide a theoretical balanced growth path consistent with permanent productivity shocks, inflation target changes, and permanent shocks to the openness of the economies. We then define the cycle as the gap between this sustainable trajectory and the gross data, thus our model properly deals with deviations of the trade balance. Finally, we find persistent and strong effects from the asymmetric increase of euro area imports during the last ten years on domestic inflation. From the first quarter of 2000 to the last quarter of 2008, we estimate the contribution of the imbalanced development of international trade on euro area inflation to an average of -0.7%, and on the 3-Month interest rate to an average of -1.4%.
    Keywords: Global Imbalances, Disinflation, Business Fluctuations, Open Economy Macroeconomics.
    JEL: E32 F41
    Date: 2011

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