nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒07‒02
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Policy Commitment and Market Expectations: Lessons Learned from Survey Based Evidence under Japan's Quantitative Easing Policy By Yoshiyuki Nakazono; Kozo Ueda
  2. Identification of Monetary Policy Shocks in Japan Using Sign Restrictions within the TVP-VAR Framework By Michal Franta
  3. Policy Games with Liquidity Constrained Consumers By Alice Albonico; Lorenza Rossi
  4. Official Dollarization as a Monetary Regime: Its Effects on El Salvador By Andrew Swiston
  5. Financial Liberalization, Weighted Monetary Aggregates and Money Demand in Indonesia By Chin-Hong, Puah; Lee-Chea, Hiew
  6. Words vs. Deeds: What Really Matters? By Charalambos G. Tsangarides; Mahvash Saeed Qureshi; Atish R. Ghosh
  7. External Monetary Shocks and Monetary Integration: Evidence from the Bulgarian Currency Board By Minea, Alexandru; Rault, Christophe
  8. Monetary aggregates, financial intermediate and the business cycle By Hong, Hao
  9. Can the Fed Talk the Hind Legs off the Stock Market? By Raes, L.B.D.; Eijffinger, S.C.W.; Mahieu, R.J.
  10. Reconsidering the Welfare Cost of Inflation in the US: A Nonparametric Estimation of the Nonlinear Long-Run Money Demand Equation using Projection Pursuit Regressions By Rangan Gupta; Anandamayee Majumdar
  11. Monetary policy effects on output and exchange rates: Results from US, UK and Japan By Mustafa Caglayan; Kostas Mouratidis; Elham Saeidinezhad
  12. Inflation Dynamics and the Great Recession By Laurence M. Ball; Sandeep Mazumder
  13. Quantitative easing and bank lending: evidence from Japan By David Bowman; Fang Cai; Sally Davies; Steven Kamin
  14. Challenges for the dollar as a reserve currency By Gianluca Benigno
  15. Monetary Union, Fiscal Crisis and the Preemption of Democracy By Fritz W. Scharpf
  16. Is the Euro-Area Core Price Index Really More Persistent than the Food and Energy Price Indexes? By José Manuel Belbute
  17. The Great Liquidity Freeze: What Does It Mean for International Banking? By Domanski, Dietrich; Turner, Philip
  18. In Which Exchange Rate Models Do Forecasters Trust? By H. Takizawa; David Hauner; Jaewoo Lee
  20. Assessing the sensitivity of inflation to economic activity By Konstantins Benkovskis; Michele Caivano; Antonello D’Agostino; Alistair Dieppe; Samuel Hurtado; Tohmas Karlsson; Eva Ortega; Tímea Várnai

  1. By: Yoshiyuki Nakazono (Waseda University and Research Fellow of the Japan Society for the Promotion of Science (E-mail: ynakazono; Kozo Ueda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: kouzou.ueda
    Abstract: The Bank of Japan conducted its quantitative easing policy ( QEP) from 2001 to 2006, with the policy commitment to maintaining its QEP until the CPI inflation rate became stably zero or higher. We evaluate its effects by using individual survey data on inflation expectations as well as interest rate expectations. Our analysis reveals a kinked relationship between interest rate expectations and inflation rate expectations at around the zero percent threshold level of inflation expectations, in tune with this policy commitment. In addition, we evaluate the effects of the policy commitment on market expectations for the future path of short-term interest rates after the termination of the QEP. We find that, even when inflation expectations exceeded the threshold, interest rate expectations responded only gradually to inflation rate expectations.
    Keywords: Commitment policy, policy duration effect, unconventional monetary policy, zero lower bound
    JEL: C23 C24 E43 E44 E52 E58
    Date: 2011–06
  2. By: Michal Franta (Czech National Bank, Economic Research Department (E-mail:
    Abstract: This paper contributes to the discussion on the functioning of the monetary policy transmission mechanism in Japan during the past three decades. It extends the methodology of time-varying parameter vector autoregressions (TVP-VAR) by employing an identification scheme based on sign restrictions. This approach allows for an explicit account of the zero lower bound on the nominal interest rate. Results suggest differences in the transmission mechanism between the quantitative easing policy period and the periods when the call rate played the role of a monetary policy instrument. Monetary policy operating through call rate movements is found to influence output more than when it targets banksf balances held at the central bank. Monetary policy operating through quantitative easing is found to influence inflation, in sharp contrast to the previous literature.
    Keywords: Structural vector autoregressive model, time-varying parameters, sign restrictions, unconventional monetary policy, zero lower bound
    JEL: C11 C15 E52
    Date: 2011–06
  3. By: Alice Albonico (Department of Economics and Quantitative Methods, University of Pavia); Lorenza Rossi (Department of Economics and Quantitative Methods, University of Pavia)
    Abstract: In the light of the recent financial crisis, we investigate the effects generated by limited asset market participation on optimal monetary and fiscal policy, where monetary and fiscal authority are independent and play strategically. We find that limited asset market participation strongly affects the optimal steady state and the optimal dynamics of the different policy regimes considered. In particular: (i) both in the long run and in short run equilibrium, a greater inflation bias is optimal than in the standard representative agent economy; (ii) in response to a markup shock, fiscal policy becomes more active as the fraction of liquidity constrained agents increases; (iii) optimal discretionary policies imply welfare losses for Ricardian, while liquidity constrained consumers experience welfare gains with respect to Ramsey.
    Keywords: liquidity constrained consumers, optimal monetary and fiscal policy, strategic interaction, inflation bias
    JEL: E3 E5
    Date: 2011–02
  4. By: Andrew Swiston
    Abstract: This paper examines El Salvador’s transition to official dollarization by comparing aspects of this regime to the fixed exchange rate regime prevailing in the 1990s. Commercial bank interest rates are analyzed under an uncovered interest parity framework, and it is found that dollarization lowered rates by 4 to 5 percent by reducing currency risk. This has generated net annual savings averaging ½ percent of GDP for the private sector and ¼ percent of GDP for the public sector (net of the losses from foregone seigniorage). Estimated Taylor rules show a strong positive association between Salvadoran output and U.S. Federal Reserve policy since dollarization, implying that this policy has served to stabilize economic activity more than it did under the peg and more than policy rates in Central American countries with independent monetary policy have done. Dollarization does not appear to have affected the transmission mechanism, as pass-through of monetary policy to commercial interest rates has been similar to pass-through under the peg and in the rest of Central America.
    Date: 2011–06–06
  5. By: Chin-Hong, Puah; Lee-Chea, Hiew
    Abstract: This study investigates the significance of Divisia monetary aggregates in formulating the monetary policy in Indonesia. A money demand function has been constructed to compare the relative performance for Simple-sum M1 and M2 (SSM1 and SSM2) and Divisia M1 and M2 (DM1 and DM2) monetary aggregates. The econometrics testing procedures that have been utilized in the estimation include unit root test, cointegration test, Vector Error Correction Model (VECM), Granger causality test and residual test. Empirical findings indicate that only DM1 model yields credible result amongst all of the money demand models. The obtained coefficients for DM1 model are consistent with a prior theoretical expectation and carry plausible magnitudes. The DM1 model is satisfactory as proven by the diagnostic tests. Divisia monetary aggregates are proven not only theoretical superior but also empirical valid as useful measurement of money for the case of Indonesia. The central bank of Indonesia may consider using Divisia monetary aggregates as the policy variables in formulating monetary policy.
    Keywords: Money Demand; Divisia Money; VECM
    JEL: C32 C43 E41
    Date: 2010–12
  6. By: Charalambos G. Tsangarides; Mahvash Saeed Qureshi; Atish R. Ghosh
    Abstract: This paper revisits the link between the nominal exchange rate regime and inflation, based on a sample of 145 emerging market and developing countries (EMDCs) over the period 1980-2010. We contend that, just as a de jure peg that is not backed by a de facto peg will have little value, de facto pegs that lack the corresponding de jure will likewise reap few of the low inflation benefits associated with pegging the exchange rate. To test our hypothesis, we exploit a novel dataset of both de jure and de facto exchange rate regime classifications. We find that pegged exchange rates are associated with significantly lower inflation in EMDCs than flexible exchange rates, and that this effect is much stronger for de facto pegs that are matched by de jure pegs than for those that are not. When it comes to anchoring expectations and delivering low inflation, therefore, both deeds and words matter.
    Keywords: Currency pegs , Developing countries , Economic models , Emerging markets , Exchange rate regimes , Floating exchange rates , Inflation , Monetary policy ,
    Date: 2011–05–10
  7. By: Minea, Alexandru (CERDI, University of Auvergne); Rault, Christophe (University of Orléans)
    Abstract: Starting July the 1st 1997, Bulgaria adopted a Currency Board (CB) monetary system. This paper aims at investigating if the adoption of the CB monetary system, which involves the cost of loosing monetary autonomy, has provided a relatively better (with respect to other CEEC) monetary integration of Bulgaria with the European Monetary Union (EMU). Since Bulgarian monetary variables are endogenous under a CB, we focus on the ECB and FED interest rates as the main sources on monetary volatility. First, we find that ECB shocks are more rapidly absorbed and have less significant impact of domestic variables, with respect to other external monetary shocks (FED rate changes). Second, the responses of Bulgarian variables following changes in the ECB interest rate present lower persistence and significance, with respect to what the previous literature emphasized for other CEEC with monetary autonomy. This latter result still holds when accounting for different sources of cross-country heterogeneity outlined in the literature, thus supporting that the adoption of the CB may have worked as a rather good device in terms of integration of Bulgaria into the EMU.
    Keywords: currency board, Bulgaria, monetary shocks, ECB interest rate, FED interest rate
    JEL: E42 E52
    Date: 2011–06
  8. By: Hong, Hao (Cardiff Business School)
    Abstract: This paper explains and evaluates the transmissions and effectiveness of monetary policy shock in a simple Cash-in-Advance (CIA) economy with financial intermediates. Lucas-Fuerst's (1992) limited participation CIA models are able to explain decreasing nominal interest rates and increasing real economic activity with monetary expansion through limited participation monetary shock and the cost channel of monetary policy. Calvo's (1983) sticky price monetary model examines the real effects of money injections through firms price setting behaviour, but it fails to generate a negative correlation between nominal interest rates and money growth rate, which has been observed in the data. This paper employs McCandless (2008) financial intermediates CIA model to explain the transmissions and impacts of monetary shocks. The model does not request limited participation monetary shock or Keynesian type of sticky price/wage, to examine the lower nominal interest rate and increasing real economic activity with monetary expansion. By extending the model with Stockman's (1981) CIA constraint, it is able to account for both positive response of consumption subject to monetary innovations, which has been found in Leeper et al. (1996) and the positive correlation between output and consumption which has been observed in the data.
    Keywords: Monetary business cycle; financial intermediate; cash-in-advance model
    JEL: E44 E52
    Date: 2011–06
  9. By: Raes, L.B.D.; Eijffinger, S.C.W.; Mahieu, R.J. (Tilburg University, Center for Economic Research)
    Abstract: Deliberately or not, by providing its stance on the prospects of the economy, rationalizing past decisions or announcing future actions, central banks in fluence financial markets' expectations of its future policy. In bad times, monetary policy communication inducing an upward revision of the path of future policy is good news for stocks. During an expansion the effect is weak and on average negative. The response of equities to central bank talk depends critically on the business cycle. There are strong industry specific effects of monetary policy actions and communication. These industry effects relate to the variation in cyclicality of different industries. Firm-specific effects of monetary policy relate to the leverage, the size and the price-earnings ratio of firms.
    Keywords: Monetary policy;Monetary policy announcements;Credit Channel;Business cycle;Stock market
    JEL: G14 E44 E52
    Date: 2011
  10. By: Rangan Gupta (Department of Economics, University of Pretoria); Anandamayee Majumdar (School of Mathematical & Statistical Sciences, Arizona State University)
    Abstract: This paper, first, estimates the appropriate, log-log or semi-log, linear long-run money demand relationship capturing the behavior US money demand over the period of 1980:Q1 to 2010:Q4, using the standard linear cointegration procedures found in the literature, and the corresponding nonparametric version of the same based on Projection Pursuit Regression (PPR) methods. We then, compare the resulting welfare costs of inflation obtained from the linear and nonlinear money demand cointegrating equations. We make the following observations: (i) The appropriate money demand relationship for the period of 1980:Q1 to 2010:Q4 is captured by a semi-log function, since no cointegrating relationship could be obtained for the log-log model; (ii) The semi-elasticity of interest rate obtained from the PPR method is found to be more than double the corresponding estimate obtained under the linear case; (iii) Based on the estimation of semi-log cointegrating equations, the welfare cost of inflation was found to at the most lie between 0.0131 percent of GDP to 0.2186 percent of GDP for inflation rates between 0 percent and 10 percent, and; (iv) In comparison, the welfare cost of inflation obtained from the semi-log non-linear long-run money demand function, obtained using the PPR method, for 0 to 10 percent of inflation ranges between 0.4929 to 1.9468 percent of GDP. These results suggest that the Federal Reserve’s current policy, which generates low but still positive rates of inflation, might not be an adequate approximation in terms of the welfare cost of inflation. Perhaps, moving all the way to a Friedman-type deflationary rule for a zero nominal interest is a more desired policy given the size of welfare loss.
    Keywords: Cointegration, Money Demand, Projection Pursuit Regression, Welfare Cost of Inflation
    JEL: E31 E41 E52
    Date: 2011–06
  11. By: Mustafa Caglayan (Department of Economics, The University of Sheffield); Kostas Mouratidis (Department of Economics, The University of Sheffield); Elham Saeidinezhad (Department of Economics, The University of Sheffield)
    Abstract: We investigate the effects of "contractionary" monetary shocks by imposing sign restrictions on the impulse responses of macroeconomic variables up to six months while allowing industrial production and exchange rate to be completely determined by the data. We show that i) the effect of an adverse monetary policy shock on industrial production is ambiguous; ii) there is price puzzle for Japan and UK which we conjecture as an outcome of excessive bank lending and poor regulation but not of passive monetary policy; ii) there is delayed overshooting puzzle for Japan and the exchange rate puzzle for the UK and the US.
    Keywords: monetary shocks, business cycles, exchange rate puzzle, price puzzle, vector autoregression
    JEL: C3 E1 E3
    Date: 2011–06
  12. By: Laurence M. Ball; Sandeep Mazumder
    Abstract: This paper examines inflation dynamics in the United States since 1960, with a particular focus on the Great Recession. A puzzle emerges when Phillips curves estimated over 1960-2007 are ussed to predice 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 vairance 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: 2011–06–01
  13. By: David Bowman; Fang Cai; Sally Davies; Steven Kamin
    Abstract: Prior to the recent financial crisis, one of the most prominent examples of unconventional monetary stimulus was Japan's "quantitative easing policy" (QEP). Most analysts agree that QEP did not succeed in stimulating aggregate demand sufficiently to overcome persistent deflation. However, it remains unclear whether QEP simply provided little stimulus, or whether its positive effects were overwhelmed by the contractionary forces in Japan's post-bubble economy. In the spirit of Kashyap and Stein (2000) and Hosono (2006), this paper uses bank-level data from 2000 to 2009 to examine the effectiveness in promoting bank lending of a key element of QEP, the Bank of Japan's injections of liquidity into the interbank market. We identify a robust, positive, and statistically significant effect of bank liquidity positions on lending, suggesting that the expansion of reserves associated with QEP likely boosted the flow of credit. However, the overall size of that boost was probably quite small. First, the estimated response of lending to liquidity positions in our regressions is small. Second, much of the effect of the BOJ's reserve injections on bank liquidity was offset as banks reduced their lending to each other. Finally, the effect of liquidity on lending appears to have held only during the initial years of QEP, when the banking system was at its weakest; by 2005, even before QEP was abandoned, the relationship between liquidity and lending had evaporated.
    Date: 2011
  14. By: Gianluca Benigno
    Abstract: Gianluca Benigno examines the extent to which the financial crisis has undermined the dollar's pre-eminence.
    Keywords: reserve currency, international, USA, China
    JEL: F31 F32 F41
    Date: 2011–06
  15. By: Fritz W. Scharpf
    Abstract: The European Monetary Union (EMU) has removed crucial instruments of macroeconomic management from the control of democratically accountable governments. Worse yet, it has been the systemic cause of destabilizing macroeconomic imbalances that member states found difficult or impossible to counteract with their remaining policy instruments. And even though the international financial crisis had its origins outside Europe, the Monetary Union has greatly increased the vulnerability of some member states to its repercussions. Its effects have undermined the economic and fiscal viability of some EMU member states, and they have frustrated political demands and expectations to an extent that may yet transform the economic crisis into a crisis of democratic legitimacy. Moreover, present efforts of EMU governments to “rescue the Euro” will do little to correct economic imbalances and vulnerabilities, but are likely to deepen economic problems and political alienation in both, the rescued and the rescuing polities.
    Date: 2011–05
  16. By: José Manuel Belbute (Departamento de Economia, CEFAGE-UE, Universidade de Évora)
    Abstract: The purpose of this paper is to measure the degree of persistence of the overall, core, food and energy Harmonized Indexes of Consumer Prices for the European Monetary Zone (HICP-EAs) and to identify its implications for decision-making in the private sector and in public policy. Using a non-parametric approach, our results demonstrate the presence of a statistically significant level of persistence in four HICP-EAs: headline, core, food and energy. Moreover, contrary to popular belief, the core index does not reflect permanent price changes. We also find evidence that the food and energy price indexes are more volatile and more persistent than the other two price indexes. Our results also show a reduction in persistence for both the headline and the core price indexes after the implementation of the single monetary policy, but not for food and energy. These results have important implications for both the private sector and for policymakers who use the core as a reference price index for their decision-making because the use of this index can lead to an erroneous perception of price movements.
    Keywords: Harmonized Index of Consumption Prices, Core Inflation, Euro Area, Persistence.
    JEL: C14 C22 E31 E52
    Date: 2011
  17. By: Domanski, Dietrich (Asian Development Bank Institute); Turner, Philip (Asian Development Bank Institute)
    Abstract: In mid-September 2008, following the bankruptcy of Lehman Brothers, international interbank markets froze and interbank lending beyond very short maturities virtually evaporated. Despite massive central bank support operations and purchases of key assets, many financial markets remained impaired for a long time. Why was this funding crisis so much worse than other past major bank failures and why has it proved so hard to cure? This paper suggests that much of that answer lies in the balance sheets of international banks and their customers. It outlines the basic building blocks of liquidity management for a bank that operates in many currencies and then discusses how the massive development of foreign exchange (forex) and interest rate derivatives markets transformed banks’ strategies in this area. It explains how the pervasive interconnectedness between major banks and markets magnified contagion effects. Finally, the paper provides some recommendations for how strategic borrowing choices by international banks could make them more stable and how regulators could assist in this process.
    Keywords: banking financial stability; financial markets; international banking; international interbank markets; liquidity management
    JEL: E44 G15 G18 G24 G28
    Date: 2011–06–24
  18. By: H. Takizawa; David Hauner; Jaewoo Lee
    Abstract: Using survey data of market expectations, we ask which popular exchange rate models appear to be consistent with expectation formation of market forecasters. Exchange rate expectations are found to be correlated with inflation differentials and productivity differentials, indicating that the relative PPP and Balassa-Samuelson effect are common inputs into expectation formation of market forecasters.
    Keywords: Economic forecasting , Exchange rates , Forecasting models , Interest rate differential , Purchasing power parity ,
    Date: 2011–05–19
  19. By: Amir Mansour Tehranchian (Department of Economics, Mazandaran University, Babolsar, Iran); Masoud Behravesh (Department of Management, Bonab Branch, Islamic Azad University, Bonab, Iran)
    Abstract: In this paper, Stieglitz’s theory regarding the threshold effects of real interest rate on investment of Iran's private sector during 1973-2008 is experimentally examined. The study showed that although the real interest rate directly affects on private investment in Iran, an increase of more than 2 percent in the real interest rate will reduce the private sector's investment. In other words, Stieglitz’s argument about a one-threshold level (close to zero) of the real interest rate is confirmed in Iran. Paying attention to the rate of inflation and threshold limit of influence of interest rate on monetary policies is considered the most important proposals of the present research
    Keywords: Private sector's investment, Real interest rate, Threshold effects
    JEL: E22 E43 E44
    Date: 2011–06
  20. By: Konstantins Benkovskis (Bank of Latvia, K. Valdemara street 2A, Riga, LV-1050, Latvia.); Michele Caivano (Banca d’Italia, Italy.); Antonello D’Agostino (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Alistair Dieppe (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Samuel Hurtado (Banco de España, Spain.); Tohmas Karlsson (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Eva Ortega (Banco de España, Spain.); Tímea Várnai (National Bank of Hungary, 1054 Szabadság tér 8/9, 1850 Budapest.)
    Abstract: A number of academic studies suggest that from the mid-1990s onwards there were changes in the link between inflation and economic activity. However, it remains unclear the extent to which this phenomenon can be ascribed to a change in the structural relationship between inflation and output, as opposed to a change in the size and nature of the shocks hitting the economy. This paper uses a suite of models, such as time-varying VAR techniques, traditional macro models, as well as DSGE models, to investigate, for various European countries as well as for the euro area, the evolution of the link between inflation and resource utilization and its dependence on the nature and size of the shocks. Our analysis suggests that the relationship between inflation and activity has indeed been changing over time, while remaining positive, with the correlation peaking during recessions. Quantitatively, the link between output and inflation is found to be highly dependent on which type of shocks hit the economy: while, in general, all demand shocks to output imply a reaction of inflation of the same sign, the latter will be less pronounced when output fluctuations are driven by supply shocks. In addition, a sharp deceleration of activity, as opposed to a subdued but protracted slowdown, results in a swifter decline in inflation. Inflation exhibits a rather strong persistence, with a negative impact still visible three years after the initial shock. JEL Classification: E31, E32, E37.
    Keywords: Demand shock, inflation response, macro model, output growth, Phillips curve.
    Date: 2011–06

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