nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒09‒05
fifteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Inflation Expectations and Monetary Policy Design: Evidence from the Laboratory (Replaces CentER DP 2009-007) By Pfajfar, D.; Zakelj, B.
  2. Exchange rate dynamics, expectations, and monetary policy By Chen, Qianying
  3. Need Singapore Fear Floating? A DSGE-VAR Approach By Hwee Kwan Chow; Paul D. McNelis
  4. Tactics and Strategy in Monetary Policy: Benjamin Friedman's Thinking and the Swiss National Bank By Gerlach, Stefan; Jordan, Thomas J.
  5. The Effectiveness of Non-traditional Monetary Policy Measures: The Case of the Bank of Japan By Kazuo Ueda
  6. Asset prices, collateral and unconventional monetary policy in a DSGE model By Björn Hilberg; Josef Hollmayr
  7. Dollar Illiquidity and Central Bank Swap Arrangements During the Global Financial Crisis By Andrew K. Rose; Mark M. Spiegel
  8. The 2007 subprime market crisis through the lens of European Central Bank auctions for short-term funds By Nuno Cassola; Ali Hortacsu; Jakub Kastl
  9. Monetary Policy Transmission and Macroeconomic Dynamics in Luxembourg: Results from a VAR Analysis By Romuald Morhs
  10. Mapping change in the federal funds market By Morten L. Bech; Carl T. Bergstrom; Rodney J. Garratt; Martin Rosvall
  11. Inflation expectations and behavior: do survey respondents act on their beliefs? By Olivier Armantier; Wändi Bruine de Bruin; Giorgio Topa; Wilbert van der Klaauw; Basit Zafar
  12. Volatility Transmission in Emerging European Foreign Exchange Markets By Evzen Kocenda; Vit Bubak; Filip Zikes
  13. Is It Desirable for Asian Economies to Hold More Asian Assets in Their Foreign Exchange Reserves?—The People’s Republic of China’s Answer By Zhang, Bin
  14. External Adjustment and the Global Crisis By Philip R. Lane; Gian Maria Milesi Ferretti
  15. Crises, rescues, and policy transmission through international banks By Buch, Claudia M.; Koch, Cathérine Tahmee; Koetter, Michael

  1. By: Pfajfar, D.; Zakelj, B. (Tilburg University, Center for Economic Research)
    Abstract: Using laboratory experiments within a New Keynesian macro framework, we explore the formation of inflation expectations and its interaction with monetary policy design. The central question in this paper is how to design monetary policy in the environment characterized by heterogeneous expectations. Rules that use actual rather than forecasted inflation produce lower inflation variability and alleviate expectational cycles. Degree of responsiveness to deviations of inflation from its target in the Taylor rule produces nonlinear effects on inflation variability. We also provide considerable support for the existence of heterogeneity of inflation expectations and show that a significant proportion of subjects are rational in our experiment. However, most subjects rather than using a single model they tend to switch between alternative models.
    Keywords: Laboratory Experiments;Inflation Expectations;New Keynesian Model;Monetary Policy Design.
    JEL: C91 C92 E37 E52
    Date: 2011
  2. By: Chen, Qianying
    Abstract: This paper re-investigates the implications of monetary policy rules on changes in exchange rate, in a risk-adjusted, uncovered interest parity model with unrestricted parameters, emphasizing the importance of modeling market expectations of monetary policy. I use consensus forecasts as a proxy for market expectations. The analysis on the Deutsche mark, Canadian dollar, Japanese yen, and the British pound relative to the U.S. dollar from 1979 to 2008 shows that, through the expectations of future monetary policy, Taylor rule fundamentals are able to forecast changes in the exchange rate, even over short-term horizons of less than two years. Furthermore, the market expectation formation processes of short-term interest rates change over time and differ across countries, which contributes to the time varying relationship between exchange rates and macroeconomic fundamentals, together with the time varying currency risk premia and exchange rate forecast errors. --
    Keywords: Exchange Rate,Monetary Policy,Expectation,Learning,VAR,Consensus Forecast
    JEL: F31 E52 D83 C32
    Date: 2011
  3. By: Hwee Kwan Chow (School of Economics, Singapore Management University); Paul D. McNelis (SDepartment of Finance, Graduate School of Business Administration, Fordham University)
    Abstract: This paper uses a DSGE-VAR model to examine the managed exchange-rate system at work in Singapore and asks if the country has any reason to fear floating the exchange rate with a Taylor rule inflation-targeting mechanism that uses the short term interest rate instead of the exchange rate as the benchmark monetary policy instrument. Our simulation results show that the use of a more flexible exchange rate system will reduce volatility in inflation and investment but consumption volatility will increase. Overall, there are neither signi…ficant welfare gains or losses in the regime shift. Given the highly open and trade dependent nature of the Singapore economy where the policy preference is for exchange rate stability, there is no impetus to abandon the present monetary regime.
    JEL: E52 E62 F41
    Date: 2010–12
  4. By: Gerlach, Stefan; Jordan, Thomas J.
    Abstract: This paper reviews the tactics and strategy of monetary policy in Switzerland, using a selection of Benjamin Friedman’s papers to organize the discussion, and starting in the early 1970s, when his academic papers started to appear in scholarly journals. The review focuses on the SNB’s experience with monetary targets in 1975-1999, the policy strategy adopted by the SNB in 2000, and the SNB’s experiences during the financial crisis that started in August 2007. On many occasions, Benjamin Friedman’s and the SNB’s thinking converge, while on others, they diverge.
    Keywords: financial crisis; inflation targeting; monetary policy; monetary targeting; Swiss National Bank
    JEL: E43 E53 E58
    Date: 2011–08
  5. By: Kazuo Ueda (Faculty of Economics, University of Tokyo)
    Abstract: This paper summarizes non-traditional monetary policy measures adopted by the Bank of Japan (BOJ) during the last two decades and by other G7 central banks since the start of the current global financial turmoil and analyzes the effectiveness of such measures. The paper begins with a typology of policies usable near the zero lower bound on interest rates (ZLB). They are:(i) forward guidance of future policy rates;(ii) targeted asset purchases;(iii) and quantitative easing (QE). Using this typology, I review the measures adopted by the BOJ and other central banks. I then offer a news analysis of the effects of the measures adopted by the BOJ on asset prices, comparing them with those adopted by the Fed. Many of the measures, with the exception of strategy (iii), are shown to have moved asset prices in the expected directions. Another exception is that most of the monetary easing measures failed to weaken the yen. Despite some effects on asset prices, however, the measures have failed to stop the deflationary trend of the Japanese economy clearly. I discuss some possible reasons for this and more general implications for monetary policy.
    Date: 2011–08
  6. By: Björn Hilberg (Goethe-Universität Frankfurt am Main, Grüneburgplatz 1, D-60629 Frankfurt am Main, Germany.); Josef Hollmayr (Goethe-Universität Frankfurt am Main, Grüneburgplatz 1, D-60629 Frankfurt am Main, Germany.)
    Abstract: In this paper we set up a New-Keynesian model that features an interbank market. The introduction of an interbank market is important to analyze liquidity problems among heterogenous agents within the financial sector. First, because this allows for a situation where increased liquidity supply by the central bank is only partially passed on to the interbank market. Second, this framework allows us to analyze one additional policy measure besides the common interest rate policy undertaken by central banks to alleviate the liquidity shortage on the interbank market. Namely haircuts on eligible assets in repurchase agreements (“Repos”). By varying haircuts applied to securities that serve as collateral in repurchase agreements the stress on the interbank market can be mitigated by bringing down the interest rate charged among banks. Furthermore an exogenous bubble process is modeled which enables us to examine the effects of a deviation of the market price of capital from its fundamental price. This leads to a discussion whether central banks should ”lean against the wind”, i.e. react to deviations of asset prices in the setting of their policy instrument. Finally, this paper tries to shed some light on the “exit strategy” that a central bank should follow after the asset price bubble bursted and the interbank market begins to work properly again. JEL Classification: E4, E5, E61, G21.
    Keywords: DSGE, monetary policy, collateral, haircuts, exit strategy.
    Date: 2011–08
  7. By: Andrew K. Rose; Mark M. Spiegel
    Abstract: While the global financial crisis was centered in the United States, it led to a surprising appreciation in the dollar, suggesting global dollar illiquidity. In response, the Federal Reserve partnered with other central banks to inject dollars into the international financial system. Empirical studies of the success of these efforts have yielded mixed results, in part because their timing is likely to be endogenous. In this paper, we examine the cross-sectional impact of these interventions. Theory consistent with dollar appreciation in the crisis suggests that their impact should be greater for countries that have greater exposure to the United States through trade and financial channels, less transparent holdings of dollar assets, and greater illiquidity difficulties. We examine these predictions for observed cross-sectional changes in CDS spreads, using a new proxy for innovations in perceived changes in sovereign risk based upon Google-search data. We find robust evidence that auctions of dollar assets by foreign central banks disproportionately benefited countries that were more exposed to the United States through either trade linkages or asset exposure. We obtain weaker results for differences in asset transparency or illiquidity. However, several of the important announcements concerning the international swap programs disproportionately benefited countries exhibiting greater asset opaqueness.
    JEL: E42 E58 F31 F33 F41 F42 G15 O24
    Date: 2011–08
  8. By: Nuno Cassola (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Ali Hortacsu (The University of Chicago, Department of Economics, 1126 E. 59th Street, Chicago, IL 60637, USA.); Jakub Kastl (Stanford University, Department of Economics, Landau Economics Building, 579 Serra Mall, USA.)
    Abstract: We study European banks’ demand for short-term funds (liquidity) during the summer 2007 subprime market crisis. We use bidding data from the European Central Bank’s auctions for one-week loans, their main channel of monetary policy implementation. Our analysis provides a high-frequency, disaggregated perspective on the 2007 crisis, which was previously studied through comparisons of collateralized and uncollateralized interbank money market rates which do not capture the heterogeneous impact of the crisis on individual banks. Through a model of bidding, we show that banks’ bids reflect their cost of obtaining short-term funds elsewhere (e.g., in the interbank market) as well as a strategic response to other bidders. The strategic response is empirically important: while a naïve interpretation of the raw bidding data may suggest that virtually all banks suffered an increase in the cost of short-term funding, we find that for about one third of the banks, the change in bidding behavior was simply a strategic response. We also find considerable heterogeneity in the short-term funding costs among banks: for over one third of the bidders, funding costs increased by more than 20 basis points, and funding costs vary widely with respect to the country-of-origin. Estimated funding costs of banks are also predictive of market- and accounting-based measures of bank performance, suggesting the external validity of our findings. JEL Classification: D44, E58, G01.
    Keywords: Multiunit auctions, primary market, structural estimation, subprime market, liquidity crisis.
    Date: 2011–08
  9. By: Romuald Morhs
    Abstract: The aim of this work is to study the interactions between monetary policy, credit, house prices and the macroeconomy in Luxembourg using a VAR model with quarterly data in levels from 1986 to 2009. The results of the structural analysis provide valuable information concerning the monetary policy transmission mechanism, the interactions between credit and house prices, and the importance of foreign shocks for the behaviour of domestic variables. Some tentative explanations related to the particular economic and financial structures of the Luxembourg economy are moreover suggested to interprete this empirical evidence. More specifically, the structural analysis leads to the following conclusions: (1) In accordance with the existing VAR literature, a contractionary monetary policy shock leads to a temporary decrease in output and to a gradual decline in prices. (2) Monetary policy transmission to the real economy is relatively strong in Luxembourg, a result that could be associated with the variable interest rate structure of loans to the private sector, the high degree of openness and the preponderance of the financial services industry. (3) The response of credit and GDP following a residential property price shock provides some scope for the existence of a house price channel of monetary policy transmission in Luxembourg. (4) Finally, domestic variables respond strongly to foreign shocks, as evidenced by both the impulse response functions and the forecast error variance decomposition.
    Keywords: Monetary policy, small open economy, VAR, macroeconomic shocks
    JEL: C32 E52 F41
    Date: 2010–12
  10. By: Morten L. Bech; Carl T. Bergstrom; Rodney J. Garratt; Martin Rosvall
    Abstract: We use an information-theoretic approach to describe changes in lending relationships between federal funds market participants around the time of the Lehman Brothers failure. Unlike previous work that conducts maximum-likelihood estimation on undirected networks, our analysis distinguishes between borrowers and lenders and looks for broader lending relationships (multibank lending cycles) that extend beyond the immediate counterparties. We find that significant changes in lending patterns emerge following implementation of the Interest on Reserves policy by the Federal Reserve on October 9, 2008.
    Keywords: Federal funds market (United States) ; Federal Reserve System ; Bank loans ; Financial crises
    Date: 2011
  11. By: Olivier Armantier; Wändi Bruine de Bruin; Giorgio Topa; Wilbert van der Klaauw; Basit Zafar
    Abstract: We compare the inflation expectations reported by consumers in a survey with their behavior in a financially incentivized investment experiment designed such that future inflation affects payoffs. The inflation expectations survey is found to be informative in the sense that the beliefs reported by the respondents are correlated with their choices in the experiment. Furthermore, most respondents appear to act on their inflation expectations showing patterns consistent (both in direction and magnitude) with expected utility theory. Respondents whose behavior cannot be rationalized tend to be less educated and to score lower on a numeracy and financial literacy scale. These findings are therefore the first to provide support to the microfoundations of modern macroeconomic models.
    Keywords: Consumer surveys ; Inflation (Finance)
    Date: 2011
  12. By: Evzen Kocenda; Vit Bubak; Filip Zikes
    Abstract: This paper studies the dynamics of volatility transmission between Central European (CE) currencies and the EUR/USD foreign exchange using model-free estimates of daily exchange rate volatility based on intraday data. We formulate a flexible yet parsimonious parametric model in which the daily realized volatility of a given exchange rate depends both on its own lags as well as on the lagged realized volatilities of the other exchange rates. We find evidence of statistically significant intra-regional volatility spillovers among the CE foreign exchange markets. With the exception of the Czech and, prior to the recent turbulent economic events, Polish currencies, we find no significant spillovers running from the EUR/USD to the CE foreign exchange markets. To measure the overall magnitude and evolution of volatility transmission over time, we construct a dynamic version of the Diebold-Yilmaz volatility spillover index and show that volatility spillovers tend to increase in periods characterized by market uncertainty.
    Keywords: Foreign exchange markets; Volatility; Spillovers; Intraday data; Nonlinear dynamics; European emerging markets
    JEL: C5 F31 G15
    Date: 2011–07–01
  13. By: Zhang, Bin (Asian Development Bank Institute)
    Abstract: The author calculates the return on the major Asian currency denominated long-term government bonds in terms of a basket of the People’s Republic of China’s (PRC) imports of goods and services, namely the real return on those assets from the PRC’s perspective. He shows that it is desirable for the PRC to substitute Asian currency denominated government bonds for US Treasury bills to maintain the purchasing power of its foreign exchange reserves.
    Keywords: foreign exchange reserves; currency basket; asian currencies
    JEL: F21 F31 G11
    Date: 2011–08–29
  14. By: Philip R. Lane; Gian Maria Milesi Ferretti
    Abstract: The period preceding the global financial crisis was characterized by a substantial widening of current account imbalances across the world. Since the onset of the crisis, these imbalances have contracted to a significant extent. In this paper, we analyze the ongoing process of external adjustment in advanced economies and emerging markets. We find that countries whose pre-crisis current account balances were in excess of what could be explained by standard economic fundamentals have experienced the largest contractions in their external balance. We subsequently examine the contributions of real exchange rates, domestic demand and domestic output to the adjustment process (allowing for differences across exchange rate regimes) and find that external adjustment in deficit countries was achieved primarily through demand compression, rather than expenditure switching. Finally, we show that changes in other investment flows were the main channel of financial account adjustment, with official external assistance and ECB liquidity cushioning the exit of private capital flows for some countries.
    JEL: F32 F34 F41 F42
    Date: 2011–08
  15. By: Buch, Claudia M.; Koch, Cathérine Tahmee; Koetter, Michael
    Abstract: The World Financial Crisis has shaken the fundamentals of international banking and triggered a downward spiral of asset prices. To prevent a further meltdown of markets, governments have intervened massively through rescues measures aimed at recapitalizing banks and through liquidity support. We use a detailed, banklevel dataset for German banks to analyze how the lending and borrowing of their foreign affiliates has responded to domestic (German) and to US crisis support schemes. We analyze how these policy interventions have spilled over into foreign markets. We identify loan supply shocks by exploiting that not all banks have received policy support and that the timing of receiving support measures has differed across banks. We find that banks covered by rescue measures of the German government have increased their foreign activities after these policy interventions, but they have not expanded relative to banks not receiving support. Banks claiming liquidity support under the Term Auction Facility (TAF) program have withdrawn from foreign markets outside the US, but they have expanded relative to affiliates of other German banks. --
    Keywords: Cross-border banking,financial crisis,government support,Term Auction Facility
    JEL: F34 G21
    Date: 2011

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