nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒10‒15
twenty-two papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary Policy Communication Under Inflation Targeting : Do Words Speak Louder Than Actions? By Selva Demiralp; Hakan Kara; Pinar Ozlu
  2. The bank lending channel in Turkey: Has it changed after the low inflation regime? By Catik, A. Nazif; Karaçuka, Mehmet
  3. Understanding Chinese Bond Yields and their Role in Monetary Policy By Nathan Porter; Nuno Cassola
  4. Unconventional Monetary Policy in Theory and in Practice By Martina Cecioni; Giuseppe Ferrero; Alessandro Secchi
  5. Conceptualizing interdependences between regulatory and monetary policies. Some preliminary considerations By Lukasz Hardt
  6. Incorporating Financial Sector Risk into Monetary Policy Models: Application to Chile By Jorge Restrepo; Carlos Garcia; Leonardo Luna; Dale F. Gray
  7. Exchange Rate Dynamics under Alternative Optimal Interest Rate Rules By Mahir Binici; Yin-Wong Cheung
  8. Inflation Targeting and Monetary Policy Transmission Mechanisms in Emerging Market Economies By Sanchita Mukherjee; Rina Bhattacharya
  9. Nonlinearity and Structural Breaks in Monetary Policy Rules with Stock Prices By Dong Jin Lee; Jong Chil Son
  10. History of monetary policy in India since independence By Ashima Goyal
  11. Price-Level Targeting and Inflation Expectations: Experimental Evidence By Robert Amano; Jim Engle-Warnick; Malik Shukayev
  12. Sectoral Labor Adjustment and Monetary Policy in a Small Open Economy By Kang Shi
  13. Optimal Monetary Policy with Endogenous Entry and Product Variety By Florin O. Bilbiie; Ippei Fujiwara; Fabio Ghironi
  14. An international comparison of voting by committees By Alexander Jung
  15. Monetary policy indeterminacy in the U.S.: results from a classical test By Efrem Castelnuovo; Luca Fanelli
  16. Incorporating Financial Stability in Inflation Targeting Frameworks By Burcu Aydin; Engin Volkan
  17. Housing Market and the Transmission of Monetary Policy: Evidence from U.S. States By Maria Christidou; Panagiotis Konstantinou
  18. A Model of Inflation in Taiwan By Gregory C. Chow
  19. Reserves and Baskets By Michael D. Bordo; Harold James
  20. The experience with macro-prudential policies of the central bank of the republic of Turkey in response to the global financial crisis By Kenc, Turalay; Turhan, M. Ibrahim; Yildirim, Onur
  21. Currency crises By Reuven Glick; Michael Hutchison
  22. Trend-cycle decomposition of output and euro area inflation forecasts: a real-time approach based on model combination By Pierre Guérin; Laurent Maurin; Matthias Mohr

  1. By: Selva Demiralp; Hakan Kara; Pinar Ozlu
    Abstract: This paper assesses the effectiveness of monetary policy communication of the Central Bank of Turkey (CBT) by quantifying the information content of the policy statements released right after the monthly Monetary Policy Committee meetings. First, we quantify the signal regarding the next interest rate decision and ask whether communication improves predictability. Our findings suggest that the role of statements in predicting the next policy move have strengthened following the adoption of full-fledged inflation targeting (IT) regime. Second, we identify the surprise component of policy communication directly from market commentaries and assess its impact on the term structure of interest rates. We find that the response of the yield curve to policy statements have become highly significant for the unanticipated changes in the monetary policy communication, especially after the implementation of the IT. We also compare the yield curve impact of the surprise component of policy decisions (actions) with the surprises in policy communication (words). Our results suggest that the relative importance of communication in driving market yields have increased through time.
    Keywords: Central Bank Communication, Predictability, Transparency
    JEL: E52 E58
    Date: 2011
  2. By: Catik, A. Nazif; Karaçuka, Mehmet
    Abstract: In this paper we aim to analyze the role of credit channel in the monetary transmission mechanism under different inflationary environments in Turkey covering the period 1986:1 - 2009:10. Our results suggest that traditional interest rate channel is only valid for the postinflation targeting period. This variable is also more effective monetary policy tool in terms of its impacts on economic activity in the both regimes. Credit shocks itself have significant power on economic activity and prices. However, the effect of monetary shocks on credit volume is very limited especially in the low inflation regime. --
    Date: 2011
  3. By: Nathan Porter; Nuno Cassola
    Abstract: China’s financial prices are informative enough for the PBC to introduce a monetary policy framework centered around interest rates. While bond yields are not fully efficient—reflecting regulation, liquidity, and segmentation—we find they contain considerable information about the state of the economy as well as evidence of an emerging transmission channel: changes in PBC rates influence the structure of Treasury, financial, and corporate bond yield curves, which are then associated with changes in growth and inflation. Coporate spreads are also a leading indicator of growth and inflation. While further liberalization will strengthen both efficiency and transmission, several necessary elements to move towards indirect monetary policy are already in place.
    Keywords: Bond markets , Bonds , China , Interest rate structures , Monetary policy ,
    Date: 2011–09–28
  4. By: Martina Cecioni (Banca d'Italia); Giuseppe Ferrero (Banca d'Italia); Alessandro Secchi (Banca d'Italia)
    Abstract: In this paper, after discussing the theoretical underpinnings of unconventional monetary policy measures, we review the existing empirical evidence on their effectiveness, focusing on those adopted by the European Central Bank and by the Federal Reserve. These measures operate in two ways: through the signalling channel and through the portfolio-balance channel. In the former, the central bank can use communication to steer interest rates and to restore confidence in the financial markets; the latter hinges on the hypothesis of imperfect substitutability of assets and liabilities in the balance sheet of the private sector and postulates that the central bank’s asset purchases and liquidity provision lower financial yields and improve funding conditions. The review of the empirical literature suggests that the unconventional measures were effective and that their impact on the economy was sizeable. However, a very large degree of uncertainty surrounds the precise quantification of these effects.
    Keywords: Central bank, unconventional monetary policy, financial crisis, signalling channel, portfolio balance channel
    JEL: E52 E58
    Date: 2011–09
  5. By: Lukasz Hardt (University of Warsaw, Faculty of Economics)
    Abstract: In this paper we investigate the interplay between regulatory and monetary policies. We analyze how changes in institutional settings modify the functioning of various channels of monetary transmission. The paper begins with a brief presentation of the main channels of monetary transmission, including credit channel, exchange rate channel, Tobin q theory, and the credit channel. After that we define a positive institutional change and we check how such adjustments can be put into the logic of monetary transmission. We show that the most profound way institutions impact the monetary transmission is via its effect on the elasticity of investments to changes in interest rates.
    Keywords: monetary transmission channels, monetary policy, regulatory policy, institutional change, financial globalization
    JEL: E44 E52 F41 O43
    Date: 2011
  6. By: Jorge Restrepo; Carlos Garcia; Leonardo Luna; Dale F. Gray
    Abstract: This paper builds a model of financial sector vulnerability and integrates it into a macroeconomic framework, typically used for monetary policy analysis. The main question to be answered with the integrated model is whether or not the central bank should include explicitly the financial stability indicator in its monetary policy (interest rate) reaction function. It is found in general, that including distance-to-default (dtd) of the banking system in the central bank reaction function reduces both inflation and output volatility. Moreover, the results are robust to different model calibrations: whenever exchange-rate pass-through is higher; financial vulnerability has a larger impact on the exchange rate, as well as on GDP (or the reverse, there is more effect of GDP on bank’s equity - i.e., what we call endogeneity), it is more efficient to include dtd in the reaction function.
    Keywords: Banking systems , Central banks , Chile , Economic models , Financial risk , Financial sector , Monetary policy ,
    Date: 2011–09–30
  7. By: Mahir Binici; Yin-Wong Cheung
    Abstract: We explore the role of interest rate policy in the exchange rate determination process. Specifically, we derive exchange rate equations from interest rate rules that are theoretically optimal under a few alternative settings. The exchange rate equation depends on its underlying interest rate rule and its performance could vary across evaluation criteria and sample periods. The exchange rate equation implied by the interest rate rule that allows for interest rate and inflation inertia under commitment offers some encouraging results – exchange rate changes “calibrated” from the equation have a positive and significant correlation with actual data, and offer good direction of change prediction. Our exercise also demonstrates the role of the foreign exchange risk premium in determining exchange rates and the difficulty of explaining exchange rate variability using only policy based fundamentals.
    Keywords: Taylor Rule, Exchange Rate Determination, Mean Squared Prediction Error, Direction of Change, Foreign Exchange Risk Premium
    JEL: F31 E52 C52
    Date: 2011
  8. By: Sanchita Mukherjee; Rina Bhattacharya
    Abstract: In this paper we empirically examine the operation of the traditional Keynesian interest rate channel of the monetary policy transmission mechanism in five potential inflation targeting economies in the MENA region and compare it with fourteen inflation targeting (IT) emerging market economies (EMEs) using panel data analysis. Contrary to some existing studies, our empirical results suggest that private consumption and investment in both groups of countries are sensitive to movements in real interest rates. Moreover, we find that the adoption of IT did not significantly alter the operation of the interest rate channel in IT EMEs. Also, the interest rate elasticities of private consumption and private investment vary with the level of development of the domestic financial market. Finally, capital account liberalization have opposite effects on private consumption and private investment in the two groups of countries.
    Keywords: Banks , Cross country analysis , Demand , Emerging markets , Inflation targeting , Interest rates , Middle East , Monetary policy , North Africa , Private consumption , Private investment , Private sector ,
    Date: 2011–10–03
  9. By: Dong Jin Lee (University of Connecticut); Jong Chil Son (The Bank of Korea)
    Abstract: This paper empirically examines how the Fed responds to stock prices and inflation movements, using the forward-looking Taylor rule augmented with the stock price gap. The typical linear policy reaction function has a substantial change after 1991, but lacks the robustness in that the estimation result is sensitive to a minor change of the sample period. To alleviate the problem, we allow for temporary and permanent variations of the reaction coefficients by introducing nonlinearity and a structural break. The time variation of the inflation coefficient shows that the Fed is more aggressive in periods of inflationary pressure. However, unlike the linear model case, we find little evidence of a significant change in the Fed's active response to inflationary pressure after the structural break at 1991:I. We also find a positive response to the stock price change after 1991:I. But the time varying pattern of the response is counter-cyclical to stock price change, which does not support the view that the Fed actively reacts to a stock price bubble.
    Keywords: Monetary policy rule, nonlinear model, stock market, structural break, and time varying coefficient
    JEL: E31 E44 E52
    Date: 2011–10
  10. By: Ashima Goyal (Indira Gandhi Institute of Development Research)
    Abstract: An SIIO paradigm, based on structure and ideas that become engraved in institutions and affect outcomes, is developed to examine and assesses monetary policy in India after independence. Narrative history, data analysis, and reporting of research demonstrate the dialectic between ideas and structure. Exogenous supply shocks are used to identify policy shocks and isolate their effects. It turns out policy was sometimes exceedingly tight when the common understanding was of a large monetary overhang. Fiscal dominance made policy procyclical. But the three factors that cause a loss of monetary autonomy-governments, markets and openness-are moderating each other. Markets moderate fiscal profligacy and global crises moderate markets and openness. Greater current congruence between ideas and structure is improving institutions and contributing to India's better performance.
    Keywords: Monetary policy history, Structure, Ideas, Institutions, Outcomes, India
    JEL: E42 E5 E58 E63
    Date: 2011–09
  11. By: Robert Amano; Jim Engle-Warnick; Malik Shukayev
    Abstract: In this paper, we use an economics decision-making experiment to test a key assumption underpinning the efficacy of price-level targeting relative to inflation targeting for business cycle stabilization and mitigating the effects of the zero lower bound on nominal interest rates. In particular, we attempt to infer whether experimental participants understand the stationary nature of the price level under price-level targeting by observing their inflation forecasting behaviour in a laboratory setting. This is an important assumption since, without it, price-level targeting can lead to worse outcomes than inflation targeting. Our main result suggests that participants formulate inflation expectations consistent with the target-reverting nature of the price level but that they do not fully utilize it in their forecasts of future inflation.
    Keywords: Monetary policy framework
    JEL: E32 E52
    Date: 2011
  12. By: Kang Shi (The Chinese University of Hong Kong and Hong Kong Institute for Monetary Research)
    Abstract: This paper studies the welfare implications of sectoral labor adjustment cost in a two-sector small open economy model with sticky prices. We find that, when the economy faces external shocks, if monetary policy can stabilize the real economy, then sectoral labor market adjustment cost will lead to welfare loss. However, if monetary policy such as fixed exchange rates cannot stabilize real variables, then some degree of labor market friction will improve welfare instead and the gain will be significant. As a result, the welfare gap between flexible exchange rates and fixed exchange rates decreases with sectoral labor market friction. This is because the friction can offset some of the nominal rigidity and become a substitute for monetary policy to stabilize the real economy.
    Keywords: Labor Adjustment Cost, Exchange Rate Policy, Two-Sector Model, Welfare
    JEL: F3 F4
    Date: 2011–09
  13. By: Florin O. Bilbiie; Ippei Fujiwara; Fabio Ghironi
    Abstract: We show that deviations from long-run stability of product prices are optimal in the presence of endogenous producer entry and product variety in a sticky-price model with monopolistic competition in which price stability would be optimal in the absence of entry. Specifically, a long-run positive (negative) rate of inflation is optimal when the benefit of variety to consumers falls short of (exceeds) the market incentives for creating that variety under flexible prices, governed by the desired markup. Plausible preference specifications and parameter values justify a long-run inflation rate of two percent or higher. Price indexation implies even larger deviations from long-run price stability. However, price stability (around this non-zero trend) is close to optimal in the short run, even in the presence of time-varying flexible-price markups that distort the allocation of resources across time and states. The central bank uses its leverage over real activity in the long run, but not in the short run. Our results point to the need for continued empirical research on the determinants of markups and investigation of the benefit of product variety to consumers.
    JEL: E31 E32 E52
    Date: 2011–10
  14. By: Alexander Jung (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: This paper provides new empirical evidence on policy-makers’ voting patterns on interest rates. Applying (pooled) Taylor-type rules and using real-time information available from published inflation reports and voting records, the paper tests for heterogeneity among committee members in three monetary policy committees: the FOMC, the Bank of England’s MPC and the Riksbank’s Executive Board. It separately estimates the empirical reaction functions with and without imposing the long-run restriction from the inertia, thereby distinguishing between the short-run and long-run responses of members to incoming information. Unconstrained reaction functions that measure the short-term response show that preference heterogeneity and some diversity of views on the inflation and economic outlook was present in all three committees. By contrast, constrained reaction functions that measure the long-term response find that evidence in favour of preference heterogeneity in all three committees is at best weak. Preference distributions in all three committees were fairly symmetric around the respective mean and diversity of views was only observed in the case of Sweden when including the financial crisis episode. A cluster analysis of the Riksbank’s Executive Board, which only comprises internal members, confirms that its members have disperse preferences and views on the transmission mechanism. For the FOMC and for the MPC this analysis suggests that among several background characteristics (membership, background, tenure), membership is a potentially relevant factor that may explain some of the differences in preferences. JEL Classification: C23, D72, D83, E58.
    Keywords: Monetary policy committee, Taylor rule, collective decision-making, voting behavior, pooled regressions, heterogeneous preferences.
    Date: 2011–10
  15. By: Efrem Castelnuovo (Università di Padova); Luca Fanelli (Università di Bologna)
    Abstract: We work with a newly developed method to empirically assess whether a specified new-Keynesian business cycle monetary model estimated with U.S. quarterly data is consistent with a unique equilibrium or multiple equilibria under rational expectations. We conduct classical tests to verify if the structural model is correctly specified. Conditional on a positive answer, we formally assess if such model is either consistent with a unique equilibrium or with indeterminacy. Importantly, our full-system approach requires neither the use of prior distributions nor that of nonstandard inference. The case of an indeterminate equilibrium in the pre-1984 sample and of a determinate equilibrium in the post-1984 sample is favored by the data. The long-run coefficients on inflation and the output gap in the monetary policy rule are found to be weakly identified. However, our results are further supported by a proposed identification-robust indicator of indeterminacy
    Keywords: GMM, Indeterminatezza, Massima Verosimiglianza, Errata specificazione, modello neo-Keynesiano per il ciclo economico, VAR, Identificazione debole GMM, Indeterminacy, Maximum Likelihood, Misspecification, new-Keynesian business cycle model, VAR, Weak identification.
    Date: 2011
  16. By: Burcu Aydin; Engin Volkan
    Abstract: The global financial crisis has exposed the limitations of a conventional inflation targeting (IT) framework in insulating an economy from shocks, and demonstrated that its rigid application may aggravate the effect of shocks on output and inflation. Accordingly, we investigate possible refinements to the IT framework by incorporating financial stability considerations. We propose a small open economy DSGE model, calibrated for Korea during the period of 2003 - 07, with real and financial frictions. The findings indicate that incorporating financial stability considerations can help smooth business cycle fluctuations more effectively than a conventional IT framework.
    Keywords: Economic models , Financial crisis , Financial stability , Global Financial Crisis 2008-2009 , Inflation targeting , Korea, Republic of , Monetary policy ,
    Date: 2011–09–26
  17. By: Maria Christidou (Department of Economics, University of Macedonia); Panagiotis Konstantinou (Department of Economics, University of Macedonia)
    Abstract: What are the effects of monetary policy on the housing market? Is the response of the housing market similar across different states? We explore the impact of monetary policy shocks on real house prices and housing investment, using US state-level data. To this end we estimate VAR models for the period 1988-2009, to assess the differential effect - if any - of a common monetary policy shock on house prices and investment. Our VAR models also allow us to explore the macroeconomic effect of wealth shocks that originate in the housing market (housing prices). Our empirical models include key macroeconomic variables, namely personal income, prices and the federal funds rate, as well as housing market variables, e.g. real house prices, given by the FHFA house price index, and housing investment, proxied by the number of housing starts. Our baseline estimates suggest that transmission of monetary policy is heterogeneous across US states. Moreover, our VAR models indicate the presence of a wealth effect across most US states, as a positive housing price innovation leads to a strong, negative response of personal income.
    Keywords: House prices, Monetary policy transmission, VAR, Wealth effect.
    JEL: C32 E21 E52 R31
    Date: 2011–09
  18. By: Gregory C. Chow (Princeton University & Academia Sinica, Taiwan)
    Abstract: The model of Chow (1987) for inflation in China is applied to explain inflation in Taiwan. A cointegration relation linear in the log of a price index and the log of the ratio of money supply to output is estimated. Inflation is explained by the change in this log ratio, lagged inflation and the lagged residual of the cointegration relation as an error correction. The model explains Taiwan’s inflation well except during the oil crises of 1973 and 1979-80.
    Keywords: inflation, Taiwan, error correction
    JEL: E31
    Date: 2011–09
  19. By: Michael D. Bordo; Harold James
    Abstract: We discuss three well known plans that were offered in the twentieth century to provide an artificial replacement for gold and key currencies as international reserves: Keynes’ Bancor, the SDR and the Ecu( predecessor to the euro).The latter two of these reserve substitutes were institutionalized but neither replaced the dollar as the principal medium of international reserve.
    JEL: F02 F33
    Date: 2011–10
  20. By: Kenc, Turalay; Turhan, M. Ibrahim; Yildirim, Onur
    Abstract: This brief country case study on Turkey aims to summarize the fundamental developments in the banking sector, which represents almost 90 percent of the financial sector in the country. The brief has two parts. The first covers the 2001 financial crisis and the developments until end of 2007, the year before the global financial crisis of 2008 started. The second part focuses on the macro-prudential policies applied by the Central Bank of the Republic of Turkey in response to the global financial crisis in three phases: (i) full liquidity support after Lehman Brothers'collapse (September 2008), (ii) the exit strategy (April 2010), and (iii) the new policy mix (final quarter of 2010).
    Keywords: Debt Markets,Banks&Banking Reform,Currencies and Exchange Rates,Emerging Markets,Bankruptcy and Resolution of Financial Distress
    Date: 2011–10–01
  21. By: Reuven Glick; Michael Hutchison
    Abstract: A currency crisis is a speculative attack on the foreign exchange value of a currency, resulting in a sharp depreciation or forcing the authorities to sell foreign exchange reserves and raise domestic interest rates to defend the currency. This article discusses analytical models of the causes of currency and associated crises, presents basic measures of the incidence of crises, evaluates the accuracy of empirical models in predicting crises, and reviews work measuring the consequences of crises on the real economy. Currency crises have large measurable costs on the economy, but our ability to predict the timing and magnitude of crises is limited by our theoretical understanding of the complex interactions between macroeconomic fundamentals, investor expectations and government policy.
    Keywords: Capital movements ; Foreign exchange
    Date: 2011
  22. By: Pierre Guérin (International Economic Analysis Department, Bank of Canada, 234 Wellington Street, Ottawa, Canada, K1A 0G9 and European University Institute); Laurent Maurin (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.); Matthias Mohr (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt, Germany.)
    Abstract: The paper focuses on the estimation of the euro area output gap. We construct model-averaged measures of the output gap in order to cope with both model uncertainty and parameter instability that are inherent to trend-cycle decomposition models of GDP. We first estimate nine models of trend-cycle decomposition of euro area GDP, both univariate and multivariate, some of them allowing for changes in the slope of trend GDP and/or its error variance using Markov-switching specifications, or including a Phillips curve. We then pool the estimates using three weighting schemes. We compute both ex-post and real-time estimates to check the stability of the estimates to GDP revisions. We finally run a forecasting experiment to evaluate the predictive power of the output gap for inflation in the euro area. We find evidence of changes in trend growth around the recessions. We also find support for model averaging techniques in order to improve the reliability of the potential output estimates in real time. Our measures help forecasting inflation over most of our evaluation sample (2001-2010) but fail dramatically over the last recession. JEL Classification: C53, E32, E37.
    Keywords: Trend-cycle decomposition, Phillips curve, unobserved components model, Kalman Filter, Markov-switching, auxiliary information, model averaging, inflation forecast, real-time analysis.
    Date: 2011–10

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