nep-mon New Economics Papers
on Monetary Economics
Issue of 2011‒12‒13
twenty-one papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Monetary policy spillovers and emerging market credit: The impact of Federal Reserve communications on sovereign CDS spreads By Ingo Fender; Bernd Hayo; Matthias Neuenkirch
  2. Monetary transmission right from the start: On the information content of the eurosystem's main refinancing operations By Abbassi, Puriya; Nautz, Dieter
  3. The International Monetary System: Living with Asymmetry By Maurice Obstfeld
  4. Macroeconomic effects of unconventional monetary policy in the Euro area By Gert Peersman
  5. China’s Dominance Hypothesis and the Emergence of a Tri-polar Global Currency System By Fratzscher, Marcel; Mehl, Arnaud
  6. The Euro and European Economic Conditions By Martin S. Feldstein
  7. Monetary policy communication under inflation targeting: Do words speak louder than actions? By Selva Demiralp; Hakan Kara; Pýnar Özlü
  8. Talking to the inattentive Public: How the media translates the Reserve Bank’s communications By Monique Reid; Stan du Plessis
  9. Volatility, Money Market Rates, and the Transmission of Monetary Policy By Seth B. Carpenter; Selva Demiralp
  10. Inflation Targeting, Exchange Rate and Financial Globalization By Muhammad Naveed Tahir
  11. Foreign Output Shocks and Monetary Policy Regimes in Small Open Economies: A DSGE Evaluation of East Asia By Joseph D. ALBA; Wai–Mun CHIA; Donghyun PARK
  12. Inflation Targeting, Exchange Rate and Financial Globalization By Muhammad Naveed Tahir
  13. Target Loans, Current Account Balances and Capital Flows: The ECB’s Rescue Facility By Hans-Werner Sinn; Timo Wollmershaeuser
  14. Monetary policy, bank size and bank lending: Evidence from Australia By Liu, Luke
  15. Exchange Rate Policy in Small Rich Economies By Francis Breedon; Thórarinn G. Pétursson; Andrew K. Rose
  16. From the General to the Specific By J. James Reade; Ulrich Volz
  17. Media bias and central bank response. Evidence from the nominal exchange rate behavior in Colombia By Rodrigo Taborda
  18. Too much of a good thing? on the effects of limiting foreign reserve accumulation By Yan, Isabel K.; Kumhof, Michael
  19. Optimal Monetary Policy Rules, Financial Amplification, and Uncertain Business Cycles By Salih Fendoglu
  20. The Impact of Monetary Policy on the Exchange Rate: puzzling evidence from three emerging economies By Emanuel Kohlscheen
  21. The effect of the interbank network structure on contagion and common shocks By Georg, Co-Pierre

  1. By: Ingo Fender (Bank for International Settlements); Bernd Hayo (Philipps-University Marburg); Matthias Neuenkirch (Philipps-University Marburg)
    Abstract: In this paper, we study the effects of US target rate changes and related communications by members of the Federal Reserve Board of Governors on spreads for emerging market sovereign credit default swaps (CDS). Using GARCH models, we find that during the pre-financial crisis sub-sample (April 2002–July 2007) CDS spreads react more to country-specific factors than to US monetary policy news. This finding is reversed during the financial crisis sub-sample (August 2007–December 2009), when US monetary policy actions and communications affect CDS spreads in a notable way. Finally, our analysis suggests that CDS spreads became more prone to spillover effects during the financial crisis.
    Keywords: Credit default swaps, emerging markets, Federal Reserve communication, financial crisis, policy spillovers
    JEL: E52 G14 G15
    Date: 2011
  2. By: Abbassi, Puriya; Nautz, Dieter
    Abstract: The Eurosystem's main refinancing operations (MRO) are key for the interbank money market and the monetary transmission process in the euro area. This paper investigates how money market rates respond to the information revealed by various aspects of an MRO auction outcome. Our results confirm that the level of MRO rates governed short-term money market rates before the financial crisis. Since the start of the financial crisis, however, the information content of MRO rates has changed. While the levels of MRO rates have lost much of their pre-crisis significance, the spread between the weighted average and the marginal MRO rate has become an important barometer for the actual situation in the money market during the crisis. --
    Keywords: monetary policy implementation,central bank auctions,European Central Bank,money markets and financial crisis
    JEL: E43 E52 E58 D44
    Date: 2011
  3. By: Maurice Obstfeld
    Abstract: This paper analyzes current stresses in the two key areas that concerned the architects of the original Bretton Woods system: international liquidity and exchange rate management. Despite radical changes since World War II in the market context for liquidity and exchange rate concerns, they remain central to discussions of international macroeconomic policy coordination. To take two prominent examples of specific (and related) coordination problems, liquidity issues are paramount in strategies of national self-insurance through foreign reserve accumulation, while recent attempts by emerging market economies (EMEs) to limit real currency appreciation have relied heavily on nominal exchange rate management. A central message is that a diverse set of potential asymmetries among sovereign member states provides fertile ground for a variety of coordination failures. The paper goes on to discuss institutions and policies that might mitigate some of these inefficiencies.
    JEL: F32 F33 F36 F42 G15
    Date: 2011–12
  4. By: Gert Peersman (Ghent University, Sint-Pietersnieuwstraat 25, B-9000 Ghent, Belgium.)
    Abstract: I find that the Eurosystem can stimulate the economy beyond the policy rate by increasing the size of its balance sheet or the monetary base. The transmission mechanism turns out to be different compared to traditional interest rate innovations: (i) whilst the effects on economic activity and consumer prices reach a peak after about one year for an interest rate innovation, this is more than six months later for a shift in the monetary base that is orthogonal to the policy rate (ii) interest rate spreads charged by banks decline persistently after a rise in the monetary base, whereas the spreads increase significantly after a fall in the policy rate (iii) there is no significant short-run liquidity effect after an interest rate innovation, that is additional bank loans are generated by a greater credit multiplier. In contrast, the multiplier declines considerably after an expansion of the Eurosystem’s balance sheet. JEL Classification: C32, E30, E44, E51, E52.
    Keywords: Unconventional monetary policy, SVARs.
    Date: 2011–11
  5. By: Fratzscher, Marcel; Mehl, Arnaud
    Abstract: This paper assesses whether the international monetary system is already tri-polar and centred around the US dollar, the euro and the Chinese renminbi (RMB). It focuses on what we call China’s" dominance hypothesis", i.e. whether the renminbi is already the dominant currency in Asia, exerting a large influence on exchange rate and monetary policies in the region, a direct reference to the old "German dominance hypothesis" which ascribed to the German mark a dominant role in Europe in the 1980s-1990s. Using a global factor model of exchange rates and a complementary event study, we find evidence that the RMB has become a key driver of currency movements in emerging Asia since the mid-2000s, and even more so since the global financial crisis. These results are consistent with China’s dominance hypothesis and with the view that the international monetary system is already tri-polar. However, we also find that China’s currency movements are to some extent affected by those in the rest of Asia.
    Keywords: China; euro; exchange rates; German dominance hypothesis; International monetary system; renminbi; tri-polarity; US dollar
    JEL: F30 F31 F33 N20
    Date: 2011–11
  6. By: Martin S. Feldstein
    Abstract: The creation of the euro should now be recognized as an experiment that has led to the sovereign debt crisis in several countries, the fragile condition of major European banks, the high levels of unemployment, and the large trade deficits that now exist in most Eurozone countries. Although the European Central Bank managed the euro in a way that achieved a low rate of inflation, other countries both in Europe and elsewhere have also had a decade of low inflation without incurring the costs of a monetary union. The emergence of these problems just a dozen years after the start of the euro in 1999 was not an accident or the result of bureaucratic mismanagement but the inevitable consequence of imposing a single currency on a very heterogeneous group of countries, a heterogeneity that includes not only economic structures but also fiscal traditions and social attitudes. This paper reviews (1) the reasons for these economic problems, (2) the political origins of the European Monetary Union, (3) the current attempts to solve the sovereign debt problem, (4) the long-term problem of inter-country differences of productivity growth and competitiveness, (5) the special problems of Greece and Italy, (6) and the pros and cons of a Greek departure from the Eurozone.
    JEL: E0
    Date: 2011–11
  7. By: Selva Demiralp (Koc University); Hakan Kara (Central Bank of Turkey Research and Monetary Policy Department); Pýnar Özlü (Central Bank of Turkey Research and Monetary Policy Department)
    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 CBT’s words match its deeds, i.e., whether communication improves predictability using the Autoregressive Conditional Hazard model. 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 and the relative importance of communication in driving market yields has increased through time.
    Keywords: Central Bank Communication, Predictability, Transparency
    JEL: E52 E58
    Date: 2011–10
  8. By: Monique Reid (Department of Economics, University of Stellenbosch); Stan du Plessis (Department of Economics, University of Stellenbosch)
    Abstract: Central bank communication is widely recognised as crucial to the implementation of monetary policy. This communication should enhance a central bank’s management of the inflation expectations of the financial markets as well as the general public – the latter being a part of the central bank’s audience that has received relatively little research attention. In this paper, the role of the media in transmitting the SARB’s communication to the general public is explored, with the aim of improving our understanding of its impact on the expectations channel of the monetary policy transmission mechanism. A deliberate evaluation of this channel could aid the design of future strategies to communicate with the general public.
    Keywords: South Africa, central bank communication, consistency, monetary policy transmission mechanism, transparent monetary policy
    JEL: E42 E52 E58
    Date: 2011
  9. By: Seth B. Carpenter (Division of Monetary Affairs Board of Governors of the Federal Reserve System); Selva Demiralp (Koc University)
    Abstract: We explore the effect of volatility in the federal funds market on the expectations hypothesis in money markets. We find that lower volatility in the bank funding markets market, all else equal, leads to a lower term premium and thus longer-term rates for a given setting of the overnight rate. The results appear to hold for the US as well as the Euro Area and the UK. The results have implications for the design of operational frameworks for the implementation of monetary policy and for the interpretation of the changes in the Libor-OIS spread during the financial crisis
    Keywords: Monetary transmission mechanism, expectations hypothesis, term premium
    JEL: E43 E52 E58
    Date: 2011–10
  10. By: Muhammad Naveed Tahir (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France)
    Abstract: In this paper we investigate the impact of financial globalization on the behaviour of inflation targeting emerging market economies with respect to exchange rate – do central banks respond to exchange rate movements or not. We use quarterly data for six emerging market inflation targeting economies from the date of their inflation targeting adoption to 2009 Q4. The study uses small open economy new Keynesian model à la Gali and Monacelli (2005), and employs multi-equation GMM technique to investigate the relationship. We find that the response of central bank to the exchange rate in case of Brazil, Chile, Mexico and Thailand is statistically significant while insignificant for Korea and Czech Republic. Theoretically, it should not be so as even under flexible inflation targeting central bank responds to inflation deviation and output gap ; we think that the peculiar characteristics of emerging markets, like fear of floating, weak financial system and low level of central bank credibility make exchange rate important for these economies.
    Keywords: Inflation Targeting; Exchange Rate; Emerging Markets
    JEL: E52 F41
    Date: 2011
  11. By: Joseph D. ALBA (Division of Economics, Nanyang Technological University, Singapore 637332, Singapore); Wai–Mun CHIA (Division of Economics, Nanyang Technological University, Singapore 637332, Singapore); Donghyun PARK (Asian Development Bank6 ADB Avenue, Mandaluyong City,Metro Manila, Philippines 1550)
    Abstract: East Asia’s small open economies were hit in varying degrees by the sharp drop in the output of major industrial countries during the global financial and economic crisis of 2008-2009. This highlights the role of monetary policy regimes in cushioning small open economies from adverse external output shocks. To assess the welfare impact of external shocks on key macroeconomic variables under different monetary policy regimes, we numerically solve and calculate the welfare loss function of a dynamic stochastic general equilibrium (DSGE) model. We find that CPI inflation targeting minimizes welfare losses for import-to-GDP ratios from 0.3 to 0.9. However, welfare under the pegged exchange rate regime is almost equivalent to CPI inflation targeting when the import-to-GDP ratio is one while the Taylor-type rule minimizes welfare when the import-to-GDP ratio is 0.1. We calibrate the model and derive welfare implications for eight East Asian small open economies.
    Keywords: Trade channel, Import-to-GDP ratio, small open economies, welfare, exchange rate regimes, inflation targeting, Taylor rule, foreign output shock
    JEL: F40 F41 E52 F31
    Date: 2011–05
  12. By: Muhammad Naveed Tahir (GATE Lyon Saint-Etienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure de Lyon)
    Abstract: In this paper we investigate the impact of financial globalization on the behaviour of inflation targeting emerging market economies with respect to exchange rate - do central banks respond to exchange rate movements or not. We use quarterly data for six emerging market inflation targeting economies from the date of their inflation targeting adoption to 2009 Q4. The study uses small open economy new Keynesian model à la Gali and Monacelli (2005), and employs multi-equation GMM technique to investigate the relationship. We find that the response of central bank to the exchange rate in case of Brazil, Chile, Mexico and Thailand is statistically significant while insignificant for Korea and Czech Republic. Theoretically, it should not be so as even under flexible inflation targeting central bank responds to inflation deviation and output gap; we think that the peculiar characteristics of emerging markets, like fear of floating, weak financial system and low level of central bank credibility make exchange rate important for these economies.
    Keywords: Inflation Targeting; Exchange Rate; Emerging Markets
    Date: 2011–11–30
  13. By: Hans-Werner Sinn; Timo Wollmershaeuser
    Abstract: The European Monetary Union is stuck in a severe balance-of-payments imbalance of a nature similar to the one that destroyed the Bretton Woods System. Greece, Ireland, Portugal, Spain and Italy have suffered from balance-of-payments deficits whose accumulated value, as measured by the Target balances in the national central banks’ balance sheets, was 404 billion euros in August 2011. The national central banks of these countries covered the deficits by creating and lending out additional central bank money that flowed to the euro core countries, Germany in particular, and crowded out the central bank money resulting from local refinancing operations. Thus the ECB forced a public capital export from the core countries that partly compensated for the now reluctant private capital flows to, and the capital flight from, the periphery countries.
    JEL: E50 E58 E63 F32 F34
    Date: 2011–11
  14. By: Liu, Luke
    Abstract: The transmission of monetary policy may hold the key to explaining the effects of policy on the economy. The objective of the study is to assess the importance of the bank lending channel in the transmission of monetary policy in Australia. In this paper, we found that the effectiveness of monetary policy varies with the size of the bank as well as the type of the loan. For different asset size and different kinds of loans, the effect of monetary policy is different. Thus, policy has distributional effects on bank loans that depend on asset size and industry in the economy.
    Keywords: Monetary policy; Bank lending; Bank size
    JEL: C23 E52 C01
    Date: 2011–06–26
  15. By: Francis Breedon (Queen Mary, University of London); Thórarinn G. Pétursson (Central Bank of Iceland); Andrew K. Rose (Haas School of Business)
    Abstract: We look at the exchange rate policy choices and outcomes for small rich economies. Small rich economies face significant policy challenges due to proportionately greater economic volatility than larger economies. These economies usually choose some form of fixed exchange rate regime, particularly in the very small economies where the per capita cost of independent monetary policy is relatively high. When such countries do choose a free or managed floating regime, they appear to derive no benefit from those regimes; their exchange rate volatility seems to rise without any significant change in fundamental economic volatility. Thus, for these countries, floating exchange rates seem to create problems for policy makers without solving any.
    Keywords: Small economies, Exchange rate regimes
    JEL: F33 E52
    Date: 2011–12
  16. By: J. James Reade; Ulrich Volz
    Abstract: This article uses automatic model selection procedures, based on the gernal-to-specific approach, to investigate inflation in China. A novelty of this article is the use of a technique called impulse indicator saturation which allows us to uncover instabilities and to specify a general model and select down to a more specific model that best explains inflation in China. By and large, our findings suggest that China has been able to insulate itself against shocks from the US, although (maybe surprisingly) monetary growth in Europe seems to have an effect. Nonetheless, the main factors impacting Chinese inflation appear to be domestic, names GDP growth and money growth.
    Keywords: Chinese inflation, dollar peg, automatic model selection procedure
    JEL: C32 E52 F33
    Date: 2011–09
  17. By: Rodrigo Taborda
    Abstract: Colombia introduced a market-determined Nominal Exchange Rate (NER) with the US Dollar in 1991, after more than 20 years of controlled and multiple exchange rates. The first nine years the NER was set by an exchange rate band system, since 1999 the exchange rate is determined in a “dirty float” market. The behavior (revaluation / devaluation) of the NER is constantly reported in news, editorials and op-eds of major newspapers of the nation. This paper shows that there is media bias in favor of reporting a revaluation episode in contrast to a devaluation one. At the same time Colombia’s central bank allegedly intervenes in the exchange rate market to reduce volatility. However, it is also shown that the central bank buys US dollars to lessen a revaluation event as a response to the media bias and not volatility. It is also found that the media bias was higher during the exchange rate band system in contrast to the free market period.
    Date: 2011–11–29
  18. By: Yan, Isabel K.; Kumhof, Michael
    Abstract: Some emerging economies have recently experienced large government surpluses and accelerating foreign exchange reserve accumulation far in excess of what would be implied by the literature on optimal reserves. China in particular has repeatedly stressed that there may be an upper limit to how many reserves it is willing to hold. Using a dynamic general equilibrium model, we show that the credible expectation of such a limit would lead to a balance of payments anti-crisis, which is characterized by an economic boom, real appreciation, growing demand for domestic currency, and domestic inflation, in the period prior to the limit being reached.
    Keywords: Balance of payments anti-crises; foreign exchange reserves; foreign exchange intervention; inflation targeting; exchange rate targeting
    JEL: E58 E52 F41 E63
    Date: 2011–09
  19. By: Salih Fendoglu
    Abstract: This paper studies whether financial variables per se should matter for monetary policy. Earlier consensus view - using financial amplification models with disturbances that have no direct effect on credit market conditions- suggests that financial variables should not be assigned an independent role in policy making. Introducing uncertainty, time- variation in cross-sectional dispersion of firms’ productive performance, alters this policy prescription. The results show that (i) optimal policy is to dampen the strength of financial amplification by responding to uncertainty (at the expense of creating a mild degree of fluctuations in inflation). Moreover, a higher uncertainty makes the planner more willing to relax the financial constraints. (ii) Credit spreads are a good proxy for uncertainty, and hence, within the class of simple monetary policy rules I consider, a non-negligible response to credit spreads -together with a strong anti-inflationary stance- achieves the highest aggregate welfare possible.
    Keywords: Optimal Monetary Policy, Financial Amplification, Uncertainty Shocks
    Date: 2011
  20. By: Emanuel Kohlscheen
    Abstract: This study investigates the impact effect of monetary policy shocks on the exchange rates of Brazil, Mexico and Chile. We find that even a focus on 1 day exchange rate changes following policy events – which reduces the potential for reverse causality considerably – fails to lend support for the conventional view that associates interest rate hikes with appreciations. This lack of empirical backing for the predictions of standard open economy models that, for instance, combine the UIP condition with rational expectations (as in Dornbusch (1976)) persists irrespective of whether we use the US Dollar or effective exchange rates, whether interest rate changes are anticipated or not, whether changes in the policy rate that were followed by exchange rate intervention are excluded or whether "contaminated" events are dropped from the analysis. We argue that it is difficult to attribute this stronger version of the exchange rate puzzle to fiscal dominance, as similar results are obtained in the case of Chile - a country that has had the highest possible short-term credit rating since 1997 and a debt/GDP ratio below 10%. Indeed, in Chile a 100 b.p. hike leads to a 2.2 to 2.6% devaluation of the Peso on impact.
    Date: 2011–11
  21. By: Georg, Co-Pierre
    Abstract: This paper proposes a dynamic multi-agent model of a banking system with central bank. Banks optimize a portfolio of risky investments and riskless excess reserves according to their risk, return, and liquidity preferences. They are linked via interbank loans and face stochastic deposit supply. Evidence is provided that the central bank stabilizes interbank markets in the short-run only. Comparing different interbank network structures, it is shown that money-center networks are more stable than random networks. Systemic risk via contagion is compared to common shocks and it is shown that both forms of systemic risk require different optimal policy responses. --
    Keywords: systemic risk,contagion,common shocks,multi-agent simulations
    JEL: C63 E52 G01 G21
    Date: 2011

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