nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒01‒03
39 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Does Government Ideology Matter in Monetary Policy?: A Panel Data Analysis for OECD Countries By Ansgar Belke; Niklas Potrafke
  2. Wavelet-based Core Inflation Measures: Evidence from Peru By Lahura, Erick; Vega, Marco
  3. Effects of monetary policy on the $/£ exchange rate. Is there a 'delayed overshooting puzzle'? By Reinhold Heinlein; Hans-Martin Krolzig
  4. The Roads Not Taken: Why the Bank of Canada Stayed With Inflation Targeting By Christopher Ragan
  5. Central bank announcements of asset purchases and the impact on global financial and commodity markets By Reuven Glick; Sylvain Leduc
  6. Central Banks’ Voting Records and Future Policy By Roman Horváth; Kateøina Šmídková; Jan Zápal
  7. Central Banks and the Financial System By Francesco Giavazzi; Alberto Giovannini
  8. The usefulness of core PCE inflation measures By Alan K. Detmeister
  9. Bond market co-movements, expected inflation and the equilibrium real exchange rate By Corrado Macchiarelli
  10. Monetary policy and the flow of funds in the Euro Area By Riccardo Bonci
  11. In the Quest of Macroprudential Policy Tools By Daniel Sámano
  12. China’s evolving reserve requirements By Ma, Guonan; Xiandong, Yan; Xi, Liu
  13. Reactions of stock market to monetary policy shocks during the global financial crisis: the Nigerian case By Aliyu, Shehu Usman Rano
  14. "Gesell Tax" and Efficiency of Monetary Exchange By Martin Menner
  15. The Great Intervention and Massive Money Injection: The Japanese Experience 2003-2004 By Tsutomu Watanabe; Tomoyoshi Yabu
  16. Capital Inflows, Exchange Rate Flexibility, and Credit Booms By Nicolas E. Magud; Carmen M. Reinhart; Esteban R. Vesperoni
  17. "Currency intervention and the global portfolio balance effect: Japanese and Swiss lessons, 2003-2004 and 2009-2010" By Petra Gerlach; Robert N McCauley; Kazuo Ueda
  18. The Effect of Monetary Policy on Commodity Prices: Disentangling the Evidence for Individual Prices By Carolina Arteaga cabrales; Joan Camilo Granados Castro; Jair Ojeda Joya
  19. Bank Leverage Regulation and Macroeconomic Dynamics By Ian Christensen; Césaire Meh; Kevin Moran
  20. Adjustment patterns to commodity terms of trade shocks: the role of exchange rate and international reserves policies By Joshua Aizenman; Sebastian Edwards; Daniel Riera-Crichton
  21. Tracking Chinese CPI inflation in real time By Mehrotra, Aaron; Funke, Michael; Yu, Hao
  22. Global Imbalances, the International Crisis and the Role of the Dollar By Riccardo Fiorentini
  23. Impact of monetary policy on gross domestic product (GDP) By Hameed, Irfan; Ume, Amen
  24. Inflation Targeting Dilemmas By Peter Sinclair
  25. Bank mergers and deposit interest rate rigidity By Valeriya Dinger
  26. Do Low Interest Rates Sow the Seeds of Financial Crises? By Simona E. Cociuba; Malik Shukayev; Alexander Ueberfeldt
  27. East African Community: Pre-conditions for an Effective Monetary Union By Durevall, Dick
  28. Why the current account may matter in a monetary union. Lesson from the financial crisis in the Euro area By Francesco Giavazzi; Luigi Spaventa
  29. Is the long-term interest rate a policy victim, a policy variable or a policy lodestar? By Philip Turner
  30. Are Bayesian Fan Charts Useful for Central Banks? Uncertainty, Forecasting, and Financial Stability Stress Tests By Michal Franta; Jozef Barunik; Roman Horvath; Katerina Smidkova
  31. Monetary Policy and the Dutch Disease in a Small Open Oil Exporting Economy By Mohamed Tahar Benkhodja
  32. On the Term Structure of Interest Rates of the Mexican Government By Santiago García-Verdú
  33. A VAR analysis for the uncovered interest parity and the ex-ante purchasing power parity: the role of marcoeconomic and financial information By Corrado Macchiarelli
  34. Explaining the interest-rate-growth differential underlying government debt dynamics By David Turner; Francesca Spinelli
  35. How Do Credit Supply Shocks Propagate Internationally? A GVAR approach By Eickmeier, Sandra; Ng, Tim
  36. Making a Weak Instrument Set Stronger: Factor-Based Estimation of the Taylor Rule By Harun Mirza; Lidia Storjohann
  37. A behavioral macroeconomic model with endogenous boom-bust cycles and leverage dynamcis By Scheffknecht, Lukas; Geiger, Felix
  38. What drives cash demand? Transactional and residual cash demand in selected countries By Sisak Balázs
  39. Measuring Standard Error of Inflation in Pakistan: A Stochastic Approach By Iqbal, Javed; Hanif, Muhammad Nadim

  1. By: Ansgar Belke; Niklas Potrafke
    Abstract: This paper examines whether government ideology has influenced monetary policy in OECD countries. We use quarterly data in the 1980.1-2005.4 period and exclude EMU countries. Our Taylor-rule specification focuses on the interactions of a new time-variant index of central bank independence with government ideology. The results show that leftist governments have somewhat lower short-term nominal interest rates than rightwing governments when central bank independence is low. In contrast, short-term nominal interest rates are higher under leftist governments when central bank independence is high. The effect is more pronounced when exchange rates are flexible. Our findings are compatible with the view that leftist governments, in an attempt to deflect blame of their traditional constituencies, have pushed market-oriented policies by delegating monetary policy to conservative central bankers.
    Keywords: Monetary policy, Taylor rule, government ideology, partisan politics, central bank independence, panel data
    JEL: E52 E58 D72 C23
    Date: 2011
  2. By: Lahura, Erick (Central Bank of Peru; Universidad Catolica del Peru); Vega, Marco (Central Bank of Peru; Universidad Catolica del Peru)
    Abstract: Under inflation targeting and other related monetary policy regimes, the identification of non-transitory in ation and forecasts about future inflation constitute key ingredients for monetary policy decisions. In practice, central banks perform these tasks using so-called "core inflation measures". In this paper we construct alternative core inflation measures using wavelet functions and multiresolution analysis (MRA), and then evaluate their relevance for monetary policy. The construction of wavelet-based core inflation measures (WIMs) is relatively new in the literature and their assessment has not been addressed formally, this paper being the first attempt to perform both tasks for the case of Peru. Another main contribution of this paper is that it proposes a VAR-based long-run criterion as an alternative criteria for evaluating core inflation measures. Evidence from Peru shows that WIMs are superior to official core inflation in terms of both the proposed criterion and forecast-based criteria.
    Keywords: Core infl ation, wavelets, forecast, structural VAR
    JEL: C45 E31 E37 E52
    Date: 2011–12
  3. By: Reinhold Heinlein; Hans-Martin Krolzig
    Abstract: The determination of the $/£ exchange rate is studied in a small symmetric macroeconometric model including UK-US differentials in inflation, output gap, short and long-term interest rates for the four decades since the breakdown of Bretton Woods. The key question addressed is the possible presence of a ‘delayed overshooting puzzle’ in the dynamic reaction of the exchange rate to monetary policy shocks. In contrast to the existing literature, we follow a data-driven modelling approach combining (i) a VAR based cointegration analysis with (ii) a graph-theoretic search for instantaneous causal relations and (iii) an automatic general-to-specific approach for the selection of a congruent parsimonious structural vector equilibrium correction model. We find that the long-run properties of the system are characterized by four cointegration relations and one stochastic trend, which is identified as the long-term interest rate differential and that appears to be driven by long-term inflation expectations as in the Fisher hypothesis. It cointegrates with the inflation differential to a stationary ‘real’ long-term rate differential and also drives the exchange rate. The short-run dynamics are characterized by a direct link from the short-term to the long-term interest rate differential. Jumps in the exchange rate after short-term interest rate variations are only significant at 10%. Overall, we find strong evidence for delayed overshooting and violations of UIP in response to monetary policy shocks.
    Keywords: Exchange Rates; Monetary Policy; Cointegration; Structural VAR; Model Selection
    JEL: C22 C32 C50
    Date: 2011–12
  4. By: Christopher Ragan (McGill University)
    Abstract: Sticking with the status quo was only one option under debate among monetary experts in the lead-up to renewal of the Bank of Canada’s inflation-targeting mandate, which was announced this week. Several other routes were available. Two of them – namely, targeting nominal GDP or targeting full employment – were arguably non-starters. Two other approaches, however, held more promise: (i) moving to a price-level targeting regime, or (ii) sticking with inflation targeting but with a lower, say 1 percent, target. Nevertheless, the renewal of the status quo keeps in place a coherent monetary policy regime that has served Canadians well.
    Keywords: Monetary Policy, Canada, Bank of Canada, inflation targeting
    JEL: E4 E52 E58
    Date: 2011–11
  5. By: Reuven Glick; Sylvain Leduc
    Abstract: We present evidence on the effects of large-scale asset purchases by the Federal Reserve and the Bank of England since 2008. We show that announcements about these purchases led to lower long-term interest rates and depreciations of the U.S. dollar and the British pound on announcement days, while commodity prices generally declined despite this more stimulative financial environment. We suggest that LSAP announcements likely involved signaling effects about future growth that led investors to downgrade their U.S. growth forecasts lowering longterm US yields, depreciating the value of the U.S. dollar, and triggering a decline in commodity prices. Moreover, our analysis illustrates the importance of controlling for market expectations when assessing these effects. We find that positive U.S. monetary surprises led to declines in commodity prices, even as long-term interest rates fell and the U.S. dollar depreciated. In contrast, on days of negative U.S. monetary surprises, i.e. when markets evidently believed that monetary policy was less stimulatory than expected, long-term yields, the value of the dollar, and commodity prices all tended to increase.
    Keywords: Open market operations ; Monetary policy ; Prices
    Date: 2011
  6. By: Roman Horváth (IES, Charles University Prague); Kateøina Šmídková (IES, Charles University Prague); Jan Zápal (London School of Economics)
    Abstract: We assess whether the voting records of central bank boards are informative about future monetary policy. First, we specify a theoretical model of central bank board decision-making and simulate the voting outcomes. Three different versions of model are estimated with simulated data: 1) democratic, 2) consensual and 3) opportunistic. These versions differ in the degree of informational influence between the chairman and other board members influence prior to the voting. The model shows that the voting pattern is informative about future monetary policy provided that the signals about the optimal policy rate are noisy and that there is sufficient independence in voting across the board members, which is in line with the democratic version. Next, the model predictions are tested on real data on five inflation targeting countries (the Czech Republic, Hungary, Poland, Sweden and the United Kingdom). Subject to various sensitivity tests, it is found that the democratic version of the model corresponds best to the real data and that in all countries the voting records are informative about future monetary policy, making a case for publishing the records.
    Keywords: monetary policy, voting record, transparency, collective decision-making.
    JEL: C78 D78 E52 E58
    Date: 2011–12
  7. By: Francesco Giavazzi; Alberto Giovannini
    Abstract: Financial systems are inherently fragile because of the very function which makes them valuable: liquidity transformation. Thus regulatory reforms, as urgent and desirable as they are, will definitely strengthen the financial system and decrease the risk of liquidity crises, but they will never eliminate it. This leaves monetary policy with a very important task. In a framework that recognizes the interactions between monetary policy and liquidity transformation 'optimal' monetary policy would consist of a modified Taylor rule in which the real rate reflects the possibility of liquidity crises and recognizes the possibility that liquidity transformation gets ubsidized. Failure to recognize this point risks leading the economy into a low interest rate trap: low interest rates induce too much risk taking and increase the probability of crises. These crises, in turn, require low interest rates to maintain the ?nancial system alive. Raising rates becomes extremely difficult in a severely weakened financial system, so monetary authorities remain stuck in a low interest rates trap. This seems a reasonable description of the situation we have experienced throughout the past decade.
    Date: 2011
  8. By: Alan K. Detmeister
    Abstract: This paper examines a number of alternative PCE price inflation measures including overall PCE inflation, PCE inflation excluding food and energy, trimmed mean PCE inflation, component-smoothed inflation, variance-weighted inflation, inflation with weights based on disaggregated regressions, and survey measures of inflation expectations. When averaging across a handful of specifications based on the primary uses of a core inflation measure three conclusions arise: 1. Inflation rates for nearly all the measures best track ex-post trend inflation or predict future overall inflation when they are averaged over a considerable number of months. Overall PCE price inflation should be averaged over 18 months or longer. A shorter averaging period is appropriate for core measures, often on the order of 12 months. 2. Even after appropriately averaging each index, core inflation indexes generally perform better than overall inflation. 3. Exclusion indexes, such as PCE excluding food and energy, perform slightly worse than many other possible core inflation measures; trimmed mean PCE, or a variance-weighted index, may be better choice for a summary inflation measure.
    Date: 2011
  9. By: Corrado Macchiarelli (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: Since the end of the fixed rates in 1973 and after the EMS sterling dismissal in 1992, the value of the pound has undergone large cyclical fluctuations on average. Of particular interest to policy makers is the understanding of whether such movements are consistent with the lack or not of a correction mechanism to some long-run equilibrium. The purpose of the present study is to understand those dynamics, how the external value of the British sterling relative to the USD evolved during the recent floating experiences, and what have been the driving forces. In this paper we assume the real exchange rate to be determined by forces relating to the goods and capital market in a general equilibrium framework. This entails testing the purchasing power parity and the uncovered interest parity together. Our findings have two important implications, both for monetary policy. First, we show that some of the observed changes in the real exchange rates can not be solely attributed to changes in inflation rates, but, possibly, also to investors’ behavior. Secondly, we show that the special US dollar status of World reserve currency results into a weaker behavior of the US bond rate on international markets. JEL Classification: E31, E43, E44, F31, C58.
    Keywords: PPP, UIP, RIP, international parity conditions.
    Date: 2011–12
  10. By: Riccardo Bonci (Banca d’Italia, Regional Economic Research, Perugia branch, Via Nazionale 91, 00184 Roma, Italy.)
    Abstract: This paper provides new evidence on the transmission of monetary policy in the euro area, assessing the impact of an unexpected increase of the short-term interest on the lending and borrowing activity of the different economic sectors. We exploit the information content of the flow-of-funds statistics, that provide the most appropriate framework to analyse the flowing of funds from one sector (the lender) to the other (the borrower). We proceed in two steps. First, we estimate a small VAR model for the euro area over the period 1991Q1 to 2009Q2. Then, we extend the benchmark VAR model in order to include the flow-of-funds series and analyse the response of the latter variables to a contractionary monetary policy shock. We find that the policy tightening is followed by a worsening of the budget deficit; firms cut on their demand for bank loans, partially replacing them with inter-company loans, and draw on their liquidity to try to offset the fall of revenues associated with the slowdown of economic activity; households reduce net borrowing and increase precautionary saving in the short run. Consistent with the bank lending channel of monetary policy at work, the interest rate hike is followed by a short-run deceleration of credit growth, mainly driven by the response of banks. JEL Classification: E32, E4, E52, G11.
    Keywords: Monetary policy; flow of funds; credit growth.
    Date: 2011–12
  11. By: Daniel Sámano
    Abstract: The global financial crisis of late 2008 could not have provided more convincing evidence that price stability is not a sufficient condition for financial stability. In order to attain both, central banks must develop macroprudential instruments in order to prevent the occurrence of systemic risk episodes. For this reason testing the effectiveness of different macroprudential tools and their interaction with monetary policy is crucial. In this paper we explore whether two policy instruments, namely, a capital adequacy ratio rule in combination with a Taylor rule may provide a better macroeconomic outcome than a Taylor rule alone. We conduct our analysis by appending a macroeconometric financial block to an otherwise standard semistructural small open economy neokeynesian model for policy analysis estimated for the Mexican economy. Our results show that with the inclusion of the second instrument, the central bank may obtain substantial gains. Specifically, the central authority can isolate financial shocks and dampen their effects over macroeconomic variables.
    Keywords: Macroprudential policy, monetary policy, capital requirements.
    JEL: E44 E52 E61
    Date: 2011–12
  12. By: Ma, Guonan (BOFIT); Xiandong, Yan (BOFIT); Xi, Liu (BOFIT)
    Abstract: This paper examines the evolving role of reserve requirements as a policy tool in China. Since 2007, the Chinese central bank (PBC) has relied more on this tool to withdraw domestic liquidity surpluses, as a cheaper substitute for open-market operation instruments in this period of rapid FX accumulation. China’s reserve requirement system has also become more complex and been used to address a range of other policy objectives, not least being macroeconomic management, financial stability and credit policy. The preference for using reserve requirements reflects the size of China’s FX sterilisation task and the associated cost considerations, a quantity-oriented monetary policy framework challenged to reconcile policy dilemmas and tactical considerations. The PBC often finds it easier to reach consensus over reserve requirement decisions than interest rate decisions and enjoys greater discretion in applying this tool. The monetary effects of reserve requirements need to be explored in conjunction with other policy actions and not in isolation. Depending on the policy mix, higher reserve requirements tend to signal a tightening bias, to squeeze excess reserves of banks, to push market interest rates higher, and to help widen net interest spreads, thus tightening domestic monetary conditions. There are, however, costs to using this policy tool, as it imposes a tax burden on Chinese banks that in turn appear to have passed a significant portion of this cost onto their customers, mostly depositors and SMEs. However, the pass-through onto bank customers appears to be partial.
    Keywords: reserve requirements; sterilisation tools; monetary policy; net interest margin and spread; tax incidence; Chinese economy
    JEL: E40 E50 E52 E58 E60 H22
    Date: 2011–12–14
  13. By: Aliyu, Shehu Usman Rano
    Abstract: This paper seeks to assess the reactions of Nigeria’s stock market to monetary policy innovations during the period of global financial crisis on the basis of monthly data over the period January, 2007 to August, 2011. In particular, stock market return was regressed against major monetary policy instruments; money stock (M1, and M2) and monetary policy rate (MPR). The theoretical basis for the paper stems from the works of new classical macroeconomics, rational expectation hypothesis. Lucas (1972) postulates that the unanticipated and not anticipated monetary shock influences real economic activity. Using the GARCH by developed Engle and Bollerslev (1986) and EGARCH by Nelson (1991) methodologies, the paper empirically assessed the impact monetary policy innovations exerts on stock returns in the Nigeria’s Stock Exchange (NSE) market during the period of the crisis. Results from the empirical analysis revealed that the unaticipated component of policy innovations on M2 and MPR exerts distabilizing effect on NSE’s returns, whereas the anticipated component does not. This lends support to the REH argument for the Nigerian stock market. The pqper strongly recommends realistic and timely policy pronouncements by the MPC to achieve stability in the market.
    Keywords: Monetary Policy; GARCH; EGARCH; Rational Expectation Hypothesis
    JEL: E52 E44 G01
    Date: 2011–11–24
  14. By: Martin Menner (Universidad de Alicante)
    Abstract: A periodic "Gesell Tax" on money holdings as a way to overcome the zero-lower-bound on nominal interest rates is studied in a framework where money is essential. For this purpose, I characterize the efficiency properties of taxing money in a full-fledged macroeconomic business cycle model of the third-generation of monetary search models. Both, inflation and "Gesell taxes" maximize steady state capital stock, output, consumption, investment and welfare at moderate levels. The Friedman rule is sub-optimal, unless accompanied by a moderate “Gesell tax”. In a recession scenario a Gesell tax speeds up the recovery in a similar way as a large fiscal stimulus but avoids "crowding out" of private consumption and investment.
    Keywords: monetary search-theory, negative interest rates, Gesell tax, capital formation, DSGE model
    JEL: D83 E19 E32 E49
    Date: 2011–12
  15. By: Tsutomu Watanabe (Faculty of Economics, The University of Tokyo); Tomoyoshi Yabu (Faculty of Business and Commerce, Keio University)
    Abstract: From the beginning of 2003 to the spring of 2004, Japan's monetary authorities conducted large-scale yen-selling/dollar-buying operations in what Taylor (2006) has labeled the "Great Intervention." This paper examines the relationship between this "Great Intervention" and the quantitative easing policy the Bank of Japan was pursuing at that time. First, we find that about 40 percent of the yen funds supplied to the market by yen-selling interventions were not offset by the BOJ's monetary operations and remained in the market for a while; this is in contrast with the preceding period, when almost 100 percent were immediately offset. Second, comparing interventions and other government payments, the extent to which the funds were offset was much smaller in the case of interventions, suggesting that the BOJ differentiated between, and responded differently to, interventions and other government payments. These two findings indicate that it is likely that the BOJ intentionally did not sterilize yen-selling interventions to achieve its policy target of maintaining the current account balances of commercial banks at the BOJ at a high level. Finally, we find that an unsterilized intervention had a greater impact on the yen-dollar rate than a sterilized one, suggesting that it matters whether an intervention is sterilized or not even when the economy is in a liquidity trap
    Date: 2011–12
  16. By: Nicolas E. Magud; Carmen M. Reinhart; Esteban R. Vesperoni
    Abstract: The prospects of expansionary monetary policies in the advanced countries for the foreseeable future have renewed the debate over policy options to cope with large capital inflows that are, at least partly, driven by low interest rates in the financial centers. Historically, capital flow bonanzas have often fueled sharp credit expansions in advanced and emerging market economies alike. Focusing primarily on emerging markets, we analyze the impact of exchange rate flexibility on credit markets during periods of large capital inflows. We show that credit grows more rapidly and its composition tilts to foreign currency in economies with less flexible exchange rate regimes, and that these results are not explained entirely by the fact that the latter attract more capital inflows than economies with more flexible regimes. Our findings thus suggest countries with less flexible exchange rate regimes may stand to benefit the most from regulatory policies that reduce banks’ incentives to tap external markets and to lend/borrow in foreign currency; these policies include marginal reserve requirements on foreign lending, currency-dependent liquidity requirements, and higher capital requirement and/or dynamic provisioning on foreign exchange loans.
    JEL: E5 F2 G15
    Date: 2011–12
  17. By: Petra Gerlach (Economic and Research Institute); Robert N McCauley (Bank for International Settlements (BIS)); Kazuo Ueda (Faculty of Economics, University of Tokyo)
    Abstract: This paper shows that the Japanese and Swiss foreign exchange interventions in 2003/04 and 2009/10 seem to have lowered long-term interest rates in a range of industrial countries, including Japan and Switzerland. It seems that this decline was triggered by the investment of the intervention funds in US and euro area bonds and that a global portfolio balance effect made this decline in interest rate spread to other markets, thus easing monetary conditions at home and abroad.
    Date: 2011–12
  18. By: Carolina Arteaga cabrales; Joan Camilo Granados Castro; Jair Ojeda Joya
    Abstract: In this paper we study the effect of monetary policy shocks on commodity prices. While most of the literature has found that expansionary shocks have a positive effect on aggregate price indices, we study the effect on individual prices of a sample of four commodities. This set of commodity prices is essential to understand the dynamics of the balance of payments in Colombia. The analysis is based on structural VAR models, we identify monetary policy shocks following [Kim, 1999, 2003] upon quarterly data for commodity prices and their fundamentals for the period 1980q1 to 2010q3. Our results show that commodity prices overshoot their long run equilibrium in response to a contractionary shock in the US monetary policy and, in contrast with literature, the response of the individual prices considered is stronger than what has been found in aggregate indices. Additionally, it is found that the monetary policy explains a substantial share of the fluctuations in prices.
    Date: 2011–12–22
  19. By: Ian Christensen; Césaire Meh; Kevin Moran
    Abstract: This paper assesses the merits of countercyclical bank balance sheet regulation for the stabilization of financial and economic cycles and examines its interaction with monetary policy. The framework used is a dynamic stochastic general equilibrium model with banks and bank capital, in which bank capital solves an asymmetric information problem between banks and their creditors. In this economy, the lending decisions of individual banks affect the riskiness of the whole banking sector, though banks do not internalize this impact. Regulation, in the form of a constraint on bank leverage, can mitigate the impact of this externality by inducing banks to alter the intensity of their monitoring efforts. We find that countercyclical bank leverage regulation can have desirable stabilization properties, particularly when financial shocks are an important source of economic fluctuations. However, the appropriate contribution of countercyclical capital requirements to stabilization after a technology shock depends on the size of the externality and on the conduct of the monetary authority.
    Keywords: Monetary policy framework; Transmission of monetary policy; Financial institutions; Financial system regulation and policies; Economic models
    JEL: E44 E52 G21
    Date: 2011
  20. By: Joshua Aizenman; Sebastian Edwards; Daniel Riera-Crichton
    Abstract: We analyze the way in which Latin American countries have adjusted to commodity terms of trade (CTOT) shocks in the 1970-2007 period. Specifically, we investigate the degree to which the active management of international reserves and exchange rates impacted the transmission of international price shocks to real exchange rates. We find that active reserve management not only lowers the short-run impact of CTOT shocks significantly, but also affects the long-run adjustment of REER, effectively lowering its volatility. We also show that relatively small increases in the average holdings of reserves by Latin American economies (to levels still well below other emerging regions current averages) would provide a policy tool as effective as a fixed exchange rate regime in insulating the economy from CTOT shocks. Reserve management could be an effective alternative to fiscal or currency policies for relatively trade closed countries and economies with relatively poor institutions or high government debt. Finally, we analyze the effects of active use of reserve accumulation aimed at smoothing REERs. The result support the view that “leaning against the wind” is potent, but more effective when intervening to support weak currencies rather than intervening to slow down the pace of real appreciation. The active reserve management reduces substantially REER volatility.
    JEL: F1 F15 F31 F32 F36 O13 O54
    Date: 2011–12
  21. By: Mehrotra, Aaron (BOFIT); Funke, Michael (BOFIT); Yu, Hao (BOFIT)
    Abstract: With recovery from the global financial crisis in 2009 and 2010, inflation emerged as a major concern for many central banks in emerging Asia. We use data observed at mixed frequencies to estimate the movement of Chinese headline inflation within the framework of a state-space model, and then take the estimated indicator to nowcast Chinese CPI inflation. The importance of forward-looking and high-frequency variables in tracking inflation dynamics is highlighted and the policy implications discussed.
    Keywords: nowcasting; CPI inflation cycle; mixed-frequency modelling; dynamic factor model; China
    JEL: C53 E31 E37
    Date: 2011–12–22
  22. By: Riccardo Fiorentini (Department of Economics (University of Verona))
    Abstract: The paper investigates the links between international global imbalances and the recent international financial crisis. It also focuses on the asymmetries of the dollar standard exchange rate regime. Global imbalances preceded the crisis but were one of the ingredients that led to the financial crash of 2007-2008. The paper rejects the ‘saving glut' explanation of the US trade deficit and shows that the key role of the dollar in the international monetary system allows the USA to exert seignorage in the international economy and created a circuit where Asian and oil-producing countries financed the US deficit. The inflow of foreign capitals increased the US domestic credit supply contributing to the development of the sub-prime bubble. The paper concludes that only the creation of a supranational monetary authority can eliminate the dangers of the asymmetric dollar standard regime.
    Keywords: Imbalances, crisis, dollaer
    JEL: F33 E21
    Date: 2011–12
  23. By: Hameed, Irfan; Ume, Amen
    Abstract: This research article focuses on the impact of Monetary Policy on GDP. GDP no doubt is affected by the Monetary Policy of the state. The research papers of various authors have been studied in this regard to prove the Hypothesis and after in depth analysis by applying Regression Analysis technique it has been observed that the relationship between the two exists. The data of past 30 years of Pakistan has been used for driving the conclusion. The study proved that the interest rate has minor relationship with GDP but the Growth in Money Supply greatly affects the GDP of an economy, obviously various unknown factors also affects the GDP. Growth in Money Supply has a huge impact on GDP. The Research study can further be used for developmental projects for the Growth of Economy, Quality improvements, Household production, the underground conomy, Health and life expectancy, the environment, Political immunity and ethnic justice.
    JEL: E51 E52 E61
    Date: 2011
  24. By: Peter Sinclair
    Abstract: This paper poses, and then attempts to answer, eleven questions about the principles and practice of inflation targeting under contemporary conditions
    Keywords: inflation targeting
    JEL: E52
    Date: 2011–12
  25. By: Valeriya Dinger
    Abstract: In this paper I revisit the debate on the impact of bank and market characteristics on the rigidity of retail bank interest rates. Whereas existing research in this area has been exclusively concerned with static measures of bank and market structure, I adopt a dynamic approach which explores the rigidity effects of the changes of bank and market structure generated by bank mergers. I find that bank mergers significantly affect the frequency of changes to deposit rates. In particular, the probability of adjusting deposit rates in response to shocks in money market rates significantly drops after mergers that involve large target banks and after mergers that generate a substantial geographical expansion of bank operations. These effects, however, materialize only after a "transition" period characterized by very frequent changes of the deposit rates.
    Keywords: Bank mergers ; Bank deposits ; Interest rates
    Date: 2011
  26. By: Simona E. Cociuba; Malik Shukayev; Alexander Ueberfeldt
    Abstract: A view advanced in the aftermath of the late-2000s financial crisis is that lower than optimal interest rates lead to excessive risk taking by financial intermediaries. We evaluate this view in a quantitative dynamic model in which interest rate policy affects risk taking by changing the amount of safe bonds that intermediaries use as collateral in the repo market. In this model with properly-priced collateral, lower than optimal interest rates reduce risk taking. We also consider the possibility that intermediaries can augment their collateral by issuing assets whose risk is underestimated by credit rating agencies, as was observed prior to the crisis. In the presence of such mispriced collateral, lower than optimal interest rates contribute to excessive risk taking and amplify the severity of recessions.
    Keywords: Transmission of monetary policy; Financial system regulation and policies
    JEL: E44 E52 G28 D53
    Date: 2011
  27. By: Durevall, Dick (Department of Economics, School of Business, Economics and Law, Göteborg University)
    Abstract: Kenya, Tanzania and Uganda signed the Treaty for the establishment of the East African Community (EAC) in 1999, which entered into force in July 2000. In 2007 it was signed by Burundi and Rwanda. According to the Treaty, EAC should first form a customs union, then a common market and a monetary union, and finally a political union. The Customs Union was formally completed in 2010, and Common Market Protocol was signed in 2009. Currently the intention is to sign the East African Monetary Union protocol 2012, while the date for actual implementation of the common currency is uncertain. The purpose of this note is to discuss preconditions for an effective monetary union among the EAC members, with a focus on Rwanda. It first outlines potential economic benefits and costs of a monetary union, and then discusses political and institutional preconditions. It concludes that although there are potentially substantive economic net-benefits, a monetary union is a risky project for political reasons. The political will among policymakers is key to successful implementation, and it could vanish with a change of government or because of discontent among influential lobby groups. However, the process towards forming are monetary union is appears to be highly beneficial the EAC members, both directly by improving monetary policy and indirectly by contributing to economic integration.<p>
    Keywords: Africa; Burundi; common currency; EAC; Kenya; monetary union; regional integration; Rwanda; Tanzania; Uganda
    JEL: F15
    Date: 2011–12–20
  28. By: Francesco Giavazzi; Luigi Spaventa
    Abstract: The current account has always been a neglected variable in the management of the Euro area and in the assessment of its members' performance; so has, as a consequence, the savings-investment balance. This paper first reviews the arguments that explain this attitude and justify, under some conditions and in some cases, the persistence of current account deficits. It then examines some peculiar features of the growth experience under monetary union in four Euro area countries which do not conform to the conventional convergence pattern. Models establishing the optimality of a succession of current account deficits in a catching-up process implicitly assume that the intertemporal budget constraint is satisfied, so that the accumulation of foreign liabilities is matched by future surpluses. In section 3 we first introduce explicitly this constraint in a simple two-period, two-good model and show that its fulfilment requires that growth be driven by an adequate increase of the country's production capacity of traded goods and services. By examining the composition of output and demand we show that this has not been the case in the four countries considered and argue that monetary union has helped relax the necessary discipline. The common monetary policy moreover did nothing to prevent an extraordinary growth of credit that fed the imbalances in the four countries. The paper closes addressing some policy issues related to the future sustainability o the monetray union.
    Date: 2011
  29. By: Philip Turner
    Abstract: Few financial variables are more fundamental than the "risk free" real long-term interest rate because it prices the terms of exchange over time. During the past 15 years, it has dropped from a range of 4 to 5% to a range of 0 to 2%. By late 2011, cyclical factors had driven it close to zero. This paper explores why. Possible persistent factors are: the investment of the large savings generated by developing Asia in highly-rated bonds; accounting and valuation rules for institutional investment; and financial sector regulation. The consequences could be far-reaching: cheaper leverage; less pressure to correct fiscal deficits; larger interest rate exposures in the financial industry; and a more cyclical bond market. During the financial crisis, central banks in the advanced countries have made the long-term interest rate a policy variable as Keynes had always advocated. This policy focus will draw more attention to the macroeconomic and financial consequences of government debt management policies. Coordination between central bank balance sheet policies and government debt management is essential. With government debt very high for years to come, bond market volatility could confront central banks with unenviable choices.
    Keywords: Long-term interest rate, bond market, government debt management, financial regulation, central banks
    Date: 2011–12
  30. By: Michal Franta; Jozef Barunik; Roman Horvath; Katerina Smidkova
    Abstract: This paper shows how fan charts generated from Bayesian vector autoregression (BVAR) models can be useful for assessing 1) the forecasting accuracy of central banks’ prediction models and 2) the credibility of stress tests carried out to evaluate financial stability. Using unique data from the Czech National Bank (CNB), we compare our BVAR fan charts for inflation, GDP growth, interest rate and the exchange rate to those of the CNB, which are based on past forecasting errors. Our results suggest that in terms of the Kullback-Leibler Information Criterion, BVAR fan charts typically do not outperform those of the CNB, providing a useful cross-check of their accuracy. However, we show how BVAR fan charts can rigorously deal with the non-negativity constraint on the nominal interest rate and usefully complement the official fan charts. Finally, we put forward how BVAR fan charts can be useful for assessing financial stability and propose a simple method for evaluating whether the assumptions of banks’ stress tests about the macroeconomic outlook are sufficiently adverse.
    Keywords: Bayesian vector autoregression, fan chart, inflation targeting, stress tests, uncertainty.
    JEL: E52 E58
    Date: 2011–11
  31. By: Mohamed Tahar Benkhodja (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France)
    Abstract: In this paper, we compare, first, the impact of a windfall and a boom sectors on the economy of an oil exporting country and their welfare implications ; in a second step, we analyze how monetary policy should be conducted to insulate the economy from the main impact of these shocks, namely the Dutch Disease. To do so, we built a Multisector DSGE model with nominal and real rigidities. The main finding is that Dutch disease effect arise after spending and resource movement effects in the following cases : i) flexible prices and wages both in the case of a windfall and in the case of a boom ; ii) flexible wage and sticky price only in the case of a …fixed exchange rate. In other cases, Dutch disease effect can be avoided if : prices are sticky and wages are flexible when the exchange rate is flexible ; iii) prices and wages are sticky whatever the objective of the central bank is in both cases : windfall and boom. We also compare the source of fluctuation that leads to Dutch disease effect and we conclude that the windfall leads to a strong e¤ect in terms of de-industrialization compared to a boom. The choice of flexible exchange rate regime also helps to improve welfare.
    Keywords: Monetary Policy, Dutch Disease, Oil Prices, Small Open Economy
    JEL: E52 F41 Q40
    Date: 2011
  32. By: Santiago García-Verdú
    Abstract: This paper, first, reviews briefly the literature on the term structure of interest rates, citing some of the most important studies done on the topic for the Mexican case in the last years. In addition, the development of the government debt market is described. Second, evidence against the expectation hypothesis is shown and the deviations of the term structure from this hypothesis are examined. Third, it is documented that much of the variability of the term structure is due to changes in its level. Fourth, some of the statistics of the term structure are associated with macroeconomic variables, specifically the short-term rate and the output gap as measured with the IGAE index. Regarding this last point, evidence is found that changes in the term structure of interest rates’ slope are associated with the monetary policy stand along the business cycle. The nominal interest rates used in the analysis go from July 2002 to June 2011.
    Keywords: Term Structure of Interest Rates, Expectation Hypothesis, Principal Component Analysis, Nominal Interest Rates.
    JEL: E43 G12
    Date: 2011–12
  33. By: Corrado Macchiarelli (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
    Abstract: This study revisits the relation between the uncovered interest parity (UIP), the ex ante purchasing power parity (EXPPP) and the real interest parity (RIP) using a VAR approach for the US dollar, the British sterling and the Japanese yen interest rates, exchange rates and changes in prices. The original contribution is on developing some joint coefficient-based tests for the three parities conditions at a long horizon. Particularly, test results are derived by rewriting the UIP, the EXPPP and the RIP as a set of cross-equation restrictions in the VAR (see also Campbell and Shiller, 1987; Bekaert and Hodrick, 2001; and Bekaert et al., 2007; King and Kurmann, 2002). Consistent with the idea of some form of proportionality among the above three parities, we find a ”forward premium” bias in both the UIP - as it is normally found in empirical analysis (e.g. Fama, 1987) - and the ex ante PPP. The latter result is new in the literature and stems from testing the PPP in expectational terms, thus assuming agents to bear on the uncertainty of future exchange rate changes and inflation dynamics. The overall results confirm the UIP to be currency-based (see also Bekaert et al., 2007) and the EXPPP to be horizon-dependent (see also Lothian and Taylor, 1996; Taylor, 2002). Moreover, we find (weak) evidence that conditioning the VAR on variables having a strong forward-looking component (i.e. share prices) helps recover a unitary coefficient in the UIP equation. JEL Classification: E31, E43, E44, F31, C58.
    Keywords: PPP, UIP, RIP, international parity conditions.
    Date: 2011–12
  34. By: David Turner; Francesca Spinelli
    Abstract: The differential between the interest rate paid to service government debt and the growth rate of the economy is a key concept in assessing fiscal sustainability. Among OECD economies, this differential was unusually low for much of the last decade compared with the 1980s and the first half of the 1990s. This paper investigates the reasons behind this profile using panel estimation on 23 OECD economies. The results suggest that the fall is partly explained by lower inflation volatility associated with the adoption of monetary policy regimes which credibly target low inflation, which might be expected to continue. However, the low differential is also partly explained by factors which are likely to be reversed in the future, including very low policy rates, the “global savings glut” and the effect which the European Monetary Union had in reducing long-term interest differentials in the pre-crisis period. The differential is also likely to rise in the future because the number of countries which have debt-to-GDP ratios above a threshold at which there appears to be an effect on sovereign risk premia has risen sharply. Moreover, debt is projected to increasingly rise above this threshold in most of these countries.<P>Expliquer le différentiel entre taux d'intérêt et croissance qui sous-tend la dynamique de la dette publique<BR>Le différentiel entre le taux d’intérêt payé sur la dette publique et le taux de croissance de l’économie est un concept clé pour évaluer la viabilité budgétaire. Parmi les économies de l’OCDE, ce différentiel a été exceptionnellement bas pendant une grande partie de la décennie passée en comparaison des années 80 et de la première moitié des années 90. Le présent document cherche à expliquer ce profil à l’aide d’une estimation en panel réalisée sur 23 pays de l’OCDE. Les résultats semblent indiquer que la diminution de l’écart s’explique en partie par une plus faible volatilité de l’inflation associée à l’adoption de régimes de politique monétaire visant de façon crédible un taux d’inflation peu élevé, un facteur qui paraît devoir persister. Cependant, cet écart peu marqué est aussi imputable, pour partie, à des facteurs qui vont sans doute s’inverser dans l’avenir, notamment des taux directeurs très bas, l’ « excédent mondial d’épargne » et l’impact de la réduction des différentiels de taux d’intérêt à long terme opérée au sein de l’Union monétaire européenne au cours de la période qui a précédé la crise. L’écart pourrait aussi se creuser dans l’avenir du fait de la forte augmentation du nombre de pays dont le ratio dette-PIB dépasse un seuil qui, apparemment, déclenche un effet sur la prime de risque souverain. De plus, la dette va sans doute dépasser de plus en plus largement ce seuil dans la plupart de ces pays.
    Keywords: fiscal sustainability, interest rate, government debt, interest-rate-growth differential, dette publique, viabilité budgétaire, taux d’intérêt, taux d'intérêt différentiel de croissance
    JEL: E43 E62 H63 H68
    Date: 2011–12–19
  35. By: Eickmeier, Sandra; Ng, Tim
    Abstract: We study how credit supply shocks in the US, the euro area and Japan are transmitted to other economies. We use the recently-developed GVAR approach to model financial variables jointly with macroeconomic variables in 33 countries for the period 1983-2009. We experiment with inter-country links that distinguish bilateral trade, portfolio investment, foreign direct investment and banking exposures, as well as asset-side vs. liability-side financial channels. Capturing both bilateral trade and inward foreign direct investment or outward banking claim exposures in a GVAR fits the data better than using trade weights only. We use sign restrictions on the short-run impulse responses to financial shocks that have the effect of reducing credit supply to the private sector. We find that negative US credit supply shocks have stronger negative effects on domestic and foreign GDP, compared to credit supply shocks from the euro area and Japan. Domestic and foreign credit and equity markets respond clearly to the credit supply shocks. Exchange rate responses are consistent with a "flight to quality" to the US dollar. The UK, another international financial centre, is also responsive to the shocks. These results are robust to the exclusion of the 2007-09 crisis episode from the sample.
    Keywords: credit supply shocks; global VAR; international business cycles; sign restrictions; trade and financial integration
    JEL: C3 F15 F36 F41 F44
    Date: 2011–12
  36. By: Harun Mirza; Lidia Storjohann
    Abstract: The problem of weak identification has recently attracted attention in the analysis of structural macroeconomic models. Using robust methods can result in large confidence sets making inference difficult. We overcome this problem in the analysis of a forward-looking Taylor rule by seeking stronger instruments. We suggest exploiting information from a large macroeconomic data set by generating factors and using them as additional instruments. This approach results in a stronger instrument set and hence smaller weak-identification robust confidence sets. It allows us to conclude that there has been a shift in monetary policy from the pre-Volcker regime to the Volcker-Greenspan tenure.
    Keywords: Taylor Rule, Weak Instruments, Factor Models
    JEL: E31 E52 C22
    Date: 2011–12
  37. By: Scheffknecht, Lukas; Geiger, Felix
    Abstract: We merge a financial market model with leverage-constrained, heterogeneous agents with a reduced-form version of the New-Keynesian standard model. Agents in both submodels are assumed to be boundedly rational. The fi nancial market model produces endogenously arising boom-bust cycles. It is also capable to generate highly non-linear deleveraging processes, fi re sales and ultimately a default scenario. Asset price booms are triggered via self-fulfilling prophecies. Asset price busts are induced by agents' choice of an increasingly fragile balance sheet structure during good times. Their vulnerability is inevitably revealed by small, randomly occurring shocks. Our transmission channel of financial market activity to the real sector embraces a recent strand of literature shedding light on the link between the active balance sheet management of financial market participants, the induced procyclical fluctuations of desired risk compensations and their final impact on the real economy. We show that a systematic central bank reaction on financial market developments dampens macroeconomic volatility considerably. Furthermore, restricting leverage in a countercyclical fashion limits the magnitude of financial cycles and hence their impact on the real economy. --
    Keywords: behavioral economics,New-Keynesian macroeconomics,monetary policy,agent-based financial market model,leverage,macroprudential regulation,financial stability,asset price bubbles,systemic risk
    JEL: E31 E41 E47 E52
    Date: 2011
  38. By: Sisak Balázs (Magyar Nemzeti Bank (central bank of Hungary))
    Abstract: The goal of this study is to determine the reasons behind high cash demand in several Central European countries, especially Hungary. We distinguish between legal and illegal cash demand in an attempt to model the former. In our approach, legal cash demand can be explained by transactional and saving motives (hoarding). We apply both direct calculation and an econometric approach in order to isolate transactional demand. Regarding the econometric approach, a number of different models are estimated to eliminate, as far as possible, endogeneity bias. We examine transactional and residual cash stock (legal hoarding and illegal cash demand) of several Central European and Western countries that have their own currency (did not introduce euro). We find that transactional cash demand is strongly influenced by the level of improvement of the payment system. There are explicit signs that interest rates negatively influence nontransactional cash demand. However, we find examples where this is not the case. In these instances, the increase of non-transactional cash demand may be caused by illegal cash demand.
    Keywords: cash demand, shadow economy, payment system, panel econometrics
    JEL: E26 E41 E42 C23
    Date: 2011
  39. By: Iqbal, Javed; Hanif, Muhammad Nadim
    Abstract: Stochastic approach to index number (and its change) has recently attracted renewed attention of researchers as it provides the standard error of index number (and its change). One of the most important uses of index number is in the case of measurement of the general price level in an economy (and then inflation of course). In this study we estimate standard errors of month on month and year on year inflation in Pakistan under stochastic approach, following Clement and Izan (1987). We contribute in this study by providing mechanism and estimating the standard error of period average of YoY inflation and apply this to Pakistan data.
    Keywords: Inflation; Pakistan
    JEL: C43 E31
    Date: 2010–12–31

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