nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒02‒01
twenty papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Strategic monetary and fiscal policy interaction in a liquidity trap By Ali al-Nowaihi; Sanjit Dhami
  2. How inflationary is an extended period of low interest rates? By Charles T. Carlstrom; Timothy S. Fuerst; Matthias Paustian
  3. The evolution of Alexandre Lamfalussy's thought on the international and European monetary system (1961-1993) By Ivo Maes
  4. 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
  5. Has the Euro affected the choice of invoicing currency? By Jenny E. Ligthart; Sebastian E. V. Werner
  6. Optimal monetary policy in a two country model with firm-level heterogeneity By Dudley Cooke
  7. Are Proposed African Monetary Unions Optimal Currency Areas? Real and Monetary Policy Convergence Analysis By Simplice A , Asongu
  8. Capital Controls and Foreign Exchange Policy By Marcel Fratzscher
  9. The Relationship between Inflation, output growth, and their Uncertainties: Evidence from selected CEE countries By Mubariz Hasanov; Tolga Omay
  10. Inflation dynamics when inflation is near zero By Jeffrey C. Fuhrer; Giovanni P. Olivei; Geoffrey M. B. Tootell
  11. Monetary Policy Implications of Financial Frictions in the Czech Republic By Jakub Rysanek; Jaromir Tonner; Osvald Vasicek
  12. Investigating the Time Varying Nature of the Link between Inflation and Currency Substitution in the Turkish Economy By Aysen Arac; Funda Telatar; Erdinc Telatar
  13. Sizing Up Repo By Arvind Krishnamurthy; Stefan Nagel; Dmitry Orlov
  14. Real and Monetary Policy Convergence: EMU Crisis to the CFA Zone By Simplice A, Asongu
  15. Monetary policy and unemployment in open economies By Engler, Philipp
  16. The Emergence of Modern Banking System in the Philippines during the American Colonial Period By Yoshiko Nagano
  17. The Philippine National Bank and Lending in Agriculture: 1916-1930 By Yoshiko Nagano
  18. Credit Supply versus Demand: Bank and Firm Balance-Sheet Channels in Good and Crisis Times By Jimenez Porras, G.; Ongena, S.; Peydro, J.L.; Saurina, J.
  19. Liquidity when it matters: QE and Tobin’s q By Driffill, John; Miller, Marcus
  20. Are banks passive liquidity backstops? deposit rates and flows during the 2007-2009 crisis By Viral V. Acharya; Nada Mora

  1. By: Ali al-Nowaihi; Sanjit Dhami
    Abstract: Given the recent experience, there is growing interest in the liquidity trap; which occurs when the nominal interest rate reaches its zero lower bound. Using the Dixit-Lambertini (2003) framework of strategic policy interaction between the Treasury and the Central Bank, we find that the optimal institutional response to the possibility of a liquidity trap has two main components. First, an optimal inflation target is given to the Central Bank. Second, the Treasury, who retains control over fiscal policy and acts as a Stackelberg leader, is given optimal output and inflation targets. This solution achieves the optimal rational expectations pre-commitment solution. This result holds true for a range of specifications about the Treasury's behavior. However, when there is the possibility of a liquidity trap, if monetary policy is delegated to an independent central bank with an optimal inflation target, but the Treasury retains discretion over fiscal policy, then the outcome can be a very poor one. 
    Keywords: liquidity trap; strategic monetary-fiscal interaction; optimal Taylor rules.
    JEL: E63 E52 E58 E61
    Date: 2011–06
  2. By: Charles T. Carlstrom; Timothy S. Fuerst; Matthias Paustian
    Abstract: Recent monetary policy experience suggests a simple test of models of monetary non-neutrality. Suppose the central bank pegs the nominal interest rate below steady state for a reasonably short period of time. Familiar intuition suggests that this should be inflationary. But a monetary model should be rejected if a reasonably short nominal rate peg results in an unreasonably large inflation response. We pursue this simple test in three variants of the familiar dynamic new Keynesian (DNK) model. All of these models fail this test. Further some variants of the model produce inflation reversals where an interest rate peg leads to sharp deflations.
    Keywords: Interest rates ; Interest rate risk
    Date: 2012
  3. By: Ivo Maes (National Bank of Belgium, Research Department; Université catholique de Louvain, Robert Triffin Chair; HUBrussel; ICHEC Brussels Management School)
    Abstract: The establishment of the European Monetary Institute (EMI), the predecessor of the European Central Bank, on 1 January 1994, was a milestone in the process of European monetary integration. In this paper, we look at the work on the international and European monetary system of Alexandre Lamfalussy, its first president. Lamfalussy pursued a threefold career: as a private banker, a central banker and an academic. Partly under the influence of Robert Triffin, Lamfalussy soon became interested in international monetary issues. This paper analyses his views on the international monetary system and on European monetary integration, including his contributions to the Delors Report, which provided the framework for European monetary union. The paper draws extensively on archival research in the Lamfalussy papers at the Bank for International Settlements and the minutes of the EEC Committee of Governors' meetings. The paper provides not only an analysis of Lamfalussy's thought on European monetary integration, but also offers crucial insight into the Weltanschauung and way of thinking of European central bankers in this period.
    Keywords: Lamfalussy, exchange rates, European monetary integration, Delors Report
    JEL: B31 E42 F36
    Date: 2011–11
  4. By: Joseph D. ALBA (Joseph D. ALBA Nanyang Technological University, Singapore); Wai-Mun CHIA (Wai-Mun CHIA Nanyang Technological University, Singapore); Donghyun PARK (Donghyun PARK Asian Development Bank (ADB), The Philippines)
    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.
    Date: 2011–12–01
  5. By: Jenny E. Ligthart (CentER and Department of Economics, Tilburg University, P.O. Box 90153, 5000 LE Tilburg, The Netherlands.); Sebastian E. V. Werner (Tilburg University, Warandelaan 2, 5037 AB Tilburg, The Netherlands.)
    Abstract: We present a new approach to study empirically the effect of the introduction of the euro on the pattern of currency invoicing. Our approach uses a compositional multinomial logit model, in which currency choice is explained by both currency-specific and country-specific determinants. We use unique quarterly panel data on the invoicing of Norwegian imports from OECD countries for the 1996-2006 period. We find that eurozone countries have substantially increased their share of home currency invoicing after the introduction of the euro, whereas the home currency share of non-eurozone countries fell slightly. In addition, the euro as a vehicle currency has overtaken the role of the US dollar in Norwegian imports. The substantial rise in producer currency invoicing by eurozone countries is primarily caused by a drop in inflation volatility and can only to a small extent be explained by an unobserved euro effect. JEL Classification: F33, F41, F42, E31, C25.
    Keywords: Euro, invoicing currency, exchange rate risk, inflation volatility, vehicle currencies, compositional multinomial logit.
    Date: 2012–01
  6. By: Dudley Cooke
    Abstract: This paper studies non-cooperative monetary policy in a two country general equilibrium model where international economic integration is endogenised through firm-level heterogeneity and monopolistic competition. Economic integration between countries is a source of policy competition, generating higher long-run inflation, and increased gains from monetary cooperation.
    Keywords: Price levels ; Macroeconomics - Econometric models
    Date: 2012
  7. By: Simplice A , Asongu
    Abstract: A spectre is hunting embryonic African monetary zones: the EMU crisis. The introduction of common currencies in West and East Africa is facing stiff challenges in the timing of monetary convergence, the imperative of bankers to apply common modeling and forecasting methods of monetary policy transmission, as well as the requirements of common structural and institutional characteristics among candidate states. Inspired by the premise of the EMU crisis, this paper assesses real and monetary policy convergence within the proposed WAM and EAM zones. In the analysis, monetary policy targets inflation and financial dynamics of depth, efficiency, activity and size while real sector policy targets economic performance in terms of GDP growth at macro and micro levels. Findings suggest overwhelming lack of convergence; an indication that candidate countries still have to work towards harmonizing cross-country differences in fundamental, structural and institutional characteristics that hamper the convergence process.
    Keywords: Currency Area; Convergence; Policy Coordination; Africa
    JEL: F15 F42 O55 F36 P52
    Date: 2012–01–19
  8. By: Marcel Fratzscher
    Abstract: The empirical analysis in the paper suggests that an FX policy objective and concerns about an overheating of the domestic economy have been the two main motives for the (re-)introduction and persistence of capital controls over the past decade. Capital controls are strongly associated with countries having significantly undervalued currencies. Capital controls also appear to be less motivated by worries about financial market volatility or fickle capital flows per se, but rather by concerns about capital inflows triggering an overheating of the economy – in the form of high credit growth, rising inflation and increased output volatility. Moreover, countries with a high level of capital controls, and those actively implementing controls, tend to be those that have fixed exchange rate regimes, a non-IT monetary policy framework and shallow financial markets. This evidence is consistent with capital controls being used, at least in part, to compensate for the absence of autonomous macroeconomic and prudential policies and effective adjustment mechanisms for dealing with capital flows.
    Date: 2011–12
  9. By: Mubariz Hasanov (Hacettepe University, Department of Economics); Tolga Omay (Cankaya University, Department of International Trade Management)
    Abstract: In this paper, we examine causal relationships among inflation rate, output growth rate, inflation uncertainty and output uncertainty for ten Central and Eastern European transition countries. For this purpose, we estimate a bivariate GARCH model that includes output growth and inflation rates for each country. Then we use conditional standard deviations of inflation and output to proxy nominal and real uncertainty, respectively, and perform Granger-causality tests. Our results suggest that inflation rate induces uncertainty about both inflation rate and output growth rate, which is detrimental for real economic activity. On the other hand, we find that output growth rate reduces macroeconomic uncertainty. In addition, we also examine and discuss causal relationships among remaining variables.
    Keywords: Inflation; Output growth; Uncertainty; Granger-Causality Tests; Transition Countries
    JEL: C32 C51 C52 E10 E30
    Date: 2012
  10. By: Jeffrey C. Fuhrer; Giovanni P. Olivei; Geoffrey M. B. Tootell
    Abstract: This paper discusses the likely evolution of U.S. inflation in the near and medium term on the basis of (1) past U.S. experience with very low levels of inflation, (2) the most recent Japanese experience with deflation, and (3) recent U.S. micro evidence on downward nominal wage rigidity. Our findings question the view that stable long-run inflation expectations and downward nominal wage rigidity will provide sufficient support to prices such that deflation can be avoided. We show that an inflation model fitted on Japanese data over the past 20 years, which accounts for both short- and long-run inflation expectations, matches the recent U.S. inflation experience quite well. While the model indicates that U.S. inflation might be subject to a lower bound, it does not rule out a prolonged period of mild deflation going forward. In addition, our micro evidence on wages suggests no obvious downward rigidity in the firm's wage costs, downward rigidity in individual wages notwithstanding. As a consequence, downward nominal wage rigidity may provide little offset to deflationary pressures in the current U.S. situation, despite some circumstantial evidence that this channel might have been at work in the past.
    Keywords: Inflation (Finance) ; Deflation (Finance) ; Deflation (Finance) - Japan
    Date: 2011
  11. By: Jakub Rysanek; Jaromir Tonner; Osvald Vasicek
    Abstract: As the global economy seems to be recovering from the 2009 financial crisis, we find it desirable to look back and analyze the Czech economy ex post. We work with a Swedish New Keynesian model of a small open economy which embeds financial frictions in light of the financial accelerator literature. Without explicitly modeling the banking sector, this model serves as a tool for understanding how a negative financial shock may spread to the real economy and how monetary policy may react. We use Bayesian techniques to estimate the model parameters to adjust the model structure closer to the evidence stemming from Czech data. Our attention focuses on a set of experiments in which we generate ex post forecasts of the economy prior to the 2009 crisis and illustrate that the monetary policy response to an upcoming crisis implied by the model with financial frictions is stronger on account of an increasing interest rate spread.
    Keywords: Bayesian methods, financial frictions.
    JEL: C53 E32 E37
    Date: 2011–12
  12. By: Aysen Arac (Hacettepe University, Department of Economics); Funda Telatar (Hacettepe University, Department of Economics); Erdinc Telatar (Hacettepe University, Department of Economics)
    Abstract: This study investigates the relationship between the rate of inflation and the degree of the currency substitution for Turkey during 1986-2006. Our results show that the correlation coefficient between the two variables has not been constant over time. The results of the Multivariate GARCH model estimated to obtain the correlation coefficients indicate that there is a nonlinear relationship between the inflation rate and the degree of currency substitution. The main policy implication of our study is that it is difficult to stop or to reverse the currency substitution unless a confidence in the domestic currency is established.
    Keywords: Currency substitution; M-GARCH
    JEL: F31 C32
    Date: 2012
  13. By: Arvind Krishnamurthy; Stefan Nagel; Dmitry Orlov
    Abstract: We measure the repo funding extended by money market funds (MMF) and securities lenders to the shadow banking system, including quantities, haircuts, and repo rates by type of underlying collateral. We find that repo played only a small role in funding private sector assets prior to the crisis, as most repos are backed by Treasury and Agency collateral. Repo with private sector collateral contracts during the crisis, but the magnitude is relatively insignificant compared with the contraction in asset-backed commercial paper (ABCP). While relatively small in aggregate, the contraction in repo particularly affected key dealer banks with large exposures to private sector securities, which then had knock-on effects on security markets, and led these dealer banks to resort to the Fed's emergency lending programs. We also find that haircuts in MMF-to-dealer repo rise less than the dealer-to-dealer or dealer-to-hedge fund repo haircuts reported in earlier papers. This finding suggests that the contraction in repo led dealers to take defensive actions, given their own capital and liquidity problems, raising credit terms to their borrowers. The picture that emerges from these findings looks less like a traditional bank run of depositors and more like a credit crunch among dealer banks.
    JEL: G01 G21 G24
    Date: 2012–01
  14. By: Simplice A, Asongu
    Abstract: A major lesson of the EMU crisis is that serious disequilibria result from regional monetary arrangements not designed to be robust to a variety of shocks. The purpose of this paper is to assess these disequilibria within the CEMAC, UEMOA and CFA zones. In the assessments, monetary policy targets inflation and financial dynamics of depth, efficiency, activity and size while real sector policy targets economic performance in terms of GDP growth. We also provide the speed of convergence and time required to achieve a 100% convergence. But for financial intermediary size within the CFA zone, findings for the most part support only unconditional convergence. There is no form of convergence within the CEMAC zone. The broad insignificance of conditional convergence results have substantial policy implications. Monetary and real policies which are often homogenous for member states are thwarted by heterogeneous structural and institutional characteristics which give rise to different levels and patterns of financial intermediary development. Therefore member states should work towards harmonizing cross-country differences in structural and institutional characteristics that hamper the effectiveness of monetary policies.
    Keywords: CFA Zone; Currency Area; Convergence; Policy Coordination
    JEL: F15 F42 O55 F36 P52
    Date: 2012–01–19
  15. By: Engler, Philipp
    Abstract: After an expansionary monetary policy shock employment increases and unemployment falls. In standard New Keynesian models the fall in aggregate unemployment does not affect employed workers at all. However, Lüchinger, Meier and Stutzer (2010) found that the risk of unemployment negatively affects utility of employed workers: An increases in aggregate unemployment decreases workers' subjective well-being, which can be explained by an increased risk of becoming unemployed. I take account of this effect in an otherwise standard New Keynesian open economy model with unemployment as in Galí (2010) and find two important results with respect to expansionary monetary policy shocks: First, the usual wealth effect in New Keynesian models of a declining labor force, which is at odds with the data as highlighted by Christiano, Trabandt and Walentin (2010), is shut down. Second, the welfare effects of such shocks improve considerably, modifying the standard results of the open economy literature that set off with Obstfeld and Rogoff's (1995) redux model. --
    Keywords: open economy macroeconomics,monetary policy,unemployment
    JEL: E24 E52 F32 F41
    Date: 2011
  16. By: Yoshiko Nagano
    Abstract: This paper aims to map the emergence and development of modern banking system in the Philippines during the American colonial period. First, the Philippine foreign trade structure under American rule is briefly surveyed. Second, the process of the enactment of various banking laws and the characteristics of such laws are examined. Third, the emergence and development of the modern banking sector is traced to their important beginnings and tracked in their later stages, and fourth, the roles of foreign exchange banks, commercial banks, and government banks in the export economy are discussed through a critical consideration of certain and exemplary case studies.
    Date: 2011–12
  17. By: Yoshiko Nagano
    Abstract: This paper examines the distinctive features of the Philippine National Bank, particularly through its lending practices in agriculture. First by examining the enactment and revision of the National Bank Act, the Bank's characteristics as an organization and operations are discussed. Second, the process by which the Bank began its operations and administration of agricultural loans is traced. Third, the 1918 dispute over lending in agriculture is depicted as a striking example of the nature of its banking operations, before presenting the dual structure of agricultural loans provided by the National Bank as the conclusion.
    Date: 2011–12
  18. By: Jimenez Porras, G.; Ongena, S.; Peydro, J.L.; Saurina, J. (Tilburg University, Center for Economic Research)
    Abstract: Abstract: Banking crises involve periods of persistently low credit and economic growth. Banks’ balance sheets are then weak but so are those of non-financial corporate borrowers. Hence, a crucial question is whether credit growth is low due to supply or to demand factors. However convincing identification has been elusive due to a lack of detailed loan application-, bank-, and firm-level data. Access to a dataset of loan applications in Spain that is matched with complete bank and firm balance-sheet data covering the period from 2002 to 2010 allows us to identify bank and firm balancesheet channels. We find robust evidence showing that bank balance-sheet strength determines the success of loan applications and the granting of loans in crisis times. The heterogeneity in firm balance-sheet strength determines loan granting in both good and crisis times, although the potency of this firm balance-sheet channel is the largest in the latter period. Our findings therefore hold important implications for both theory and policy.
    Keywords: bank lending channel;credit supply;business cycle;credit crunch;capital;liquidity.
    JEL: E32 E44 E5 G21 G28
    Date: 2012
  19. By: Driffill, John (Birkbeck, University of London); Miller, Marcus (University of Warwick)
    Abstract: When financial markets freeze in fear, borrowing costs for solvent governments may fall towards zero in a flight to quality – but credit-worthy private borrowers can be starved of external funding. In Kiyotaki and Moore (2008), where liquidity crisis is captured by the effective rationing of private credit, tightening credit constraints have direct effects on investment. If prices are sticky, the effects on aggregate demand can be pronounced – as reported by FRBNY for the US economy using a calibrated DSGE-style framework modified to include such frictions. In such an environment, two factors stand out. First the recycling of credit flows by central banks can dramatically ease credit-rationing faced by private investors: this is the rationale for Quantitative Easing. Second, revenue-neutral fiscal transfers aimed at would-be investors can have similar effects. We show these features in a stripped- down macro model of inter-temporal optimisation subject to credit constraints.
    Keywords: Credit Constraints; Temporary Equilibrium; Liquidity Shocks
    Date: 2011
  20. By: Viral V. Acharya; Nada Mora
    Abstract: Can banks maintain their advantage as liquidity providers when they are heavily exposed to a financial crisis? The standard argument - that banks can - hinges on deposit inflows that are seeking a safe haven and provide banks with a natural hedge to fund drawn credit lines and other commitments. We shed new light on this issue by studying the behavior of bank deposit rates and inflows during the 2007-09 crisis. Our results indicate that the role of the banking system as a stabilizing liquidity insurer is not one of the passive recipient, but of an active seeker, of deposits. We find that banks facing a funding squeeze sought to attract deposits by offering higher rates. Banks offering higher rates were also those most exposed to liquidity demand shocks (as measured by their unused commitments, wholesale funding dependence, and limited liquid assets), as well as with fundamentally weak balance-sheets (as measured by their non-performing loans or by subsequent failure). Such rate increases have a competitive effect in that they lead other banks to offer higher rates as well. Overall, the results present a nuanced view of deposit rates and flows to banks in a crisis, one that reflects banks not just as safety havens but also as stressed entities scrambling for deposits.
    Date: 2011

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