nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒04‒17
23 papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Currency Momentum Strategies By Lukas Menkhoff; Lucio Sarno; Maik Schmeling; Andreas Schrimpf
  2. The financial accelerator and monetary policy rules By Günes Kamber; Christoph Thoenissen
  3. Inflation Targeting and Financial Stability By Michael Woodford
  4. Inflation Forecast Contracts By Gersbach, Hans; Hahn, Volker
  5. "Control of Finance as a Prerequisite for Successful Monetary Policy: A Reinterpretation of Henry Simons's Rules versus Authorities in Monetary Policy" By Thorvald Grung Moe
  6. On Introduction of Sound Money By Volodymyr Vysochansky
  7. "Shadow Banking and the Limits of Central Bank Liquidity Support: How to Achieve a Better Balance between Global and Official Liquidity" By Thorvald Grung Moe
  8. The Macroeconomic Effects of Reserve Requirements By Glocker, Ch.; Towbin P.
  9. The bank lending channel of monetary policy transmission: evidence from an emerging aarket, India By Saumitra, Bhaduri; Toto, Goyal
  10. Capital Controls with International Reserve Accumulation: Can this Be Optimal ? By Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
  11. Monetary Transmission in Pakistan: The Balance Sheet Channel By Shabbir, Safia
  12. Design and Implementation of a Common Currency Area in the East African Community By Thomas Kigabo RUSUHUZWA; Paul Robert MASSON
  13. The natural rate of interest in a small open economy By Fernando de Holanda Barbosa
  14. Central banks under German rule during World War II: The case of Norway By Harald Espeli
  15. Assessing uncertainty in Europe and the US: is there a common uncertainty factor? By Sauter, Oliver
  16. Properties of Foreign Exchange Risk Premiums By Lucio Sarno; Paul Schneider; Christian Wagner
  17. Can the exchange rate, inflation and domestic risk factors be overlooked in international asset pricing? By Begoña Font Belaire
  18. Asymmetric information in credit markets, bank leverage cycles and macroeconomic dynamics By Ansgar Rannenberg
  19. A note on excess money growth and inflation dynamics: evidence from threshold regression By Saumitra, Bhaduri; Raja, Sethudurai
  20. Inflation and Unit Labor Cost By Robert G. King; Mark W. Watson
  21. The Yen Real Exchange Rate May Not Be Stationary After All: New Evidence from Non-linear Unit-Root Tests By Hyeongwoo Kim; Young-Kyu Moh
  22. The economic and monetary union countries vs. the global crisis By Kowalski, Tadeusz
  23. Banking Bubbles and Financial Crisis By Jianjun Miao; PENGFEI WANG

  1. By: Lukas Menkhoff (Department of Economics, Leibniz Universitätt Hannover, Germany); Lucio Sarno (Faculty of Finance, Cass Business School, City University London, UK; Centre for Economic Policy Research (CEPR), UK; The Rimini Centre for Economic Analysis (RCEA), Italy); Maik Schmeling (Department of Economics, Leibniz Universitätt Hannover, Germany); Andreas Schrimpf (Bank for International Settlements, Switzerland)
    Abstract: We provide a broad empirical investigation of momentum strategies in foreign exchange markets. We find a signicant cross-sectional spread in excess returns of up to 10% p.a. between past winner and loser currencies. This spread in excess returns is not explained by traditional risk factors and shows behavior consistent with investor over- and under-reaction. Moreover, currency momentum is mostly driven by return continuation in spot rates and has very different properties from the widely studied carry trade. However, there seem to be very effective limits to arbitrage which prevent momentum returns from being easily exploitable in foreign exchange markets.
    Keywords: Momentum returns, Limits to Arbitrage, Idiosyncratic Volatility, Carry Trades
    JEL: F31 G12 G15
    Date: 2012–03
  2. By: Günes Kamber; Christoph Thoenissen (Reserve Bank of New Zealand)
    Abstract: The ability of financial frictions to amplify the output response of monetary policy, as in the financial accelerator model of Bernanke et al (1999), is analysed for a wider class of policy rules where the policy interest rate responds to both inflation and the output gap. When policy makers respond to the output gap as well as inflation, the standard financial accelerator model reacts less to an interest rate shock than does a comparable model without an operational financial accelerator mechanism. In recessions, when firm-specific volatility rises, financial acceleration due to financial frictions is further reduced, even under pure inflation targeting.
    JEL: E32 E52
    Date: 2012–02
  3. By: Michael Woodford
    Abstract: A number of commentators have argued that the desirability of inflation targeting as a framework for monetary policy analysis should be reconsidered in light of the global financial crisis, on the ground that it requires neglect of the implications of monetary policy for financial stability. This paper argues that monetary policy may indeed affect the severity of risks to financial stability, but that it is possible to generalize an inflation targeting framework to take account of financial stability concerns alongside traditional stabilization objectives. The resulting framework can still be viewed as a form of flexible inflation targeting; in particular, the paper proposes a target criterion that would still imply an invariant long-run price level, despite fluctuations over time in risks to financial stability or even the occurrence of occasional financial crises.
    JEL: E52
    Date: 2012–04
  4. By: Gersbach, Hans; Hahn, Volker
    Abstract: We introduce a new type of incentive contract for central bankers: inflation forecast contracts, which make central bankers’ remunerations contingent on the precision of their inflation forecasts. We show that such contracts enable central bankers to influence inflation expectations more effectively, thus facilitating more successful stabilization of current inflation. Inflation forecast contracts improve the accuracy of inflation forecasts, but have adverse consequences for output. On balance, paying central bankers according to their forecasting performance improves welfare. Optimal inflation forecast contracts stipulate high rewards for accurate forecasts.
    Keywords: central banks; incentive contracts; inflation forecast targeting; inflation targeting; intermediate targets; transparency
    JEL: E58
    Date: 2012–04
  5. By: Thorvald Grung Moe
    Abstract: Henry Simons's 1936 article "Rules versus Authorities in Monetary Policy" is a classical reference in the literature on central bank independence and rule-based policy. A closer reading of the article reveals a more nuanced policy prescription, with significant emphasis on the need to control short-term borrowing; bank credit is seen as highly unstable, and price level controls, in Simons's view, are not be possible without limiting banks' ability to create money by extending loans. These elements of Simons's theory of money form the basis for Hyman P. Minsky's financial instability hypothesis. This should not come as a surprise, as Simons was Minsky's teacher at the University of Chicago in the late 1930s. I review the similarities between their theories of financial instability and the relevance of their work for the current discussion of macroprudential tools and the conduct of monetary policy. According to Minsky and Simons, control of finance is a prerequisite for successful monetary policy and economic stabilization.
    Keywords: Monetary Policy; Financial Stability; Narrow Banking; Financial Regulation
    JEL: B22 E42 E52 G28
    Date: 2012–04
  6. By: Volodymyr Vysochansky (Uzhhorod University)
    Abstract: World financial crisis unveiled the precarious position of modern monetary system based on a centralized fiat money supply and fractional-reserve banking. The scale of the crisis and the threat of major inflation, which has already become a reality on commodities markets, confirm the instability of the monetary system. In order to define weak spots of the system and consider possible solutions on how to address them it is necessary to revise the nature of its elements, and in particular of money. The paper is devoted to the issues of money with commodity backing and approaches of its introduction. Model of self-adjusting money creation/redemption based on ETF technology and respective stock and commodity exchange infrastructure is proposed as an incentive to stimulate discussion about potential improvement of the modern monetary system.
    Keywords: money, commodities, exchange-traded funds, monetary system regulation
    JEL: E4 E5 G1
    Date: 2012–03–27
  7. By: Thorvald Grung Moe
    Abstract: Global liquidity provision is highly procyclical. The recent financial crisis has resulted in a flight to safety, with severe strains in key funding markets leading central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot's advice to "lend freely at high rates against good collateral" has been stretched to the limit in order to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask, How elastic should the supply of central bank currency be? Even when the central bank has the ability to create abundant official liquidity, there should be some limits to its support for the financial sector. Traditionally, the misuse of the fiat money privilege has been limited by self-imposed rules that central bank loans must be fully backed by gold or collateralized in some other way. But since the onset of the crisis, we have seen how this constraint has been relaxed to accommodate the demand for market support. My suggestion is that there has to be some upper limit, and that we should work hard to find guidelines and policies that can limit the need for central bank liquidity support in future crises. In this paper, I review the recent expansion of central bank liquidity support during the crisis, before discussing the collateral polices related to central banks' lender-of-last-resort and market-maker-of-last-resort policies and their rationale. I then examine the relationship between the central bank and the treasury, and the potential threat to central bank independence if they venture into too much risky balance sheet expansion. A discussion about the exceptional growth of the shadow banking system follows. I introduce the concept of "liquidity illusion" to describe the fragility upon which much of the sector is based, and note that market growth has been based largely on a "fair-weather" view that central banks will support the market on rainy days. I argue that we need a better theoretical framework to understand the growth in the shadow banking system and the role of central banks in providing liquidity in a crisis. Recently, the concept of "endogenous finance" has been used to explain the strong procyclical tendencies of the global financial system. I show that this concept was central to Hyman P. Minsky's theory of financial instability, and suggest that his insights should be integrated into the ongoing search for a better theoretical framework for understanding the growth of the shadow banking system and how we can limit official liquidity support for this system. I end the paper with a summary and a discussion of some of the policy issues. I note that the Basel III "package" will hopefully reduce the need for central bank liquidity support in the future, but suggest that further structural reforms of the financial sector are needed to ease the tension between freewheeling private credit expansion and the limited ability or willingness of central banks to provide unlimited official liquidity support in a future crisis.
    Keywords: Financial Regulation; Financial Stability; Monetary Policy; Central Bank Policy
    JEL: E44 E52 E58 G28
    Date: 2012–04
  8. By: Glocker, Ch.; Towbin P.
    Abstract: Monetary authorities in emerging markets are often reluctant to raise interest rates when dealing with credit booms driven by capital inflows, as they fear that an increase attracts even more capital and appreciates the currency. A number of countries therefore use reserve requirements as an additional policy instrument. The present study provides evidence on their macroeconomic effects. We estimate a vector autoregressive (VAR) model for the Brazilian economy and identify interest rate and reserve requirement shocks. For both instruments a discretionary tightening leads to a decline in domestic credit. We find, however, very different effects for other macroeconomic aggregates. In contrast to interest rate policy, a positive reserve requirement shock leads to an exchange rate depreciation and an improvement in the current account, but also to an increase in prices. The results suggest that reserve requirement policy can complement interest rate policy in pursuing a financial stability objective, but cannot be its substitute with regards to a price stability objective.
    Keywords: Reserve Requirements, Capital flows, Monetary Policy, Business Cycle.
    JEL: E58 E52 F32 F41
    Date: 2012
  9. By: Saumitra, Bhaduri; Toto, Goyal
    Abstract: This study analyzes the monetary policy transmission in India with the help of bank lending channel hypothesis. We test the shift in loan supply emanating from the changes in the prime policy rate used by the Reserve Bank of India. Using yearly bank balance sheet data from 1996 to 2007, the paper provides evidence of an operational BLC in India. Further, segregating banks by asset size and liquidity, we find that small, illiquid banks are more affected by policy changes, and the effect is more pronounced in areas of non-priority sector lending. Finally, the domestically owned banks are more sensitive to policy rate changes vis-à-vis foreign banks.
    Keywords: Bnak lending Channel India
    JEL: G38
    Date: 2012–04–10
  10. By: Philippe Bacchetta; Kenza Benhima; Yannick Kalantzis
    Abstract: Motivated by the Chinese experience, we analyze a semi-open economy where the central bank has access to international capital markets, but the private sector has not. This enables the central bank to choose an interest rate different from the international rate. We examine the optimal policy of the central bank by modelling it as a Ramsey planner who can choose the level of domestic public debt and of international reserves. The central bank can improve savings opportunities of credit-constrained consumers modelled as in Woodford (1990). We find that in a steady state it is optimal for the central bank to replicate the open economy, i.e., to issue debt financed by the accumulation of reserves so that the domestic interest rate equals the foreign rate. When the economy is in transition, however, a rapidly growing economy has a higher welfare without capital mobility and the optimal interest rate differs from the international rate. We argue that the domestic interest rate should be temporarily above the international rate. We also find that capital controls can still help reach the first best when the planner has more fiscal instruments.
    Keywords: reserve accumulation; capital controls; Ramsey planner; credit constraints
    JEL: E58 F36 F41
    Date: 2011–12
  11. By: Shabbir, Safia
    Abstract: Using data of non-financial listed firms over a period of 1999-2010, this paper investigates the effectiveness of balance sheet channel in monetary transmission mechanism in Pakistan. By classifying firms as SME and large, this paper finds a strong evidence for the existence of net worth channel in Pakistan. A tight monetary policy worsens the net worth of both the SME and large firms, with SME getting more hit thereby further affecting their cash flows, short-term borrowing, and revenues.
    Keywords: Monetary Policy; Monetary Transmission; Firm; Models with Panel Data
    JEL: E52 E50 C33 H32
    Date: 2012–04–02
  12. By: Thomas Kigabo RUSUHUZWA; Paul Robert MASSON
    Abstract: The East African Community (EAC) has fast-tracked its plans to create a single currency for the five countries making up the region, and hopes to conclude negotiations on a monetary union protocol by the end of 2012. While the benefits of lower transactions costs from a common currency may be significant, countries will also lose the ability to use monetary policy to respond to different shocks. Evidence presented shows that the countries differ in a number of respects, facing asymmetric shocks and different production structures. Countries have had difficulty meeting convergence criteria, most seriously as concerns fiscal deficits. Preparation for monetary union will require effective institutions for macroeconomic surveillance and enforcing fiscal discipline, and euro zone experience indicates that these institutions will be difficult to design and take a considerable time to become effective. This suggests that a timetable for monetary union in the EAC should allow for a substantial initial period of institution building. In order to have some visible evidence of the commitment to monetary union, in the meantime the EAC may want to consider introducing a common basket currency in the form of notes and coin, to circulate in parallel with national currencies.
    Keywords: EAC monetary union, fiscal surveillance, optimum currency areas, parallel currencies, regional integration
    JEL: E42 E58 E61 F33 F55
    Date: 2012–04–04
  13. By: Fernando de Holanda Barbosa (FGV)
    Abstract: The goal of this paper is to show that the natural rate of interest in a small open economy, with access to the world capital markets, is equal to the international real rate of interest. We show this property by using the infinitely-lived overlapping generations model and we use this model to analyze both fixed and flexible exchange rate regimes.
    Keywords: small open economy; natural rate of interest; complete and incomplete asset markets
    JEL: F41
    Date: 2011
  14. By: Harald Espeli (Norges Bank (Central Bank of Norway))
    Abstract: Until the German invasion of Norway 9 April 1940 the Norwegian central bank had been one of the most independent in Western Europe. This article investigates the agency of the Norwegian central bank during the German occupation and compares it with central banks in other German occupied countries. The Norwegian central bank seems to have been more accommodating to German wishes and demands than the central banks in other German occupied countries in Western Europe.
    Keywords: Central banks, World War II, German occupation, Norway
    JEL: H56 N44 N94
    Date: 2012–03–20
  15. By: Sauter, Oliver
    Abstract: This paper is an empirical investigation of uncertainty in the Euro Zone as well as the US. It conducts a factor analysis of uncertainty measures starting in 2001 until the end of 2011. For this purpose I use survey-based data provided by the ECB and the Federal Reserve Bank of Philadelphia as well as the stock market indices VSTOXX and VIX, both measures of implied volatility of stock market movements. Each measure shows an increase in uncertainty during the last years marked by the financial turmoil. Given the rise in uncertainty, the question arises whether this uncertainty is driven by the same underlying forces. For the Euro Zone, I show that uncertainty can be separated into driving forces of short and long-term uncertainty. In the US there is a sharp distinction between uncertainty that drives stock market and “real” variables on the one hand and inflation (short and long-term) on the other hand. Combing both data sets, factor analysis delivers (1) an international stock market factor, (2) a common European uncertainty factor and (3) an US-inflation uncertainty factor.
    Keywords: monetary policy; uncertainty; survey forecast; forecast disagreement; factor analysis
    JEL: E5 E3
    Date: 2012–03
  16. By: Lucio Sarno (Faculty of Finance, Cass Business School, City University London, UK; Centre for Economic Policy Research (CEPR), UK; The Rimini Centre for Economic Analysis (RCEA), Italy); Paul Schneider (Finance Group, Warwick Business School, University of Warwick, UK); Christian Wagner (Institute for Finance, Banking and Insurance, Vienna University of Economics and Business, Austria)
    Abstract: We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating affine (multi-currency) term structure models reveals a noticeable tradeoff between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global affine model generate unbiased predictions for currency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals.
    Keywords: term structure; exchange rates; forward bias; predictability
    JEL: F31 E43 G10
    Date: 2012–03
  17. By: Begoña Font Belaire (Universitat de València)
    Date: 2012–03
  18. By: Ansgar Rannenberg (Deutsche Bundesbank, Economics Department)
    Abstract: The paper adds a moral hazard problem between banks and depositors as in Gertler and Karadi (2011) to a DSGE model with a costly state verification problem between entrepreneurs and banks as in Bernanke, Gertler and Girlchrist (1999, BGG). This modification amplifies the response of the external finance premium and the overall economy to monetary policy and productivity shocks. It allows the model to match the volatility and correlation with output of the external finance premium, bank leverage, entrepreneurial leverage and other variables in US data better than a BGG-type model. A reasonably calibrated simulation of a bank balance sheet shock produces a downturn of a magnitude similar to the "Great Recession".
    Keywords: Financial accelerator, bank leverage, DSGE model
    JEL: E44 G21
    Date: 2012–04
  19. By: Saumitra, Bhaduri; Raja, Sethudurai
    Abstract: We test the effect of excess money growth on inflation using Threshold Regression technique developed by Hansen (2000). The empirical test is conducted using annual data from India for the period from 1953-54 to 2007-08. The results clearly exhibits that the relationship is not linear and without a strong credit growth, excess money growth has lesser inflationary effects.
    Keywords: Excess Money Growth; Quantity Theory of Money; Inflation and Threshold Regression
    JEL: E51
    Date: 2012–04–11
  20. By: Robert G. King (Boston University, Department of Economics); Mark W. Watson (Department of Economics and Woodrow Wilson School, Princeton University)
    Abstract: We study two decompositions of inflation, , motivated by a New Keynesian Pricing Equation. The first uses four components: lagged , expected future , real unit labor cost ( ), and a residual. The second uses two components: fundamental inflation (discounted expected future ) and a residual. We find large low-frequency differences between actual and fundamental inflation. From 1999-2011 fundamental inflation fell by more than 15 percentage points, while actual inflation changed little. We discuss this discrepancy in terms of the data (a large drop in labor's share of income) and through the lens of a canonical structural model (Smets-Wouters (2007)).
    Date: 2012–01
  21. By: Hyeongwoo Kim; Young-Kyu Moh
    Abstract: Researchers have encountered difficulties in finding empirical evidence of Purchasing Power Parity (PPP) especially when conventional linear unit root tests are employed for the Japanese yen real exchange rate. Chortareas and Kapetanios (2004), however, report strong evidence in favor of a Balassa-Samuelson type model of PPP by applying a nonlinear unit root test by Kapetanios et al. (2003) for the other G7 and Asian currencies relative to the Japanese yen, claiming that the yen real exchange rate may be (trend) stationary. We question the validity of this remark. First, we note that their claim is upset when we extend the data until 2008 even when the same nonlinear unit root test is used. Second, we apply the inf-t test by Park and Shintani (2005, 2010) which does not require the Taylor approximation, and find strong evidence against nonstationarity for most yen real exchange rates. Our results also corroborate the findings of Kim and Moh (2010) who report a possibility of misspecification problems with the use of Taylor-approximation based tests.
    Date: 2012–04
  22. By: Kowalski, Tadeusz
    Abstract: The global financial and economic crisis revealed institutional weaknesses and structural problems of particular Economic and Monetary Union (EMU) countries. The crisis and slowdown that followed had an impact on their relative competitiveness. Financial and economic turbulences of recent years shed new light on the scale and scope of interdependences in the world economy. They uncovered economic and institutional flaws of the very EMU itself. The paper focuses on EMU countries real sector reactions to the financial disturbances. Both comparative static and dynamic approaches are used in order to assess the scope and pace of adjustments triggered by the global crisis.
    Keywords: financial crisis; competitiveness; Economic and Monetary Union
    JEL: F34 F14 F33 F43 F40 F42 E32 F41
    Date: 2012–02–14
  23. By: Jianjun Miao (Department of Economics, Boston University, CEMA, Central University of Finance and Economics, and AFR, Zhejiang University); PENGFEI WANG (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.)
    Abstract: This paper develops a macroeconomic model with a banking sector in which banks face endogenous borrowing constraints. There is no uncertainty about economic fundamentals. Banking bubbles can emerge through a positive feedback loop mechanism. Changes in household confidence can cause the collapse of bubbles, resulting in a financial crisis. Credit policy can mitigate economic downturns but also incur an efficiency loss. Bank capital requirements can prevent the formation of banking bubbles by limiting leverage. But a too restrictive requirement leads to less lending and hence less production.
    Keywords: Banking Bubble, Multiple Equilibria, Financial Crisis, Self-ful?lling Prophecy, Credit Policy, Capital Requirements, Borrowing Constraints
    JEL: E2 E44 G01 G20
    Date: 2012–01

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