nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒05‒08
sixteen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Asymmetric monetary policy rules for open economies: Evidence from four countries By Caglayan, Mustafa; Jehan, Zainab; Mouratidis, Kostas
  2. Monetary policy and the flow of funds in the euro area By Riccardo Bonci
  3. The Information Content of Central Bank Minutes By Apel, Mikael; Blix Grimaldi, Marianna
  4. Monetary Transmission and the Search for Liquidity By Victor E. Li
  5. Output Gaps and Robust Monetary Policy Rules By Billi, Roberto M.
  6. Volatility Transmission in Emerging European Foreign Exchange Markets By Evzen Kocenda; Vit Bubak; Filip Zikes
  7. Regional Effects of Monetary Policy in Sweden By Svensson, Emma
  8. Liquidity, Term Spreads and Monetary Policy By Yunus Aksoy; Henriqu S Basso
  9. Real Wages and Monetary Policy: A DSGE Approach By Bryan Perry; Kerk L. Phillips; David E. Spencer
  10. A simple empirical measure of central banks' conservatism By Levieuge, Grégory; Lucotte, Yannick
  11. The monetary growth order By G\"unter von Kiedrowski; E\"ors Szathm\'ary
  12. Propping up Europe? By Jean Pisani-Ferry; Guntram B. Wolff
  13. Financial Architecture and the Monetary Transmission Mechanism in Tanzania By Peter Montiel; Christopher Adam; Wilfred Mbowe; Stephen O’Connell
  14. Modelling the liquidity ratio as macroprudential instrument By Jan Willem van den End; Mark Kruidhof
  15. The failure of financial macroeconomics and what to do about it By Chatelain, Jean-Bernard; Ralf, Kirsten
  16. "Introduction to an Alternative History of Money" By L. Randall Wray

  1. By: Caglayan, Mustafa; Jehan, Zainab; Mouratidis, Kostas
    Abstract: This study presents an analytical framework to examine the policy reaction function of a central bank in an open economy context while allowing for asymmetric preferences. The paper then empirically examines the policy rule obtained from this framework using quarterly data for the US, Canada, Japan, and the UK. The results, based on GMM approach, provide evidence that domestic policy is affected by changes in the foreign interest rate and exchange rate. We also provide evidence of the presence of asymmetries in response to the inflation rate and output gap for all the sample countries.
    Keywords: Monetary policy rule; asymmetric preferences; open economy
    JEL: E58 E52 F41
    Date: 2012–04–26
  2. By: Riccardo Bonci (Bank of 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 rates on the lending and borrowing activity in different economic sectors. We exploit the information content of the flow-of-funds statistics, providing the best framework to analyse the flow of funds from lenders to borrowers. After estimating a small VAR for the euro area, we extend the benchmark model with the flow-of-funds series, analysing the response of these variables to a contractionary monetary policy shock. We find that the policy tightening is followed by a worsening of the budget deficit, firms cut down on their demand for bank loans, partially replacing them with inter-company loans, and draw on their liquidity to try to offset the fall in revenue associated with the slowdown in economic activity, while households increase precautionary saving in the short run. Consistent with the bank lending channel of monetary policy, the interest rate hike is followed by a short-run deceleration in credit growth, mainly driven by the response of banks.
    Keywords: euro area, monetary policy, flow of funds, credit growth.
    JEL: E32 E4 E52 G11
    Date: 2012–03
  3. By: Apel, Mikael (Monetary Policy Department, Central Bank of Sweden); Blix Grimaldi, Marianna (Monetary Policy Department, Central Bank of Sweden)
    Abstract: One characteristic feature of central banks today is that policy decisions are almost exclusively made by a committee rather than by a single policy maker. Another is that central banks are considerably more transparent than they used to be. Together, this has brought to the fore an important but so far unresolved issue: to what extent should a central bank’s communication reflect the full spectrum of opinions among its committee members? Does information on all members’ views make monetary policy easier to understand and predict, or does it make it harder? We address this issue by employing a novel method. We measure the sentiment and tone of the minutes of the Swedish central bank using an automated content analysis that converts the qualitative information in the minutes to a quantitative measure. We find that this measure is useful in predicting future policy rate decisions.
    Keywords: Central Bank Communication; Minutes; Content Analysis
    JEL: D71 D83 E52 E58
    Date: 2012–04–01
  4. By: Victor E. Li (Department of Economics and Statistics, Villanova School of Business, Villanova University)
    Abstract: This paper evaluates the implications of search and matching frictions in the financial market for the transmission of monetary policy. Borrowers and lenders participate in a decentralized loan market for the purpose of establishing long-term credit relationships and the provision of loanable funds to productive firms. Locating credit relationships is costly in terms of time and real resources and the interest rate is negotiated via a bargaining mechanism. This structure is incorporated into an otherwise standard monetary business cycle framework and used to study how such frictions in the credit market contribute to explaining the contemporaneous impact and propagation of monetary growth shocks and inflation. It is found that while anticipated inflation negatively impacts real activity it can also increase loan market participation and the inflow of newly established credit relationships. It is shown that while bargaining and costly search mitigate the traditional inflation tax effect of monetary injections, the existence of long term lending relations tend to dampen the immediate liquidity effects. The model also indicates that there may not necessarily exist a negative correlation between credit market tightness and aggregate activity. Furthermore, search frictions provide a potentially important mechanism for explaining the persistence of monetary shocks, an issue that has been problematic in limited participation models of the transmission mechanism.
    Keywords: Firms; Search Model, Financial Market, Bargaining, Monetary Transmission
    JEL: D83 D9 E0 E4
    Date: 2012–04
  5. By: Billi, Roberto M. (Research Department, Central Bank of Sweden)
    Abstract: Policymakers often use the output gap, a noisy signal of economic activity, as a guide for setting monetary policy. Noise in the data argues for policy caution. At the same time, the zero bound on nominal interest rates constrains the central bank's ability to stimulate the economy during downturns. In such an environment, greater policy stimulus may be needed to stabilize the economy. Thus, noisy data and the zero bound present policymakers with a dilemma in deciding the appropriate stance for monetary policy. I investigate this dilemma in a small New Keynesian model, and show that policymakers should pay more attention to output gaps than suggested by previous research.
    Keywords: output gap; measurement errors; monetary policy; zero lower bound
    JEL: E52 E58
    Date: 2012–03–01
  6. By: Evzen Kocenda; Vit Bubak; Filip Zikes
    Abstract: This paper studies the dynamics of volatility transmission between Central European (CE) currencies and the EUR/USD foreign exchange using model-free estimates of daily exchange rate volatility based on intraday data. We formulate a flexible yet parsimonious parametric model in which the daily realized volatility of a given exchange rate depends both on its own lags as well as on the lagged realized volatilities of the other exchange rates. We find evidence of statistically significant intra-regional volatility spillovers among the CE foreign exchange markets. With the exception of the Czech and, prior to the recent turbulent economic events, Polish currencies, we find no significant spillovers running from the EUR/USD to the CE foreign exchange markets. To measure the overall magnitude and evolution of volatility transmission over time, we construct a dynamic version of the Diebold-Yilmaz volatility spillover index and show that volatility spillovers tend to increase in periods characterized by market uncertainty.
    Keywords: Foreign exchange markets; Volatility; Spillovers; Intraday data; Nonlinear dynamics; European emerging markets
    JEL: C5 F31 G15
    Date: 2011–07–01
  7. By: Svensson, Emma (Department of Economics, Lund University)
    Abstract: This paper investigates the effects on employment in 21 Swedish regions of a monetary policy shock using a VAR model with exogenous foreign variables for the 1993:1-2007:4 period. The regional impulse responses clearly indicate asymmetric effects in which employment falls significantly in some regions, while not changing significantly in others. These differences seem to stem from the interest and exchange rate channel, whereby regions with larger shares of employment in the goods sector and higher export intensity are adversely affected. In addition, there is one group of regions that, surprisingly, see increased employment in response to the same policy shock.
    Keywords: monetary transmission; vector autoregression (VAR); regional differences
    JEL: C32 E52 F41
    Date: 2012–04–28
  8. By: Yunus Aksoy (Department of Economics, Mathematics & Statistics, Birkbeck); Henriqu S Basso (University of Warwick)
    Abstract: We propose a model that delivers endogenous variations in term spreads driven primarily by banks' portfolio decision and their appetite to bear the risk of maturity transformation. We first show that fluctuations of the future profitability of banks' portfolios affect their ability to cover for any liquidity shortage and hence influence the premium they require to carry maturity risk. During a boom, profitability is increasing and thus spreads are low, while during a recession profitability is decreasing and spreads are high, in accordance with the cyclical properties of term spreads in the data. Second, we use the model to look at monetary policy and show that allowing banks to sell long-term assets to the central bank after a liquidity shock leads to a sharp decrease in long-term rates and term spreads. Such interventions have significant impact on long-term investment, decreasing the amplitude of output responses after a liquidity shock. The short-term rate does not need to be decreased as much and inflation turns out to be much higher than if no QE interventions were implemented. Finally, we provide macro and micro-econometric evidence for the U.S. confirming the importance of expected financial business profitability in the determination of term spread fluctuations.
    Keywords: Yield Curve, Quantitative Easing, Maturity Risk, Bank Portfolio
    JEL: E43 E44 E52 G20
    Date: 2012–04
  9. By: Bryan Perry (Department of Economics, Brigham Young University); Kerk L. Phillips (Department of Economics, Brigham Young University); David E. Spencer (Department of Economics, Brigham Young University)
    Abstract: Economists have long investigated the cyclical behavior of real wages in order to draw inferences regarding the relative stickiness of prices and wages. Recent studies have adopted techniques intended to identify monetary shocks and examined the response of real wages and output or employment to such shocks. A finding that real wages are procyclical in response to a positive monetary policy shock, for example, is taken as evidence that prices are stickier than wages. In this paper, we show that factors other than wage and price stickiness affect the response of real wages to a monetary policy shock. Accordingly, examining the response of real wages is not enough to sort out the relative stickiness of prices and wages. We use two prominent DSGE models to help us address this issue. These models incorporate both sticky wages and prices but in different ways. The first model (Huang, Liu, and Phaneuf, American Economic Review, 2004) is relatively simple and is not intended for policy analysis. Its relative simplicity allows us to approach the issues both analytically and through simulations. The second model (Smets and Wouters, American Economic Review, 2007) is a relatively complex model of the U.S. economy with many frictions and intended to be useful for policy analysis. Because of its complexity, we must rely principally on simulation exercises. Using these models we offer robust evidence that the real wage response to monetary policy is affected in important ways by properties of the economy other than stickiness of wages and prices, such as the importance of intermediate goods in the production process and the size of key elasticities. Consequently, we cannot appropriately infer the relative stickiness of wages and prices from examining only the response of real wages to a monetary policy shock.
    Keywords: real wages, monetary policy, DSGE models
    JEL: E32 E52 E10
    Date: 2012–04
  10. By: Levieuge, Grégory; Lucotte, Yannick
    Abstract: In this paper we suggest a simple empirical and model-independent measure of Central Banks' Conservatism, based on the Taylor curve. This new indicator can easily be extended in time and space, whatever the underlying monetary regime of the considered countries. We demonstrate that it evolves in accordance with the monetary experiences of 32 OECD member countries from 1980, and is largely equivalent to the model-based measure provided by Krause & Méndez [Southern Economic Journal, 2005]. We finally bring forward the interest of such an indicator for further empirical analysis dealing with the preferences of Central Banks.
    Keywords: Central Banks' preferences; Conservatism; Taylor curve; Taylor rule
    JEL: E43 E58 E52 E47
    Date: 2012–04–28
  11. By: G\"unter von Kiedrowski; E\"ors Szathm\'ary
    Abstract: Growth of monetary assets and debts is commonly described by the formula of compound interest which for the case of continuous compounding is the exponential growth law. Its differential form is dc/dt = i c where dc/dt describes the rate of monetary growth, i the compounded interest rate and c the actual principal. Exponential growth of this type is fixed to be neither resource-limited nor self-limiting which is in contrast to real economic growth (such as the GDP) which may have exponential, but also subexponential, linear, saturation, and even decline phases. As a result assets and debts commonly outgrow their economic fundament giving rise to the financial equivalent of Malthusian catastrophes after a certain interval of time. We here introduce an alternative for exponential compounding and propose to replace dc/dt = i c by dc/dt = i c^p where the exponent p (called reaction order in chemistry) is a quantity which will be termed monetary growth order. The monetary growth order p is seen as a tuning handle which enables to adjust gross monetary growth to real economic growth. It is suggested that the central banks take a serious look to this control instrument which allows tuning in crisis situations and immediate return to the exponential norm if needed.
    Date: 2012–04
  12. By: Jean Pisani-Ferry; Guntram B. Wolff
    Abstract: The Bank of England, the Federal Reserve (Fed) and the European Central Bank (ECB) have responded to the crisis with exceptional initiatives resulting in a major increase in their balance sheets. After the ECBâ??s end-2011 launch of three-year bank refinancing (LTRO), there has been speculation that all three have de facto embarked on â??quantitative easingâ??. However, major differences remain: the Bank of England and Fed have mostly relied on large-scale purchases of government bonds, while the ECB has relied on lending to financial institutions with repurchase agreements of collateral (repos). The LTRO has successfully mitigated funding needs and reduced interbank stress, and has had a significant impact on sovereign bond yields in southern euro-area countries, and increased southern banksâ?? government debt holdings, while northern banks have reduced sovereign exposure. The LTRO has had only weak effects on funding for households and non-financial corporations; credit dynamics remain weak particularly in the southern euro area. Underlying structural problems relating to banks, the macroeconomic adjustment and the euro areaâ??s governance need to be addressed before financial stability and economic growth can return. Monetary policy cannot fundamentally address these problems and is made less effective by economic/institutional heterogeneity. This Policy Contribution is based on a briefing paper prepared for the European Parliament Economic and Monetary Affairs Committeeâ??s Monetary Dialogue of 25 April 2012. In the video below, Jean Pisani-Ferry and Guntram Wolff discuss the findings of this policy contribution. <iframe width="400" height="288" src="" frameborder="0" allowfullscreen></iframe>
    Date: 2012–04
  13. By: Peter Montiel; Christopher Adam; Wilfred Mbowe; Stephen O’Connell
    Date: 2012
  14. By: Jan Willem van den End; Mark Kruidhof
    Abstract: The Basel 3 Liquidity Coverage Ratio (LCR) is a micro prudential instrument to strengthen the liquidity position of banks. However if in extreme scenarios the LCR becomes a binding constraint, the interaction of bank behaviour with the regulatory rule can have negative externalities. We simulate the systemic implications of the LCR by a liquidity stress-testing model, which takes into account the impact of bank reactions on second round feedback effects. We show that a flexible approach of the LCR, in particular one which recognises less liquid assets in the buffer, is a useful macroprudential instrument to mitigate its adverse side-effects during times of stress. At extreme stress levels the instrument becomes ineffective and the lender of last resort has to underpin the stability of the system.
    Keywords: Financial stability; Banks; Liquidity; Regulation
    JEL: C15 E44 G21 G32 G28
    Date: 2012–04
  15. By: Chatelain, Jean-Bernard; Ralf, Kirsten
    Abstract: The bargaining power of international banks is currently still very high as compared to what it was at the time of the Bretton Woods conference. As a consequence, systemic financial crises are likely to remain recurrent phenomena with large effects on macroeconomic aggregates. Mainstream macroeconomic models dealing with financial frictions failed to explain at least eight features of the ongoing crisis. We therefore suggest two complementary assumptions: (I) A systemic bankruptcy risk stable equilibrium may be feasible, besides another stable equilibrium related to a stability corridor, (II) inefficient financial markets rarely ensure that the price of an asset is equal to its “fundamental long term value”. Both assumptions are compatible with a structural research programme taking into account the Lucas' critique (1976) but may start a creative destruction process of the Lucas' view of business cycles theory.
    Keywords: asset prices; liquidity trap; monetary policy; financial stability; business cycles; liquidity trap; dynamic stochastic general equilibrium models
    JEL: E5 E6 E4 E3
    Date: 2012–05–01
  16. By: L. Randall Wray
    Abstract: This paper integrates the various strands of an alternative, heterodox view on the origins of money and the development of the modern financial system in a manner that is consistent with the findings of historians and anthropologists. As is well known, the orthodox story of money's origins and evolution begins with the creation of a medium of exchange to reduce the costs of barter. To be sure, the history of money is "lost in the mists of time," as money's invention probably predates writing. Further, the history of money is contentious. And, finally, even orthodox economists would reject the Robinson Crusoe story and the evolution from a commodity money through to modern fiat money as historically accurate. Rather, the story told about the origins and evolution of money is designed to shed light on the "nature" of money. The orthodox story draws attention to money as a transactions-cost-minimizing medium of exchange. Heterodox economists reject the formalist methodology adopted by orthodox economists in favor of a substantivist methodology. In the formalist methodology, the economist begins with the "rational" economic agent facing scarce resources and unlimited wants. Since the formalist methodology abstracts from historical and institutional detail, it must be applicable to all human societies. Heterodoxy argues that economics has to do with a study of the institutionalized interactions among humans and between humans and nature. The economy is a component of culture; or, more specifically, of the material life process of society. As such, substantivist economics cannot abstract from the institutions that help to shape economic processes; and the substantivist problem is not the formal one of choice, but a problem concerning production and distribution. A powerful critique of the orthodox story regarding money can be developed using the findings of comparative anthropology, comparative history, and comparative economics. Given the embedded nature of economic phenomenon in prior societies, an understanding of what money is and what it does in capitalist societies is essential to this approach. This can then be contrasted with the functioning of precapitalist societies in order to allow identification of which types of precapitalist societies would use money and what money would be used for in these societies. This understanding is essential for informed speculation on the origins of money. The comparative approach used by heterodox economists begins with an understanding of the role money plays in capitalist economies, which shares essential features with analyses developed by a wide range of Institutionalist, Keynesian, Post Keynesian, and Marxist macroeconomists. This paper uses the understanding developed by comparative anthropology and comparative history of precapitalist societies in order to logically reconstruct the origins of money.
    Keywords: Origins of Money; Evolution of Financial System; Substantivist Methodology; Comparative History; Nature of Money
    JEL: B5 B25 B41 E11 E12 N01 N2 P1
    Date: 2012–05

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