nep-mon New Economics Papers
on Monetary Economics
Issue of 2012‒06‒05
seventeen papers chosen by
Bernd Hayo
Philipps-University Marburg

  1. Arithmetic is absolute: euro area adjustment By Guntram B. Wolff
  2. Indian money market dynamics By Nath, Golaka; Raja N, Aparna
  3. Non-rational expectations and the transmission mechanism By Harrison, Richard; Taylor, Tim
  4. The Dynamics of UK and US Inflation Expectations By Gefang, Deborah; Koop, Gary; Potter, Simon M.
  5. Fixed interest rates over finite horizons By Blake, Andrew
  6. On Measuring the Efficiency of Monetary Policy By Briec, Walter; Gabillon, Emmanuelle; Lasselle, Laurence
  7. Realised and Optimal Monetary Policy Rules in an Estimated Markov-Switching DSGE Model of the United Kingdom By Chen, Xiaoshan; MacDonald, Ronald
  8. Estimating the Demand for Settlement Balances in the Canadian Large Value Transfer System By Nellie Zhang
  9. Why price inflation in developed countries is systematically underestimated By Kitov, Ivan
  10. Transmission of macro-liquidity shocks to liquidity-sorted stock portfolios’ returns: The role of the financial crisis By Florackis, Chris; Kostakis, Alexandros; Kontonikas, Alexandros
  11. Estimating Phillips Curves in Turbulent Times using the ECB’s Survey of Professional Forecasters By Koop, Gary; Onorante, Luca
  12. Ordering Policy Rules with an Unconditional Welfare Measure By Damjanovic, Tatiana; Damjanovic, Vladislav; Nolan, Charles
  13. Identifying the De Facto Exchange Rate Regime for Moldova: A State-Space Approach By Vitalie Ciubotaru
  14. The RMB Debate: Empirical Analysis on the Effects of Exchange Rate Shocks in China and Japan By Soyoung Kim; Yoonbai Kim
  15. The macroeconomic impacts of Chinese currency appreciation on China and the rest of world : A global computable general equilibrium analysis By Yang, Jun; Zhang, Wei; Tokgoz, Simla
  16. Forecasting Inflation Using Dynamic Model Averaging By Koop, Gary; Korobilis, Dimitris
  17. Understanding Liquidity and Credit Risks in the Financial Crisis By Gefang, Deborah; Koop, Gary; Potter, Simon M.

  1. By: Guntram B. Wolff
    Abstract: The European Central Bankâ??s monetary policy targets the euro-area average inflation rate. By setting conditions for the area as a whole it should ensure symmetric price adjustment. Indeed, consumer price inflation rates provide little evidence of asymmetricadjustment during 2009-11. Only Ireland, which is too small to trigger a symmetric reaction, had significantly lower inflation rates than the average. Some asymmetry is visible in total economy unit labour costs (ULC) during 2009- 11, whereas wages appear to develop more symmetrically. ULC adjustment has been largely disconnected from consumer price developments. This makes it difficult for the monetary transmission channel to operate fully and ensure consumer price adjustments. Structural reforms to remove price rigidities are key. The forecast is worrying. While the European Commission forecasts that Greek inflation rates will fall, German and Italian inflation rates will not adjust in the right direction during 2012-13. Less inflation in Italy and more inflation in Germany are urgently needed to achieve rebalancing in the euro area."
    Date: 2012–05
  2. By: Nath, Golaka; Raja N, Aparna
    Abstract: The short term market is an important source for banks and institutions to secure funds to align their short term asset liability mismatches. Central Banks use the market to signal policy stance changes. In India, Reserve Bank of India uses monetary policy not only to signal the policy stances but also uses the same to map growth dynamics of the economy. The short term rates generally synchronize with policy rates in a manner that helps smooth transmission of monetary policy. In India, the short term market heavily revolves around daily LAF of RBI as well as overnight inter-bank Call Money, Repo and CBLO markets. Effort to develop a term money market has not been very successful. The article looked at creating an indexed rate taking into account all three segments into consideration rather than picking up only one rate. The liquidity was estimated as ratio of LAF and Net Demand and Time Liability (NDTL). The relationship between indexed rate and liquidity was tested and found to be rational. The article also found rational relationship between the spread of Inter-bank Call and Repo and ratio of LAF and NDTL along with money market transaction volume.
    Keywords: Indian Money market; Repo Market; CBLO; LAF; Liquidity adjustment Facility; Open Market Operations; NDTL
    JEL: E51 E58 E52 E50 E61
    Date: 2012–02–28
  3. By: Harrison, Richard (Bank of England); Taylor, Tim (Bank of England)
    Abstract: In this paper, we compare two approaches to modelling behaviour under non-rational expectations in a benchmark New Keynesian model. The ‘Euler equation’ approach modifies the equations derived under the assumption of rational expectations by replacing the rational expectations operator with an alternative assumption about expectations formation. The ‘long-horizon’ expectations approach solves the decision rules of households and firms conditional on their expectations for future events that are outside of their control, so that spending and price-setting decisions depend on expectations extending into the distant future. Both approaches can be defended as descriptions of (distinct) forms of boundedly rational behaviour, but have different implications both for the form of the equations that govern the dynamics of the economy and the ease of deriving those equations. In this paper we construct two versions of a benchmark New Keynesian model in which non-rational expectations are modelled using the Euler equation and long-horizon approaches and show that both approaches have very similar implications for macroeconomic dynamics when departures from rational expectations are relatively small. But as expectations depart further from rationality, the two approaches can generate significantly different implications for the behaviour of key variables.
    Keywords: Expectations; monetary transmission mechanism
    JEL: D84 E17
    Date: 2012–05–18
  4. By: Gefang, Deborah; Koop, Gary; Potter, Simon M.
    Abstract: This paper investigates the relationship between short term and long term inflation expectations in the US and the UK with a focus on inflation pass through (i.e. how changes in short term expectations affect long term expectations). An econometric methodology is used which allows us to uncover the relationship between inflation pass through and various explanatory variables. We relate our empirical results to theoretical models of anchored, contained and unmoored inflation expectations. For neither country do we fi nd anchored or unmoored inflation expectations. For the US, contained inflation expectations are found. For the UK, our findings are not consistent with the specifi c model of contained inflation expectations presented here, but are consistent with a more broad view of expectations being constrained by the existence of an inflation target.
    Date: 2011
  5. By: Blake, Andrew (Bank of England)
    Abstract: We consider finite horizon conditioning paths for nominal interest rates in New Keynesian monetary policy models. This is done two ways. First, we develop a simple way to use policy interventions in the form of interest rate shocks to achieve the conditioning path and show this yields a unique solution. We then modify this method to generate an infinity of solutions making the model better behaved but effectively indeterminate. Second, we use two-part rules where a specially designed targeting rule generates fixed interest rates endogenously over the initial period before reverting to a more conventional instrument rule. We show that the two approaches are equivalent. We discuss appropriate selection criteria over the resulting equilibria.
    Keywords: Fixed nominal interest rates; uniqueness; indeterminacy
    JEL: C63 E47 E61
    Date: 2012–05–18
  6. By: Briec, Walter; Gabillon, Emmanuelle; Lasselle, Laurence
    Abstract: Cecchetti et al. (2006) develop a method for allocating macroeconomic performance changes among the structure of the economy, variability of supply shocks and monetary policy. We propose a dual approach of their method by borrowing well-known tools from production theory, namely the Farrell measure and the Malmquist index. Following FÄare et al (1994) we propose a decomposition of the efficiency of monetary policy. It is shown that the global efficiency changes can be rewritten as the product of the changes in macroeconomic performance, minimum quadratic loss, and efficiency frontier.
    Keywords: e±ciency frontier, inflation variability, Farrell measure, Malmquist index,
    Date: 2011
  7. By: Chen, Xiaoshan; MacDonald, Ronald
    Abstract: This paper investigates underlying changes in the UK economy over the past thirtyfive years using a small open economy DSGE model. Using Bayesian analysis, we find UK monetary policy, nominal price rigidity and exogenous shocks, are all subject to regime shifting. A model incorporating these changes is used to estimate the realised monetary policy and derive the optimal monetary policy for the UK. This allows us to assess the effectiveness of the realised policy in terms of stabilising economic fluctuations, and, in turn, provide an indication of whether there is room for monetary authorities to further improve their policies.
    Keywords: Markov-switching, Bayesian analysis, DSGE models,
    Date: 2011
  8. By: Nellie Zhang
    Abstract: This paper applies a static model of an interest rate corridor to the Canadian data, and estimates the aggregate demand for central-bank settlement balances in the Large Value Transfer System (LVTS). The empirical specification controls for various calendar effects that have been shown to cause fluctuations in LVTS payment flows. The analysis takes into account the downward divergence of the overnight interest rate from the target rate, which has been persistent since 2005. The results suggest that a target of $3 billion for LVTS settlement balances does not seem excessive during the time period when Canadian monetary policy was operating at the effective lower bound (ELB). Specifically, the model projects that, if the consistent downward divergence of overnight interest rate is taken into account, then on average $2.405 billion of LVTS settlement balances would probably have been sufficient to achieve the goal of keeping the overnight interest rate at or very close to the lower bound of the corridor. However, by targeting a slightly higher level, the Bank of Canada could be 95% certain that the overnight interest rate would on average not exceed its policy rate at the lower bound of the corridor. In addition, the estimation shows that the point elasticity of overnight interest rate is around 0.17 when the daily level of settlement balances is targeted at $3 billion under the ELB framework.
    Keywords: Interest rates; Monetary policy implementation; Payment, clearing, and settlement systems
    JEL: G01 E40 E50 C36
    Date: 2012
  9. By: Kitov, Ivan
    Abstract: There is an extensive historical dataset on real GDP per capita prepared by Angus Maddison. This dataset covers the period since 1870 with continuous annual estimates in developed countries. All time series for individual economies have a clear structural break between 1940 and 1950. The behavior before 1940 and after 1950 can be accurately (R2 from 0.7 to 0.99) approximated by linear time trends. The corresponding slopes of regressions lines before and after the break differ by a factor of 4 (Switzerland) to 19 (Spain). We have extrapolated the early trends into the second interval and obtained much lower estimates of real GDP per capita in 2011: from 2.4 (Switzerland) to 5.0 (Japan) times smaller than the current levels. When the current linear trends are extrapolated into the past, they intercept the zero line between 1908 (Switzerland) and 1944 (Japan). There is likely an internal conflict between the estimating procedures before 1940 and after 1950. A reasonable explanation of the discrepancy is that the GDP deflator in developed countries has been highly underestimated since 1950. In the USA, the GDP deflator is underestimated by a factor of 1.4. This is exactly the ratio of the interest rate controlled by the Federal Reserve and the rate of inflation. Hence, the Federal Reserve actually retains its interest rate at the level of true price inflation when corrected for the bias in the GDP deflator.
    Keywords: real GDP; price inflation; interest rate; central bank; developed countries
    JEL: E43 O47 E31 E01
    Date: 2012–05–27
  10. By: Florackis, Chris; Kostakis, Alexandros; Kontonikas, Alexandros
    Abstract: This study examines the impact of macro-liquidity shocks on the returns of UK stock portfolios sorted on the basis of a series of micro-liquidity measures. The macro-liquidity shocks are extracted on the meeting days of the Bank of England Monetary Policy Committee relative to market expectations embedded in futures contracts on the 3-month LIBOR during the period June 1999- December 2009. We report definitive evidence that these shocks are transmitted to the cross-section of liquidity-sorted portfolios, with most liquid stocks playing a very active role. Our results emphatically document that the shocks-returns relationship has reversed its sign during the recent financial crisis; the standard inverse relationship between interest rate surprises and portfolios’ returns before the crisis has turned into positive during the crisis. This finding confirms the inability of interest rate cuts to boost returns in the shortrun during the crisis, because these were perceived by market participants as a signal of a deteriorating economic outlook.
    Keywords: Liquidity Shocks, Monetary Policy, Market Micro-Structure, Stock Returns,
    Date: 2011
  11. By: Koop, Gary; Onorante, Luca
    Abstract: This paper uses forecasts from the European Central Bank's Survey of Professional Forecasters to investigate the relationship between inflation and inflation expectations in the euro area. We use theoretical structures based on the New Keynesian and Neoclassical Phillips curves to inform our empirical work. Given the relatively short data span of the Survey of Professional Forecasters and the need to control for many explanatory variables, we use dynamic model averaging in order to ensure a parsimonious econometric speci cation. We use both regression-based and VAR-based methods. We find no support for the backward looking behavior embedded in the Neo-classical Phillips curve. Much more support is found for the forward looking behavior of the New Keynesian Phillips curve, but most of this support is found after the beginning of the financial crisis.
    Keywords: inflation expectations, survey of professional forecasters, Phillips curve, Bayesian,
    Date: 2011
  12. By: Damjanovic, Tatiana; Damjanovic, Vladislav; Nolan, Charles
    Abstract: The unconditional expectation of social welfare is often used to assess alternative macroeconomic policy rules in applied quantitative research. It is shown that it is generally possible to derive a linear - quadratic problem that approximates the exact non-linear problem where the unconditional expectation of the objective is maximised and the steady-state is distorted. Thus, the measure of pol icy performance is a linear combinat ion of second moments of economic variables which is relatively easy to compute numerically, and can be used to rank alternative policy rules. The approach is applied to a simple Calvo-type model under various monetary policy rules.
    Keywords: Linear-quadratic approximation, unconditional expectations, optimal monetary policy, ranking simple policy rules,
    Date: 2011
  13. By: Vitalie Ciubotaru (Graduate School of Economics, Osaka University)
    Abstract: It has been noted that there is an inconsistency between the Moldovan monetary authoritiesf declared pursuit of price stability and the de facto exchange rate peg. This paper looks into the exchange rate regime of the Moldovan leu (MDL) aiming to identify the de facto regime, to test whether it differes from the de jure regime stipulated by legislation, whether it can be described by a basket peg (and, if so, to determine the composition of this basket), and whether the regime has been stable over time. The methodology used in our analysis is the celebrated Frankel-Wei regression, to which we apply a Kalman filter algorithm. We show that the MDL generally follows a peg to the US dollar with varying implicit weight and fluctuation bands. Surprisingly, despite the large share of euro-denominated transactions on the Moldovan exchange market, and an even larger share of euro-denominated assets, the euro has never exhibited any statistically signicant weight.
    Keywords: Exchange Rate Regime, Moldovan Leu, Frankel-Wei Regression, Kalman Filter, Empirical Fluctuation Process
    JEL: E42 F31 P33
    Date: 2012–05
  14. By: Soyoung Kim (Seoul National University and Hong Kong Institute for Monetary Research); Yoonbai Kim (University of Kentucky)
    Abstract: For a better understanding of the ongoing debates on the RMB, this paper investigates the effects of exchange rate shocks on output and the current account for China and Japan. We use structural vector auto-regression models and find that yen appreciation reduces current account surpluses while having no strong effect on output in Japan. RMB appreciation, on the other hand, has an insignificant effect on the current account, although it tends to reduce output in China. For China, dollar pricing with vertical trade integration seems responsible for the insignificant effect on the current account.
    Keywords: Renminbi Appreciation, Current Account Imbalance, VAR, Exchange Rate Shocks, Recession
    Date: 2012–05
  15. By: Yang, Jun; Zhang, Wei; Tokgoz, Simla
    Abstract: There has been contentious debate surrounding the issue of undervaluation of the Chinese Renminbi. Despite continuous international political pressure to appreciate its currency, the Chinese government has resisted significant changes. A key question underlining the debate is whether a Renminbi appreciation would deliver substantial gains for exports and employment as the United States has argued or a significant slowdown of Chinese economy as feared by the Chinese government, and if so to what extent. This paper analyzes the ex-ante, short-term impacts of the Chinese Renminbi appreciation on the Chinese and world economies using the novel approach of modeling nominal exchange rate adjustment in the Global Trade Analysis Project, a global computable general equilibrium model. Scenario results show that the Chinese economy will be affected negatively, with lower real gross domestic product, lower employment rates, and a decline in the trade surplus. Chinese currency appreciation has a positive impact on the GDP of the major countries and regions, but by a small margin. With a higher Chinese exchange rate, trade balances for other trading partner countries, with the exception of the United States, improve.
    Keywords: Computable general equilibrium model, Exchange rate, Economic impacts, Renminbi appreciation,
    Date: 2012
  16. By: Koop, Gary; Korobilis, Dimitris
    Abstract: We forecast quarterly US inflation based on the generalized Phillips curve using econometric methods which incorporate dynamic model averaging. These methods not only allow for coe¢ cients to change over time, but also allow for the entire forecasting model to change over time. We nd that dynamic model averaging leads to substantial forecasting improvements over simple benchmark regressions and more sophisticated approaches such as those using time varying coe¢ cient models. We also provide evidence on which sets of predictors are relevant for forecasting in each period.
    Keywords: Bayesian, State space model, Phillips curve,
    Date: 2011
  17. By: Gefang, Deborah; Koop, Gary; Potter, Simon M.
    Abstract: This paper develops a structured dynamic factor model for the spreads between London Interbank Offered Rate (LIBOR) and overnight index swap (OIS) rates for a panel of banks. Our model involves latent factors which reflect liquidity and credit risk. Our empirical results show that surges in the short term LIBOR-OIS spreads during the 2007-2009 fi nancial crisis were largely driven by liquidity risk. However, credit risk played a more signifi cant role in the longer term (twelve-month) LIBOR-OIS spread. The liquidity risk factors are more volatile than the credit risk factor. Most of the familiar events in the financial crisis are linked more to movements in liquidity risk than credit risk.
    Date: 2011

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